<PAGE>
===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No. )
Filed by the Registrant [X]
Filed by a Party other than the Registrant [_]
Check the appropriate box:
[_] Preliminary Proxy Statement [_] CONFIDENTIAL, FOR USE OF THE
COMMISSION ONLY (AS PERMITTED BY
RULE 14A-6(E)(2))
[X] Definitive Proxy Statement
[_] Definitive Additional Materials
[_] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
HOUSTON INDUSTRIES INCORPORATED
- --------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required
[_] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
(1) Title of each class of securities to which transaction applies:
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(2) Aggregate number of securities to which transaction applies:
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(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which
the filing fee is calculated and state how it was determined):
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(4) Proposed maximum aggregate value of transaction:
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(5) Total fee paid:
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[_] Fee paid previously with preliminary materials.
[_] Check box if any part of the fee is offset as provided by Exchange
Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee
was paid previously. Identify the previous filing by registration statement
number, or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
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(4) Date Filed:
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Notes:
<PAGE>
[Logo of Reliant Energy]
Houston
Industries
Incorporated
doing business as
Reliant Energy, Incorporated
Notice of Annual Meeting of Shareholders
to be held on May 5, 1999
and Proxy Statement
<PAGE>
Table of Contents
<TABLE>
<CAPTION>
Page
----
<S> <C>
Notice of Annual Meeting of Shareholders
Proxy Statement........................................................... 1
Voting Information...................................................... 1
Information About Directors............................................. 1
Stock Ownership......................................................... 5
Executive Compensation Tables........................................... 6
Retirement Plans, Related Benefits and Other Arrangements............... 8
Report of the Compensation Committee.................................... 12
Stock Performance Graph................................................. 16
Proposal to Change the Company's Name by Amending the Restated Articles
of Incorporation....................................................... 17
Ratification of Appointment of Independent Accountants and Auditors..... 17
Shareholder Proposals for 2000 Annual Meeting........................... 17
Director Nominations for 2000 Annual Meeting of Shareholders............ 18
General Information..................................................... 18
Section 16(a) Beneficial Ownership Reporting Compliance................. 18
Annual Report to Shareholders........................................... 18
</TABLE>
<PAGE>
[Logo of Reliant Energy appears here]
Notice of Annual Meeting of Shareholders
Dear Shareholder:
You are cordially invited to attend the Houston Industries Incorporated 1999
Annual Meeting of shareholders. The meeting will be held in the Auditorium of
Reliant Energy Plaza, 1111 Louisiana, Houston, Texas, at 9:00 a.m. Central
time, on Wednesday, May 5, 1999. At the meeting, shareholders will be asked
to:
. elect four Class III Directors for three-year terms;
. vote to approve changing the corporate name to "Reliant Energy,
Incorporated", by amending the Company's Restated Articles of
Incorporation;
. ratify the appointment of Deloitte & Touche LLP as independent
accountants and auditors for the Company for 1999; and
. conduct other business if properly raised.
Shareholders of record at the close of business on March 8, 1999 are
entitled to vote. Each share entitles the holder to one vote. You may vote by
either attending the meeting or by proxy card. For specific voting
information, please see "Voting Information" on page 1. Even if you plan to
attend the meeting, please sign, date and return the enclosed proxy card.
Sincerely,
/s/ Hugh Rice Kelly
Hugh Rice Kelly
Executive Vice President,
General Counsel and
Corporate Secretary
Dated and first mailed
to Shareholders
on March 29, 1999
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
(d/b/a Reliant Energy, Incorporated)
1111 Louisiana, Houston, Texas 77002
(713) 207-3000
PROXY STATEMENT
Voting Information
Who may vote. Shareholders recorded in our stock register on March 8, 1999,
may vote at the meeting. As of March 8, 1999, there were 296,329,501 shares of
common stock outstanding. Each share of common stock has one vote.
Voting by proxy or in person. Your vote is important. You may vote in person
at the meeting or by proxy. We recommend you vote by proxy even if you plan to
attend the meeting. You may always change your vote at the meeting. Giving us
your proxy means that you authorize us to vote your shares at the meeting in
the manner you indicated on your proxy card. You may vote for all, some or
none of our director candidates. You may also vote for or against the other
proposals or abstain from voting.
If you sign and return the enclosed proxy card but do not specify how to
vote, we will vote your shares in favor of the director candidates, in favor
of the corporate name change and in favor of the ratification of independent
accountants.
Your proxy may be revoked before it is voted by submitting a new proxy with
a later date, by voting in person at the meeting, or by giving written notice
to Mr. Robert E. Smith, Assistant Corporate Secretary, at the Company's
address shown above.
If you plan to attend the meeting and your shares are held by banks, brokers
or investment plans (in "street name"), you will need proof of ownership to be
admitted to the meeting. A recent brokerage statement or letter from your
broker or bank are examples of proof of ownership.
Quorum needed. In order to carry on the business of the meeting we must have
a quorum. This means at least a majority of the outstanding shares eligible to
vote must be represented at the meeting, either by proxy or in person. Shares
owned by the Company are not voted and do not count for this purpose.
Votes needed. The director candidates receiving the most votes will be
elected to fill the Class III seats on the Board. Approval of the amendment to
the Company's Restated Articles of Incorporation to change the corporate name
requires the favorable vote of a majority of the outstanding shares of common
stock. Ratification of the appointment of independent accountants requires the
favorable vote of a majority of the shares of common stock voted for or
against the matter. Abstentions and broker non-votes count for quorum
proposes. For voting purposes, abstentions and broker non-votes have the same
effect as a vote against the amendment to change the corporate name but do not
affect the determination of whether the appointment of independent accountants
is ratified. Broker non-votes occur when a broker returns a proxy but does not
have authority to vote on a particular proposal.
Information About Directors
The Company's Board of Directors is divided into three classes having
staggered terms of three years. The term of office of the directors in Class
III expires at this year's meeting. The terms of office of the Class I and
Class II directors will expire in 2000 and 2001, respectively. At each annual
meeting, directors are elected to succeed the Class of directors whose terms
have expired.
Under the Company's bylaws, no director is permitted to stand for reelection
after serving on the Board for 10 years, unless such director was a director
as of April 1, 1992, or is an employee of the Company or one of its
<PAGE>
affiliates. A director is not permitted under the Bylaws to serve as a
director after the next annual meeting following the month in which the
director reaches age 70. In accordance with this age policy, Mr. Robert C.
Hanna will retire from the Board at the meeting, prior to the end of his Class
II term. In addition, Class III director Mr. Joseph M. Grant, whose term
expires at the meeting, will not stand for reelection. The directors will
continue to serve until their terms expire, unless they die, resign or are
removed before such time.
The Class III directors are up for election to a three-year term ending at
the annual meeting in 2002. Those nominees are current directors James A.
Baker, III, Richard E. Balzhiser, O. Holcombe Crosswell and Don D. Jordan. If
a Class III nominee becomes unavailable for election before the meeting, the
Board of Directors can name a substitute nominee and proxies will be voted for
such substitute nominee pursuant to discretionary authority.
Information about each of the nominees and the continuing directors is
provided below.
Class III Directors--Term Expiring 2002
James A. Baker, III, age 68, has been a director since 1996. Mr. Baker is
currently a senior partner in the law firm of Baker & Botts, L.L.P. in
Houston, Texas, Senior Counselor to The Carlyle Group, a merchant banking firm
in Washington, D. C., and a director of Electronic Data Systems. He served as
the U.S. Secretary of State from January 1989 through August 1992 and as White
House Chief of Staff and Senior Counselor to President Bush from August 1992
to January 1993. From 1985 to 1988, Mr. Baker was the U.S. Secretary of the
Treasury and Chairman of the President's Economic Policy Council in the
administration of President Reagan, having previously served as President
Reagan's White House Chief of Staff from 1981 to 1985 and as President Ford's
Under Secretary of Commerce in 1975.
Richard E. Balzhiser, Ph.D., age 66, has been a director since 1996. Dr.
Balzhiser is President Emeritus of the Electric Power Research Institute
(EPRI) in Palo Alto, California, a collaborative research and development
organization funded by member electric utilities. Dr. Balzhiser joined EPRI in
1973 as Director of the Fossil Fuel Advanced Systems Division. He became Vice
President of Research and Development in 1979 and Executive Vice President in
1987 and served as President and Chief Executive Officer from 1988 through
August 1996. He is a director of Electrosource Inc.
O. Holcombe Crosswell, age 58, has been a director since 1997. Mr. Crosswell
is President of Griggs Corporation, a real estate and investment company in
Houston, Texas.
Don D. Jordan, age 66, has been a director since 1974. Mr. Jordan is
Chairman and Chief Executive Officer of the Company. Effective June 1, 1999,
Mr. Jordan will step down as Chief Executive Officer and continue employment
as Chairman of the Board of the Company. He also serves as an advisory
director of Chase Bank of Texas, National Association and a director of AEGIS
Insurance Services, Inc. and BJ Services Company, Inc.
The Board of Directors recommends a vote FOR all nominees for Class III
Director.
Class I Directors--Term Expiring 2000
Robert J. Cruikshank, age 68, has been a director since 1993. Mr. Cruikshank
is primarily engaged in managing his personal investments in Houston, Texas.
Prior to his retirement in 1993, he was a Senior Partner in the accounting
firm of Deloitte & Touche. Mr. Cruikshank serves as a director of Kaiser
Aluminum Corporation, MAXXAM Inc., Texas Biotechnology Corporation, Weingarten
Realty Investors and as an advisory director of Compass Bank.
Linnet F. Deily, age 53, has been a director since 1993. Ms. Deily is
President, Schwab Retail Group of Charles Schwab & Co., Inc. in San Francisco,
California and is a member of the firm's management committee.
2
<PAGE>
She previously served as Chairman, Chief Executive Officer and President of
First Interstate Bank of Texas, N.A. until April 1996, having been Chairman
since 1992, Chief Executive Officer since 1991 and President of First
Interstate Bank of Texas since 1988.
Lee W. Hogan, age 54, has been a director since 1995. Mr. Hogan is Executive
Vice President of the Company and President and Chief Executive Officer of its
Reliant Energy Retail Group, having served in those capacities since January
1997. He has served since 1990 in various positions as an executive officer of
the Company and its corporate predecessors and subsidiaries.
T. Milton Honea, age 66, has been a director since 1997. Mr. Honea was
Chairman of the Board, President and Chief Executive Officer of NorAm Energy
Corp. (NorAm) until its acquisition by the Company in 1997, having served in
that capacity since December 1992. He was Executive Vice President of NorAm
from October 1991 until July 1992 and President and Chief Operating Officer of
Arkansas Louisiana Gas Company, a division of NorAm, from October 1984 to
October 1991.
Alexander F. Schilt, Ph.D., age 58, has been a director since 1992. Dr.
Schilt is the President of the InterAmerican University Council for Economic
and Social Development. He served as Chancellor of the University of Houston
until August 1995. Prior to 1990, he was President of Eastern Washington
University in Cheney and Spokane, Washington.
Class II Directors--Term Expiring 2001
Milton Carroll, age 48, has been a director since 1992. Mr. Carroll is
Chairman, President and Chief Executive Officer of Instrument Products, Inc.,
an oil-tool manufacturing company in Houston, Texas. He is a director of
Health Care Service Corporation, Seagull Energy Corporation and TEPPCO
Partners, L.P.
John T. Cater, age 63, has been a director since 1983. Mr. Cater is
President of Compass Bank--Houston. He previously served as Chairman and a
director of River Oaks Trust Company and as President, Chief Operating Officer
and a director of MCorp, a Texas bank holding company.
R. Steve Letbetter, age 50, has been a director since 1995. Mr. Letbetter is
President and Chief Operating Officer of the Company, having served in that
capacity since January 1997. Effective June 1, 1999, Mr. Letbetter will become
President and Chief Executive Officer of the Company. He has served since 1978
in various positions as an executive officer of the Company and its corporate
predecessors. Mr. Letbetter is a director of Chase Bank of Texas--Houston.
Board Organization and Committees
The Board of Directors directs the management of the business and affairs of
the Company. The Board appoints committees to help carry out its duties.
Several committees oversee specific matters affecting the Company, including
the Executive Committee, the Audit Committee, the Finance Committee, the
Compensation Committee, the Nuclear Committee and the Unregulated Business
Committee. Last year the Board met nine times and the committees met a total
of 23 times. Each director attended more than 75 percent of the meetings of
the Board of Directors and the committees on which he or she served.
The Executive Committee consists of seven members: Mr. Carroll, Mr. Cater,
Mr. Cruikshank, Ms. Deily, Mr. Honea, Mr. Jordan and Mr. Letbetter. This
committee reviews management recommendations for organizational changes,
consults on duties of executive officers and recommends potential candidates
for election to the Board of Directors. In evaluating potential director
nominees, the Executive Committee will consider qualified persons recommended
by shareholders. Any shareholder wishing to make a recommendation should write
to the Chairman of the Executive Committee at the Company's address shown
above. The committee met twice in 1998.
The Audit Committee consists of five non-employee directors: Mr. Carroll,
Mr. Crosswell, Mr. Cruikshank, Mr. Grant and Dr. Schilt. This committee
oversees accounting and internal control matters. The committee
3
<PAGE>
recommends to the Board of Directors the selection of the firm of independent
public accountants to audit the financial statements of the Company and its
subsidiaries and reviews and approves the plan and scope of the independent
public accountants' audit and non-audit services and related fees. The
committee met four times in 1998.
The Finance Committee consists of five members: Mr. Cater, Ms. Deily, Mr.
Grant, Mr. Hogan and Mr. Jordan. This committee reviews the Company's
financial policies and strategies, including capital structure, and approves
specific debt and equity offerings within limits set by the Board. The
committee met five times in 1998.
The Compensation Committee consists of four non-employee directors: Dr.
Balzhiser, Mr. Cruikshank, Ms. Deily and Mr. Hanna. This committee oversees
compensation and benefits for the Company's senior officers, including salary,
bonus and incentive awards. The committee reviews human resource programs and
monitors and, in certain cases, administers employee benefit plans. The
committee's report on executive compensation begins on page 12. The committee
met four times in 1998.
The Nuclear Committee consists of three non-employee directors: Dr.
Balzhiser, Mr. Crosswell and Dr. Schilt. This Committee reviews the Company's
nuclear development efforts and operations and makes recommendations about
nuclear regulatory reports and licensing requirements, management evaluations
of nuclear engineering and construction, and operations progress and
performance. The committee met three times in 1998.
The Unregulated Business Committee consists of four directors: Dr.
Balzhiser, Ms. Deily, Mr. Honea and Mr. Jordan. This committee reviews the
Company's strategy and activities in the areas of domestic and foreign
independent power generation projects and the privatization of foreign
generating and distribution facilities. The committee met five times in 1998.
Compensation of Directors
Company employees receive no extra pay for serving as directors. Each non-
employee director receives an annual retainer fee of $20,000, a fee of $1,000
for each board and committee meeting attended and 500 shares of Company common
stock annually under the Stock Plan for Outside Directors. Directors may defer
all or part of their annual retainer fees and meeting fees under the Company's
deferred compensation plan. The deferred compensation plan currently provides
for accrual of interest on deferred director compensation at a rate equal to
the average annual yield on the Moody's Long-Term Corporate Bond Index plus
two percentage points.
Non-employee directors participate in a director benefits plan under which a
director who serves at least one full year will receive an annual cash amount
equal to the annual retainer in the year the director terminates service.
Benefits under this plan commence the January following the later of the
director's termination of service or attainment of age 65, for a period equal
to the number of full years of service of the director.
Non-employee directors may also participate in the Company's executive life
insurance plan described under "Retirement Plans, Related Benefits and Other
Agreements." This plan provides split-dollar life insurance with a death
benefit equal to six times the director's annual retainer with coverage
continuing after termination of service as a director. The plan also permits
the Company to provide for a tax reimbursement payment to make the directors
whole for any imputed income recognized with respect to the term portion of
the annual insurance premiums. Upon death, the Company will receive the
balance of the insurance proceeds payable in excess of the specified death
benefit. The plan is designed so that the proceeds received by the Company are
expected to be at least sufficient to cover the Company's cumulative outlays
to pay premiums and the after-tax cost to the Company of the tax reimbursement
payments.
Baker & Botts, L.L.P. has provided legal services to the Company and its
subsidiaries during 1998, and is continuing to provide legal services during
1999. Class III nominee Mr. Baker is a senior partner at such firm.
Mr. Carroll performed consulting services for the Company during 1998 in
connection with deregulation issues, for which he was paid an aggregate of
$260,000.
4
<PAGE>
Stock Ownership
The following table gives information as of February 1, 1999, about the
stock ownership of any beneficial owner of more than 5% of the Company's
common stock, the directors, the Chief Executive Officer, the four most highly
compensated other executive officers, and the executive officers and directors
as a group. Each director and officer and the directors and officers as a
group beneficially owns less than 1% of the Company's outstanding common
stock.
<TABLE>
<CAPTION>
Number of
Name Shares
---- ----------
<S> <C>
Northern Trust Corporation........................... 31,054,460(1)
50 South LaSalle Street
Chicago, Illinois 60675
James A. Baker, III.................................. 2,500
Richard E. Balzhiser................................. 1,600
Milton Carroll....................................... 3,900
John T. Cater........................................ 3,500(2)
O. Holcombe Crosswell................................ 11,095
Robert J. Cruikshank................................. 3,500
Linnet F. Deily...................................... 3,500(3)
Joseph M. Grant...................................... 5,311
Robert C. Hanna...................................... 30,433
Lee W. Hogan......................................... 67,272(4)(5)
T. Milton Honea...................................... 101,971
Don D. Jordan........................................ 555,718(4)(5)(6)
Hugh Rice Kelly...................................... 117,288(4)(5)
R. Steve Letbetter................................... 139,277(4)(5)
Stephen W. Naeve..................................... 63,796(4)(5)
Alexander F. Schilt.................................. 2,300
All of the above and other executive officers as a
group (20 persons).................................. 1,310,719(4)(5)
</TABLE>
- --------
(1) This represents 10.5% of the outstanding common stock of the Company. This
information is as of December 31, 1998 and is based on a Schedule 13G
filed with the Securities and Exchange Commission (SEC) on February 9,
1999 by Northern Trust Corporation and certain of its subsidiaries. The
13G reports sole voting power for 657,533 shares, shared voting power for
30,375,625 shares, sole dispositive power for 996,760 shares and shared
dispositive power for 74,501 shares. The Company understands that the
shares reported include 29,962,679 shares held as trustee of the Company's
savings plans.
(2) Includes 2,000 shares held by adult children.
(3) Owned jointly with spouse.
(4) Includes shares held under the Company's savings plan, as to which the
participant has sole voting power (subject to such power being exercised
by the plan's trustee in the same proportion as directed shares in the
savings plan are voted in the event the participant does not exercise
voting power).
(5) Includes shares covered by exercisable stock options as follows: Mr.
Hogan--24,334 shares; Mr. Jordan--166,872 shares; Mr. Kelly--49,884
shares; Mr. Letbetter--72,463 shares; Mr. Naeve--31,349 shares; and the
group--444,585 shares.
(6) Includes 1,152 shares owned jointly with spouse.
5
<PAGE>
Executive Compensation Tables
These tables show the compensation of the Company's chief executive officer
and the four other most highly compensated executive officers.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long-Term Compensation
---------------------------------
Annual Compensation Awards Payouts
------------------------------------------ ---------------------- ----------
Restricted Securities
Name and Principal Other Annual Stock Underlying LTIP All Other
Position Year Salary(1) Bonus(1) Compensation(2) Award(3) Options (#) Payouts(4) Compensation(5)
------------------ ---- ---------- ---------- --------------- ---------- ----------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Don D. Jordan........... 1998 $1,235,000 $1,852,500 $97,653 $1,025,825 $1,361,548
Chairman and Chief 1997 1,000,000 1,080,000 640,754 $3,525,000 33,803 621,392 2,047,142
Executive Officer 1996 962,292 1,050,000 13,300 27,985 767,440 819,105
R. Steve Letbetter...... 1998 559,583 624,750 65,225 100,000 307,714 101,093
President and Chief 1997 481,250 447,525 266 9,938 151,612 77,401
Operating Officer 1996 416,000 330,750 228 7,815 138,831 45,151
Lee W. Hogan............ 1998 429,167 405,000 61,126 50,000 335,000 60,847
Executive Vice
President 1997 372,917 324,000 1,616 43,981
of the Company and
Chief 1996 310,000 401,722 1,260 42,360 20,913
Executive Officer of
the Retail Energy Group
Hugh Rice Kelly......... 1998 370,500 311,850 837 50,000 241,672 86,907
Executive Vice
President, 1997 355,417 218,700 782 6,292 141,497 69,091
General Counsel and 1996 344,833 209,400 705 5,563 176,311 37,495
Corporate Secretary
Stephen W. Naeve........ 1998 344,167 328,500 61 50,000 105,758 38,498
Executive Vice
President 1997 294,167 191,363 55 4,777 55,724 30,128
and Chief Financial 1996 237,917 159,000 43 2,462 62,457 20,682
Officer
</TABLE>
- --------
(1) The amounts shown include salary and bonus earned as well as earned but
deferred.
(2) In 1998, the Company discontinued providing vehicles for its executive
officers and paid to the executive officers a one-time transition payment
as follows: Mr. Jordan, $46,700; Mr. Letbetter, $46,700; and Mr. Hogan,
$46,700.
(3) On February 25, 1997, Mr. Jordan received a grant of 150,000 shares of
restricted stock, to vest on June 1, 1999, pursuant to an employment
agreement with the Company. The amount shown is the closing market price of
150,000 shares of Common Stock on February 25, 1997. The closing market
price of 150,000 shares of common stock on December 31, 1998 was
$4,809,375.
(4) 1998 amounts represent the dollar value of the Company common stock paid in
1998 based on the achievement of performance goals for the 1995-1997
performance cycle, plus dividend equivalent accruals during the performance
period.
(5) 1998 amounts include (i) matching contributions to the Company's savings
plans and accruals under the savings restoration plans as follows: Mr.
Jordan, $142,983; Mr. Letbetter, $92,404; Mr. Hogan, $55,068; Mr. Kelly,
$64,131; and Mr. Naeve $30,479; (ii) the term portion of the premiums paid
by the Company under split-dollar life insurance policies purchased in
connection with the Company's executive life insurance plan, as follows:
Mr. Jordan, $28,200; Mr. Letbetter, $436; Mr. Hogan, $2,496; Mr. Kelly,
$1,202; and Mr. Naeve, $88; and (iii) accrued interest on deferred
compensation that exceeds 120% of the applicable federal long-term rate as
follows: Mr. Jordan, $1,190,365; Mr. Letbetter, $8,253; Mr. Hogan, $3,283;
Mr. Kelly, $21,574 and Mr. Naeve, $7,931.
6
<PAGE>
OPTION GRANTS IN 1998
<TABLE>
<CAPTION>
Individual Grants
-------------------
Shares % of 1998 Exercise/ Grant
Underlying Employee Base Date
Options Option Price Per Expiration Present
Name Granted(1) Grants Share ($) Date Value(2)
- ---- ---------- --------- --------- ---------- --------
<S> <C> <C> <C> <C> <C>
R. Steve Letbetter........... 100,000 4.49% 25.8125 3/2/08 $427,000
Lee W. Hogan................. 50,000 2.24% 25.8125 3/2/08 213,500
Hugh Rice Kelly.............. 50,000 2.24% 25.8125 3/2/08 213,500
Stephen W. Naeve............. 50,000 2.24% 25.8125 3/2/08 213,500
</TABLE>
- --------
(1) Option grants vest in one-third increments per year from the date of grant
(so long as the officer remains an employee). All options would
immediately vest upon a change in control as defined in the Company's
long-term incentive plan. A "change in control" generally is deemed to
have occurred if (a) any person or group becomes the direct or indirect
beneficial owner of 30% or more of the Company's outstanding voting
securities; (b) the majority of the Board changes as a result of or in
connection with, certain transactions; (c) as a result of a merger or
consolidation, less than 70% of the surviving corporation's outstanding
voting securities is owned by former shareholders of the Company
(excluding any party to the transaction or their affiliates); (d) a tender
offer or exchange offer is made and consummated for the ownership of 30%
or more of the Company's outstanding voting securities; or (e) the Company
transfers all or substantially all of its assets to another corporation
that is not wholly owned by the Company.
(2) Grant date value is based on the Black-Scholes option pricing model
assuming a ten-year term, volatility of 24.012%, an annual dividend of
$1.50 per share, and a risk-free interest rate of 5.65%. Actual gains, if
any, will be dependent on future performance of the common stock.
1998 YEAR END OPTION VALUES
<TABLE>
<CAPTION>
Number of Unexercised Value of Unexercised
Options at December 31, In-the-Money Options at
1998 December 31, 1998(2)
------------------------- --------------------------
Name(1) Exercisable/Unexercisable Exercisable/Unexercisable
- ------- ------------------------- --------------------------
<S> <C> <C> <C> <C>
Don D. Jordan............... 146,277 31,863 $ 1,102,052 $ 202,636
R. Steve Letbetter.......... 33,213 109,230 255,479 396,412
Lee W. Hogan................ 7,668 50,000 51,798 168,750
Hugh Rice Kelly............. 29,266 56,049 221,257 207,037
Stephen W. Naeve............ 12,269 54,006 93,466 194,996
</TABLE>
- --------
(1) None of the named officers exercised any options in 1998.
(2) Based on the average of the high and low sales prices of the Common Stock
on the New York Stock Exchange Composite Tape, as reported in The Wall
Street Journal for December 31, 1998.
7
<PAGE>
LONG-TERM INCENTIVE PLAN--AWARDS IN 1998(1)
<TABLE>
<CAPTION>
Estimated Future Payouts
Under Non-Stock Price-
Based Plans(2)
Performance ------------------------
Period Target Maximum
Number Until Threshold Number Number
of Maturation Number of of of
Name Shares or Payout Shares Shares Shares
- ---- ------ ----------- --------- ------ -------
<S> <C> <C> <C> <C> <C>
R. Steve Letbetter.................. 12,952 12/31/00 6,476 12,952 19,428
Lee W. Hogan........................ 8,466 12/31/00 4,233 8,466 12,699
Hugh Rice Kelly..................... 6,095 12/31/00 3,048 6,095 9,143
Stephen W. Naeve.................... 5,333 12/31/00 2,667 5,333 8,000
</TABLE>
- --------
(1) Amounts shown are potential payouts of awards of common stock under the
Company's long term incentive plan. Such awards have a three-year
performance cycle. Payouts are based on growth in earnings per share,
total shareholder return and cash return on capitalization. If a change in
control occurs, such amounts will be paid in cash at the maximum level,
without regard to the achievement of performance goals. See the Report of
the Compensation Committee on page 12 for more information about the long-
term plan.
(2) The table does not reflect dividend equivalent accruals during the
performance period.
Retirement Plans, Related Benefits and Other Arrangements
PENSION PLAN TABLE
<TABLE>
<CAPTION>
Final
Average
Annual Estimated Annual Pension Based on Years of Service(2)
Compensation ----------------------------------------------------------------------
At Age 65(1) 15 20 25 30 ^35
- ------------ -------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
$ 500,000 $143,318 $ 191,091 $ 238,863 $ 286,636 $ 334,409
$ 750,000 $216,068 $ 288,091 $ 360,113 $ 432,136 $ 504,159
$1,000,000 $288,818 $ 385,091 $ 481,363 $ 577,636 $ 673,909
$1,250,000 $361,568 $ 482,091 $ 602,613 $ 723,136 $ 843,659
$1,500,000 $434,318 $ 579,091 $ 723,863 $ 868,636 $1,013,409
$1,750,000 $507,068 $ 676,091 $ 845,113 $1,014,136 $1,183,159
$2,000,000 $579,818 $ 773,091 $ 966,363 $1,159,636 $1,352,909
$2,250,000 $652,568 $ 870,091 $1,087,613 $1,305,136 $1,522,659
$2,500,000 $725,318 $ 967,091 $1,208,863 $1,450,636 $1,692,409
$2,750,000 $798,068 $1,064,091 $1,330,113 $1,596,136 $1,862,159
$3,000,000 $870,818 $1,161,091 $1,451,363 $1,741,636 $2,031,909
$3,250,000 $943,568 $1,258,091 $1,572,613 $1,887,136 $2,201,659
</TABLE>
- --------
(1) Effective January 1, 1999, the retirement plan provides a new cash balance
benefit formula in place of the final average formula on which the
benefits shown above are based. Retirement benefits for persons retiring
on or before December 31, 2008 will be based on the higher of the benefit
calculated under the final average formula and that calculated under the
new formula. For the named officers, benefits under the amended plan are
not expected to exceed the amounts reflected in the table. Final average
annual compensation means the highest compensation for 36 consecutive
months out of the 120 consecutive months immediately preceding retirement.
It includes only salary and bonus amounts. At December 31, 1998, the
credited years of service for the following persons were: 35 years for Mr.
Jordan; 25 years for Mr. Letbetter; 8 years for Mr. Hogan; 24 years for
Mr. Kelly (10 of which result from a supplemental agreement) and 26 years
for Mr. Naeve. Under a supplemental agreement with Mr. Hogan, upon the
earliest of his normal retirement, disability or death, Mr. Hogan will be
eligible for supplemental pension benefits determined as if his employment
had commenced fifteen years prior to his first day of actual employment
with the Company.
(2) Amounts are determined on a single-life annuity basis and are not subject
to any deduction for Social Security or other offsetting amounts. The
qualified pension plan limits compensation and benefits in accordance with
provisions of the Internal Revenue Code. Pension benefits based on
compensation above the qualified plan limit or in excess of the limit on
annual benefits are provided through the benefits restoration plan.
8
<PAGE>
The Company maintains an executive benefits plan that provides certain
salary continuation, disability and death benefits to certain key officers of
the Company and certain of its subsidiaries. All of the named officers
participate in this plan pursuant to individual agreements that generally
provide for (i) a salary continuation benefit of 100% of the officer's current
salary for twelve months after death during active employment and then 50% of
salary for nine years or until the deceased officer would have attained age
65, if later, and (ii) if the officer retires after attainment of age 65, an
annual post-retirement death benefit of 50% of the officer's preretirement
annual salary payable for six years. Coverage under this plan has not been
provided to persons attaining executive officer status after July 1, 1996.
The Company has an executive life insurance plan providing split-dollar life
insurance in the form of a death benefit for officers and members of the Board
of Directors. The death benefit coverage varies but in each case is based on
coverage (either single life or second to die) that is available for the same
amount of premium that could purchase coverage equal to four times current
salary for Messrs. Letbetter and Hogan; two times current salary for Mr. Kelly
and Mr. Naeve; thirty million dollars for Mr. Jordan; and six times the annual
retainer for the Company's non-employee directors. The plan also provides that
the Company may make payments to the covered individuals to compensate for tax
consequences of imputed income that they must recognize for federal income tax
purposes based on the term portion of the annual premiums. If a covered
executive retires at age 65 or at an earlier age under circumstances approved
by the Board of Directors, rights under the plan vest so that coverage is
continued based on the same death benefit in effect at the time of retirement.
Upon death, the Company will receive the balance of the insurance proceeds
payable in excess of the specified death benefit which is expected to be at
least sufficient to cover the Company's cumulative outlays to pay premiums and
the after-tax cost to the Company of the tax reimbursement payments. There is
no arrangement or understanding under which any covered individuals will
receive or be allocated any interest in any cash surrender value under the
policy.
Since 1985, the Company has had in effect deferred compensation plans which
permit eligible participants to elect each year to defer a percentage of that
year's salary (prior to December 1993 up to 25% or 40%, depending on age, and
beginning in December 1993, 100%) and up to 100% of that year's annual bonus.
In general, employees who attain the age of 60 during employment and
participate in the Company's deferred compensation plans may elect to have
their deferred compensation amounts repaid in (1) fifteen equal annual
installments commencing at the later of age 65 or termination of employment or
(2) a lump sum distribution following termination of employment. Directors
participating in these plans are entitled to receive distributions at age 70
or upon leaving the Board, whichever is later. Interest generally accrues on
deferrals made in 1989 and subsequent years at a rate equal to Moody's Long-
Term Corporate Bond Index plus 2%, determined annually until termination when
the rate is fixed at the greater of the rate in effect at age 64 or at age 65.
Fixed rates of 19% to 24% were established for deferrals made in 1985 through
1988, as a result of then higher prevailing rates and other factors. Current
accruals of the above-market portion of the interest on deferred compensation
amounts are included in the "All Other Compensation" column of the Summary
Compensation Table.
The Company and one of its subsidiaries, Reliant Energy International, Inc.,
are parties to a trust agreement with an independent trustee establishing a
"rabbi trust" for the purpose of funding benefits payable to participants
(which include each of the named officers) under the Company's deferred
compensation plans, executive incentive compensation plans, benefits
restoration plan and savings restoration plan (Designated Plans). The trust is
a grantor trust, irrevocable except in the event of an unfavorable ruling by
the Internal Revenue Service as to the tax status of the trust or certain
changes in tax law. It is currently funded with a nominal amount of cash. The
Company and Reliant Energy International, Inc. are required to make future
contributions to the grantor trust when required by the provisions of the
Designated Plans or when required by the Company's benefits committee. The
benefits committee consists of officers of the Company designated by the Board
of Directors and has general responsibility for funding decisions and
selection of investment managers for the Company's retirement plan and other
administrative matters in connection with other employee benefit plans of the
Company. If there is a change in control (defined in a manner generally the
same as the comparable definition in the Company's long-term incentive
compensation plan), the Company and Reliant Energy International are
9
<PAGE>
required to fully fund the grantor trust, within 15 days following the change
in control, with an amount equal to the entire benefit to which each
participant would be entitled under the Designated Plans as of the date of the
change in control (calculated on the basis of the present value of the
projected future benefits payable under the Designated Plans). The assets of
the grantor trust are required to be held separate and apart from the other
funds of the Company and its subsidiaries, but remain subject to claims of
general creditors under applicable state and federal law.
In 1997, the Company entered into an amended and restated employment
agreement with Mr. Jordan providing for an extension of his employment for two
years beyond his normal retirement date (June 1, 1997). The 1997 agreement
provides for the employment of Mr. Jordan as Chairman of the Board and Chief
Executive Officer of the Company until June 1, 1999, subject to early
termination or extension in certain circumstances. In March 1999, the Company
and Mr. Jordan entered into a new amended and restated employment agreement to
become effective June 1, 1999, which provides that he will step down as Chief
Executive Officer of the Company on that date and continue employment as
Chairman of the Board until December 31, 2000, subject to early termination in
certain circumstances.
Both the 1997 and 1999 employment agreements provide that during the
employment period, Mr. Jordan will receive compensation and benefits including
(i) a base salary not less than a specified minimum (the amount in effect on
January 8, 1997 under the 1997 agreement, to be increased to $1,460,000
annually under the 1999 agreement), (ii) annual bonus awards based on amounts
payable under the Company's executive incentive compensation plan and long-
term incentive compensation plan, except that no awards will be made to Mr.
Jordan under the latter plan for performance cycles commencing after 1997 and
(iii) participation in other employee benefit plans and programs on generally
the same basis as other peer executives. The 1997 agreement provides for Mr.
Jordan to receive, in lieu of long-term incentive compensation plan awards for
performance cycles beginning in 1998 and 1999, an award of 300,000 restricted
shares of Common Stock. The Company has also agreed that within 60 days after
the expiration of the employment period under the 1999 agreement, the Board of
Directors will review Mr. Jordan's performance and the extent to which his
efforts have contributed to an increase in shareholder value and determine if
a cash bonus or other compensation in addition to that otherwise provided
under the agreement is appropriate. Any such additional bonus would be at the
discretion of the Board of Directors.
