UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
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COMMISSION FILE NUMBER 1-31449
TEXAS GENCO HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 76-0695920
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1111 LOUISIANA
HOUSTON, TEXAS 77002
(Address of principal executive offices) (Zip Code)
(713) 207-1111
(Registrant's telephone number, including area code)
--------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of November 3, 2003, Texas Genco Holdings, Inc. (Texas Genco) had 80,000,000
shares of common stock outstanding, including 64,764,240 shares which were held
by Utility Holding, LLC, a wholly owned subsidiary of CenterPoint Energy, Inc.
TEXAS GENCO HOLDINGS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements. ............................................................... 1
Statements of Consolidated Operations
Three Months and Nine Months Ended September 30, 2002 and 2003 (unaudited) ........... 1
Consolidated Balance Sheets
December 31, 2002 and September 30, 2003 (unaudited) ................................. 2
Statements of Consolidated Cash Flows
Nine Months Ended September 30, 2002 and 2003 (unaudited) ............................ 3
Notes to Unaudited Consolidated Interim Financial Statements ............................ 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations .......................................................................... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk .......................... 20
Item 4. Controls and Procedures ............................................................. 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ................................................................... 22
Item 5. Other Information ................................................................... 22
Item 6. Exhibits and Reports on Form 8-K .................................................... 30
i
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
From time to time we make statements concerning our expectations, beliefs,
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are not historical facts. These
statements are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
from those expressed or implied by these statements. You can generally identify
our forward-looking statements by the words "anticipate," "believe," "continue,"
"could," "estimate," "expect," "forecast," "goal," "intend," "may," "objective,"
"plan," "potential," "predict," "projection," "should," "will," or other similar
words.
We have based our forward-looking statements on our management's beliefs and
assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, we cannot assure you that actual results will
not differ materially from those expressed or implied by our forward-looking
statements.
Some of the factors that could cause actual results to differ from those
expressed or implied by our forward-looking statements are described under "Risk
Factors" in Item 5 of Part II of this report.
You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement.
ii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TEXAS GENCO HOLDINGS, INC.
STATEMENTS OF CONSOLIDATED OPERATIONS
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2002 2003 2002 2003
----------- ----------- ----------- -----------
REVENUES:
Energy revenues ..................................... $ 346,855 $ 404,553 $ 893,664 $ 1,006,719
Capacity and other revenues ......................... 179,533 252,810 372,019 587,742
----------- ----------- ----------- -----------
Total .......................................... 526,388 657,363 1,265,683 1,594,461
----------- ----------- ----------- -----------
EXPENSES:
Fuel costs .......................................... 337,581 365,913 813,805 923,220
Purchased power ..................................... 34,593 20,259 87,217 55,227
Operation and maintenance ........................... 98,604 100,783 272,219 311,434
Depreciation and amortization ....................... 38,836 40,778 117,768 119,248
Taxes other than income taxes ....................... 10,062 5,084 48,840 27,858
----------- ----------- ----------- -----------
Total .......................................... 519,676 532,817 1,339,849 1,436,987
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) ............................... 6,712 124,546 (74,166) 157,474
OTHER INCOME .......................................... 434 919 3,338 2,208
INTEREST EXPENSE ...................................... (8,331) (1,298) (24,282) (6,923)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE ......................... (1,185) 124,167 (95,110) 152,759
INCOME TAX BENEFIT (EXPENSE) .......................... 4,483 (41,761) 45,422 (47,942)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE ................................... 3,298 82,406 (49,688) 104,817
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX .... -- -- -- 98,910
----------- ----------- ----------- -----------
NET INCOME (LOSS) ..................................... $ 3,298 $ 82,406 $ (49,688) $ 203,727
=========== =========== =========== ===========
BASIC AND DILUTED EARNINGS PER SHARE:
Income (Loss) Before Cumulative Effect of
Accounting Change ................................ $ 0.04 $ 1.03 $ (0.62) $ 1.31
Cumulative Effect of Accounting Change, net
of tax ........................................... -- -- -- 1.24
----------- ----------- ----------- -----------
Net Income (Loss) ................................... $ 0.04 $ 1.03 $ (0.62) $ 2.55
=========== =========== =========== ===========
See Notes to the Company's Unaudited Consolidated Interim Financial Statements
1
TEXAS GENCO HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
DECEMBER 31, SEPTEMBER 30,
2002 2003
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ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................................... $ 578 $ 385
Customer accounts receivable ............................................ 68,604 108,137
Accounts receivable, other .............................................. 4,544 5,450
Materials and supplies .................................................. 92,869 92,034
Fuel stock and petroleum products ....................................... 63,298 80,268
Prepaid expenses ........................................................ 4,024 1,571
------------- -------------
Total current assets ............................................... 233,917 287,845
------------- -------------
PROPERTY, PLANT AND EQUIPMENT, NET ........................................ 3,980,770 4,128,010
------------- -------------
OTHER ASSETS:
Nuclear decommissioning trust ........................................... 162,576 179,213
Other ................................................................... 11,584 28,325
