<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 SEPTEMBER 30, 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)
<TABLE>
<S> <C>
Texas 74-0694415
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
</TABLE>
(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)
<TABLE>
Delaware 76-0511406
<S> <C>
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1111 Louisiana
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
</TABLE>
(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 November 9, 1998, Houston Industries Incorporated had 284,475,688 shares
of common stock outstanding, including 11,751,632 ESOP shares not deemed
outstanding for financial statement purposes and excluding 102,797 shares held
as treasury stock. As of November 9, 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 SEPTEMBER 30, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Part I. Financial Information Page No.
--------
<S> <C>
COMPANY
Item 1. Financial Statements
Statements of Consolidated Income
Three Months and Nine Months Ended
September 30, 1998 and 1997 (unaudited) 1
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997 (unaudited) 2
Statements of Consolidated Cash Flows
Nine Months Ended September 30, 1998 and 1997 (unaudited) 4
Statements of Consolidated Retained Earnings
Three Months and Nine Months Ended
September 30, 1998 and 1997 (unaudited) 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 19
Item 3. Quantitative and Qualitative Disclosures
About Market Risk of the Company 41
NORAM
Item 1. Financial Statements
Statements of Consolidated Income
Three Months and Nine Months Ended
September 30, 1998 and 1997 (unaudited) 42
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997 (unaudited) 43
</TABLE>
(i)
<PAGE> 3
HOUSTON INDUSTRIES INCORPORATED
AND NORAM ENERGY CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS - CONTINUED
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Statements of Consolidated Cash Flows
Nine Months Ended September 30, 1998 and 1997 (unaudited) 45
Consolidated Statements of Stockholder's Equity
Three Months and Nine Months Ended
September 30, 1998 and 1997 (unaudited) 46
Notes to Unaudited Consolidated Financial Statements 47
Item 2. Management's Narrative Analysis of the
Results of Operations of NorAm Energy Corp.
and Consolidated Subsidiaries 51
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 61
Item 5. Other Information 61
Item 6. Exhibits and Reports on Form 8-K 62
Signature(s) 63
</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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Electric Operations........................... $ 1,415,832 $ 1,387,262 $ 3,443,694 $ 3,286,816
Natural Gas Distribution...................... 249,004 180,288 1,280,889 180,288
Interstate Pipeline........................... 70,394 39,035 217,891 39,035
Energy Marketing.............................. 1,642,373 551,229 3,730,602 551,229
International................................. 31,813 21,458 228,494 61,386
Other......................................... 214,853 17,132 264,795 20,199
Eliminations ................................. (155,475) (37,853) (322,128) (37,853)
------------- ------------- ------------- -------------
Total...................................... 3,468,794 2,158,551 8,844,237 4,101,100
------------- ------------- ------------- -------------
EXPENSES:
Fuel and cost of gas sold..................... 1,134,356 772,306 3,468,553 1,249,514
Purchased power............................... 970,041 226,952 1,872,557 406,576
Operation and maintenance..................... 472,365 426,253 1,280,044 923,549
Taxes other than income taxes................. 118,872 86,168 298,227 208,507
Depreciation and amortization................. 267,204 184,156 677,838 446,889
------------- ------------- ------------- -------------
Total...................................... 2,962,838 1,695,835 7,597,219 3,235,035
------------- ------------- ------------- -------------
OPERATING INCOME.................................. 505,956 462,716 1,247,018 866,065
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
Unrealized loss on ACES....................... (40,231) (484,009)
Time Warner dividend income................... 10,313 10,313 30,937 31,028
Other- net.................................... 2,691 14,724 16,201 13,631
------------- ------------- ------------- -------------
Total...................................... (27,227) 25,037 (436,871) 44,659
------------- ------------- ------------- -------------
INTEREST AND OTHER CHARGES:
Interest on long-term debt.................... 101,229 91,874 310,584 217,513
Other interest................................ 20,227 18,667 67,620 51,826
Distributions on trust securities ............ 7,248 7,055 21,960 18,728
Allowance for borrowed funds used during
construction.............................. (1,398) (47) (2,967) (1,892)
Preferred dividends of subsidiary............. 33 2,255
------------- ------------- ------------- -------------
Total...................................... 127,306 117,582 397,197 288,430
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES AND PREFERRED
DIVIDENDS....................................... 351,423 370,171 412,950 622,294
INCOME TAXES...................................... 104,066 126,209 152,528 197,249
------------- ------------- ------------- -------------
NET INCOME........................................ 247,357 243,962 260,422 425,045
PREFERRED DIVIDENDS............................... 97 64 292 64
------------- ------------- ------------- -------------
NET INCOME AVAILABLE FOR COMMON STOCK............. $ 247,260 $ 243,898 $ 260,130 $ 424,981
============= ============= ============= =============
BASIC EARNINGS PER COMMON SHARE................... $ .87 $ .93 $ .92 $ 1.74
DILUTED EARNINGS PER COMMON SHARE................. $ .87 $ .92 $ .91 $ 1.74
</TABLE>
See Notes to Unaudited Consolidated Financial Statements.
1
<PAGE> 5
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- ---------------
<S> <C> <C>
PROPERTY, PLANT AND EQUIPMENT - AT COST:
Electric plant:
Plant in service............................................................. $ 13,077,006 $ 12,614,000
Construction work in progress................................................ 243,332 224,959
Nuclear fuel................................................................. 263,502 255,567
Plant held for future use.................................................... 48,588 48,631
Gas plant and pipelines:
Natural Gas Distribution..................................................... 1,441,865 1,326,442
Interstate Pipelines......................................................... 1,284,127 1,258,087
Energy Marketing............................................................. 180,755 162,519
Other property.................................................................. 194,403 149,019
--------------- ---------------
Total..................................................................... 16,733,578 16,039,224
Less accumulated depreciation and amortization.................................. 5,341,204 4,770,179
--------------- ---------------
Property, plant and equipment - net.......................................... 11,392,374 11,269,045
--------------- ---------------
CURRENT ASSETS:
Cash and cash equivalents....................................................... 56,303 51,712
Accounts receivable - net....................................................... 1,460,097 962,974
Accrued unbilled revenues....................................................... 159,446 205,860
Time Warner dividends receivable................................................ 10,313 10,313
Fuel stock and petroleum products............................................... 210,395 88,819
Materials and supplies, at average cost......................................... 169,402 156,160
Restricted deposit for bond redemption.......................................... 68,700
Prepayments and other current assets............................................ 79,754 42,169
--------------- ---------------
Total current assets......................................................... 2,214,410 1,518,007
--------------- ---------------
OTHER ASSETS:
Goodwill-net.................................................................... 2,109,554 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............................................................. 912,596 704,102
Deferred plant costs - net...................................................... 542,232 561,569
Deferred debits................................................................. 520,052 510,686
Regulatory tax asset - net...................................................... 415,870 356,509
Unamortized debt expense and premium on reacquired debt......................... 208,393 202,453
Fuel-related debits............................................................. 196,629 197,304
Recoverable project costs - net................................................. 47,720 78,485
--------------- ---------------
Total other assets........................................................... 5,943,046 5,627,503
--------------- ---------------
Total..................................................................... $ 19,549,830 $ 18,414,555
=============== ===============
</TABLE>
See Notes to Unaudited Consolidated Financial Statements.
2
<PAGE> 6
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
CAPITALIZATION AND LIABILITIES
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- --------------
<S> <C> <C>
CAPITALIZATION:
Common stock equity:
Common stock, no par value................................................... $ 3,135,548 $ 3,112,098
Treasury stock, at cost...................................................... (2,274) (2,066)
Unearned ESOP shares......................................................... (219,863) (229,827)
Retained earnings............................................................ 1,956,048 2,013,055
Cumulative foreign currency translation adjustment........................... (6,022) (821)
Unrealized loss on marketable equity securities.............................. (16,543) (5,634)
--------------- --------------
Total common stock equity................................................ 4,846,894 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....... 342,280 362,172
--------------- --------------
Long-term debt:
Automatic common exchange securities (ACES)..................................... 1,657,794 1,173,786
Debentures...................................................................... 966,157 669,291
First mortgage bonds............................................................ 1,864,656 2,495,459
Notes payable................................................................... 522,070 745,889
Pollution control revenue bonds................................................. 581,385 118,000
Other........................................................................... 14,760 15,590
--------------- --------------
Total long-term debt......................................................... 5,606,822 5,218,015
--------------- --------------
Total capitalization..................................................... 10,805,736 10,476,732
--------------- --------------
CURRENT LIABILITIES:
Notes payable................................................................... 1,918,150 2,124,956
Accounts payable................................................................ 1,424,471 879,612
Taxes accrued................................................................... 310,583 240,739
Interest accrued ............................................................... 108,867 109,901
Dividends declared.............................................................. 111,047 110,716
Customer deposits............................................................... 79,196 82,437
Current portion of long-term debt............................................... 612,062 251,169
Other........................................................................... 227,557 193,384
--------------- --------------
Total current liabilities....................................................
4,791,933 3,992,914
--------------- --------------
DEFERRED CREDITS:
Accumulated deferred income taxes............................................... 2,636,737 2,792,781
Benefit obligations............................................................. 461,979 397,586
Unamortized investment tax credit............................................... 333,980 349,072
Fuel-related credits............................................................ 117,000 75,956
Other........................................................................... 402,465 329,514
--------------- --------------
Total deferred credits....................................................... 3,952,161 3,944,909
--------------- --------------
COMMITMENTS AND CONTINGENCIES (NOTE 1 AND NOTE 10)
--------------- --------------
Total..................................................................... $ 19,549,830 $ 18,414,555
=============== ==============
</TABLE>
See Notes to Unaudited 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>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income...................................................................... $ 260,422 $ 425,045
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization................................................ 677,838 446,889
Amortization of nuclear fuel................................................. 19,753 21,727
Deferred income taxes........................................................ (155,782) 23,973
Investment tax credit........................................................ (15,092) (14,740)
Unrealized loss on ACES...................................................... 484,009
Contribution of marketable equity securities to charitable trust............. 19,463
Fuel cost under recovery..................................................... (80,331) (168,367)
Changes in other assets and liabilities:
Accounts receivable - net................................................ (591,241) 75,006
Account receivable - IRS................................................. 140,532
Fuel surcharge........................................................... 73,539 101,196
Inventory................................................................ (129,444) 21,260
Other current assets..................................................... (37,801) (13,584)
Accounts payable......................................................... 528,582 (95,054)
Interest and taxes accrued............................................... 58,810 73,724
Other current liabilities................................................ (17,200) 43,590
Other - net.............................................................. (42,515) (13,628)
--------------- ---------------
Net cash provided by operating activities............................ 1,174,079 946,500
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (including allowance for borrowed funds used during
construction)................................................................ (447,152) (180,472)
Purchase of NorAm Energy Corp., net of cash acquired............................ (1,422,672)
Sale of equity investments in foreign electric system projects.................. 242,744
Equity investment in non-rate regulated foreign electric systems (including (240,377) (215,020)
capitalized interest).......................................................
Non-rate regulated domestic electric power project acquisitions (including
capitalized interest)....................................................... (275,056)
Equity investments in non-rate regulated domestic electric power projects....... (42,439)
Sale of Time Warner securities.................................................. 25,043
Other - net..................................................................... (40,339) (10,484)
--------------- ---------------
Net cash used in investing activities............................... (802,619) (1,803,605)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of ACES -net................................................. 1,020,770
Proceeds from sale of Company obligated mandatorily redeemable trust
preferred securities of subsidiary trusts holding solely subordinated
debentures of Company -net................................................... 340,785
Payment of matured bonds........................................................ (76,000) (190,000)
Proceeds from issuance of debentures............................................ 298,514
Restricted deposit for bond redemption.......................................... (68,700)
Proceeds from issuance of pollution control revenue bonds....................... 454,258 115,739
Redemption of preferred stock................................................... (153,628)
Payment of common stock dividends............................................... (316,968) (281,009)
Increase/(decrease) in notes payable - net...................................... (226,836) 144,765
Extinguishment of long-term debt................................................ (402,587) (190,338)
Conversion of convertible securities............................................ (10,399)
Other - net..................................................................... (18,151) 95,427
--------------- ---------------
Net cash provided by (used in) financing activities................. (366,869) 902,511
--------------- ---------------
NET INCREASE IN CASH AND CASH EQUIVALENTS........................................... 4,591 45,406
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.................................... 51,712 8,001
--------------- ---------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.......................................... $ 56,303 $ 53,407
=============== ===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized)........................................... $ 400,412 $ 274,560
Income taxes.................................................................... 302,474 113,128
</TABLE>
See Notes to Unaudited 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
1998 1997 1998 1997
--------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Balance at Beginning of Period..................... $ 1,815,435 $ 2,003,194 $ 2,013,055 $ 1,997,490
Net Income for the Period.......................... 247,357 243,962 260,422 425,045
--------------- -------------- -------------- --------------
Total......................................... 2,062,792 2,247,156 2,273,477 2,422,535
Preferred Stock Dividends.......................... (97) (64) (292) (64)
Common Stock Dividends............................. (106,647) (105,766) (317,137) (281,145)
--------------- -------------- -------------- --------------
Balance at End of Period........................... $ 1,956,048 2,141,326 1,956,048 2,141,326
=============== ============== ============== ==============
</TABLE>
See Notes to Unaudited Consolidated Financial Statements.
5
<PAGE> 9
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The unaudited interim financial statements and notes (Company's 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 Company's Consolidated Financial Statements in the
joint Annual Report on Form 10-K (Form 10-K) of the Company (File No. 1-3187)
and NorAm (File No. 1-13265) for the fiscal year ended December 31, 1997. The
Form 10-K includes the consolidated financial statements of the Company
(Company's 10-K Financial Statements) and the consolidated financial statements
of NorAm (NorAm's 10-K Financial Statements) for the year ended December 31,
1997.
The Company's Interim Financial Statements omit certain information
included in financial statements prepared in accordance with generally accepted
accounting principles and should be read in combination with the Form 10-K as
updated by the joint Quarterly Reports on Form 10-Q of the Company and NorAm for
the quarters ended March 31, 1998 (First Quarter 10-Q) and June 30, 1998 (Second
Quarter 10-Q). For additional information regarding the presentation of interim
period results, see Note 13 to the Company's Interim Financial Statements below.
The following notes to the financial statements in the Form 10-K relate
to material contingencies. These notes, as updated by the notes contained in the
Company's Interim Financial Statements, are incorporated herein by reference:
Company's 10-K Financial Statements: 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's 10-K Financial Statements: 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 for all periods beginning on and after the Acquisition Date. The
following table presents certain unaudited pro forma information for the three
and nine month periods ended September 30, 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>
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------------------------------
1998 1997 1997
ACTUAL ACTUAL PRO FORMA
------------- ------------- -------------
<S> <C> <C> <C>
Revenues......................................... $ 3,469 $ 2,159 $ 2,555
Net Income (1)................................... $ 247 $ 244 $ 224
Basic Earnings Per Share (1)..................... $ 0.87 $ 0.93 $ 0.80
Diluted Earnings Per Share (1)................... $ 0.87 $ 0.92 $ 0.80
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------------------------------
1998 1997 1997
ACTUAL ACTUAL PRO FORMA
------------- ------------- -------------
<S> <C> <C> <C>
Revenues......................................... $ 8,844 $ 4,101 $ 7,438
Net Income (1)................................... $ 260 $ 425 $ 441
Basic Earnings Per Share (1)..................... $ 0.92 $ 1.74 $ 1.57
Diluted Earnings Per Share (1)................... $ 0.91 $ 1.74 $ 1.56
</TABLE>
- ------------------
(1) Includes a $26 million or $0.09 basic earnings per share and a $314 million
or $1.10 basic earnings per share (after-tax) non-cash unrealized
accounting loss recorded in the three and nine month periods ended
September 30, 1998, respectively, relating to the Company's Automatic
Common Exchange Securities (ACES). For additional information on the
unrealized accounting loss, see Note 6 to the Company's Interim Financial
Statements.
These and other pro forma results appearing in the 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 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 10-K Financial Statements.
(3) COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income."
"Comprehensive income" is defined to include not only net income (loss), but
also all changes in stockholders' equity during a reporting period except
changes resulting from investments by stockholders and distributions to
stockholders. The Company's
7
<PAGE> 11
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
comprehensive income consists of net income, foreign currency translation
adjustments (net of tax) and unrealized gains (losses) on the Company's
investment in marketable equity securities.
For the three months ended September 30, 1998, the Company's total
comprehensive income was $241 million compared to $248 million in the
corresponding period in 1997. For the nine months ended September 30, 1998, the
Company's total comprehensive income was $244 million compared to $429 million
in the corresponding period in 1997.
Under SFAS No. 130, the Company will begin to report and separately
display total comprehensive income and the components that comprise
comprehensive income in the year-end financial statements appearing in the
Company's Annual Report on Form 10-K for the year ending December 31, 1998 and
subsequent annual reports.
(4) FOREIGN CURRENCY ADJUSTMENTS
Assets and liabilities of the Company's international operations, where
the local currency is the functional currency, have been translated into U.S.
dollars using the exchange rate at the balance sheet date. Revenues, expenses,
gains, and losses have been translated using the weighted average exchange rate
for each month prevailing during the periods reported. Cumulative adjustments
resulting from translation have been recorded in stockholders' equity. When the
U.S. dollar is the functional currency, the financial statements of
international operations are remeasured in U.S. dollars using historical
exchange rates for non-monetary accounts and the current rate for all other
accounts. All exchange gains and losses from remeasurement and foreign currency
transactions are included in consolidated net income. Foreign exchange gains and
losses are not material for any period presented. Fluctuations in foreign
currency exchange rates relative to the U.S. dollar can have an impact on the
reported equity earnings of the Company's foreign investments. For additional
information about the Company's equity investments in foreign affiliates, see
Note 5 to the Company's 10-K Financial Statements.
(5) DEPRECIATION
The Company calculates depreciation using the straight-line method. The
Company's depreciation expense for the three and nine month periods ended
September 30, 1998 was $227 million and $559 million, respectively, compared to
$128 million and $334 million for the same periods in 1997. For information
regarding the additional depreciation of electric utility generating assets
under a transition to competition plan implemented in January 1998, see Note
10(a) to the Company's Interim Financial Statements.
(6) INVESTMENT 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 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 10-K Financial
Statements.
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 million in each of the three month
periods ended September 30, 1998 and 1997 and $31 million in each of the nine
month periods ended September 30, 1998 and 1997.
8
<PAGE> 12
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
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 unrealized,
non-cash 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 September 30, 1998, the market price of Time Warner common stock
was $87.563 per share. Accordingly, the Company recognized an increase of $40
million and $484 million during the three and nine month periods ended September
30, 1998, respectively, in the unrealized liability relating to its ACES
indebtedness (which resulted in an after-tax earnings reduction for such periods
of $26 million or $.09 basic earnings per share and $314 million or $1.10 basic
earnings per share, respectively). The Company believes that the cumulative
unrealized loss for the ACES of $605 million is more than economically offset by
the approximately $1 billion unrecorded unrealized gain at September 30, 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 September 30, 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 $49 million. Any gain related to the increase in
the fair value of Time Warner common stock would be recognized as a component of
net income upon the sale of the TW Preferred or the shares of common stock into
which such TW Preferred is converted.
(7) CAPITAL STOCK
(a) Common Stock.
At September 30, 1998, the Company had 284,471,909 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 (11,674,063 and 12,388,551
at September 30, 1998 and December 31, 1997, respectively) and (ii) treasury
shares (102,544 and 93,459 at September 30, 1998 and December 31, 1997,
respectively).
9
<PAGE> 13
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
The Company has authorized the repurchase of up to $89 million of its
common stock, $361 million of common stock having been previously purchased
pursuant to a repurchase program authorized in 1996. Purchases of the Company's
common stock, which may not be preceded by public announcement, may be made in
open market or privately negotiated transactions from time to time as determined
by management. Such repurchases are subject to market conditions, applicable
legal requirements, available cash and other factors.
(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:
10
<PAGE> 14
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------- ---------------------------
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
1998(1) 1997 1998(2) 1997
--------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Basic EPS Calculation:
Income before preferred dividends....................... $ 247,357 $ 243,962 $ 260,422 $ 425,045
Less: Preferred dividends............................... 97 64 292 64
----------- ---------- ---------- -----------
Net income attributable to common stock................. $ 247,260 $ 243,898 $ 260,130 $ 424,981
=========== ========== ========== ===========
Weighted average shares outstanding..................... 284,344 263,373 283,965 243,769
Basic EPS:
Income before preferred dividends....................... $ 0.870 $ 0.926 $ 0.916 $ 1.743
Less: Preferred dividends............................... -- -- -- --
----------- ---------- ---------- -----------
Net income attributable to common stock................. $ 0.870 $ 0.926 $ 0.916 $ 1.743
=========== ========== ========== ============
Diluted EPS Calculation:
Income before preferred dividends....................... $ 247,357 $ 243,962 $ 260,422 $ 425,045
Plus: Income impact of assumed conversions:
Interest on 6 1/4% convertible debentures............ 14 207 43 207
----------- ---------- ---------- -----------
Income before preferred dividends assuming dilution..... 247,371 244,169 260,465 425,252
Less: Preferred dividends............................... 97 64 292 64
----------- ---------- ---------- -----------
Net income attributable to common stock................. $ 247,274 $ 244,105 $ 260,173 $ 425,188
============ ========== =========== ============
Weighted average shares outstanding..................... 284,344 263,373 283,965 243,769
Plus: Incremental shares from assumed conversions:
Stock options........................................ 165 18 154 21
Restricted stock..................................... 492 369 492 369
6 1/4% convertible debentures........................ 44 946 44 946
------------ ----------- ----------- ------------
Weighted average shares assuming dilution............... 285,045 264,706 284,655 245,105
============ =========== =========== ============
Diluted EPS:
Income before preferred dividends....................... $ 0.867 $ 0.922 $ 0.914 $ 1.735
Less: Preferred dividends............................... -- -- -- --
------------ ----------- ----------- ------------
Net income attributable to common stock................. $ 0.867 $ 0.922 $ 0.914 $ 1.735
============ =========== =========== ============
</TABLE>
- -----------------
(1) For the three months ended September 30, 1998, the computation of diluted
EPS excludes purchase options for 379 shares of common stock, because the
exercise prices for such shares (ranging from $30.18 to $35.18 per share)
were greater than the $29.07 per share average market price for the period
and would thus be anti-dilutive if exercised.
(2) For the nine months ended September 30, 1998, the computation of diluted
EPS excludes purchase options for 379 shares of common stock, because the
exercise prices for such shares (ranging from $30.18 to $35.18 per share)
were greater than the $28.28 per share average market price for the period
and would thus be anti-dilutive if exercised.
11
<PAGE> 15
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(c) Preferred Stock.
At September 30, 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 September 30, 1998 and December 31, 1997, the Company had 10,000,000
authorized shares of preference stock. Of the authorized shares of preference
stock, the Company has designated 700,000 shares as Series A Preference Stock,
27,000 shares as Series B Preference Stock and 1,575 shares as Series C
Preference Stock.
At September 30, 1998, the number of shares of Series B Preference
Stock and Series C Preference Stock issued and outstanding was 17,000 and 1,575,
respectively. The shares of 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 (see Notes
7(b) and 8(c) to the Company's 10-K Financial Statements with respect to Series
B Preference Stock and Notes 6(d) and 8(b) to the Company's Interim Financial
Statements in the First Quarter 10-Q with respect to Series C Preference Stock).
The shares of Series A Preference Stock are issuable only pursuant to the
Company's Shareholder Rights Agreement. At September 30, 1998, there were no
shares of Series A Preference Stock outstanding.
(8) 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 (of which $1.3 million were outstanding at September 30, 1998),
issued by a statutory business trust formed by NorAm, see Note 9 to the
Company's 10-K Financial Statements. The sole asset of each trust consists of
junior subordinated debentures of the Company or NorAm 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.
(9) LONG-TERM DEBT AND SHORT-TERM FINANCING
(a) Consolidated Debt.
The following table summarizes the Company's outstanding consolidated
long-term and short-term indebtedness. At September 30, 1998, approximately $1.8
billion of this debt represents indebtedness of NorAm.
12
<PAGE> 16
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
CONSOLIDATED LONG-TERM DEBT AND SHORT-TERM BORROWINGS
(IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------------------- ------------------------------
LONG-TERM CURRENT (1) LONG-TERM CURRENT (1)
Short-Term Borrowings:
<S> <C> <C> <C> <C>
Commercial Paper......................... $ 1,465 $ 1,435
Lines of Credit.......................... 150 390
NorAm Receivables Facility............... 300 300
Notes Payable............................ 3
-------------- ------------ ------------ -------------
Total Short-Term Borrowings................ 1,918 2,125
-------------- ------------ ------------ -------------
Long-Term Debt - net:
ACES..................................... $ 1,658 $ 1,174
Debentures(2)(3)......................... 966 669
First Mortgage Bonds(2).................. 1,865 239 2,495
Pollution Control Bonds.................. 581 118 5
NorAm Medium-Term Notes(3)............... 179 182 79
Notes Payable(3)......................... 343 372 565 166
Capital Leases........................... 15 1 15 1
-------------- ------------ ------------ -------------
Total Long-Term Debt....................... 5,607 612 5,218 251
-------------- ------------ ------------ -------------
Total Long-Term and Short-Term Debt...... $ 5,607 $ 2,530 $ 5,218 $ 2,376
============== ============ ============ =============
</TABLE>
- --------------
(1) Includes amounts due within one year of the date noted.
