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EXHIBIT 99.a
RELIANT ENERGY RESOURCES CORP.
Items Incorporated by Reference
ITEMS INCORPORATED BY REFERENCE FROM THE RELIANT ENERGY AND RESOURCES FORM 10-K:
o Item 3. LEGAL PROCEEDINGS
(b) Resources Corp.
For a description of certain legal and regulatory proceedings affecting
Resources, see Note 8(d) to Resources' Consolidated Financial Statements, which
note is incorporated herein by reference.
o Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF THE COMPANY -- CERTAIN FACTORS AFFECTING
FUTURE EARNINGS OF THE COMPANY
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) state and federal legislative or regulatory developments,
(ii) national or regional economic conditions, (iii) industrial, commercial and
residential growth in service territories of the Company, (iv) the timing and
extent of changes in commodity prices and interest rates, (v) weather variations
and other natural phenomena, (vi) growth in opportunities for the Company's
diversified operations, (vii) the results of financing efforts, (viii) the
ability to consummate and timing of consummation of pending acquisitions and
dispositions, (ix) the speed, degree and effect of continued electric industry
restructuring in North America and Western Europe, and (x) risks incidental to
the Company's overseas operations, including the effects of fluctuations in
foreign currency exchange rates.
In order to adapt to the increasingly competitive environment, 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 businesses and new products, services and
customer strategies.
COMPETITION AND RESTRUCTURING OF THE TEXAS 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.
Texas Electric Choice Plan. In June 1999, the Texas legislature adopted
legislation that substantially amends the regulatory structure governing
electric utilities in Texas in order to allow retail competition beginning with
respect to pilot projects for up to 5% of each utility's load in all customer
classes in June 2001 and for all other customers on January 1,2002. In
preparation for that competition, the Company expects to make significant
changes in the electric utility operations it conducts through Reliant Energy
HL&P. Under the Legislation, on January 1, 2002, most retail customers of
investor-owned electric utilities in Texas will be entitled to purchase their
electricity from any of a number of "retail electric providers" which will
have been certified by the Texas Utility Commission. Power generators will sell
electric energy to wholesale purchasers, including retail electric providers, at
unregulated rates beginning January 1, 2002. For further information regarding
the Legislation, see Note 3 to the Company's Consolidated Financial Statements.
Stranded Costs. Pursuant to the Legislation, Reliant Energy HL&P will be
entitled to recover its stranded costs (i.e., the excess of net book value of
generation assets, as defined by the Legislation, over the market value of those
assets) and its regulatory assets related to generation. The Legislation
prescribes specific methods for determining the amount of stranded costs and the
details for their recovery. However, during the base rate freeze period from
1999 through 2001, earnings above the utility's authorized return formula will
be applied in a manner to accelerate depreciation of generation related plant
assets for regulatory purposes. In addition, depreciation expense for
transmission and
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distribution related assets may be redirected to generation assets for
regulatory purposes during that period. The Legislation also provides for
Reliant Energy HL&P, or a special purpose entity, to issue securitization bonds
for the recovery of generation related regulatory assets and stranded costs. Any
stranded costs not recovered through the securitization bonds will be recovered
through a non-bypassable charge to transmission and distribution customers.
Accounting. At June 30, 1999, the Company performed an impairment test
of its previously regulated electric generation assets pursuant to SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of", on a plant specific basis. The Company determined that $797
million of electric generation assets were impaired as of June 30, 1999. Of such
amounts, $745 million relate to the South Texas Project and $52 million relate
to two gas-fired generation plants. The Legislation provides recovery of this
impairment through regulated cash flows during the transition period and
through non-bypassable charges to transmission and distribution customers. As
such, a regulatory asset has been recorded for an amount equal to the
impairment loss and is included on the Company's Consolidated Balance Sheets as
a regulatory asset.
The impairment analysis requires estimates of possible future market
prices, load growth, competition and many other factors over the lives of the
plants. The resulting impairment loss is highly dependent on these underlying
assumptions. In addition, after January 10,2004, Reliant Energy HL&P must
finalize and reconcile stranded costs (as defined by the Legislation) in a
filing with the Texas Utility Commission. Any difference between the fair market
value and the regulatory net book value of the generation assets (as defined by
the Legislation) will either be refunded or collected through future
transmission and distribution rates. This final reconciliation allows
alternative methods of third party valuation of the fair market value of these
assets, including outright sale, stock valuations and asset exchanges. Because
generally accepted accounting principles require the Company to estimate fair
market values on a plant-by-plant basis in advance of the final reconciliation,
the financial impacts of the Legislation with respect to stranded costs are
subject to material changes. Factors affecting such change may include
estimation risk, uncertainty of future energy prices and the economic lives of
the plants. If events occur that make the recovery of all or a portion of the
regulatory assets associated with the generation plant impairment loss and
deferred debits created from discontinuance of SFAS No. 71, "Accounting for the
Effects of Certain Types of Regulation" pursuant to the Legislation no longer
probable, the Company will write off the corresponding balance of such assets as
a non-cash charge against earnings.