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Total other assets ................................................. 174,160 207,538
------------- -------------
TOTAL ASSETS .................................................... $ 4,388,847 $ 4,623,393
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable - affiliated companies, net ........................... $ 22,652 $ 5,111
Accounts payable, fuel .................................................. 76,399 94,087
Accounts payable, other ................................................. 43,877 55,107
Notes payable - affiliated companies, net ............................... 86,186 29,353
Taxes and interest accrued .............................................. 38,591 96,142
Deferred capacity auction revenue ....................................... 48,721 55,559
Other ................................................................... 15,918 16,582
------------- -------------
Total current liabilities .......................................... 332,344 351,941
------------- -------------
OTHER LIABILITIES:
Accumulated deferred income taxes, net .................................. 813,246 851,303
Unamortized investment tax credit ....................................... 170,569 161,460
Nuclear decommissioning reserve ......................................... 139,664 193,490
Benefit obligations ..................................................... 15,751 17,338
Accrued reclamation costs ............................................... 39,765 4,085
Notes payable - affiliated companies, net .............................. 18,995 18,571
Other ................................................................... 34,470 56,810
------------- -------------
Total other liabilities ............................................ 1,232,460 1,303,057
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COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 4)
SHAREHOLDERS' EQUITY:
Common stock (80,000,000 shares outstanding at December 31, 2002 and
September 30, 2003, respectively) ..................................... 1 1
Additional paid-in capital .............................................. 2,878,502 2,879,127
Retained earnings (deficit) ............................................. (54,460) 89,267
------------- -------------
Total shareholders' equity ......................................... 2,824,043 2,968,395
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ...................... $ 4,388,847 $ 4,623,393
============= =============
See Notes to the Company's Unaudited Consolidated Interim Financial Statements
2
TEXAS GENCO HOLDINGS, INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2002 2003
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .............................................. $ (49,688) $ 203,727
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization ............................... 117,768 119,248
Fuel-related amortization ................................... 20,269 15,920
Deferred income taxes ....................................... (25,077) (15,202)
Investment tax credit ....................................... (9,924) (9,109)
Cumulative effect of accounting change ...................... -- (98,910)
Changes in other assets and liabilities:
Accounts receivable ....................................... (94,592) (40,439)
Inventory ................................................. 32,094 (16,135)
Accounts payable .......................................... (50,534) 28,918
Accounts payable, affiliate ............................... (13,555) (17,543)
Taxes and interest accrued ................................ (63,418) 57,551
Accrued reclamation costs ................................. 5,896 3,992
Benefit obligations ....................................... (19,962) 1,587
Deferred revenue from capacity auctions ................... 23,291 6,838
Other current assets ...................................... (2,164) 2,453
Other current liabilities ................................. 3,814 664
Other long-term assets .................................... 25,765 (1,839)
Other long-term liabilities ............................... 477 (7,478)
------------- -------------
Net cash provided by (used in) operating activities .... (99,540) 234,243
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ........................................... (199,079) (117,181)
------------- -------------
Net cash used in investing activities .................. (199,079) (117,181)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of common stock dividends .............................. -- (60,000)
Net change in capitalization activity .......................... 225,280 --
Increase (decrease) in short-term notes payable, affiliate ..... 74,288 (56,831)
Decrease in long-term notes payable, affiliate ................. -- (424)
------------- -------------
Net cash provided by (used in) financing activities .... 299,568 (117,255)
------------- -------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ............. 949 (193)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ................. -- 578
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ....................... $ 949 $ 385
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest ....................................................... $ 2,314 $ 7,705
Income taxes ................................................... -- --
See Notes to the Company's Unaudited Consolidated Interim Financial Statements
3
TEXAS GENCO HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
General. Included in this Quarterly Report on Form 10-Q of Texas Genco
Holdings, Inc. (Texas Genco or the Company) are the Company's consolidated
interim financial statements and notes (Interim Financial Statements), which
include its wholly owned subsidiaries. The Interim Financial Statements are
unaudited, omit certain financial statement disclosures and should be read with
the Company's Annual Report on Form 10-K for the year ended December 31, 2002
and the Quarterly Reports on Form 10-Q of Texas Genco for the quarters ended
March 31, 2003 and June 30, 2003.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America (GAAP) 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.
The Company's Interim Financial Statements reflect all normal recurring
adjustments that are, in the opinion of management, necessary to present fairly
the financial position and results of operations for the respective periods.
Amounts reported in the Company's Statements of Consolidated Operations are not
necessarily indicative of amounts expected for a full year period due to the
effects of, among other things, (a) seasonal variations in energy consumption,
(b) timing of maintenance and other expenditures and (c) acquisitions and
dispositions of assets and other interests.