Under the 1997 employment agreement, Mr. Jordan's right to 150,000 shares of
the restricted shares of Common Stock will vest if he continues to be employed
by the Company until June 1, 1999, subject to earlier vesting if the Company
terminates his employment without Cause (as defined), if he terminates
employment for Good Reason (as defined) or if his employment terminates by
reason of death, disability or retirement with the consent of the Board of
Directors or by reason of the occurrence of a Change in Control (as defined).
His right to the other 150,000 restricted shares of Common Stock is generally
subject to vesting provisions based on achievement of the same performance
goals that are applicable to his performance-based restricted stock award
under the long-term incentive compensation plan for the 1997-1999 performance
cycle (as estimated on the June 1, 1999 vesting date), subject to earlier
vesting of the entire award if the Company terminates his employment without
Cause, if he terminates employment for Good Reason or if his employment
terminates by reason of the occurrence of a Change in Control, or of a
prorated, performance-based portion of the award if his employment terminates
by reason of death, disability or retirement with the consent of the Board of
Directors. Under the new agreement which will become effective June 1, 1999,
Mr. Jordan's receipt of the shares of Common Stock that would otherwise be
deliverable on June 1, 1999 will be deferred until termination of his extended
employment period, with crediting of dividend equivalents and interest thereon
during the deferral period.
Mr. Jordan's 1997 employment agreement provides for an extension of the
commencement date of the fifteen annual installment payments of salary and
bonus previously deferred under the Company's deferred compensation plans for
one year following the end of the period of employment under that agreement,
if Mr. Jordan remains employed through the end of that period, in
consideration of Mr. Jordan's agreement to make himself available as a
consultant during that year. Under the 1999 employment agreement, the
commencement date of the deferred payments was further extended until June 1,
2002.
10
<PAGE>
The 1997 employment agreement with Mr. Jordan provided for an election at
retirement to retain the group life insurance coverage normally provided to
similarly situated active employees of the Company. In lieu of providing this
coverage through the group program, the Company elected to purchase an
individual policy for Mr. Jordan for a single sum premium, which is included
in the "All Other Compensation" column of the Summary Compensation Table for
1997, and to make an additional payment to him in an amount necessary to make
him whole on an after-tax basis against the tax liability incurred by him as a
result of the receipt of the policy, which is included in the "Other Annual
Compensation" column for 1997.
The 1997 agreement provides for termination of the employment period prior
to June 1, 1999 upon the occurrence of a Change in Control or, if a binding
agreement to effect a Change in Control is in effect on June 1, 1999, for
extension of the employment period to the earlier of the date a Change in
Control occurs or the termination of such agreement. Under the new agreement,
neither the occurrence after June 1, 1999 of a Change in Control nor the
pendency on June 1, 1999 of an agreement to effect a Change in Control will
result in an early termination or extension of Mr. Jordan's employment period.
The 1997 agreement provides that upon any termination of the employment
period by reason of the occurrence of a Change in Control, or, while the
Company is a party to any agreement to effect a Change in Control, the Company
terminates Mr. Jordan's employment without Cause or Mr. Jordan terminates his
employment for Good Reason or by reason of death, disability or retirement
with the consent of the Company, the Company will pay Mr. Jordan a cash
payment equal to 2.99 times the sum of his base salary, target annual bonus
(currently 100% of his base salary) and the fair market value of 150,000
shares of Common Stock. The new employment agreement which will become
effective June 1, 1999 does not provide for any payments triggered by a Change
in Control but provides that if the Company terminates Mr. Jordan's employment
without Cause or Mr. Jordan terminates his employment for Good Reason or by
reason of death, disability or retirement with the consent of the Company, the
Company will pay Mr. Jordan a lump sum payment equal to his salary and target
bonus payments through December 31, 2000 and will continue welfare benefit
coverages until that date. Under both agreements, the Company is required to
fulfill certain obligations generally applicable upon termination of
employment. In the event that welfare benefit continuation coverage provided
to Mr. Jordan would result in the imposition of income tax on Mr. Jordan, the
1999 agreement provides for additional payments to him in an amount necessary
to offset the effect of the tax.
In the event and to the extent that payments made under the agreements would
result in the imposition of an excise tax (and related loss of deduction to
the Company), additional payments would be made to Mr. Jordan in an amount
necessary to offset the effect of the excise tax and any consequent income
tax.
In November 1997, the Company entered into severance agreements with certain
executive officers, including Mr. Letbetter, Mr. Hogan, Mr. Kelly and Mr.
Naeve. These severance agreements provide for the payment of certain benefits
in the event of a covered termination of employment occurring within three
years after the occurrence of a Change in Control. A covered termination
occurs if the officer's employment is terminated for reasons other than death,
disability, termination on or after age 65, termination for Cause (as
defined), or resignation by the officer unless the resignation occurs during a
61-day period commencing on the date the officer experiences a significant
reduction in his duties, remuneration, or principal place of employment
following or in anticipation of a Change in Control. Under the agreements an
officer experiencing a covered termination of employment will be entitled to
payment of three times a prescribed covered compensation amount as well as
certain welfare benefits. An officer's covered compensation amount for this
purpose is the sum of his annual salary, target annual bonus (currently
ranging from 45% to 100% of base salary) and an amount (stated as a percentage
of base salary, currently ranging from 45% to 105%) based on the maximum
payout under the officer's grant of performance-based restricted stock under
the Company's long-term incentive compensation plan. In addition, in the event
of a covered termination, the agreements provide for certain additional
benefits, including reimbursement of certain expenses associated with
obtaining new employment, provision of financial planning services, provision
of benefits under the Company's supplemental retirement plans calculated as if
the affected officer had remained employed throughout a three-year period
following the Change in Control, and a
11
<PAGE>
tax gross-up payment in an amount necessary to make the officer whole after
payment of any excise tax resulting from payments under the severance
agreement and any associated income and other taxes. The agreements expire in
September 2000.
Generally, a Change in Control will be deemed to occur under the 1997
employment agreement with Mr. Jordan and under the severance agreements
described in the preceding paragraph, if (i) the individuals constituting the
Board of Directors of the Company on September 1, 1997, including their
designated successors (Incumbent Directors) cease to constitute a majority of
the Board, (ii) an individual, entity or group acquires beneficial ownership
of 30% or more of the Company's outstanding voting stock, unless the
acquisition is from the Company in a transaction approved by a majority of the
Incumbent Directors, (iii) a merger or other business combination involving
the Company is consummated unless, immediately following the transaction, (a)
the Company's stockholders prior to the business combination own more than 70%
of the outstanding shares of voting stock of the resulting parent entity in
the same relative proportions, (b) the total fair market value of any
consideration paid to another entity or its stockholders, plus the amount of
long-term debt of the entity acquired does not exceed 50% of the sum
(determined prior to the transaction) of the fair market value of the
Company's outstanding voting stock and the amount of its consolidated long-
term debt, (c) there is not a 30% stockholder of the resulting parent entity
and (d) a majority of the board of the resulting parent entity after the
transaction were Incumbent Directors immediately prior to consummation of the
business combination or (iv) there is a disposition of 70% or more of the
assets of the Company and its consolidated subsidiaries unless, immediately
following the transaction, the Company's stockholders prior to such
transaction own more than 70% of the then outstanding shares of voting stock
of the Company and of the parent entity that acquires the largest portion of
such assets and a majority of the members of the board of directors of the
Company and of such acquiring parent entity were Incumbent Directors
immediately prior to the transaction.
Report of the Compensation Committee
The Compensation Committee (Committee) is composed entirely of nonemployee
directors. Committee members are not eligible to participate in any of the
compensation programs that the Committee administers. The Committee reviews
and makes recommendations to the Board concerning all executive officer
compensation, including salary and non-incentive based compensation, and the
design of the Company's incentive compensation plans for executives. The
Committee oversees and administers the Company's incentive compensation
programs including the determination of the annual and long-term incentive
awards to the Company's executive officers.
Compensation Policy. The Company's executive compensation policy is to have
compensation programs that:
. strengthen the relationship between pay and performance;
. attract, retain and encourage the development of highly qualified and
experienced executives;
. promote overall corporate performance; and
. provide compensation that is competitive externally and equitable
internally.
The Company retains an independent consulting firm to provide, at least
biennially, a review of the executive compensation practices of companies
considered comparable to the Company in terms of size, type of business,
performance, position and compensation philosophy. In response to the
increased competition in the energy industry and changes in the size and mix
of the Company's business, the database is comprised of both traditional
utility and general industry companies. (The companies included in the data
are not identical to the group of companies identified in the Standard &
Poor's group index of electric utility companies (S&P Electric Companies
Index) used in the creation of the "Stock Performance Graph" included in this
proxy statement because the Committee believes that the Company's most direct
competitors for executive talent are not in all cases the same as the
companies included in the index chosen for comparing shareholder returns.) In
applying the information in the database, the Company utilizes a total
compensation approach; that is, the total value of
12
<PAGE>
base salary, short- and long-term incentives is considered in establishing
ranges for the Company's executives. As a result of using this total
compensation approach, a larger portion of compensation opportunity for the
Company's executives is performance-based, through the use of annual and long-
term incentive plans. In evaluating individual executive officers, the Company
utilizes comparative data from the most relevant companies in the database.
For example, the total compensation of an executive officer in the electric
utility business of the Company is compared to data for other electric utility
companies in the database.
The Committee also obtains peer group data regarding the performance of
groups of companies in the utility industry, the nonregulated power industry
and other industries. This industry-specific data is used primarily in the
formulation of performance measurements related to the Company's individual
subsidiaries or business units.
In addition to considering comparative data and other peer groups, the
Committee makes its own subjective determination of executive officer
performance. In making such determinations, the Committee also takes into
account the chief executive officer's evaluations of other executive officers'
performance.
The Committee periodically evaluates the Company's executive compensation
programs in light of the provisions of the Internal Revenue Code relating to
the disallowance of deductions for compensation in excess of $1 million for
certain executive officers unless certain requirements are met. The Committee
does not anticipate any payment of compensation in 1999 or 2000 in excess of
that which is deductible under those rules, taking into account expected
deferrals of compensation by affected executive officers. Except for the long-
term performance incentive awards established for the Company's nonregulated
power business, the performance goals for awards under the Company's long-term
incentive awards program qualify for an exception to the deductibility limit
applicable to certain performance-based compensation for which the performance
goals have been approved by shareholders. The Committee may consider in the
future whether or not to submit for shareholder approval the performance goals
applicable to the annual incentive awards or the long-term incentive awards
established for the Company's nonregulated power business, or make any
adjustments to the performance goals for those incentive awards that would be
necessary in order to qualify for the performance-based exception of the tax
provisions. The Company reserves the right to structure compensation in a
manner not eligible for exception from the deductibility limit.
Components of Compensation. The key elements of the Company's executive
compensation program are base salary, annual incentive awards and long-term
incentive awards. The Committee evaluates each element of compensation
separately and in relation to the other elements of an executive's total
compensation package, taking into consideration relevant comparative data for
compensation at the 50th percentile and 75th percentile. Compared to companies
in the database, total targeted compensation may vary from below the 50th
percentile to above the 75th percentile depending on an executive officer's
tenure, experience, leadership and level of responsibility. Because a
significant portion of an executive officer's compensation includes at-risk
components based on business performance, if the performance exceeds that of
the relevant peer group, compensation should be above the targeted levels;
likewise, if performance falls below that of the peer group, compensation
should be below the targeted level.
Base Salaries. The Committee's annual recommendations to the Board
concerning each executive officer's base salary are based on the Committee's
analysis of salary levels for comparable executive officer positions, its
subjective evaluation and, except in the case of Mr. Jordan, management's
evaluation of each executive officer's individual performance and level of
responsibility.
Annual Incentive Compensation. The annual incentive awards program provides
executive officers with annual bonuses based on the achievement of Committee-
approved performance goals. Those annually determined performance goals
generally are based upon financial objectives of the Company and its
subsidiaries or business units and are designed to encourage improved
operating results and foster achievement of particular strategic objectives.
Performance goals for 1998 were primarily based on earnings per share. Certain
officers also had business unit goals that affected a portion of their
performance goals.
Annual incentive awards for executive officers in 1998 had target award
levels that ranged from 45% to 100% of base salary depending on the executive
officer's level of responsibility. A threshold level of
13
<PAGE>
performance results in an award that is 50% of target, and a maximum level of
performance results in an award that is either 50% or 100% over the target
level depending on the applicable business unit plan. For 1998, the goals for
the Company's executive officers were achieved at levels that resulted in
bonuses ranging from 15% over target to 100% over target.
Long-term Incentive Compensation. The long-term incentive awards program
provides stock-based incentive compensation for executive officers in the form
of grants of performance shares, stock options and stock appreciation rights.
Upon review of the comparative data, the Company determined that the number of
stock options granted to executive officers in past years was at the low end
of the range for the relevant companies in the database. Accordingly, for
1998, the number of performance shares and stock options was established to
shift a greater portion of the long-term incentive to stock options. In
addition, the Committee has adopted a stock ownership guideline applicable to
all of the Company's officers that establishes a goal of ownership of the
Company's common stock representing a value of at least two times the
officer's base salary.
Performance goals for the long-term incentive awards (made in the form of
performance shares) are generally based on financial objectives measurable
over a three-year performance cycle. For the performance cycle that ended in
1997, under which payments were made in 1998, goals included a combination of
consolidated and subsidiary or business unit goals, weighted 25% and 75% of
the total, respectively. The Company's consolidated goal for this performance
cycle was based on the Company's ranking in total return to shareholders
compared to a group of other electric utilities and utility holding companies.
The subsidiary or business unit goals for this performance cycle were based on
the following financial objectives: for the electric utility operations,
establishing a model for competitive pricing in a deregulated market and
achieving certain cash flow performance in relation to a group of 21 other
electric utility companies and for the nonregulated power business, closing
transactions related to certain projects. The performance goals for the
performance cycle that commenced in 1998 consist of three objectives: growth
in earnings per share, total return to shareholders relative to the S&P 500
Electric Utilities Index, and cash return on capitalization relative to the
same peer group.
The target number of performance shares granted is based on a percentage of
base salary divided by the average market price of common stock over a
prescribed period prior to the beginning of the performance cycle. In
determining the size of the grant, the Committee reviews comparative data,
considers the level of responsibility of each of the Company's executive
officers and the recommendations of the chief executive officer, and then
makes a subjective determination of the appropriate target so that the award
is in a range of 30% to 70% of base salary.
Achievement of the performance goals at the target level results in a payout
level of 100% of the performance shares for both the performance cycle that
paid out in 1998 and the performance cycle that commenced in 1998. For both of
these performance cycles, attainment of the threshold level of performance
results in payouts of 50% of the target number of shares and the attainment of
the maximum level results in payouts of up to 50% over the target number of
shares.
For the performance cycle concluding in 1997 that paid out in 1998, the
composite goals for the Company's executive officers were achieved at levels
that resulted in payouts ranging from 1% under target to 4% over target.
Annual grants of stock options are made at an option price not less than the
fair market value of the common stock on the date of grant. This design is
intended to focus executive officers on the creation of shareholder value over
the long-term and encourage equity ownership in the Company.
In determining the size of stock option grants to executive officers, the
Committee reviews comparative data. For 1998, grants ranged from 35,000 to
100,000 options, depending on the executive officer's position.
The Committee also grants long-term awards under a long-term incentive plan
established for the Company's nonregulated power business. Awards were made to
one executive officer of the Company under this plan during 1998 in lieu of
the grant of performance shares and stock options as discussed above.
14
<PAGE>
Chief Executive Officer Compensation. Under Mr. Jordan's 1997 employment
contract, Mr. Jordan's base salary must be in an amount not less than his
salary in effect in January 1997, which was $1,000,000 per year. In 1998, Mr.
Jordan's base salary was increased to $1,235,000 primarily as a result of a
review of comparative data and consideration of Mr. Jordan's extensive
involvement as President of the World Energy Congress. Mr. Jordan's annual
incentive bonus for 1998 was determined using the criteria described above for
executive officers generally. His target annual incentive award for 1998 was
100% of his base salary, with the payment level based on earnings per share.
The 1998 annual incentive award payment was based on achievement of his goal
at 50% over the target level. In the case of awards under the long-term
incentive program, the target number of performance shares was valued at 70%
of Mr. Jordan's base salary for the performance cycle that paid out in 1998
and was based 25% on achievement of the Company's consolidated goal and 75% on
achievement of the subsidiary or business unit goals for the electric utility
operations and the nonregulated power business (85% and 15%, respectively).
Long-term incentive awards paid out in 1998 represent a composite achievement
of 4% over the target level of performance.
In 1997, the Committee and the full Board of Directors determined that
entering into an employment contract with Mr. Jordan to extend his employment
for two years beyond his normal retirement date was in the best interests of
the Company and its shareholders because of the extremely rapid pace of change
in the industry and the Committee's subjective evaluation of the benefits of
Mr. Jordan's experience, knowledge and industry leadership in positioning the
Company to best meet the challenges and exploit the opportunities of this
period of transition. In connection with this agreement, it was agreed that
Mr. Jordan would not participate in the Company's long-term incentive program
for any performance cycle beginning after the one that commenced in 1997.
Instead, he received a grant of 150,000 restricted shares of Common Stock
which vest based solely on his continued service during the extended
employment period, and an additional 150,000 restricted shares of Common Stock
which vest based both on continued service and on achievement of the same
performance goals that are applicable to his award under the long-term
incentive compensation plan for the cycle that commenced in 1997. In addition,
the agreement provides for the extension of the commencement date of deferred
payments under the Company's deferred compensation plan, providing him the
continued benefit of above-market interest rates on the deferrals during the
period of the extension. Additional details regarding the 1997 employment
contract and a new employment agreement entered into in March 1999 are shown
elsewhere in this Proxy Statement.
Robert J. Cruikshank
Richard E. Balzhiser
Linnet F. Deily
Robert C. Hanna
15
<PAGE>
Stock Performance Graph
The graph below compares the yearly percentage change in the cumulative
total shareholder return on the common stock with the cumulative total return
of the S&P 500 Index and the S&P Electric Companies Index for the period
commencing December 31, 1993 and ending December 31, 1998.
FIVE YEAR CUMULATIVE TOTAL RETURN(1)(2)
[Graph appears here]
<TABLE>
<CAPTION>
December 31,
-----------------------------
1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Reliant Energy, Incorporated..................... $100 $ 81 $119 $119 $150 $190
S&P Electric Companies Index..................... $100 $ 87 $114 $114 $144 $166
S&P 500 Index.................................... $100 $101 $139 $171 $229 $294
</TABLE>
(1) Assumes that the value of the investment in common stock and each index
was $100 on December 31, 1993 and that all dividends were reinvested.
(2) Historical stock price performance is not necessarily indicative of future
price performance.
16
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Proposal to Change the Company's Name by Amending the Restated Articles of
Incorporation
The Board of Directors has unanimously approved a proposal to change the
Company's name to "Reliant Energy, Incorporated" by amending the Company's
Restated Articles of Incorporation. The proposed amendment would replace the
first sentence of Article I of the Restated Articles of Incorporation with the
following: "The name of the corporation is Reliant Energy, Incorporated."
In 1997, we engaged in a merger that made us one of the largest combination
electric and natural gas companies in the nation. A natural fit, the merger
provided a number of significant strategic advantages. This new single entity
became a stronger, more capable company, quickly becoming highly respected,
not only in our own community, but also throughout the entire country and in
international markets. In 1998, as we established a strong presence throughout
the energy industry, we adopted one common vision--We will be the one people
choose for energy, innovation, opportunity, and investment. However, because
we were operating under many different names (i.e., Arkla, Entex, Minnegasco,
HL&P and NorAm), consumers were unaware of the true breadth and depth of the
company's scope, resources and capabilities. With our common vision, we knew
we needed to bring all our operating companies together in order to implement
our long-term strategies and support our common vision of being the "one"
people choose. Management began a comprehensive study to find out what
identity would best support our vision. In February 1999, we adopted a single
name and a visual identity that could be shared by all business units, clearly
communicating the links between us. Please assist us in this endeavor by
voting in favor of the amendment to the Restated Articles of Incorporation to
change the corporate name to Reliant Energy, Incorporated.
Requisite Vote. To approve the amendment to the Restated Articles of
Incorporation we need the affirmative vote of a majority of the outstanding
shares of common stock. If the requisite vote is not obtained, the amendment
will not become effective.
The Board of Directors recommends a vote FOR approval of the Amendment.
Ratification of Appointment of Independent Accountants and Auditors
The Board of Directors, upon the recommendation of the Audit Committee, has
appointed Deloitte & Touche LLP as independent accountants and auditors to
conduct the annual audit of the Company's accounts for the year 1999. Deloitte
& Touche LLP (and their predecessors) have served as independent accountants
and auditors for the Company and its predecessors since 1932. Approval
requires the affirmative vote of a majority of shares of Common Stock voted
for or against the matter. If ratification of the appointment is not approved,
the Board will reconsider the appointment.
Representatives of Deloitte & Touche LLP will be present at the annual
meeting and will have an opportunity to make a statement if they wish. They
will be available to respond to appropriate questions from shareholders at the
meeting.
The Board of Directors recommends a vote FOR the ratification of the
appointment of Deloitte & Touche LLP as independent accountants and auditors.
Shareholder Proposals for 2000 Annual Meeting
Any shareholder who intends to present a proposal at the 2000 annual meeting
of shareholders and who requests inclusion of the proposal in the Company's
proxy statement and form of proxy relating to that meeting in accordance with
applicable rules of the SEC must file such proposal with the Company by
November 26, 1999.
The Company's bylaws also require advance notice of other proposals by
shareholders to be presented for action at an annual meeting. In the case of
the 2000 annual meeting, the required notice must be received by the Company's
Corporate Secretary between November 8, 1999 and February 6, 2000. The
proposal must constitute a proper subject to be brought before the meeting and
the notice must contain prescribed information including a
17
<PAGE>
description of the proposal and the reasons for bringing it before the
meeting, proof of the proponent's status as a shareholder and the number of
shares held and a description of all arrangements and understandings between
the proponent and anyone else in connection with the proposal. If the proposal
is for an amendment of the bylaws, the notice must also include the text of
the proposal and be accompanied by an opinion of counsel to the effect the
proposal would not conflict with the Company's Restated Articles of
Incorporation or Texas law. A copy of the Bylaws describing the requirements
for notice of shareholder proposals may be obtained by writing Mr. Hugh Rice
Kelly, Corporate Secretary, at the Company's address shown above.
Director Nominations for 2000 Annual Meeting of Shareholders
The Company's bylaws provide that a shareholder may nominate a director for
election if the shareholder sends a notice to the Company's Corporate
Secretary identifying any other person making such nomination with the
shareholder and providing proof of shareholder status. This notice must be
received at the Company's principal executive offices between November 8, 1999
and February 6, 2000. The shareholder must also provide the information about
the nominee that would be required to be disclosed in next year's proxy
statement. The Company is not required to include any shareholder proposed
nominee in the proxy statement. A copy of the Bylaws describing the
requirements for nomination of director candidates by shareholders may be
obtained by writing Mr. Hugh Rice Kelly, Corporate Secretary, at the Company's
address shown above.
General Information
The Company began mailing this proxy statement and the accompanying proxy
card to shareholders on March 29, 1999. The proxy statement and proxy card are
being furnished at the direction of the Board of Directors. The Company will
pay all solicitation costs including the fee of Morrow & Co., who will help
the Company solicit proxies for $9,500, plus expenses. The Company will
reimburse brokerage firms, nominees, fiduciaries, custodians and other agents
for their expenses in distributing proxy material to the beneficial owners of
the Company's common stock. In addition, certain of the Company's directors,
officers and employees may solicit proxies by telephone and personal contact.
The Board of Directors does not intend to bring any other matters before the
meeting and has not been informed that any other matters are to be properly
presented to the meeting by others. If other business is properly raised, your
proxy card authorizes the people named as proxies to vote as they think best.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1935 requires the Company's
directors, executive officers, and holders of more than 10% of the Company's
common stock to file with the SEC initial reports of ownership and reports of
changes in ownership of the Company's common stock. The Company believes that
during the fiscal year ended December 31, 1998, its officers and directors
complied with all these filing requirements.
Annual Report to Shareholders
The Summary Annual Report to Shareholders, together with the Appendix A--
1998 Financial Statements, which contains the Company's consolidated financial
statements for the year ended December 31, 1998, accompany the proxy material
being mailed to all shareholders. The Summary Annual Report is not a part of
the proxy solicitation material.
By Order of the Board of Directors,
/s/ Don D. Jordan
Don D. Jordan
Chairman and Chief Executive Officer
March 29, 1999
18
<PAGE>
[RELIANT ENERGY LOGO]
HOUSTON
INDUSTRIES
INCORPORATED
DOING BUSINESS AS
RELIANT ENERGY, INCORPORATED
APPENDIX A
1998 FINANCIAL STATEMENTS
<PAGE>
TABLE OF CONTENTS
Forward Looking Information................................................ 1
Management's Discussion and Analysis of Financial Condition
and Results of Operations of the Company............................. 2
Quantitative and Qualitative Disclosures About Market Risk.................28
Financial Statements and Supplementary Data of the Company.................32
Statements of Consolidated Income..........................................32
Statements of Consolidated Retained Earnings and Comprehensive Income......33
Consolidated Balance Sheets................................................34
Consolidated Statements of Capitalization..................................36
Statements of Consolidated Cash Flows......................................39
Notes to Consolidated Financial Statements.................................41
Independent Auditor's Report...............................................83
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED
1998 FINANCIAL INFORMATION
This Appendix A is derived from Item 7 (Management's Discussion and
Analysis of Financial Condition and Results of Operations), Item 7A
(Quantitative and Qualitative Disclosures About Market Risk) and Item 8
(Financial Statements and Supplementary Data) of the Annual Report on Form 10-K
of Houston Industries Incorporated (Company) for the year ended December 31,
1998 (Form 10-K). A copy of the Form 10-K may be obtained without charge by
contacting the Investor Relations department of the Company at 1111 Louisiana,
Houston, Texas 77002. Reference is made to the 10-K for additional information
about the business and operations of the Company and its subsidiaries.
FORWARD LOOKING INFORMATION
---------------------------
From time to time, the Company and Reliant Energy Resources Corp. (Resources)
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 Resources 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 structures 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 Resources; (iii) the weather and other natural phenomena; (iv) the
timing and extent of changes in commodity prices and interest rates; (v) changes
in environmental and other laws and regulations to which the Company, Resources
and their respective subsidiaries are subject or other external factors over
which the Company and Resources have no control; (vi) the results of financing
efforts; (vii) growth in opportunities for the Company's and Resources'
subsidiaries and diversified operations; and (viii) risks incidental to the
Company's overseas operations (including the effects of fluctuations in foreign
currency exchange rates).
The following sections of Appendix A contain forward-looking statements
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company -- Results of Operations by Business Segment --
Wholesale Energy," "Management's Discussion and Analysis of Financial Condition
and Results of Operations of the Company -- Results of Operations by Business
Segment -- International," "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," "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," "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," "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," "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 --
Environmental Expenditures" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations of the Company -- Liquidity and
Capital Resources -- Company Consolidated Capital Requirements,"
"--Consolidated Sources of Capital Resources and Liquidity" and "Quantitative
and Qualitative Disclosures About Market Risk."
1
<PAGE>
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 the
Company's consolidated financial statements and notes contained herein
(Company's Consolidated Financial Statements).
The Company is a diversified international energy services company. It
operates the nation's tenth largest electric utility in terms of kilowatt-hour
(KWH) sales, and its three natural gas distribution divisions together form the
nation's third largest natural gas distribution operation in terms of customers
served. The Company also invests in international and domestic electric utility
privatizations, gas distribution projects and the development of non-rate
regulated power generation projects. The Company is also a major interstate
natural gas pipeline and energy services company, providing gas transportation,
supply, gathering and storage, and wholesale natural gas and electric power
marketing services.
Effective January 1, 1998, the Company reconfigured its financial reporting
segments to include the following: Electric Operations, Natural Gas
Distribution, Interstate Pipelines, Wholesale Energy Marketing and Generation
(Wholesale Energy), International and Corporate. For segment reporting
information, see Note 15 to the Company's Consolidated Financial Statements.
On August 6, 1997 (Acquisition Date), the Company acquired Reliant Energy
Resources Corp. (formerly, NorAm Energy Corp.) (Resources), a natural gas
gathering, transmission, marketing and distribution company. The acquisition
(Merger) was accounted for as a purchase; accordingly, the Company's results of
operations for 1997 include the results of operations of Resources only for the
period beginning on August 6, 1997 (Acquisition Date).
To enhance comparability between reporting periods, certain information is
presented on a pro forma basis and reflects the acquisition of Resources as if
it had occurred at the beginning of the 1996 and 1997 reporting periods
presented. Pro forma purchase-related adjustments include amortization of
goodwill and the allocation of the fair value of certain assets and liabilities
of Resources. The pro forma results of operations are not necessarily indicative
of the combined results of operations that actually would have occurred had the
acquisition occurred on such dates. The Company believes, however, that the
presentation of pro forma data provides a more meaningful comparative standard
for assessing changes in the Company's financial condition and results of
operations during the years ended December 31, 1997 and 1996, since the pro
forma presentation (i) combines a full year of results of the Company's and
Resources' operations and (ii) gives retroactive effect to purchase-related
adjustments, including the amortization of goodwill and the allocation of the
fair market value of certain Resources assets and liabilities.
All dollar amounts in tables that follow are in millions, except for per share
data, percentages and throughput and other operations data.
2
<PAGE>
CONSOLIDATED RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
ACTUAL PRO FORMA
------------------------------------ -------------
TWELVE TWELVE
MONTHS ENDED MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------------------ PERCENT ------------- PERCENT
1998 1997 CHANGE 1997 CHANGE
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues................................... $11,488 $6,878 67% $10,191 13%
Operating Expenses......................... 10,011 5,813 72% 8,976 12%
Operating Income........................... 1,477 1,065 39% 1,215 22%
Other Expenses, Net(1)..................... 1,649 437 277% 546 202%
Income Taxes............................... (30) 206 -- 232 --
Net Income (Loss)(2)....................... (142) 421 -- 437 --
Basic and Diluted Earnings (Loss) Per
Share................................... (.50) 1.66 -- 1.55 --
</TABLE>
_________
(1) Includes a $1,176 million unrealized accounting loss in 1998 compared to a
$121 million unrealized accounting loss incurred in 1997 relating to the
Company's 7% Automatic Common Exchange Securities (ACES). See Note 1(n) to
the Company's Consolidated Financial Statements.
(2) Includes $37 million of interest income attributable to a tax refund in
1997.
<TABLE>
<CAPTION>
ACTUAL PRO FORMA
--------------------------------- --------------------------
TWELVE MONTHS ENDED TWELVE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------------- PERCENT -------------------------- PERCENT
1997 1996 CHANGE 1997 1996 CHANGE
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues........................... $6,878 $4,095 68% $10,191 8,884 15%
Operating Expenses................. 5,813 3,105 87% 8,976 7,617 18%
Operating Income................... 1,065 990 8% 1,215 1,267 (4%)
Other Expenses, Net................ 437 385 14% 546 596 (8%)
Income Taxes....................... 206 200 3% 232 245 (5%)
Net Income......................... 421 405 4% 437 426 3%
Basic and Diluted Earnings Per 1.66 1.66 -- 1.55 1.46 6%
Share...........................
</TABLE>
1998 Compared to 1997 (Actual). The Company reported a consolidated net loss
for $764 million on the ACES in 1998. In 1997, the 1998 of $142 million ($.50
per share) compared Company recorded a non-cash, unrealized to consolidated net
income of $421 million accounting loss (after-tax) of $79 million on ($1.66 per
share) in 1997. The consolidated net the ACES, which was partially offset by $37
loss resulted from the accounting treatment of million of non-recurring interest
income related the ACES, which were issued in July 1997. The to a refund of
federal income taxes in 1997. Company recorded a non-cash, unrealized For a
discussion of the ACES accounting loss, accounting loss (after-tax) of see
"--Certain Factors Affecting Future Earnings of the Company and its Subsidiaries
Accounting Treatment of ACES."
After adjusting for non-recurring and other charges (as described above) in
both years, net income for 1998 would have been $622 million ($2.19 per share)
compared to $463 million ($1.83 per share) in 1997. The increase in adjusted
net income for 1998 compared to 1997 was due to improved results from the
Company's Interstate Pipeline, Wholesale Energy and International segments. Net
income for 1998 included an $80 million, or $.28 per share, gain on the sale of
an investment in an electric distribution system in Argentina. Also
contributing to the increase were earnings from the businesses acquired in the
Merger. These effects were partially offset by additional depreciation of
regulated power generation assets in compliance with Reliant Energy HL&P's rate
of return cap, as described below, and increased interest expense primarily
related to the Merger.
1998 Compared to 1997 (Pro Forma). The Company's reported consolidated net
loss for 1998 was $142 million ($.50 per share) compared to pro forma earnings
of $437 million ($1.55 per share) in 1997.
3
<PAGE>
Excluding the non-recurring and other charges described above, net income for
1998 would have been $622 million ($2.19 per share) compared to pro forma net
income of $479 million ($1.70 per share) in 1997. The increase in adjusted net
income compared to adjusted pro forma 1997 net income is due primarily to the
same factors discussed above.
1997 Compared to 1996 (Actual). The Company reported consolidated net income
in 1997 of $421 million ($1.66 per share) compared to $405 million ($1.66 per
share) in 1996. Although net income increased by $16 million, the Company's
basic and diluted earnings per share remained the same due to the issuance of
approximately 47.8 million additional shares of the Company's common stock in
the Merger. The Company's net income in 1997 reflected the net impact of $42
million from the ACES accounting loss partially offset by non-recurring interest
income. In 1996, the Company recorded non-recurring, after-tax charges of (i)
$62 million for the settlement of South Texas Project Electric Generating
Station (South Texas Project) litigation claims and (ii) $5 million associated
with an investment in two tire-to-energy plants in Illinois.
After adjusting for non-recurring and other charges in both years, net income
for 1997 would have been $463 million ($1.83 per share) compared to $472 million
($1.93 per share) in 1996. The decrease is due in part to the additional
amortization of certain lignite reserves by Electric Operations, the
amortization of goodwill recorded in the Merger and increased interest expense.
The increase in interest on long-term debt and other interest reflect both (i)
the $1.4 billion indebtedness incurred by the Company to fund a portion of the
cost of the Merger and (ii) the consolidation of Resources' existing
indebtedness with that of the Company. Partially offsetting these effects were
increased Electric Operations' sales due to customer growth, improved results at
International and the additional operating income generated by the new business
units acquired in the Merger.
1997 Compared to 1996 (Pro Forma). The Company's pro forma consolidated net
income for 1997 was $437 million ($1.55 per share) compared to $426 million
($1.46 per share) in 1996.
Excluding the non-recurring and other charges described above, the Company's
1997 pro forma net income would have been $479 million ($1.70 per share)
compared to $493 million ($1.69 per share) in 1996. This decrease in pro forma
earnings, as adjusted for non-recurring and other charges, was principally the
result of (i) hedging-related losses incurred in the first quarter of 1997 by a
subsidiary of Resources, which losses were not reflected in the Company's actual
results of operations since they were incurred prior to the Merger, (ii) a
weather-related decline in sales volumes of Natural Gas Distribution and (iii)
increased administrative and general expenses associated with increased staffing
and marketing in connection with increasing the scope of energy marketing
activities.