(2) Includes unamortized discount related to debentures of approximately $1
million at September 30, 1998 and December 31, 1997 and unamortized discount
related to first mortgage bonds of approximately $11 million and $14 million at
September 30, 1998 and December 31, 1997, respectively.
(3) Includes unamortized premium related to fair value adjustments of
approximately $19 million and $16 million for debentures at September 30, 1998
and December 31, 1997, respectively. The unamortized premium for NorAm long-term
and current medium-term notes was approximately $13 million and $0 at September
30, 1998, respectively, and $17 million and $3 million at December 31, 1997,
respectively. The unamortized premium for long-term and current notes payable
was approximately $4 million each at September 30, 1998 and $14 million and $3
million, respectively, at December 31, 1997.
Consolidated maturities of long-term debt and sinking fund requirements
for the Company (including NorAm) are $156 million for the remainder of 1998.
(b) Financing Developments
Company: At September 30, 1998, a financing subsidiary of the Company
had $1.3 billion in commercial paper borrowings supported by a $1.6 billion
revolving credit facility. As of September 30, 1998, the weighted average
interest rate of these commercial paper borrowings was 5.89%. Proceeds from the
initial issuance of commercial paper under this facility were used to fund a
portion of the acquisition of NorAm. For information regarding this facility,
see Note 8(c) to the Company's 10-K Financial Statements and Note 8(b) to the
Company's Interim Financial Statements in the First Quarter 10-Q.
13
<PAGE> 17
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
At September 30, 1998, another financing subsidiary of the Company had
$150 million in borrowings under a separate credit facility. At September 30,
1998, the weighted average interest rate of these borrowings was 5.89%. Proceeds
under this facility were used to fund a portion of the acquisition of electric
generating plants acquired by Houston Industries Power Generation, Inc. (HIPG,
Inc.) in April 1998. The facility will terminate on December 31, 1998. For
additional information regarding this facility, see Note 8(b) to the Company's
Interim Financial Statements in the First Quarter 10-Q.
The Company meets its short-term financing needs primarily through the
sale of commercial paper supported by a $200 million revolving credit facility.
At September 30, 1998, the Company had no commercial paper or other borrowings
outstanding under this facility. For additional information, see Note 8(d) to
the Company's 10-K Financial Statements.
In September 1998, the Brazos River Authority (BRA) issued on behalf of
the Company $68.7 million aggregate principal amount of pollution control
revenue refunding bonds. The BRA bonds, which bear a coupon rate of 4.90%, will
mature in October 2015. The proceeds of the bond offering were deposited into a
restricted trust account for the redemption in October 1998 of $68.7 million
principal amount of the 7 3/4% BRA Series 1988D pollution control bonds at 102%
of their aggregate principal amount. Because the redemption of the Series 1988D
pollution control bonds occurred subsequent to the third quarter of 1998, the
Company's Interim Financial Statements report both series of bonds to be
outstanding at September 30, 1998.
For information regarding the Company's notice to change (effective in
the fourth quarter of 1998) the method of interest rate determination for $118
million aggregate principal amount of pollution control bonds, see Note 12(b) to
the Company's Interim Financial Statements.
For information regarding (i) the repayment at maturity of $5 million
of floating-rate pollution control revenue bonds and (ii) the redemption of all
outstanding 8.25% Brazos River Authority (BRA Series 1988A pollution control
revenue bonds ($100 million), 8.25% BRA Series 1998B pollution control revenue
bonds ($90 million), and 8.10% BRA Series 1988C pollution control revenue ($100
million) (all of which occurred in the second quarter of 1998), see Note 8(b) to
the Company's Interim Financial Statements in the Second Quarter 10-Q. For
information regarding the issuance of (i) $104.7 million aggregate principal
amount of pollution control revenue bonds by the Matagarda County Navigation
District Number One (MCND), and (ii) $290 million aggregate principal amount of
pollution control revenue refunding bonds by the BRA (all of which occurred in
the first quarter of 1998), see Note 8(c) the Company's Interim Financial
Statements in the First Quarter 10-Q.
NorAm: During the third quarter of 1998, NorAm repurchased $6 million
aggregate principal amount of its 6% convertible subordinated debentures due
2012 at an average purchase price equal to 97.4% of the aggregate principal
amount of the debentures, plus accrued interest. NorAm expects to use the
repurchased debentures to satisfy part of the debentures' sinking fund
requirements in March 1999 and March 2000.
14
<PAGE> 18
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
During the third quarter of 1998, NorAm repaid the following
medium-term notes at maturity:
<TABLE>
<CAPTION>
Series Principal Amount
------------------------------ ------------------
<S> <C> <C>
9.07% due July 20, 1998 $ 15.0 million
8.60% due September 1, 1998 3.0 million
8.58% due September 1, 1998 5.0 million
8.64% due September 4, 1998 12.5 million
8.50% due September 14, 1998 0.5 million
8.60% due September 15, 1998 6.0 million
8.43% due September 17, 1998 5.0 million
------------------
Total $ 47.0 million
==================
</TABLE>
At September 30, 1998, NorAm had $206 million in commercial paper
borrowings supported by a $350 million revolving credit facility (NorAm Credit
Facility). At such date, the weighted average interest rate of borrowings under
this facility was 5.94%. Under a trade receivables facility that expires in
August 1999, NorAm sells with limited recourse an undivided interest (limited to
a maximum of $300 million) in a designated pool of accounts receivable. The
amount of receivables sold and uncollected at September 30, 1998, was $300
million. The weighted average interest rate at such date was 5.5%. For
additional information regarding NorAm's trade receivables facility, see Note
8(g) to the Company's 10-K Financial Statements.
For information regarding NorAm's issuance in the fourth quarter of
1998 of $500 million aggregate principal amount of debt securities, see Note 12
to the Company's Interim Financial Statements.
For information regarding NorAm's repayment at maturity of $28 million
of its medium-term notes (having an average interest rate of 8.74%) in the
second quarter of 1998, see Note 8(b) to the Company's Interim Financial
Statements in the Second Quarter 10-Q. For information regarding (i) NorAm's
issuance in February 1998 of $300 million principal amount of 6.5% debentures
due February 1, 2008, (ii) NorAm's repayment at maturity of $1 million of its
9.30% medium-term notes in January 1998 and (iii) NorAm's satisfaction of the
$6.5 million sinking fund requirement for its 6% convertible subordinated
debentures due 2012 using debentures purchased in 1996 and 1997 in the first
quarter of 1998, see Note 8(d) to the Company's Interim Financial Statements in
the First Quarter 10-Q.
(10) REGULATORY MATTERS
(a) Transition Plan (Docket No. 18465)
In June 1998, the Public Utility Commission of Texas (Texas Utility
Commission) issued an order approving a transition to competition plan
(Transition Plan) filed by the Company's electric operations division (Electric
Operations) in December 1997. The order also approved the implementation of base
rate credits to residential customers of 4% in 1998 and an additional 2% in
1999. Commercial customers whose monthly billing is 1,000 kva or less receive
base rate credits of 2% in each of 1998 and 1999. The Company implemented the
Transition Plan effective January 1, 1998.
15
<PAGE> 19
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
In order to reduce the Company's exposure to potentially stranded costs
related to generating assets, the Transition Plan permits the Company to
redirect depreciation expenses that the Company otherwise would apply to
transmission, distribution and general plant assets to generation assets. The
redirected depreciation expense was $49 million and $145 million for the quarter
and nine months ended September 30, 1998, respectively. In addition, the
Transition Plan provides that all earnings by Electric Operations above a 9.844%
overall annual rate of return on invested capital will be used to write-down
Electric Operation's investment in generation assets. The $91 million in
additional depreciation recorded in the third quarter of 1998 ($171 million for
the nine months ended September 30, 1998) is an estimate of the amount of
additional depreciation necessary under the earnings cap, given the uncertainty
of weather and the level of revenues and expenses during the remainder of the
year and the level of year end invested capital.
For additional information regarding the Transition Plan, see Note 3(b)
to the Company's 10-K Financial Statements.
Review of the Texas Utility Commission's order in Docket No. 18465 is
currently pending before the Travis County District Court. In August 1998, the
Office of the Attorney General for the State of Texas and a Texas municipality
filed an appeal seeking, among other things, to reverse the portion of the Texas
Utility Commission's order relating to the redirection of depreciation expenses
under the Transition Plan. For information regarding appeals of Texas Utility
Commission decisions, see Note 3(a) to the Company's 10-K Financial Statements.
Because of the number of variables that can affect the ultimate resolution of an
appeal of Commission orders, the Company is not in a position at this time to
predict the outcome of this matter or the ultimate effect that adverse action by
the courts could have on the Company.
(b) Nuclear Insurance
The Company has a 30.8% interest in the South Texas Project Electric
Generating Station (South Texas Project), a nuclear generating plant consisting
of two 1,250 megawatt nuclear generating units.
Effective August 1998, the Nuclear Regulatory Commission increased the
maximum secondary retrospective deferred premium to $88.09 million per reactor
per incident (but not to exceed $10 million in any one year) from $75.5 million
per reactor per incident. The premium is for liability insurance coverage for
nuclear incidents at licensed, operating commercial nuclear power plants. The
change reflects an inflation adjustment required by the Price-Anderson
Amendments Act of 1988. For additional information on nuclear insurance, see
Note 4(c) to the Company's 10-K Financial Statements.
(c) Low-level Radioactive Waste
The 1980 Federal Low-Level Radioactive Waste Policy Act directed states
to assume responsibility for the disposal of low-level nuclear waste generated
within their borders. Under this Act, states may combine with other states and
seek consent from the U.S. Congress for regional compacts to construct and
operate low-level nuclear waste sites. Two sites (the Envirocare facility in
Utah and the Barnwell facility in South Carolina) are currently licensed and
available to the South Texas Project for disposal of all classes of low-level
waste. The South Texas Project has entered into a contract with the operator of
the Barnwell facility to dispose of all of the South Texas Project's low-level
nuclear waste through June 1999.
A bill establishing an interstate compact among Texas, Maine and
Vermont was signed into law on September 20, 1998. The compact limits access to
a Texas waste disposal facility to the three compact members and provides for
contributions from Maine and Vermont toward the construction of such a facility.
In October 1998, the Texas Natural Resource Conservation Commission denied the
application of the Texas Low-Level Radioactive Waste Disposal Authority
(Waste Disposal Authority) to build and operate a low-level waste disposal
facility in Hudspeth County, Texas. In the event the Barnwell facility stops
accepting waste before a Texas site is opened, the South Texas Project would
store its waste in an interim storage facility located at the nuclear plant.
The plant currently has storage capacity for at least five years of low-level
nuclear waste generated by the project.
16
<PAGE> 20
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(11) ACQUISITIONS AND DISPOSITIONS
In July 1998, HIPG, Inc. purchased from Southern California Edison
Company (SCE), a 1500 MW generating plant for $43 million.
(12) SUBSEQUENT EVENTS
(a) Investment in Colombian Distribution Company.
On October 13, 1998, HI Energy and Electricidad de Caracas, SACA, a
Venezuelan electric distribution company (EDC), announced the closing of their
joint acquisition of 65% of the stock of two Colombian electric distribution
companies (collectively, the Corelca system companies). The Corelca system
companies serve approximately 1.2 million customers in the Atlantic coastal
region of Colombia, including the cities of Santa Marta, Barranquilla and
Cartagena. The shares of the Corelca system companies are indirectly held by an
offshore holding company jointly owned by special purpose subsidiaries of EDC
and HI Energy.
The purchase price for the Corelca system companies was approximately
$522 million, excluding transaction costs. The purchase price was funded with
capital contributions from HI Energy and EDC and a $100 million loan obtained by
the holding company from a United States bank. The loan will mature on October
31, 2003. HI Energy funded its capital contributions with a portion of the
proceeds from the sale of Empresa Distribuidora de La Plata S.A. (EDELAP) and
capital contributions from the company. Under the terms of a support agreement,
HI Energy and EDC have agreed, among other things, to repurchase up to $50
million of the loan from the bank to the extent that the bank is unable to
syndicate that portion of the loan to other banks on or prior to June 15, 1999.
(b) Pollution Control Bonds.
In October 1998, the Company delivered its notice to change the
interest rate determination method for (i) the MCND Series 1997 pollution
control revenue refunding bonds due November 2028 ($68 million aggregate
principal amount outstanding) and (ii) the BRA Series 1997 pollution control
revenue refunding bonds due November 2018 ($50 million aggregate principal
amount outstanding). Subject to the satisfaction of certain conditions
precedent, the notice provides that, effective November 24, 1998, the method by
which interest on the bonds is calculated will convert from a floating rate mode
to a long-term fixed rate mode. As set forth in the notice, the long-term
interest rate for the MCND Series 1997 will be 5 1/8% and the long-term interest
rate for the BRA Series 1997 will be 5.05%.
The MCND and BRA Series 1997 bonds, which were issued in January 1997,
are subject to mandatory tender on November 24, 1998 in connection with the
change in the interest rate determination method. The purchase price of the
tendered bonds (100% of their principal amount plus accrued interest) is
expected to be funded with the proceeds from the underwritten remarketing of the
fixed-rate bonds. For additional information regarding the MCND and BRA Series
1997 bonds, see Note 8(f) to the Company's 10-K Financial Statements.
17
<PAGE> 21
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(c) Offering of NorAm Debt Securities.
In November 1998, NorAm sold $500 million aggregate principal amount of
its 6 3/8% Term Enhanced ReMarketable Securities (TERM Notes). The net proceeds
of $514 million from the offering of the TERM Notes and from the sale of the
related option to remarket the TERM Notes (as described below) will be used for
general corporate purposes, including the repayment of (i) $178.5 million of
NorAm's outstanding commercial paper and (ii) a $150 million term loan of NorAm
that matures on November 13, 1998. The TERM Notes are unsecured obligations of
NorAm which bear interest at the annual rate of 6 3/8% through November 1, 2003.
On November 1, 2003, the holders of the TERM Notes are required to tender their
notes at 100% of their principal amount. Concurrent with the offering, NorAm
received proceeds of $18.375 million from the sale of an option to remarket the
notes in 2003. The proceeds received from the sale of the option will be
amortized over the stated term of the securities. If the option is not
exercised, NorAm will repurchase the TERM Notes at 100% of their principal
amount on November 1, 2003. If the option is exercised, the TERM Notes will be
remarketed on a date, selected by NorAm, within the 52-week period beginning
November 1, 2003. During such period and prior to remarketing, the TERM Notes
will bear interest at rates, adjusted weekly, based on an index selected by
NorAm. If the TERM Notes are remarketed, the final maturity date of the TERM
Notes will be November 1, 2013, subject to adjustment, and the effective
interest rate on the remarketed TERM Notes will be 5.66% plus the Company's
applicable credit spread at the time of such remarketing.
(13) 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 affecting energy consumption and (iii) the timing of maintenance and
other expenditures and (iv) acquisitions and dispositions of assets and other
interests. 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.
18
<PAGE> 22
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 Form 10-K, Management's Narrative
Analysis of the Results of Operations of NorAm and Consolidated Subsidiaries in
Item 7 of the Form 10-K, the Company's consolidated financial statements and
notes contained in Item 8 of the Form 10-K and Item 1 of this Form 10-Q. The
Company from time to time makes use in its presentations and other
communications of projections, forecasts and other non-historical information.
For a discussion of the qualifications and assumptions underlying the use of
such forward looking information, see Item 5 of this Form 10-Q.
HOUSTON INDUSTRIES INCORPORATED
Houston Industries Incorporated (Company), together with various
divisions and subsidiaries, including NorAm Energy Corp. (NorAm), is a
diversified international energy services company.
The Company's electric operations segment (Electric Operations)
operates the nation's tenth largest electric utility in terms of kilowatt-hour
(KWH) sales; and its natural gas distribution segment (Natural Gas Distribution)
operates the nation's third largest natural gas distribution operation in terms
of customers served. The Company, through its interstate pipeline segment
(Interstate Pipeline), operates two interstate natural gas pipelines. The
Company provides natural gas transportation, supply, gathering and storage, and
wholesale natural gas and electric power trading and marketing services through
its energy marketing segment (Energy Marketing) and invests, through its
international (International) and corporate (Corporate) segments, in foreign
electric and gas utility operations and domestic non-rate regulated power
generation projects.
CONSOLIDATED RESULTS OF OPERATIONS
The Company's actual and pro forma results of operations for the
third quarter and nine month periods ended September 30,1998 and 1997 are
summarized in the following table. The Company's actual results of operations
include results of operations for NorAm for periods on and after August 6, 1997
(Acquisition Date). The Company's pro forma results of operations give effect to
the acquisition of NorAm as if it had occurred as of January 1, 1997. 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 the
acquisition of NorAm occurred at the beginning of such period. In general, the
effects of the acquisition of NorAm include (i) significant increases in
amortization attributable to purchase accounting, (ii) increased shares
outstanding and interest expense and (iii) inclusion of additional revenues and
operating expenses from the newly acquired NorAm business.
19
<PAGE> 23
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------------------------------- PERCENT
1998 1997 1997 CHANGE
---------- ---------- ------------ ------------
(ACTUAL) (ACTUAL) (PRO FORMA) (1998 ACTUAL
(IN MILLIONS, EXCEPT PER SHARE DATA) TO 1997
PRO FORMA)
<S> <C> <C> <C> <C>
Revenues ......................................... $ 3,469 $ 2,159 $ 2,555 36%
Operating Expenses ............................... 2,963 1,696 2,107 41%
Operating Income ................................. 506 463 449 13%
Other Expenses, Net (1) .......................... 155 93 108 44%
Income Taxes ..................................... 104 126 117 (11%)
Net Income (1) ................................... 247 244 224 10%
Basic Earnings Per Share (1) ..................... 0.87 0.93 0.80 9%
Diluted Earnings Per Share (1) ................... 0.87 0.92 0.80 9%
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------------------- PERCENT
1998 1997 1997 CHANGE
---------- ---------- ------------ ------------
(ACTUAL) (ACTUAL) (PRO FORMA) (1998 ACTUAL
(IN MILLIONS, EXCEPT PER SHARE DATA) TO 1997
PRO FORMA)
<S> <C> <C> <C> <C>
Revenues ......................................... $ 8,844 $ 4,101 $ 7,438 19%
Operating Expenses ............................... 7,597 3,235 6,422 18%
Operating Income ................................. 1,247 866 1,016 23%
Other Expenses, Net (2) .......................... 834 244 352 137%
Income Taxes ..................................... 153 197 223 (31%)
Net Income (2) ................................... 260 425 441 (41%)
Basic Earnings Per Share (2) ..................... 0.92 1.74 1.57 (41%)
Diluted Earnings Per Share (2) ................... 0.91 1.74 1.56 (42%)
</TABLE>
- ------------
(1) Includes a $40 million ($26 million after-tax) or $0.09 basic earnings per
share non-cash unrealized accounting loss recorded in the three month
period ended September 30, 1998, relating to the Company's 7% Automatic
Common Exchange Securities (ACES).
See Note 6 to the Company's Interim Financial Statements.
(2) Includes a $484 million ($314 million after-tax) or $1.10 basic earnings
per share non-cash unrealized accounting loss recorded in the nine month
period ended September 30, 1998, relating to the ACES. (See Note 6 to the
Company's Interim Financial Statements.)
Third Quarter of 1998 Compared to Third Quarter of 1997 (Actual). The
Company had net income of $247 million for the third quarter of 1998 ($0.87
basic earnings per share) compared to net income of $244 million ($0.93 basic
earnings per share) in the comparable period in 1997. The Company's results of
operations for the third quarter of 1998 include a $26 million (after-tax)
non-cash, unrealized accounting loss on the ACES. For information regarding this
accounting loss, see Note 6 to the Company's Interim Financial Statements.
Excluding the ACES accounting loss, the Company would have had
adjusted net income of $273 million ($0.96 basic earnings per share) for the
third quarter of 1998. The increase in third quarter adjusted net income is
primarily attributable to improved earnings from the Company's non-rate
regulated power generation business (reported in the Corporate segment) and its
International segment. Improved results of operations from the Interstate
Pipeline and Energy Marketing segments also contributed to the increase in
adjusted net income. These effects were partially offset by (i) additional
depreciation of Electric Operations' generation assets of $91 million ($78
million over the prior comparable period), (ii) base rate credits resulting from
the Transition Plan (described below), (iii) seasonal-related operating losses
at Natural Gas Distribution, and (iv) increased interest expense primarily
related to the NorAm acquisition.
20
<PAGE> 24
Third Quarter of 1998 (Actual) Compared to Third Quarter of 1997 (Pro
Forma). The Company's net income for the third quarter of 1998 was $247 million
($0.87 basic earnings per share) compared to pro forma net income of $224
million ($0.80 basic earnings per share) in the third quarter of 1997. Excluding
the accounting loss attributable to the ACES securities, the Company's adjusted
net income for the third quarter of 1998 would have been $273 million ($0.96
basic earnings per share) compared to $224 million ($0.80 basic earnings per
share) in the third quarter of 1997. The increase in actual net income over pro
forma net income was caused by the same factors discussed above except for the
increase in interest expense and the losses at Natural Gas Distribution which
were comparable between periods (excluding non-recurring items discussed below).
The decrease in income taxes in the third quarter of 1998 reflects the impact of
a reduction in the Company's estimate of tax expense for the year.
Nine Month Period ended September 30, 1998 (Actual) Compared to Nine
Month Period ended September 30, 1997 (Actual). The Company had net income of
$260 million for the nine month period ended September 30, 1998, ($0.92 basic
earnings per share) compared to net income of $425 million ($1.74 basic earnings
per share) for the comparable period in 1997. The Company's results of
operations for the nine month period reflect a $314 million (after-tax)
non-cash, unrealized accounting loss relating to the ACES. Excluding this
accounting loss, the Company would have had adjusted net income of $574 million
($2.02 basic earnings per share). The increase in adjusted net income for the
nine month period is attributable to (i) an $80 million ($0.28 basic earnings
per share) after-tax gain recorded in connection with the sale of an investment
in an Argentine electric utility system, (ii) earnings from the Company's
non-rate regulated power generation business and its International segment, and
(iii) the incremental earnings generated by the business segments acquired in
the NorAm acquisition.
Nine Months ended September 30, 1998 (Actual) Compared to Nine Months
ended September 30, 1997 (Pro Forma). The Company's net income for the nine
month period ended September 30, 1998 was $260 million ($0.92 basic earnings per
share) compared to pro forma net income of $441 million ($1.57 basic earnings
per share) in the first nine months of 1997.
Excluding the accounting loss relating to the ACES, the Company's
adjusted net income for the nine month period ended September 30, 1998, would
have been $574 million ($2.02 basic earnings per share) compared to pro forma
net income of $441 million ($1.57 basic earnings per share) for the comparable
period in 1997. The increase in adjusted net income is due to the $80 million
after-tax gain on the sale of an investment in an Argentine electric utility
system and increased equity earnings at International, and increased earnings of
the Company's non-rate regulated power generation business. These factors were
partially offset by decreased operating income at Natural Gas Distribution due
to warmer weather in 1998 as compared to 1997. The decrease in income taxes in
the nine month period ended September 30, 1998, is primarily attributable to the
tax benefit associated with the unrealized accounting loss related to the ACES.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The following table presents operating income on (i) an actual basis
for the three and nine month periods ended September 30, 1998 and 1997 and (ii)
a pro forma basis for the three and nine month periods ended September 30, 1997
(assuming the NorAm acquisition had occurred on January 1, 1997) for each of the
Company's business segments (other than Electric Operations, which is presented
on an actual basis for all reported periods).
21
<PAGE> 25
OPERATING INCOME (LOSS) BY BUSINESS SEGMENT
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------
1998 1997 1997
------------- ------------- -------------
(ACTUAL) (ACTUAL) (PRO FORMA)(1)
(IN MILLIONS)
<S> <C> <C> <C>
Electric Operations .............................. $ 419 $ 457 $ 457
Natural Gas Distribution ......................... (20) (6) (15)
Interstate Pipeline .............................. 27 14 20
Energy Marketing ................................. 7 5
International .................................... 14 6 6
Corporate ........................................ 59 (13) (19)
------------- ------------- -------------
Total Consolidated ......................... $ 506 $ 463 $ 449
============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------
1998 1997 1997
------------- ------------- -------------
(ACTUAL) (ACTUAL) (PRO FORMA)(1)
(IN MILLIONS)
<S> <C> <C> <C>
Electric Operations .............................. $ 855 $ 883 $ 883
Natural Gas Distribution ......................... 75 (6) 92
Interstate Pipeline .............................. 92 14 81
Energy Marketing ................................. 11 5 4
International .................................... 176 14 12
Corporate ........................................ 38 (44) (56)
------------- ------------- -------------
Total Consolidated ......................... $ 1,247 $ 866 $ 1,016
============= ============= =============
</TABLE>
- ------------
(1) Pro forma adjustments give effect to purchase-related adjustments,
including amortization of goodwill and the revaluation of the fair market value
of certain NorAm assets and liabilities since the Acquisition Date.