Background. In June 1999, the Texas legislature enacted an electric
restructuring law that substantially amended the regulatory structure governing
electric utilities in Texas in order to encourage retail electric competition.
Reliant Energy, Incorporated (Reliant Energy) submitted a restructuring proposal
to the Public Utility Commission of Texas (Texas Utility Commission) in response
to the law. Texas Genco was formed in August 2001 to hold the portfolio of
generating facilities previously owned by the unincorporated electric utility
division of Reliant Energy.
In August 2002, Reliant Energy conveyed all of its electric generating
facilities to the Company, which was accounted for as a business combination of
entities under common control. The Company subsequently became an indirect
wholly owned subsidiary of CenterPoint Energy, Inc. (CenterPoint Energy). As
used herein, CenterPoint Energy also refers to the former Reliant Energy for
dates prior to the restructuring.
CenterPoint Energy is a registered public utility holding company under the
Public Utility Holding Company Act of 1935, as amended (1935 Act). The 1935 Act
and related rules and regulations impose a number of restrictions on the
activities of CenterPoint Energy and its subsidiaries. On October 23, 2003, the
Federal Energy Regulatory Commission granted exempt wholesale generator (EWG)
status to Texas Genco. Upon receipt of EWG status, Texas Genco became exempt
from the 1935 Act. Therefore, Securities and Exchange Commission (SEC) approval
is not required for Texas Genco to issue securities or provide goods or services
to CenterPoint Energy's utility subsidiaries or third parties. SEC approval will
be required, however, for CenterPoint Energy and its affiliates to continue to
provide goods and services to Texas Genco after December 31, 2003. Except in an
emergency situation (in which CenterPoint Energy could provide funding pursuant
to applicable SEC rules), CenterPoint Energy would be required to obtain further
approval from the SEC to issue and sell securities for purposes of funding Texas
Genco's operations or for CenterPoint Energy to guarantee a security of Texas
Genco. Also, SEC policy precludes borrowing by Texas Genco from CenterPoint
Energy's utility subsidiaries.
Basis of Presentation. The consolidated financial statements include the
operations of Texas Genco and its subsidiaries, which manage and operate the
Company's electric generation operations. Beginning January 1, 2002, CenterPoint
Energy's generation business was segregated from CenterPoint Energy's electric
utility as a separate reporting business segment and began selling electricity
in the Texas deregulated electricity market (ERCOT market) at prices determined
by the market. Accordingly, the net income (loss) before the cumulative effect
of accounting change reflects the results of market-based prices for power.
Included in operations are allocations from CenterPoint Energy for corporate
services that included accounting, finance, investor relations, planning, legal,
communications, governmental and regulatory affairs and human resources, as well
as information technology
4
services and other services such as corporate security, facilities management,
accounts receivable, accounts payable and payroll, office support services and
purchasing and logistics. From January 1, 2002 through the Company's acquisition
of its generation facilities in August 31, 2002, various allocation
methodologies were employed to separate the results of operations and financial
condition of the generation-related portion of CenterPoint Energy's business
from CenterPoint Energy's historical financial statements. Interest expense was
calculated based on an allocation methodology that charged the Company with
financing and equity costs of CenterPoint Energy in proportion to the Company's
share of total net assets. Interest expense in 2002 through August 31, 2002 was
allocated based upon the remaining electric utility debt not specifically
identified with Reliant Energy's transmission and distribution utility upon
deregulation. Effective with the restructuring of Reliant Energy, no long-term
debt was assumed by the Company and interest is incurred on borrowings from
CenterPoint Energy. Management believes these allocation methodologies to be
reasonable. Had the Company actually existed as a separate company prior to
August 31, 2002, its results could have significantly differed from those
presented herein.
Texas Genco's Board of Directors declared an 80,000-for-one stock split that
was effected on December 18, 2002. On January 6, 2003, CenterPoint Energy
distributed approximately 19% of the 80 million outstanding shares of Texas
Genco's common stock to CenterPoint Energy's shareholders. Earnings per share
for 2002 has been presented as if the 80 million shares were outstanding in
accordance with Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share." The number of shares outstanding for purposes of computing
both basic and diluted earnings per share is 80 million for the three months and
nine months ended September 30, 2002 and 2003.
The Company declared and paid a dividend of $0.25 per share of common stock
in each of the first, second and third quarters of 2003.
The following notes to the consolidated annual financial statements in the
Texas Genco Form 10-K (Texas Genco Notes) relate to certain contingencies. These
notes, as updated herein, are incorporated herein by reference:
Texas Genco Notes: Note 2(f) (Long-Lived Assets and Intangibles), 2(h)
(Reclamation Costs) and Note 8 (Commitments and Contingencies).