Pro forma consolidated net income for 1997 and 1996 exceeds actual
consolidated net income for such years because purchase-related costs were more
than offset on a pro forma basis by Resources' earnings for the periods prior to
the Acquisition Date. Such earnings were not part of the reported actual results
of the Company.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
All business segment data (other than data relating to Electric Operations)
are presented on a pro forma basis for 1997 and 1996 as if the acquisition of
Resources had occurred on January 1 of each year presented.
The following table presents operating income on (i) an actual basis for the
years ended December 31, 1998 and 1997, and (ii) a pro forma basis for each of
the Company's business segments for the years ended December 31, 1997 and 1996.
4
<PAGE>
OPERATING INCOME (LOSS) BY BUSINESS SEGMENT
<TABLE>
<CAPTION>
ACTUAL PRO FORMA
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
-------------------------------- -----------------------------
1998 1997(1) 1997(2) 1996(2)
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Electric Operations.............................. $1,014 $ 995 $ 995 $ 997
Natural Gas Distribution......................... 138 55 152 160
Interstate Pipeline.............................. 128 32 99 108
Wholesale Energy................................. 59 1 (15) 22
International.................................... 182 20 17 (1)
Corporate........................................ (44) (38) (32) (19)
--------- ---------- ---------- ----------
Total Consolidated............................... $1,477 $1,065 $1,216 $1,267
--------- ---------- ---------- ----------
</TABLE>
__________
(1) Includes Resources business segments beginning on the Acquisition Date.
(2) Electric Operations operating income data are actual and not pro forma.
ELECTRIC OPERATIONS
Electric Operations' business is conducted under the name "Reliant Energy
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). Electric Operations constitutes the
Company's largest business segment, representing 69% of the Company's
consolidated operating income for 1998.
Electric Operations' earnings are capped at an agreed overall rate of return
formula on a calendar year basis as part of the transition to competition plan
(Transition Plan) approved by the Public Utility Commission of Texas (Texas
Utility Commission) and effective January 1, 1998. As a result of this plan,
any earnings in 1998 or 1999 above the maximum allowed return cap of 9.844% on
invested capital will be offset by additional depreciation of Electric
Operations' generation assets. The Transition Plan 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 1000
kva or less receive base rate credits of 2% in 1998 and 1999. For more
information regarding the Transition Plan, including a pending judicial review
of portions of the Transition Plan, see Note 3(b) to the Company's Consolidated
Financial Statements.
The following table provides summary data, before taxes, regarding the actual
results of operations of Electric Operations for 1998, 1997 and 1996.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------------------- PERCENT
1998 1997 CHANGE
------------- ------------- -------------
<S> <C> <C> <C>
Operating Revenues:
Base Revenues(1).......................................................... $2,969 $2,839 5%
Reconcilable Fuel Revenues(2)............................................. 1,381 1,413 (2%)
------------- -------------
Total Operating Revenues.............................................. 4,350 4,252 2%
------------- -------------
Operating Expenses:
Fuel Expense.............................................................. 1,064 1,091 (2%)
Purchased Power........................................................... 391 386 1%
Operation Expense......................................................... 635 641 (1%)
Maintenance Expense....................................................... 234 228 3%
Depreciation and Amortization Expense..................................... 650 569 14%
Other Operating Expenses.................................................. 362 342 6%
------------- -------------
Total Operating Expenses.............................................. 3,336 3,257 2%
------------- -------------
Operating Income............................................................. $1,014 $ 995 2%
============= =============
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------------------- PERCENT
1997 1996 CHANGE
------------- ------------- -------------
<S> <C> <C> <C>
Operating Revenues:
Base Revenues(1).......................................................... $2,839 $2,743 3%
Reconcilable Fuel Revenues(2)............................................. 1,413 1,282 10%
------------- -------------
Total Operating Revenues.............................................. 4,252 4,025 6%
------------- -------------
Operating Expense:
Fuel Expense.............................................................. 1,091 1,025 6%
Purchased Power........................................................... 386 322 20%
Operation Expense......................................................... 641 543 18%
Maintenance Expense....................................................... 228 249 (8%)
Depreciation and Amortization Expense..................................... 569 546 4%
Other Operating Expenses.................................................. 342 343 --
------------- -------------
Total Operating Expenses.............................................. 3,257 3,028 8%
------------- -------------
Operating Income............................................................. $ 995 $ 997 --
------------- -------------
</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 surcharges net
of adjustments for over/under recovery. See "-- Operating Revenues --
Electric Operations."
OPERATING INCOME -- ELECTRIC OPERATIONS
1998 Compared to 1997. Electric Operations' operating income (before income
taxes) was $1,014 million compared with $995 million the previous year. The
increase of $19 million in operating income was due to higher revenues from the
unusually hot weather in 1998 and customer growth, reduced by base rate credits
provided under the Transition Plan. Under the Transition Plan, the Company
recorded additional depreciation on Electric Operation's generation assets,
which resulted in depreciation and amortization expense increasing by $82
million between 1997 and 1998. Total KWH sales rose 8% during 1998, with
increases of 9% in residential sales, 6% in commercial sales and 3% in firm
industrial sales.
1997 Compared to 1996. Electric Operations' operating income (before income
taxes) was $995 million in 1997 compared with $997 million in 1996. The
decrease in operating income was due to increases in operations expense and
depreciation and amortization expense in 1997, partially offset by increased
revenues from electric sales growth and decreases in maintenance expense, as
described below. Total KWH sales rose 3% during 1997, with increases of 1% in
residential sales, 6% in commercial sales and 2% in firm industrial sales.
OPERATING REVENUES -- ELECTRIC OPERATIONS
1998 Compared to 1997. Electric Operations' $130 million increase in 1998
base revenues is primarily the result of unusually hot weather and the impact of
customer growth, net of base rate credits implemented under the Transition Plan.
In 1998, Electric Operations implemented a base rate discount of $74 million.
In addition, growth in usage and number of customers contributed an additional
$48 million in base revenues in 1998.
Electric Operations' 2% decrease in reconcilable fuel revenue in 1998 resulted
primarily from decreased natural gas prices. The decrease in natural gas prices,
however, was largely offset by increased KWH sales resulting from hotter
weather. The Texas Utility Commission provides for recovery of certain fuel and
purchased power costs through a fixed fuel factor included in electric rates.
The fixed fuel factor is established during either a utility's general rate
proceeding or its fuel factor proceeding and is generally effective for a
minimum of six months. Revenues collected through such factor are adjusted
monthly to equal expenses; therefore, such revenues and expenses have no effect
on earnings unless fuel costs are determined not to be recoverable. The
adjusted over/under recovery of fuel costs is recorded on the Company's
Consolidated Balance Sheets as fuel-related credits or fuel-related debits,
respectively. Fuel costs are
6
<PAGE>
reviewed during periodic fuel reconciliation proceedings, which are required at
least every three years. Electric Operations filed a fuel reconciliation
proceeding with the Texas Utility Commission on January 30, 1998 covering $3.5
billion of fuel costs for the three year period ending July 31, 1997. In
December 1998, the Texas Utility Commission issued a final order that allowed
Electric Operations to recover eligible fuel costs for the three-year period
ending July 31, 1997, with some exceptions. Under the order, the Company
reclassified $40 million in costs associated with certain fuel-related capital
improvement projects from eligible fuel expense to invested capital. The order
also required an additional reduction of $12 million in eligible fuel expense
relating to the three-year period ending July 31, 1997.
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 overall fixed fuel
factor and a temporary 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 approved fuel factor and surcharge were implemented for
customer billings beginning July 1, 1998. As of December 31, 1998 and 1997,
Electric Operations' cumulative under-recovery of fuel costs was $45 million and
$172 million including interest, respectively.
1997 Compared to 1996. Electric Operations' 3% increase in base revenue in
1997 compared to 1996 was primarily the result of newly recorded transmission
revenues. Electric Operations' transmission revenues (which are considered
miscellaneous revenues) in 1997 were $86 million but were offset by transmission
expenses of $88 million. For information regarding these transmission revenues,
see "-- Certain Factors Affecting Future Earnings of the Company and its
Subsidiaries -- Competition and Restructuring of Electric Utility Industry"
below. Electric Operations' 10% increase in reconcilable fuel revenue in 1997
resulted primarily from increased natural gas prices in that year.
In 1997, Electric Operations implemented (i) a $70 million temporary fuel
surcharge (inclusive of interest) effective for the first six months of 1997 and
(ii) a $62 million temporary fuel surcharge (inclusive of interest) effective
for the last six months of 1997. In December 1997, the Texas Utility Commission
approved the implementation of a $102 million (inclusive of interest) temporary
fuel surcharge which was implemented by Electric Operations on January 1, 1998
with recovery extending from 8 months to 16 months depending on the customer
class. Electric Operations requested the surcharge in order to recover its
under-recovery of fuel expenses for the period March 1997 through August 1997.
This under-recovery was included in the surcharge that began July 1, 1998.
FUEL AND PURCHASED POWER EXPENSE -- ELECTRIC OPERATIONS
Fuel costs constitute the single largest expense for Electric Operations. The
mix of fuel sources for generation of electricity is determined primarily by
system load and the unit cost of fuel consumed. The average cost of fuel used
by Electric Operations in 1998 was $1.70 per million British Thermal Units
(MMBtu) ($2.18 for natural gas, $1.78 for coal, $1.19 for lignite, and $.48 for
nuclear). In 1997, the average cost of fuel was $1.87 per MMBtu ($2.60 for
natural gas, $2.02 for coal, $1.08 for lignite, and $0.54 for nuclear). Fuel
costs are reconciled to fuel revenues resulting in no effect on earnings unless
fuel costs are determined not to be recoverable.
1998 Compared to 1997. Fuel expenses in 1998 decreased by $27 million or 2%
below 1997 expenses. The decrease was driven by a significant decrease in the
average unit cost of natural gas, which declined from $2.60 per MMBtu in 1997 to
$2.18 per MMBtu in 1998. Purchased power expenses increased in 1998 by $5
million or 1% over 1997 expenses. This increase was a result of additional
purchases through the Electric Reliability Council of Texas (ERCOT) of $18
million offset by a reduction in purchases from cogenerators of $13 million.
Additionally, 1998 fuel expense includes a $12 million charge to non-recoverable
fuel in accordance with the Fuel Reconciliation Proceeding discussed above.
7
<PAGE>
1997 Compared to 1996. Fuel expenses in 1997 increased by $66 million or 6%
over 1996 expenses. The increase was driven by significant increases in the
average unit cost of natural gas, which rose to $2.60 per MMBtu in 1997 from
$2.31 per MMBtu in 1996. Purchased power expenses increased in 1997 by $63
million or 20% over 1996 expenses. This change was driven primarily due to
higher prices paid to qualifying facilities for purchased electric energy
principally as a result of increases in natural gas prices, energy purchased
under Electric Operations' joint dispatching agreement with the city of San
Antonio (see Note 12(c) to the Company's Consolidated Financial Statements) and
Electric Operations' participation in the newly deregulated Texas wholesale
energy market in order to buy and sell energy to provide lower costs to its
customers.
OPERATION AND MAINTENANCE EXPENSES, DEPRECIATION, AMORTIZATION AND OTHER --
ELECTRIC OPERATIONS
In order to reduce Electric Operations' exposure to potentially stranded costs
related to generating assets, the Transition Plan permits the redirection of
depreciation expense to generation assets from transmission, distribution and
general plant assets. In addition, the Transition Plan provides that all
earnings above a 9.844% overall annual rate of return on invested capital be
used to recover Electric Operations' investment in generation assets. As a
result, Electric Operations recorded $194 million in additional depreciation and
redirected $195 million in existing depreciation expense to generation assets in
1998.
1998 Compared to 1997. Operation, maintenance and other operating expenses
increased $20 million in 1998, including $9 million due to transmission tariffs
within ERCOT. These transmission expenses were largely offset by $7 million in
transmission tariff revenue. Franchise fees paid to cities increased $11
million due to increased sales in 1998.
In 1998, the Company recorded additional depreciation expense for Electric
Operations of $194 million, which is $144 million more than recorded during the
same period last year, as provided by the Transition Plan. The comparative
increase was less than it otherwise would have been because amortization of the
investment in lignite reserves associated with a canceled generation project was
$62 million lower in 1998 than in 1997. In 1996, Electric Operations began
amortizing its $153 million investment in these lignite reserves. The lignite
reserves will be fully amortized no later than 2002.
1997 Compared to 1996. Operations and maintenance expense increased $76
million in 1997. The increase included $88 million due to transmission tariff
expenses within ERCOT, offset by $86 million of transmission tariff revenue.
In 1997, Electric Operations incurred $17 million in work force severance
expenses compared to $30 million of such expenses in 1996.
Depreciation and amortization expense increased $23 million in 1997 compared
to 1996. The increase is due to the additional amortization of $16 million of
Electric Operations' investment in lignite reserves. In 1997 and 1996, Electric
Operations wrote down its investment in the South Texas Project by $50 million
in addition to ordinary depreciation associated with the South Texas Project.
The additional amortization of the lignite reserves and the depreciation of the
South Texas Project were permitted under Electric Operations' rate order in
Docket 12065. For additional information regarding these amortizations, see
Note 1(f) to the Company's Consolidated Financial Statements.
NATURAL GAS DISTRIBUTION
Natural Gas Distribution operations are conducted through three unincorporated
divisions of Resources (Reliant Energy Arkla, Reliant Energy Entex and Reliant
Energy Minnegasco) and are included in the Company's actual consolidated results
of operations beginning on the Acquisition Date. These operations consist of
natural gas sales to, and natural gas transportation for, residential,
commercial and industrial customers in six states: Arkansas, Louisiana,
Minnesota, Mississippi, Oklahoma and Texas.
8
<PAGE>
The following tables provide summary data regarding the actual results of
operations of Natural Gas Distribution for 1998 and unaudited pro forma
financial results of operations for 1997 and 1996.
<TABLE>
<CAPTION>
ACTUAL PRO FORMA
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, PERCENT
1998 1997 CHANGE
------------- -------------- ------------
<S> <C> <C> <C>
Operating Revenues:
Base Revenues.................................................... $ 779 $ 814 (4%)
Recovered Gas Revenues........................................... 1,034 1,388 (26%)
---------- ----------
Total Operating Revenues........................................ 1,813 2,202 (18%)
---------- ----------
Operating Expenses:
Natural Gas...................................................... 1,085 1,440 (25%)
Operation and Maintenance........................................ 368 384 (4%)
Depreciation and Amortization.................................... 130 124 5%
Other Operating Expenses......................................... 92 102 (10%)
---------- ----------
Total Operating Expenses........................................ 1,675 2,050 (18%)
---------- ----------
Operating Income.................................................. $ 138 $ 152 (9%)
========== ==========
Throughput Data (in billion cubic feet (BCF)):
Residential and Commercial Sales................................. 286 326 (12%)
Industrial Sales................................................. 56 59 (5%)
Transportation................................................... 44 42 5%
---------- ----------
Total Throughput................................................ 386 427 (10%)
========== ==========
</TABLE>
<TABLE>
<CAPTION>
PRO FORMA YEAR ENDED
DECEMBER 31,
------------------------------- PERCENT
1997 1996 CHANGE
----------- ---------- ---------
<S> <C> <C> <C>
Operating Revenues:
Base Revenues.................................................... $ 814 $ 764 7%
Recovered Gas Revenues........................................... 1,388 1,349 3%
----------- ---------
Total Operating Revenues........................................ 2,202 2,113 4%
----------- ---------
Operating Expenses:
Natural Gas...................................................... 1,440 1,348 7%
Operation and Maintenance........................................ 384 381 1%
Depreciation and Amortization.................................... 124 121 2%
Other Operating Expenses(1)...................................... 102 103 (1%)
----------- ---------
Total Operating Expenses........................................ 2,050 1,953 5%
----------- ---------
Operating Income.................................................. $ 152 $ 160 (5%)
=========== =========
Throughput Data (in BCF):
Residential and Commercial Sales................................. 326 333 (2%)
Industrial Sales................................................. 59 58 2%
Transportation................................................... 42 42 --
----------- ---------
Total Throughput................................................ 427 433 (1%)
=========== =========
</TABLE>
__________
(1) Before a $6 million one-time charge incurred in 1996 for early retirement
and severance costs.
1998 (Actual) Compared to 1997 (Pro Forma). Operating income was $138 million
in 1998 compared to pro forma operating income of $152 million in 1997. The $14
million decrease reflects the lower demand for natural gas heating that resulted
from milder weather in 1998. The negative impact of weather was partially offset
by (i) the favorable impact of purchased gas adjustments during this period on
Reliant Energy Arkla's operating income, (ii) lower operating expenses and (iii)
increased revenue resulting from Reliant Energy Minnegasco's performance based
rate plan.
9
<PAGE>
The $389 million decrease in 1998 actual operating revenues compared to 1997
pro forma operating revenues is primarily attributable to a decrease in the
price of purchased gas and decreased sales volume primarily due to milder
weather in 1998.
1997 Compared to 1996 (Pro Forma). Pro forma operating income was $152 million
in 1997 compared to $160 million (before a one-time charge of $6 million for
early retirement and severance) in 1996. The decrease of approximately $8
million in 1997 pro forma operating income is principally due to decreased
Reliant Energy Minnegasco customer usage because of warmer weather and customer
conservation, decreased Reliant Energy Arkla customer usage because of warmer
weather (primarily in the first quarter of 1997) and the unfavorable impact in
1997 of a purchased gas adjustment mechanism on Reliant Energy Arkla. Partially
offsetting the decrease was an increase in Reliant Energy Minnegasco's
performance based rate incentive recoveries and customer growth and increased
revenues from Reliant Energy Entex due to rate relief granted in 1996 and fully
reflected in 1997.
The increase of approximately $89 million in pro forma Natural Gas
Distribution operating revenue for the year ended December 31, 1997 in
comparison to the corresponding period of 1996 is principally due to the
increase in the market price of gas.
The $92 million increase in purchased gas costs in 1997 compared to 1996
primarily reflects the increase in Natural Gas Distribution's average cost of
gas in 1997 (consistent with the overall increase in the market price of gas
during such period) along with the purchased gas adjustment referenced above.
INTERSTATE PIPELINES
Interstate Pipelines' operations are conducted through Reliant Energy Gas
Transmission Company (REGT) and Mississippi River Transmission Corporation
(MRT), two wholly owned subsidiaries of Resources.
The following table provides summary data regarding the actual results of
operations of Interstate Pipelines for 1998 and pro forma results of operations
for 1997 and 1996.
<TABLE>
<CAPTION>
ACTUAL PRO FORMA
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, PERCENT
1998 1997 CHANGE
---------------- ---------------- ---------------
<S> <C> <C> <C>
Operating Revenues................................................ $ 282 $ 295 (4%)
Operating Expenses:
Natural Gas...................................................... 27 45 (40%)
Operation and Maintenance........................................ 69 88 (22%)
Depreciation and Amortization.................................... 44 48 (8%)
Other Operating Expenses......................................... 14 15 (7%)
------------ ------------
Total Operating Expenses........................................ 154 196 (21%)
------------ ------------
Operating Income.................................................. $ 128 $ 99 29%
============ ============
Throughput Data (in MMBtu):
Natural Gas Sales................................................. 16 18 (11%)
Transportation.................................................... 825 911 (9%)
Elimination(1)................................................... (15) (17) 12%
------------ -----------
Total Throughput.................................................. 826 912 (9%)
============ ===========
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
PRO FORMA YEAR ENDED
DECEMBER 31,
------------------------------------- PERCENT
1997 1996 CHANGE
---------------- ---------------- ---------------
<S> <C> <C> <C>
Operating Revenues................................................ $ 295 $ 347 (15%)
Operating Expenses:
Natural Gas...................................................... 45 76 (41%)
Operation and Maintenance........................................ 88 82 7%
Depreciation and Amortization.................................... 48 50 (4%)
Other Operating Expenses(1)...................................... 15 31 (52%)
------------ ------------
Total Operating Expenses........................................ 196 239 (18%)
------------ ------------
Operating Income.................................................. $ 99 $ 108 (8%)
============ ============
Throughput Data (in MMBtu):
Natural Gas Sales................................................. 18 33 (45%)
Transportation.................................................... 911 952 (4%)
Elimination(1).................................................. (17) (31) 45%
------------ ------------
Total Throughput.................................................. 912 954 (4%)
============ ============
</TABLE>
________
(1) Elimination of volumes both transported and sold.
1998 (Actual) Compared to 1997 (Pro Forma). Interstate Pipelines' operating
income for 1998 was $128 million compared to $99 million for 1997 on a pro forma
basis. The increase in operating income for 1998 is primarily due to $11 million
of pre-tax, non-recurring items recorded in 1998 for favorable litigation and
rate case settlements. The increase in operating income also reflects improved
operating margins and reductions in operating expenses. The increase in
operating income for 1998 was partially offset by $7 million of non-recurring
transportation revenues recorded in the first quarter of 1997, as discussed
below.
Operating revenues for Interstate Pipelines decreased by $13 million in 1998
compared to pro forma 1997 revenues. 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
Reliant Energy Arkla related to transportation service. The settlement with
Reliant Energy Arkla resulted in reduced transportation rates which also reduced
revenues for 1998. Lower spot prices in the fourth quarter of 1998 and reduced
sales volumes also contributed to the reduction in operating revenues. These
decreases were partially offset by 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. The 4% decline in total
throughput reflected the impact of unseasonably warm winter weather.
Interstate Pipelines' 1998 operating expense declined $42 million in
comparison to 1997 pro forma operating expense. Contributing to the decrease
were the MRT rate settlement in the first quarter of 1998, which provided for a
retroactive reduction of MRT's depreciation rates, the impact of continued cost
control initiatives and reduced pension and benefit expenses.
Natural gas expense decreased $18 million in 1998 compared to pro forma
natural gas expense in 1997 primarily due to lower gas sales volumes and lower
prices for purchased gas.
Operation and maintenance expense decreased $19 million in 1998 in comparison
to pro forma operation and maintenance expense for 1997. The decrease was
primarily due to the impact of cost control initiatives and decreased
maintenance due to milder weather in the first quarter of 1998.
Depreciation expense decreased $4 million in 1998, compared to pro forma
depreciation expense in 1997 primarily due to a rate settlement recorded in the
first quarter of 1998. The rate settlement, effective January 1998, provided
for a $5 million reduction of MRT's depreciation rates retroactive to July 1996.
11
<PAGE>
During 1998, Interstate Pipelines' largest unaffiliated customer was a natural
gas utility that serves the greater St. Louis metropolitan area. Revenues from
this customer are generated pursuant to several long-term firm transportation
and storage contracts that currently are scheduled to expire at various dates
between October 1999 and May 2000. Interstate Pipeline is currently negotiating
with the natural gas utility to renew these agreements. If such contracts are
not renewed, the results of operations of Interstate Pipelines will be adversely
affected.
1997 Compared to 1996 (Pro Forma). Pro forma operating income was $99
million in 1997 compared to $108 million (before a one-time charge of $17
million for early retirement and severance) in 1996. This decrease of
approximately $9 million in Interstate Pipelines' pro forma operating income
between 1997 and 1996 results primarily from three factors: (i) a 6% decrease in
transportation revenues, (ii) a 43% decrease in natural gas sales revenue (as
described below) and (iii) lower demand for natural gas transportation as a
result of lower natural gas consumption (primarily weather-related) in the
eastern markets served by the segment. These factors were offset partially by an
approximately 18% decline in operating expenses primarily due to decreases in
gas purchased.
Pro forma operating revenues for Interstate Pipelines decreased by $52 million
(15%) for the year ended December 31, 1997 in comparison to the corresponding
period of 1996. The decrease in revenues primarily reflects a decline in natural
gas sales revenue resulting from the expiration in 1996 of an unbundled natural
gas sales contract between Interstate Pipelines and Reliant Energy Arkla.
Natural gas sales to Natural Gas Distribution were $60 million in 1996 and none
in 1997.
The decline in transportation revenues is largely attributable to price
differentials between the average spot price for Mid-continent natural gas
(Interstate Pipelines' primary supply area) and Gulf Coast natural gas in 1997.
The $31 million decrease in gas purchased costs in 1997 compared to 1996 is
largely attributable to the expiration of long-term supply contracts entered
into prior to unbundling, as discussed above. Other operating expenses decreased
in 1997 compared to 1996 primarily due to the elimination of non-recurring costs
combined with cost reductions related to the 1996 early retirement and severance
program and reductions in costs allocated from Resources.
WHOLESALE ENERGY
Wholesale Energy includes the acquisition, development and operation of, and
sales of capacity and energy from, non-utility power generation facilities; the
operations of the Company's wholesale energy trading and marketing business; and
natural gas gathering activities.
Reliant Energy Power Generation, Inc. (Power Generation) was formed in March
1997 to pursue the acquisition of electric generation assets as well as the
development of new non-rate regulated power generation facilities. Since March
1997, the Company has invested approximately $348 million in Power Generation
acquisitions and development projects. Power Generation currently has entered
into commitments associated with various generation projects amounting to $252
million. The Company expects that Power Generation will actively pursue the
acquisition of additional generation assets and the development of additional
new non-rate regulated generation projects. Depending on the timing and success
of Power Generation's future efforts, the company believes that resulting
expenditures could be substantial. During 1997, Power Generations' results were
included in the Corporate segment. Segment information for 1997 for Wholesale
Energy has been revised to reflect the inclusion of Power Generation, and the
exclusion of Reliant Energy Retail, Inc., which is now reported as part of the
Corporate segment.
To minimize the Company's risks associated with fluctuations in the price of
natural gas and transportation, the Company, primarily through Reliant Energy
Services, Inc. (Reliant Energy Services), a wholly owned subsidiary of
Resources, 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 natural gas storage and heating oil
inventory, (iii) future power sales by and natural gas purchase by generation
facilities, (iv) crude oil and refined products and (v) certain anticipated
transactions, some of which carry off-balance sheet risk. Reliant Energy
Services also enters into commodity derivatives in its trading and price risk
management activities. For a discussion of the Company's accounting treatment of
derivative instruments, see Note 2 to the Company's Consolidated Financial
Statements and "Quantitative and Qualitative Disclosures About Market Risk."
12
<PAGE>
The Company believes that Reliant Energy Services' energy trading, marketing,
and risk management activities complement Power Generation's strategy of
developing and/or acquiring unregulated generation assets in key markets.
Reliant Energy Services supplies fuel to Power Generation's existing generation
assets and sells electricity produced by these assets. As a result, the Company
has made, and expects to continue to make, significant investments in developing
Reliant Energy Services' internal software, trading and personnel resources.
The following table provides summary data regarding the actual results of
operations of Wholesale Energy for 1998 and pro forma results of operations of
Wholesale Energy for 1997 and 1996.
<TABLE>
<CAPTION>
ACTUAL PRO FORMA
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, PERCENT
1998 1997 CHANGE
-------------- ------------- -------------
<S> <C> <C> <C>
Operating Revenues................................................ $ 4,456 $ 3,042 46%
Operating Expenses:
Natural Gas...................................................... 2,367 2,618 (10%)
Purchased Power.................................................. 1,829 313 484%
Operation and Maintenance........................................ 178 117 52%
Depreciation and Amortization.................................... 18 7 157%
Other Operating Expenses......................................... 5 2 150%
------------ ------------
Total Operating Expenses...................................... 4,397 3,057 44%
------------ ------------
Operating Income.................................................. $ 59 $ (15) --
============ ============
Operations Data:
Natural Gas (in BCF):
Sales........................................................... 1,168 958 22%
Gathering....................................................... 237 242 (2%)
------------ ------------
Total......................................................... 1,405 1,200 17%
============ ============
Electricity (in thousand MWH):
Wholesale Power Sales........................................... 65,228 24,997 161%
============ ============
</TABLE>
<TABLE>
<CAPTION>
PRO FORMA YEAR ENDED
DECEMBER 31,
------------------------------------- PERCENT
1997 1996 CHANGE
---------------- ---------------- -------------
<S> <C> <C> <C>
Operating Revenues................................................ $ 3,042 $2,146 42%
Operating Expenses:
Natural Gas...................................................... 2,618 1,967 33%
Purchased Power.................................................. 313 63 397%
Operation and Maintenance........................................ 117 87 34%
Depreciation and Amortization.................................... 7 6 17%
Other Operating Expenses......................................... 2 1 100%
------------ ------------
Total Operating Expenses...................................... 3,057 2,124 44%
------------ ------------
Operating Income (loss)........................................... $ (15) $ 22 (168%)
============ ============
Operations Data:
Natural Gas (in BCF):
Sales........................................................... 958 877 9%
Gathering....................................................... 242 231 5%
------------ ------------
Total......................................................... 1,200 1,108 8%
============ ============
Electricity (in thousand MWH):
Wholesale Power Sales........................................... 24,997 2,776 800%
============ ============
</TABLE>
13
<PAGE>
1998 (Actual) Compared to 1997 (Pro Forma). Wholesale Energy reported
operating income of $59 million compared to a pro forma loss of $15 million in
1997. This increase was primarily due to operating results from Power
Generation's investment in non-regulated generating assets and related trading
and marketing activities. Capitalization of previously expensed development
costs related to successful project starts in Nevada, California and Texas also
contributed to the increase. These improved results were partially offset by
increased operating expenses at Reliant Energy Services, as discussed below. In
1997, operating income was negatively affected by hedging losses at Reliant
Energy Services 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 totaling $17 million.
Operating revenues for Wholesale Energy increased $1.4 billion (46%) in
comparison to pro forma 1997 operating revenues due almost entirely to an
increase in wholesale power sales by Power Generation and Reliant Energy
Services. The benefit of the increase in natural gas sales volume was primarily
offset by lower gas sales prices.
Operating expense increased $1.3 billion compared to pro forma operating
expense for 1997 primarily due to $1.5 billion in increased power costs related
to energy trading and marketing activities. Natural gas expenses decreased $251
million (10%) compared to pro forma 1997 due to the reduction in the price of
natural gas in 1998. Operation and maintenance expense increased $61 million
(52%) in 1998 primarily due to power plant acquisitions in California and costs
associated with staffing increases at Reliant Energy Services to support
increased sales and marketing efforts and an increase in a credit reserve due to
increased counterparty credit and performance risk associated with higher prices
and higher volatility in the electric power market recorded in the second
quarter of 1998.
1997 Compared to 1996 (Pro Forma). The pro forma operating loss for 1997
was $15 million compared to operating income of $22 million in 1996. This
decrease of approximately $37 million (168%) was primarily attributed to: (i)
hedging losses associated with anticipated first quarter 1997 sales under
peaking contracts and (ii) losses from the sale of natural gas held in storage
and unhedged in the first quarter of 1997 totaling $17 million. In addition,
operating expenses increased $11 million largely due to increased staffing and
marketing activities made in support of the increased sales and expanded
marketing efforts. Partially offsetting these unfavorable impacts were increased
margins from natural gas gathering activities.
Pro forma operating revenues for Wholesale Energy increased by $896 million
(42%) for 1997 in comparison to 1996 due to increased natural gas and
electricity trading volumes. Increased volumes in 1997 had minimal effect on
operating income due to low operating margins in both periods.
Natural gas and purchased power expense increased $901 million (44%) in 1997
compared to 1996 primarily due to increased gas and electricity marketing
activities net of hedging losses and losses from the sale of natural gas, as
discussed above.
INTERNATIONAL
International includes the results of operations of Reliant Energy
International, Inc. (Reliant Energy International) and the international
operations of Resources (Resources International). Reliant Energy International
is 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. Substantially all of Reliant
Energy International's operations to date have been in Central and South
America.
International intends to evaluate and consider a wide array of potential
business strategies, including possible acquisitions, restructurings,
reorganizations and/or dispositions of currently owned properties or
investments. The Company believes pursuit of any of the above strategies, or any
combination thereof could have a significant impact on the business, operations
and financial condition of International or the Company.
14
<PAGE>
For information regarding foreign currency matters, including the impact of
the devaluation of the Brazilian real in the first quarter of 1999, see Note 16
to the Company's Consolidated Financial Statements and "-- Certain Factors
Affecting Future Earnings of the Company and its Subsidiaries -- Risks of
International Operations" and "Quantitative and Qualitative Disclosures about
Market Risk." For additional information about the accounting treatment of
certain of International's foreign investments, see Note 5 to the Company's
Consolidated Financial Statements.
Results of operations data for International are presented in the following
table on an actual basis for 1998 and on a pro forma basis as if the acquisition
of Resources had occurred as of January 1, 1997 and 1996, as applicable. The
primary pro forma adjustment made to this segment in connection with the
acquisition is to give effect to the development costs and other expenditures
incurred by Resources International prior to the Acquisition Date. The
adjustment had no effect on operating revenues.
<TABLE>
<CAPTION>
PRO FORMA
ACTUAL PRO FORMA YEAR ENDED
YEAR ENDED YEAR ENDED PERCENT ------------------------- PERCENT
1998 1997 CHANGE 1997 1996 CHANGE
---------- ------------ ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Operating Revenues............... $ 259 $ 92 182% $ 92 $ 62 48%
Operating Expenses:
Fuel........................... 20 21 (5%) 21 19 11%
Operation and Maintenance...... 53 50 6% 50 42 19%
Depreciation and amortization.. 4 4 4 2 100%
---------- ------------ ----------- ----------
Total Operating
Expenses.............. 77 75 3% 75 63 19%
---------- ------------ ----------- ----------
Operating Income (Loss).......... $ 182 $ 17 $ 17 $ (1)
========== ============ =========== ==========
</TABLE>
1998 (Actual) Compared to 1997 (Pro Forma). International had operating
income of $182 million compared to pro forma operating income of $17 million in
1997. The increase in operating income is primarily due to a $138 million
pretax gain on the sale of Reliant Energy International's 63% interest in an
Argentine electric distribution company. Equity earnings from Reliant Energy
International's 1998 acquisitions of equity interests in utility systems in El
Salvador and Colombia also contributed to the increase in operating income.
1997 Compared to 1996 (Pro Forma). Pro forma operating income for 1997 was
$17 million compared to an operating loss of $1 million for 1996. 1996 includes
an $8 million pre-tax non-recurring charge related to the write-off of a portion
of Reliant Energy International's investment in two tire-to-energy plants.
Excluding non-recurring charges, International would have had operating income
in 1996 of $7 million. The remaining increase in 1997 operating income is due to
increased equity earnings of $32 million partially offset by higher operation
expenses resulting from increased corporate and project development costs.
Equity earnings increased primarily due to investments in Brazil and Colombia.
Light Servicos de Eletricidade S.A. (Light) reported enhanced results and a full
year of operations in 1997 compared to only seven months in 1996. Reliant
Energy International's June 1997 investment in a 28.35% indirect interest in
Empresa de Energia del Pacifico S.A.E.S.P (EPSA), a Colombian electric utility
also contributed to the increase in equity income.
CORPORATE
Corporate. Corporate includes the operations of certain non-rate regulated
retail services businesses, certain real estate holdings of the Company,
unallocated corporate costs and inter-unit eliminations.
Corporate had an operating loss of $44 million for 1998 compared to a pro
forma operating loss of $32 million for 1997. The increased loss was primarily
due to expensed development costs, increased expenses associated with
information system costs and increased liabilities associated with certain
compensation plans.
In 1997, Corporate's pro forma operating loss was $32 million compared to a
pro forma operating loss of $19 million in 1996. The increase in pro forma
operating loss was primarily due to losses from the Company's non-regulated
utility service businesses, consumer services and non-regulated retail electric
services businesses.