ELECTRIC OPERATIONS
Electric Operations activities 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 results of
operations of Electric Operations, including operating statistics, for the three
and nine month periods ended September 30, 1998 and 1997.
22
<PAGE> 26
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- --------
(ACTUAL) (ACTUAL)
(IN MILLIONS)
<S> <C> <C> <C>
Base Revenues (1) ................................ $ 959 $ 918 4%
Transmission Revenues ............................ 27 19 42%
Reconcilable Fuel Revenues (2) ................... 430 450 (4%)
Operating Expenses:
Fuel ........................................ 361 366 (1%)
Purchased Power ............................. 85 99 (14%)
Operation and Maintenance ................... 265 246 8%
Depreciation and Amortization ............... 209 151 38%
Other Taxes ................................. 77 68 13%
---------- ----------
Operating Income ................................. $ 419 $ 457 (8%)
========== ==========
Electric Sales (MWH):
Residential ................................. 7,971,198 7,191,954 11%
Commercial .................................. 4,860,627 4,593,227 6%
Industrial - Firm ........................... 7,018,296 6,671,742 5%
Municipal & Public Utilities ................ 95,204 81,076 17%
---------- ----------
Total Firm Billed Sales .......................... 19,945,325 18,537,999 8%
========== ==========
Average Cost of Fuel (Cents/MMBtu) ............... 173.4 190.9 (9%)
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- -------
(ACTUAL) (ACTUAL)
(IN MILLIONS)
<S> <C> <C> <C>
Base Revenues (1) ................................ $ 2,274 $ 2,160 5%
Transmission Revenues ............................ 70 64 9%
Reconcilable Fuel Revenues (2) ................... 1,100 1,062 4%
Operating Expenses:
Fuel ........................................ 856 833 3%
Purchased Power ............................. 291 279 4%
Operation and Maintenance ................... 723 690 5%
Depreciation and Amortization ............... 524 412 27%
Other Taxes ................................. 195 189 3%
---------- ----------
Operating Income ................................. $ 855 $ 883 (3%)
========== ==========
Electric Sales (MWH):
Residential ................................. 16,043,238 14,839,034 8%
Commercial .................................. 12,182,317 11,597,494 5%
Industrial - Firm ........................... 20,160,044 19,377,067 4%
Municipal & Public Utilities ................ 253,113 239,531 6%
---------- ----------
Total Firm Billed Sales .......................... 48,638,712 46,053,126 6%
========== ==========
Average Cost of Fuel (Cents/MMBtu) ............... 176.7 184.2 (4%)
</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 over/under recovery. See below.
23
<PAGE> 27
For the three month and nine month periods ended September 30, 1998,
Electric Operations' operating income decreased $38 million and $28 million,
respectively, below operating income for the same periods of 1997. The decrease
in operating income is due to (i) additional depreciation of the South Texas
Project Electric Generating Station of $91 million and $171 million for the
three month and nine month periods ended September 30, 1998 (which is $78
million and $133 million more than recorded during the same periods in 1997),
(ii) the implementation of transition to competition base rate credits beginning
January 1, 1998 and (iii) increases in operating expenses. These factors were
partially offset by increased sales as a result of unusually hot weather in
1998.
HL&P's earnings are capped at an overall rate of return on a calendar
year basis as part of its transition to competition plan (Transition Plan)
approved by the Public Utility Commission of Texas (Texas Utility Commission) in
June 1998. As a result of this plan, any earnings above the maximum allowed
return cap of 9.844 % on invested capital will be offset by additional
depreciation of HL&P's generation assets. For information regarding the
Transition Plan, see Note 10(a) to the Company's Interim Financial Statements.
Electric Operations' increase in base revenues of $41 million and
$114 million for the three month and nine month periods ended September 30,
1998, respectively, compared to the same periods of 1997, is primarily the
result of unusually hot weather, net of base rate credits implemented under the
Transition Plan. The base rate credits lowered base revenues by $28 million and
$56 million for the three and nine months ended September 30, 1998.
Transmission revenues include revenues collected through a pricing
and billing mechanism implemented by the Texas Utility Commission for wholesale
transmission services within the Electric Reliability Council of Texas (ERCOT).
Electric Operations began recording these revenues and associated expenses in
the second quarter of 1997. For the three and nine month periods ended September
30, 1998, transmission revenues of $27 million and $70 million, respectively,
were offset by transmission expenses of $29 million and $73 million,
respectively. For the three and nine month periods ended September 30, 1997,
transmission revenues of $19 million and $64 million, respectively, were offset
by transmission expenses of $22 million and $66 million, respectively. For
information regarding transmission revenues, 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--Competition--Electric Operations -- Competition in Wholesale
Market" in the Company's Form 10-K.
Fuel revenues include revenues generated by a fixed fuel factor
established by the Texas Utility Commission and included in electric rates to
permit the Company to recover certain fuel and purchased power costs. The fixed
fuel factor is established during general rate proceedings or periodic fuel
factor proceedings and is generally effective for a minimum of six months. Since
reconcilable fuel revenues are adjusted monthly to equal expenses, fuel revenues
and expenses have no effect on earnings unless the Texas Utility Commission
subsequently determines that a utility's fuel costs are not recoverable.
In January 1998, Electric Operations filed a fuel reconciliation for
the three year period ending July 1997 covering approximately $3.5 billion of
eligible fuel expenses. On October 15, 1998, Electric Operations and all other
parties in this proceeding filed with the Texas Utility Commission an Unanimous
Stipulation resolving all fuel reconciliation issues. This case is pending final
approval and is not expected to have a material effect on Electric Operations'
results of operations.
In April 1998, Electric Operations filed a petition to revise the
fixed fuel factor and implement a surcharge for under-collected fuel costs. The
Texas Utility Commission approved implementation of the revised fixed fuel
factor and a fuel surcharge in the amount of $125 million (inclusive of the
previously existing fuel surcharge balance) to be collected over a 12 to 18
month period. The revised fixed fuel factor
24
<PAGE> 28
implemented July 1, 1998 is $0.019 compared to $0.017 fixed factor in place
since 1995. As of September 30, 1998, Electric Operations' cumulative
under-recovery of fuel costs was $182 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 for the three month and nine month
periods ended September 30, 1998 decreased by $19 million or 4% and increased by
$35 million or 3%, respectively, compared to the same periods in 1997. The three
month period decrease was driven by a decline in the cost of natural gas (from
$2.43 to $2.08 per MMBtu), coal (from $1.98 to $1.82 per MMBtu), and nuclear
fuel (from $0.53 to $0.48 per MMBtu), net of an increase in the production of
electricity. The 3% increase for the nine months ended September 30, 1998 is due
primarily to increased production of electricity, net of an overall decrease in
the average price of fuel and purchased power. See Note 12(c) to the Company's
10-K Financial Statements for information on Electric Operations' joint
dispatching agreement with the City of San Antonio for purchased power.
Operations and maintenance expenses for the three months ended
September 30, 1998, increased $19 million compared to the same period in 1997
due primarily to (i) ERCOT transmission tariffs discussed above, (ii) increased
liabilities associated with benefit plans and (iii) increased franchise taxes
due to higher KWH sales.
For the nine month period ended September 30, 1998, operation and
maintenance expense increased $33 million, due primarily to the items mentioned
above, along with the scheduling of routine plant maintenance and inspection
outages, additional tree-trimming activities and franchise taxes due to higher
KWH sales.
NATURAL GAS DISTRIBUTION
Natural Gas Distribution operations are conducted through the Arkla,
Entex and Minnegasco divisions of NorAm. 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, on an
actual basis for the third quarter and nine month periods ended September 30,
1998 and on a pro forma basis for the third quarter and nine month periods ended
September 30, 1997 (as if the acquisition of NorAm had occurred as of January 1,
1997).
25
<PAGE> 29
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------------ PERCENT
1998 1997 CHANGE
------------ ------------ --------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ............................... $ 249 $ 272 (8%)
Operating Expenses:
Natural Gas ................................. 126 145 (13%)
Operation and Maintenance ................... 91 90 1%
Depreciation and Amortization ............... 33 31 6%
Other Operating Expenses .................... 19 21 (10%)
------------ ------------
Total Operating Expenses ................ 269 287 (6%)
------------ ------------
Operating Loss ................................... $ (20) $ (15) (33%)
============ ============
Throughput Data (in Bcf):
Residential and Commercial Sales ............ 31 32 (3%)
Industrial Sales ............................ 14 14 --
Transportation .............................. 9 9 --
------------ ------------
Total Throughput ......................... 54 55 (2%)
============ ============
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------- PERCENT
1998 1997 CHANGE
------------ ----------- --------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ............................... $ 1,281 $ 1,490 (14%)
Operating Expenses:
Natural Gas ................................. 757 948 (20%)
Operation and Maintenance ................... 282 283 --
Depreciation and Amortization ............... 97 92 5%
Other Operating Expenses .................... 70 75 (7%)
---------- ----------
Total Operating Expenses ................ 1,206 1,398 (14%)
---------- ----------
Operating Income ................................. $ 75 $ 92 (18%)
========== ==========
Throughput Data (in Bcf):
Residential and Commercial Sales ............ 200 220 (9%)
Industrial Sales ............................ 42 42 --
Transportation .............................. 32 31 3%
---------- ----------
Total Throughput ......................... 274 293 (6%)
========== ==========
</TABLE>
Natural Gas Distribution's operating loss increased $5 million in the
third quarter of 1998, over its $15 million pro forma operating loss in the same
period of 1997. The third quarter of 1997 included approximately $4 million
non-recurring income recorded in connection with the successful appeal of the
Minnegasco division's 1993 and 1995 rate cases.
Operating income for the nine month period ended September 30, 1998
decreased $17 million compared to pro forma operating income in the same period
of 1997. The $17 million decrease in operating income is due primarily to (i)
milder winter weather in the first three months of 1998, (ii) the impact in 1997
of the Minnegasco division's rate case appeal as discussed above and (iii) lower
demand for natural gas heating in the second and third quarters of 1998. The
decrease in operating income was partially offset by reduced charges at Arkla
associated with the methodology of calculating the price of gas charged to
customers (the Purchased Gas Adjustment).
26
<PAGE> 30
Natural Gas Distribution operating revenues decreased $23 million and
$209 million for the third quarter and nine months ended September 30, 1998,
respectively, compared to pro forma operating revenues for the corresponding
periods of 1997 due principally to (i) the weather-related decline in customer
usage and (ii) lower natural gas prices. In addition, the impact in 1997 of the
Minnegasco division's rate case appeal (as discussed above) also resulted in
higher revenues in 1997 compared to 1998.
Operating expenses decreased $18 million and $192 million in the
third quarter and nine months ended September 30, 1998, respectively, compared
to pro forma operating expenses in the same period of 1997 due primarily to the
reduced cost of gas and the Purchased Gas Adjustment.
Demand for natural gas distribution services is seasonal in nature,
reflecting the higher demand for natural gas for use in heating in the winter
months.
INTERSTATE PIPELINE
Interstate Pipeline operations are conducted primarily 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 third quarter and nine months ended September 30, 1998 and on a
pro forma basis for third quarter and nine months ended September 30, 1997 (as
if the acquisition of NorAm had occurred as of January 1, 1997).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------------ PERCENT
1998 1997 CHANGE
------------ ------------ --------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ............................... $ 70 $ 67 4%
Operating Expenses:
Natural Gas ................................. 6 10 (40%)
Operation and Maintenance ................... 20 20 --
Depreciation and Amortization ............... 13 13 --
Other Operating Expenses .................... 4 4 --
---------- ----------
Total Operating Expenses ............... 43 47 (9%)
---------- ----------
Operating Income ................................. $ 27 $ 20 35%
========== ==========
Throughput Data (in million MMBtu):
Natural Gas Sales ............................. 4 4 --
Transportation ................................ 186 205 (9%)
Elimination (1) .......................... (4) (4) --
---------- ----------
Total Throughput ................................. 186 205 (9%)
========== ==========
</TABLE>
27
<PAGE> 31
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------- PERCENT
1998 1997 CHANGE
------------ ----------- --------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ............................... $ 218 $ 226 (4%)
Operating Expenses:
Natural Gas ................................. 22 29 (24%)
Operation and Maintenance ................... 60 66 (9%)
Depreciation and Amortization ............... 32 39 (18%)
Other Operating Expenses .................... 12 11 9%
---------- ----------
Total Operating Expenses ............... 126 145 (13%)
---------- ----------
Operating Income ................................. $ 92 $ 81 14%
========== ==========
Throughput Data (in million MMBtu):
Natural Gas Sales ............................. 12 14 (14%)
Transportation ................................ 610 667 (9%)
Elimination (1) .......................... (11) (13) 15%
---------- ----------
Total Throughput ................................. 611 668 (9%)
========== ==========
</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 increased $7 million and $11
million in the third quarter and nine months ended September 30, 1998,
respectively, over pro forma operating income for the same periods in 1997. The
increase in operating income for the third quarter of 1998 is primarily due to
improved operating margins and reductions in the cost of natural gas, as
discussed below. The increase in operating income for the nine month period of
1998 is primarily due to $11 million of pre-tax non-recurring items recorded in
1998 for litigation and rate case settlements as well as improved operating
margins and reductions in operating expenses. The increase in operating income
in the nine month period ended September 30, 1998 was offset by $7 million of
non-recurring transportation revenues recorded in the first quarter of 1997, as
discussed below.
Operating revenues for Interstate Pipeline increased $3 million in
the third quarter of 1998, over pro forma operating revenues for the same period
in 1997. This increase in operating revenues is primarily due to a
weather-related demand for natural gas used to fuel electric generation plants
during the summer cooling season.
Operating revenues decreased $8 million in the nine month period
ended September 30, 1998, from pro forma operating revenues for the same period
in 1997. The decrease in revenues is due in part to $7 million of non-recurring
transportation revenues recognized in the first quarter of 1997. These revenues
were recognized following a settlement with the Arkla division of NorAm related
to service provided in several of Arkla's operating jurisdictions. In addition,
the settlement with Arkla resulted in reduced transportation rates, which also
reduced revenues for the period. These decreases were partially offset by (i)
the settlement of outstanding gas purchase contract litigation which resulted in
the recognition of approximately $6 million of revenues in the second quarter of
1998 and (ii) the factors discussed above for the third quarter.
Natural gas expense decreased $4 million and $7 million in the third
quarter and nine months ended September 30, 1998, respectively, when compared to
pro forma natural gas expense in the same periods in 1997 primarily due to lower
gas sales volumes and lower prices for purchased gas.
28
<PAGE> 32
Operation and maintenance expense decreased $6 million in the nine
months ended September 30, 1998, respectively, in comparison to pro forma
operation and maintenance expense for the same period in 1997. The decrease was
primarily due to lower costs resulting from cost control initiatives and
decreased maintenance due to milder weather in the first quarter of 1998.
Depreciation expense decreased $7 million in the nine month period
ended September 30, 1998, compared to pro forma depreciation expense in the same
period of 1997 primarily due to a $5 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
Energy Marketing includes the operations of NorAm's wholesale energy
trading and marketing business, and retail energy marketing business and natural
gas gathering activities of NorAm (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 results of
operations of Energy Marketing, including operating statistics, on an actual
basis for the third quarter and nine months ended September 30, 1998 and on a
pro forma basis for the third quarter and nine months ended September 30, 1997
(as if the acquisition of NorAm had occurred as of January 1, 1997).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
----------------------------- PERCENT
1998 1997 CHANGE
------------ ----------- --------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ............................... $ 1,642 $ 842 95%
Operating Expenses:
Natural Gas ................................. 687 587 17%
Purchased Power ............................. 906 220 312%
Operation and Maintenance ................... 36 31 16%
Depreciation and Amortization ............... 4 3 33%
Other Operating Expenses .................... 2 1 100%
---------- ----------
Total Operating Expenses ............... 1,635 842 94%
========== ==========
Operating Income (Loss) .......................... $ 7 $ -- --
========== ==========
Operations Data:
Natural Gas (in Bcf):
Sales ..................................... 364 284 28%
Transportation ............................ 3 5 (40%)
Gathering ................................. 60 60 --
---------- ----------
Total ................................ 427 349 22%
---------- ----------
Electricity:
Wholesale Power Sales (in thousand MWH) ... 22,353 8,099 176%
---------- ----------
</TABLE>
29
<PAGE> 33
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------- PERCENT
1998 1997 CHANGE
------------ ----------- --------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ............................... $ 3,731 $ 2,535 47%
Operating Expenses:
Natural Gas ................................. 2,012 2,022 --
Purchased Power ............................. 1,604 429 274%
Operation and Maintenance ................... 89 69 29%
Depreciation and Amortization ............... 10 8 25%
Other Operating Expenses .................... 5 3 67%
---------- ----------
Total Operating Expenses ............... 3,720 2,531 47%
---------- ----------
Operating Income ................................. $ 11 $ 4 175%
========== ==========
Operations Data:
Natural Gas (in Bcf):
Sales ..................................... 1,013 878 15%
Transportation ............................ 16 17 (6%)
Gathering ................................. 175 182 (4%)
---------- ----------
Total ................................ 1,204 1,077 12%
---------- ----------
Electricity:
Wholesale Power Sales (in thousand MWH) ... 52,471 17,660 197%
---------- ----------
</TABLE>
Energy Marketing's operating income increased $7 million for both the
three and nine months ended September 30, 1998 over pro forma operating income
for the same periods in 1997. The increase in third quarter operating income
primarily reflects increased margins and sales volumes at NES for the third
quarter of 1998 compared to the same period of 1997. This increase was partially
offset by higher operating expenses as discussed below. Operating income for the
nine months ended September 30, 1997 included $17 million in hedging losses
associated with sales under peaking contracts and losses from the sale of
natural gas held in storage and unhedged in the first quarter of 1997.
Operating revenues for Energy Marketing increased $800 million and
$1.2 billion for the third quarter and nine months ended September 30, 1998,
respectively, when compared to the same periods in 1997 due primarily to
increases in wholesale power sales of $692 million and $1.2 billion in the third
quarter and nine month periods of 1998, respectively. The increases in operating
revenues and wholesale power sales were due to increased trading activity in
1998.
Natural gas expenses increased $100 million for the third quarter of
1998, compared to the same period of 1997. This increase is attributable to
increased gas marketing activities, partially offset by a decrease in the price
of natural gas. In the nine months ended September 30, 1998, natural gas
expenses decreased $10 million when compared to the same period of 1997. This
decrease is due to the reduction in the price of natural gas in 1998 and the
impact of hedging losses in 1997 mentioned above, partially offset by increased
gas marketing activities.
Purchased power expenses increased $686 million and $1.2 billion for
the third quarter and nine months ended September 30, 1998, respectively,
compared to the same periods in 1997 due to increased power marketing
activities.
30
<PAGE> 34
Operation and maintenance expenses increased $5 million and $20
million for the third quarter and nine months ended September 30, 1998,
respectively, when compared to 1997 pro forma operation and maintenance expenses
for the same periods in 1997. This increase is largely due to increased staffing
in support of the expanded trading and marketing efforts at NES. The Company
believes that NES' energy trading, marketing and risk management services
complement the development and/or acquisition of non-rate regulated 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. The increase in operation and maintenance
expenses for the nine month period ended September 30, 1998 is also due to a $4
million expense associated with an increase in reserves due to increased counter
party credit and performance risk associated with higher prices and higher
volatility in the electric power market in the second quarter of this year.
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 10-K Financial Statements,
Item 7A (Quantitative and Qualitative Disclosure About Market Risk) in the Form
10-K.
INTERNATIONAL
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 third quarter and nine months ended
September 30, 1998, and on a pro forma basis for the third quarter and nine
months ended September 30, 1997, as if the NorAm acquisition had occurred on
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>
THREE MONTHS ENDED
SEPTEMBER 30,
----------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- --------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ............................ $ 32 $ 21 52%
Operating Expenses:
Fuel ........................................ 5 4 25%
Operation and Maintenance ................... 12 10 20%
Depreciation and Amortization ............... 1 1 --
---------- ----------
Total Operating Expenses ................ 18 15 20%
---------- ----------
Operating Income .............................. $ 14 $ 6 133%
========== ==========
</TABLE>
31
<PAGE> 35
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- --------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ............................... $ 229 $ 61 275%
Operating Expenses:
Fuel ........................................... 15 16 (6%)
Operation and Maintenance ...................... 35 32 9%
Depreciation and Amortization .................. 3 1 200%
---------- ----------
Total Operating Expenses ................... 53 49 8%
---------- ----------
Operating Income ................................. $ 176 $ 12 1,367%
========== ==========
</TABLE>
International's operating income increased $8 million and $164
million for the third quarter and nine months ended September 30, 1998,
respectively, compared to pro forma operating income for the same periods in
1997. The increase in operating income in the nine month period is due primarily
to the $138 million pre-tax gain on the sale of International's 63 percent
interest in Empresa Distribuidora de La Plata S.A. (EDELAP). Excluding the sale
of its investment in EDELAP, International's operating income for the nine
months ended September 30, 1998 would have been $38 million (compared to $12
million on a pro forma basis in the prior period). The increases in operating
income for the third quarter and nine month period ended September 30, 1998
reflect increased equity earnings from International's investments. HI Energy's
1998 acquisitions, which include equity interests in three distribution systems
in El Salvador and two distribution systems in Colombia have contributed to
these increases.
For information regarding recent acquisitions and dispositions by
International, see Note 12(a) to the Company's Interim Financial Statements and
Note 10(a) to the Company's Interim Financial Statements in the Second Quarter
10-Q. For information regarding foreign currency matters, see Note 4 to the
Company's Interim Financial Statements and "--Certain Factors Affecting Future
Earnings of the Company and its Subsidiaries - Risks of International
Operations." For information regarding International's investment strategies,
see "Management's Discussion and Analysis of Financial Condition and Results
of Operations of the Company -- Results of Operations by Business Segment --
International" in the Form 10-K.
CORPORATE
General. The Company's corporate and other business segment
(Corporate) includes corporate costs, certain of the Company's real estate
holdings and inter-unit eliminations. In addition, Corporate includes the
results of operations of (i) Houston Industries Power Generation, Inc. (HIPG,
Inc.), a wholly owned subsidiary of the Company, which is engaged in the
acquisition, development and operation of domestic non-rate regulated power
generation facilities, and (ii) the Company's consumer and retail customer
services operations. The Company's consumer and retail customer services
operations provide energy products and services to a variety of industrial and
commercial and residential customers, including energy efficiency services and
air-conditioning services.
In the third quarter of 1998, Corporate had operating income of $59
million compared to a pro forma operating loss of $19 million for the comparable
period in 1997. Corporate's operating income for the nine month period ended
September 30, 1998, was $38 million compared to a pro forma operating loss of
$56 million for the same period in 1997. The increases are primarily due to
earnings from HIPG, Inc.'s investment in non-rate regulated generating assets
and related trading and marketing activities. Also contributing to the increase
for the nine month period ended September 30, 1998 are the capitalization of
previously expensed development costs and non-recurring costs associated with
the 1997 irrevocable contribution of 450,000 shares of Time Warner common stock
(having a market value of $21.9 million and a book value of $19.5 million) to a
charitable foundation established by the Company.
32
<PAGE> 36
HIPG, Inc. HIPG, Inc. participates in the domestic independent power
markets through the acquisition of existing power plants and the development of
new power plants (greenfield projects). HIPG, Inc.'s business strategy is to
develop a commercial generation portfolio that complements the Company's other
operations, including the electric and natural gas trading and marketing
operations of NES.
In April 1998, HIPG, Inc. acquired four natural gas-fired, electric
generating plants (2,276 MW) from Southern California Edison Company (SCE) for
approximately $230 million. In July 1998, HIPG, Inc. acquired another generating
plant (1,500 MW) from SCE for approximately $43 million. All of the plants are
located in southern California. Certain units of the plants have been designated
as "must-run facilities" under California's Independent System Operator's (ISO)
electric restructuring law. These units operate, in part, under agreements that
allow the ISO to call upon them to provide voltage support, congestion
management and ancillary services. NES, an affiliate of HIPG, Inc., is acting as
the plants' exclusive power marketer and supplier of natural gas. In accordance
with the provisions of the asset sale agreements, HIPG, Inc. was required to
contract with SCE to operate and maintain the plants with existing plant
employees through April 2000. HIPG, Inc. however exercises management authority
over the plants' operations. HIPG, Inc. financed the purchase price of these
generating plants with intercompany advances. The funds for such advances were
obtained by a financing subsidiary of the Company under a $150 million bridge
loan and from the issuance of commercial paper at a financing subsidiary. For
information regarding the bridge loan, see Note 8(b) to the Company's First
Quarter 10-Q and Note 8(b) to the Company's Interim Financial Statements.