For information regarding certain environmental matters and legal
proceedings, see Note 4.
(2) NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting for
Asset Retirement Obligations" (SFAS No. 143). SFAS No. 143 requires the fair
value of an asset retirement obligation to be recognized as a liability is
incurred and capitalized as part of the cost of the related tangible long-lived
assets. Over time, the liability is accreted to its present value each period,
and the capitalized cost is depreciated over the useful life of the related
asset. Retirement obligations associated with long-lived assets included within
the scope of SFAS No. 143 are those for which a legal obligation exists under
enacted laws, statutes and written or oral contracts, including obligations
arising under the doctrine of promissory estoppel.
The Company has identified retirement obligations for nuclear
decommissioning at the South Texas Project Electric Generating Station (South
Texas Project) and for lignite mine operations at the mine supplying the
Limestone electric generation facility. Prior to adoption of SFAS No. 143, the
Company had recorded liabilities for nuclear decommissioning and the reclamation
of the lignite mine. Liabilities were recorded for estimated decommissioning
obligations of $139.7 million and $39.7 million for reclamation of the lignite
at December 31, 2002. Upon adoption of SFAS No. 143 on January 1, 2003, the
Company reversed the $139.7 million previously accrued for the nuclear
decommissioning of the South Texas Project and recorded a plant asset of $99.1
million offset by accumulated depreciation of $35.8 million as well as a
retirement obligation of $186.7 million. The $16.3 million difference between
amounts previously recorded and the amounts recorded upon adoption of SFAS No.
143 is being deferred as a liability as the recovery of nuclear decommissioning
costs continues to be regulated by the Texas Utility Commission. Accordingly,
any difference between assets and liabilities associated with nuclear
decommissioning are recorded as a receivable or liability as such amount will be
funded by or returned to customers of CenterPoint Houston or its successor (see
Note 4(a)). The Company also reversed the $39.7 million it had previously
recorded for the mine reclamation and recorded a plant asset of $1.9 million
offset by accumulated depreciation of $0.4 million as well as a retirement
obligation of $3.8 million. The $37.4 million difference between
5
amounts previously recorded and the amounts recorded upon adoption of SFAS No.
143 was recorded as a cumulative effect of accounting change. The Company has
also identified other asset retirement obligations that cannot be estimated
because the assets associated with the retirement obligations have an
indeterminate life.
The following represents the balances of the asset retirement obligation as
of January 1, 2003 and the additions and accretion of the asset retirement
obligation for the nine months ended September 30, 2003:
BALANCE,
BALANCE, LIABILITIES LIABILITIES CASH FLOW SEPTEMBER 30,
JANUARY 1, 2003 INCURRED SETTLED ACCRETION REVISIONS 2003
--------------- ----------- ----------- --------- --------- -------------
(IN MILLIONS)
Nuclear decommissioning ... $ 186.7 -- -- $ 6.8 -- $ 193.5
Lignite mine .............. 3.8 -- -- 0.3 -- 4.1
--------------- ----------- ----------- --------- --------- -------------
$ 190.5 -- -- $ 7.1 -- $ 197.6
=============== =========== =========== ========= ========= =============
The following represents the pro-forma effect on the Company's net income
for the three months and nine months ended September 30, 2002, as if the Company
had adopted SFAS No. 143 as of January 1, 2002:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
------------------ ------------------
(IN THOUSANDS)
Net income (loss) as reported ...... $ 3,298 $ (49,688)
Pro-forma net income (loss) ........ 6,585 (46,023)
DILUTED EARNINGS PER SHARE:
Net income (loss) as reported ...... $ 0.04 $ (0.62)
Pro-forma net income (loss) ........ 0.08 (0.58)
The following represents the Company's asset retirement obligations on a
pro-forma basis as if it had adopted SFAS No. 143 as of December 31, 2002:
AS REPORTED PRO-FORMA
----------- -----------
(IN MILLIONS)
Nuclear decommissioning ..... $ 139.7 $ 186.7
Lignite mine ................ 39.7 3.8
----------- -----------
Total ..................... $ 179.4 $ 190.5
=========== ===========
The Company has previously recognized removal costs as a component of
depreciation expense. Upon adoption of SFAS No. 143, the Company reversed $115
million of previously recognized removal costs as a cumulative effect of
accounting change. The total cumulative effect recognized upon adoption of SFAS
No. 143 was $99 million after- tax ($152 million pre-tax).