In the fourth quarter of 1999, Reliant Energy HL&P filed an application
to securitize its generation related regulatory assets as defined by the
Legislation. The Texas Utility Commission, Reliant Energy HL&P and other
interested parties have been discussing proposed methodologies for calculating
the amount of such assets to be securitized. The parties have reached an
agreement in principle as to the amount to be securitized, which reflects the
economic value of the nominal book amount which prior to the deregulation
legislation would have been collected through rates over a much longer time
period. The Company has determined that a pre-tax accounting loss of $282
million exists. Therefore, the Company recorded an after-tax extraordinary loss
of $183 million for this accounting impairment of these regulatory assets in
1999.
Transmission System Open Access. 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. 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.
Transition Plan. In June 1998, the Texas Utility Commission approved the
Transition Plan filed by Reliant Energy HL&P in December 1997. Certain parties
have appealed the order approving the Transition Plan. The provisions of the
Transition Plan expired by their own terms as of December 31, 1999. For
additional information, see Note 4 to the Company's Consolidated Financial
Statements.
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COMPETITION -- RELIANT ENERGY EUROPE OPERATIONS
The European energy market is highly competitive. In addition, over the
next several years, an increasing consolidation of the participants in the Dutch
generating market is expected to occur.
Reliant Energy Europe competes in the Netherlands primarily against the
three other largest Dutch generating companies, various cogenerators of electric
power, various alternate sources of power and non-Dutch generators of electric
power, primarily from Germany. At present, the Dutch electricity system has
three operational interconnection points with Germany and two interconnection
points with Belgium. There are also a number of projects that are at various
stages of development and that may increase the number of interconnections in
the future including interconnections with Norway and the United Kingdom. The
Belgian interconnections are used to import electricity from France but a larger
portion of Dutch imports comes from Germany. In 1998, net power imports into the
Netherlands were approximately 11.7 terawatt hours. Based on current
information, it is estimated that net power imports into the Netherlands in 1999
increased significantly from 1998.
In 1999, UNA and the three other largest Dutch generators supplied
approximately 60% of the electricity consumed in the Netherlands. Smaller Dutch
producers supplied about 28% and the remainder was imported. The Dutch
electricity market is expected to be gradually opened for wholesale competition
including certain commercial and industrial customers beginning in 2001.
Competition is expected to increase in subsequent years and it is anticipated
that the market for small businesses and residential customers will become open
to competition by 2007. The timing of the opening of these markets is subject,
however, to change at the discretion of the Minister of Economic Affairs.
The trading and marketing operations of Reliant Energy Europe will also be
subject to increasing levels of competition. As of March 1,2000, there were
approximately 25 trading and marketing companies registered with the Amsterdam
Power Exchange. Competition for marketing customers is intense and is expected
to increase with the deregulation of the market. The primary elements of
competition in both the generation and trading and marketing side of Reliant
Energy Europe's business operations are price, credit-support and supply and
delivery reliability.
COMPETITION -- OTHER OPERATIONS
Wholesale Energy By the third quarter of 2000, Reliant Energy expects that
the Company will own and operate over 8,000 MW of non-rate regulated electric
generation assets that serve the wholesale energy markets located in the states
of California and Florida, and the Southwest, Midwest and Mid-Atlantic regions
of the United States. Competitive factors affecting the results of operations of
these generation assets include: new market entrants, construction by others of
more efficient generation assets, the actions of regulatory authorities and
weather.
Other competitors operate power generation projects in most of the regions
where the Company has invested in non-rate regulated generation assets. Although
local permitting and siting issues often reduce the risk of a rapid growth in
supply of generation capacity in any particular region, over time, projects are
likely to be built which will increase competition and lower the value of some
of the Company's non-rate regulated electric generation assets.
The regulatory environment of the wholesale energy markets in which the
Company invests may adversely affect the competitive conditions of those
markets. In several regions, notably California and in the PJM Power Pool Region
(in the Mid-Atlantic region of the United States), the independent system
operators have chosen to rely on price caps and market redesigns as a way of
minimizing market volatility.
The results of operations of the Company's non-rate regulated generation
assets are also affected by the weather conditions in the relevant wholesale
energy markets. Extreme seasonal weather conditions typically increase the
demand for wholesale energy. Conversely, mild weather conditions typically have
the opposite effect. In some regions, especially California, weather conditions
associated with hydroelectric generation resources such as rainfall and snowpack
can significantly influence market prices for electric power by increasing or
decreasing the availability and timing of hydro-based generation which is
imported into the California market.