15
<PAGE>
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
OF THE COMPANY AND ITS SUBSIDIARIES
Earnings for the past three years are not necessarily indicative of future
earnings and results. The level of future earnings depends on numerous factors
including (i) the future growth in the Company's and its subsidiaries' energy
sales; (ii) weather; (iii) the success of the Company's and its subsidiaries'
entry into non-rate regulated businesses such as energy marketing and
international and domestic power projects; (iv) the Company's and its
subsidiaries' ability to respond to rapid changes in a competitive environment
and in the legislative and regulatory framework under which they have
traditionally operated; (v) rates of economic growth in the Company's and its
subsidiaries' service areas; (vi) the ability of the Company and its
subsidiaries to control costs and to maintain pricing structures that are both
attractive to customers and profitable; (vii) the outcome of future rate
proceedings; (viii) the effect that foreign exchange rate changes may have on
the Company's investments in international operations; and (ix) future
legislative initiatives.
In order to adapt to the increasingly competitive environment in which the
Company operates, the Company continues to evaluate a wide array of potential
business strategies, including business combinations or acquisitions involving
other utility or non-utility businesses or properties, internal restructuring,
reorganizations or dispositions of currently owned properties or currently
operating business units and new products, services and customer strategies. In
addition, the Company continues to engage in new business ventures, such as
electric power trading and marketing, which arise from competitive and
regulatory changes in the utility industry.
COMPETITION AND RESTRUCTURING OF THE ELECTRIC UTILITY INDUSTRY
The electric utility industry is becoming increasingly competitive due to
changing government regulations, technological developments and the availability
of alternative energy sources.
Long-Term Trends in Electric Utility Industry. The electric utility industry
historically has been composed of vertically integrated companies providing
electric service on an exclusive basis within governmentally-defined geographic
areas. Prices for electric service have typically been set by governmental
authorities under principles designed to provide the utility with an opportunity
to recover its cost of providing electric service plus a reasonable return on
its invested capital. Federal legislation and regulation as well as legislative
and regulatory initiatives in various states have encouraged competition among
electric utility and non-utility owned power generators. These developments,
combined with increased demand for lower-priced electricity and technological
advances in electric generation, have continued to move the electric utility
industry in the direction of more competition.
Based on a strategic review of the Company's business and of ongoing
developments in the electric utility and related industries regarding
competition, regulation and consolidation, the Company's management believes
that the electric utility industry will continue its path toward competition,
albeit on a state-by-state basis. The Company's management also believes the
business of electricity and natural gas are converging and consolidating and
these trends will alter the structure and business practices of companies
serving these markets in the future.
Competition in Wholesale Market. The Federal Energy Policy Act of 1992, the
Public Utility Regulatory Act of 1995 (now the Texas Utilities Code) and
regulations promulgated by the Federal Energy Regulatory Commission (FERC)
contain provisions intended to facilitate the development of a wholesale energy
market. Although Reliant Energy HL&P's wholesale sales traditionally have
accounted for less than 1% of its total revenues, the expansion of competition
in the wholesale electric market is significant in that it has increased the
range of non-utility competitors, such as exempt wholesale generators (EWGs) and
power marketers, in the Texas electric market as well as resulted in fundamental
changes in the operation of the state transmission grid.
In February 1996, the Texas Utility Commission adopted rules granting third-
party users of transmission systems open access to such systems at rates, terms
and conditions comparable to those available to utilities owning such
transmission assets. Under the Texas Utility Commission order implementing the
rule, Reliant Energy HL&P was required to separate, on an operational basis, its
wholesale power marketing operations from the operations of the transmission
grid and, for purposes of transmission pricing, to disclose each of its separate
costs of generation, transmission and distribution.
16
<PAGE>
Within ERCOT, an independent system operator (ISO) manages the state's
electric grid, ensuring system reliability and providing non-discriminatory
transmission access to all power producers and traders. The ERCOT ISO, the
first in the nation, is a key component for implementing the Texas Utility
Commission's overall strategy to create a competitive wholesale market. ERCOT
formed an ad hoc committee in early 1998 to investigate the potential impacts of
a competitive retail market on the ISO. The ERCOT committee report was released
in December 1998 and concluded that the ISO's role and function would
necessarily expand in a competitive retail environment, but the changes required
of the ISO to support retail choice should not impede introduction of retail
choice.
Competition in Retail Market. The Company estimates that, since 1978,
cogeneration projects representing approximately one-third of current total peak
generating capability have been built in the Houston area and that, as a result,
Reliant Energy HL&P has seen a reduction of approximately 2,500 MW in customer
load to self-generation. Reliant Energy HL&P has utilized flexible pricing to
respond to situations where large industrial customers have an alternative to
buying power from it, primarily by constructing their own generating facilities.
Under a tariff option approved by the Texas Utility Commission in 1995, Reliant
Energy HL&P was permitted to implement contracts based upon flexible pricing for
up to 700 MW. Currently, this rate is fully subscribed.
Texas law currently does not permit retail sales by unregulated entities such
as cogenerators. The Company anticipates that cogenerators and other interests
will continue to exert pressure to obtain access to the electric transmission
and distribution systems of regulated utilities for the purpose of making retail
sales to customers of regulated utilities.
Legislative Proposals. A number of proposals to restructure the electric
utility industry have been introduced in the 1999 session of the Texas
legislature. If adopted, legislation may permit and encourage alternative
suppliers to compete to serve Reliant Energy HL&P's current rate-regulated
retail customers. The various legislative proposals include provisions
governing recovery of stranded costs and permitting securitization of those
costs; freezing rates until 2002; requiring firm sales of energy to competing
retail electric providers; requiring disaggregation of generation, transmission
and distribution, and retail sales into separate companies; and limiting the
ability of existing utilities' affiliates competing for retail electric
customers on the basis of price until they have lost a substantial percentage of
their residential and small commercial load to alternative retail providers. In
addition to the Texas legislative proposals, a number of federal legislative
proposals to promote retail electric competition or restructure the U.S.
electric utility industry have been introduced during the current congressional
session.
At this time, the Company is unable to make any prediction as to whether any
legislation to restructure electric operations or provide retail competition
will be enacted or as to the content or impact on the Company of any legislation
which may be enacted. However, because the proposed legislation is intended to
fundamentally restructure electric utility operations, it is likely that enacted
legislation would have a material impact on the Company.
Stranded Costs. As the U.S. electric utility industry continues its
transition to a more competitive environment, a substantial amount of fixed
costs previously approved for recovery under traditional utility regulatory
practices (including regulatory assets and liabilities) may become "stranded,"
i.e., unrecoverable at competitive market prices. The issue of stranded costs
could be particularly significant with respect to fixed costs incurred in
connection with the past construction of generation plants, such as nuclear
power plants, which, because of their high fixed costs, would not command the
same price for their output as they have in a regulated environment.
In January 1997, the Texas Utility Commission delivered a report to the Texas
legislature on stranded investments in the electric utility industry in Texas
(referred to by the Texas Utility Commission as "Excess Cost Over Market")
(ECOM). In April 1998, the Texas Utility Commission submitted to the Texas
Senate Interim Committee on Electric Utility Restructuring an updated study of
ECOM estimates. Assuming that retail competition is adopted at the beginning of
2002, the updated study estimated that the total amount of stranded costs for
all Texas electric utilities could be $4.5 billion. If instead, retail
competition is adopted one year later, the study estimates statewide ECOM to be
$3.3 billion. Estimates of ECOM vary widely and there is inherent uncertainty
in calculating these costs.
17
<PAGE>
Transition Plan. In June 1998, the Texas Utility Commission approved the
Transition Plan filed by Reliant Energy HL&P in December 1997. The Transition
Plan included base rate credits to residential and certain commercial customers
in 1998 and 1999, an overall rate of return cap formula for 1998 and 1999 and
approval of accounting procedures designed to accelerate recovery of stranded
costs which may arise under restructuring legislation. The Transition Plan
permits the redirection of depreciation expense to generation assets that
Electric Operations otherwise would apply to transmission, distribution and
general plant assets. In addition, the Transition Plan provides that all
earnings above a 9.844% overall annual rate of return on invested capital be
used to recover Electric Operations' investment in generation assets. In 1998,
Reliant Energy HL&P recorded an additional $194 million in depreciation under
the Transition Plan. Certain parties have appealed the order approving the
Transition Plan. For additional information, see Notes 1(f) and 3(b) to the
Company's Consolidated Financial Statements.
COMPETITION -- OTHER OPERATIONS
Natural Gas Distribution competes primarily with alternate energy sources such
as electricity and other fuel sources as well as with providers of energy
conservation products. In addition, as a result of federal regulatory changes
affecting interstate pipelines, it has become possible for other natural gas
suppliers and distributors to bypass Natural Gas Distribution's facilities and
market, sell and/or transport natural gas directly to small commercial and/or
large volume customers.
The Interstate Pipeline segment competes with other interstate and intrastate
pipelines in the transportation and storage of natural gas. The principal
elements of competition among pipelines are rates, terms of service, and
flexibility and reliability of service. Interstate Pipeline competes indirectly
with other forms of energy available to its customers, including electricity,
coal and fuel oils. The primary competitive factor is price. Changes in the
availability of energy and pipeline capacity, the level of business activity,
conservation and governmental regulations, the capability to convert to
alternative fuels, and other factors, including weather, affect the demand for
natural gas in areas served by Interstate Pipeline and the level of competition
for transport and storage services.
Reliant Energy Services competes for sales in its gas and power trading and
marketing business with other natural gas and power merchants, producers and
pipelines based on its ability to aggregate supplies at competitive prices from
different sources and locations and to efficiently utilize transportation from
third-party pipelines and transmission from electric utilities. Reliant Energy
Services also competes against other energy marketers on the basis of its
relative financial position and access to credit sources. This competitive
factor reflects the tendency of energy customers, natural gas suppliers and
natural gas transporters to seek financial guarantees and other assurances that
their energy contracts will be satisfied. As pricing information becomes
increasingly available in the energy trading and marketing business and as
deregulation in the electricity markets continues to accelerate, the Company
anticipates that Reliant Energy Services will experience greater competition and
downward pressure on per-unit profit margins in the energy marketing industry.
Competition for acquisition of international and domestic non-rate regulated
power projects is intense. International and Power Generation compete against a
number of other participants in the non-utility power generation industry, some
of which have greater financial resources and have been engaged in non-utility
power projects for periods longer than the Company and have accumulated greater
portfolios of projects. Competitive factors relevant to the non-utility power
industry include financial resources, access to non-recourse funding and
regulatory factors.
FLUCTUATIONS IN COMMODITY PRICES AND DERIVATIVE INSTRUMENTS
For information regarding the Company's exposure to risk as a result of
fluctuations in commodity prices and derivative instruments, see "Quantitative
and Qualitative Disclosures About Market Risk."
ACCOUNTING TREATMENT OF ACES
The Company accounts for its investment in Time Warner Convertible Preferred
Stock (TW Preferred) under the cost method. As a result of the Company's
issuance of the ACES, a portion of the increase in the market value above
$27.7922 per share of Time Warner common stock (the security into which the TW
Preferred is convertible) (TW
18
<PAGE>
Common) results in unrealized accounting losses to the Company, pending the
conversion of the Company's TW Preferred into TW Common. For consistency
purposes, the TW Common and related per share prices retroactively reflect a 2
for 1 stock split effective December 15, 1998.
Prior to the conversion of the TW Preferred into TW Common, when the market
price of TW Common increases above $27.7922, the Company records in Other Income
(Expense) an unrealized, non-cash accounting loss for the ACES equal to the
aggregate amount of such increase as applicable to all ACES multiplied by
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 TW Common that underlies
the TW Preferred. Upon conversion of the TW Preferred (which is anticipated to
occur in June 1999 when the preferential dividend on the TW Preferred expires),
the Company will begin recording future unrealized net changes in the market
prices of the TW Common and the ACES as a component of common stock equity and
other comprehensive income.
As of December 31, 1998, the market price of TW Common was $62.062 per share.
Accordingly, the Company recognized an increase of $1.2 billion in 1998 in the
unrealized liability relating to its ACES indebtedness (which resulted in an
after-tax earnings reduction of $764 million or $2.69 basic earnings per share
in 1998). The Company believes that the cumulative unrealized loss for the ACES
of approximately $1.3 billion is more than economically offset by the
approximately $1.8 billion unrecorded unrealized gain at December 31, 1998
relating to the increase in the fair value of the TW Common underlying the
investment in TW Preferred since the date of its acquisition. Any gain related
to the increase in fair value of TW Common would be recognized as a component of
net income upon the sale of the TW Preferred or the shares of TW Common into
which such TW Preferred is converted. As of March 11, 1999, the price of TW
Common was $70.75 per share, which would have resulted in the Company
recognizing an additional increase of $329 million in the unrealized liability
represented by its indebtedness under the ACES. The related unrecorded
unrealized gain as of March 11, 1999 would have been computed as an additional
$398 million.
Excluding the unrealized, non-cash accounting loss for ACES, the Company's
retained earnings and total common stock equity would have been $2.3 billion and
$5.2 billion, respectively.
IMPACT OF THE YEAR 2000 ISSUE AND OTHER SYSTEM IMPLEMENTATION 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-Year 2000
compliant programs.
Compliance Program. In 1997, the Company initiated a corporate-wide Year 2000
project to address mainframe application systems, information technology (IT)
related equipment, system software, client-developed applications, building
controls and non-IT embedded systems such as process controls for energy
production and delivery. Incorporated into this project were Resources' and
other Company subsidiaries' mainframe applications, infrastructures, embedded
systems and client-developed applications that will not be migrated into
existing or planned Company or Resources systems prior to the year 2000. The
evaluation of Year 2000 issues included those related to significant customers,
key vendors, service suppliers and other parties material to the Company's and
its subsidiaries' 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.
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 (Priority 1); activities that would impact back
office activities such as billing (Priority 2); activities that would cause
inconvenience or productivity loss in normal business operations (e.g., air
conditioning systems and elevators) (Priority 3). 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
personnel systems and equipment. The remediation and replacement work on the
majority of IT systems, non-IT systems and infrastructure began in the first
quarter of 1998 and is expected to be completed by the
19
<PAGE>
second quarter of 1999. Testing of these systems began in the second quarter of
1998 and is scheduled to be completed in third quarter of 1999. The following
table illustrates the Company's completion percentages for the Year 2000
activities as of February 28, 1999:
<TABLE>
<CAPTION>
PRIORITY 1 PRIORITY 2 PRIORITY 3
---------- ---------- ----------
<S> <C> <C> <C>
Assessment............................................. 95% 86% 96%
Conversion............................................. 86% 70% 91%
Testing................................................ 80% 61% 87%
Implementation......................................... 76% 54% 75%
</TABLE>
Costs to Address Year 2000 Compliance Issues. 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 with respect to the Company and its subsidiaries will be between $35
and $40 million. This estimate includes approximately $7 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 $12 million during 1998. The remaining costs related to
resolving the Year 2000 issue are expected to be expended in 1999. The Company
expects to fund these expenditures through internal sources.
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 customer care, finance and accounting, human resources,
materials management and service delivery components. The Company's purchase of
this software license and 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 Resources 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 problem, the
Company does not deem the costs of the SAP system as directly related to its
Year 2000 compliance program. Portions of the SAP system were implemented in
December 1998 and March 1999, and it is expected that the final portion of the
SAP system will be fully implemented by July 2000. The estimated costs of
implementing the SAP system is approximately $182 million, inclusive of internal
costs. In 1998, the Company and its subsidiaries spent $108 million of such
costs. In 1999, the Company and its subsidiaries expect to spend $59 million
with the remaining amounts to be spent in 2000.
The estimated Year 2000 project costs do not give effect to any future
corporate acquisitions or divestitures made by the Company or its subsidiaries.
Risks and Contingency Plans. The major systems which pose the greatest Year
2000 risks for the Company and its subsidiaries if implementation of the Year
2000 compliance program is not successful are the process control systems for
energy delivery systems; the time in use, demand and recorder metering system
for commercial and industrial customers; the outage analysis system; and the
power billing systems. The potential problems related to these systems are
temporary electric service interruptions to customers, temporary interruptions
in revenue data gathering and temporary poor customer relations resulting from
delayed billing. Although the Company does not believe that this scenario will
occur, the Company has considerable experience responding to emergency
situations, including computer failure. Existing emergency operations, disaster
recovery and business continuation plans are being enhanced to ensure
preparedness and to mitigate the long-term effect of such a scenario.
The North American Electric Reliability Council (NERC) is coordinating
electric utility industry contingency planning on a national level. Additional
contingency planning is being done at the regional electric reliability council
level. Reliant Energy HL&P filed a draft Year 2000 Contingency Plan with NERC
and with the Texas Utility Commission in December 1998. The draft plan
addresses restoration of electric service and related business processes, and is
designed to work in conjunction with the Emergency Operating Plan and with the
plans of NERC and ERCOT. A final contingency plan is scheduled to be complete by
June 30, 1999. In addition, Reliant Energy HL&P will participate in industry
preparedness drills, such as the two NERC drills scheduled to be held on April
9, 1999 and September 9, 1999.
20
<PAGE>
The existing business continuity disaster recovery and emergency operations
plans are being reviewed and enhanced, and where necessary, additional plans
will be developed to include mitigation strategies and action plans specifically
addressing potential Year 2000 scenarios. The expected completion date for
these plans is June 30, 1999.
In order to assist in preparing for and mitigating the foregoing scenarios,
the Company intends to complete all mission critical Year 2000 remediation and
testing activity by the end of the second 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. The Company expects to meet with mission-critical third parties,
including suppliers, in order to ascertain and assess the relative risks of
Year-2000-related issues, and to mitigate such risks. 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. 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 and its subsidiaries' operations.
RISKS OF INTERNATIONAL OPERATIONS
The Company's international operations are subject to various risks incidental
to investing or 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. The Company'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.
Impact of Currency Fluctuations on Company Earnings. The Company, through
Reliant Energy International's subsidiaries, owns 11.69% of the stock of Light
and, through its investment in Light, an 8.753% interest in the stock of
Metropolitana Electricidade de Sao Paulo S.A. (Metropolitana). 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 December 31, 1998, Light and Metropolitana had total borrowings of
approximately $3.2 billion denominated in non-local currencies. Because of the
devaluation of the Brazilian real subsequent to December 31, 1998, Light and
Metropolitana are expected to record a charge to March 31, 1999 earnings that
reflects the increase in the liability represented by their non-local currency
denominated bank borrowings relative to the Brazilian real. 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 will also be
reflected in the Company's consolidated earnings to the extent of the Company's
11.69% ownership interest in Light. At December 31, 1998, one U. S. dollar could
be exchanged for 1.21 Brazilian reais. Using the exchange rate of 2.06
Brazilian reais in effect at the end of February, and the average exchange rate
in effect since the end of the year, the Company estimates that its share of the
after-tax charge to be recorded by Light would be approximately $125 million.
This estimate does not reflect the possibility of additional fluctuations in the
exchange rate and does not include other non-debt-related impacts of Brazil's
currency devaluation on Light's and Metropolitana's future earnings.
None of Light's or Metropolitana's tariff adjustment mechanisms are directly
indexed to the U.S. dollar or other non-local currencies. Each company
currently is evaluating various options including regulatory rate relief to
mitigate the impact of the devaluation of the Brazilian real. For example, the
long-term concession contracts under which Light and Metropolitana operate
contain mechanisms for adjusting electricity tariffs to reflect changes in
operating costs resulting from inflation. If the devaluation of the Brazilian
real results in an increase in the local rate of inflation and if an adjustment
to tariff rates is made promptly to reflect such increase, the Company believes
that the financial results of Light and Metropolitana should be protected, at
least in part, from the effects of devaluation. However, there can be no
assurance the implementation of such tariff adjustments will be timely or that
the economic impact of the devaluation will be completely reflected in increased
inflation rates.
21
<PAGE>
Certain of Reliant Energy International's other foreign electric distribution
companies have incurred U.S. dollar and other non-local currency indebtedness
(approximately $71 million at December 31, 1998). For further analysis of
foreign currency fluctuations in the Company's earnings and cash flows, see
"Quantitative and Qualitative Disclosures About Market Risk -- Foreign Currency
Exchange Rate Risk."
Impact of Foreign Currency Devaluation on Project Capital Resources. In the
first quarter of 1999, approximately $117 million of Metropolitana's U.S. dollar
denominated debt will mature. In the second quarter of 1999, approximately $980
million of Light's and approximately $696 million of Metropolitana's U.S. and
non-local currency denominated bank debt will mature. In March 1999, Light
refinanced approximately $130 million of its U.S. dollar denominated debt
through a local currency denominational loan. The ability of Light and
Metropolitana to repay or refinance their debt obligations at maturity is
dependent on many factors, including local and international economic conditions
prevailing at the time such debt matures.
If economic conditions in the international markets continue to be unsettled
or deteriorate, it is possible that Light, Metropolitana and the other foreign
electric distribution companies in which the Company holds investments might
encounter difficulties in refinancing their debt (both local currency and non-
local currency borrowings) on terms and conditions that are commercially
acceptable to them and their shareholders. In such circumstances, in lieu of
declaring a default or extending the maturity, it is possible that lenders might
seek to require, among other things, higher borrowing rates, and additional
equity contributions and/or increased levels of credit support from the
shareholders of such entities. The availability or terms of refinancing such
debt cannot be assured.
Currency fluctuation and instability affecting Latin America may also
adversely affect Reliant Energy International's ability to refinance its equity
investments with debt. In 1998, Reliant Energy International invested $411 in
Colombia and El Salvador. As of January 1999, $100 million of these investments
were refinanced with debt. Reliant Energy International intends to refinance
approximately $75 million more of such initial investments with debt.
ENVIRONMENTAL EXPENDITURES
The Company and its subsidiaries, including Resources, are subject to numerous
environmental laws and regulations, which require them to incur substantial
costs to operate existing facilities, construct and operate new facilities, and
mitigate or remove the effect of past operations on the environment.
Clean Air Act Expenditures. The Company expects the majority of capital
expenditures associated with environmental matters to be incurred by Electric
Operations in connection with new emission limitations under the Federal Clean
Air Act (Clean Air Act) for oxides of nitrogen (NOx). The standards applicable
to Electric Operations' generating units in the Houston, Texas area will become
effective in November 1999. NOx reduction costs incurred by Electric Operations
totaled approximately $7 million in 1998. The Company estimates that Electric
Operations will incur approximately $8 million in 1999 and $10 million in 2000
for such expenditures. The Texas Natural Resources Conservation Commission
(TNRCC) has indicated that additional NOx reduction will be required after 2000;
however, since the magnitude and timing of these reductions have not yet been
established, it is impossible for the Company to estimate a reasonable range of
such expenditures at this time.
In 1998, Wholesale Energy spent approximately $100,000 in order to comply with
NOx reduction with respect to Southern California generating facilities acquired
by Power Generation from Southern California Edison (SCE) in 1998. In 1999,
based on existing requirements, the Company projects that it will spend an
additional $100,000 on NOx reduction standards with respect to such plants and
approximately $1 million on continuous emission monitoring system upgrades for
such plants.
Site Remediation Expenditures. From time to time the Company and its
subsidiaries have received notices from regulatory authorities or others
regarding their status as potentially responsible parties in connection with
sites found to require remediation due to the presence of environmental
contaminants.
22
<PAGE>
The Company's identified sites with respect to which it may be claimed to have
a remediation liability include several sites for which there is a lack of
current available information, including the nature and magnitude of
contamination, and the extent, if any, to which the Company may be held
responsible for contributing to any costs incurred for remediating these sites.
Thus, no reasonable estimate of cleanup costs can now be made for these sites.
Based on currently available information, the Company believes that such costs
ultimately will not materially affect its financial position, results of
operations or cash flows. There can be no assurance, however, that future
developments, including additional information about existing sites or the
identification of new sites, will not require material revisions to such
estimates. For information about specific sites that are the subject of
remediation claims, see Note 12(h) to the Company's Consolidated Financial
Statements and Note 8(g) to Resources' Consolidated Financial Statements, each
of which is incorporated herein by reference.
Mercury Contamination. Like other natural gas pipelines, Resources' 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 Resources at some sites in the
past, and Resources has conducted remediation at sites found to be contaminated.
Although Resources 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 of Resources and others in the natural gas industry to
date and on the current regulations regarding remediation of such sites, the
Company and Resources believe that the cost of any remediation of such sites
will not be material to the Company's or Resources' financial position, results
of operations or cash flows.
Other. In addition, the Company has been named as a defendant in litigation
related to such sites and in recent years has been named, along with numerous
others, as a defendant in several lawsuits filed by a large number of
individuals who claim injury due to exposure to asbestos while working at sites
along the Texas Gulf Coast. Most of these claimants have been workers who
participated in construction of various industrial facilities, including power
plants, and some of the claimants have worked at locations owned by the Company.
The Company anticipates that additional claims like those received may be
asserted in the future and intends to continue its practice of vigorously
contesting claims which it does not consider to have merit. Although their
ultimate outcome cannot be predicted at this time, the Company does not believe,
based on its experience to date, that these matters, either individually or in
the aggregate, will have a material adverse effect on the Company's financial
position, results of operations or cash flows.
OTHER CONTINGENCIES
For a description of certain other legal and regulatory proceedings affecting
the Company and its subsidiaries, see Notes 3, 4, 5 and 12 to the Company's
Consolidated Financial Statements, and Note 8 to Resources' Consolidated
Financial Statements, which notes are incorporated herein by reference.
23
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Company Consolidated Capital Requirements
The liquidity and capital requirements of the Company and its subsidiaries are
affected primarily by capital programs and debt service requirements. The
capital requirements for 1998 were, and as estimated for 1999 through 2003 are,
as follows (in millions):
<TABLE>
1998 1999 2000 2001 2002 2003
----- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Electric capital and nuclear fuel
(excluding allowance for funds used
during construction) (AFUDC)............ $ 429 $ 490 $ 432 $ 379 $ 370 $ 370
Natural Gas Distribution(3).............. 162 185 173 172 168 169
Interstate Pipeline(3)................... 59 30 28 17 17 17
Wholesale Energy (excluding capitalized
interest)(2)............................ 364 154 156 25 12 10
International (excluding capitalized
interest)(2)............................ 427 3 2 3
Corporate................................ 30 64 42 53 55 54
Maturities of long-term debt, preferred
stock and minimum capital lease
payments (3)............................ 240 402 2,758 438 1,895 199
--------- ---------- --------- --------- --------- ---------
Total(1)............................... $1,711 $1,328 $3,591 $1,087 $2,517 $ 819
========= ========== ========= ========= ========= =========
</TABLE>
__________
(1) Expenditures in the table do not reflect expenditures associated with the
Year 2000 issue. For a discussion of these expenditures, see "--Certain
Factors Affecting Future Earnings of the Company and its Subsidiaries --
Impact of the Year 2000 Issue and Other System Implementation Issues."
(2) Expenditures in the table reflect only expenditures made or to be made
under existing contractual commitments entered into by International and
Wholesale Energy. The Company expects that Reliant Energy International
and Power Generation will continue to participate as bidders in future
acquisitions of independent power projects, privatizations of generation
and distribution facilities and sales of generating assets. International
and Wholesale Energy capital requirements are expected to be met through
advances from the Company, the proceeds of project financings and the
proceeds of borrowings at the Company's finance subsidiaries. Additional
capital expenditures are dependent upon the nature and extent of future
project commitments (some of which may be substantial).
(3) All of the capital requirements for Natural Gas Distribution and Interstate
Pipelines represent requirements at Resources. Wholesale Energy
requirements allocable to Resources for the respective periods shown are
$21 million, $45 million, $23 million, $16 million, $12 million and $10
million. The components of "Maturities of long-term debt, preferred stock
and minimum capital lease payments" allocable to Resources for the
respective periods shown are $227 million, $207 million, $228 million, $151
million, $7 million and $7 million.
For the year ended December 31, 1998, the Company's net cash provided by
operating activities increased $315 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
Resources acquisition, (ii) increased sales at Electric Operations due to
unusually hot weather during the second and third quarters of 1998 and (iii) the
receipt of a refund of federal income taxes and related interest income.
Net cash used in investing activities decreased $752 million for the year
ended December 31, 1998, compared to the same period in 1997, due to the
Resources acquisition. Investing activities for the year ended December 31,
1998 included (i) the acquisition and construction of non-rate regulated power
generation projects, (ii) the acquisition of investments in foreign electric
distribution systems and (iii) the sale of an investment in an Argentine
electric distribution company.
24
<PAGE>
Net cash used in financing activities for the year ended December 31, 1998
reflected a $218 million outflow compared to an inflow of $914 million in the
same period in 1997. The cash inflow in 1997 included $1 billion in proceeds
from the issuance of the 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
Resources acquisition. The proceeds from the ACES were used to retire $1
billion of commercial paper borrowings.
In June 1998, the Company repaid at maturity $5 million of floating-rate
pollution control revenue bonds issued on its behalf. In February 1999, the
Company repaid at maturity $170.5 million of medium-term notes collateralized by
first mortgage bonds.
The Company has approximately $400 million of consolidated debt maturing in
1999.
During 1998, Resources repaid at maturity $76 million of medium-term notes and
a $150 million term loan. In March 1998, Resources satisfied the $6.5 million
sinking fund requirement for its 6% convertible subordinated debentures due 2012
using debentures purchased in 1996 and 1997. During 1998, Resources purchased
and retired $6.7 million aggregate principal amount of its 6% convertible
subordinated debentures due 2012 at an average purchase price of 97.3% of the
aggregate principal amount plus accrued interest. During 1999, Resources
purchased and retired $5.8 million aggregate principal amount of its 6%
convertible subordinated debentures due 2012 at an average purchase price of
98.4% of the aggregate principal amount plus accrued interest. The debentures
purchased in 1998 and 1999 are expected to be used to satisfy the March 1999,
March 2000 and March 2001 sinking fund requirements. Resources has $200 million
of debt maturing in July 1999.
During 1998, a subsidiary of Reliant Energy International retired $13.1
million of its debt under a loan facility established in connection with the
financing of the acquisition costs of Light. Approximately $22.3 million of
debt under this loan facility is scheduled to be retired in 1999.
COMPANY CONSOLIDATED SOURCES OF CAPITAL RESOURCES AND LIQUIDITY
At December 31, 1998, FinanceCo, a limited partnership subsidiary of the
Company, had a $1.6 billion revolving credit facility (FinanceCo Facility)
terminating in 2002. At December 31, 1998, the FinanceCo Facility supported
$1.4 billion in commercial paper borrowings having a weighted average interest
rate of 5.88%. For additional information regarding the FinanceCo Facility, see
Note 8(c) to the Company's Consolidated Financial Statements.
At December 31, 1998, the Company, exclusive of Resources and other
subsidiaries, had a revolving credit facility of $200 million which could be
used to support the Company's issuance of up to $200 million of commercial
paper. At December 31, 1998, the Company had no loans outstanding under the
facility and no commercial paper borrowings.
In March 1998, Resources replaced its $400 million revolving credit facility
with a five-year $350 million revolving credit facility (Resources Credit
Facility), which could be used to support Resources' issuance of up to $350
million of commercial paper. At December 31, 1998, Resources had no loans
outstanding under the unsecured facility and no commercial paper borrowings.
The Company expects to amend the Resources Credit Facility in March 1999 to
include a $65 million sub-facility under which letters of credit may be
obtained. Prior to the amendment, Resources previously obtained letters of
credit under a $65 million committed facility which was terminated in December
1998. Subsequent to the December 1998 termination and prior to the amendment to
the Credit Facility, Resources obtained letters of credit under an uncommitted
line.
At December 31, 1998, Resources had a trade receivables facility of $300
million under which receivables of $300 million had been sold. For additional
information regarding Resources' Credit Facilities, see Note 8(g) to the
Company's Consolidated Financial Statements.
25
<PAGE>
In March 1998, a limited partnership special purpose subsidiary of the Company
(FinanceCo II) executed a $150 million credit agreement with a bank (FinanceCo
II Facility). Proceeds from $150 million of borrowings under the FinanceCo II
Facility were used to fund a portion of Wholesale Energy's April 1998 purchase
of four electric generation plants. Borrowings under the FinanceCo II Facility
were repaid at maturity in March 1999 with commercial paper issued at FinanceCo.
For additional information regarding the FinanceCo II Facility, see Note 8(c) to
the Company's Consolidated Financial Statements.
In January 1998, 5.25% ($29.7 million) and 5.15% ($75 million) pollution
control revenue refunding bonds were issued on behalf of the Company by the
Matagorda County Navigation District Number One (MCND). Proceeds from the
issuance were used in February 1998 to redeem, at 102% of the $104.7 million
aggregate principal amount, pollution control revenue bonds.
In February 1998, Resources issued $300 million of 6 1/2 % debentures due
February 1, 2008. The proceeds from the sale of the debentures were used to
repay short-term indebtedness of Resources, including the short-term
indebtedness incurred in connection with the purchase in 1997 of $101.4 million
of its 10% debentures and the repayment of $53 million of Resources debt that
matured in December 1997 and January 1998.
In February 1998, 5 1/8% pollution control revenue refunding bonds aggregating
$290 million were issued on behalf of the Company by the Brazos River Authority
(BRA). Proceeds from the issuance were used in May 1998 to redeem, at 102% of
the $290 million aggregate principal amount, pollution control revenue bonds.
In September 1998, 4.90% pollution control revenue refunding bonds aggregating
$68.7 million were issued on behalf of the Company by the BRA. Proceeds from
the issuance were used in October 1998 to redeem, at 102% of the $68.7 million
aggregate principal amount, pollution control revenue bonds.
In November 1998, the Company effected a change in the method of
interest rate determination on the MCND Series 1997 pollution control revenue
refunding bonds due November 2028 ($68 million aggregate principal amount
outstanding) and the BRA Series 1997 pollution control revenue refunding bonds
due November 2018 ($50 million aggregate principal amount outstanding). The
method by which interest on the bonds is determined changed from a floating rate
mode to a long-term fixed rate mode. The interest rate on the MCND Series 1997
bonds and the BRA Series 1997 bonds until their maturity is 5 1/8% and 5.05%,
respectively.
In November 1998, Resources sold $500 million of its 6 3/8% Term
Enhanced ReMarketable Securities (TERM Notes). The net proceeds from the
offering were used for general corporate purposes, including the repayment of
(i) $178.5 million of Resources' outstanding commercial paper and (ii) a $150
million term loan of Resources that matured on November 13, 1998. For
additional information regarding the TERM Notes offering, see Note 8(h) to the
Company's Consolidated Financial Statements and Note 4(b) to Resources'
Consolidated Financial Statements.
In December 1997, Sempra Energy Resources and Power Generation formed El
Dorado Energy, a joint venture formed to build, own and operate a 492 MW natural
gas power plant in Boulder City, Nevada. Power Generation invested $25 million
and $2 million in El Dorado in 1998 and 1997, respectively. Total cost for the
project is estimated to be $263 million. In October 1998, El Dorado Energy
obtained a 15 year, $158 million non-recourse loan to finance the project. The
loan represents approximately 60% of the estimated total project cost.
In February 1999, a Delaware statutory business trust (REI Trust I)
established by the Company issued $375 million of preferred securities. The
preferred securities have a distribution rate of 7.20% payable quarterly in
arrears, a stated liquidation amount of $25 per preferred security and must be
redeemed by March 2048. REI Trust I sold the preferred securities to the public
and used the proceeds to purchase $375 million aggregate principal amount of
subordinated debentures (REI Debentures) from the Company having an interest
rate corresponding to the distribution rate of the preferred securities and a
maturity date corresponding to the mandatory redemption date of the preferred
securities. Proceeds from the sale of the REI Debentures were used by the
Company for general corporate purposes including the repayment of short-term
debt. For further discussion, see Note 16(b) to the Company's Consolidated
Financial Statements.
26
<PAGE>
At December 31, 1998, the Company had shelf registration statements providing
for the issuance of $230 million aggregate liquidation value of its preferred
stock and $580 million aggregate principal amount of its debt securities. In
the first quarter of 1999, the Company registered $500 million of trust
preferred securities and junior subordinated debt securities, of which $125
million remains available for issuance. The issuance of all securities
registered by the Company and its affiliates is subject to market and other
conditions.