In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" (SFAS No. 145). SFAS No. 145
eliminates the current requirement that gains and losses on debt extinguishment
must be classified as extraordinary items in the income statement. Instead, such
gains and losses will be classified as extraordinary items only if they are
deemed to be unusual and infrequent. SFAS No. 145 also requires that capital
leases that are modified so that the resulting lease agreement is classified as
an operating lease be accounted for as a sale-leaseback transaction. The changes
related to debt extinguishment are effective for fiscal years beginning after
May 15, 2002, and the changes related to lease accounting are effective for
transactions occurring after May 15, 2002. The Company has applied this guidance
as it relates to lease accounting and the accounting provisions related to debt
extinguishment. Upon adoption of SFAS No. 145, any gain or loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods is required to be reclassified. No such reclassification was required in
either the three months or nine months ended September 30, 2002.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies Emerging Issues Task Force (EITF) No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain
6
Costs Incurred in a Restructuring)" (EITF No. 94-3). The principal difference
between SFAS No. 146 and EITF No. 94-3 relates to the requirements for
recognition of a liability for costs associated with an exit or disposal
activity. SFAS No. 146 requires that a liability be recognized for a cost
associated with an exit or disposal activity when it is incurred. A liability is
incurred when a transaction or event occurs that leaves an entity little or no
discretion to avoid the future transfer or use of assets to settle the
liability. Under EITF No. 94-3, a liability for an exit cost was recognized at
the date of an entity's commitment to an exit plan. In addition, SFAS No. 146
also requires that a liability for a cost associated with an exit or disposal
activity be recognized at its fair value when it is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002. The Company adopted the provisions of SFAS No. 146 on January 1, 2003. The
adoption of SFAS No. 146 had no effect on the Company's consolidated financial
statements.
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. In addition, FIN 45 requires disclosures about the guarantees that
an entity has issued. The provision for initial recognition and measurement of
the liability will be applied on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions of FIN 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of FIN 45 did not materially affect the
Company's consolidated financial statements.
In January 2003, the FASB issued FIN No. 46 "Consolidation of Variable
Interest Entities, an Interpretation of Accounting Research Bulletin No. 51"
(FIN 46). FIN 46 requires certain variable interest entities to be consolidated
by the primary beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. On October 9, 2003, the FASB deferred the application of FIN
46 until the end of the first interim or annual period ending after December 15,
2003 for variable interest entities created before February 1, 2003. The FASB is
currently considering several amendments to FIN 46, and the Company will analyze
the impact, if any, these changes may have on its consolidated financial
statements upon ultimate implementation of FIN 46. The Company does not expect
the adoption of FIN 46 to have a material effect on its consolidated financial
statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" (SFAS No. 149). SFAS No. 149 has
added additional criteria which were effective on July 1, 2003 for new,
acquired, or newly modified forward contracts. The Company engages in forward
contracts for the sale of power. The majority of these forward contracts are
entered into either through state mandated Texas Utility Commission auctions or
auctions mandated by an agreement with Reliant Resources. All of the Company's
contracts resulting from these auctions specify the product types, the plant or
group of plants from which the auctioned products are derived, the delivery
location and specific delivery requirements, and pricing for each of the
products. The Company has applied the criteria from current accounting
literature, including SFAS No. 133 Implementation Issue No. C-15 - "Scope
Exceptions: Normal Purchases and Normal Sales Exception for Option-Type
Contracts and Forward Contracts in Electricity", to both the state mandated and
the contractually mandated auction contracts and believes they meet the
definition of capacity contracts. Accordingly, the Company considers these
contracts as normal sales contracts rather than as derivatives. The Company has
evaluated its forward commodity contracts under the new requirements of SFAS No.
149. The adoption of SFAS No. 149 did not change previous accounting conclusions
relating to forward power sales contracts entered into in connection with the
state mandated or contractually mandated auctions, and did not have a material
effect on the Company's consolidated financial statements.
(3) RELATED PARTY TRANSACTIONS AND MAJOR CUSTOMERS
As of December 31, 2002, the Company had $86 million in short-term
borrowings and $19 million in long-term borrowings from CenterPoint Energy and
its subsidiaries. As of September 30, 2003, the Company had $29 million in
short-term borrowings and $19 million in long-term borrowings from CenterPoint
Energy and its subsidiaries. Such borrowings are used for working capital
purposes. Interest expense associated with the borrowings for the three months
and nine months ended September 30, 2003 was $2 million and $10 million,
respectively. As of September 30, 2003, the weighted average interest rate on
such borrowings was 6.4%. In addition, for the three
7
months and nine months ended September 30, 2002, $6 million and $25 million of
interest expense was allocated to the Company related to the remaining electric
utility debt not specifically identified with CenterPoint Energy's transmission
and distribution utility upon deregulation.
The 1935 Act generally prohibits borrowings by CenterPoint Energy from its
subsidiaries, including the Company, either through the money pools or
otherwise.
From time to time, the Company has receivables from, or payables to,
CenterPoint Energy or its subsidiaries. As of December 31, 2002 and September
30, 2003, the Company had net accounts payable to affiliates of $23 million and
$5 million, respectively.