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Competition for acquisition of international and domestic non-rate
regulated power projects is intense. The Company competes 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 larger
portfolios of projects. Competitive factors relevant to the non-utility power
industry include financial resources, access to non-recourse funding and
regulatory factors.
Reliant Energy Services competes for sales in its natural gas, electric
power and other energy derivatives trading and marketing business with other
energy 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, wholesale energy suppliers and transporters to seek financial
guarantees and other assurances that their energy contracts will be satisfied.
As pricing information becomes increasingly available in the energy trading and
marketing business and as deregulation in the electricity markets continues to
accelerate, the Company anticipates that Reliant Energy Services will experience
greater competition and downward pressure on per-unit profit margins in the
energy marketing industry.
Natural Gas Distribution. Natural Gas Distribution competes primarily
with alternate energy sources such as electricity and other fuel sources. 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.
Interstate Pipelines. The Interstate Pipelines 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
Pipelines 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
Pipelines and the level of competition for transport and storage services.
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" in Item 7A of this Report.
INDEXED DEBT SECURITIES (ACES AND ZENS) AND TIME WARNER INVESTMENT
For information on Reliant Energy's indexed debt securities and its
investment in TW Common, see "Quantitative and Qualitative Disclosures About
Market Risk" in Item 7A of this Report and Note 8 to the Company's Consolidated
Financial Statements.
IMPACT OF THE YEAR 2000 ISSUE AND OTHER SYSTEM IMPLEMENTATION ISSUES
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. The evaluation of Year 2000 issues included those related to
significant customers, key vendors, service suppliers and other parties material
to the Company's operations.
Remediation and testing of all systems and equipment were completed
during 1999. The Company did not experience any Year 2000 problems that
significantly affected the operations of the Company. The Company will
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continue to monitor and assess potential future problems. Total direct costs of
resolving the Year 2000 issue with respect to the Company were $29 million.
The Company is in the process of implementing SAP America, Inc.'s (SAP)
proprietary R/3 enterprise software. Although the implementation of the SAP
system had 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, March 1999 and September 1999, and it is expected that the final portion
of the SAP system will be fully implemented by the fourth quarter of 2002. The
cost of implementing the SAP system is currently estimated to be approximately
$237 million, inclusive of internal costs. As of December 31, 1999, $192 million
has been spent on the implementation.
ENTRY INTO THE EUROPEAN MARKET
Reliant Energy Europe owns, operates and sells power from generation
facilities in the Netherlands and plans to participate in the emerging wholesale
energy trading and marketing industry in the Netherlands and other countries in
Europe. Reliant Energy expects that the Dutch electric industry will undergo
change in response to market deregulation in 2001. These expected changes
include the anticipated expiration of certain transition agreements which have
governed the basic tariff rates that UNA and other generators have charged their
customers. Based on current forecasts and other assumptions, the revenues of
UNA could decline significantly from 1999 revenues after 2000.
One of the factors that could have a significant impact on the Dutch energy
industry, including the operations of UNA, is the ultimate resolution of
stranded cost issues in the Netherlands. The Dutch government is currently
seeking to establish a transitional regime in order to solve the problem of
stranded costs, which relate primarily to investments and contracts entered into
by SEP and certain licensed generators prior to the liberalization of the
market. SEP is owned in equal shares by each of the four large Dutch generating
companies, including UNA.
In connection with the acquisition of UNA, the selling shareholders of UNA
agreed to indemnify UNA for certain stranded costs in an amount not to exceed
NLG 1.4 billion (approximately $639 million based on an exchange rate of 2.19
NLG per U.S. dollar as of December 31, 1999), which may be increased in certain
circumstances at the option of the Company up to NLG 1.9 billion (approximately
$868 million). Of the total consideration paid by the Company for the shares of
UNA, NLG 900 million (approximately $411 million) has been placed by the
selling shareholders in an escrow account to secure the indemnity obligations.
Although Reliant Energy believes that the indemnity provision will be sufficient
to cover UNA's ultimate share of any stranded cost obligation, this belief is
based on numerous assumptions regarding the ultimate outcome and timing of the
resolution of the stranded cost issue, the existing shareholders timely
performance of their obligations under the indemnity arrangement, and the amount
of stranded costs which at present is not determinable.
The Dutch government is expected to propose a legislative initiative
regarding stranded costs to the Dutch cabinet in March 2000. The proposed
legislation will be sent to the Dutch council of state for review. It is not
anticipated that the legislation will be reviewed by parliament until late in
the summer of 2000.
For information about the Company's exposure through its investment in
Reliant Energy Europe to losses resulting from fluctuations in currency rates,
see "Quantitative and Qualitative Disclosures About Market Risk" in Item 7A of
this Form 10-K.