HIPG, Inc., through its subsidiaries, is currently developing the
following power projects: a 480 MW gas-fired merchant plant located in Boulder
City, Nevada (El Dorado Project) and a 100 MW cogeneration plant located in
Orange, Texas (Sabine Cogeneration Project). HIPG, Inc. owns a 50% interest in
each of these projects. Construction of the El Dorado Project began in April
1998, and construction of the Sabine Cogeneration Project began in November
1998. The projected completion date for the El Dorado Project and the Sabine
Cogeneration Project is the fourth quarter of 1999. In October 1998, the El
Dorado Project obtained a $158 million non-recourse loan representing
approximately 60% of the estimated total project cost. As of September 30, 1998,
capitalized costs for these projects under construction or under development
were approximately $46 million.
For information regarding expenditures made or to be made by HIPG,
Inc. under existing commitments, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations of the Company -- Results of
Operations by Business Segment - Corporate" in the Company's Interim Financial
Statements in the First Quarter 10-Q.
The Company expects that HIPG, Inc. will continue to participate
actively in non-rate regulated power projects, including "greenfield" projects,
competitive auctions, and other acquisitions of generation assets. The amount of
expenditures associated with these activities is dependent upon the nature and
extent of future project commitments; however, some of these expenditures could
be substantial. HIPG, Inc. intends to finance a portion of its non-rate
regulated power projects through the proceeds from project financings
(financings where lenders limit their recourse for the payment of amounts loaned
to a project's revenues, equity investment and physical assets), and through
equity investment and loans from the Company.
33
<PAGE> 37
The successful completion of "greenfield" and other non-rate
regulated power projects is dependent upon a number of factors, which include,
among other things, risks associated with failures of siting, financing,
construction, permitting, governmental approvals, termination of power sales
contracts (if any) as a result of a failure to meet certain construction
milestones and the uncertainties arising from the gradual deregulation of HIPG
Inc.'s markets. Many of the facilities being acquired or developed by HIPG, Inc.
are "merchant plants" without a dedicated offtake customer and such facilities
are sensitive to market and regulatory factors and other considerations.
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 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 and the pending appeal, of the Texas Utility
Commission's order implementing the Transition Plan, see Note 10(a) to the
Company's 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 6 to the Company's Interim Financial Statements.
RISKS OF INTERNATIONAL OPERATIONS
HI Energy's international operations are subject to various risks
incidental to operating in emerging market countries. These risks include
political risks, such as governmental instability, and economic risks, such as
fluctuations in currency exchange rates, restrictions on the repatriation of
foreign earnings and/or restrictions on the conversion of local currency
earnings into U.S. dollars. HI Energy's international operations are also highly
capital intensive and thus, dependent to a significant extent on the continued
availability of bank financing and other sources of capital on commercially
acceptable terms.
The devaluation of a country's local currency can generally be
expected to result in an increase in the inflation rates of that country. The
long-term concession contracts under which HI Energy's foreign electric
distribution companies operate contain mechanisms for adjusting electricity
tariffs (Adjustments) to reflect changes in operating costs resulting from
inflation; however, these Adjustments are made only at specified intervals or,
in certain cases, on an interim basis upon application to the local regulatory
authorities. None of these Adjustments are indexed to the U.S. dollar or other
non-local currencies.
34
<PAGE> 38
Assuming that a devaluation in local currency will be reflected in an
increase in the local rate of inflation and assuming that an adjustment to
tariff rates is made promptly to reflect such increase, the Company believes
that the results of operations of its foreign electric distribution companies
should be protected, at least in part, from the effects of fluctuations in
currency exchange rates. If, however, there was a significant delay in the
implementation of the tariff adjustments or the economic impact of the
devaluation was not completely reflected in increased inflation rates, a
devaluation of local currencies could have an adverse impact on the results of
operations of these companies, and to the extent of the Company's ownership
interests in such companies, the Company's consolidated earnings. Depending on
the length of such delays and the severity of such devaluation, such impact
could be material.
HI Energy owns approximately 11.7% of the stock of Light -- Servicos
de Eletricidade S.A. (Light) and, through its investment in Light, an
approximate 8.8% indirect interest in the stock of Metropolitana Eletricidade de
Sao Paulo S.A. (Metropolitana). Light and Metropolitana are each Brazilian
corporations. Light provides electric distribution services to the city of Rio
de Janeiro and surrounding areas, and Metropolitana provides electric
distribution services to the metropolitan area of Sao Paulo, Brazil. The Company
accounts for its investment in Light under the equity method of accounting and
records its proportionate share, based on stock ownership, in the net income of
Light and its affiliates (including Metropolitana) as part of the Company's
consolidated net income.
At September 30, 1998, Light and Metropolitana had incurred,
respectively, $2.1 billion and $1.1 billion in U.S. and other non-local currency
denominated bank debt. In the event of a devaluation of the Brazilian real, the
Company believes that Light and Metropolitana would record a charge to their
quarterly earnings equal to the increase in the liability resulting from such
devaluation. This charge to earnings would be in addition to whatever other
economic impact on Light and Metropolitana might result from such devaluation.
Because the Company uses the Brazilian real as the functional currency in which
it reports Light's equity earnings, the resulting decrease in Light's earnings
would also be reflected in the Company's consolidated earnings to the extent of
the Company's 11.7% ownership interest in Light.
Although certain of HI Energy's other foreign electric distribution
companies have incurred U.S. dollar and other non-local currency indebtedness
(approximately $73 million at September 30, 1998), the Company believes, based
on the current amount of such indebtedness and the relative size of these equity
investments to the Company's overall results of operations, that a devaluation
of these currencies would not have a material adverse impact on the Company's
consolidated earnings.
Based on information provided by Light, the Company estimates that
approximately $980 million of Light's U.S. and non-local currency denominated
bank debt will mature in the second quarter of 1999 (of which $875 million
represents short-term U.S. dollar indebtedness incurred in connection with
Light's acquisition of Metropolitana). The Company further estimates that
approximately $595 million of Metropolitana's U.S. and non-local currency
denominated bank debt will mature in the second quarter of 1999 (of which $580
million represents short-term U.S. dollar denominated debt incurred to refinance
Metropolitana's previously existing debt). In addition, approximately $130
million of Light's, and approximately $180 million of Metropolitana's U.S.
dollar denominated commercial paper indebtedness, will mature in the first half
of 1999. The ability of Light and Metropolitana to repay or refinance these debt
obligations at maturity is dependent on many factors, including local and
international economic conditions prevailing at the time such debt matures.
35
<PAGE> 39
If current international and local economic conditions continue or
deteriorate, it is possible that Light, Metropolitana and the other foreign
electric distribution companies might encounter difficulties in refinancing
their debt on terms and conditions that are commercially acceptable to them and
their shareholders. In such circumstances, it is possible that lenders might
seek to require, among other things, higher borrowing rates, additional equity
contributions and/or increased levels of credit support from such shareholders,
or that the availability or terms of refinancing such debt might otherwise be
adversely affected.
IMPACT OF YEAR 2000 COMPUTER SOFTWARE ISSUES
Year 2000 Problem. At midnight on December 31, 1999, unless the
proper modifications have been made, the program logic in many of the world's
computer systems will start to produce erroneous results because, among other
things, the systems will incorrectly read the date "01/01/00" as being January 1
of the year 1900 or another incorrect date. In addition, certain systems may
fail to detect that the year 2000 is a leap year. Problems can also arise
earlier than January 1, 2000, as dates in the next millennium are entered into
non-compliant year 2000 programs.
Company's Plan to Address Year 2000 Problem. In 1997, the Company
initiated a corporate wide year 2000 project to address mainframe application
systems, information technology (IT) related equipment, system software,
user-developed applications, building controls, and non-IT embedded systems such
as process controls for energy production and delivery. Incorporated into this
project were NorAm and other Company subsidiary mainframe applications,
infrastructures, embedded systems and user-developed applications that will not
be migrated into existing or planned Company systems prior to the year 2000. The
evaluation of year 2000 issues included significant customers, key vendors,
service suppliers and other parties material to the Company's operations. In the
course of this evaluation, the Company has sought written assurances from such
third parties as to their state of year 2000 readiness.
Company's State of Readiness. Work has been prioritized in accordance
with business risk. The highest priority has been assigned to activities that
would disrupt the physical delivery of energy; next are activities that would
impact back office activities such as customer service and billing; and finally,
the lowest priority has been assigned to activities that would cause
inconvenience or productivity loss in normal business operations (e.g. air
conditioning systems and elevators). All business units have completed an
analysis of critical systems and equipment that control the production and
delivery of energy, as well as corporate, departmental and personal systems and
equipment.
Costs to Address Year 2000 Problem. Based on current internal
studies, as well as recently solicited bids from various computer software
vendors, the Company estimates that the total direct cost of resolving the year
2000 issue will be between $35 and $40 million. This estimate includes
approximately $6 million related to salaries and expenses of existing employees
and approximately $3 million in hardware purchases that the company expects to
capitalize. In addition, the $35 to $40 million estimate includes approximately
$2 million spent prior to 1998 and approximately $4 million expended through the
end of the third quarter of 1998. The majority of the costs related to resolving
the year 2000 issue are expected to be expended in 1999. The Company expects to
fund these expenditures through internal capital resources.
In September 1997, the Company entered into an agreement with SAP
America, Inc. (SAP) to license SAP proprietary R/3 enterprise software. The
licensed software includes finance, human resources, materials management,
service delivery, and customer care components. The Company's decision to
license this software and purchase related computer hardware is part of its
response to changes in the electric utility and energy services industries as
well as changes in the Company's businesses and operations resulting from the
acquisition of NorAm and the Company's expansion into the energy trading and
marketing business. Although it is anticipated that the implementation of the
SAP system will have the incidental effect of negating the need to modify many
of the Company's computer systems to accommodate the year 2000
36
<PAGE> 40
problem, the Company does not deem the costs of the SAP system as directly
related to its year 2000 compliance program. The estimated cost of implementing
the SAP system is approximately $182 million, inclusive of internal costs. For
additional information, 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 -- Impact of the Year 2000
Issue and Other System Implementation Issues" in Item 7 of the Form 10-K.
Risks and Contingency Plans. The major applications which pose the
greatest year 2000 risks for the Company if the year 2000 Project is not
successful are the electric transmission and distribution automation system; the
time in use, demand and recorder metering system for commercial and industrial
customers; and the power billing system. The potential problems related to these
systems are electric service interruptions to customers, interrupted revenue
data gathering and poor customer relations resulting from delayed billing,
respectively.
In order to assist in preparing for and mitigating the foregoing
scenarios, the Company intends to complete all Year 2000 remediation and testing
activity by the end of the third quarter of 1999. In addition, the Company has
initiated Year 2000 communications with significant customers, key vendors,
service suppliers and other parties material to the Company's operations and is
diligently monitoring the progress of such third parties' Year 2000 projects.
Notwithstanding the foregoing, the Company cautions that (i) the nature of
testing is such that it cannot comprehensively address all future combinations
of dates and events and (ii) it is impossible for the Company to assess with
precision or certainty the compliance of third parties with Year 2000
remediation efforts. For these reasons, the Company intends to revise and expand
its various disaster recovery, business continuation and emergency operations
plans to address specific Year 2000 contingencies (including those discussed
above) and alternatives in the event that Year 2000 failures of automatic
systems and equipment occur. This contingency planning is still in the
preliminary phase, however, final Year 2000 specific plans are scheduled to be
completed prior to mid-year 1999. Due to the speculative and uncertain nature of
contingency planning, there can be no assurance that such plans actually will be
sufficient to reduce the risk of material impacts on the Company's operations
due to Year 2000 issues.
Forward Looking Statements. The estimated costs of the Company's year
2000 project, the timetable for becoming year 2000 ready, as well as the
implementation of the SAP system constitute "forward looking statements" as
defined in the Private Securities Litigation Reform Act of 1995 (see Item 5 of
this Form 10-Q). Investors are cautioned that such estimates are based on
numerous assumptions by management, including assumptions regarding the
continued availability of certain resources, the accuracy of representations
made by third parties concerning their year 2000 readiness status, and other
factors. The estimated year 2000 project costs also do not give effect to any
future corporate acquisitions or divestitures made by the Company or its
subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
COMPANY CONSOLIDATED SOURCES OF CAPITAL RESOURCES AND LIQUIDITY
Company. For the nine month period ended September 30, 1998, the
Company's net cash provided by operating activities increased $228 million over
the same period in 1997. The increase in net cash from operating activities is
due primarily to (i) incremental cash flow provided by the business segments
purchased in the NorAm acquisition and (ii) increased sales at Electric
Operations due to unusually hot weather during the second and third quarter of
1998.
37
<PAGE> 41
Net cash used in investing activities decreased $1 billion for the
nine month period ended September 30, 1998, compared to the same period in 1997.
The decline reflects the purchase price expended in 1997 for the NorAm
acquisition. Investing activities for the nine month period ended September 30,
1998, included (i) the acquisition of non-rate regulated power generation
projects and related project expenditures, (ii) the acquisition of investments
in foreign electric distribution systems and (iii) the sale of an Argentine
electric distribution company.
Net cash used in financing activities for the nine month period ended
September 30, 1998, reflected a $367 million outflow compared to an inflow of
$903 million in the same period in 1997. The cash inflow in 1997 included $1
billion in proceeds from the issuance of ACES and the proceeds from the issuance
of $1.4 billion in commercial paper borrowings used to finance a portion of the
cost of the NorAm acquisition. The proceeds from the ACES were used to retire $1
billion of commercial paper borrowings.
At September 30, 1998, the Company, exclusive of subsidiaries, had a
revolving credit facility of $200 million used to support the issuance of up to
$200 million of commercial paper. There were no commercial paper borrowings and
no loans outstanding under this facility at September 30, 1998. In addition, at
September 30, 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.
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 Matagorda County Navigation District Number One. 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 refunding bonds
aggregating $290 million were issued on behalf of the Company by the Brazos
River Authority (BRA). The 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.
In September 1998, pollution control revenue refunding bonds
aggregating $68.7 million were issued on behalf of the Company by the BRA. The
bonds bear an interest rate of 4.90% and mature in October 2015. Proceeds from
the issuance were used in October 1998 to redeem, at 102% of the aggregate
principal amount, pollution control revenue bonds aggregating $68.7 million.
In the first quarter of 1999, $170.5 million of the Company's
medium-term notes, series A, 9.8%-9.85%, will mature. The Company expects to
fund these debt repayments with cash generated by operations, borrowings under
other facilities and/or other capital sources.
For information about the Company's issuance of a notice to change
the method of determining the interest rate on $118 million of outstanding
pollution control revenue refunding bonds issued on behalf of the Company, see
Note 12(b) to the Company's Interim Financial Statements.
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.
38
<PAGE> 42
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 the second quarter of 1998, NorAm
repaid at maturity $28 million of medium-term notes carrying an average interest
rate of 8.74%. In the third quarter of 1998, NorAm repaid at maturity $47
million of medium-term notes carrying an average interest rate of 8.74%. For
information regarding these repayments, see Note 9(b) to the Company's Interim
Financial Statements. During the third quarter of 1998, NorAm purchased $6
million aggregate principal amount of its 6% convertible subordinated debentures
due 2012 at an average purchase price of 97.4% of the aggregate principal amount
plus accrued interest. The purchased debentures are expected to be used to
partially satisfy March 1999 and March 2000 sinking fund requirements.
In March 1998, NorAm replaced its $400 million revolving credit
facility with a five-year $350 million revolving credit facility which supports
NorAm's issuance of up to $350 million of commercial paper. Borrowings under the
NorAm credit facility are unsecured. At September 30, 1998, NorAm had $205.6
million of outstanding commercial paper. At September 30, 1998, NorAm also had a
$300 million trade receivables facility under which receivables of $300 million
had been sold.
In November 1998, NorAm sold $500 million aggregate principal amount
of its 6 3/8% Term Enhanced Remarketable Securities (TERM Notes). The net
proceeds from the offering and from the related sale of an option to remarket
the TERM Notes will be used for general corporate purposes, including the
repayment of (i) a $178.5 million aggregate principal amount of NorAm's
commercial paper and (ii) a $150 million term loan of NorAm, which matures in
the fourth quarter of 1998. For additional information regarding the TERM Notes
offering, see Note 12(c) to the Company's Interim Financial Statements.
Financing Subsidiaries. At September 30, 1998, Houston Industries
FinanceCo LP's (FinanceCo) $1.6 billion revolving credit facility supported $1.3
billion in commercial paper borrowings having a weighted average interest rate
of 5.89%. 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 10-K
Consolidated Financial Statements.
In March 1998, FinanceCo II, a limited partnership subsidiary of the
Company, entered into a $150 million credit facility under which it had borrowed
$150 million at September 30, 1998. Proceeds from borrowings under the facility
were used to fund a portion of HIPG, Inc.'s April 1998 purchase of four electric
generation plants. In August 1998, this facility's termination date was extended
to December 31, 1998. For additional information regarding the facility, see
Note 8(b) to the Company's Interim Financial Statements in the First Quarter
10-Q.
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. The money fund's net funding
requirements are generally met with commercial paper issued by a financing
subsidiary.
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.
39
<PAGE> 43
NEW ACCOUNTING ISSUES
For calendar year 1998, the Company and NorAm will adopt 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). SFAS No. 131 requires that companies
report in their financial statements financial and descriptive information about
reportable operating segments defined by reference to 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 post-retirement benefit plans.
In 2000, the Company and NorAm expect to adopt SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. The
Company is in the process of determining the effect of adoption of SFAS No. 133.
For information regarding the Company's adoption, effective January 1,
1998, of SFAS No. 130, "Reporting Comprehensive Income," see Note 3 to the
Company's Interim Financial Statements.
40
<PAGE> 44
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 in the Form 10-K.
In the third quarter and nine months ended September 30, 1998, the
Company recorded an additional $26 million and $314 million, respectively,
unrealized loss (net of tax) related to the ACES. For further discussion of this
loss, see Note 6 to the Company's Interim Financial Statements. 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 10% in the price
of the Time Warner common stock above its September 30, 1998 market value of
$87.563 per share would result in the recognition of an additional unrealized
accounting loss (net of tax) of approximately $108 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.
For a discussion of the impact of fluctuations in currency exchange
rates on the Company's equity investments, 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 -
Risks of International Operations."
41
<PAGE> 45
ITEM 1. FINANCIAL STATEMENTS.
NORAM ENERGY CORP. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
CURRENT CURRENT CURRENT FORMER FORMER
NORAM NORAM NORAM NORAM NORAM
----------- ----------- ----------- ----------- -----------
THREE MONTHS NINE MONTHS TWO MONTHS ONE MONTH SEVEN MONTHS
ENDED ENDED ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, JULY 31, JULY 31,
1998 1998 1997 1997 1997
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
REVENUES: ................................. $ 1,930,463 $ 5,072,969 $ 749,412 $ 396,868 $ 3,337,048
EXPENSES:
Natural gas and purchased power, net ... 1,676,274 4,202,962 528,669 334,176 2,700,400
Operation and maintenance .............. 159,430 460,725 159,554 52,696 306,309
Depreciation and amortization .......... 53,240 144,305 31,798 12,456 84,901
Taxes other than income taxes .......... 24,865 86,734 17,767 8,419 73,142
Merger transaction costs ............... 843 15,918 17,256
----------- ----------- ----------- ----------- -----------
1,913,809 4,894,726 738,631 423,665 3,182,008
----------- ----------- ----------- ----------- -----------
Operating Income .......................... 16,654 178,243 10,781 (26,797) 155,040
OTHER INCOME (EXPENSE):
Interest expense, net .................. (25,736) (78,115) (18,471) (10,665) (78,660)
Distributions on trust securities ...... (106) (533) (903) (6,317)
Other - net ............................ 1,049 5,585 258 1,115 7,210
----------- ----------- ----------- ----------- -----------
(24,793) (73,063) (18,213) (10,453) (77,767)
----------- ----------- ----------- ----------- -----------
Income (loss) Before Income Taxes ......... (8,139) 105,180 (7,432) (37,250) 77,273
Income Tax Expense (Benefit) .............. (1,104) 53,759 (786) (14,013) 31,398
----------- ----------- ----------- ----------- -----------
Income Before Extraordinary Item .......... (7,035) 51,421 (6,646) (23,237) 45,875
Extraordinary gain on early retirement of
debt, less taxes ....................... 237
----------- ----------- ----------- ----------- -----------
Net Income (loss) ......................... $ (7,035) $ 51,421 $ (6,646) $ (23,237) $ 46,112
=========== =========== =========== =========== ===========
</TABLE>
See Notes to NorAm's Unaudited Consolidated Financial Statements.
42
<PAGE> 46
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
PROPERTY, PLANT AND EQUIPMENT
Natural Gas Distribution ............................. $ 1,441,865 $ 1,326,442
Interstate Pipeline .................................. 1,284,127 1,258,087
Energy Marketing ..................................... 180,755 162,519
Other ................................................ 13,487 14,972
------------ ------------
Total ............................................ 2,920,234 2,762,020
Less accumulated depreciation and amortization ....... 160,936 59,531
------------ ------------
Property, plant and equipment - net .................. 2,759,298 2,702,489
------------ ------------
CURRENT ASSETS
Cash and cash equivalents ............................ 22,411 35,682
Accounts and notes receivable, principally customer .. 1,452,782 969,248
Accounts receivable - affiliated companies ........... 48,409 10,161
Income tax receivable ................................ 50,202 7,292
Gas in underground storage ........................... 102,516 63,702
Materials and supplies ............................... 41,822 29,611
Gas purchased in advance of delivery ................. 6,200 6,200
Fuel stock and petroleum products .................... 65,416 345
Other current assets ................................. 51,037 16,749
------------ ------------
Total current assets ............................. 1,840,795 1,138,990
------------ ------------
OTHER ASSETS
Goodwill, net ........................................ 2,060,712 2,026,395
Prepaid pension asset ................................ 71,357 92,064
Investment in marketable equity securities ........... 9,954 27,046
Regulatory asset for environmental costs ............. 20,736 21,745
Gas purchased in advance of delivery ................. 21,582 29,048
Deferred debits, net ................................. 86,692 93,010
------------ ------------
Total other assets ............................... 2,271,033 2,289,308
------------ ------------
TOTAL ASSETS ............................................. $ 6,871,126 $ 6,130,787
============ ============
</TABLE>
See Notes to NorAm's Unaudited Consolidated Financial Statements
43
<PAGE> 47
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
September 30, 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 .............................................. 72,268 20,847
Unrealized loss on marketable equity securities, net of tax .... (16,543) (5,634)
----------- -----------
Total stockholder's equity ................................. 2,519,557 2,479,045
----------- -----------
NORAM-OBLIGATED MANDATORILY REDEEMABLE CONVERTIBLE TRUST PREFERRED
SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY
SUBORDINATED DEBENTURES OF NORAM, NET .......................... 1,253 21,290
LONG-TERM DEBT, LESS CURRENT MATURITIES ............................ 999,211 916,703
CURRENT LIABILITIES:
Current maturities of long-term debt ........................... 354,962 232,145
Notes payable to banks ......................................... 205,600 390,000
Notes payable to parent ........................................ 22,100
Receivables facility ........................................... 300,000 300,000
Accounts payable, principally trade ............................ 1,201,686 668,269
Accounts payable - affiliated companies ........................ 141,368
Interest payable ............................................... 19,743 27,273
General taxes .................................................. 43,267 41,315
Customer deposits .............................................. 35,529 36,626
Other current liabilities ...................................... 132,351 133,278
----------- -----------
Total current liabilities .................................. 2,434,506 1,851,006
----------- -----------
DEFERRED CREDITS AND OTHER LIABILITIES:
Accumulated deferred income taxes .............................. 502,116 488,299
Estimated environmental remediation costs ...................... 20,736 21,745
Payable under capacity lease agreement ......................... 41,000 41,000
Benefit obligations ............................................ 194,968 182,687
Estimated obligations under indemnification provisions of sale
Agreements ..................................................... 6,581 11,391
Other .......................................................... 151,198 117,621
----------- -----------
Total deferred credits and other liabilities ............... 916,599 862,743
----------- -----------
Commitments and Contingencies
Total Liabilities and Stockholder's Equity ......................... $ 6,871,126 $ 6,130,787
=========== ===========
</TABLE>
See Notes to NorAm's Unaudited Consolidated Financial Statements
44
<PAGE> 48
NORAM ENERGY CORP. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
CURRENT CURRENT FORMER
NORAM NORAM NORAM
------------ ------------ ------------
NINE MONTHS TWO MONTHS SEVEN MONTHS
ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, JULY 31,
1998 1997 1997
------------ ------------ ------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income ............................................................... $ 51,421 $ (6,646) $ 46,112
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization ........................................ 144,305 31,798 84,901
Deferred income taxes ................................................ 19,339 8,748 14,589
Extraordinary (gain), less taxes ..................................... (237)
Changes in other assets and liabilities, net of the effects of the
acquisition:
Accounts and notes receivable-net ................................. (521,782) 11,805 313,586
Inventories ....................................................... (116,942) (30,749) 9,980
Other current assets .............................................. (18,056) (8,812) (1,128)
Accounts payable .................................................. 652,629 (63,621) (224,590)
Interest and taxes accrued ........................................ (55,780) (16,378) (19,996)
Other current liabilities ......................................... (34,844) 10,100 (22,633)
Other - net ....................................................... 72,028 (1,674) (1,312)
------------ ------------ ------------
Net cash provided by (used in) operating activities ........... 192,318 (65,429) 199,272
------------ ------------ ------------
Cash Flows from Investing Activities:
Purchase of NorAm, net cash acquired ..................................... (1,422,672)
Capital expenditures ..................................................... (184,301) (28,740) (88,638)
Other - net .............................................................. 4,032 (275) (6,424)
------------ ------------ ------------
Net cash used in investing activities ......................... (180,269) (1,451,687) (95,062)
------------ ------------ ------------
Cash Flows from Financing Activities:
Cash portion of capital contribution from Houston Industries ............. 1,426,067
Retirements and reacquisitions of long-term debt ......................... (76,000) (488) (230,667)
Issuance of bank term loan, due 1998 ..................................... 150,000
Proceeds from sale of debentures ......................................... 298,514
Increase (decrease) in notes payable ..................................... (216,931) 107,500 (42,500)
Increase in receivables facility ......................................... 19,000 41,000
Common and preferred stock dividends ..................................... (19,281)
Conversion of convertible securities ..................................... (10,399)
Other-net ................................................................ (20,504) (13,103) (27,348)
------------ ------------ ------------
Net cash provided by (used in) financing activities ........... (25,320) 1,538,976 (128,796)
------------ ------------ ------------
Net Increase (Decrease) in Cash and Cash Equivalents ......................... (13,271) 21,860 (24,586)
Cash and Cash Equivalents at Beginning of the Period ......................... 35,682 27,981
------------ ------------ ------------
Cash and Cash Equivalents at End of the Period ............................... $ 22,411 $ 21,860 $ 3,395
============ ============ ============
Supplemental Disclosure of Cash Flow Information:
Interest (net of amounts capitalized) .................................... $ 43,783 $ 25,600 $ 67,100
Income taxes, net ........................................................ (17,265) 13,000 20,900
</TABLE>
Notes to NorAm's Unaudited Consolidated Financial Statements.