During the three months ended September 30, 2002 and 2003, the sales and
services by the Company to Reliant Resources and its subsidiaries totaled $362
million and $496 million, respectively. During the nine months ended September
30, 2002 and 2003, the sales and services by the Company to Reliant Resources
and its subsidiaries totaled $850 million and $1.2 billion, respectively. During
the three months ended September 30, 2002 and 2003 and the nine months ended
September 30, 2003, there were no sales and services by the Company to
CenterPoint Energy and its affiliates. During the nine months ended September
30, 2002, the sales and services by the Company to CenterPoint Energy and its
affiliates totaled $56 million.
During the three and nine months ended September 30, 2002, the sales and
services by the Company to a major customer other than Reliant Resources totaled
$92 million and $165 million, respectively. During the three and nine months
ended September 30, 2003, the sales and services by the Company to a major
customer other than Reliant Resources totaled $67 million and $160 million,
respectively.
During the three and nine months ended September 30, 2002, purchases of
power by the Company from Reliant Resources were $5 million and $29 million,
respectively. During the three months ended September 30, 2002 and 2003,
purchases of natural gas by the Company from CenterPoint Energy and its
affiliates were $7 million and $14 million, respectively. During the nine months
ended September 30, 2002 and 2003, purchases of natural gas by the Company from
CenterPoint Energy and its affiliates were $24 million and $23 million,
respectively.
CenterPoint Energy and certain of its subsidiaries provide some corporate
services to the Company. The costs of services have been directly charged to the
Company using methods that management believes are reasonable. These methods
include negotiated usage rates, dedicated asset assignment, and proportionate
corporate formulas based on assets, operating expenses and employees. These
charges are not necessarily indicative of what would have been incurred had the
Company not been an affiliate of CenterPoint Energy, and are included primarily
in operation and maintenance expenses. Amounts charged to the Company for these
services were $9 million and $7 million for the three months ended September 30,
2002 and 2003, respectively. Amounts charged to the Company for these services
were $35 million and $24 million for the nine months ended September 30, 2002
and 2003, respectively.
(4) COMMITMENTS AND CONTINGENCIES
(a) Environmental, Legal and Other.
Clean Air Standards. The Texas electric restructuring law and regulations
adopted by the Texas Commission on Environmental Quality in 2001 require
substantial reductions in emission of oxides of nitrogen (NOx) from electric
generating units. The Company is currently installing cost-effective controls at
its generating plants to comply with these requirements. Through September 30,
2003, the Company has invested $639 million for NOx emission control, and plans
to make expenditures of up to approximately $157 million for the remainder of
2003 through 2007. The Texas Utility Commission has determined that the
Company's emission control plan is the most cost-effective option for achieving
compliance with applicable air quality standards for the Company's generating
facilities.
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.
8
Under the Price Anderson Act, the maximum liability to the public of owners
of nuclear power plants was $10.5 billion as of September 30, 2003. Owners are
required under the Price Anderson Act to insure their liability for nuclear
incidents and protective evacuations. The Company and the other owners currently
maintain the required nuclear liability insurance and participate in the
industry retrospective rating plan under which the owners of the South Texas
Project are subject to maximum retrospective assessments in the aggregate per
incident of up to $100.6 million per reactor. The owners are jointly and
severally liable at a rate not to exceed $10 million per incident per year. In
addition, the security procedures at this facility have been enhanced to provide
additional protection against terrorist attacks.
There can be no assurance that all potential losses or liabilities
associated with the South Texas Project 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.
Nuclear Decommissioning. The Company contributed $2.9 million in 2002 to
trusts established to fund its share of the decommissioning costs for the South
Texas Project, and expects to contribute $2.9 million in 2003. There are various
investment restrictions imposed upon the Company by the Texas Utility Commission
and the United States Nuclear Regulatory Commission (NRC) relating to the
Company's nuclear decommissioning trusts. The Company and CenterPoint Energy
have each appointed two members to the Nuclear Decommissioning Trust Investment
Committee which establishes the investment policy of the trusts and oversees the
investment of the trusts' assets. The securities held by the trusts for
decommissioning costs had an estimated fair value of $179 million as of
September 30, 2003, of which approximately 39% were fixed-rate debt securities
and the remaining 61% were equity securities. In July 1999, an outside
consultant estimated the Company's portion of decommissioning costs to be
approximately $363 million. While the 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 and changes in regulatory requirements, technology and costs of
labor, materials and equipment. Pursuant to the Texas electric restructuring
law, costs associated with nuclear decommissioning that have not been recovered
as of January 1, 2002, will continue to be subject to cost-of-service rate
regulation and will be included in a charge to transmission and distribution
customers. CenterPoint Energy is contractually obligated to indemnify the
Company from and against any obligations relating to the decommissioning not
otherwise satisfied through collections by CenterPoint Houston.