The Company owns 11 million shares of non-publicly traded TW Preferred. The TW
Preferred, which is entitled to cumulative annual dividends of $3.75 per share
until July 6, 1999, and is currently convertible at the option of the Company
into 45.8 million shares of Time Warner common stock. The Company's ability to
transfer, sell or pledge the shares of TW Preferred is not restricted pursuant
to the terms of the ACES. The Company reviews its investment in Time Warner on a
regular basis and does not expect to maintain its investment in Time Warner
indefinitely. For additional information regarding the Company's investment in
Time Warner securities, see Notes 1(n) and (e) to the Company's Consolidated
Financial Statements.
For information regarding the potential impact of foreign currency devaluation
on the Company's future liquidity needs, see "--Certain Factors Affecting Future
Earnings of the Company's and its Subsidiaries -- Risks of International
Operations."
The Company and its subsidiaries participate from time to time in competitive
bids for generating and distribution assets through its Wholesale Energy and
International segments. Although the Company believes that its current level of
cash and borrowing capability along with future cash flows from operations are
sufficient to meet the existing operational needs of its businesses, the Company
may, when it deems necessary, or when it acquires and operates new businesses
and assets, supplement its available cash resources by seeking funds in the
equity or debt markets.
NEW ACCOUNTING ISSUES
In 1998, the Company and Resources adopted SFAS No. 130, "Reporting
Comprehensive Income" (SFAS No. 130), 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). For further discussion of these accounting statements, see Note 15 to
the Company's Consolidated Financial Statements and Note 9 to Resources'
Consolidated Financial Statements.
In 2000, the Company and Resources expect to adopt SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities" (SFAS No. 133), which
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
on its consolidated financial statements.
In December 1998, The Emerging Issues Task Force of the Financial Accounting
Standards Board reached consensus on Issue 98-10, "Accounting for Contracts
Involved in Energy Trading and Risk Management Activities" (EITF Issue 98-10).
EITF Issue 98-10 requires energy trading contracts to be recorded at fair value
on the balance sheet, with the changes in fair value included in earnings. EITF
Issue 98-10 is effective for fiscal years beginning after December 15, 1998.
The Company expects to adopt EITF Issue 98-10 in the first quarter of 1999. The
Company does not expect the implementation of EITF Issue 98-10 to be material to
its consolidated financial statements.
27
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
INTEREST RATE RISK
The Company and its subsidiaries have long-term debt, Company/ Resources
obligated mandatorily redeemable preferred securities of subsidiary trusts
holding solely junior subordinated debentures of the Company/Resources (Trust
Securities), securities held in the Company's nuclear decommissioning trust,
bank facilities, certain lease obligations and interest rate swaps which subject
the Company, Resources and certain of their subsidiaries to the risk of loss
associated with movements in market interest rates.
At December 31, 1998, the Company and certain of its subsidiaries had issued
fixed-rate long-term debt (excluding ACES) and Trust Securities aggregating $5.0
billion in principal amount and having a fair value of $5.2 billion. These
instruments are fixed-rate and, therefore, do not expose the Company and its
subsidiaries to the risk of earnings loss due to changes in market interest
rates (see Notes 8 and 9 to the Company's Consolidated Financial Statements).
However, the fair value of these instruments would increase by approximately
$260.6 million if interest rates were to decline by 10% from their levels at
December 31, 1998. In general, such an increase in fair value would impact
earnings and cash flows only if the Company and its subsidiaries were to
reacquire all or a portion of these instruments in the open market prior to
their maturity.
The Company and certain of its subsidiaries' floating-rate obligations
aggregated $1.8 billion at December 31, 1998 (see Note 8 to the Company's
Consolidated Financial Statements), inclusive of (i) amounts borrowed under
short-term and long-term credit facilities of the Company and its subsidiaries
(including the issuance of commercial paper supported by such facilities), (ii)
borrowings underlying Resources' receivables facility and (iii) amounts subject
to a master leasing agreement of Resources under which lease payments vary
depending on short-term interest rates. These floating-rate obligations expose
the Company, Resources and their subsidiaries to the risk of increased interest
and lease expense in the event of increases in short-term interest rates. If
the floating rates were to increase by 10% from December 31, 1998 levels, the
Company's consolidated interest expense and expense under operating leases would
increase by a total of approximately $0.9 million each month in which such
increase continued.
As discussed in Notes 1(o), 4(c) and 13 to the Company's Consolidated
Financial Statements, the Company contributes $14.8 million per year to a trust
established to fund the Company's share of the decommissioning costs for the
South Texas Project. The securities held by the trust for decommissioning costs
had an estimated fair value of $119.1 million as of December 31, 1998, of which
approximately 44% were fixed-rate debt securities that subject the Company to
risk of loss of fair value with movements in market interest rates. If interest
rates were to increase by 10% from their levels at December 31, 1998, the
decrease in fair value of the fixed-rate debt securities would not be material
to the Company. In addition, the risk of an economic loss is mitigated at this
time as a result of the Company's regulated status. Any unrealized gains or
losses are accounted for in accordance with SFAS No. 71 as a regulatory
asset/liability because the Company believes that its future contributions which
are currently recovered through the rate-making process will be adjusted for
these gains and losses.
Certain subsidiaries of the Company have entered into interest rate swaps for
the purpose of decreasing the amount of debt subject to interest rate
fluctuations. At December 31, 1998, these interest rate swaps had an aggregate
notional amount of $75.4 million, which the Company could terminate at a cost of
$3.2 million (see Notes 2 and 13 to the Company's Consolidated Financial
Statements). An increase of 10% in the December 31, 1998 level of interest rates
would not increase the cost of termination of the swaps by a material amount to
the Company. Swap termination costs would impact the Company's and its
subsidiaries' earnings and cash flows only if all or a portion of the swap
instruments were terminated prior to their expiration.
As discussed in Note 8(h) to the Company's Consolidated Financial Statements,
Resources sold $500 million aggregate principal amount of its 6 3/8% TERM Notes
which included an embedded option to remarket the securities. The option is
expected to be exercised in the event that the ten-year Treasury rate in 2003 is
below 5.66%. At December 31, 1998, the Company could terminate the option at a
cost of $30.7 million. A decrease of 10% in the December 31, 1998 level of
interest rates would not increase the cost of termination of the option by a
material amount to the Company.
28
<PAGE>
The change in exposure to loss in earnings and cash flows related to interest
rate risk from December 31, 1997 to December 31, 1998 is not material to the
Company.
EQUITY MARKET RISK
The Company holds an investment in TW Preferred which is convertible into Time
Warner common stock (TW Common) as described in "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 --
Accounting Treatment of ACES." As a result, the Company is exposed to losses in
the fair value of this security. For purposes of analyzing market risk in this
Appendix A, the Company assumed that the TW Preferred was converted into TW
Common. In addition, Resources' investment in the common stock of Itron, Inc.
(Itron) exposes the Company and Resources to losses in the fair value of Itron
common stock. A 10% decline in the market value per share of TW Common and Itron
common stock from the December 31, 1998 levels would result in a loss in fair
value of approximately $284.4 million and $1.1 million, respectively.
The Company's and its subsidiaries' ability to realize gains and losses
related to the TW Preferred and the Itron common stock is limited by the
following: (i) the TW Preferred is not publicly traded and its sale is subject
to certain limitations and (ii) the market for the common stock of Itron is
fairly illiquid.
The ACES expose the Company to accounting losses as the Company is required to
record in Other Income (Expense) an unrealized accounting loss equal to (i) the
aggregate amount of the increase in the market price of TW Common above $27.7922
as applicable to all ACES multiplied by (ii) 0.8264. Prior to the conversion of
the TW Preferred into TW Common, such loss would affect earnings. After
conversion, such loss would be recognized as an adjustment to common stock
equity through a reduction of other comprehensive income. However, there would
be an offsetting increase in common stock equity through an increase in
accumulated other comprehensive income on the Company's Statements of
Consolidated Retained Earnings and Comprehensive Income for the fair value
increase in the investment in TW Common. For additional information on the
accounting treatment and related accounting losses recorded in 1998 of the ACES,
see Note 1(n) to the Company's Consolidated Financial Statements. An increase of
15% in the price of the TW Common above its December 31, 1998 market value of
$62.062 per share would result in the recognition of an additional unrealized
accounting loss (net of tax) of approximately $229.1 million. The Company
believes that this additional unrealized loss for the ACES would be more than
economically hedged by the unrecorded unrealized gain relating to the increase
in the fair value of the TW Common underlying the investment in TW Preferred
since the date of its acquisition.
For a discussion of the non-cash, unrealized accounting loss recorded in 1998
and 1997 related to the ACES, see "-- Certain Factors Affecting Future Earnings
of the Company and its Subsidiaries -- Accounting Treatment of ACES."
As discussed above under "-- Interest Rate Risk," the Company contributes to a
trust established to fund the Company's share of the decommissioning costs for
the South Texas Project which held debt and equity securities as of December 31,
1998. The equity securities expose the Company to losses in fair value. If the
market prices of the individual equity securities were to decrease by 10% from
their levels at December 31, 1998, the resulting loss in fair value of these
securities would not be material to the Company. Currently, the risk of an
economic loss is mitigated as a result of the Company's regulated status as
discussed above under "--Interest Rate Risk."
FOREIGN CURRENCY EXCHANGE RATE RISK
As further described in "Certain Factors Affecting Future Earnings of the
Company and Its Subsidiaries -- Risks of International Operations," the Company,
through Reliant Energy International invests in certain foreign operations which
to date have been primarily in South America. As of December 31, 1998, the
Company's Consolidated Balance Sheets reflected $1.1 billion of foreign
investments, a substantial portion of which represent investments accounted for
under the equity method. These foreign investments expose the Company to risk
of loss in earnings and cash flows due to the fluctuation in foreign currencies
relative to the Company's consolidated reporting currency, the U.S. dollar. The
29
<PAGE>
Company accounts for adjustments resulting from translation of its investments
with functional currencies other than the U.S. dollar as a charge or credit
directly to a separate component of stockholders' equity. For further discussion
of the accounting for foreign currency adjustments, see Note 1(p) in the Notes
to the Company's Consolidated Financial Statements. The cumulative translation
loss of $34 million, recorded as of December 31, 1998, will be realized as a
loss in earnings and cash flows only upon the disposition of the related
investment. The foreign currency loss in earnings and cash flows related to
debt obligations held by foreign operations in currencies other than their own
functional currencies was not material to the Company as of December 31, 1997.
In addition, certain of Reliant Energy International's foreign operations have
entered into obligations in currencies other than their own functional
currencies which expose the Company to a loss in earnings. In such cases, as
the respective investment's functional currency devalues relative to the non-
local currencies, the Company will record its proportionate share of its
investments' foreign currency transaction losses related to the non-local
currency denominated debt. At December 31, 1998, Light and Metropolitana had
borrowings of approximately $3.2 billion denominated in non-local currencies.
Because of the devaluation of the Brazilian real subsequent to December 31,
1998, Light and Metropolitana are expected to record a charge to earnings for
the quarter ended March 31, 1999, primarily related to foreign currency
transaction losses on their non-local currency denominated debt. For further
discussion and analysis of the possible effect on the Company's Consolidated
Financial Statements, see "Certain Factors Affecting Future Earnings of the
Company and Its Subsidiaries -- Risks of International Operations."
The company attempts to manage and mitigate this foreign risk by properly
balancing the higher cost of financing with local denominated debt against the
risk of devaluation of that local currency and including a measure of the risk
of devaluation in all its financial plans. In addition, where possible, Reliant
Energy International attempts to structure its tariffs and revenue contracts to
ensure some measure of adjustment due to changes in inflation and currency
exchange rates; however, there can be no assurance that such efforts will
compensate for the full effect of currency devaluation, if any.
ENERGY COMMODITY PRICE RISK
As further described in Note 2 to the Company's Consolidated Financial
Statements, certain of the Company's subsidiaries utilize a variety of
derivative financial instruments (Derivatives), including swaps and exchange-
traded futures and options, as part of the Company's overall hedging strategies
and for trading purposes. To reduce the risk from the adverse effect of market
fluctuations in the price of electric power, natural gas, crude oil and refined
products and related transportation, Resources and certain subsidiaries of the
Company and Resources enter into futures transactions, forward contracts, swaps
and options (Energy Derivatives) in order to hedge certain commodities in
storage, as well as certain expected purchases, sales and transportation of
energy commodities (a portion of which are firm commitments at the inception of
the hedge). The Company's policies prohibit the use of leveraged financial
instruments. In addition, Reliant Energy Services, a subsidiary of Resources,
maintains a portfolio of Energy Derivatives to provide price risk management
services and for trading purposes (Trading Derivatives).
The Company uses value-at-risk and a sensitivity analysis method for assessing
the market risk of its derivatives.
With respect to the Energy Derivatives (other than Trading Derivatives) held
by subsidiaries of the Company and Resources as of December 31, 1998, a decrease
of 10% in the market prices of natural gas and electric power from year-end
levels would decrease the fair value of these instruments by approximately $3
million. As of December 31, 1997, a decrease of 10% in the prices of natural
gas would have resulted in a loss of $7 million in fair values of the Energy
Derivatives (other than for trading purposes).
30
<PAGE>
The above analysis of the Energy Derivatives utilized for hedging purposes
does not include the favorable impact that the same hypothetical price movement
would have on the Company's and its subsidiaries' physical purchases and sales
of natural gas and electric power to which the hedges relate. The portfolio of
Energy Derivatives held for hedging purposes is no greater than the notional
quantity of the expected or committed transaction volume of physical commodities
with equal and opposite commodity price risk for the same time periods.
Furthermore, the Energy Derivative portfolio is managed to complement the
physical transaction portfolio, reducing overall risks within limits. Therefore,
the adverse impact to the fair value of the portfolio of Energy Derivatives held
for hedging purposes associated with the hypothetical changes in commodity
prices referenced above would be offset by a favorable impact on the underlying
hedged physical transactions, assuming (i) the Energy Derivatives are not closed
out in advance of their expected term, (ii) the Energy Derivatives continue to
function effectively as hedges of the underlying risk and (iii) as applicable,
anticipated transactions occur as expected.
The disclosure with respect to the Energy Derivatives relies on the assumption
that the contracts will exist parallel to the underlying physical transactions.
If the underlying transactions or positions are liquidated prior to the maturity
of the Energy Derivatives, a loss on the financial instruments may occur, or the
options might be worthless as determined by the prevailing market value on their
termination or maturity date, whichever comes first.
With respect to the Trading Derivatives held by Reliant Energy Services,
consisting of natural gas, electric power, crude oil and refined products,
physical forwards, swaps, options and exchange-traded futures, this subsidiary
is exposed to losses in fair value due to changes in the price and volatility of
the underlying derivatives. During the year ended December 31, 1998 and 1997,
the highest, lowest and average monthly value-at-risk in the Trading Derivative
portfolio was less than $5 million at a 95% confidence level and for a holding
period of one business day. The Company uses the variance/covariance method for
calculating the value-at-risk and includes the delta approximation for options
positions.
The Company has established a Corporate Risk Oversight Committee comprised of
corporate and business segment officers that oversees all corporate price and
credit risk activities, including derivative trading activities discussed above.
The committee's duties are to establish the Company's policies and to monitor
and ensure compliance with risk management policies and procedures and the
trading limits established by the Company's board of directors.
31
<PAGE>
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA OF THE COMPANY
HOUSTON INDUSTRIES INCORPORATED
D/B/A RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(Thousands of Dollars except per share amounts)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1998 1997 1996
---------------- ---------------- -----------------
<S> <C> <C> <C>
REVENUES:
Electric Operations.............................................. $ 4,350,275 $4,251,243 $4,025,027
Natural Gas Distribution......................................... 1,812,676 892,569
Interstate Pipelines............................................. 282,496 108,333
Wholesale Energy................................................. 4,456,158 1,364,658
International.................................................... 258,945 92,028 62,059
Other............................................................ 748,922 339,731 8,191
Eliminations..................................................... (421,008) (170,337)
------------ ------------ -----------
Total.......................................................... 11,488,464 6,878,225 4,095,277
------------ ------------ -----------
EXPENSES:
Fuel and cost of gas sold........................................ 4,784,704 2,852,375 1,043,618
Purchased power.................................................. 2,215,049 698,823 322,263
Operation and maintenance........................................ 1,660,531 1,216,126 942,604
Taxes other than income taxes.................................... 494,175 394,526 246,288
Depreciation and amortization.................................... 856,617 651,875 550,038
------------ ------------ -----------
Total.......................................................... 10,011,076 5,813,725 3,104,811
------------ ------------ -----------
OPERATING INCOME.................................................. 1,477,388 1,064,500 990,466
------------ ------------ -----------
OTHER INCOME (EXPENSE):
Unrealized loss on ACES.......................................... (1,176,211) (121,402)
Litigation settlements........................................... (95,000)
Time Warner dividend income...................................... 41,250 41,340 41,610
Interest income -- IRS refund.................................... 981 56,269
Other -- net..................................................... 23,870 10,347 (2,022)
------------ ------------ -----------
Total.......................................................... (1,110,110) (13,446) (55,412)
------------ ------------ -----------
INTEREST AND OTHER CHARGES:
Interest on long-term debt....................................... 416,138 320,845 276,242
Other interest................................................... 97,767 77,112 33,738
Distribution on trust securities................................. 29,201 26,230
Allowance for borrowed funds used during construction............ (4,304) (2,872) (2,598)
Preferred dividends of subsidiary................................ 2,255 22,563
------------ ------------ -----------
Total.......................................................... 538,802 423,570 329,945
------------ ------------ -----------
INCOME (LOSS) BEFORE INCOME TAXES AND PREFERRED DIVIDENDS......... (171,524) 627,484 605,109
INCOME TAX EXPENSE (BENEFIT)...................................... (30,432) 206,374 200,165
------------ ------------ -----------
NET INCOME (LOSS)................................................. (141,092) 421,110 404,944
PREFERRED DIVIDENDS............................................... 390 162
------------ ------------ -----------
NET INCOME (LOSS) AVAILABLE FOR COMMON STOCK...................... $ (141,482) $ 420,948 $ 404,944
------------ ------------ -----------
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE....................... $(0.50) $1.66 $1.66
============ ============ ===========
</TABLE>
See Notes to the Company's Consolidated Financial Statements
32
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
D/B/A RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED RETAINED EARNINGS
AND COMPREHENSIVE INCOME
(Thousands of Dollars, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------------------
1998 1997 1996
--------------------------- ----------------------------- ------------------------
<S> <C> <C> <C> <C> <C> <C>
RETAINED EARNINGS:
Balance at beginning of year....... $2,013,055 $1,997,490 $1,953,672
Net income (loss) available for
common stock...................... (141,482) $(141,482) 420,948 $420,948 404,944 $404,944
---------- ---------- ----------
Total............................. 1,871,573 2,418,438 2,358,616
Common stock dividends:
$1.50 per share (1996-1998)....... (426,492) (405,383) (361,126)
---------- ---------- ----------
Balance at end of year............. $1,445,081 $2,013,055 $1,997,490
========== ========== ==========
ACCUMULATED OTHER COMPREHENSIVE
INCOME (LOSS), NET OF TAX:
Balance at beginning of year....... $ (6,455) $ (363)
Foreign currency translation
adjustments....................... (32,790) (32,790) (458) (458) $ (363) (363)
Unrealized loss on available for
sale securities (net of tax)...... (10,370) (10,370) (5,634) (5,634)
---------- ---------- ----------
Balance at end of year............. $ (49,615) $ (6,455) $ (363)
========== ========== ==========
--------- -------- --------
COMPREHENSIVE INCOME (LOSS)......... $(184,642) $414,856 $404,581
========== ======== ========
</TABLE>
See Notes to the Company's Consolidated Financial Statements
33
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
D/B/A RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
ASSETS
<TABLE>
<CAPTION>
December 31,
------------------------------------
1998 1997
---------------- ----------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents........................................................ $ 29,673 $ 51,712
Accounts receivable net......................................................... 726,377 962,974
Accrued unbilled revenues........................................................ 175,515 205,860
Time Warner dividends receivable................................................. 10,313 10,313
Fuel stock and petroleum products................................................ 211,750 88,819
Materials and supplies, at average cost.......................................... 171,998 156,160
Price risk management assets..................................................... 265,203
Prepayments and other current assets............................................. 78,342 93,903
----------- -----------
Total current assets............................................................ 1,669,171 1,569,741
----------- -----------
PROPERTY, PLANT AND EQUIPMENT -- AT COST:
Electric......................................................................... 13,969,302 13,249,855
Natural gas...................................................................... 1,686,159 1,500,278
Interstate pipelines............................................................. 1,302,829 1,258,087
Other property................................................................... 72,299 42,321
----------- -----------
Total........................................................................... 17,030,589 16,050,541
Less accumulated depreciation and amortization................................... 5,499,448 4,770,179
----------- -----------
Property, plant and equipment net.............................................. 11,531,141 11,280,362
----------- -----------
OTHER ASSETS:
Goodwill net.................................................................... 2,098,890 2,026,395
Equity investments and advances to unconsolidated subsidiaries................... 1,051,600 704,102
Investment in Time Warner securities............................................. 990,000 990,000
Deferred plant costs net........................................................ 535,787 561,569
Deferred debits.................................................................. 514,930 478,686
Unamortized debt expense and premium on reacquired debt.......................... 208,350 202,453
Regulatory tax asset net........................................................ 418,339 356,509
Fuel-related debits.............................................................. 65,278 197,304
Recoverable project costs net................................................... 55,036 78,485
----------- -----------
Total other assets.............................................................. 5,938,210 5,595,503
----------- -----------
Total.......................................................................... $19,138,522 $18,445,606
=========== ===========
</TABLE>
See Notes to the Company's Consolidated Financial Statements
34
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
D/B/A RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Thousands of Dollars)
CAPITALIZATION AND LIABILITIES
<TABLE>
<CAPTION>
December 31,
------------------------------------
1998 1997
---------------- ----------------
<S> <C> <C>
CURRENT LIABILITIES:
Notes payable.................................................................... $ 1,812,739 $ 2,124,956
Accounts payable................................................................. 807,977 879,612
Taxes accrued.................................................................... 252,581 240,739
Interest accrued................................................................. 115,201 109,901
Dividends declared............................................................... 111,058 110,716
Customer deposits................................................................ 77,937 82,437
Price risk management liabilities................................................ 227,652
Current portion of long-term debt................................................ 397,454 251,169
Other............................................................................ 268,343 224,435
----------- -----------
Total current liabilities....................................................... 4,070,942 4,023,965
----------- -----------
DEFERRED CREDITS:
Accumulated deferred income taxes................................................ 2,364,036 2,792,781
Benefit obligations.............................................................. 378,747 397,586
Unamortized investment tax credit................................................ 328,949 349,072
Fuel-related credits............................................................. 88,639 75,956
Other............................................................................ 442,361 329,514
----------- -----------
Total deferred credits.......................................................... 3,602,732 3,944,909
----------- -----------
CAPITALIZATION (STATEMENTS ON FOLLOWING PAGES):
Long-term debt................................................................... 6,800,748 5,218,015
Company/Resources obligated mandatorily redeemable preferred securities of
subsidiary trusts holding solely junior subordinated debentures of
Company/Resources............................................................... 342,232 362,172
Preference stock, none outstanding...............................................
Cumulative preferred stock, not subject to mandatory redemption.................. 9,740 9,740
Common stock equity.............................................................. 4,312,128 4,886,805
----------- -----------
Total capitalization............................................................ 11,464,848 10,476,732
----------- -----------
COMMITMENTS AND CONTINGENCIES (NOTE 12)
Total.......................................................................... $19,138,522 $18,445,606
=========== ===========
</TABLE>
See Notes to the Company's Consolidated Financial Statements
35
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
D/B/A RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CAPITALIZATION
(Thousands of Dollars)
<TABLE>
<CAPTION>
December 31,
-------------------------------------
1998 1997
---------------- ----------------
<S> <C> <C>
Long-Term Debt:
7% Automatic common exchange securities, due 2000................................ $2,349,997 $1,173,786
---------- ----------
Debentures:
9-3/8% series, due 2001.................................................... 250,000 250,000
7-7/8% series, due 2002.................................................... 100,000 100,000
8.9% series, due 2006...................................................... 163,357 165,055
6% convertible subordinated, due 2012...................................... 104,617 107,180
10% series, due 2019....................................................... 47,562 47,773
6-1/2% series, due 2008.................................................... 300,000
6-3/8% series, due 2003.................................................... 500,000
Unamortized premium........................................................ 17,046
Unamortized discount....................................................... (532) (717)
---------- ----------
Total debentures............................................................... 1,482,050 669,291
---------- ----------
First Mortgage Bonds:
9.15% series, due 2021..................................................... 102,442 102,442
8-3/4% series, due 2022.................................................... 62,275 62,275
7-3/4% series, due 2023.................................................... 250,000 250,000
7-1/2% series, due 2023.................................................... 200,000 200,000
4.90% pollution control series, due 2003................................... 16,600 16,600
7% pollution control series, due 2008...................................... 19,200 19,200
6-3/8% pollution control series, due 2012.................................. 33,470 33,470
6-3/8% pollution control series, due 2012.................................. 12,100 12,100
8-1/4% pollution control series, due 2015.................................. 90,000
5.80% pollution control series, due 2015................................... 91,945 91,945
7-3/4% pollution control series, due 2015.................................. 68,700
5.80% pollution control series, due 2015................................... 58,905 58,905
6.70% pollution control series, due 2017................................... 43,820 43,820
5.60% pollution control series, due 2017................................... 83,565 83,565
7.20% pollution control series, due 2018................................... 75,000 75,000
7.20% pollution control series, due 2018................................... 100,000 100,000
7-7/8% pollution control series, due 2019.................................. 29,685
7.70% pollution control series, due 2019................................... 75,000
8-1/4% pollution control series, due 2019.................................. 100,000
8.10% pollution control series, due 2019................................... 100,000
7-5/8% pollution control series, due 2019.................................. 100,000 100,000
7-1/8% pollution control series, due 2019.................................. 100,000 100,000
7.60% pollution control series, due 2019................................... 70,315 70,315
6.70% pollution control series, due 2027................................... 56,095 56,095
6.10% medium-term notes, series C, due 2000................................ 150,000 150,000
8.15% medium-term notes, series B, due 2002................................ 100,000 100,000
6.50% medium-term notes, series C, due 2003................................ 150,000 150,000
9.85% medium-term notes, due 1999.......................................... 25,400 25,400
9.80% medium-term notes, due 1999.......................................... 145,100 145,100
Unamortized discount....................................................... (9,948) (14,158)
---------- ----------
Total first mortgage bonds..................................................... 2,036,284 2,495,459
---------- ----------
(continued on next page)
</TABLE>
36
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
D/B/A RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CAPITALIZATION -- (Continued)
(Thousands of Dollars)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------
1998 1997
----------------- -----------------
<S> <C> <C>
Pollution Control Revenue Bonds:
Gulf Coast 1980-T series, floating rate, due 1998.......................... $ 5,000
4.90% BRA 1998D, due 2015.................................................. $ 68,700
5.05% BRA 1997, due 2018................................................... 50,000 50,000
5.125% BRA 1998A, due 2019................................................. 100,000
5.125% BRA 1998C, due 2019................................................. 100,000
5.125% BRA 1998B, due 2020................................................. 90,000
5.125% MCND 1997, due 2028................................................. 68,000 68,000
5.25% MCND 1998A, due 2029................................................. 29,685
5.15% MCND 1998B, due 2029................................................. 75,000
--------- ---------
Total pollution control revenue bonds.......................................... 581,385 123,000
--------- ---------
Medium-Term Notes:
Series A, 9.30%-9.39%, due 1999-2000....................................... 23,063 24,838
Series B, 8.43%-9.23%, due 1999-2001....................................... 154,626 236,367
--------- ---------
Total medium-term notes........................................................ 177,689 261,205
--------- ---------
Capitalized lease obligations, discount rates of 5.2%-11.7%, due 1999-2018..... 14,883 16,166
Notes payable.................................................................. 555,914 730,277
--------- ---------
Subtotal................................................................... 570,797 746,443
--------- ---------
Total.......................................................................... 7,198,202 5,469,184
Current maturities............................................................. (397,454) (251,169)
--------- ---------
Total long-term debt........................................................... 6,800,748 5,218,015
--------- ---------
Company/Resources obligated mandatorily redeemable preferred securities of
subsidiary trusts holding solely junior subordinated debentures of
Company/Resources:
8.125% Trust Preferred Securities, Series A...................................... 250,000 250,000
8.257% Trust Capital Securities, Series B........................................ 100,000 100,000
6 1/4 % Convertible Trust Originated Preferred Securities....................... 1,178 21,730
Unamortized Issuance Costs....................................................... (8,946) (9,558)
--------- ---------
Total Company/Resources obligated mandatorily redeemable preferred securities
of subsidiary trusts holding solely junior subordinated debentures of
Company/Resources-net......................................................... 342,232 362,172
--------- ---------
Cumulative Preferred Stock, no par; authorized, 10,000,000 shares; outstanding
97,397 shares each at December 31, 1998 and 1997, (entitled upon involuntary
liquidation to $100 per share):
Not subject to mandatory redemption:
$4.00 series, 97,397 shares..................................................... 9,740 9,740
--------- ---------
Preference Stock, no par; authorized, 10,000,000 shares; none outstanding.........
(continued on next page)
</TABLE>
37
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
D/B/A RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CAPITALIZATION -- (Continued)
(Thousands of Dollars)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
Common Stock Equity:
Common stock, no par; authorized, 700,000,000 shares; issued, 296,271,063 and
295,357,276 shares at December 31, 1998 and 1997, respectively.................. $ 3,136,826 $ 3,112,098
Treasury stock, at cost; 102,805 and 93,459 shares at December 31, 1998 and
1997, respectively.............................................................. (2,384) (2,066)
Unearned ESOP shares, 11,674,063 and 12,388,551 shares at December 31, 1998 and
1997, respectively.............................................................. (217,780) (229,827)
Retained earnings................................................................ 1,445,081 2,013,055
Accumulated other comprehensive loss............................................. (49,615) (6,455)
----------- -----------
Total common stock equity.................................................... 4,312,128 4,886,805
----------- -----------
Total capitalization......................................................... $11,464,848 $10,476,732
=========== ===========
</TABLE>
See Notes to the Company's Consolidated Financial Statements
38
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
(Thousands of Dollars)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) available for common stock........................... $ (141,482) $ 420,948 $ 404,944
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization......................................... 856,617 651,875 550,038
Amortization of nuclear fuel.......................................... 25,529 28,237 33,875
Deferred income taxes................................................. (423,904) 35,523 54,098
Investment tax credit................................................. (20,123) (19,777) (18,404)
Unrealized loss on ACES............................................... 1,176,211 121,402
Contribution of marketable equity securities to charitable trust...... 19,463
Undistributed earnings of equity investments in
unconsolidated subsidiaries.......................................... (27,350) (3,142) (15,290)
Fuel cost over (under) recovery....................................... (22,545) (212,683) (137,362)
Changes in other assets and liabilities:
Accounts receivable net............................................. 266,938 (436,580) (15,478)
Fuel surcharge....................................................... 94,912 128,864
Inventory............................................................ (121,793) 55,111 21,624
Other current assets................................................. (15,705) 6,966 (306)
Accounts payable..................................................... (92,652) 191,840 21,674
Interest and taxes accrued........................................... 7,044 18,425 4,413
Other current liabilities............................................ 33,078 2,985 (4,135)
Net price risk management assets..................................... (29,857)
Other net........................................................... (139,559) 101,302 14,629
---------- ---------- ----------
Net cash provided by operating activities.......................... 1,425,359 1,110,759 914,320
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (including allowance for borrowed funds
used during construction)............................................. (743,455) (328,724) (317,532)
Purchase of Resources, net of cash acquired............................ (1,422,672)
Non-rate regulated electric power project expenditures (including
capitalized interest)................................................. (292,398)
Sale of equity investments in foreign electric system projects......... 242,744
Equity investment and advances to unconsolidated subsidiaries.......... (445,042) (234,852) (495,379)
Sale of Time Warner securities......................................... 25,043
Other-net.............................................................. 8,375 (20,248) (19,989)
---------- ---------- -----------
Net cash used in investing activities............................... $(1,229,776) $(1,981,453) $ (832,900)
---------- ---------- -----------
(continued on next page)
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
HOUSTON INDUSTRIES INCORPORATED
d/b/a/ RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS -- (Continued)
Increase (Decrease) in Cash and Cash Equivalents
(Thousands of Dollars)
YEAR ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
---------- ---------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of ACES net.............................. $ 1,020,777
Proceeds from sale of Company obligated mandatorily
redeemable trust preferred securities of subsidiary trusts
holding solely subordinated debentures of Company net...... 340,785
Purchase of treasury stock................................... $ (361,196)
Payment of matured bonds..................................... $ (226,000) (277,000) (150,000)
Proceeds from issuance of debentures......................... 812,849
Proceeds from issuance of pollution control revenue bonds.... 454,258 115,739
Redemption of preferred stock................................ (153,628) (271,400)
Payment of common stock dividends............................ (426,265) (405,288) (361,126)
Increase/(decrease) in notes payable net.................... (348,044) 587,791 1,331,572
Extinguishment of long-term debt............................. (471,287) (303,893) (285,263)
Conversion of convertible securities......................... (10,450) (9,504)
Other net................................................... (2,683) (1,374) 12,215
---------- -------- ---------
Net cash provided by (used in) financing activities....... (217,622) 914,405 (85,198)
---------- -------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.......... (22,039) 43,711 (3,778)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.............. 51,712 8,001 11,779
---------- -------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................... $ 29,673 $ 51,712 $ 8,001
========== ======== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized)........................ $ 511,165 $437,952 $ 311,792
Income taxes................................................. 484,376 171,539 139,898
</TABLE>
The aggregate consideration paid in August 1997 to former stockholders of
Resources in connection with the Merger consisted of $1.4 billion in cash and
47.8 million shares of the Company's common stock valued at approximately $1.0
billion. The overall transaction was valued at $4.0 billion consisting of $2.4
billion for Former Resources' common stock and common stock equivalents and $1.6
billion of Former Resources' debt.
See Notes to the Company's Consolidated Financial Statements
40
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Three Years December 31, 1998
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of Operations.
Houston Industries Incorporated d/b/a Reliant Energy, Incorporated (Company),
together with its subsidiaries, is a diversified international energy services
company. The Company is both an electric utility company and a utility holding
company. The Company's wholly owned subsidiary, Reliant Energy Resources Corp.
(Resources), operates in various phases of the natural gas industry, including
distribution, transmission, marketing and gathering.
Effective January 1, 1998, the Company reconfigured its financial reporting
segments to include the following: Electric Operations, Natural Gas
Distribution, Interstate Pipeline, Wholesale Energy Marketing and Generation
(Wholesale Energy), International and Corporate. Electric Operations includes
operations of Reliant Energy HL&P. Natural Gas Distribution consists of natural
gas sales to, and natural gas transportation for, residential, commercial and
industrial customers. Interstate Pipeline includes the interstate natural gas
pipeline operations of Resources. Wholesale Energy is engaged in the
acquisition, development and operation of non-rate regulated power generation
facilities as well as the wholesale energy marketing and natural gas gathering
businesses. International participates in the development and acquisition of
foreign independent power projects and the privatization of foreign generation
and distribution facilities. Corporate includes the Company's unregulated
retail electric services business, certain real estate holdings of the Company
and corporate costs.
In February 1999, the Company began doing business as Reliant Energy,
Incorporated. On May 5, 1999, the Company's shareholders will vote on a proposal
to amend the Restated Articles of Incorporation to change its name to "Reliant
Energy, Incorporated."