45
<PAGE> 49
NORAM ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
UNREALIZED
GAIN (LOSS)
RETAINED ON MARKETABLE
COMMON STOCK(1) PAID-IN EARNINGS SECURITIES
------------ ------------ ------------ ------------ ------------ ------------
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 ............................. 46,112 46,112
CASH DIVIDENDS:
Common stock - $0.07 per share ......... (19,281) (19,281)
Change in Market Value of Marketable 5,874 5,874
Equity Securities, net of tax .......
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 ........................ 347,527 216 5,796 6,012
------------ ------------ ------------ ------------ ------------ ------------
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 2,460,233 2,460,234
Net Income ............................. (6,646) (6,646)
Change in Market Value of Marketable
Equity Securities, net of tax ........ 3,809 3,809
------------ ------------ ------------ ------------ ------------ ------------
BALANCE AT SEPTEMBER 30, 1997 .......... 1,000 1 2,460,233 (6,646) 3,809 2,457,397
------------ ------------ ------------ ------------ ------------ ------------
Capital contribution from Parent ....... 3,598 3,598
Net Income ............................. 27,493 27,493
Change in Market Value of Marketable
Equity Securities, net of tax ........ (9,443) (9,443)
------------ ------------ ------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1997 ........... 1,000 1 2,463,831 20,847 (5,634) 2,479,045
------------ ------------ ------------ ------------ ------------ ------------
Net Income ............................. 51,421 51,421
Change in Market Value of Marketable
Equity Securities, net of tax ....... (10,909) (10,909)
------------ ------------ ------------ ------------- ------------ ------------
BALANCE AT SEPTEMBER 30, 1998 .......... 1,000 $ 1 $ 2,463,831 $ 72,268 $ (16,543) $ 2,519,557
------------ ------------ ------------ ------------- ------------ ------------
</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 Unaudited Consolidated Financial Statements.
46
<PAGE> 50
NORAM ENERGY CORP. 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 unaudited interim financial statements and notes (NorAm's Interim
Financial Statements) in this Form 10-Q (Form 10-Q) include the accounts of
NorAm and its wholly owned subsidiaries. NorAm's Interim Financial Statements
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 (Form 10-K) of Houston Industries
(File No. 1-3187) and NorAm (File No. 1-13265) for the year ended December 31,
1997. The Form 10-K includes the consolidated financial statements of Houston
Industries (Houston Industries' 10-K Financial Statements) and the Consolidated
Financial Statements of NorAm (NorAm's 10-K Financial Statements) for the year
ended December 31, 1997. For additional information regarding the presentation
of interim period results, see Note 6 below.
The following notes to NorAm's Form 10-K Financial Statements relate to
material contingencies. These notes, as updated by the notes contained in
NorAm's Interim Financial Statements, are incorporated herein by reference and
include the following:
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 to certain assets of NorAm, principally
47
<PAGE> 51
consisting of (1) the 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.
If the Merger had occurred on January 1, 1997, NorAm's unaudited pro
forma net loss for the third quarter of 1997 would have been $22 million and
NorAm's unaudited pro forma net loss for the first nine months of 1997 would
have been $39 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, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" (SFAS No.
130). "Comprehensive income" is defined to include all changes in stockholders'
equity during a reporting period except changes resulting from investments by
stockholders and distributions to stockholders. NorAm's comprehensive income
consists of net income (loss) and unrealized gains or losses on NorAm's
investment in marketable equity securities.
For the three months ended September 30, 1998, NorAm's total
comprehensive loss was $13 million compared to $34 million in the corresponding
period in 1997. For the nine months ended September 30, 1998, NorAm's total
comprehensive income was $41 million compared to $43 million in the
corresponding period in 1997.
Under SFAS No. 130, NorAm will begin to report and separately display
total comprehensive income and the components that comprise comprehensive income
in the year-end financial statements appearing in NorAm's Annual Report on 10-K
for the year ending 1998 and subsequent annual reports.
(4) DEPRECIATION
NorAm calculates depreciation using the straight-line method. NorAm's
depreciation expense for the third quarter and nine months ended September 30,
1998 was $40 million and $103 million, respectively.
48
<PAGE> 52
(5) LONG-TERM DEBT AND SHORT-TERM FINANCINGS
During the third quarter of 1998, NorAm repurchased $6 million
aggregate principal amount of its 6% convertible subordinated debentures due
2012 at an average purchase price equal to 97.4% of the aggregate principal
amount of the debentures, plus accrued interest. NorAm expects to use the
repurchased debentures to satisfy part of the debentures' sinking fund
requirements in March 1999 and March 2000.
<TABLE>
<CAPTION>
Series Principal Amount
----------------------------- ------------------
<S> <C>
9.07% due July 20, 1998 $ 15.0 million
8.60% due September 1, 1998 3.0 million
8.58% due September 1, 1998 5.0 million
8.64% due September 4, 1998 12.5 million
8.50% due September 14, 1998 0.5 million
8.60% due September 15, 1998 6.0 million
8.43% due September 17, 1998 5.0 million
------------------
Total $ 47.0 million
==================
</TABLE>
At September 30, 1998, NorAm had $206 million in commercial paper
borrowings supported by a $350 million revolving credit facility (NorAm Credit
Facility). At such date, the weighted average interest rate of borrowings under
this facility was 5.94%. Under a trade receivables facility that expires in
August 1999, NorAm sells with limited recourse an undivided interest (limited to
a maximum of $300 million) in a designated pool of accounts receivable. The
amount of receivables sold and uncollected at September 30, 1998, was $300
million. The weighted average interest rate at such date was 5.5%. For
additional information regarding NorAm's trade receivables facility, see Note
4(a) to NorAm's 10-K Financial Statements.
For information regarding NorAm's issuance in the fourth quarter of
1998 of $500 million aggregate principal amount of debt securities, see Note
7.
For information regarding NorAm's repayment at maturity of $28 million
of its medium-term notes (having an average interest rate of 8.74%), see Note 5
to NorAm's Interim Financial Statements in the Second Quarter 10-Q. For
information regarding (i) NorAm's issuance in February 1998 of $300 million
principal amount of 6.5% debentures due February 1, 2008, (ii) NorAm's repayment
at maturity of $1 million of its 9.30% medium-term notes and (iii) NorAm's
satisfaction of the $6.5 million sinking fund requirement for its 6% convertible
subordinated debentures due 2012 using debentures purchased in 1996 and 1997,
see Note 5 to NorAm's Interim Financial Statements in the First Quarter 10-Q.
(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
$1.3 million were outstanding at September 30, 1998, see Note 5 to NorAm's Form
10-K Financial Statements. 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.
49
<PAGE> 53
(7) SUBSEQUENT EVENTS
In November 1998, NorAm sold $500 million aggregate principal amount of
its 6 3/8% Term Enhanced ReMarketable Securities (TERM Notes). The net proceeds
of $514 million from the offering of the TERM Notes and from the sale of the
related option to remarket the TERM notes (as described below) will be used for
general corporate purposes, including the repayment of (i) $178.5 million of
NorAm's outstanding commercial paper and (ii) a $150 million term loan of NorAm
that matures on November 13, 1998. The TERM Notes are unsecured obligations of
NorAm which bear interest at the annual rate of 6 3/8% through November 1, 2003.
On November 1, 2003, the holders of the TERM Notes are required to tender their
notes at 100% of their principal amount. Concurrent with the offering, NorAm
received proceeds of $18.375 million from the sale of an option to remarket the
notes in 2003. The proceeds received from the sale of the option will be
amortized over the stated term of the securities. If the option is not
exercised, NorAm will repurchase the TERM Notes at 100% of their principal
amount on November 1, 2003. If the option is exercised, the TERM Notes will be
remarketed on a date, selected by NorAm, within the 52-week period beginning
November 1, 2003. During such period and prior to remarketing, the TERM Notes
will bear interest at rates, adjusted weekly, based on index selected by NorAm.
If the TERM Notes are remarketed, the final maturity date of the TERM Notes will
be November 1, 2013, subject to adjustment, and the effective interest rate on
the remarketed TERM Notes will be 5.66% plus the Company's applicable credit
spread at the time of such remarketing.
(8) 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 variation
affecting 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.
50
<PAGE> 54
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS OF NORAM
ENERGY CORP. AND CONSOLIDATED SUBSIDIARIES.
NorAm Energy Corp. (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 (Quantitative and Qualitative Disclosures
about Market Risk) 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 third quarter and first nine months of 1998 and the third quarter and first
nine months of 1997, respectively. Reference is made to Management's Narrative
Analysis of the Results of Operations of NorAm and consolidated subsidiaries in
Item 7 of the Form 10-K, NorAm's consolidated financial statements and notes
contained in Item 8 of the Form 10-K and NorAm's Interim Financial Statements
contained in this Form 10-Q. For a discussion of the qualifications and
assumptions underlying the use of forward looking information, see Item 5 of
this Form 10-Q.
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 95% of NorAm's total
revenues, income or loss and identifiable assets in the third quarter and first
nine months 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.
CONSOLIDATED RESULTS OF OPERATIONS
Seasonality and Other Factors. NorAm's results of operations are
seasonal due to 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 - Competition - Other
Operations, - Impact of the Year 2000 Issue and Other System Implementation
Issues, and - Environmental Expenditures" in the Form 10-K.
51
<PAGE> 55
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 third quarters and nine months ended September 30,
1998 and 1997 and on a pro forma basis for the third quarter and nine months
ended September 30, 1997, followed by a discussion of significant variances in
period-to-period results:
SELECTED FINANCIAL RESULTS:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------- ----------------
1998 1997 1997 PERCENTAGE
(ACTUAL) (ACTUAL) (1) (PRO FORMA) (2) CHANGE
------------ ------------ --------------- ----------------
(THOUSANDS OF DOLLARS) (1998 ACTUAL TO
OPERATING REVENUES: ........................ 1997 PRO FORMA)
<S> <C> <C> <C> <C>
Natural Gas Distribution ................ $ 249,004 $ 272,201 $ 272,201 (9%)
Interstate Pipeline ..................... 70,394 67,651 67,651 4%
Energy Marketing ........................ 1,642,374 842,034 842,034 95%
Corporate and Other ..................... 24,047 22,087 22,087 9%
Elimination of Intersegment Revenue(3) .. (55,356) (57,693) (57,693) 4%
------------ ------------ ------------
$ 1,930,463 $ 1,146,280 $ 1,146,280 68%
============ ============ ============
Operating Income (Loss):
Natural Gas Distribution ................ (20,324) (12,735) (15,000) (35%)
Interstate Pipeline ..................... 27,421 21,090 19,747 39%
Energy Marketing ........................ 7,439 769
Corporate and Other ..................... 2,118 (8,379) (7,185) 129%
------------ ------------ ------------
16,654 745 (2,438)
Merger Transaction Costs (4) .............. 16,761 843 (100%)
------------ ------------ ------------
Consolidated ............................... 16,654 (16,016) (3,281) 608%
Interest Expense, Net ...................... 25,736 29,136 26,376 (2%)
Distributions on Subsidiary Trust Securities 106 903 903 (88%)
Other (Income) and Deductions .............. (1,049) (1,373) (1,373) 24%
Income Tax Expense (Benefit) ............... (1,104) (14,799) (7,099) 84%
============ ============ ============
Net Income (Loss) ....................... $ (7,035) $ (29,883) $ (22,088) 68%
============ ============ ============
</TABLE>
52
<PAGE> 56
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------- ---------------
1998 1997 1997 PERCENTAGE
(ACTUAL) (ACTUAL) (1) (PRO FORMA) (2) CHANGE
------------ ------------ --------------- ---------------
(THOUSANDS OF DOLLARS) (1998 ACTUAL TO
OPERATING REVENUES: ........................ 1997 PRO FORMA)
<S> <C> <C> <C> <C>
Natural Gas Distribution ..................... $ 1,280,889 $ 1,490,020 $ 1,490,020 (14%)
Interstate Pipeline .......................... 217,891 225,746 225,746 (3%)
Energy Marketing ............................. 3,730,602 2,535,348 2,535,348 47%
Corporate and Other .......................... 59,773 57,517 57,517 4%
Elimination of Intersegment Revenues(3) ...... (216,186) (222,171) (222,171) 3%
------------ ------------ ------------
$ 5,072,969 $ 4,086,460 $ 4,086,460 24%
============ ============ ============
OPERATING INCOME (LOSS):
Natural Gas Distribution ..................... 75,124 105,695 92,000 (18%)
Interstate Pipeline .......................... 92,343 90,467 81,000 14%
Energy Marketing ............................. 10,834 7,982 4,000 171%
Corporate and Other .......................... (58) (20,224) (15,362) 100%
------------ ------------ ------------
178,243 183,920 161,638 10%
Merger Transaction Costs(4) ..................... 18,099 843 (100%)
------------ ------------ ------------
Consolidated .................................... 178,243 165,821 160,795
Interest Expense, Net ........................... 78,115 97,131 77,817 0%
Distributions on Subsidiary Trust Securities .... 533 6,317 6,317 (92%)
Other (Income) and Deductions ................... (5,585) (7,468) (7,467) 25%
Income Tax Expense .............................. 53,759 30,612 45,805 17%
------------ ------------ ------------
Income Before Extraordinary Item ................ 51,421 39,229 38,323 34%
Extraordinary Item .............................. 237 237 (100%)
------------ ------------ ------------
Net Income ...................................... $ 51,421 $ 39,466 $ 38,560 33%
============ ============ ============
</TABLE>
(1) 1997 (Actual) includes two months of Current NorAm and seven months of
Former NorAm.
(2) 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.
(3) Elimination of operating revenues derived from sales to affiliated business
units.
(4) Expenses associated with completion of the business combination with
Houston Industries. See Note 2 of the accompanying Notes to Consolidated
Financial Statements.
Third Quarter of 1998 Compared to Third Quarter of 1997 (Actual).
NorAm had a consolidated net loss of $7 million for the third quarter of 1998
compared to a net loss of $30 million in the same period in 1997. The net loss
for the third quarter of 1997 included $17 million of expenses associated with
completion of the acquisition of NorAm by Houston Industries. Excluding these
costs, earnings for the third quarter of 1998 increased $13 million compared to
the same period of 1997. The increase in earnings is primarily attributable to
increased operating income at Interstate Pipeline and Energy Marketing and
reduced expenses at Corporate, partially offset by the purchase accounting
effects of the Merger, including the amortization of goodwill and adjustments
to interest expense and decreased operating income at Natural Gas Distribution.
Third Quarter of 1998 Actual Compared to Third Quarter of 1997 (Pro
Forma). NorAm had a consolidated net loss of $7 million for the third quarter
of 1998 compared to a pro forma consolidated net loss of $22 million in the
same period in 1997. The increase in earnings is primarily attributable to
increased operating income at Interstate Pipeline and Energy Marketing and
reduced expenses at Corporate, partially offset by decreased operating income
at Natural Gas Distribution, as described below.
53
<PAGE> 57
Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997 (Actual). NorAm had consolidated net income of $51 million
for the nine months ended September 30, 1998 compared to net income of $39
million in the same period in 1997. The increase in earnings is primarily
attributable to increased operating income at Interstate Pipeline and Energy
Marketing and reduced expenses at Corporate, partially offset by the purchase
accounting effects of the Merger, including the amortization of goodwill and
adjustments to interest expense and decreased operating income at Natural Gas
Distribution, as described below.
Nine Months Ended September 30, 1998 Actual Compared to 1997 Pro
Forma. NorAm had consolidated net income of $51 million for the nine months
ended September 30, 1998 compared to pro forma net income of $39 million in the
nine months ended September 30, 1997. The increase in earnings is primarily
attributable to increased operating income at Interstate Pipeline and Energy
Marketing and reduced expenses at Corporate, partially offset by decreased
operating income at Natural Gas Distribution, as described below.
RESULTS OF OPERATIONS BY BUSINESS UNIT
NATURAL GAS DISTRIBUTION
Natural Gas Distribution operations are conducted through the Arkla,
Entex and Minnegasco divisions of NorAm. 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, on an
actual basis for the third quarter and nine month periods ended September 30,
1998 and on a pro forma basis for the third quarter and nine month periods
ended September 30, 1997 (as if the acquisition of NorAm by Houston Industries
had occurred as of January 1, 1997).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- ----------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues .................................... $ 249 $ 272 (8%)
Operating Expenses:
Natural Gas ...................................... 126 145 (13%)
Operation and Maintenance ........................ 91 90 1%
Depreciation and Amortization .................... 33 31 6%
Other Operating Expenses ......................... 19 21 (10%)
---------- ----------
Total Operating Expenses ..................... 269 287 (6%)
---------- ----------
Operating Loss ........................................ $ (20) $ (15) (33%)
========== ==========
Throughput Data (in Bcf):
Residential and Commercial Sales ................. 31 32 (3%)
Industrial Sales ................................. 14 14 --
Transportation ................................... 9 9 --
---------- ----------
Total Throughput .............................. 54 55 (2%)
========== ==========
</TABLE>
54
<PAGE> 58
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- ----------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues .................................... $ 1,281 $ 1,490 (14%)
Operating Expenses:
Natural Gas ...................................... 757 948 (20%)
Operation and Maintenance ........................ 282 283 --
Depreciation and Amortization .................... 97 92 5%
Other Operating Expenses ......................... 70 75 (7%)
---------- ----------
Total Operating Expenses ..................... 1,206 1,398 (14%)
---------- ----------
Operating Income ...................................... $ 75 $ 92 (18%)
========== ==========
Throughput Data (in Bcf):
Residential and Commercial Sales ................. 200 220 (9%)
Industrial Sales ................................. 42 42 --
Transportation ................................... 32 31 3%
---------- ----------
Total Throughput .............................. 274 293 (6%)
========== ==========
</TABLE>
Natural Gas Distribution's operating loss increased $5 million in the
third quarter of 1998, over its $15 million pro forma operating loss in the
same period of 1997. The third quarter of 1997 included approximately $4
million non-recurring income recorded in connection with the successful appeal
of the Minnegasco division's 1993 and 1995 rate cases.
Operating income for the nine month period ended September 30, 1998
decreased $17 million compared to pro forma operating income in the same period
of 1997. The $17 million decrease in operating income is due primarily to (i)
milder winter weather in the first three months of 1998, (ii) the impact in
1997 of the Minnegasco division's rate case appeal as discussed above and (iii)
lower demand for natural gas heating in the second and third quarters of 1998.
The decrease in operating income was partially offset by reduced charges at
Arkla associated with the methodology of calculating the price of gas charged
to customers (the Purchased Gas Adjustment).
Natural Gas Distribution operating revenues decreased $23 million and
$209 million for the third quarter and nine months ended September 30, 1998,
respectively, compared to pro forma operating revenues for the corresponding
periods of 1997 due principally to (i) the weather-related factors decline in
customer usage and (ii) lower natural gas prices. In addition, the impact in
1997 of the Minnegasco division's rate case appeal (as discussed above) also
resulted in higher revenues in 1997 compared to 1998.
Operating expenses decreased $18 million and $192 million in the third
quarter and nine months ended September 30, 1998, respectively, compared to pro
forma operating expenses in the same period of 1997 due primarily to the
reduced cost of gas and the Purchased Gas Adjustment.
Demand for natural gas distribution services is seasonal in nature,
reflecting the higher demand for natural gas for use in heating in the winter
months.
55
<PAGE> 59
INTERSTATE PIPELINE
Interstate Pipeline operations are conducted primarily 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 third quarter and nine months ended September 30, 1998 and on a
pro forma basis for third quarter and nine months ended September 30, 1997 (as
if the acquisition of NorAm by Houston Industries had occurred as of January 1,
1997).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- -----------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ..................................... $ 70 $ 67 4%
Operating Expenses:
Natural Gas ....................................... 6 10 (40%)
Operation and Maintenance ......................... 20 20 --
Depreciation and Amortization ..................... 13 13 --
Other Operating Expenses .......................... 4 4 --
---------- ----------
Total Operating Expenses ..................... 43 47 (9%)
---------- ----------
Operating Income ....................................... $ 27 $ 20 35%
========== ==========
Throughput Data (in million MMBtu):
Natural Gas Sales .................................. 4 4 --
Transportation ...................................... 186 205 (9%)
Elimination (1) ................................ (4) (4) --
---------- ----------
Total Throughput ....................................... 186 205 (9%)
========== ==========
</TABLE>
56
<PAGE> 60
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- ----------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues .................................... $ 218 $ 226 (4%)
Operating Expenses:
Natural Gas ...................................... 22 29 (24%)
Operation and Maintenance ........................ 60 66 (9%)
Depreciation and Amortization .................... 32 39 (18%)
Other Operating Expenses ......................... 12 11 9%
---------- ----------
Total Operating Expenses .................... 126 145 (13%)
---------- ----------
Operating Income ...................................... $ 92 $ 81 14%
========== ==========
Throughput Data (in million MMBtu):
Natural Gas Sales .................................. 12 14 (14%)
Transportation ..................................... 610 667 (9%)
Elimination (1) ............................... (11) (13) 15%
---------- ----------
Total Throughput ...................................... 611 668 (9%)
========== ==========
</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 increased $7 million and $11
million in the third quarter and nine months ended September 30, 1998,
respectively, over pro forma operating income for the same periods in 1997.
The increase in operating income for the third quarter of 1998 is primarily due
to improved operating margins and reductions in the cost of natural gas, as
discussed below. The increase in operating income for the nine month period of
1998 is primarily due to $11 million of pre-tax non-recurring items recorded in
1998 for litigation and rate case settlements as well as improved operating
margins and reductions in operating expenses. The increase in operating income
in the nine month period ended September 30, 1998 was offset by $7 million of
non-recurring transportation revenues recorded in the first quarter of 1997, as
discussed below.
Operating revenues for Interstate Pipeline increased $3 million in the
third quarter of 1998, over pro forma operating revenues for the same period in
1997. This increase in operating revenues is primarily due to a weather-
related demand for natural gas used to fuel electric generation plants during
the summer cooling season.
Operating revenues decreased $8 million in the nine month period ended
September 30, 1998, from pro forma operating revenues for the same period in
1997. The decrease in revenues is due in part to $7 million of non-recurring
transportation revenues recognized in the first quarter of 1997. These
revenues were recognized following a settlement with the Arkla division of
NorAm related to service provided in several of Arkla's operating
jurisdictions. In addition, the settlement with Arkla resulted in reduced
transportation rates, which also reduced revenues for the period. These
decreases were partially offset by (i) the settlement of outstanding gas
purchase contract litigation which resulted in the recognition of approximately
$6 million of revenues in the second quarter of 1998 and (ii) the factors
discussed above for the third quarter.
Natural gas expense decreased $4 million and $7 million in the third
quarter and nine months ended September 30, 1998, respectively, when compared
to pro forma natural gas expense in the same periods in 1997 primarily due to
lower gas sales volumes and lower prices for purchased gas.