Joint Operating Agreement with City of San Antonio. The Company has a joint
operating agreement with the City Public Service Board of San Antonio to share
savings from the joint dispatching of each party's generating assets.
Dispatching the two generating systems jointly results in savings of fuel and
related expenses due to a more efficient utilization of each party's lowest cost
resources. The two parties currently share equally the savings resulting from
joint dispatch. The agreement terminates in 2009.
Supplier Suits. The Company and CenterPoint Energy currently are engaged in
a dispute with Northwestern Resources Co. (NWR), the supplier of fuel to the
Limestone electric generation facility, over the terms and pricing at which NWR
supplies fuel to that facility under a 1999 settlement agreement between the
parties and under ancillary obligations. NWR has initiated a lawsuit in state
district court in Limestone County, Texas seeking a declaratory judgment stating
that the defendants have breached their obligations under the agreements by
modifying the generation facility to burn coal from the Powder River Basin and
by purchasing coal from the Powder River Basin without first giving NWR a right
of first refusal to supply lignite at a price that is equal to or less than the
coal from the Powder River Basin. The Company has asserted counterclaims against
NWR for unpaid production royalties and other fees owed by NWR under the terms
of various leases between the parties. The Company also seeks rulings that it
has not breached its obligations regarding the modification of its facilities
and the burning of Powder River Basin coal. The judge has ruled that price
issues must be arbitrated in accordance with the contract.
(b) Option to Purchase CenterPoint Energy's Interest in the Company.
Reliant Resources has an option (Reliant Resources Option) to purchase all
of the shares of common stock of the Company owned by CenterPoint Energy.
Reliant Resources has no obligation to exercise the option. The Reliant
Resources Option may be exercised between January 10, 2004 and January 24, 2004.
The per share exercise price under the Reliant Resources Option will equal the
average daily closing price on The New York Stock Exchange for
9
the 30 consecutive trading days with the highest average closing price for any
30 day trading period during the last 120 trading days ending January 9, 2004,
plus a control premium, up to a maximum of 10%, to the extent a control premium
is included in the valuation determination made by the Texas Utility Commission
relating to the market value of the Company. As of November 7, 2003, the highest
average consecutive 30-day closing price for Texas Genco stock was $26.50. The
per share exercise price is also subject to adjustment based on the difference
between the per share dividends paid to CenterPoint Energy during the period
from January 6, 2003 through the option closing date and the Company's actual
per share earnings during that period. Reliant Resources has agreed that if it
exercises the Reliant Resources Option and purchases the shares of the Company's
common stock, Reliant Resources will also purchase from CenterPoint Energy all
notes and other payables owed by the Company to CenterPoint Energy as of the
option closing date, at their principal amount plus accrued interest. Similarly,
if there are notes or payables owed to the Company by CenterPoint Energy as of
the option closing date, Reliant Resources will assume those obligations in
exchange for a payment from CenterPoint Energy of an amount equal to the
principal plus accrued interest.
In the event that Reliant Resources exercises the Reliant Resources Option
in 2004, the Company would be required to step-up or step-down the tax basis in
all of its assets following the date of the sale to be equivalent generally to
the value of the equity of the Company (based upon the purchase price) plus the
principal amount of the Company's indebtedness at the time of the purchase. The
resulting step-up or step-down in the basis of the Company's assets would impact
its future tax liabilities. A step-up would reduce the Company's future tax
liabilities, while a step-down would increase its liabilities. The Company
cannot currently project the impact of this tax election because it is dependent
on (1) Reliant Resources' exercise of its option in 2004, and (2) the purchase
price to be paid by Reliant Resources in 2004, which is not known at this time.
It is possible that Reliant Resources may decline to exercise its option.
CenterPoint Energy has engaged a financial advisor to assist it in exploring its
alternatives for monetizing its 81% ownership interest in the Company in the
event the Reliant Resources Option is not exercised, including possible sale of
its ownership interest in the Company or of the Company's individual generating
assets.
Exercise of the Reliant Resources Option by Reliant Resources will be
subject to various regulatory approvals, including Hart-Scott-Rodino antitrust
clearance, approval by the Federal Energy Regulatory Commission and United
States Nuclear Regulatory Commission (NRC) license transfer approval.
(5) SUBSEQUENT EVENT
On November 6, 2003, the Company's board of directors declared a quarterly
cash dividend of $0.25 per share of common stock payable on December 19, 2003 to
shareholders of record as of the close of business on November 26, 2003.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in combination with the
Company's Interim Financial Statements and notes contained in Item 1 of this
report.
OVERVIEW
We are one of the largest wholesale electric power generating companies in
the United States. As of September 30, 2003, the aggregate net generating
capacity of our portfolio of assets was 14,153 megawatts (MW), of which 2,990 MW
are currently mothballed. We sell electric generation capacity, energy and
ancillary services in the Electric Reliability Council of Texas (ERCOT) market,
which is the largest power market in the State of Texas and encompasses the
majority of the population centers in the State of Texas. ERCOT facilitates
reliable grid operations for approximately 85% of the demand for power in the
state.