(b) Resources Acquisition.
On August 6, 1997 (Acquisition Date), the former parent corporation (Former
Parent) of the Company, merged with and into the Company and NorAm Energy Corp.,
a natural gas gathering, transmission, marketing and distribution company
(Former NorAm), merged with and into Resources. Effective upon the mergers
(collectively, the Merger), each outstanding share of common stock of Former
Parent was converted into one share of common stock (including associated
preference stock purchase rights) of the Company, and 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 the Company. 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 the Company's
common stock valued at approximately $1.0 billion. The overall transaction was
valued at $4.0 billion consisting of $2.4 billion for Former NorAm's common
stock and common stock equivalents and $1.6 billion of Former NorAm debt ($1.3
billion of which was long-term debt).
The Company recorded the acquisition under the purchase method of accounting
with assets and liabilities of Former NorAm reflected at their estimated fair
values as of the Acquisition Date. The excess of the purchase price over the
fair value of net assets acquired was initially estimated at $2 billion. In
1998, the fair value estimates of the assets acquired and liabilities assumed
were finalized resulting in a $78 million increase in goodwill. The Company has
recorded the excess of the acquisition cost over the fair value of the net
assets acquired as goodwill and is amortizing this amount over 40 years. The
Company's fair value adjustments included increases in property, plant and
equipment, long-term debt, unrecognized pension and postretirement benefits
liabilities and related deferred taxes.
41
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company's results of operations incorporate Resources' results of
operations only for the period beginning on the Acquisition Date. The following
table presents certain actual financial information for the year ended December
31, 1998 and unaudited pro forma information for the years ended December 31,
1997 and 1996, as if the Merger had occurred on January 1, 1997 and 1996,
respectively.
ACTUAL AND PRO FORMA COMBINED RESULTS OF OPERATIONS
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------
1998 1997 1996
-------------- -------------------------------- ---------------------------
ACTUAL ACTUAL PRO FORMA ACTUAL PRO FORMA
-------------- -------------- -------------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues........................................ $11,488 $6,878 $10,191 $4,095 $8,884
Net Income (Loss) Available for Common Stock(1). $ (142) $ 421 $ 437 $ 405 $ 426
Basic and Diluted Earnings (Loss) Per Share(1).. $ (.50) $ 1.66 $ 1.55 $ 1.66 $ 1.46
</TABLE>
________
(1) Net income (loss) available for common stock for 1998 and 1997 are
negatively impacted by $764 million and $79 million ($2.69 and $0.31 per
share) respectively, related to the unrealized loss on the Company's 7%
Automatic Common Exchange Securities (ACES).
These and other pro forma results appearing in this Appendix A are based on
assumptions deemed appropriate by the Company's management, have been prepared
for informational purposes only and are not necessarily indicative of the
combined results that would have resulted had the Merger occurred at the
beginning of the 1996 and 1997 reporting periods presented. Purchase-related
adjustments to results of operations include amortization of goodwill and the
effects on depreciation, amortization, interest expense and deferred income
taxes of the assessed fair value of certain Resources assets and liabilities.
(c) Regulatory Assets and Other Long-Lived Assets.
The Company and certain subsidiaries of Resources apply the accounting
policies established in SFAS No. 71, "Accounting for the Effects of Certain
Types of Regulation" (SFAS No. 71), to the accounts of Electric Operations,
Natural Gas Distribution and the Interstate Pipeline operations of a subsidiary
of Resources. 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/liabilities reflected on the
Company's Consolidated Balance Sheet as of December 31, 1998, 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.............................................. $ 536 $ $ 536
Recoverable project costs -- net......................................... 55 55
Regulatory tax asset -- net.............................................. 418 418
Unamortized loss on reacquired debt...................................... 140 140
Fuel-related debits/credits -- net....................................... (15) (15)
Other deferred debits.................................................... 54 12 66
------- ------ ------
Total.......................................................... $1,188 $ 12 $1,200
------- ------ ------
</TABLE>
If, as a result of changes in regulation or competition, the Company's and
Resources' ability to recover these assets and liabilities would not be assured,
then pursuant to SFAS No. 101, "Accounting for the Discontinuation of
Application of SFAS No. 71" (SFAS No. 101) and SFAS No. 121, "Accounting for the
Impairment of Long-Lived
42
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Assets and for Long-Lived Assets to Be Disposed Of" (SFAS No. 121), the Company
and Resources would be required to write off or write down such regulatory
assets and liabilities, unless some form of transition cost recovery continues
through rates established and collected for their remaining regulated
operations. In addition, the Company and Resources would be required to
determine any impairment to the carrying costs of deregulated plant and
inventory assets. In order to reduce exposure to potentially stranded costs
related to generation assets, Electric Operations redirected $195 million of
depreciation in 1998 from transmission, distribution and general plant assets to
generation assets. Such redirection is in accordance with the Company's
transition to competition plan (Transition Plan) described in Note 1(f). If
Electric Operations was required to apply SFAS No. 101 to the generation portion
of its business only, the cumulative amount of redirected depreciation of $195
million would become a regulatory asset of the transmission and distribution
portion of its business.
Effective January 1, 1996, the Company and Resources 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 Resources.
In July 1997, the Emerging Issues Task Force (EITF) of the Financial
Accounting Standards Board 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 how the plan will affect the
segment to be deregulated. 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. As a
part of the Transition Plan the Company has agreed to support future legislation
providing for retail customer choice effective December 31, 2001 and other
provisions consistent with those in the 1997 proposed Texas legislation. At this
time, the Company is unable to make any predictions as to the details of
legislation being considered by the Texas legislature or the likelihood that
such legislation will ultimately be enacted. Although the Company has
determined that no impairment loss or write-offs of regulatory assets or
carrying costs of plant and inventory assets need to be recognized for
applicable assets of Electric Operations as of December 31, 1998, this
conclusion may change in 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.
(d) Principles of Consolidation.
The consolidated financial statements include the accounts of the Company and
its wholly owned and majority owned subsidiaries including, effective as of the
Acquisition Date, the accounts of Resources and its wholly owned and majority
owned subsidiaries.
Investments in entities in which the Company or its subsidiaries have an
ownership interest between 20% and 50% or are able to exercise significant
influence are accounted for using the equity method. For additional information
regarding investments recorded using the equity method or the cost method of
accounting, see Note 5.
All significant intercompany transactions and balances are eliminated in
consolidation.
(e) Property, Plant and Equipment and Goodwill.
Property, plant and equipment are stated at original cost of the acquirer.
Repair and maintenance costs are expensed. Depreciation is computed using the
straight-line method.
43
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Goodwill is being amortized on a straight-line basis over 30 to 40 years. The
Company had $76.3 million and $21.6 million accumulated goodwill amortization at
December 31, 1998 and 1997, respectively. The Company will periodically compare
the carrying value of its goodwill to the anticipated undiscounted future
operating income from the businesses whose acquisition gave rise to the goodwill
and as of yet no impairment is indicated or expected.
(f) Depreciation and Amortization Expense.
The Company's consolidated depreciation expense for 1998 was $548 million
compared to $475 million for 1997 and $410 million for 1996.
In June 1998, the Public Utility Commission of Texas (Texas Utility
Commission) issued an order approving the Transition Plan filed by Electric
Operations in December 1997. In order to reduce Electric Operations' exposure
to potentially stranded costs related to generation assets, the Transition Plan
permits the redirection to generation assets of depreciation expense that
Electric Operations otherwise would apply to transmission, distribution and
general plant assets. In addition, the Transition Plan provides that all
earnings above a 9.844% overall annual rate of return on invested capital be
used to recover Electric Operations' investment in generation assets. Electric
Operations implemented the Transition Plan effective January 1, 1998 and
pursuant to its terms, recorded an aggregate of $194 million in additional
depreciation and $195 million in redirected depreciation in 1998.
The Company's depreciation and amortization expenses included $50 million of
additional depreciation relating to the South Texas Project Electric Generating
Station (South Texas Project) in both 1997 and 1996 and goodwill amortization
relating to the acquisition of Resources of $55 million in 1998 and $22 million
in 1997. For additional information regarding the operation of goodwill in
connection with the Merger, see Note 1(b) above. The depreciation expense
recorded for the South Texas Project was made pursuant to the terms of the
Company's 1995 rate case settlement (1995 Rate Case Settlement), which permitted
the Company to write down as much as $50 million per year of its investment in
the South Texas Project through December 31, 1999. These write-downs are treated
under the 1995 Rate Case Settlement as reasonable and necessary expenses for
purposes of any future earnings reviews or other proceedings.
In 1998, 1997 and 1996, the Company, as permitted by the 1995 Rate Case
Settlement, also amortized $4 million, $66 million and $50 million (pre-tax),
respectively, of its $153 million investment in certain lignite reserves
associated with a canceled generating station. The Company's remaining
investment in the canceled generating station and certain lignite reserves will
be amortized fully no later than December 31, 2002.
(g) Deferred Plant Costs.
Under a "deferred accounting" plan authorized by the Texas Utility Commission,
Electric Operations was permitted for regulatory purposes to accrue carrying
costs in the form of allowance for funds used during construction (AFUDC) on its
investment in the South Texas Project and to defer and capitalize depreciation
and other operating costs on its investment after commercial operation until
such costs were reflected in rates. In addition, the Texas Utility Commission
authorized Electric Operations under a "qualified phase-in plan" to capitalize
allowable costs (including return) deferred for future recovery as deferred
charges.
In 1991, Electric Operations ceased all cost deferrals related to the South
Texas Project and began amortizing such amounts on a straight-line basis. The
accumulated deferrals for "deferred accounting" are being amortized over the
estimated depreciable life of the South Texas Project. The accumulated deferrals
for the "qualified phase-in plan" are being amortized over a ten-year phase-in
period that commenced in 1991. The amortization of all deferred plant costs
(which totaled $26 million for each of the years 1998, 1997 and 1996) is
included on the Company's Statements of Consolidated Income as depreciation and
amortization expense.
44
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(h) Fuel Stock and Petroleum Products.
Gas inventory (primarily using the average cost method) was $96 million and
$72 million at December 31, 1998 and 1997, respectively. Coal and lignite
inventory balances (using last-in, first-out) were $24 million and $7 million,
respectively, at December 31, 1998 and $8 million and $6 million, respectively,
at December 31, 1997. Oil inventory balances, principally heating oil, were $85
million and $3 million at December 31, 1998 and 1997, respectively.
Heating oil is used in trading operations and are marked-to-market in
connection with the price risk management activities discussed in Note 2.
(i) Revenues.
The Company records electricity and natural gas sales under the full accrual
method, whereby unbilled electricity and natural gas sales are estimated and
recorded each month. International revenues include electricity sales of a
majority owned foreign electric utility, which are also recorded under the full
accrual method, and equity income (net of foreign taxes) in unconsolidated
investments of Reliant Energy International. In 1998, International's revenues
included the gain on the sale of an Argentine distribution system. Included in
other revenues are management fees and other sales and services, which are
recorded when earned.
Revenue eliminations of $421 million and $170 million for the years ended
December 31, 1998 and 1997, respectively, represent intersegment sales of
natural gas and transportation services. For the year ended December 31, 1998,
Interstate Pipeline had intersegment revenues of $156 million, Wholesale Energy
had intersegment sales of $167 million and Corporate had $98 million of
intersegment retail sales. For the five month period ended December 31, 1997,
Interstate Pipeline had intersegment revenues of $59 million, Wholesale Energy
had intersegment sales of $76 million and Corporate had $35 million of
intersegment retail sales.
(j) Earnings Per Common 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 reconciles numerators and denominators of the Company's
basic and diluted earnings per share calculations:
45
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1998 1997 1996
---------------- ---------------- ----------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Basic EPS Calculation:
Net Income (loss)................................................ $(141,092) $421,110 $404,944
Less: Preferred dividends........................................ 390 162
--------- -------- --------
Net income (loss) available for common stock..................... $(141,482) $420,948 $404,944
========= ======== ========
Weighted average shares outstanding.............................. 284,095 253,599 244,443
Basic EPS:
Net Income (loss)................................................ $ (.50) $ 1.66 $ 1.66
Less: Preferred dividends........................................ -- -- --
--------- -------- --------
Net income (loss) available for common stock..................... $ (.50) $ 1.66 $ 1.66
========= ======== ========
Diluted EPS Calculation:
Net Income (loss)................................................ $(141,092) $421,110 $404,944
Plus: Income impact of assumed conversions
Interest on 6-1/4% convertible debentures..................... 668
--------- -------- --------
Net Income (loss) assuming dilution.............................. (141,092) 421,778 404,944
Less: Preferred dividends........................................ 390 162
--------- -------- --------
Net income (loss) available for common stock assuming dilution... $(141,482) $421,616 $404,944
========= ======== ========
Weighted average shares outstanding.............................. 284,095 253,599 244,443
Plus: Incremental shares from assumed conversions: (1)
Stock options................................................. 89 33
6-1/4% convertible debentures................................. 510
--------- -------- --------
Weighted average shares assuming dilution........................ 284,095 254,198 244,476
========= ======== ========
Diluted EPS:
Net Income (loss)................................................ $ (.50) $ 1.66 $ 1.66
Less: Preferred dividends........................................ -- -- --
--------- -------- --------
Net income (loss) available for common stock..................... $ (.50) $ 1.66 $ 1.66
========= ======== ========
</TABLE>
________________
(1) No assumed conversions were included in the computation of diluted earnings
per share for 1998 because additional shares outstanding would result in an
anti-dilutive per share amount. The computation of diluted EPS for 1998
excludes 492,000 shares of restricted stock and purchase options for
434,000 shares of common stock which would be anti-dilutive if exercised.
(k) Statements of Consolidated Cash Flows.
For purposes of reporting cash flows, cash equivalents are considered to be
short-term, highly liquid investments readily convertible to cash.
(l) Derivative Financial Instruments (Risk Management).
For information regarding the Company's accounting for derivative financial
instruments associated with its subsidiaries' natural gas, electric power and
transportation risk management activities, see Note 2.
(m) Income Taxes.
The Company and its subsidiaries file a consolidated federal income tax
return. The Company follows a policy of comprehensive interperiod income tax
allocation. Investment tax credits were deferred and are being amortized over
the estimated lives of the related property. For additional information
regarding income taxes, see Note 11.
46
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(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 45.8 million shares of
Time Warner common stock (TW Common). Each share of TW Preferred is entitled to
two votes (voting together with the holders of the TW Common as a single class).
The Company has accounted for its investment in TW Preferred under the cost
method at a value of $990 million on the Company's Consolidated Balance Sheets.
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 in 1998 and 1997 and $41.6 million in 1996.
To monetize its investment in the TW Preferred, the Company sold in July 1997,
22.9 million of ACES. At maturity in July 2000, the principal amount of the ACES
will be mandatorily exchangeable by the Company into either (i) a number of
shares of TW Common based on an exchange rate or (ii) cash having an equal
value. Subject to adjustments that may result from certain dilution events, the
exchange rate for each ACES is determined as follows: (i) 1.6528 shares of TW
Common if the price of TW Common at maturity (Maturity Price) is at least
$27.7922 per share, (ii) a fractional share of TW Common such that the
fractional share will have a value equal to $22.96875 if the Maturity Price is
less than $27.7922 but greater than $22.96875 and (iii) one share of TW Common
if the Maturity Price is not more than $22.96875. The closing price of TW Common
was $62.062 per share on December 31, 1998.
Prior to maturity, the Company has the option of redeeming the ACES if (i)
changes in federal tax regulations require recognition of a taxable gain on the
Company's TW Preferred and (ii) the Company could defer such gain by redeeming
the ACES. The redemption price is 105% of the closing sales price of the ACES as
determined over a period prior to the redemption notice. The redemption price
may be paid in cash or in shares of TW Common or a combination of the two.
As a result of the issuance of the ACES, a portion of the increase in the
market value above $27.7922 per share of TW Common results in non-cash,
unrealized accounting losses to the Company for the ACES, pending the conversion
of the Company's TW Preferred into TW Common. For example, prior to the
conversion, when the market price of TW Common increases above $27.7922, 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 TW Common that underlies the TW Preferred. Upon conversion of the TW
Preferred (anticipated to occur in July 1999), the Company will begin recording
future unrealized net changes in the market prices of the TW Common and the ACES
as a component of common stock equity and other comprehensive income.
As of December 31, 1998 and 1997, the market price of TW Common was $62.062
and $31.00 per share, respectively. Accordingly, the Company recognized an
increase of $1.2 billion in 1998 and $121 million in 1997 in the unrealized
liability relating to its ACES indebtedness (which resulted in an after-tax
earnings reduction of $764 million or $2.69 basic earnings per share and $79
million or $.31 basic earnings per share, respectively). The Company believes
that the cumulative unrealized loss for the ACES of approximately $1.3 billion
is more than economically hedged by the approximately $1.8 billion unrecorded
unrealized gain at December 31, 1998 relating to the increase in the fair value
of the TW Common underlying the investment in TW Preferred since the date of its
acquisition. Any gain related to the increase in fair value of TW Common would
be recognized as a component of net income upon the sale of the TW Preferred or
the shares of TW Common into which such TW Preferred is
47
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
converted. As of March 11, 1999, the price of TW Common was $70.75 per share
which would have resulted in the Company recognizing an additional increase of
$329 million in the unrealized liability relating to its ACES indebtedness. The
related unrecorded unrealized gain as of March 11, 1999 would have been computed
as an additional $398 million.
(o) Investment in Other Debt and Equity Securities.
The securities held in the Company's nuclear decommissioning trust are
classified as "available-for-sale" and, in accordance with SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities" (SFAS No.
115), are reported at estimated fair value of $119.1 million as of December 31,
1998 and $92.9 million as of December 31, 1997 on the Company's Consolidated
Balance Sheets under deferred debits. The liability for nuclear decommissioning
is reported on the Company's Consolidated Balance Sheets under deferred credits.
Any unrealized gains or losses are accounted for in accordance with SFAS No. 71
as a regulatory asset/liability and reported on the Company's Consolidated
Balance Sheets as a deferred debit/credit.
The Company, through Resources, holds certain equity securities classified as
"available-for-sale" and in accordance with SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," reports such investments at
estimated fair value on the Company's Consolidated Balance Sheets as deferred
debits and any unrealized gain or loss, net of tax, as a separate component of
stockholders' equity and other comprehensive income. At December 31, 1998 and
1997, the accumulated unrealized loss, net of tax, relating to these equity
securities was approximately $16.0 million and $5.6 million.
(p) Foreign Currency Adjustments.
International assets and liabilities 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 and other comprehensive income. When
the U.S dollar is the functional currency, the financial statements of
International are remeasured in U.S. dollars using historical exchange rates for
non-monetary accounts and the current rate at the respective balance sheet date
and the weighted average exchange rate for all other balance sheet and income
statement accounts, respectively. All exchange gains and losses from
remeasurement and foreign currency transactions are included in consolidated net
income. However, 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 investments
in unconsolidated affiliates, see Note 5. For additional information about the
Company's investments in Brazil and the devaluation of the Brazilian real in
January 1999, see Note 16(a).
(q) Reclassifications and Use of Estimates.
Certain amounts from the previous years have been reclassified to conform to
the 1998 presentation of financial statements. Such reclassifications do not
affect earnings.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
48
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(r) Change in Accounting Principle.
In the fourth quarter of 1998, the Company adopted mark-to-market accounting
for all of the energy price risk management and trading activities of Reliant
Energy Services. Under mark-to-market accounting, the Company records the fair
value of energyrelated derivative financial instruments, including physical
forward contracts, swaps, options and exchange-traded futures contracts at each
balance sheet date. Such amounts are recorded in the Company's Consolidated
Balance Sheet as price risk management assets, price risk management
liabilities, deferred debits and deferred liabilities. The realized and
unrealized gains (losses) are recorded as a component of operating revenues in
the Company's Consolidated Statements of Income. The Company has applied mark-
to-market accounting retroactively to January 1, 1998. This change was made in
order to adopt a generally accepted accounting methodology that provided
consistency between financial reporting and the methodology used in all reported
periods by the Company in managing its trading activities. There was no
material cumulative effect resulting from the accounting change.
The Company will adopt Emerging Issues Task Force Issue 98-10, "Accounting for
Contracts Involved in Energy Trading and Risk Management Activities" in the
first quarter of 1999 for Reliant Energy Services' trading activities. The
Company does not expect the implementation of EITF Issue 98-10 to be material to
its consolidated financial statements.
(s) New Accounting Pronouncement.
In 2000, the Company expects to adopt Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS No. 133), which establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. The Company is in the process of
determining the effect of adopting SFAS No. 133.
(t) Comprehensive Income.
Accumulated other comprehensive loss at December 31, 1998 included foreign
currency translation adjustments of $34 million and an unrealized loss on
available for sale securities of $16 million, net of tax of $9 million. At
December 31, 1997, accumulated other comprehensive loss included foreign
currency translation adjustments of $.8 million and unrealized loss on available
for sale securities of $6 million, net of tax of $3 million. In 1996,
accumulated other comprehensive loss included foreign currency translation
adjustments of $.4 million.
(u) Other.
For information regarding executive incentive compensation, pensions and other
benefits, see Note 10.
(2) DERIVATIVE FINANCIAL INSTRUMENTS
(a) Price Risk Management and Trading Activities.
The Company, through Reliant Energy Services, offers energy price risk
management services primarily in the natural gas, electric and crude oil and
refined product industries. Reliant Energy Services provides these services by
utilizing, a variety of derivative financial instruments, including fixed and
variable-priced physical forward contracts, 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 (Trading Derivatives). Fixed-price swap agreements require payments to,
or receipts of payments from, counterparties based on the differential between a
fixed and variable price for the commodity. Variable-price swap agreements
require payments to, or receipts of payments from, counterparties based on the
differential between industry pricing publications or exchange quotations.
49
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Prior to 1998, Reliant Energy Services applied hedge accounting to certain
physical commodity activities that qualified for hedge accounting. In 1998,
Reliant Energy Services adopted mark-to-market accounting for all of its price
risk management and trading activities. Accordingly, as of such date such
Trading Derivatives 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 price risk management assets/liabilities and deferred debits/credits
on the Company's Consolidated Balance Sheets (See Note 1(r)).
The notional quantities, maximum terms and the estimated fair value of Trading
Derivative at December 31, 1998 are presented below (volumes in billions of
British thermal units equivalent (BBtue) and dollars in millions):
<TABLE>
<CAPTION>
VOLUME-FIXED
VOLUME-FIXED PRICE MAXIMUM
1998 PRICE PAYOR RECEIVER TERM (YEARS)
- ---- ------------ ------------ -----------
<S> <C> <C> <C>
Natural gas.................................................. 937,264 977,293 9
Electricity.................................................. 122,950 124,878 3
Crude oil and products....................................... 205,499 204,223 3
</TABLE>
<TABLE>
<CAPTION>
AVERAGE FAIR
FAIR VALUE VALUE(a)
------------------------------ -----------------------------
1998 ASSETS LIABILITIES ASSETS LIABILITIES
- ---- ---------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Natural gas.............................................. $ 224 $ 213 $ 124 $ 108
Electricity.............................................. 34 33 186 186
Crude oil and products................................... 29 23 21 17
--------- --------- --------- ---------
$ 287 $ 269 $ 331 $ 311
========= ========= ========= =========
</TABLE>
The notional quantities, maximum terms and the estimated fair value of
derivative financial instruments at December 31, 1997 are presented below
(volumes in Bbtue and dollars in millions):
<TABLE>
<CAPTION>
VOLUME-FIXED
VOLUME-FIXED PRICE MAXIMUM
1997 PRICE PAYOR RECEIVER TERM (YEARS)
- ---- ------------ ------------ -----------
<S> <C> <C> <C>
Natural gas.................................................. 85,701 64,890 4
Electricity.................................................. 40,511 42,976 1
</TABLE>
<TABLE>
<CAPTION>
AVERAGE FAIR
FAIR VALUE VALUE(a)
------------------------------ -----------------------------
1997 ASSETS LIABILITIES ASSETS LIABILITIES
- ---- ---------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Natural gas.............................................. $ 46 $ 39 $ 56 $ 48
Electricity.............................................. 6 6 3 2
--------- --------- --------- ---------
$ 52 $ 45 $ 59 $ 50
========= ========= ========= ========
</TABLE>
_________
(a) Computed using the ending balance of each month.
In addition to the fixed-price notional volumes above, Reliant Energy Services
also has variable-priced agreements, as discussed above, totaling 1,702,977 and
101,465 BBtue as of December 31, 1998 and 1997, respectively. Notional amounts
reflect the volume of transactions but do not represent the amounts exchanged by
the parties to the financial instruments. Accordingly, notional amounts do not
accurately measure the Company's exposure to market or credit risks.
All of the fair value shown in the table above at December 31, 1998 and
substantially all of the fair value at December 31, 1997 have been recognized in
income. The fair value as of December 31, 1998 and 1997 was
50
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
estimated using quoted prices where available and considering the liquidity of
the market for the Trading Derivatives. The prices are subject to significant
changes based on changing market conditions.
At December 31, 1998, $22 million of the fair value of the assets and $41
million of the fair value of the liabilities are recorded as long-term in
deferred debits and deferred credits, respectively on the Company's Consolidated
Balance Sheets.
The weighted-average term of the trading portfolio, based on volumes, is less
than one year. The maximum and average terms disclosed herein are not indicative
of likely future cash flows, as these positions may be changed by new
transactions in the trading portfolio at any time in response to changing market
conditions, market liquidity and the Company's risk management portfolio needs
and strategies. Terms regarding cash settlements of these contracts vary with
respect to the actual timing of cash receipts and payments.
In addition to the risk associated with price movements, credit risk is also
inherent in the Company's and its subsidiaries' risk management activities.
Credit risk relates to the risk of loss resulting from non-performance of
contractual obligations by a counterparty. The following table shows the
composition of the total price risk management assets of Reliant Energy Services
as of December 31, 1998.
<TABLE>
<CAPTION>
INVESTMENT
GRADE (1) TOTAL
--------------------------------------
(THOUSANDS OF DOLLARS)
------------ --------------
<S> <C> <C>
Energy marketers........................................................... $102,458 $123,779
Financial institutions..................................................... 61,572 61,572
Gas and electric utilities................................................. 46,880 48,015
Oil and gas producers...................................................... 7,197 8,323
Industrials................................................................ 1,807 3,233
Independent power producers................................................ 1,452 1,463
Others..................................................................... 45,421 46,696
----------- ---------
Total.................................................................... $266,787 293,081
===========
Credit and other reserves.................................................. (6,464)
---------
Energy price risk management assets (2).................................... $286,617
=========
</TABLE>
_________
(1) "Investment Grade" is primarily determined using publicly available credit
ratings along with the consideration of credit support (e.g., parent
company guarantees) and collateral, which encompass cash and standby
letters of credit.
(2) The Company has credit risk exposure with respect to two investment grade
customers each of which represents an amount greater than 5% but less than
10% of Price Risk Management Assets.
(b) Non-Trading Activities.
To reduce the risk from market fluctuations in the price of electric power,
natural gas and related transportation, the Company, Resources 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. The Company applies hedge accounting with
respect to its derivative financial instruments.
51
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Certain subsidiaries of the Company also utilize interest-rate derivatives
(principally interest-rate swaps) in order to adjust the portion of its overall
borrowings which are subject to interest rate risk and also utilize such
derivatives to effectively fix the interest rate on debt expected to be issued
for refunding purposes.
For transactions involving either Energy Derivatives or interest-rate
derivatives, hedge accounting is applied only if the derivative (i) reduces the
price risk of the underlying hedged item and (ii) is designated as a hedge at
its inception. Additionally, the derivatives must be expected to result in
financial impacts which are inversely correlated to those of the item(s) to be
hedged. This correlation (a measure of hedge effectiveness) is measured both at
the inception of the hedge and on an ongoing basis, with an acceptable level of
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 Statements 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, 1998, subsidiaries of Resources were fixed-price payors and
fixed-price receivers in Energy Derivatives covering 42,498 billion British
thermal units (Bbtu) and 3,930 BBtu of natural gas, respectively. At December
31, 1997, subsidiaries of Resources 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, 1998 and 1997, subsidiaries of
Resources were parties to variable-priced Energy Derivatives totaling 21,437
Bbtu and 3,630 BBtu of natural gas, respectively. The weighted average maturity
of these instruments is less than one year.
The notional amount is intended to be indicative of the Company's 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.
52
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(c) Trading and Non-trading -- General Policy.
In addition to the risk associated with price movements, credit risk is also
inherent in the Company's 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 only minor losses due to the credit risk
associated with these arrangements, the Company has off-balance sheet risk to
the extent that the counterparties to these transactions may fail to perform as
required by the terms of each such contract. In order to minimize this risk, the
Company and/or its subsidiaries, as the case may be, enter into such contracts
primarily with those counterparties with a minimum Standard & Poor's or Moody's
rating of BBB- or Baa3, respectively. For long-term arrangements, the Company
and its subsidiaries periodically review the financial condition of such firms
in addition to monitoring the effectiveness of these financial contracts in
achieving the Company's objectives. Should the counterparties to these
arrangements fail to perform, the Company would seek to compel performance at
law or otherwise or obtain compensatory damages in lieu thereof. The Company
might be forced to acquire alternative hedging arrangements or be required to
honor the underlying commitment at then- current market prices. In such event,
the Company might incur additional loss to the extent of amounts, if any,
already paid to the counterparties. In view of its criteria for selecting
counterparties, its process for monitoring the financial strength of these
counterparties and its experience to date in successfully completing these
transactions, the Company believes that the risk of incurring a significant
financial statement loss due to the non-performance of counterparties to these
transactions is minimal.
The Company's policies prohibit the use of leveraged financial instruments.
The Company has established a Corporate Risk Oversight Committee, comprised of
corporate and business segment officers, to oversee all corporate price and
credit risks, including Reliant Energy Services' trading, marketing and risk
management activities. The Corporate Risk Oversight Committee's responsibilities
include reviewing the Company's and its subsidiaries' hedging, trading and price
risk management strategies, activities and limits and monitoring to ensure
compliance with the Company's risk management policies and procedures and
trading limits established by the Company's board of directors.
(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 Plan.
In June 1998, the Texas Utility Commission issued an order in Docket No. 18465
approving the Company's Transition Plan filed by Electric Operations in December
1997. The Transition Plan included 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 are entitled to receive base rate credits of 2% in
each of 1998 and 1999. The Company implemented the Transition Plan effective
January 1, 1998.
For information about additional depreciation of generation assets and
redirecting depreciation pursuant to the Transition Plan, see Note 1(f).
53
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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. 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.
(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 megawatt (MW) nuclear generating units and bears a corresponding 30.8%
share of capital and operating costs associated with the project. As of December
31, 1998, the Company's investment in the South Texas Project (including AFUDC)
was $1.4 billion (net of $1.1 billion accumulated depreciation). The Company's
investment in nuclear fuel (including AFUDC) was $41 million (net of $230
million amortization) as of such date.
The South Texas Project is owned as a tenancy in common among its four co-
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 co-owners have delegated management and operation responsibility for the
South Texas Project to the South Texas Nuclear Operating Company (STPNOC).
STPNOC is managed by a board of directors comprised of one director from each of
the four owners, along with the chief executive officer of STPNOC. The four
owners provide oversight through an owners' committee comprised of
representatives of each of the owners and through the board of directors of
STPNOC. Prior to November 1997, the Company was the operator of the South Texas
Project.
(b) 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 $16.5 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, the maximum liability to the public of
owners of nuclear power plants, such as the South Texas Project, was $9.145
billion as of December 31, 1998. Owners are required under the Price Anderson
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 $83.9 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.
54
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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, results of operations and cash flows.
(c) 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 the accounting treatment for the 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. An update of
the 1994 study is in the process of being completed.
(d) Assessment Fees for Spent Fuel Disposal and Enrichment and Decommissioning.
By contract, the United States Department of Energy (DOE) has committed itself
ultimately to take possession of all spent fuel generated by the South Texas
Project. The DOE contract currently requires payment of a spent fuel disposal
fee on nuclear plant-generated electricity of one mill (one-tenth of a cent) per
net KWH sold. This fee is subject to adjustment to ensure full cost recovery by
the DOE. The Energy Policy Act also includes a provision that assesses a fee
upon domestic utilities that purchased nuclear fuel enrichment services from the
DOE before October 24, 1992. The South Texas Project's assessment is
approximately $2 million per year (subject to escalation for inflation). The
Company has a remaining estimated liability of $5 million for such assessments.
(e) 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. 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).
(5) EQUITY INVESTMENTS AND ADVANCES TO UNCONSOLIDATED SUBSIDIARIES
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 and its subsidiaries' equity investments and advances in
unconsolidated subsidiaries at December 31, 1998 and 1997 were $1 billion and
$704 million, respectively. The Company's and its subsidiaries' equity income
from these investments, included in International revenues and other net income,
was $71 million, $49 million and $17 million in 1998, 1997 and 1996,
respectively. Dividends received from the investments amounted to $44 million
and $46 million in 1998 and 1997, respectively. No dividends were received from
these investments in 1996.
55
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(a) International.
In April 1998, Light Servios de Eletricidade S.A. (Light), a Brazilian
corporation in which Reliant Energy International, Inc. (Reliant Energy
International) indirectly owns an 11.69% common stock interest, purchased 74.88%
of the common stock of Metropolitana Eletricidade de Sao Paulo S.A.
(Metropolitana), an electric distribution company that serves the metropolitan
area of Sao Paulo, Brazil. The purchase price for the shares was approximately
$1.8 billion and was financed with proceeds from bank borrowings. As of
December 31, 1998, Light and Metropolitana had approximately $3.2 billion in
non-local currency denominated borrowings. For information regarding foreign
currency adjustments, see Note 1(p). For information about the devaluation of
the Brazilian real in January 1999, see Note 16(a).
In May 1997, Reliant Energy International increased its indirect ownership
interest in the Argentine electric utility from 48% to 63%. The purchase price
of the additional interest was $28 million.
On June 30, 1998, Reliant Energy International sold its 63% ownership interest
in an Argentine affiliate and certain related assets for approximately $243
million. Reliant Energy International acquired its initial ownership interests
in the electric utility in 1992. The Company recorded an $80 million after-tax
gain from this sale in the second quarter of 1998.
In 1998, a subsidiary of Reliant Energy International acquired for
approximately $150 million, equity interests (currently ranging from
approximately 36% to 45%) in three electric distribution systems located in El
Salvador. Corporacion EDC S.A.C.A. (CEDC), Reliant Energy International's
partner in this venture, acquired majority interests in the systems when they
were privatized in early 1998. On June 30, 1998, CEDC closed on the sale of
approximately half of its interests in the systems to a subsidiary of Reliant
Energy International.
In August 1998, Reliant Energy International and CEDC jointly acquired,
through subsidiaries, 65% of the stock of two Colombian electric distribution
companies, Electricaribe and Electrocosta. The shares of these companies are
indirectly held by an offshore holding company jointly owned by special purpose
subsidiaries of CEDC and Reliant Energy International.
The purchase price for the joint investment in Electricaribe and Electrocosta
was approximately $522 million, excluding transaction costs. The purchase price
was funded with capital contributions from Reliant Energy International and CEDC
and a U.S. $200 million loan obtained by the holding company from a United
States bank. A $100 million advance on the loan was obtained in October 1998
with subsequent advances of $25 million and $75 million obtained in December
1998 and January 1999, respectively. The loan will mature on October 31, 2003.
Reliant Energy International funded its capital contributions with a portion of
the proceeds from the sale of the Argentine affiliate discussed above and
capital contributions from the Company. Under the terms of a support
agreement, Reliant Energy International and CEDC have agreed, among other
things, to repurchase up to U.S. $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.