57
<PAGE> 61
Operation and maintenance expense decreased $6 million in the nine
months ended September 30, 1998, respectively, in comparison to pro forma
operation and maintenance expense for the same period in 1997. The decrease
was primarily due to lower costs resulting from cost control initiatives and
decreased maintenance due to milder weather in the first quarter of 1998.
Depreciation expense decreased $7 million in the nine month period
ended September 30, 1998, compared to pro forma depreciation expense in the
same period of 1997 primarily due to a $5 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
Energy Marketing includes the operations of NorAm's wholesale energy
trading and marketing business, and retail energy marketing business and
natural gas gathering activities of NorAm (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 results of
operations of Energy Marketing, including operating statistics, on an actual
basis for the third quarter and nine months ended September 30, 1998 and on a
pro forma basis for the third quarter and nine months ended September 30, 1997
(as if the acquisition of NorAm by Houston Industries had occurred as of
January 1, 1997).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- ----------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ...................................... $ 1,642 $ 842 95%
Operating Expenses:
Natural Gas ........................................ 687 587 17%
Purchased Power .................................... 906 220 312%
Operation and Maintenance .......................... 36 31 16%
Depreciation and Amortization ...................... 4 3 33%
Other Operating Expenses ........................... 2 1 100%
---------- ----------
Total Operating Expenses ...................... 1,635 842 94%
---------- ----------
Operating Income (Loss) ................................. $ 7 $ -- --
========== ==========
Operations Data:
Natural Gas (in Bcf):
Sales ............................................ 364 284 28%
Transportation ................................... 3 5 (40%)
Gathering ........................................ 60 60 --
---------- ----------
Total ....................................... 427 349 22%
---------- ----------
Electricity:
Wholesale Power Sales (in thousand MWH) .......... 22,353 8,099 176%
========== ==========
</TABLE>
58
<PAGE> 62
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------- PERCENT
1998 1997 CHANGE
---------- ---------- ----------
(ACTUAL) (PRO FORMA)
(IN MILLIONS)
<S> <C> <C> <C>
Operating Revenues ...................................... $ 3,731 $ 2,535 47%
Operating Expenses:
Natural Gas ........................................ 2,012 2,022 --
Purchased Power .................................... 1,604 429 274%
Operation and Maintenance .......................... 89 69 29%
Depreciation and Amortization ...................... 10 8 25%
Other Operating Expenses ........................... 5 3 67%
---------- ----------
Total Operating Expenses ...................... 3,720 2,531 47%
---------- ----------
Operating Income ........................................ $ 11 $ 4 175%
========== ==========
Operations Data:
Natural Gas (in Bcf):
Sales ............................................ 1,013 878 15%
Transportation ................................... 16 17 (6%)
Gathering ........................................ 175 182 (4%)
---------- ----------
Total ....................................... 1,204 1,077 12%
========== ==========
Electricity:
Wholesale Power Sales (in thousand MWH) .......... 52,471 17,660 197%
========== ==========
</TABLE>
Energy Marketing's operating income increased $7 million for both the
three and nine months ended September 30, 1998 over pro forma operating income
for the same periods in 1997. The increase in third quarter operating income
primarily reflects increased margins and sales volumes at NES for the third
quarter of 1998 compared to the same period of 1997. This increase was
partially offset by higher operating expenses as discussed below. Operating
income for the nine months ended September 30, 1997 included $17 million in
hedging losses associated with sales under peaking contracts and losses from
the sale of natural gas held in storage and unhedged in the first quarter of
1997.
Operating revenues for Energy Marketing increased $800 million and
$1.2 billion for the third quarter and nine months ended September 30, 1998,
respectively, when compared to the same periods in 1997 due primarily to
increases in wholesale power sales of $692 million and $1.2 billion in the
third quarter and nine month periods of 1998, respectively. The increases in
operating revenues and wholesale power sales were due to increased trading
activity in 1998.
Natural gas expenses increased $100 million for the third quarter of
1998, compared to the same period of 1997. This increase is attributable to
increased gas marketing activities, partially offset by a decrease in the price
of natural gas. In the nine months ended September 30, 1998, natural gas
expenses decreased $10 million when compared to the same period of 1997. This
decrease is due to the reduction in the price of natural gas in 1998 and the
impact of hedging losses in 1997 mentioned above, partially offset by increased
gas marketing activities.
Purchased power expenses increased $686 million and $1.2 billion for
the third quarter and nine months ended September 30, 1998, respectively,
compared to the same periods in 1997 due to increased power marketing
activities.
59
<PAGE> 63
Operation and maintenance expenses increased $5 million and $20
million for the third quarter and nine months ended September 30, 1998,
respectively, when compared to 1997 pro forma operation and maintenance
expenses for the same periods in 1997. This increase is largely due to
increased staffing in support of the expanded trading and marketing efforts at
NES. NorAm believes that NES' energy trading, marketing and risk management
services complement the development and/or acquisition of non-rate regulated
generation assets in other markets. As a result, NorAm has made, and expects
to continue to make, significant investments in developing NES' internal
software, trading and personnel resources. The increase in operation and
maintenance expenses for the nine month period ended September 30, 1998 is also
due to a $4 million expense associated with an increase in reserves due to
increased counter party credit and performance risk associated with higher
prices and higher volatility in the electric power market in the second quarter
of this year.
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 the NorAm's treatment of derivative instruments, see
Note 2 to the NorAm's 10-K Financial Statements, Item 7A (Quantitative and
Qualitative Disclosure About Market Risk) in the Form 10-K, and Item 3
(Quantitative and Qualitative Disclosures About Market Risk) in this Form 10-Q.
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 loss decreased $10 million and $20 million,
respectively, in the third quarter and nine months ended September 30, 1998
compared to the same periods of 1997. The decreases are primarily attributable
to reduced corporate expenses as a result of the Merger.
For information about the impact of year 2000 software issues, see
"Management's Discussion and Analysis and Financial Condition of Resulting
Operations - Certain Factors Affecting Future Earnings of the Company and its
Subsidiaries - Impact of Year 2000 Computer Software Issues." Based on current
internal studies, as well as recently solicited bids from various software
vendors, NorAm estimates that the total direct cost of resolving the year 2000
issue will be between $4.5 million and $5.5 million, of which $2.8 million has
already been expended.
NEW ACCOUNTING ISSUES
Reference is made to "Management's Discussion and Analysis of
Financial Condition and Results of Operations of NorAm's - New Accounting
Issues" in Item 2 (Houston Industries) in the Form 10-Q for a discussion of
certain new accounting issues.
60
<PAGE> 64
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
For a description of legal proceedings affecting the Company
and its subsidiaries, including NorAm, see (i) Part I, Item 3,
of the Company's Form 10-K, Notes 3, 5 and 12 to the Company's
Financial Statements in the Form 10-K and Note 8 to NorAm's
Financial Statements in the Form 10-K, (ii) Part II, Item 1,
of the First Quarter 10-Q, (iii) Part II, Item 1, of the
Second Quarter 10-Q and (iv) Note 10(a) to the Company's
Interim Financial Statements.
ITEM 5. OTHER INFORMATION.
Forward Looking Statements. From time to time, the Company and
NorAm may make statements regarding their assumptions,
projections, expectations, intentions, or beliefs about future
events. These statements and other statements that are not
historical facts are intended as "forward-looking statements"
under the Private Securities Litigation Reform Act of 1995.
The Company and NorAm caution that assumptions, projections,
expectations, intentions, or beliefs about future events may
and often do vary materially from actual results and the
differences between assumptions, projections, expectations,
intentions or beliefs and actual results can be material.
Accordingly, there can be no assurance actual results will not
differ materially from those expressed or implied by the
forward looking statements.
The following are some of the factors that could cause actual
results to differ from those expressed or implied in forward
looking statements: (i) state and federal legislative and
regulatory initiatives that affect cost and investment
recovery, have an impact on rate restructures and affect the
speed and degree to which competition enters the electric and
natural gas industries; (ii) industrial, commercial and
residential growth in service territories of the Company and
NorAm; (iv) the weather and other natural phenomena; (v) the
timing and extent of changes in commodity prices and interest
rates; (vi) changes in environmental and other laws and
regulations to which the Company, NorAm and their respective
subsidiaries are subject or other external factors over which
the Company and NorAm have no control; (vii) the results of
financing efforts; (viii) growth in opportunities for the
Company's and NorAm's subsidiaries and diversified operations;
(ix) risks incidental to the Company's overseas operations
(including the effects of fluctuations in foreign currency
exchange rates); (x) the effect of the Company's and NorAm's
accounting policies; and (xi) other factors discussed in this
and other filings by the Company and NorAm with the Securities
and Exchange Commission (SEC).
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.
Shareholder Proposals. In September 1998, the Board of
Directors of the Company amended the provisions of the
Company's bylaws that relate to certain resolutions or motions
proposed by the Company's shareholders. Under the amendments,
a resolution or motion proposed by a shareholder will be
considered for vote of the shareholders only if it meets the
criteria of Article II, Section 9 (Proper Business Annual
Meeting of Shareholders), or Article II,
61
<PAGE> 65
Section 10 (Proper Business - Special Meeting of
Shareholders), as the case may be. For additional information,
reference is made to the Company's Amended and Restated Bylaws
filed as exhibit 3 to this Form 10-Q.
Under applicable SEC regulations, the persons named in the
proxies solicited by the Company's Board of Directors may
exercise discretionary voting authority with respect to any
shareholder proposal (other than certain proposals submitted
for inclusion in a proxy statement) that are received on and
after February 10, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Company:
Exhibit 3 - Amended and Restated Bylaws (adopted on September
2, 1998).
Exhibit 12 - Ratio of Earnings to Fixed Charges and Preferred
Dividends.
Exhibit 27 - Financial Data Schedule (included in electronic
filing only).
Exhibit 99(a) - Notes 1(c), 1(n), 2, 3, 4, 5 and 12 to the
Company's Financial Statements included on pages 64 through
65, 68 through 77 and 92 through 94 of the Form 10-K.
NorAm:
Exhibit 12 - Ratio of Earnings to Fixed Charges and Preferred
Dividends
Exhibit 27 - Financial Data Schedule (included in electronic
filing only) .
Exhibit 99(a) - Notes 1(c), 2 and 8 to the NorAm Financial
Statements included on pages 116 through 121 and pages 132
through 135 of the Form 10-K.
(b) Reports on Form 8-K.
Company:
Form 8-K (Item 5 Other Events) dated October 13, 1998, and
filed on October 21, 1998
NorAm:
Form 8-K (Item 5 Other Events) dated November 5, 1998, and
filed on November 10, 1998
62
<PAGE> 66
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
--------------------------------
Vice President and Comptroller
(Principal Accounting Officer)
Date: November 12, 1998
63
<PAGE> 67
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
------------------------------
Vice President and Comptroller
(Principal Accounting Officer)
Date: November 12, 1998
<PAGE> 68
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBITS DESCRIPTION
<S> <C>
COMPANY:
Exhibit 3 - Amended and Restated Bylaws (adopted on September 2, 1998).
Exhibit 12 - Ratio of Earnings to Fixed Charges and Preferred Dividends.
Exhibit 27 - Financial Data Schedule (included in electronic filing only).
Exhibit 99(a) - Notes 1(c), 1(n), 2, 3, 4, 5 and 12 to the Company's Financial
Statements included on pages 72 through 77 and 92 through 94
of the Form 10-K.
NORAM:
Exhibit 12 - Ratio of Earnings to Fixed Charges and Preferred Dividends
Exhibit 27 - Financial Data Schedule (included in electronic filing only).
Exhibit 99(a) - Notes 1(c), 2 and 8 to the NorAm Financial Statements included
on pages 116 through 121 and pages 132 through 135 of the
Form 10-K.
</TABLE>
<PAGE> 1
HI -- EXHIBIT 3
AMENDED AND RESTATED BYLAWS
OF
HOUSTON INDUSTRIES INCORPORATED
Adopted and Amended by Resolution of the Board of Directors on
September 2, 1998
ARTICLE I
CAPITAL STOCK
Section 1. Share Ownership. Shares for the capital stock of the
Company may be certificated or uncertificated. Owners of shares of the capital
stock of the Company shall be recorded in the share transfer records of the
Company and ownership of such shares shall be evidenced by a certificate or
book entry notation in the share transfer records of the Company. Any
certificates representing such shares shall be signed by the Chairman of the
Board, if there is one, the Chief Executive Officer, if there is one, the
President or a Vice President and either the Secretary or an Assistant
Secretary and shall be sealed with the seal of the Company, which signatures
and seal may be facsimiles. In case any officer who has signed or whose
facsimile signature has been placed upon such certificate shall have ceased to
be such officer before such certificate is issued, it may be issued by the
Company with the same effect as if he were such officer at the date of its
issuance.
Section 2. Shareholders of Record. The Board of Directors of the
Company may appoint one or more transfer agents or registrars of any class of
stock of the Company. The Company may be its own transfer agent if so
appointed by the Board of Directors. The Company shall be entitled to treat
the holder of record of any shares of the Company as the owner thereof for all
purposes, and shall not be bound to recognize any equitable or other claim to,
or interest in, such shares or any rights deriving from such shares, on the
part of any other person, including (but without limitation) a purchaser,
assignee or transferee, unless and until such other person becomes the holder
of record of such shares, whether or not the Company shall have either actual
or constructive notice of the interest of such other person.
Section 3. Transfer of Shares. The shares of the capital stock of
the Company shall be transferable in the share transfer records of the Company
by the holder of record thereof, or his duly authorized attorney or legal
representative. All certificates representing shares surrendered for transfer,
properly endorsed, shall be canceled and new certificates for a like number of
shares shall be issued therefor. In the case of lost, stolen, destroyed or
mutilated certificates representing shares
<PAGE> 2
for which the Company has been requested to issue new certificates, new
certificates or other evidence of such new shares may be issued upon such
conditions as may be required by the Board of Directors or the Secretary for
the protection of the Company and any transfer agent or registrar.
Uncertificated shares shall be transferred in the share transfer records of the
Company upon the written instruction originated by the appropriate person to
transfer the shares.
Section 4. Shareholders of Record and Fixing of Record Date. For the
purpose of determining shareholders entitled to notice of or to vote at any
meeting of shareholders or any adjournment thereof, or entitled to receive a
distribution by the Company (other than a distribution involving a purchase or
redemption by the Company of any of its own shares) or a share dividend, or in
order to make a determination of shareholders for any other proper purpose
(other than determining shareholders entitled to consent to action by
shareholders proposed to be taken without a meeting of shareholders), the Board
of Directors may provide that the share transfer records shall be closed for a
stated period of not more than sixty days, and in the case of a meeting of
shareholders not less than ten days, immediately preceding the meeting, or it
may fix in advance a record date for any such determination of shareholders,
such date to be not more than sixty days, and in the case of a meeting of
shareholders not less than ten days, prior to the date on which the particular
action requiring such determination of shareholders is to be taken. If the
share transfer records are not closed and no record date is fixed for the
determination of shareholders entitled to notice of or to vote at a meeting of
shareholders, or shareholders entitled to receive a distribution (other than a
distribution involving a purchase or redemption by the Company of any of its
own shares) or a share dividend, the date on which notice of the meeting is
mailed or the date on which the resolution of the Board of Directors declaring
such distribution or share dividend is adopted, as the case may be, shall be
the record date for such determination of shareholders. When a determination
of shareholders entitled to vote at any meeting of shareholders has been made
as herein provided, such determination shall apply to any adjournment thereof
except where the determination has been made through the closing of the share
transfer records and the stated period of closing has expired.
ARTICLE II
MEETINGS OF SHAREHOLDERS
Section 1. Place of Meetings. All meetings of shareholders shall be
held at the registered office of the Company, in the City of Houston, Texas, or
at such other place within or without the State of Texas as may be designated
by the Board of Directors or officer calling the meeting.
Section 2. Annual Meeting. The annual meeting of the shareholders
shall be held on such date and at such time as shall be designated from time to
time by the Board of Directors or as may otherwise be stated in the notice of
the meeting. Failure to designate a time for the annual meeting or to hold the
annual meeting at the designated time shall not work a dissolution of the
Company.
Page 2 of 21
<PAGE> 3
Section 3. Special Meetings. Special meetings of the shareholders
may be called by the Chairman of the Board, if there is one, the Chief
Executive Officer, if there is one, the President, the Secretary, the Board of
Directors, the holders of not less than one-tenth of all of the shares
outstanding and entitled to vote at such meeting or such other persons as may
be authorized in the Articles of Incorporation of the Company.
Section 4. Notice of Meeting. Written or printed notice of all
meetings stating the place, day and hour of the meeting and, in case of a
special meeting, the purpose or purposes for which the meeting is called, shall
be delivered not less than ten nor more than sixty days before the date of the
meeting, either personally or by mail, by or at the direction of the Chairman
of the Board, if there is one, the Chief Executive Officer, if there is one,
the President, the Secretary or the officer or person calling the meeting to
each shareholder of record entitled to vote at such meetings . If mailed, such
notice shall be deemed to be delivered when deposited in the United States mail
addressed to the shareholder at his address as it appears on the share transfer
records of the Company, with postage thereon prepaid.
Any notice required to be given to any shareholder, under any
provision of the Texas Business Corporation Act, as amended (TBCA), the
Articles of Incorporation of the Company or these Bylaws, need not be given to
a shareholder if notice of two consecutive annual meetings and all notices of
meetings held during the period between those annual meetings, if any, or all
(but in no event less than two) payments (if sent by first class mail) of
distributions or interest on securities during a 12-month period have been
mailed to that person, addressed at his address as shown on the share transfer
records of the Company, and have been returned undeliverable. Any action or
meeting taken or held without notice to such person shall have the same force
and effect as if the notice had been duly given. If such a person delivers to
the Company a written notice setting forth his then current address, the
requirement that notice be given to that person shall be reinstated.
Section 5. Voting List. The officer or agent having charge of the
share transfer records for shares of the Company shall make, at least ten days
before each meeting of shareholders, a complete list of the shareholders
entitled to vote at such meeting or any adjournment thereof, arranged in
alphabetical order, with the address of and the number of shares held by each,
which list, for a period of ten days prior to such meeting, shall be kept on
file at the registered office of the Company and shall be subject to inspection
by any shareholder at any time during usual business hours. Such list shall
also be produced and kept open at the time and place of the meeting and shall
be subject to the inspection of any shareholder during the whole time of the
meeting. The original share transfer records shall be prima facie evidence as
to who are the shareholders entitled to examine such list or to vote at any
meeting of shareholders. Failure to comply with any requirements of this
Section 5 shall not affect the validity of any action taken at such meeting.
Section 6. Voting; Proxies. Except as otherwise provided in the
Articles of Incorporation of the Company or as otherwise provided in the TBCA,
each holder of shares of capital stock of the Company entitled to vote shall be
entitled to one vote for each share standing in his name on the records of the
Company, either in person or by proxy executed in writing by him or by his duly
Page 3 of 21
<PAGE> 4
authorized attorney-in-fact. A proxy shall be revocable unless expressly
provided therein to be irrevocable and the proxy is coupled with an interest.
At each election of directors, every holder of shares of the Company entitled
to vote shall have the right to vote, in person or by proxy, the number of
shares owned by him for as many persons as there are directors to be elected,
and for whose election he has a right to vote, but in no event shall he be
permitted to cumulate his votes for one or more directors.
Section 7. Quorum and Vote of Shareholders. Except as otherwise
provided by law, the Articles of Incorporation of the Company or these Bylaws,
the holders of a majority of shares entitled to vote, represented in person or
by proxy, shall constitute a quorum at a meeting of shareholders, but, if a
quorum is not represented, a majority in interest of those represented may
adjourn the meeting from time to time. Directors shall be elected by a
plurality of the votes cast by the holders of shares entitled to vote in the
election of directors at a meeting of shareholders at which a quorum is
present. With respect to each matter other than the election of directors as
to which no other voting requirement is specified by law, the Articles of
Incorporation of the Company or in this Section 7 or in Article VII of these
Bylaws, the affirmative vote of the holders of a majority of the shares
entitled to vote on that matter and represented in person or by proxy at a
meeting at which a quorum is present shall be the act of the shareholders.
With respect to a matter submitted to a vote of the shareholders as to which a
shareholder approval requirement is applicable under the shareholder approval
policy of the New York Stock Exchange, Rule 16b-3 under the Securities Exchange
Act of 1934, as amended (Exchange Act), or any provision of the Internal
Revenue Code, in each case for which no higher voting requirement is specified
by law, the Articles of Incorporation of the Company or these Bylaws, the
affirmative vote of the holders of a majority of the shares entitled to vote
on, and voted for or against, that matter at a meeting at which a quorum is
present shall be the act of the shareholders, provided that approval of such
matter shall also be conditioned on any more restrictive requirement of such
shareholder approval policy, Rule 16b- 3 or Internal Revenue Code provision, as
applicable, being satisfied. With respect to the approval of independent
public accountants (if submitted for a vote of the shareholders), the
affirmative vote of the holders of a majority of the shares entitled to vote
on, and voted for or against, that matter at a meeting of shareholders at which
a quorum is present shall be the act of the shareholders.
Section 8. Presiding Officer and Conduct of Meetings. The Chairman
of the Board, if there is one, or in his absence, the Chief Executive Officer,
if there is one, or in his absence, the President shall preside at all meetings
of the shareholders or, if such officers are not present at a meeting, by such
other person as the Board of Directors shall designate or if no such person is
designated by the Board of Directors, the most senior officer of the Company
present at the meeting. The Secretary of the Company, if present, shall act as
secretary of each meeting of shareholders; if he is not present at a meeting,
then such person as may be designated by the presiding officer shall act as
secretary of the meeting. Meetings of shareholders shall follow reasonable and
fair procedure. Subject to the foregoing, the conduct of any meeting of
shareholders and the determination of procedure and rules shall be within the
absolute discretion of the officer presiding at such meeting (Chairman of the
Meeting), and there shall be no appeal from any ruling of the Chairman of the
Meeting with respect to procedure or rules. Accordingly, in any meeting of
shareholders or part thereof, the Chairman of
Page 4 of 21
<PAGE> 5
the Meeting shall have the sole power to determine appropriate rules or to
dispense with theretofore prevailing rules. Without limiting the foregoing,
the following rules shall apply:
(a) If disorder should arise which prevents continuation of
the legitimate business of meeting, the Chairman of the Meeting may
announce the adjournment of the meeting; and upon so doing, the
meeting shall be immediately adjourned.
(b) The Chairman of the Meeting may ask or require that
anyone not a bona fide shareholder or proxy leave the meeting.
(c) A resolution or motion proposed by a shareholder shall
only be considered for vote of the shareholders if it meets the
criteria of Article II, Section 9 (Proper Business -- Annual Meeting
of Shareholders) or Article II, Section 10 (Proper Business -- Special
Meeting of Shareholders), as the case may be. The Chairman of the
Meeting may propose any resolution or motion for vote of the
shareholders.
(d) The order of business at all meetings of shareholders
shall be determined by the Chairman of the Meeting.
(e) The Chairman of the Meeting may impose any reasonable
limits with respect to participation in the meeting by shareholders,
including, but not limited to, limits on the amount of time taken up
by the remarks or questions of any shareholder, limits on the number
of questions per shareholder and limits as to the subject matter and
timing of questions and remarks by shareholders.
(f) Before any meeting of shareholders, the Board of
Directors may appoint three persons other than nominees for office to
act as inspectors of election at the meeting or its adjournment. If
no inspectors of election are so appointed, the Chairman of the
Meeting may, and on the request of any shareholder or a shareholder's
proxy shall, appoint inspectors of election at the meeting of the
shareholders and the number of such inspectors shall be three. If any
person appointed as inspector fails to appear or fails or refuses to
act, the Chairman of the Meeting may, and upon the request of any
shareholder or a shareholder's proxy shall, appoint a person to fill
such vacancy.
The duties of the inspectors shall be to:
(i) determine the number of shares outstanding and
the voting power of each, the shares represented at the
meeting, the existence of a quorum, and the authenticity,
validity and effect of proxies and ballots;
(ii) receive votes or ballots;
Page 5 of 21
<PAGE> 6
(iii) hear and determine all challenges and
questions in any way arising in connection with the vote;
(iv) count and tabulate all votes;
(v) report to the Board of Directors the results
based on the information assembled by the inspectors; and
(vi) do any other acts that may be proper to conduct
the election or vote with fairness to all shareholders.
Notwithstanding the foregoing, the final certification of the
results of the election or other matter acted upon at a
meeting of shareholders shall be made by the Board of
Directors.
All determinations of the Chairman of the Meeting shall be conclusive
unless a matter is determined otherwise upon motion duly adopted by the
affirmative vote of the holders of at least 80% of the voting power of the
shares of capital stock of the Company entitled to vote in the election of
directors held by shareholders present in person or represented by proxy at
such meeting.