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RISK OF OPERATIONS IN EMERGING MARKETS
Reliant Energy Latin America's 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 Latin American 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 owns
11.78% of the stock of Light Servicos de Eletricidade S.A. (Light) and, through
its investment in Light, a 9.2% interest in the stock of Metropolitana
Electricidade de Sao Paulo S.A. (Metropolitana). As of December 31, 1999 and
1998, Light and Metropolitana had total borrowings of $2.9 billion and $3.2
billion, respectively, denominated in non-local currencies. During the first
quarter of 1999, the Brazilian real was devalued and allowed to float against
other major currencies. The effects of devaluation on the non-local currency
denominated borrowings caused the Company to record an after-tax charge for the
year ended December 31, 1999 of $102 million as a result of foreign currency
transaction losses recorded by both Light and Metropolitana in such periods. For
additional information regarding the effect of the devaluation of the Brazilian
real, see Note 7(a) in the Company's Consolidated Financial Statements.
Light's and Metropolitana's tariff adjustment mechanisms are not
directly indexed to the U.S. dollar or other non-local currencies. To partially
offset the devaluation of the Brazilian real, and the resulting increased
operating costs and inflation, Light and Metropolitana received tariff rate
increases of 16% and 21%, respectively, which were phased in during June and
July 1999. Light also received its annual rate adjustment in November 1999
resulting in a tariff rate increase of 11%. The Company is pursuing additional
tariff increases to mitigate the impact of the devaluation; however, there can
be no assurance that such adjustments will be timely or that they will permit
substantial recovery of the impact of the devaluation.
Certain of Reliant Energy Latin America's other foreign electric
distribution companies have incurred U.S. dollar and other non-local currency
indebtedness (approximately $600 million at December 31, 1999). 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" in Item 7A of this Form 10-K.
Impact of Foreign Currency Devaluation on Projected Capital Resources.
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. For a discussion of the Company's anticipated
capital contributions in 2000, see "-- Liquidity and Capital Resources -- Future
Sources and Uses of Cash Flows -- Reliant Energy Latin America Capital
Contributions and Advances." In 2000, $1.6 billion of debt obligations of Light
and Metropolitana will mature. The availability or terms of refinancing such
debt cannot be assured. Currency fluctuation and instability affecting Latin
America may also adversely affect the Company's ability to refinance its equity
investments with debt.
ENVIRONMENTAL EXPENDITURES
The Company is subject to numerous environmental laws and regulations,
which require it 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.
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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). NOx reduction costs
incurred by Electric Operations generating units in the Houston, Texas area
totaled approximately $7 million in 1999 and $7 million in 1998. The Texas
Natural Resources Conservation Commission (TNRCC) is currently considering
additional NOx reduction requirements for electric generating units and other
industrial sources located in the Houston metropolitan area and the eastern half
of Texas as a means to attain the Clean Air Act standard for ozone. Although the
magnitude and timing of these requirements will not be established by the TNRCC
until November, 2000, NOx reductions approaching 90% of the emissions level are
anticipated. Expenditures for NOx controls on Electric Operations' generating
units have been estimated at $500 million to $600 million during the period 2000
through 2003, with an estimated $80 million to be incurred during 2000. In
addition, the Legislation created a program mandating air emissions reductions
for certain generating facilities of Electric Operations. The Legislation
provides for stranded cost recovery for costs associated with this obligation
incurred before May 1, 2003. For further information regarding the Legislation,
see Note 3 to the Company's Consolidated Financial Statements.
Site Remediation Expenditures. From time to time the Company has received
notices from regulatory authorities or others regarding its status as a
potentially responsible party in connection with sites found to require
remediation due to the presence of environmental contaminants. Based on
currently available information, Reliant Energy believes that remediation costs
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 Reliant Energy's estimates. For
information about specific sites that are the subject of remediation claims,
see Note 14(h) to the Company's Consolidated Financial Statements and Note 8(d)
to Resources' Consolidated Financial Statements.
Mercury Contamination. Like other natural gas pipelines, the Company's
pipeline operations have in the past employed elemental mercury in meters used
on its pipelines. Although the mercury has now been removed from the meters, it
is possible that small amounts of mercury have been spilled at some of those
sites in the course of normal maintenance and replacement operations and that
such spills have contaminated the immediate area around the meters with
elemental mercury. Such contamination has been found by Resources at some sites
in the past, and the Company has conducted remediation at sites found to be
contaminated. Although the Company 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 the Company and others in the natural
gas industry to date and on the current regulations regarding remediation of
such sites, the Company believes 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, see Notes 3, 4 and 14 to the Company's Consolidated
Financial Statements and Note 8 to Resources' Consolidated Financial Statements.
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