In June 1997, a consortium of investors which included a subsidiary of Reliant
Energy International, 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 province of Colombia, including the
area surrounding the city of Cali. Reliant Energy International contributed
$152 million of the purchase price for a 28.35% ownership interest in EPSA. In
addition to its distribution facilities, EPSA owns 850 MW of electric generation
capacity.
Reliant Energy International 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 a preliminary basis, using 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
56
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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) Combined Financial Statement Data of Equity Investments and Advances to
Unconsolidated Subsidiaries.
The following table sets forth certain summarized financial information of the
Company's unconsolidated affiliates as of December 31, 1998 and 1997 and for the
years then ended or periods from the respective affiliates' acquisition date
through December 31, 1998, 1997 and 1996, if shorter:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Income Statement:
Revenues.......................................... $2,449,335 $2,011,927 $994,743
Operating Expenses................................ 1,762,166 1,460,248 768,993
Net Income........................................ 514,005 403,323 149,038
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1998 1997
---------------------- -----------------------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Balance Sheet:
Current Assets........................................................ $ 1,841,857 $ 726,997
Noncurrent Assets..................................................... 13,643,747 5,791,858
Current Liabilities................................................... 4,074,603 566,596
Noncurrent Liabilities................................................ 6,284,821 1,398,385
Owners' Equity........................................................ 5,126,180 4,553,874
</TABLE>
(6) COMMON STOCK
At December 31, 1998 and 1997 the Company had 296,271,063 and 295,357,276
shares of common stock issued, respectively (out of a total of 700,000,000
authorized shares).
At December 31, 1998 and 1997, the Company had 284,494,195 and 282,875,266
common shares outstanding, respectively. Outstanding common shares exclude (i)
shares pledged to secure a loan to the Company's Employee Stock Ownership Plan
(11,674,063 and 12,388,551 at December 31, 1998 and 1997, respectively) and (ii)
treasury shares (102,805 and 93,459 at December 31, 1998 and 1997,
respectively). At December 31, 1998 and 1997, the treasury shares of common
stock held by the Company represent shares which were received from holders of
Company stock options who surrendered shares of Company common stock as partial
payment for the exercise price of their stock options.
In 1998, the Company paid four regular quarterly dividends aggregating $1.50
per share on its common stock pursuant to dividend declarations made in December
1997, March 1998, June 1998 and September 1998. In December 1998, the Company
declared its regular quarterly dividend of $0.375 per share to be paid in March
1999. For information regarding certain restrictions on payments of dividends,
see Note 8(c).
57
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(7) PREFERRED AND PREFERENCE STOCK
(a) Preferred Stock.
At December 31, 1998 and 1997, the Company had 10,000,000 authorized shares of
preferred stock, of which 97,397 shares were outstanding. As of such date, the
Company's only outstanding series of preferred stock was its $4.00 Preferred
Stock. The $4.00 Preferred Stock pays an annual dividend of $4.00 per share, is
redeemable at $105 per share and has a liquidation price of $100 per share.
(b) Preference Stock.
At December 31, 1998 and 1997, the Company had 10,000,000 authorized shares of
preference stock, of which 700,000 shares are classified as Series A Preference
Stock and 27,000 shares are classified as Series B Preference Stock. As of
December 31, 1998 and 1997, there were no shares of Series A Preference Stock
issued and outstanding (such shares being issuable in accordance with the
Company's Shareholder Rights Agreement upon the occurrence of certain events).
The number of shares of Series B Preference Stock issued and outstanding as of
December 31, 1998 and 1997 was 17,000. On March 27, 1998, the Company
designated 1,575 shares of its preference stock as Series C Preference Stock.
As of December 31, 1998, the number of shares of Series C Preference Stock
issued and outstanding was 1,575. The shares of Series B and Series C
Preference Stock are not deemed outstanding for financial reporting purposes
because they are held by wholly owned financing subsidiaries of the Company. See
Note 8(c).
Each share of common stock of the Company includes one associated preference
stock purchase right (Company Right). Under certain circumstances, each Company
Right entitles the registered holder to purchase from the Company a unit
consisting of one-thousandth of a share (Fractional Share) of Series A
Preference Stock, without par value (Series A Preference Stock), at a purchase
price of $42.50 per Fractional Share, subject to adjustments. The shareholder
rights plan was adopted by the shareholders of Former Parent in August 1990 and
was assumed by the Company, with certain amendments, effective upon the Merger.
(8) LONG-TERM DEBT AND SHORT-TERM BORROWINGS
(a) Consolidated Debt.
The Company's consolidated long-term and short-term debt outstanding is
summarized in the following table. Of the amount of long-term and short-term
debt outstanding as of December 31, 1998, $2 billion represents debt of
Resources which was adjusted to fair market value as of the Acquisition Date.
58
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
CONSOLIDATED LONG-TERM DEBT AND SHORT-TERM BORROWINGS
(in millions)
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------------------------ ------------------------------------
LONG-TERM CURRENT(1) LONG-TERM CURRENT(1)
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Short-term Borrowings:
Commercial Paper................................. $1,360 $1,435
Lines of Credit.................................. 150 390
Resources Receivables Facility................... 300 300
Notes Payables................................... 3
---------------- ---------------- ---------------- ----------------
Total Short-term Borrowings....................... 1,813 2,125
---------------- ---------------- ---------------- ----------------
Long-term Debt-net:
ACES............................................. $2,350 $1,174
Debentures(2)(3)................................. 1,482 669
First Mortgage Bonds(2).......................... 1,866 170 2,495
Pollution Control Bonds.......................... 581 118 5
Resources Medium-term Notes(3)................... 178 182 79
Notes Payable(3)................................. 330 226 565 166
Capital Leases................................... 14 1 15 1
---------------- ---------------- ---------------- ----------------
Total Long-term Debt.............................. 6,801 397 5,218 251
---------------- ---------------- ---------------- ----------------
Total Borrowings................................. $6,801 $2,210 $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 December 31, 1998 and 1997 and unamortized premium related to
debentures of approximately $17 million at December 31, 1998. The
unamortized discount related to first mortgage bonds was approximately $10
million and $14 million at December 31, 1998 and 1997, respectively.
(3) Includes unamortized premium related to fair value adjustments of
approximately $18.1 million and $15.8 million for Debentures at December
31, 1998 and 1997, respectively. The unamortized premium for Resources
long-term and medium-term notes at December 31, 1998 was approximately $12
million and $0, respectively, and $0 and $3 million at December 31 1997,
respectively. The unamortized premium for long-term and current notes
payable was approximately $3 million each at December 31, 1998 and $14
million and $3 million, respectively at December 31, 1997. See Note 1(b).
Consolidated maturities of long-term debt and sinking fund requirements for
the Company (including Resources) are approximately $402 million in 1999, $2.8
billion in 2000, $438 million in 2001, $1.9 billion in 2002 and $199 million in
2003.
(b) First Mortgage Bonds.
As of December 31, 1998, the Company had an aggregate of $2.0 billion
principal amount of its first mortgage bonds issued and outstanding.
Sinking or improvement fund requirements of the Company's first mortgage bonds
outstanding will be approximately $24 million in 1999, $17 million in 2000, $16
million in 2001 and 2002 and $13 million in 2003. Such requirements may be
satisfied by certification of property additions at 100% of the requirements.
Sinking or improvement fund requirements for 1998 and prior years have been
satisfied by certification of property additions.
The Company has agreed to expend an amount each year for replacements and
improvements in respect of its depreciable mortgaged utility property equal to
$1,450,000 plus 2% of net additions to such mortgaged property made after March
31, 1948 and before July 1 of the preceding year. Such requirement may be met
with cash, first
59
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
mortgage bonds, gross property additions or expenditures for repairs or
replacements, or by taking credit for property additions at 100% of the
requirements. The replacement fund requirement to be satisfied in 1999 is
approximately $316.6 million.
The amount of the first mortgage bonds that may be issued by the Company is
unlimited as to issuance, but limited by property, earnings and other provisions
of the Mortgage and Deed of Trust dated as of November 1, 1944, between the
Company and South Texas Commercial National Bank of Houston (Chase Bank of
Texas, National Association, as Successor Trustee) and the supplemental
indentures thereto. Substantially all physical assets used in the conduct of the
business and operations of Electric Operations are subject to liens securing the
long-term debt under the mortgage.
(c) FinanceCo and FinanceCo II Credit Facilities.
In August 1997, a limited partnership special purpose subsidiary of the
Company (FinanceCo) established a five-year, $1.644 billion revolving credit
facility (FinanceCo Facility). The FinanceCo Facility supported $1.360 billion
in commercial paper borrowings by FinanceCo at December 31, 1998 recorded as
notes payable on the Company's Consolidated Balance Sheet. The weighted average
interest rate of these borrowings was 5.88% at December 31, 1998 and 6.15% at
December 31, 1997.
Borrowings under the FinanceCo Facility bear interest at a rate based upon the
London interbank offered rate (LIBOR) plus a margin, a base rate or at a rate
determined through a bidding process. The FinanceCo Facility may be used (i) to
support the issuance of commercial paper or other short-term indebtedness of
FinanceCo, (ii) subject to certain limitations, to finance purchases of Company
common stock and (iii) subject to certain limitations, to provide funds for
general purposes of FinanceCo, including the making of intercompany loans to, or
securing letters of credit for the benefit of, FinanceCo's affiliates.
The FinanceCo Facility requires the Company to maintain a ratio of
consolidated indebtedness for borrowed money to consolidated capitalization (as
defined) that does not exceed 0.65:1.00. The FinanceCo Facility also contains
restrictions applicable to the Company and certain of its subsidiaries with
respect to, among other things, (i) liens, (ii) consolidations, mergers and
dispositions of assets, (iii) dividends and purchases of common stock, (iv)
certain types of investments and (v) certain changes in its business. The
FinanceCo Facility contains customary covenants and default provisions
applicable to FinanceCo and its subsidiaries, including limitations on, among
other things, additional indebtedness (other than certain permitted
indebtedness), liens and certain investments or loans.
Subject to certain conditions and limitations, the Company is required to make
cash payments from time to time to FinanceCo from excess cash flow (as defined
in the FinanceCo Facility) to the extent necessary to enable FinanceCo to meet
its financial obligations. At December 31, 1998, commercial paper supported by
the FinanceCo Facility was secured by pledges of (i) all of the limited and
general partner interests of FinanceCo, (ii) the Series B Preference Stock and
(iii) certain intercompany notes held by FinanceCo. The obligations under the
FinanceCo Facility are not secured by the utility assets of the Company or
Resources or by the Company's investment in Time Warner securities.
In March 1998, a limited partnership special purpose subsidiary of the Company
(FinanceCo II) executed a $150 million credit agreement (FinanceCo II Facility)
which terminated March 2, 1999. Proceeds from $150 million of borrowings under
the FinanceCo II Facility were used to fund a portion of the April 1998 purchase
by Reliant Energy Power Generation, Inc. (Power Generation) of four electric
generation plants. Borrowings under the FinanceCo II Facility bore interest at
LIBOR-based and negotiated rates. At December 31, 1998, FinanceCo II had $150
million of borrowings under this facility at an interest rate of 5.75%. In March
1999, the $150 million of borrowings under the FinanceCo II facility were paid
at maturity with borrowings under the FinanceCo facility.
60
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(d) Company Credit Facility.
The Company meets its short-term financing needs primarily through sales of
commercial paper supported by a $200 million revolving credit facility.
Borrowings under the facility are unsecured and a facility fee is paid. At
December 31, 1998, there was no outstanding commercial paper and there were no
outstanding borrowings under the bank facility.
(e) ACES.
For information regarding the Company's ACES, including certain accounting
losses that may result upon increases in the price of Time Warner common stock,
see Note 1(n).
(f) Pollution Control Revenue Bonds.
In January 1998, the Matagorda County Navigation District Number One (MCND)
issued on behalf of the Company $104.7 million aggregate principal amount of
pollution control revenue refunding bonds ($29.7 million at 5.25% and $75
million at 5.15%). The MCND bonds will mature in 2029. Proceeds from the
issuance were used in February 1998 to redeem all outstanding 7 7/8% MCND Series
1989A pollution control revenue bonds ($29.7 million) and 7.70% MCND Series
1989B pollution control revenue bonds ($75 million) at a redemption price of
102% of the aggregate principal amount of each series.
In February 1998, the Brazos River Authority (BRA) issued on behalf of the
Company $290 million aggregate principal amount of pollution control revenue
refunding bonds. The BRA bonds will mature in May 2019 ($200 million at 5 1/8%)
and November 2020 ($90 million at 5 1/8%). Proceeds from the issuance were used
in May 1998 to redeem all outstanding 8.25% BRA Series 1988A pollution control
revenue bonds ($100 million), 8.25% BRA Series 1988B pollution control revenue
bonds ($90 million) and 8.10% BRA Series 1988C pollution control revenue bonds
($100 million) at a redemption price of 102% of the aggregate principal amount
of each series.
In June 1998, the Company repaid at maturity $5 million of its floating-rate
pollution control revenue bonds issued on its behalf.
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 4.9% and mature in October 2015. Proceeds from the issuance
were used in October 1998 to redeem $68.7 million principal amount of the
7 3/4% BRA Series 1988D pollution control bonds at a redemption price of 102% of
the aggregate principal amount.
In November 1998, the Company changed 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). The method by which interest
on the bonds is determined changed from a floating rate mode to a long-term
fixed rate mode. The interest rate for the MCND Series 1997 bonds will be
5 1/8% until maturity of the bonds, and the interest rate for the BRA Series
1997 bonds will be 5.05% until maturity of the bonds. The MCND and BRA Series
1997 bonds, which were issued in January 1997, were mandatorily tendered in
November 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) was funded with the proceeds from a remarketing of the
fixed-rate bonds.
(g) Resources Credit Facilities.
In 1998, Resources met its short-term financing needs primarily through a bank
facility, bank lines of credit, a receivables facility and the issuance of
commercial paper. In March 1998, Resources replaced its $400 million
61
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
revolving credit facility with a five-year $350 million revolving credit
facility (Resources Credit Facility). Borrowings under the Resources Credit
Facility are unsecured and bear interest at a rate based upon either LIBOR plus
a margin, a base rate or a rate determined through a bidding process. The
Resources Credit Facility is used to support Resources' issuance of up to $350
million of commercial paper. There were no commercial paper borrowings and no
loans outstanding under the Resources Credit Facility at December 31, 1998.
Borrowings under Resources' prior credit facility at December 31, 1997 were $340
million. In addition, Resources had $50 million of outstanding loans under
uncommitted lines of credit at December 31, 1997 having a weighted average
interest of 6.829%.
A $65 million committed bank facility under which Resources obtained letters
of credit and all of Resources' uncommitted lines of credit were terminated in
1998. Subsequent to the December 1998 termination, Resources obtained letters
of credit under an uncommitted line. Resources expects to amend the Resources
Credit Facility in March 1999 to add a $65 million letter of credit subfacility.
Under a trade receivables facility (Receivables Facility) which expires in
August 1999, Resources sells, with limited recourse, an undivided interest
(limited to a maximum of $300 million) in a designated pool of its and certain
of its subsidiaries' accounts receivable. The amount of receivables sold and
uncollected was $300 million at December 31, 1998 and 1997, respectively. The
weighted average interest rate was approximately 5.54% and 5.65% at December 31,
1998 and 1997, respectively. Certain of the remaining receivables serve as
collateral for receivables sold and represent the maximum exposure to Resources
should all receivables sold prove ultimately uncollectible. Resources has
retained servicing responsibility under the Receivables Facility for which it is
paid a servicing fee. Pursuant to SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments Liabilities" (SFAS No. 125),
the receivables are recorded as assets and amounts received by Resources under
the Receivables Facility are recorded as notes payable.
(h) Resources Long-term Debt.
At December 31, 1998, Resources had issued and outstanding $109.6 million
aggregate principal amount of its 6% Convertible Subordinated Debentures due
2012 (Subordinated Debentures). The holders of the Subordinated Debentures
receive interest quarterly and have the right at any time on or before the
maturity date thereof to convert each Subordinated Debenture into 0.65 shares of
Company common stock and $14.24 in cash. Resources is required to make annual
sinking fund payments of $6.5 million on the Subordinated Debentures, which
began on March 15, 1997 and on each succeeding March 15 up to and including
March 15, 2011. Resources (i) may credit against the sinking fund requirements
any Subordinated Debentures redeemed by Resources and Subordinated Debentures
which have been converted at the option of the holder and (ii) may deliver
purchased Subordinated Debentures in satisfaction of the sinking fund
requirements. During 1998, Resources purchased $6.7 million aggregate principal
amount of its Subordinated Debentures at an average purchase price of 97.3% of
the aggregate principal amount plus accrued interest.
In February 1998, Resources 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 Resources, including the
indebtedness incurred in connection with the 1997 purchase of $101 million
aggregate principal amount of its 10% debentures and the repayment of $53
million aggregate principal amount of Resources debt that matured in December
1997 and January 1998. In connection with the issuance of the 6.5% debentures,
Resources received approximately $1 million upon unwinding a $300 million
treasury rate lock agreement, which was tied to the interest rate on 10-year
treasury bonds. The rate lock agreement was executed in January 1998, and
proceeds from the unwind will be amortized over the 10 year life of Resources'
6.5% debentures.
62
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
During 1998, Resources repaid the following medium-term notes at maturity:
<TABLE>
<CAPTION>
SERIES PRINCIPAL AMOUNT
------------------------------------ ---------------------
(MILLIONS OF DOLLARS)
<S> <C>
9.30% due January 15, 1998 $ 1.0
8.74% due May 14, 1998 20.0
8.76% due May 14, 1998 5.0
8.73% due May 15, 1998 3.0
9.07% due July 20, 1998 15.0
8.60% due September 1, 1998 3.0
8.58% due September 1, 1998 5.0
8.64% due September 4, 1998 12.5
8.50% due September 14, 1998 0.5
8.60% due September 15, 1998 6.0
8.43% due September 17, 1998 5.0
--------------
Total $ 76.0
==============
</TABLE>
In November 1998, Resources sold $500 million aggregate principal amount of
its 6 3/8% Term Enhanced ReMarketable Securities (TERM Notes). Included within
the TERM Notes is an embedded option sold to an investment bank which gives the
investment bank the right to remarket the TERM Notes in 2003 if it chooses to
exercise the option. The net proceeds of $514 million from the offering of the
TERM Notes were used for general corporate purposes, including the repayment of
(i) $178.5 million of Resources' outstanding commercial paper and (ii) a $150
million term loan of Resources that matured on November 13, 1998. The TERM
Notes are unsecured obligations of Resources which bear interest at an 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. The portion of the proceeds attributable to the option premium will be
amortized over the stated term of the securities. If the option is not
exercised, Resources 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 Resources, 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
Resources. 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 Resources'
applicable credit spread at the time of such remarketing.
(i) Restrictions on Resources' Debt.
Under the provisions of Resources Credit Facility, Resources' total debt is
limited to 55% of its total capitalization. At December 31, 1998, this
provision did not significantly restrict Resources' ability to issue debt or to
pay dividends. At December 31, 1998, Resources ratio of total debt to total
capitalization was 40.13%.
(j) Reliant Energy International Debt.
In 1996, a subsidiary of Reliant Energy International entered into a $167.5
million loan agreement in order to refinance a portion of the acquisition costs
of Light. The full proceeds of the loan, net of a $17.5 million debt reserve
account established for the benefit of the lenders, were funded in April 1997.
The loan (included in Long-term debt) is secured by, among other things, a
pledge of the shares of Light and of a subsidiary of Reliant Energy
International that is the indirect holder of the shares of Light.
63
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(9) TRUST SECURITIES
(a) Company.
In February 1997, two Delaware statutory business trusts (Reliant Trusts)
established by the Company issued (i) $250 million of preferred securities and
(ii) $100 million of capital securities, respectively. The preferred securities
have a distribution rate of 8.125% payable quarterly in arrears, a stated
liquidation amount of $25 per preferred security and must be redeemed by March
2046. The capital securities have a distribution rate of 8.257% payable
quarterly in arrears, a stated liquidation amount of $1,000 per capital security
and must be redeemed by February 2037.
The Reliant Trusts sold the preferred and capital securities to the public and
used the proceeds to purchase $350 million aggregate principal amount of
subordinated debentures (Debentures) from the Company having interest rates
corresponding to the distribution rates of the securities and maturity dates
corresponding to the mandatory redemption dates of the securities. The Reliant
Trusts are accounted for as wholly owned consolidated subsidiaries of the
Company. The Debentures represent the Reliant Trusts' sole assets and its entire
operations. The Company has fully and unconditionally guaranteed, on a
subordinated basis, each Trust's obligations, including the payment of
distributions and all other payments due with respect to the respective
preferred and capital securities. The preferred and capital securities are
mandatorily redeemable upon the repayment of the related Debentures at their
stated maturity or earlier redemption.
Subject to certain limitations, the Company has the option of deferring
payments of interest on the Debentures held by the Reliant Trusts. If and for
as long as interest payments on the Debentures have been deferred, or an event
of default under the indenture relating thereto has occurred and is continuing,
the Company may not pay dividends on its capital stock. As of December 31,
1998, no interest payments on the Debentures had been deferred.
(b) Resources.
In June 1996, a Delaware statutory business trust (Resources Trust)
established by Resources issued in a public offering $172.5 million of
convertible preferred securities and sold approximately $5.3 million of
Resources Trust common securities (106,720 securities, representing 100% of the
Resources Trust's common equity) to Resources. The convertible preferred
securities have a distribution rate of 6.25% payable quarterly in arrears, a
stated liquidation amount of $50 per convertible preferred security and must be
redeemed by 2026. The Resources Trust sold the convertible preferred securities
to the public and used the proceeds, in addition to the common securities
proceeds, to purchase $177.8 million of 6.25% Convertible Junior Subordinated
Debentures from Resources, which Debentures have an interest rate corresponding
to the distribution rate of the convertible preferred securities and a maturity
date corresponding to the mandatory redemption date of the convertible preferred
securities. The Resources Trust is accounted for as a wholly owned consolidated
subsidiary of Resources. The junior subordinated debentures represent the sole
assets of the Resources Trust and its entire operations. Resources has fully
and unconditionally guaranteed, on a subordinated basis, the Resources Trust's
obligations, including the payment of distributions and all other payments, with
respect to the convertible preferred securities. The convertible preferred
securities are mandatorily redeemable upon the repayment of the related junior
subordinated debentures at their stated maturity or earlier redemption. Each
convertible preferred security is convertible at the option of the holder into
$33.62 of cash and 1.55 shares of Company common stock. During 1998,
convertible preferred securities aggregating $15.5 million were converted,
leaving $0.9 million liquidation amount of convertible preferred securities
outstanding at December 31, 1998.
64
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Subject to certain limitations, Resources has the option of deferring payments
of interest on the debentures held by the Resources Trust. If and for as long
as interest payments on the debentures have been deferred, or on event of
default under the indenture relating thereto has occurred and is continuing,
Resources may not pay dividends on its capital stock. As of December 31, 1998,
no interest payments on the debentures had been deferred.
(10) STOCK-BASED INCENTIVE COMPENSATION PLANS AND RETIREMENT PLANS
(a) Incentive Compensation Plans.
The Company has Long-Term Incentive Compensation Plans (LICP) and other
incentive compensation plans that provide for the issuance of stock-based
incentives (including performance-based stock compensation and restricted
shares, stock options and stock appreciation rights) to key employees of the
Company, including officers. As of December 31, 1998, 273 current and former
employees participated in the plans. A maximum of approximately 9 million shares
of common stock may be issued under these plans. Under the LICP, beginning one
year after the grant date, the options become exercisable in one-third
increments each year. Performance-based stock compensation issued and restricted
shares granted were 98,413 in 1998, 704,865 in 1997 and 69,905 in 1996.
Stock option activity for the years 1996 through 1998 is summarized below:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
NUMBER PRICE AT DATE OF
OF SHARES GRANT OR EXERCISE
--------------------- ---------------------
<S> <C> <C>
Outstanding at December 31, 1995......................................... 411,342 $21.1414
Options Granted........................................................ 101,798 $ 24.375
Options Exercised...................................................... (574) $ 17.75
Options Withheld for Taxes............................................. (90)
Options Canceled....................................................... (13,824)
Outstanding at December 31, 1996......................................... 498,652 $21.7796
Options Granted........................................................ 382,954 $21.0673
Options Converted at Acquisition(1).................................... 622,504 $12.9002
Options Exercised(1)................................................... (281,053) $ 9.2063
Options Withheld for Taxes............................................. (72)
Options Canceled....................................................... (148,418)
Outstanding at December 31, 1997......................................... 1,074,567 $19.0728
Options Granted........................................................ 2,243,535 $26.3112
Options Exercised(1)................................................... (287,591) $15.6576
Option Withheld for Taxes.............................................. (6,854)
Options Canceled....................................................... (78,003)
Outstanding at December 31, 1998......................................... 2,945,654 $24.8668
</TABLE>
<TABLE>
<CAPTION>
NUMBER RANGE OF EXERCISE
OF SHARES PRICES
--------------------- ---------------------
<S> <C> <C>
Exercisable at:
December 31, 1998...................................................... 531,855 $ 7.00-35.18
December 31, 1997...................................................... 645,304 $ 7.00-35.18
December 31, 1996...................................................... 280,270 $17.75-23.25
</TABLE>
__________
(1) Effective upon the Merger, each holder of an unexpired Resources stock
option, whether or not then exercisable, was entitled to elect to either (i)
have all or any portion of their Resources stock options canceled and
"cashed out" or (ii) have all or any portion of their Resources stock
options converted to the Company's stock options. There were 828,297
Resources stock options converted into 622,504 of the Company's stock
65
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
options at the Acquisition Date. Options exercised during 1998 and 1997
included approximately 210,000 and 277,000 shares, respectively, related to
Resources stock options which were converted at the Merger.
Effective January 1, 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation" (SFAS No. 123). In accordance with SFAS No. 123, the
Company will continue to apply the existing rules contained in Accounting
Principles Opinion No. 25, "Accounting for Stock Issued to Employees," and
disclose the required pro forma effect on net income and earnings per share of
the fair value based method of accounting for stock compensation as required by
SFAS No. 123.
The following pro forma summary of the Company's consolidated results of
operations has been prepared as if the fair value based method of accounting for
employee stock compensation required by SFAS No. 123 had been applied:
<TABLE>
<CAPTION>
1998 1997 1996
--------------- --------------- ---------------
(THOUSANDS OF DOLLARS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net Income (Loss) available for common stock as reported............. $(141,482) $420,948 $404,944
SFAS No. 123 effect.................................................. (6,383) (2,374) (1,098)
--------------- --------------- ---------------
Pro forma Net Income (Loss) available for common stock............... $(147,865) $418,574 $403,846
=============== =============== ===============
Pro forma Basic Earnings per Common Share............................ $ (.50) $ 1.66 $ 1.66
Pro forma Diluted Earnings per Common Share.......................... (.52) 1.65 1.66
</TABLE>
The fair value of options granted during 1996, 1997 and 1998 was calculated
using the Black-Scholes model. The significant assumptions incorporated in the
Black-Scholes model in estimating the fair value of the options include (i) an
interest rate of 5.65% for 1996, 6.58% for 1997 and 5.65% for 1998 that
represents the interest rate on a U.S. Treasury security with a maturity date
corresponding with the option term, (ii) an option term of ten years, (iii)
volatility of 15.713% for 1996, 22.06% for 1997 and 24.01% for 1998 calculated
using daily stock prices for the period prior to the grant date and (iv)
expected common dividends of $1.50 per share representing annualized dividends
at the date of grant.
(b) Pension.
The Company has a noncontributory retirement plan which covers the employees
of the Company and its subsidiaries other than Resources. Resources has two
noncontributory retirement plans: (i) the plan which covers the employees of
Resources other than Minnegasco employees and (ii) the plan which covers
Minnegasco employees. The plans provide retirement benefits based on years of
service and compensation. The Company's and Resources' funding policy is to
contribute amounts annually in accordance with applicable regulations in order
to achieve adequate funding of projected benefit obligations. The assets of the
plans consist principally of common stocks and high-quality, interest-bearing
obligations. The net periodic pension costs, prepaid pension costs and benefit
obligation have been determined separately for each plan.
In 1998, the Company adopted SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits" (SFAS No. 132). SFAS No. 132
revises employers' disclosures about pension and other postretirement benefit
plans. It does not change the measurement or recognition of those plans.
66
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Net pension cost for the Company attributable to continuing operations
includes the following components:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1998 1997 1996
----------------- ---------------- ----------------
(THOUSAND OF DOLLARS)
<S> <C> <C> <C>
Service cost -- benefits earned during the period.................... $ 33,436 $ 26,848 $ 24,392
Interest cost on projected benefit obligation........................ 85,132 67,641 51,560
Expected (return) loss on plan assets................................ (121,196) (86,372) (57,818)
Net amortization..................................................... 6 6 6
----------------- ---------------- ----------------
Net pension cost........................................... (2,622) 8,123 18,140
Transfer of obligation to STPNOC..................................... (6,077)
SFAS No. 88 -- curtailment expense................................... 12,947 12,698
----------------- ---------------- ----------------
Total pension cost......................................... $ (2,622) $ 14,993 $ 30,838
================= ================ ================
</TABLE>
Following are reconciliations of the Company's beginning and ending balances
of its retirement plan benefit obligation, plan assets and funded status for
1998 and 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1998 1997
-------------------- --------------------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Change in Benefit Obligation
Benefit obligation, beginning of year................................... $1,246,582 $ 756,597
Service cost............................................................ 33,436 26,848
Interest cost........................................................... 85,132 67,641
Benefits paid........................................................... (69,182) (71,924)
Plan amendments......................................................... (161,326)
Acquisitions and divestitures........................................... 439,545
Actuarial (gain) loss................................................... 254,802 27,875
-------------------- --------------------
Benefit obligation, end of year......................................... $1,389,444 $1,246,582
-------------------- --------------------
CHANGE IN PLAN ASSETS
Plan asset, beginning of year........................................... 1,304,023 675,401
Benefits paid........................................................... (69,182) (71,924)
Employer contributions.................................................. 47,406 41,332
Acquisitions and divestitures........................................... 534,692
Actual investment return................................................ 147,635 124,522
-------------------- --------------------
Plan assets, end of year................................................ $1,429,882 $1,304,023
-------------------- --------------------
RECONCILIATION OF FUNDED STATUS
Funded status........................................................... 40,438 57,441
Unrecognized transition (asset) or obligation........................... (7,205) (9,008)
Unrecognized prior service cost......................................... (148,400) 14,734
Unrecognized actuarial (gain) loss...................................... 240,864 12,501
-------------------- --------------------
Net amount recognized................................................... $ 125,697 $ 75,668
==================== ====================
</TABLE>
67
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Amounts recognized in the Company's Consolidated Balance Sheet consist of:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1997
-------------------- --------------------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Prepaid benefit cost....................................................... $125,697 $ 95,815
Accrued benefit liability.................................................. (20,147)
-------------------- --------------------
Net amount recognized...................................................... $125,697 $ 75,668
==================== ====================
</TABLE>
The benefit obligation was determined using an assumed discount rate of 6.50%
in 1998 and 7.25% in 1997 and 1996. A long-term annual rate of compensation
increase ranging from 3.5% to 5.5% in 1998 and 4% to 6% in 1997 and 1996 was
assumed for both the Company and Resources plans, respectively. The assumed
long-term rate of return on plan assets was 10% in 1998 and 9.5% in 1997 and
1996 (10% for the Resources plans in 1997). The transitional asset at January 1,
1986, is being recognized over approximately 17 years, and the prior service
cost is being recognized over approximately 15 years for the Company's plan. The
unrecognized transitional asset, prior service cost and net (gain) or loss
related to the Resources' plans were recognized at the Acquisition Date.
Pursuant to SFAS No. 71, the Company's deferred costs associated with the
increases in its benefit obligations related to a 1995 early retirement
incentive program were amortized through the period ending December 31, 1997. In
1997 and 1996, the Company amortized $12.9 million and $12.7 million,
respectively, of those costs as a curtailment under SFAS No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and
for Termination Benefits" (SFAS No. 88), with regards to the Company's early
retirement program.
In 1998, the Company's board of directors approved an amendment, effective
January 1, 1999, which converted the present value of the accrued benefits under
the existing pension plans into a cash balance pension plan. Under the cash
balance formula, each participant has an account, for recordkeeping purposes
only, to which credits are allocated annually based on a percentage of the
participant's pay. The applicable percentage is 4%.
The purpose of the plan change is to continue to provide uniform retirement
income benefits across all employee groups, which are competitive both within
the utility industry as well as with other companies within the United States.
The Company will continue to reflect the costs of the pension plan according
to the provisions of SFAS No. 87, as amended by SFAS No. 132. As a result of
the January 1, 1999, amendment, which is reflected in the December 31, 1998
disclosure, the Company's benefit obligation declined $161 million. The plan
amendment had no impact on 1998 expense.
The actuarial loss is due to changes in certain actuarial assumptions.
(c) Savings Plan.
The Company has an employee savings plan that qualifies as cash or deferred
arrangements under Section 401(k) of the Internal Revenue Code of 1986, as
amended (IRC). Under the plan, participating employees may contribute a portion
of their compensation, pretax or after-tax, up to a maximum of 16% of
compensation limited by an annual deferral limit ($10,000 for calendar year
1998) prescribed by IRC Section 402(g) and the IRC Section 415 annual additions
limits. Through 1998, the Company matched 70% of the first 6% of each employee's
compensation contributed, subject to a vesting schedule which entitled the
employee to a percentage of the matching contributions depending on years of
service. Substantially all of the Company's match is invested in the Company's
common stock.
68
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
In October 1990, the Company amended its savings plan to add a leveraged
Employee Stock Ownership Plan (ESOP) component. The Company may use ESOP shares
to satisfy its obligation to make matching contributions under the savings plan.
Debt service on the ESOP loan is paid using all dividends on shares in the ESOP,
interest earnings on funds held in the ESOP and cash contributions by the
Company. Shares of the Company's common stock are released from the encumbrance
of the ESOP loan based on the proportion of debt service paid during the period.
As provided for under Statement of Position 93-6 (SOP 93-6), the Company
recognizes benefit expense for the ESOP equal to the fair value of the ESOP
shares committed to be released. In accordance with SOP 93-6, the Company
credits to unearned ESOP shares the original purchase price of ESOP shares
committed to be released to plan participants with the difference between the
fair value of the shares and the original purchase price recorded to common
stock. Dividends on allocated ESOP shares are recorded as a reduction to
retained earnings; dividends on unallocated ESOP shares are recorded as a
reduction of debt or accrued interest on the ESOP loan.
The Company's savings plan benefit expense attributable to operations was
$13.8 million, $18.4 million and $16.0 million in 1998, 1997 and 1996,
respectively.
The ESOP shares were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------
1998 1997
------------------- --------------------
<S> <C> <C>
Allocated shares transferred/distributed from the
Savings Plan(1)............................................................ 1,916,508 1,920,406
Allocated shares............................................................. 5,171,613 4,453,227
Unearned shares.............................................................. 11,674,063 12,388,551
------------ ------------
Total original ESOP shares.............................................. 18,762,184 18,762,184
============ ============
Fair value of unearned ESOP shares........................................... $374,270,460 $331,393,739
</TABLE>
__________
(1) 1,102,203 allocated shares transferred are related to shares transferred to
STPNOC in December 1997.
Resources has an employee savings plan (Resources Savings Plan) which covers
substantially all employees other than Reliant Energy Minnegasco employees.