Section 9. Proper Business -- Annual Meeting of Shareholders. At any
annual meeting of shareholders, only such business shall be conducted as shall
be a proper subject for the meeting and shall have been properly brought before
the meeting. To be properly brought before an annual meeting of shareholders,
business (other than business relating to (i) any nomination of directors,
which is governed by Article III, Section 3, or (ii) any alteration, amendment
or repeal of the Bylaws or any adoption of new Bylaws, which is governed by
Article VII hereof) must (a) be specified in the notice of such meeting (or any
supplement thereto) given by or at the direction of the Board of Directors (or
any duly authorized committee thereof), (b) otherwise be properly brought
before the meeting by or at the direction of the Chairman of the Meeting or the
Board of Directors (or any duly authorized committee thereof) or (c) otherwise
(i) be properly requested to be brought before the meeting by a shareholder of
record entitled to vote in the election of directors generally, in compliance
with the provisions of this Section 9 and (ii) constitute a proper subject to
be brought before such meeting. For business to be properly brought before an
annual meeting of shareholders, any shareholder who intends to bring any matter
(other than a matter relating to (i) any nomination of directors, which is
governed by Article III, Section 3, or (ii) any alteration, amendment or repeal
of the Bylaws or any adoption of new Bylaws, which is governed by Article VII
hereof) before an annual meeting of shareholders and is entitled to vote on
such matter must deliver written notice of such shareholder's intent to bring
such matter before the annual meeting of shareholders, either by personal
delivery or by United States mail, postage prepaid, to the Secretary of the
Company. Such notice must be received by the Secretary not less than 90 days
nor more than 180 days prior to the date on which the immediately preceding
year's annual meeting of shareholders was held. In no event shall the public
disclosure of an adjournment of an annual meeting of shareholders commence a
new time period for the giving of a shareholder's notice as described above.
Page 6 of 21
<PAGE> 7
To be in proper written form, a shareholder's notice to the Secretary
shall set forth as to each matter the shareholder proposes to bring before the
annual meeting of shareholders (a) a brief description of the business desired
to be brought before the meeting and the reasons for conducting such business
at the meeting, (b) the name and address, as they appear on the Company's books
and records, of the shareholder proposing such business, (c) evidence
reasonably satisfactory to the Secretary of the Company, of such shareholder's
status as such and of the number of shares of each class of capital stock of
the Company of which such shareholder is the beneficial owner, (d) a
description of all arrangements or understandings between such shareholder and
any other person or persons (including their names) in connection with the
proposal of such business by such shareholder and any material interest of such
shareholder in such business and (e) a representation that such shareholder
intends to appear in person or by proxy at the annual meeting to bring such
business before the meeting. No business shall be conducted at an annual
meeting of shareholders except in accordance with the procedures set forth in
this Section 9. Beneficial ownership shall be determined in accordance with
Rule 13d-3 under the Exchange Act. When used in these Bylaws, "person" has the
meaning ascribed to such term in Section 2(a)(2) of the Securities Act of 1933,
as amended, as the context may require.
Within thirty days after such shareholder shall have submitted the
aforesaid items, the Secretary or the Board of Directors of the Company shall
determine whether the proposed business has been properly requested to be
brought before the annual meeting of shareholders and shall notify such
shareholder in writing of its determination. If such shareholder fails to
submit a required item in the form or within the time indicated, or if the
Secretary or the Board of Directors of the Company determines that the proposed
business otherwise has not been properly requested, then such proposal by such
shareholder shall not be voted upon by the shareholders of the Company at such
annual meeting of shareholders. The Chairman of the Meeting shall, if the
facts warrant, determine and declare to the meeting that a proposal made by a
shareholder of the Company pursuant to this Section 9 was not made in
accordance with the procedures prescribed by these Bylaws, and if he should so
determine, he shall so declare to the meeting and the defective proposal shall
be disregarded.
Nothing in this Section 9 shall be interpreted or construed to require
the inclusion of information about any such proposal in any proxy statement
distributed by, at the direction of, or on behalf of the Board of Directors or
the Company.
Section 10. Proper Business -- Special Meeting of Shareholders. At
any special meeting of shareholders, only such business shall be conducted as
shall have been stated in the notice of such meeting or shall otherwise have
been properly brought before the meeting by or at the direction of the Chairman
of the Meeting or the Board of Directors (or any duly authorized committee
thereof).
Page 7 of 21
<PAGE> 8
ARTICLE III
DIRECTORS
Section 1. Classification of Board of Directors; Qualifications. The
business and affairs of the Company shall be managed by the Board of Directors.
Each director elected by the holders of Preferred Stock pursuant to
Section 6 of Division A of Article VI of the Articles of Incorporation of the
Company (or elected by such directors to fill a vacancy) shall serve for a term
ending upon the earlier of the election of his successor or the termination at
any time of a right of the holders of Preferred Stock to elect members of the
Board of Directors.
At each annual election, the directors chosen to succeed those whose
terms then expire shall be of the same class as the directors they succeed,
unless, by reason of any intervening changes in the authorized number of
directors, the Board of Directors shall designate one or more directorships
whose term then expires as directorships of another class in order more nearly
to achieve equality of number of directors among the classes.
Notwithstanding the rule that the three classes shall be as nearly
equal in number of directors as possible, in the event of any change in the
authorized number of directors, each director then continuing to serve as such
shall nevertheless continue as a director of the class of which he is a member
until the expiration of his current term, or his prior death, resignation,
disqualification or removal. If any newly created directorship may, consistent
with the rule that the three classes shall be as nearly equal in number of
directors as possible, be allocated to any of the three classes, the Board of
Directors shall allocate it to that available class whose term of office is due
to expire at the earliest date following such allocation. No decrease in the
number of directors constituting the Board of Directors shall shorten the term
of any incumbent director.
No person shall be eligible to serve as a director of the Company
subsequent to the annual meeting of shareholders occurring on or after the
first day of the month immediately following the month of such person's
seventieth birthday. No person shall be eligible to stand for reelection at
the annual meeting of shareholders on or immediately following the tenth
anniversary of such person's initial election or appointment to the Board of
Directors. Any vacancy on the Board of Directors resulting from any director
being rendered ineligible to serve as a director of the Company by the
immediately preceding two sentences shall be filled by the shareholders
entitled to vote thereon at such annual meeting of shareholders. Any director
chosen to succeed a director who is so rendered ineligible to serve as a
director of the Company shall be of the same class as the director he succeeds.
Notwithstanding the rule that a director may not stand for reelection at the
annual meeting of shareholders on or immediately following the tenth
anniversary of such person's initial election or appointment to the Board of
Directors, an incumbent director may nevertheless continue as a director until
the expiration of his current term, or his prior death, resignation,
disqualification or removal; provided, however, that no person serving as a
director as of April 1, 1992 shall be affected by such
Page 8 of 21
<PAGE> 9
term limitation provision, nor shall such term limitation provision apply to
directors who are also employees of the Company or its corporate affiliates.
The above notwithstanding, each director shall serve until his
successor shall have been duly elected and qualified, unless he shall resign,
become disqualified, disabled or shall otherwise be removed.
No person shall be eligible for election or reelection or to continue
to serve as a member of the Board of Directors who is an officer, director,
agent, representative, partner, employee, or nominee of, or otherwise acting at
the direction of, or acting in concert with, (a) a "public-utility company"
(other than any direct or indirect subsidiary of the Company) as such term is
defined in Section 2(a)(5) of the Public Utility Holding Company Act of 1935,
as in effect on May 1, 1996 (35 Act), or (b) an "affiliate" (as defined in
either Section 2(a)(11) of the 35 Act or in Rule 405 under the Securities Act
of 1933, as amended) of any such "public-utility company" specified in clause
(a) immediately preceding.
Section 2. Newly Created Directorships and Vacancies. Newly created
directorships resulting from any increase in the number of directors may be
filled by the affirmative vote of a majority of the directors then in office
for a term of office continuing only until the next election of one or more
directors by the shareholders entitled to vote thereon, or may be filled by
election at an annual or special meeting of the shareholders called for that
purpose; provided, however, that the Board of Directors shall not fill more
than two such directorships during the period between two successive annual
meetings of shareholders. Except as provided in Section 1 of this Article III,
any vacancies on the Board of Directors resulting from death, resignation,
disqualification, removal or other cause may be filled by the affirmative vote
of a majority of the remaining directors then in office, even though less than
a quorum of the Board of Directors, or may be filled by election at an annual
or special meeting of the shareholders called for that purpose. Any director
elected to fill any such vacancy shall hold office for the remainder of the
full term of the director whose departure from the Board of Directors created
the vacancy and until such newly elected director's successor shall have been
duly elected and qualified.
Notwithstanding the foregoing paragraph of this Section 2, whenever
holders of outstanding shares of Preference Stock are entitled to elect members
of the Board of Directors pursuant to the provisions of Section 6 of Division A
of Article VI of the Articles of Incorporation of the Company, any vacancy or
vacancies resulting by reason of the death, resignation, disqualification or
removal of any director or directors or any increase in the number of directors
shall be filled in accordance with the provisions of such section.
Section 3. Nomination of Directors. Nominations for the election of
directors may be made by the Board of Directors or by any shareholder
(Nominator) entitled to vote in the election of directors. Such nominations,
other than those made by the Board of Directors, shall be made in writing
pursuant to timely notice delivered to or mailed and received by the Secretary
of the Company as set forth in this Section 3. To be timely in connection with
an annual meeting of
Page 9 of 21
<PAGE> 10
shareholders, a Nominator's notice, setting forth the name and address of the
person to be nominated, shall be delivered to or mailed and received at the
principal executive offices of the Company not less than ninety days nor more
than 180 days prior to the date on which the immediately preceding year's
annual meeting of shareholders was held. To be timely in connection with any
election of a director at a special meeting of the shareholders, a Nominator's
notice, setting forth the name of the person to be nominated, shall be
delivered to or mailed and received at the principal executive offices of the
Company not less than forty days nor more than sixty days prior to the date of
such meeting; provided, however, that in the event that less than forty-seven
days' notice or prior public disclosure of the date of the special meeting of
the shareholders is given or made to the shareholders, the Nominator's notice
to be timely must be so received not later than the close of business on the
seventh day following the day on which such notice of date of the meeting was
mailed or such public disclosure was made. At such time, the Nominator shall
also submit written evidence, reasonably satisfactory to the Secretary of the
Company, that the Nominator is a shareholder of the Company and shall identify
in writing (a) the name and address of the Nominator, (b) the number of shares
of each class of capital stock of the Company owned beneficially by the
Nominator, (c) the name and address of each of the persons with whom the
Nominator is acting in concert, (d) the number of shares of capital stock
beneficially owned by each such person with whom the Nominator is acting in
concert, and (e) a description of all arrangements or understandings between
the Nominator and each nominee and any other persons with whom the Nominator is
acting in concert pursuant to which the nomination or nominations are to be
made. At such time, the Nominator shall also submit in writing (i) the
information with respect to each such proposed nominee that would be required
to be provided in a proxy statement prepared in accordance with Regulation 14A
under the Exchange Act and (ii) a notarized affidavit executed by each such
proposed nominee to the effect that, if elected as a member of the Board of
Directors, he will serve and that he is eligible for election as a member of
the Board of Directors. Within thirty days (or such shorter time period that
may exist prior to the date of the meeting) after the Nominator has submitted
the aforesaid items to the Secretary of the Company, the Secretary of the
Company shall determine whether the evidence of the Nominator's status as a
shareholder submitted by the Nominator is reasonably satisfactory and shall
notify the Nominator in writing of his determination. The failure of the
Secretary of the Company to find such evidence reasonably satisfactory, or the
failure of the Nominator to submit the requisite information in the form or
within the time indicated, shall make the person to be nominated ineligible for
nomination at the meeting at which such person is proposed to be nominated.
The presiding person at each meeting of shareholders shall, if the facts
warrant, determine and declare to the meeting that a nomination was not made in
accordance with the procedures prescribed by these Bylaws, and if he should so
determine, he shall so declare to the meeting and the defective nomination
shall be disregarded. Beneficial ownership shall be determined in accordance
with Rule 13d-3 under the Exchange Act.
Section 4. Place of Meetings and Meetings by Telephone. Meetings of
the Board of Directors may be held either within or without the State of Texas,
at whatever place is specified by the officer calling the meeting. Meetings of
the Board of Directors may also be held by means of conference telephone or
similar communications equipment by means of which all persons participating in
the meeting can hear each other. Participation in such a meeting by means of
conference
Page 10 of 21
<PAGE> 11
telephone or similar communications equipment shall constitute presence in
person at such meeting, except where a director participates in a meeting for
the express purpose of objecting to the transaction of any business on the
ground that the meeting is not lawfully called or convened. In the absence of
specific designation by the officer calling the meeting, the meetings shall be
held at the principal office of the Company.
Section 5. Regular Meetings. The Board of Directors shall meet each
year immediately following the annual meeting of the shareholders for the
transaction of such business as may properly be brought before the meeting.
The Board of Directors shall also meet regularly at such other times as shall
be designated by the Board of Directors. No notice of any kind to either
existing or newly elected members of the Board of Directors for such annual or
regular meetings shall be necessary.
Section 6. Special Meetings. Special meetings of the Board of
Directors may be held at any time upon the call of the Chairman of the Board,
if there is one, the Chief Executive Officer, if there is one, the President or
the Secretary of the Company or a majority of the directors then in office.
Notice shall be sent by mail, facsimile or telegram to the last known address
of the director at least two days before the meeting, or oral notice may be
substituted for such written notice if received not later than the day
preceding such meeting. Notice of the time, place and purpose of such meeting
may be waived in writing before or after such meeting, and shall be equivalent
to the giving of notice. Attendance of a director at such meeting shall also
constitute a waiver of notice thereof, except where he attends for the express
purpose of objecting to the transaction of any business on the ground that the
meeting is not lawfully called or convened. Except as otherwise provided by
these Bylaws, neither the business to be transacted at, nor the purpose of, any
regular or special meeting of the Board of Directors need be specified in the
notice or waiver of notice of such meeting.
Section 7. Quorum and Voting. Except as otherwise provided by law,
the Articles of Incorporation of the Company or these Bylaws, a majority of the
number of directors fixed in the manner provided in these Bylaws as from time
to time amended shall constitute a quorum for the transaction of business.
Except as otherwise provided by law, the Articles of Incorporation of the
Company or these Bylaws, the affirmative vote of a majority of the directors
present at any meeting at which there is a quorum shall be the act of the Board
of Directors. Any regular or special directors' meeting may be adjourned from
time to time by those present, whether a quorum is present or not.
Section 8. Compensation. Directors shall receive such compensation
for their services as shall be determined by the Board of Directors.
Section 9. Removal. No director of the Company shall be removed from
his office as a director by vote or other action of the shareholders or
otherwise except (a) with cause, as defined below, by the affirmative vote of
the holders of at least a majority of the voting power of all outstanding
shares of capital stock of the Company entitled to vote in the election of
directors, voting together as a single class, or (b) without cause by (i) the
affirmative vote of at least 80% of all directors then in office at any regular
or special meeting of the Board of Directors called for that
Page 11 of 21
<PAGE> 12
purpose or (ii) the affirmative vote of the holders of at least 80% of the
voting power of all outstanding shares of capital stock of the Company entitled
to vote in the election of directors, voting together as a single class.
Except as may otherwise be provided by law, cause for removal of a
director shall be construed to exist only if: (a) the director whose removal
is proposed has been convicted, or where a director is granted immunity to
testify where another has been convicted, of a felony by a court of competent
jurisdiction and such conviction is no longer subject to direct appeal; (b)
such director has been found by the affirmative vote of at least 80% of all
directors then in office at any regular or special meeting of the Board of
Directors called for that purpose or by a court of competent jurisdiction to
have been negligent or guilty of misconduct in the performance of his duties to
the Company in a matter of substantial importance to the Company; or (c) such
director has been adjudicated by a court of competent jurisdiction to be
mentally incompetent, which mental incompetency directly affects his ability as
a director of the Company.
Notwithstanding the first paragraph of this Section 9, whenever
holders of outstanding shares of Preference Stock are entitled to elect members
of the Board of Directors pursuant to the provisions of Section 6 of Division A
of Article VI of the Articles of Incorporation of the Company, any director of
the Company may be removed in accordance with the provisions of such section.
No proposal by a shareholder to remove a director of the Company,
regardless of whether such director was elected by holders of outstanding
shares of Preference Stock (or elected by such directors to fill a vacancy),
shall be voted upon at a meeting of the shareholders unless such shareholder
shall have delivered or mailed in a timely manner (as set forth in this Section
9) and in writing to the Secretary of the Company (a) notice of such proposal,
(b) a statement of the grounds, if any, on which such director is proposed to
be removed, (c) evidence, reasonably satisfactory to the Secretary of the
Company, of such shareholder's status as such and of the number of shares of
each class of the capital stock of the Company beneficially owned by such
shareholder, (d) a list of the names and addresses of other beneficial owners
of shares of the capital stock of the Company, if any, with whom such
shareholder is acting in concert, and of the number of shares of each class of
the capital stock of the Company beneficially owned by each such beneficial
owner, and (e) an opinion of counsel, which counsel and the form and substance
of which opinion shall be reasonably satisfactory to the Board of Directors of
the Company (excluding the director proposed to be removed), to the effect
that, if adopted at a duly called special or annual meeting of the shareholders
of the Company by the required vote as set forth in the first paragraph of this
Section 9, such removal would not be in conflict with the laws of the State of
Texas, the Articles of Incorporation of the Company or these Bylaws. To be
timely in connection with an annual meeting of shareholders, a shareholder's
notice and other aforesaid items shall be delivered to or mailed and received
at the principal executive offices of the Company not less than ninety nor more
than 180 days prior to the date on which the immediately preceding year's
annual meeting of shareholders was held. To be timely in connection with the
removal of any director at a special meeting of the shareholders, a
shareholder's notice and other aforesaid items shall be delivered to or mailed
and received at the principal executive offices of the Company not less than
forty days nor more than sixty days prior
Page 12 of 21
<PAGE> 13
to the date of such meeting; provided, however, that in the event that less
than forty-seven days' notice or prior public disclosure of the date of the
special meeting of shareholders is given or made to the shareholders, the
shareholder's notice and other aforesaid items to be timely must be so received
not later than the close of business on the seventh day following the day on
which such notice of date of the meeting was mailed or such public disclosure
was made. Within thirty days (or such shorter period that may exist prior to
the date of the meeting) after such shareholder shall have delivered the
aforesaid items to the Secretary of the Company, the Secretary and the Board of
Directors of the Company shall respectively determine whether the items to be
ruled upon by them are reasonably satisfactory and shall notify such
shareholder in writing of their respective determinations. If such shareholder
fails to submit a required item in the form or within the time indicated, or if
the Secretary or the Board of Directors of the Company determines that the
items to be ruled upon by them are not reasonably satisfactory, then such
proposal by such shareholder may not be voted upon by the shareholders of the
Company at such meeting of shareholders. The presiding person at each meeting
of shareholders shall, if the facts warrant, determine and declare to the
meeting that a proposal to remove a director of the Company was not made in
accordance with the procedures prescribed by these Bylaws, and if he should so
determine, he shall so declare to the meeting and the defective proposal shall
be disregarded. Beneficial ownership shall be determined as specified in
accordance with Rule 13d-3 under the Exchange Act.
Section 10. Executive and Other Committees. The Board of Directors,
by resolution or resolutions adopted by a majority of the full Board of
Directors, may designate one or more members of the Board of Directors to
constitute an Executive Committee, and one or more other committees, which
shall in each case be comprised of such number of directors as the Board of
Directors may determine from time to time. Subject to such restrictions as may
be contained in the Company's Articles of Incorporation or that may be imposed
by the TBCA, any such committee shall have and may exercise such powers and
authority of the Board of Directors in the management of the business and
affairs of the Company as the Board of Directors may determine by resolution
and specify in the respective resolutions appointing them, or as permitted by
applicable law, including, without limitation, the power and authority to (a)
authorize a distribution, (b) authorize the issuance of shares of the Company
and (c) exercise the authority of the Board of Directors vested in it pursuant
to Article 2.13 of the TBCA or such successor statute as may be in effect from
time to time. Each duly-authorized action taken with respect to a given
matter by any such duly-appointed committee of the Board of Directors shall
have the same force and effect as the action of the full Board of Directors and
shall constitute for all purposes the action of the full Board of Directors
with respect to such matter.
The designation of any such committee and the delegation thereto of
authority shall not operate to relieve the Board of Directors, or any member
thereof, of any responsibility imposed upon it or him by law, nor shall such
committee function where action of the Board of Directors cannot be delegated
to a committee thereof under applicable law. The Board of Directors shall have
the power at any time to change the membership of any such committee and to
fill vacancies in it. A majority of the members of any such committee shall
constitute a quorum. The Board of Directors shall name a chairman at the time
it designates members to a committee. Each such committee shall
Page 13 of 21
<PAGE> 14
appoint such subcommittees and assistants as it may deem necessary. Except as
otherwise provided by the Board of Directors, meetings of any committee shall
be conducted in accordance with the provisions of Sections 4 and 6 of this
Article III as the same shall from time to time be amended. Any member of any
such committee elected or appointed by the Board of Directors may be removed by
the Board of Directors whenever in its judgment the best interests of the
Company will be served thereby, but such removal shall be without prejudice to
the contract rights, if any, of the person so removed. Election or appointment
of a member of a committee shall not of itself create contract rights.
ARTICLE IV
OFFICERS
Section 1. Officers. The officers of the Company shall consist of a
President and a Secretary and such other officers and agents as the Board of
Directors may from time to time elect or appoint, which may include, without
limitation, a Chairman of the Board, a Chief Executive Officer, one or more
Vice Presidents (whose seniority and titles, including Executive Vice
Presidents, Senior Vice Presidents and such assistant or subordinate Vice
Presidents, may be specified by the Board of Directors), a Treasurer, one or
more Assistant Treasurers, and one or more Assistant Secretaries. Each officer
shall hold office until his successor shall have been duly elected and shall
qualify or until his death or until he shall resign or shall have been removed
in the manner hereinafter provided. Any two or more offices may be held by the
same person. Except for the Chairman of the Board, if any, no officer need be
a director.
Section 2. Vacancies; Removal. Whenever any vacancies shall occur in
any office by death, resignation, increase in the number of offices of the
Company, or otherwise, the officer so elected shall hold office until his
successor is chosen and qualified. The Board of Directors may at any time
remove any officer of the Company, whenever in its judgment the best interests
of the Company will be served thereby, but such removal shall be without
prejudice to the contract rights, if any, of the person so removed. Election
or appointment of an officer or agent shall not of itself create contract
rights.
Section 3. Powers and Duties of Officers. The officers of the
Company shall have such powers and duties as generally pertain to their offices
as well as such powers and duties as from time to time shall be conferred by
the Board of Directors.
Page 14 of 21
<PAGE> 15
ARTICLE V
INDEMNIFICATION
Section 1. General. The Company shall indemnify and hold harmless
the Indemnitee (as this and all other capitalized words are defined in this
Article or in Article 2.02-1 of the TBCA), to the fullest extent permitted, or
not prohibited, by the TBCA or other applicable law as the same exists or may
hereafter be amended (but in the case of any such amendment, with respect to
Matters occurring before such amendment, only to the extent that such amendment
permits the Company to provide broader indemnification rights than said law
permitted the Company to provide prior to such amendment). The provisions set
forth below in this Article are provided as means of furtherance and
implementation of, and not in limitation on, the obligation expressed in this
Section 1.
Section 2. Advancement or Reimbursement of Expenses. The rights of
the Indemnitee provided under Section 1 of this Article shall include, but not
be limited to, the right to be indemnified and to have Expenses advanced
(including the payment of expenses before final disposition of a Proceeding) in
all Proceedings to the fullest extent permitted, or not prohibited, by the TBCA
or other applicable law. If the Indemnitee is not wholly successful, on the
merits or otherwise, in a Proceeding, but is successful, on the merits or
otherwise, as to any Matter in such Proceeding, the Company shall indemnify the
Indemnitee against all Expenses actually and reasonably incurred by him or on
his behalf relating to each Matter. The termination of any Matter in a
Proceeding by dismissal, with or without prejudice, shall be deemed to be a
successful result as to such Matter. In addition, to the extent the Indemnitee
is, by reason of his Corporate Status, a witness or otherwise participates in
any Proceeding at a time when he is not named a defendant or respondent in the
Proceeding, he shall be indemnified against all Expenses actually and
reasonably incurred by him or on his behalf in connection therewith. The
Indemnitee shall be advanced Expenses, within ten days after any request for
such advancement, to the fullest extent permitted, or not prohibited, by
Article 2.02-1 of the TBCA; provided that the Indemnitee has provided to the
Company all affirmations, acknowledgments, representations and undertakings
that may be required of the Indemnitee by Article 2.02-1 of the TBCA.