Under the terms of the Resources Savings Plan, employees may contribute up to
12% of total compensation, which contributions up to 6% are matched by the
Company. The Reliant Energy Minnegasco employees are covered by a savings plan,
the terms of which are somewhat similar to the Resources Savings Plan. Employer
contributions related to the Resources and Reliant Energy Minnegasco Savings
Plan were $10.8 million and $3.7 million in 1998 and 1997 since the Acquisition
Date, respectively.
(d) Postretirement Benefits.
The Company and Resources record the liability for postretirement benefit
plans other than pensions (primarily health care) under SFAS No. 106,
"Employer's Accounting for Postretirement Benefits Other Than Pensions" (SFAS
No. 106). The Company is amortizing over a 22 year period approximately $213
million to cover the "transition cost" of adopting SFAS No. 106 (i.e., the
Company's liability for postretirement benefits payable with respect to employee
service years accrued prior to the adoption of SFAS No. 106). The unrecognized
transitional asset and net (gain) loss related to the Resources plans were
recognized at the Acquisition Date.
As provided in the 1995 Rate Case Settlement, Electric Operations is required
to fund during each year in an irrevocable external trust approximately $22
million of postretirement benefit costs which are included in its rates. Reliant
Energy Minnegasco is required to fund postretirement benefit costs for the
amount included in its rates. The Company and Resources, excluding Electric
Operations and Reliant Energy Minnegasco, will continue funding their
postretirement benefits on a pay-as-you-go basis.
69
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Following are reconciliations of the Company's beginning and ending
balances of its postretirement benefit plans benefit obligation, plan assets and
funded status for 1998 and 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------
1998 1997
-------------------- --------------------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning of year................................... $ 269,531 $ 144,275
Service cost............................................................ 8,060 8,927
Interest cost........................................................... 17,270 14,176
Benefits paid........................................................... (20,662) (11,963)
Participant contributions............................................... 2,960 1,591
Plan amendments......................................................... 98,918
Acquisitions............................................................ 115,721
Divestitures............................................................ (10,277)
Actuarial (gain) loss................................................... 33,734 7,081
-------------------- --------------------
Benefit obligation, end of year......................................... $ 409,811 $ 269,531
-------------------- --------------------
CHANGE IN PLAN ASSETS
Plan asset, beginning of year........................................... $ 56,340 $ 38,493
Benefits paid........................................................... (20,662) (11,963)
Employer contributions.................................................. 32,889 18,440
Participant contributions............................................... 2,960 1,591
Acquisitions............................................................ 2,909
Divestitures............................................................ (6,000)
Actual investment return................................................ 12,541 12,870
-------------------- --------------------
Plan assets, end of year................................................ $ 84,068 $ 56,340
-------------------- --------------------
RECONCILIATION OF FUNDED STATUS
Funded status........................................................... $(325,743) $(213,191)
Unrecognized transition (asset) or obligation........................... 144,046 153,175
Unrecognized prior service cost......................................... 98,918
Unrecognized actuarial (gain) loss...................................... (61,530) (94,531)
-------------------- --------------------
Net amount recognized at end of year.................................... $(144,309) $(154,547)
==================== ====================
</TABLE>
The assumed health care cost trend rates used in measuring the postretirement
benefit obligation in 1998 are as follows:
Medical -- under 65................................................ 6.0%
Medical -- 65 and over............................................. 6.7%
The assumed health care rates gradually decline to 5.4% for both medical
categories by 2001. The accumulated postretirement benefit obligation was
determined using an assumed discount rate of 6.5% for 1998 and 7.25% for 1997.
A long-term annual rate of compensation increase ranging from 3.5% to 5.5% and
4.0% to 6.0% was assumed in 1998 and 1997, respectively. The assumed long-term
rate of return on plan assets was 10% in 1998 and 9.5% in 1997.
If the health care cost trend rate assumptions were increased by 1%, the
accumulated postretirement benefit obligation as of December 31, 1998 would be
increased by approximately 4.7%. The annual effect of the 1%
70
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
increase on the total of the service and interest costs would be an increase of
approximately 5.1%. If the healthcare cost trend rate assumptions were decreased
by 1%, the accumulated postretirement benefit obligation as of December 31, 1998
would be decreased by approximately 4.3%. The annual effect of the 1% decrease
on the total of the service and interest costs would be a decrease of 4.6%.
In 1998, the Company's board of directors approved an amendment, effective
January 1, 1999, which created an account balance based on credited service at
December 31, 1998. Under the new plan, each participant has an account, for
recordkeeping purposes only, to which a $750 credit is allocated annually. This
account balance vests after 5 years of service after age 50. At retirement the
account balance can be used to purchase medical benefits. It may not be taken
as cash.
The purpose of the plan change is to continue to provide uniform retiree
medical benefits across all employee groups, which are competitive both within
the utility industry as well as with other companies within the United States.
The Company will continue to reflect the costs of the retiree medical plan
according to the provisions of SFAS No. 106 as amended by SFAS No. 132. As a
result of the January 1, 1999 amendment, which is reflected in the December 31,
1998 disclosure, the Company's benefit obligation increased $99 million. The
plan amendment had no impact on 1998 expense.
The actuarial loss is due to changes in certain actuarial assumptions.
(e) Postemployment Benefits.
The Company records postemployment benefits based on SFAS No. 112, "Employer's
Accounting for Postemployment Benefits," which requires the recognition of a
liability for benefits provided to former or inactive employees, their
beneficiaries and covered dependents, after employment but before retirement
(primarily health care and life insurance benefits for participants in the long-
term disability plan). Net postemployment benefit costs were not material in
1998, 1997 and 1996.
(11) INCOME TAXES
The Company records income taxes under SFAS No. 109, "Accounting for Income
Taxes" (SFAS No. 109), which, among other things, (i) requires that the
liability method be used in computing deferred taxes on all temporary
differences between book and tax bases of assets other than nondeductible
goodwill; (ii) requires that deferred tax liabilities and assets be adjusted for
an enacted change in tax laws or rates; and (iii) prohibits net-of-tax
accounting and reporting. SFAS No. 109 requires that regulated enterprises
recognize such adjustments as regulatory assets or liabilities if it is probable
that such amounts will be recovered from or returned to customers in future
rates.
The Company's current and deferred components of income tax expense (benefit)
are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Current.............................................................. $ 439,322 $199,011 $150,658
Deferred............................................................. (469,754) 7,363 49,507
--------------- --------------- ---------------
Income taxes......................................................... $ (30,432) $206,374 $200,165
=============== =============== ===============
</TABLE>
71
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
The Company's effective income tax rates are lower than statutory corporate
rates for each year as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Income (loss) before income taxes...................................... $(171,524) $627,484 $605,109
Preferred dividends of subsidiary...................................... 2,255 22,563
--------------- --------------- ---------------
Total................................................................ (171,524) 629,739 627,672
Statutory rate......................................................... 35% 35% 35%
--------------- --------------- ---------------
Income taxes at statutory rate......................................... (60,033) 220,409 219,685
--------------- --------------- ---------------
Net addition (reduction) in taxes resulting from:
State income taxes, net of federal income tax benefit................. 16,853 (9)
Amortization of investment tax credit................................. (20,123) (19,777) (18,404)
Excess deferred taxes................................................. (4,011) (5,570) (4,331)
Difference between book and tax depreciation for which deferred taxes 37,069 27,466 22,638
have not been normalized.............................................
Equity dividend exclusion............................................. (980) (5,075) (10,194)
Equity income - foreign affiliates.................................... (23,241) (17,011) (5,936)
Goodwill.............................................................. 18,049 7,242
Other - net........................................................... 5,985 (1,301) (3,293)
--------------- --------------- ---------------
Total................................................................ 29,601 (14,035) (19,520)
--------------- --------------- ---------------
Income taxes........................................................... $ (30,432) $206,374 $200,165
=============== =============== ===============
Effective rate......................................................... 17.7% 32.8% 31.9%
</TABLE>
72
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
Following are the Company's tax effects of temporary differences attributable
to continuing operations resulting in deferred tax assets and liabilities:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------
1998 1997
------------------ ----------------
(THOUSANDS OF DOLLARS)
<S> <C> <C>
Deferred Tax Assets:
Alternative minimum tax credit carryforwards................................... $ 39,893 $ 60,669
Employee benefits.............................................................. 154,746 145,794
Disallowed plant cost - net.................................................... 56,219 22,378
ACES........................................................................... 454,165 42,491
State operating loss carryforwards............................................. 23,178 29,515
Deferred state income taxes.................................................... 14,455 14,460
Other.......................................................................... 92,659 69,235
Valuation allowance............................................................ (8,591) (6,353)
Total deferred tax assets - net............................................. $ 826,724 378,189
------------------ ----------------
Deferred Tax Liabilities:
Depreciation................................................................... $2,106,860 $2,115,717
Deferred plant costs - net..................................................... 147,278 186,472
Regulatory tax asset - net..................................................... 418,339 356,509
Capitalized taxes, employee benefits and removal costs......................... 60,099 46,584
Gain on sale of cable television subsidiary.................................... 222,942 222,942
Deferred state income taxes.................................................... 70,000 70,000
Deferred gas costs............................................................. 13,663 34,113
Loss on reacquired debt........................................................ 44,077 39,503
Other.......................................................................... 107,502 99,130
------------------ ----------------
Total deferred tax liabilities.............................................. 3,190,760 3,170,970
------------------ ----------------
Accumulated deferred income taxes - net................................ $2,364,036 $2,792,781
================== ================
</TABLE>
Tax Refund Case. In July 1990, the Company paid approximately $104.5 million
to the Internal Revenue Service (IRS) following an IRS audit of Former Parent's
1983 and 1984 federal income tax returns. In November 1991, Former Parent filed
a refund suit in the U.S. Court of Federal Claims seeking the return of $52.1
million of tax and $36.3 million of accrued interest, plus interest on both of
those amounts accruing after July 1990. The major contested issue in the refund
case involved the IRS allegation that certain amounts related to the over-
recovery of fuel costs should have been included as taxable income in 1983 and
1984 even though the Company had an obligation to refund the over-recoveries to
its ratepayers.
In September 1997, the United States Court of Appeals upheld a lower court
ruling that the Company (as successor corporation to Former Parent) was due a
refund of federal income taxes assessed on fuel over-recoveries during 1983 and
1984 that subsequently were refunded to Electric Operations' customers.
In February 1998, the Company received a refund of approximately $142 million
in taxes and interest paid by Former Parent in July 1990, including interest
accrued since 1990 in the amount of approximately $57 million. After giving
effect to the Company's deferred recognition of the 1990 tax payment and payment
of federal income taxes due on the accrued interest on the refund, the refund
had the effect of increasing the Company's earnings in the fourth quarter of
1997 by $37 million (after-tax).
Tax Attribute Carryforwards. At December 31, 1998, Resources has approximately
$368 million of state net operating losses available to offset future state
taxable income through the year 2013. In addition, Resources has approximately
$33 million of federal alternative minimum tax credits which are available to
reduce future federal income taxes payable, if any, over an indefinite period
(although not below the tentative minimum tax otherwise due
73
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
in any year), and approximately $2.6 million of state alternative minimum tax
credits which are available to reduce future state income taxes payable, if any,
through the year 2001. The valuation allowance reflects a net increase of $2.3
million in 1998. This net increase results from a reassessment of Resources'
usage of state tax attributes, including the future ability to use state net
operating loss and alternative minimum tax credit carryforwards offset by
changes in valuation allowances provided for expiring state net operating loss
carryforwards.
(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
$210 million in 1999, $187 million in 2000 and $188 million in 2001.
Additionally, minimum payment obligations for lignite mining and lease
agreements are approximately $9 million for 1999, $10 million for 2000 and $10
million for 2001. Minimum payment obligations for both natural gas purchase and
storage contracts associated with Electric Operations are approximately $10
million in 1999, $9 million in 2000 and $9 million in 2001.
The Company also has commitments to purchase firm capacity from two
cogenerators totaling approximately $22 million in both 1999 and 2000. Texas
Utility Commission rules currently allow recovery of these costs through
Electric Operations' base rates for electric service and additionally authorize
the Company to charge or credit customers through a purchased power cost
recovery factor for any variation in actual purchased power costs from the cost
utilized to determine its base rates. In the event that the Texas Utility
Commission, at some future date, does not allow recovery through rates of any
amount of purchased power payments, these two firm capacity contracts contain
provisions allowing the Company to suspend or reduce payments and seek repayment
for amounts disallowed. Both of these firm capacity contracts have initial
terms ending March 31, 2005.
(c) Operations Agreement with City of San Antonio.
As part of the 1996 settlement of certain litigation claims asserted by the
City of San Antonio with respect to the South Texas Project, 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 and 1998, savings generated for CPS'
account for a full year of operation were approximately $22 million and $14
million, respectively.
74
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(d) Transportation Agreement.
Resources had an agreement (ANR Agreement) with ANR Pipeline Company (ANR)
which contemplated that Resources would transfer to ANR an interest in certain
of Resources' pipeline and related assets. The interest represented capacity of
250 Mmcf/day. Under the ANR Agreement, an ANR affiliate advanced $125 million
to Resources. Subsequently, the parties restructured the ANR Agreement and
Resources refunded in 1995 and 1993, respectively, $50 million and $34 million
to ANR or an affiliate. Resources recorded $41 million as a liability
reflecting ANR's or its affiliates' use of 130 Mmcf/day of capacity in certain
of Resources' transportation facilities. The level of transportation will
decline to 100 Mmcf/day in the year 2003 with a refund of $5 million to an ANR
affiliate. 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 the Company's
obligations under non-cancelable long-term operating leases:
Minimum Lease Commitments at December 31, 1998 (1)
(Millions of Dollars)
1999.................................................................. $ 20
2000.................................................................. 16
2001.................................................................. 15
2002.................................................................. 11
2003.................................................................. 10
2004 and beyond....................................................... 66
----
Total....................................................... $138
----
__________
(1) Principally consisting of rental agreements for building space and data
processing equipment and vehicles (including major work equipment).
Resources 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. Resources does not expect to lease additional property under
this lease agreement.
Total rental expense for all Resources' leases was approximately $25 million
in 1998. Total rental expense for all leases in 1997 since the Acquisition Date
was approximately $15 million.
(f) Letters of Credit.
At December 31, 1998, the Company and Resources had letters of credit
incidental with their ordinary business operations totaling approximately $34
million under which they are obligated to reimburse drawings, if any.
(g) Indemnity Provisions.
At December 31, 1998, Resources had a $5.8 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 Resources'
former subsidiaries or divisions, including the sale of (i) Louisiana Intrastate
Gas Corporation, a former Resources subsidiary engaged in the intrastate
pipeline and liquids extraction business; (ii) Arkla Exploration Company, a
former Resources subsidiary engaged in oil and gas exploration and production
activities; and (iii) Dyco Petroleum Company, a former Resources subsidiary
engaged in oil and gas exploration and production.
75
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(h) Environmental Matters
The Company is a defendant in litigation arising out of the environmental
remediation of a site in Corpus Christi, Texas. The litigation was instituted
in 1985 by adjacent landowners. The litigation is pending before the United
States District Court for the Southern District of Texas, Corpus Christi
Division. The site was operated by third parties as a metals reclaiming
operation. Although the Company neither operated nor owned the site, certain
transformers and other equipment originally sold by the Company may have been
delivered to the site by third parties. The Company and others have remediated
the site pursuant to a plan approved by appropriate state agencies and a federal
court. To date, the Company has recovered or has commitments to recover from
other responsible parties $2.2 million of the more than $3 million it has spent
on remediation.
In 1992, the United States Environmental Protection Agency (EPA) (i)
identified the Company, along with several other parties, as "potentially
responsible parties" (PRP) under the Comprehensive Environmental Response,
Compensation and Liability Act (CERCLA) for the costs of cleaning up a site
located adjacent to one of the Company's transmission lines in La Marque, Texas
and (ii) issued an administrative order for the remediation of the site. The
Company believes that the EPA took this action solely on the basis of
information indicating that the Company in the 1950s acquired record title to a
portion of the land on which the site is located. The Company does not believe
that it now or previously has held any ownership interest in the property
covered by the order and has obtained a judgement to that effect from a court in
Galveston County, Texas. Based on this judgement and other defenses that the
Company believes to be meritorious, the Company has elected not to adhere to the
EPA's administrative order, even though the Company understands that other PRPs
are proceeding with site remediation. To date, neither the EPA nor any other
PRP has instituted an action against the Company for any share of the
remediation costs for the site. However, if the Company was determined to be a
responsible party, the Company could be jointly and severally liable along with
the other PRPs for the aggregate remediation costs of the site (which the
Company currently estimates to be approximately $80 million in the aggregate)
and could be assessed substantial fines and damage claims. Although the
ultimate outcome of this matter cannot currently be predicted at this time, the
Company does not believe that this case will have a material adverse effect on
the Company's financial condition, liquidity or results of operations.
From time to time the Company and its subsidiaries have received notices from
regulatory authorities or others regarding their status as potential PRPs in
connection with sites found to require remediation due to the presence of
environmental contaminants. In addition, the Company has been named as
defendant in litigation related to such sites and in recent years has been
named, along with numerous others, as a defendant in several lawsuits filed by a
large number of individuals who claim injury due to exposure to asbestos while
working at sites along the Texas Gulf Coast. Most of these claimants have been
workers who participated in construction of various industrial facilities,
including power plants, and some of the claimants have worked at locations owned
by the Company. The Company anticipates that additional claims like those
received may be asserted in the future and intends to continue its practice of
vigorously contesting claims which it does not consider to have merit. Although
their ultimate outcome cannot be predicted at this time, the Company does not
believe, based on its experience to date, that these matters, either
individually or in the aggregate, will have a material adverse effect on the
Company's financial position, results of operation or cash flows.
(i) 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 Resources 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,
76
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
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 Resources' 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 Electric Operations on receipts from sales to other
utilities and on receipts from services as well as sales of electricity.
Plaintiffs advance their claims notwithstanding their failure to notice such
claims over the previous four decades. Because all of the franchise ordinances
affecting Electric Operations expressly impose fees only on receipts from sales
of electricity for consumption within a city, the Company regards plaintiffs'
allegations as spurious and is vigorously contesting the matter. The plaintiffs'
pleadings assert that their damages exceed $250 million. The District Court for
Harris County has granted a partial summary judgment in favor of the Company
dismissing all claims for franchise fees based on sales tax collections. Other
motions for partial summary judgement remain pending. 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.
(13) ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------------------------------
1998 1997
--------------------------------------- -----------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------------------- ---------------- --------------- ----------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C>
Financial Assets:
Company:
Investment in Time Warner securities.......... $ 990,000 $2,843,585 $ 990,000 $1,420,360
Resources:
Energy Derivatives - non-trading.............. -- -- 9,399 13,060
Financial Liabilities:
Company:
First mortgage bonds.......................... 2,036,284 2,177,434 2,495,459 2,651,260
Pollution control revenue bonds............... 581,385 582,069 123,000 123,000
Debentures.................................... 349,468 378,825 349,283 379,490
ACES.......................................... 2,349,997 2,436,949 1,173,786 1,307,247
Trust preferred and capital securities........ 341,075 366,182 340,882 366,220
Interest rate swaps........................... 109 3,160 65 1,679
Resources:
Long-term debt................................ 1,513,289 1,746,641 1,148,848 1,147,344
Trust preferred securities.................... 1,157 1,467 21,290 24,569
Energy Derivatives - non-trading.............. -- 8,166 -- --
Interest rate swaps........................... -- -- -- 755
</TABLE>
The fair values of cash and short-term investments, investment in the
Company's nuclear decommissioning trust, short-term and other notes payable and
floating rate debt of Reliant Energy International are estimated to be
equivalent to carrying amounts. The remaining fair values have been determined
using quoted market prices of the same or similar securities when available or
other estimation techniques.
77
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
The fair value of financial instruments included in the trading operations of
Reliant Energy Services are marked-to-market at December 31, 1998 (see Note 2).
Therefore, they are stated at fair value and are excluded from the table.
(14) UNAUDITED QUARTERLY INFORMATION
The following unaudited quarterly financial information includes, in the
opinion of management, all adjustments (which comprise only normal recurring
accruals) necessary for a fair presentation. Quarterly results are not
necessarily indicative of a full year's operations because of seasonality and
other factors, including rate increases and variations in operating expense
patterns. Results of operations of the Resources businesses, purchased in 1997,
are included beginning on the Acquisition Date.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-----------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------------- ---------------- ---------------- ----------------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues (1)........................................ $2,631,322 $2,736,626 $3,465,487 $2,655,029
Operating Income (1)................................ 282,892 455,809 512,955 225,732
Net Income (Loss) available for common stock (1).... (30,115) 41,484 251,709 (404,560)
Basic Earnings (Loss) per Common Share (2).......... (.11) .15 .89 (1.42)
Diluted Earnings (Loss) per Common Share (2) (.11) .15 .88 (1.42)
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
----------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------------- ---------------- ---------------- ----------------
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues............................................ $878,101 $1,064,448 $2,158,054 $2,777,622
Operating Income.................................... 156,216 247,172 462,716 198,396
Net Income (Loss) available for common stock........ 59,620 121,463 243,898 (4,033)
Basic Earnings (Loss) per Common Share (2).......... .26 .52 .93 (.01)
Diluted earnings (Loss) per Common Share (2)........ .26 .52 .92 (.01)
</TABLE>
__________
(1) Includes retroactive adjustment for change in accounting for energy price
risk management and trading activities of Reliant Energy Services to mark-
to-market accounting for the first, second and third quarters of 1998.
(See Note 1(r))
(2) Quarterly earnings per common share are based on the weighted average
number of shares outstanding during the quarter, and the sum of the
quarters may not equal annual earnings per common share.
(15) REPORTABLE SEGMENTS
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information" (SFAS No. 131). The
Company's determination of reportable segments considers the strategic operating
units under which the Company manages sales of various products and services to
wholesale or retail customers in differing regulatory environments. The
determination of reportable segments under SFAS No. 131 differs from that
required in prior years, therefore business segment information for 1997 and
1996 has been restated to comply with SFAS No. 131. Consistent with the
purchase accounting treatment for the Merger, financial information for
Resources is included in the segment disclosures only for periods beginning on
the Acquisition Date.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies except that certain executive benefit
costs have not been allocated to segments. The Company evaluates performance
based on operating income excluding certain corporate costs not allocated to the
segments. The Company accounts for intersegment sales as if the sales were to
third parties, that is, at current market prices.
78
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
In accordance with SFAS No. 131, the Company has identified the following
reportable segments: Electric Operations, Natural Gas Distribution, Interstate
Pipelines, Wholesale Energy and Marketing (Wholesale Energy), International and
Corporate. Electric Operations provides electric generation, transmission,
distribution and sales to customers. Natural Gas Distribution operations
consist of natural gas sales to, and natural gas transportation for,
residential, commercial and industrial customers. Interstate Pipelines conducts
interstate natural gas pipeline operations. Wholesale Energy is engaged in the
acquisition, development and operation of non-rate regulated power generation
[Afacilities as well as the wholesale energy trading and marketing and natural
gas gathering businesses. International participates in the development and
acquisition of foreign independent power projects and the privatization of
foreign generation and distribution facilities. Corporate includes the Company's
unregulated retail electric services business, certain real estate holdings of
the Company and corporate costs.
Financial data for business segments, products and services and geographic
areas are as follows:
<TABLE>
<CAPTION>
ELECTRIC NATURAL GAS INTERSTATE WHOLESALE INTER- CORPORATE RECONCILING CONSOLI-
OPERATIONS DISTRIBUTION PIPELINES ENERGY NATIONAL AND OTHER ELIMINATIONS DATED
---------- ------------- ---------- --------- --------- ----------- ------------ --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
As of and for the Year Ended
December 31, 1998:
- ----------------------------
Revenues from external customers.... $ 4,350,275 $1,811,509 $ 126,988 $ 4,289,006 $ 258,945 $ 651,741 $11,488,464
Intersegment revenues............... 1,167 155,508 167,152 97,181 $(421,008)
Depreciation and amortization....... 650,264 129,777 44,025 18,204 3,820 10,527 856,617
Operating income.................... 1,013,979 137,955 128,328 59,170 181,707 (43,751) 1,477,388
Total assets........................ 10,404,447 3,110,718 2,050,636 1,535,007 1,242,689 1,710,920 (915,895) 19,138,522
Equity investments in and advances
to unconsolidated subsidiaries..... 42,252 1,009,348 1,051,600
Expenditures for additions to
long-lived assets.................. 433,474 161,735 59,358 365,512 435,077 28,077 1,483,233
As of and for the Year Ended
December 31, 1997:
- -----------------------------
Revenues from external customers.... 4,251,243 892,064 49,655 1,288,357 92,028 304,878 6,878,225
Intersegment revenues............... 505 58,678 76,301 34,853 (170,337)
Depreciation and amortization....... 568,541 51,883 19,088 2,633 3,470 6,260 651,875
Operating income.................... 994,938 54,502 31,978 912 19,510 (37,340) 1,064,500
Total assets........................ 10,540,849 3,073,525 2,031,879 777,638 869,485 1,749,916 (597,686) 18,445,606
Equity investments in and advances
to unconsolidated subsidiaries..... 3,325 700,777 704,102
Expenditures for additions to
long-lived assets.................. 236,977 61,078 16,304 14,038 231,528 23,899 583,824
For the Year Ended
December 31, 1996:
- ---------------------
Revenues from external customers.... 4,025,027 62,059 8,191 4,095,277
Depreciation and amortization....... 545,685 1,648 2,705 550,038
Operating income.................... 997,147 2,339 (9,020) 990,466
Expenditures for additions to
long-lived assets.................. 317,532 495,379 19,989 832,900
</TABLE>
79
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
RECONCILIATION OF OPERATING INCOME TO NET INCOME (IN THOUSANDS):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
<S> <C> <C> <C>
Operating income.................................... $ 1,477,388 $1,064,500 $ 990,466
Interest income - IRS refund........................ 981 56,269
Dividend income..................................... 41,250 41,340 41,610
Interest expense.................................... (513,905) (397,957) (309,980)
Unrealized loss on ACES............................. (1,176,211) (121,402)
Litigation settlements.............................. (95,000)
Distribution on trust securities.................... (29,201) (26,230)
Preferred dividends of subsidiary................... (2,255) (22,563)
Income tax benefit (expense)........................ 30,432 (206,374) (200,165)
Other income (expense).............................. 27,784 13,057 576
----------- ---------- ---------
Net income (loss) available for Common Stock........ $ (141,482) $ 420,948 $ 404,944
=========== ========== =========
</TABLE>
REVENUES BY PRODUCTS AND SERVICES (IN THOUSANDS):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
<S> <C> <C> <C>
Retail power sales.................................. $ 4,359,857 $4,253,893 $4,025,027
Retail gas sales.................................... 2,362,504 1,153,968
Wholesale energy and energy related sales........... 4,248,181 1,271,400
Gas transport....................................... 167,812 66,265
Equity income from international investments........ 258,945 92,028 62,059
Energy products and services........................ 91,165 40,671 8,191
----------- ---------- ----------
Total............................................... $11,488,464 $6,878,225 $4,095,277
=========== ========== ===========
</TABLE>
REVENUES AND LONG-LIVED ASSETS BY GEOGRAPHIC AREAS (IN THOUSANDS):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
<S> <C> <C> <C>
Revenues:
US.................................................. $11,229,519 $6,786,197 $4,033,218
International....................................... 258,945 92,028 62,059
----------- ---------- ----------
Total............................................... $11,488,464 $6,878,225 $4,095,277
=========== ========== ==========
Long-lived assets:
US.................................................. $14,865,161 $14,691,820
International....................................... 1,195,849 837,536
----------- -----------
Total............................................... $16,061,010 $15,529,356
=========== ===========
</TABLE>
(16) SUBSEQUENT EVENTS
(a) Foreign Currency Devaluation.
In January 1999, the Brazilian real was devalued and allowed to float against
other major currencies. The Company expects to take a charge against first
quarter earnings as a result of the Brazilian devaluation. The charge will
reflect the Company's proportionate share of the foreign currency transaction
loss impact of the devaluation on
80
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
foreign denominated debt of Brazilian corporations in which the Company holds an
equity interest. The amount of the charge will not be known until the end of the
first quarter.
At December 31, 1998, one U.S. dollar could be exchanged for 1.21 Brazilian
reais. Using the exchange rate of 2.06 reais/dollar in effect at the end of
February, and the average exchange rate in effect since the end of the year, the
Company estimates that its share of the after-tax charge that would be recorded
by the Brazilian companies in which it owns an interest would be approximately
$125 million.
(b) Trust Preferred Securities.
In February 1999, a Delaware statutory business trust (REI Trust I)
established by the Company issued $375 million of preferred securities. The
preferred securities have a distribution rate of 7.20% payable quarterly in
arrears, a stated liquidation amount of $25 per preferred security and must be
redeemed by March 2048. REI Trust I sold the preferred securities to the public
and used the proceeds to purchase $375 million aggregate principal amount of
subordinated debentures (REI Debentures) from the Company having an interest
rate corresponding to the distribution rate of the preferred securities and a
maturity date corresponding to the mandatory redemption date of the preferred
securities. Proceeds from the sale of the REI Debentures were used by the
Company for general corporate purposes, including the repayment of short-term
debt. REI Trust I is accounted for as a wholly owned consolidated subsidiary of
the Company. The REI Debentures are the REI Trust I's sole asset and its entire
operations. The Company has fully and unconditionally guaranteed, on a
subordinated basis, REI Trust I's obligations, including the payment of
distributions and all other payments due with respect to the preferred
securities. The preferred securities are mandatorily redeemable upon the
repayment of the REI Debentures at their stated maturity or earlier redemption.
Subject to certain limitations, the Company has the option of deferring payments
of interest on the REI Debentures held by REI Trust I. If and for as long as
interest payments on the REI Debentures have been deferred, or an event of
default under the indenture relating thereto has occurred and is continuing, the
Company may not pay dividends on its capital stock.
(c) Investment in Dutch Generating Company.
On March 10, 1999, the Company and N.V. Energieproduktiebedrijf UNA, a Dutch
electric generating company (UNA), announced their intent to enter into a
strategic partnership in the Netherlands. The transaction would involve the
initial acquisition by a subsidiary of the Company of 40% of the capital stock
of UNA for cash and a commitment to purchase the remaining 60% of the shares of
UNA for cash by December 31, 2006.
UNA is based in Utrecht and owns 3,400 megawatts of electric generating
capacity. The capacity is primarily fueled by natural gas.
The purchase price for the initial 40% interest will be approximately NLG 1.6
billion (approximately $ U.S. 840 million at an exchange rate of NLG 1.88 per
U.S. dollar). Of this amount, the shareholders of UNA will receive a cash
payment of approximately NLG 675 million (approximately $ U.S. 360 million) in
exchange for shares representing 15% of the total capital stock of UNA. UNA
will receive (i) a cash payment of approximately NLG 21 million (approximately $
U.S. 11 million) and (ii) a five-year promissory note from a subsidiary of the
Company in the principal amount of approximately NLG 875 million (approximately
$ U.S. 465 million) for 25% of the total capital stock of the Company,
representing newly issued shares. The promissory note will bear interest at the
one-year EURIBOR rate, determined annually, and will be payable, subject to
certain conditions, on demand.
Under the proposed terms of the acquisition, the shareholders of UNA would
agree to sell (i) an additional 12% of the total capital stock to the Company no
later than December 31, 2002 and (ii) the remaining 48% of the capital stock of
UNA no later than December 31, 2006. The purchase price for the remaining 60%
of the capital stock of UNA is approximately NLG 2.7 billion (approximately $
U.S. 1.4 billion). The purchase obligations under the definitive agreements are
in Dutch guilders.
81
<PAGE>
HOUSTON INDUSTRIES INCORPORATED
d/b/a RELIANT ENERGY, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
The Company expects to record its initial investment in UNA under the equity
method of accounting. The acquisition of the initial 40% of the capital stock
of UNA is subject to various approvals. It is anticipated that the closing for
this 40% interest will occur in June 1999.
82
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Houston Industries Incorporated
d/b/a Reliant Energy, Incorporated:
We have audited the accompanying consolidated balance sheets and the
consolidated statements of capitalization of Houston Industries Incorporated
d/b/a Reliant Energy, Incorporated and its subsidiaries (the "Company") as of
December 31, 1998 and 1997, and the related statements of consolidated income,
consolidated retained earnings and comprehensive income, and consolidated cash
flows for each of the three years in the period ended December 31, 1998. Our
audits also included the Company's financial statement schedule listed in Item
14(a)(3). These financial statements and the financial statement schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and the financial statement schedule
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Reliant Energy, Incorporated and
its subsidiaries at December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Houston, Texas
February 25, 1999
83
<PAGE>
HOUSTON INDUSTRIES INCORPORATED d/b/a RELIANT ENERGY, INCORPORATED
PROXY - COMMON STOCK
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned hereby appoints D. D. Jordan, R. Steve Letbetter and Lee W.
Hogan, and each of them as proxies, with full power of substitution, to vote as
designated on the reverse side, all shares of common stock held by the
undersigned at the annual meeting of shareholders of Houston Industries
Incorporated to be held May 5, 1999, at 9 AM (CDT) in the Auditorium of Reliant
Energy Plaza, 1111 Louisiana Street, Houston, Texas, or any adjournments
thereof, and with discretionary authority to vote on all other matters that may
properly come before the meeting.
IF YOU WISH TO VOTE IN ACCORDANCE WITH THE
RECOMMENDATIONS OF THE BOARD OF DIRECTORS, YOU MAY
JUST SIGN AND DATE BELOW AND MAIL IN THE POSTAGE-
PAID ENVELOPE PROVIDED. SPECIFIC CHOICES MAY BE
MADE ON THE REVERSE SIDE. IN THE ABSENCE OF
INSTRUCTIONS TO THE CONTRARY, THE SHARES
REPRESENTED WILL BE VOTED IN ACCORDANCE WITH THE
BOARD'S RECOMMENDATION.
Dated:_____________________________________, 1999
Signature:________________________________________
SIGNATURE:________________________________________
NOTE: PLEASE SIGN EXACTLY AS NAME(S) APPEARS
HEREON. JOINT OWNERS SHOULD EACH SIGN. WHEN
SIGNING AS ATTORNEY, EXECUTOR, ADMINISTRATOR,
TRUSTEE OR GUARDIAN, PLEASE GIVE FULL TITLE.
DO YOU PLAN TO ATTEND THE ANNUAL MEETING?________
DETACH AND MAIL CARD
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<PAGE>
HOUSTON INDUSTRIES INCORPORATED d/b/a RELIANT ENERGY, INCORPORATED
PROXY (CONTINUED)
1999 ANNUAL MEETING OF SHAREHOLDERS
The nominees for Class III directors are James A. Baker, III, Richard E.
Balzhiser, O. Holcombe Crosswell, Joseph M. Grant and Don D. Jordan. Their
terms will expire in 2002. Your Board of Directors recommends that you vote FOR
all nominees for director, FOR the amendment to the Company's Restated Articles
of Incorporation to change the corporate name and FOR the appointment of
Deloitte & Touche LLP as independent accountants and auditors for 1999. To
withhold authority to vote for any individual nominee, please write that
nominee's name in the space provided below.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C>
WITH- FOR ALL FOR AGAINST ABSTAIN
FOR HOLD EXCEPT
2. Amendment of Restated Articles [ ] [ ] [ ]
1. Election of nominees [ ] [ ] [ ] of Incorporation to change the
for director in corporate name
Class III
3. Appoint Deloitte & Touche LLP [ ] [ ] [ ]
as independent accountants
Exceptions:___________________________________ and auditors for 1999
____________________________________________
____________________________________________
</TABLE>
DETACH AND MAIL CARD
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