Section 3. Determination of Request. Upon written request to the
Company by an Indemnitee for indemnification pursuant to these Bylaws, a
determination, if required by applicable law, with respect to an Indemnitee's
entitlement thereto shall be made in accordance with Article 2.02-1 of the
TBCA; provided, however, that notwithstanding the foregoing, if a Change in
Control shall have occurred, such determination shall be made by Special Legal
Counsel selected by the Indemnitee, unless the Indemnitee shall request that
such determination be made in accordance with Article 2.02-1F (1) or (2). The
Company shall pay any and all reasonable fees and expenses of Special Legal
Counsel incurred in connection with any such determination. If a Change in
Control shall have occurred, the Indemnitee shall be presumed (except as
otherwise expressly provided in this Article) to be entitled to
indemnification under this Article upon submission of a request to the Company
for indemnification, and thereafter the Company shall have the burden of proof
in overcoming that presumption in reaching a determination contrary to that
presumption. The
Page 15 of 21
<PAGE> 16
presumption shall be used by Special Legal Counsel, or such other person or
persons determining entitlement to indemnification, as a basis for a
determination of entitlement to indemnification unless the Company provides
information sufficient to overcome such presumption by clear and convincing
evidence or the investigation, review and analysis of Special Legal Counsel or
such other person or persons convinces him or them by clear and convincing
evidence that the presumption should not apply.
Section 4. Effect of Certain Proceedings. The termination of any
Proceeding or of any Matter therein, by judgment, order, settlement or
conviction, or upon a plea of nolo contendere or its equivalent, shall not
(except as otherwise expressly provided in this Article) of itself adversely
affect the right of the Indemnitee to indemnification or create a presumption
that (a) the Indemnitee did not conduct himself in good faith and in a manner
which he reasonably believed, in the case of conduct in his official capacity
as a director of the Company, to be in the best interests of the Company, or,
in all other cases, that at least his conduct was not opposed to the Company's
best interests, or (b) with respect to any criminal Proceeding, that the
Indemnitee had reasonable cause to believe that his conduct was unlawful.
Section 5. Expenses of Enforcement of Article. In the event that an
Indemnitee, pursuant to this Article, seeks a judicial adjudication to enforce
his rights under, or to recover damages for breach of, rights created under or
pursuant to this Article, the Indemnitee shall be entitled to recover from the
Company, and shall be indemnified by the Company against, any and all Expenses
actually and reasonably incurred by him in such judicial adjudication but only
if he prevails therein. If it shall be determined in said judicial
adjudication that the Indemnitee is entitled to receive part but not all of the
indemnification or advancement of Expenses sought, the Expenses incurred by
Indemnitee in connection with such judicial adjudication shall be reasonably
prorated in good faith by counsel for the Indemnitee. Notwithstanding the
foregoing, if a Change in Control shall have occurred, Indemnitee shall be
entitled to indemnification under this Section regardless of whether indemnitee
ultimately prevails in such judicial adjudication.
Section 6. Nonexclusive Rights. The rights of indemnification and to
receive advancement of Expenses as provided by this Article shall not be deemed
exclusive of any other rights to which the Indemnitee may at any time be
entitled under applicable law, the Articles of Incorporation of the Company,
these Bylaws, agreement, insurance, arrangement, a vote of shareholders or a
resolution of directors, or otherwise. No amendment, alteration or repeal of
this Article or any provision thereof shall be effective as to any Indemnitee
for acts, events and circumstances that occurred, in whole or in part, before
such amendment, alteration or repeal. The provisions of this Article shall
continue as to an Indemnitee whose Corporate Status has ceased and shall inure
to the benefit of his heirs, executors and administrators.
Section 7. Invalidity. If any provision or provisions of this
Article shall be held to be invalid, illegal or unenforceable for any reason
whatsoever, the validity, legality and enforceability of the remaining
provisions shall not in any way be affected or impaired thereby; and, to the
fullest extent
Page 16 of 21
<PAGE> 17
possible, the provisions of this Article shall be construed so as to give
effect to the intent manifested by the provision held invalid, illegal or
unenforceable.
Section 8. Definitions. For purposes of this Article:
"Change of Control" means a change in control of the Company
occurring after the date of adoption of these Bylaws in any of the
following circumstances: (a) there shall have occurred an event
required to be reported in response to Item 6(e) of Schedule 14A of
Regulation 14A (or in response to any similar item on any similar
schedule or form) promulgated under the Exchange Act, whether or not
the Company is then subject to such reporting requirement; (b) any
"person" (as such term is used in Section 13(d) and 14(d) of the
Exchange Act), other than a trustee or other fiduciary holding
securities under an employee benefit plan of the Company or a
corporation or other entity owned directly or indirectly by the
shareholders of the Company in substantially the same proportions as
their ownership of stock of the Company, shall have become the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act),
directly or indirectly, of securities of the Company representing 30%
or more of the combined voting power of the Company's then outstanding
voting securities without prior approval of at least two-thirds of the
members of the Board of Directors in office immediately prior to such
person attaining such percentage interest; (c) the Company is a party
to a merger, consolidation, share exchange, sale of assets or other
reorganization, or a proxy contest, as a consequence of which members
of the Board of Directors in office immediately prior to such
transaction or event constitute less than a majority of the Board of
Directors thereafter; (d) during any fifteen month period, individuals
who at the beginning of such period constituted the Board of Directors
(including for this purpose any new director whose election or
nomination for election by the Company's shareholders was approved by
a vote of at least two- thirds of the directors then still in office
who were directors at the beginning of such period) cease for any
reason to constitute at least a majority of the Board of Directors.
"Corporate Status" means the status of a person who is or was
a director, officer, partner, venturer, proprietor, trustee, employee
(including an employee acting in his Designated Professional
Capacity), or agent or similar functionary of the Company or of any
other foreign or domestic corporation, partnership, joint venture,
sole proprietorship, trust, employee benefit plan or other enterprise
which such person is or was serving in such capacity at the request of
the Company. The Company hereby acknowledges that unless and until
the Company provides the Indemnitee with written notice to the
contrary, the Indemnitee's service as a director, officer, partner,
venturer, proprietor, trustee, employee, agent or similar functionary
of an Affiliate of the Company shall be conclusively presumed to be at
the Company's request. An Affiliate of the Company shall be deemed to
be (a) any foreign or domestic corporation in which the Company owns
or controls, directly or indirectly, 5% or more of the shares entitled
to be voted in the election of directors of such corporation; (b) any
foreign or domestic partnership, joint venture, proprietorship or
other enterprise in which the Company owns or controls, directly or
indirectly, 5% or more of the
Page 17 of 21
<PAGE> 18
revenue interests in such partnership, joint venture, proprietorship
or other enterprise; or (c) any trust or employee benefit plan the
beneficiaries of which include the Company, any Affiliate of the
Company as defined in the foregoing clauses (a) and (b) or any of the
directors, officers, partners, venturers, proprietors, employees,
agents or similar functionaries of the Company or of such Affiliates
of the Company.
"Expenses" shall include all reasonable attorneys' fees,
retainers, court costs, transcript costs, fees of experts, witness
fees, travel expenses, duplicating costs, printing and binding costs,
telephone charges, postage, delivery service fees, and all other
disbursements or expenses of the types customarily incurred in
connection with prosecuting, defending, preparing to prosecute or
defend, investigating, or being or preparing to be a witness in a
Proceeding.
"Indemnitee" includes any person who is, or is threatened to
be made, a witness in or a party to any Proceeding as described in
Section 1 or 2 of this Article by reason of his Corporate Status.
"Matter" is a claim, a material issue, or a substantial
request for relief.
"Proceeding" includes any threatened, pending or completed
action, suit, arbitration, alternate dispute resolution proceeding,
investigation, administrative hearing and any other proceeding,
whether civil, criminal, administrative, investigative or other, any
appeal in such action, suit, arbitration, proceeding or hearing, or
any inquiry or investigation, whether conducted by or on behalf of the
Company, a subsidiary of the Company or any other party, formal or
informal, that the Indemnitee in good faith believes might lead to the
institution of any such action, suit, arbitration, proceeding,
investigation or hearing, except one initiated by an Indemnitee
pursuant to Section 5 of this Article.
"Special Legal Counsel" means a law firm, or member of a law
firm, that is experienced in matters of corporation law and neither
presently is, nor in the five years previous to his selection or
appointment has been, retained to represent: (a) the Company or the
Indemnitee in any matter material to either such party; (b) any other
party to the Proceeding giving rise to a claim for indemnification
hereunder; or (c) the beneficial owner, directly or indirectly, of
securities of the Company representing 30% or more of the combined
voting power of the Company's then outstanding voting securities.
Notwithstanding the foregoing, the term "Special Legal Counsel" shall
not include any person who, under the applicable standards of
professional conduct then prevailing, would have a conflict of
interest in representing either the Company or the Indemnitee in an
action to determine the Indemnitee's rights to indemnification under
these Bylaws.
For the purposes of this Article, an employee acting in his
"Designated Professional Capacity" shall include, but not be limited
to, a physician, nurse, psychologist or therapist, registered
surveyor, registered engineer, registered architect, attorney,
certified public
Page 18 of 21
<PAGE> 19
accountant or other person who renders such professional services
within the course and scope of his employment, who is licensed by
appropriate regulatory authorities to practice such profession and
who, while acting in the course of such employment, committed or is
alleged to have committed any negligent acts, errors or omissions in
rendering such professional services at the request of the Company or
pursuant to his employment (including, without limitation, rendering
written or oral opinions to third parties).
Section 9. Notice. Any communication required or permitted to the
Company under this Article shall be addressed to the Secretary of the Company
and any such communication to the Indemnitee shall be addressed to his home
address unless he specifies otherwise and shall be personally delivered or
delivered by overnight mail or courier delivery.
Section 10. Insurance and Self-Insurance Arrangements. The Company
may procure or maintain insurance or other similar arrangements, at its
expense, to protect itself and any Indemnitee against any expense, liability or
loss asserted against or incurred by such person, incurred by him in such a
capacity or arising out of his Corporate Status as such a person, whether or
not the Company would have the power to indemnify such person against such
expense or liability. In considering the cost and availability of such
insurance, the Company (through the exercise of the business judgment of its
directors and officers) may, from time to time, purchase insurance which
provides for any and all of (a) deductibles, (b) limits on payments required to
be made by the insurer, or (c) coverage which may not be as comprehensive as
that previously included in insurance purchased by the Company. The purchase
of insurance with deductibles, limits on payments and coverage exclusions will
be deemed to be in the best interest of the Company but may not be in the best
interest of certain of the persons covered thereby. As to the Company,
purchasing insurance with deductibles, limits on payments, and coverage
exclusions is similar to the Company's practice of self-insurance in other
areas. In order to protect the Indemnitees who would otherwise be more fully
or entirely covered under such policies, the Company shall indemnify and hold
each of them harmless as provided in Section 1 or 2 of this Article, without
regard to whether the Company would otherwise be entitled to indemnify such
officer or director under the other provisions of this Article, or under any
law, agreement, vote of shareholders or directors or other arrangement, to the
extent (i) of such deductibles, (ii) of amounts exceeding payments required to
be made by an insurer or (iii) that prior policies of officer's and director's
liability insurance held by the Company or its predecessors would have provided
for payment to such officer or director. Notwithstanding the foregoing
provision of this Section, no Indemnitee shall be entitled to indemnification
for the results of such person's conduct that is intentionally adverse to the
interests of the Company. This Section is authorized by Section 2.02-1(R) of
the TBCA as in effect on May 1, 1996, and further is intended to establish an
arrangement of self-insurance pursuant to that section.
Page 19 of 21
<PAGE> 20
ARTICLE VI
MISCELLANEOUS PROVISIONS
Section 1. Offices. The principal office of the Company shall be
located in Houston, Texas, unless and until changed by resolution of the Board
of Directors. The Company may also have offices at such other places as the
Board of Directors may designate from time to time, or as the business of the
Company may require. The principal office and registered office may be, but
need not be, the same.
Section 2. Resignations. Any director or officer may resign at any
time. Such resignations shall be made in writing and shall take effect at the
time specified therein, or, if no time be specified, at the time of its receipt
by the Chairman of the Board, if there is one, the Chief Executive Officer, if
there is one, the President or the Secretary. The acceptance of a resignation
shall not be necessary to make it effective, unless expressly so provided in
the resignation.
Section 3. Seal. The seal of the Company shall be circular in form,
with the name "HOUSTON INDUSTRIES INCORPORATED."
Section 4. Separability. If one or more of the provisions of these
Bylaws shall be held to be invalid, illegal or unenforceable, such invalidity,
illegality or unenforceability shall not affect any other provision hereof and
these Bylaws shall be construed as if such invalid, illegal or unenforceable
provision or provisions had never been contained herein.
ARTICLE VII
AMENDMENT OF BYLAWS
Section 1. Vote Requirements. The Board of Directors shall have the
power to alter, amend or repeal the Bylaws or adopt new Bylaws by the
affirmative vote of at least 80% of all directors then in office at any regular
or special meeting of the Board of Directors, subject to repeal or change by
the affirmative vote of the holders of at least 80% of the voting power of all
the shares of the Company entitled to vote in the election of directors, voting
together as a single class.
Section 2. Shareholder Proposals. No proposal by a shareholder made
pursuant to Section 1 of this Article VII may be voted upon at an annual
meeting of shareholders unless such shareholder shall have delivered or mailed
in a timely manner (as set forth in this Section 2) and in writing to the
Secretary of the Company (a) notice of such proposal and the text of the
proposed alteration, amendment or repeal, (b) evidence reasonably satisfactory
to the Secretary of the Company, of such shareholder's status as such and of
the number of shares of each class of capital stock of the Company of which
such shareholder is the beneficial owner, (c) a list of the names and addresses
of other beneficial owners of shares of the capital stock of the Company, if
any, with whom such
Page 20 of 21
<PAGE> 21
shareholder is acting in concert, and the number of shares of each class of
capital stock of the Company beneficially owned by each such beneficial owner
and (d) an opinion of counsel, which counsel and the form and substance of
which opinion shall be reasonably satisfactory to the Board of Directors of the
Company, to the effect that the Bylaws (if any) resulting from the adoption of
such proposal would not be in conflict with the Articles of Incorporation of
the Company or the laws of the State of Texas. To be timely in connection with
an annual meeting of shareholders, a shareholder's notice and other aforesaid
items shall be delivered to or mailed and received at the principal executive
offices of the Company not less than ninety nor more than 180 days prior to the
date on which the immediately preceding year's annual meeting of shareholders
was held. In no event shall the public disclosure of an adjournment of an
annual meeting of shareholders commence a new time period for the giving of a
shareholder's notice as described above.
Within thirty days after such shareholder shall have submitted the
aforesaid items, the Secretary or the Board of Directors of the Company shall
determine whether the items to be ruled upon by them are reasonably
satisfactory and shall notify such shareholder in writing of its determination.
If such shareholder fails to submit a required item in the form or within the
time indicated, or if the Secretary or the Board of Directors of the Company
determines that the items to be ruled upon by them are not reasonably
satisfactory, then such proposal by such shareholder may not be voted upon by
the shareholders of the Company at such annual meeting of shareholders. The
Chairman of the Meeting shall, if the facts warrant, determine and declare to
the meeting that a proposal by a shareholder of the Company made pursuant to
Section 1 of this Article VII was not made in accordance with the procedures
prescribed by these Bylaws, and if he should so determine, he shall so declare
to the meeting and the defective proposal shall be disregarded. Beneficial
ownership shall be determined in accordance with Rule 13d-3 under the Exchange
Act.
Nothing in this Section 2 shall be interpreted or construed to require
the inclusion of information about any such proposal in any proxy statement
distributed by, at the direction of, or on behalf of the Board of Directors or
the Company.
No proposal by a shareholder made pursuant to Section 1 of this
Article VII shall be voted upon at a special meeting of shareholders unless
such proposal has been stated in the notice of such special meeting or shall
otherwise have been properly brought before the meeting by or at the direction
of the Chairman of the Meeting or the Board of Directors (or any duly
authorized committee thereof).
Page 21 of 21
<PAGE> 1
HI -- EXHIBIT 12
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS TWELVE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1998
--------------- ----------------
<S> <C> <C>
FIXED CHARGES AS DEFINED:
(1) Interest on Long-Term Debt................................. $ 310,584 413,916
(2) Other Interest............................................. 67,620 92,906
(3) Capitalized Interest....................................... 8,187 10,357
(4) Distribution on Trust Securities........................... 21,960 29,462
(5) Interest Component of Rentals Charged to Operating Expense. 7,863 10,705
--------------- ----------------
(6) Total Fixed Charges........................................ $ 416,214 $ 557,346
=============== ================
EARNINGS AS DEFINED:
(7) Income from Continuing Operations.......................... $ 260,422 $ 256,487
(8) Income Taxes for Continuing Operations..................... 152,528 161,653
(9) Fixed Charges (line 6)..................................... 416,214 557,346
(10) Capitalized Interest....................................... (8,187) (10,357)
--------------- ----------------
(11) Income from Continuing Operations Before Income Taxes and
Fixed Charges.............................................. $ 820,977 $ 965,129
=============== ================
RATIO OF EARNINGS TO FIXED CHARGES (LINE 11 DIVIDED BY LINE 6) 1.97 1.73
PREFERRED DIVIDENDS REQUIREMENTS:
(12) Preferred Stock Dividends.................................. $ 292 $ 390
(13) Less Tax Deduction for Preferred Dividends................. 27 54
--------------- ----------------
(14) Total...................................................... $ 265 $ 336
(15) Ratio of Pre-Tax Income from continuing operations to Net
Income (line 7 plus line 8 divided by line 7).............. 1.59 1.63
(16) Line 14 times line 15...................................... $ 421 $ 548
(17) Add Back Tax Deduction (line 13)........................... 27 54
--------------- ----------------
(18) Preferred Dividends Factor................................. 448 602
=============== ================
(19) Total Fixed Charges (line 6)............................... $ 416,214 $ 557,346
(20) Preferred Dividends Factor (line 18)....................... 448 602
--------------- ----------------
(21) Total...................................................... 416,662 557,948
=============== ================
RATIOS OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS (LINE 11 --------------- ----------------
DIVIDED BY LINE 21).................................................... 1.97 1.73
=============== ================
</TABLE>
<TABLE> <S> <C>
<ARTICLE> OPUR1
<MULTIPLIER> 1,000
<CIK> 0000048732
<NAME> HOUSTON INDUSTRIES INCORPORATED
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 9,552,268
<OTHER-PROPERTY-AND-INVEST> 3,742,702
<TOTAL-CURRENT-ASSETS> 2,214,410
<TOTAL-DEFERRED-CHARGES> 4,040,450
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 19,549,830
<COMMON> 2,890,846
<CAPITAL-SURPLUS-PAID-IN> 0
<RETAINED-EARNINGS> 1,956,048
<TOTAL-COMMON-STOCKHOLDERS-EQ> 4,846,894
0
9,740
<LONG-TERM-DEBT-NET> 5,934,342
<SHORT-TERM-NOTES> 0
<LONG-TERM-NOTES-PAYABLE> 452,900
<COMMERCIAL-PAPER-OBLIGATIONS> 1,465,250
<LONG-TERM-DEBT-CURRENT-PORT> 610,923
0
<CAPITAL-LEASE-OBLIGATIONS> 14,760
<LEASES-CURRENT> 1,139
<OTHER-ITEMS-CAPITAL-AND-LIAB> 6,213,882
<TOT-CAPITALIZATION-AND-LIAB> 19,549,830
<GROSS-OPERATING-REVENUE> 8,844,237
<INCOME-TAX-EXPENSE> 152,528
<OTHER-OPERATING-EXPENSES> 7,597,219
<TOTAL-OPERATING-EXPENSES> 7,597,219
<OPERATING-INCOME-LOSS> 1,247,018
<OTHER-INCOME-NET> (436,871)
<INCOME-BEFORE-INTEREST-EXPEN> 810,147<F1>
<TOTAL-INTEREST-EXPENSE> 397,197
<NET-INCOME> 260,422
292
<EARNINGS-AVAILABLE-FOR-COMM> 260,130
<COMMON-STOCK-DIVIDENDS> 317,137
<TOTAL-INTEREST-ON-BONDS> 255,333
<CASH-FLOW-OPERATIONS> 1,174,079
<EPS-PRIMARY> 0.92
<EPS-DILUTED> 0.91
<FN>
<F1>TOTAL ANNUAL INTEREST CHARGES ON ALL BONDS IS AS OF YEAR-TO-DATE 9/30/98.
</FN>
</TABLE>
<PAGE> 1
HI -- EXHIBIT 99(a)
HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(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 plan should cease when the
legislation and enabling rate order contain sufficient detail for the utility
to reasonably determine what the transition plan will entail. In addition, EITF
97-4 requires the regulatory assets and liabilities to be allocated to the
applicable portion of the electric utility from which the source of the
regulated cash flows will be derived. On June 2, 1997, the Texas legislature
adjourned without having adopted or taken any formal action with respect to
various proposals concerning the restructuring of the Texas electric utility
industry, including proposals related to retail electric competition and
stranded cost recovery. At this time, the Company cannot predict what, if any,
action the Texas legislature may take in the next legislative session
(scheduled to commence in 1999) with respect to any of these proposals or the
ultimate form in which such proposals may be adopted, if at all. Although the
Company has determined that no impairment loss or write-offs of regulatory
assets need be recognized for applicable assets of continuing operations as of
December 31, 1997, this conclusion may change in
<PAGE> 2
the future (i) as competition influences wholesale and retail pricing in the
electric utility industry, (ii) depending on regulatory action, if any and
(iii) depending on legislation, if any, that is passed.
(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 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.
(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, 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.
<PAGE> 3
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.
(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
<PAGE> 4
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.
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
<PAGE> 5
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 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
<PAGE> 6
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 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.
<PAGE> 7
(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 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
<PAGE> 8
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.
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
<PAGE> 9
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 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.
(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
<PAGE> 10
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 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.
<PAGE> 11
(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.
(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.
<PAGE> 1
NorAm -- EXHIBIT 12
NORAM ENERGY CORP. AND SUBSIDIARIES
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS TWELVE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- ----------------
1998 1998
--------------- ----------------
<S> <C> <C>
Income from Continuing Operations...................................... $ 51,421 $ 78,914
Income Taxes for Continuing Operations................................. 53,759 78,928
Non-Utility Interest Capitalized....................................... 0 0
--------------- ----------------
Income from Continuing Operations Before Income Taxes.................. 105,180 157,842
Fixed Charges:
Interest.......................................................... 78,115 107,134
Distribution on Trust Securities.................................. 533 812
Portion of Rents Considered to Represent an Interest Factor....... 6,747 9,241
--------------- ----------------
Total Fixed Charges........................................... 85,395 117,187
--------------- ----------------
Income from Continuing Operations Before Income Taxes and
Fixed Charges................................................. $ 190,575 $ 275,029
=============== ================
Ratio of Earnings to Fixed Charges..................................... 2.23 2.35
=============== ================
</TABLE>
<TABLE> <S> <C>
<ARTICLE> OPUR1
<MULTIPLIER> 1,000
<CIK> 0001042773
<NAME> NORAM ENERGY CORP.
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 1,332,139
<OTHER-PROPERTY-AND-INVEST> 1,437,113
<TOTAL-CURRENT-ASSETS> 1,840,795
<TOTAL-DEFERRED-CHARGES> 2,261,079
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 6,871,126
<COMMON> 1
<CAPITAL-SURPLUS-PAID-IN> 2,447,288
<RETAINED-EARNINGS> 72,268
<TOTAL-COMMON-STOCKHOLDERS-EQ> 2,519,557
0
0
<LONG-TERM-DEBT-NET> 1,000,464
<SHORT-TERM-NOTES> 0
<LONG-TERM-NOTES-PAYABLE> 300,000
<COMMERCIAL-PAPER-OBLIGATIONS> 205,600
<LONG-TERM-DEBT-CURRENT-PORT> 354,962
0
<CAPITAL-LEASE-OBLIGATIONS> 0
<LEASES-CURRENT> 0
<OTHER-ITEMS-CAPITAL-AND-LIAB> 2,490,543
<TOT-CAPITALIZATION-AND-LIAB> 6,871,126
<GROSS-OPERATING-REVENUE> 5,072,969
<INCOME-TAX-EXPENSE> 53,759
<OTHER-OPERATING-EXPENSES> 4,894,726
<TOTAL-OPERATING-EXPENSES> 4,894,726
<OPERATING-INCOME-LOSS> 178,243
<OTHER-INCOME-NET> 5,585
<INCOME-BEFORE-INTEREST-EXPEN> 183,828<F1>
<TOTAL-INTEREST-EXPENSE> 78,648
<NET-INCOME> 51,421
0
<EARNINGS-AVAILABLE-FOR-COMM> 51,421
<COMMON-STOCK-DIVIDENDS> 0
<TOTAL-INTEREST-ON-BONDS> 78,115
<CASH-FLOW-OPERATIONS> 192,318
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1>TOTAL ANNUAL INTEREST CHARGES ON ALL BONDS IS AS OF YEAR-TO-DATE 9/30/98.
</FN>
</TABLE>
<PAGE> 1
NorAm -- EXHIBIT 99(a)
NORAM ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
(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.
(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.
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 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 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.
(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).
<PAGE> 2
(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 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
<PAGE> 3
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.
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.