OUR SEPARATION FROM CENTERPOINT ENERGY
Legislation enacted by the Texas legislature in 1999 (Texas electric
restructuring law) required the restructuring of electric utilities in Texas in
order to separate their power generation, transmission and distribution, and
retail electric provider businesses into separate units. In March 2001, the
Public Utility Commission of Texas (Texas Utility Commission) approved a
business separation plan for Reliant Energy, Incorporated (Reliant Energy)
involving the separation of Reliant Energy's generation, transmission and
distribution, and retail businesses into three separate companies. Effective
August 31, 2002, Reliant Energy consummated a restructuring transaction (the
Restructuring) in accordance with its business separation plan in which it,
among other things:
o conveyed all of its electric generating facilities to us;
o became a subsidiary of CenterPoint Energy, Inc. (CenterPoint Energy);
and
o converted into a limited liability company named CenterPoint Energy
Houston Electric, LLC (CenterPoint Houston).
Although our portfolio of generating facilities was formerly owned by the
unincorporated electric utility division of Reliant Energy, for convenience we
describe our business as if we had owned and operated our generation facilities
prior to the date they were conveyed to us. The book value of the net assets
conveyed to us by Reliant Energy on August 31, 2002 was approximately $2.8
billion.
CenterPoint Energy is a registered public utility holding company under the
Public Utility Holding Company Act of 1935, as amended (1935 Act). The 1935 Act
and related rules and regulations impose a number of restrictions on the
activities of CenterPoint Energy and its subsidiaries. On October 23, 2003, the
Federal Energy Regulatory Commission granted exempt wholesale generator (EWG)
status to us. Upon receipt of EWG status, we became exempt from the 1935 Act.
Therefore, Securities and Exchange Commission (SEC) approval is not required for
us to issue securities or provide goods or services to CenterPoint Energy's
utility subsidiaries or third parties. SEC approval will be required, however,
for CenterPoint Energy and its affiliates to continue to provide goods and
services to us after December 31, 2003. Except in an emergency situation (in
which CenterPoint Energy could provide funding pursuant to applicable SEC
rules), CenterPoint Energy would be required to obtain further approval from the
SEC to issue and sell securities for purposes of funding Texas Genco's
operations or for CenterPoint Energy to guarantee a security of Texas Genco.
Also, SEC policy precludes us from borrowing from CenterPoint Energy's utility
subsidiaries.
On January 6, 2003, CenterPoint Energy distributed approximately 19% of the
80 million outstanding shares of our common stock to CenterPoint Energy's
shareholders. As used herein, CenterPoint Energy also refers to the former
Reliant Energy for dates prior to the Restructuring.
Our energy costs consist primarily of fuel costs associated with consuming
nuclear fuel, gas, oil, lignite and coal to generate electricity, as well as our
power purchases from the wholesale marketplace. The recent deregulation of the
ERCOT market has impacted our energy costs in several ways. As a result of
requirements under the Texas electric restructuring law and the terms of our
agreements with CenterPoint Energy, we are obligated to sell through capacity
auctions substantially all of our available capacity and related ancillary
services through 2003. In these
11
auctions, we sell on a forward basis firm entitlements to capacity and ancillary
services dispatched within specified operational constraints. Although we have
reserved a portion of our aggregate net generation capacity from our capacity
auctions for planned or forced outages at our facilities, unanticipated plant
outages or other unforeseen problems with our generation facilities could result
in our firm capacity and ancillary services commitments exceeding our available
generation capacity. As a result, we could be required to obtain replacement
power from third parties in the open market to satisfy our firm commitments
which could involve the incurrence of significant additional costs. High
wholesale power prices for replacement power in the ERCOT market could increase
our energy costs and affect earnings and net cash flow. In addition, an
unexpected outage at one of our lower cost facilities could require us to run
one of our higher cost plants in order to satisfy our obligations.
In 2002, our capacity auctions were consummated at market-based prices that
resulted in returns substantially below the historical regulated return on our
facilities. However, we have seen significant improvement in auction prices for
our 2003 capacity entitlements. Since the pricing of generation products is
sensitive to natural gas prices, higher natural gas prices in the latter part of
2002 and in the first nine months of 2003 have positively influenced the prices
in our recent capacity auctions. Because we have a significant amount of
low-cost baseload solid fuel and nuclear generating units, higher natural gas
prices generally increase the margin of our baseload capacity entitlements since
prospective purchasers face higher-cost gas-fired generation alternatives. With
the higher market prices and our efforts to reduce our operating costs, we have
experienced improved profitability during the first nine months of 2003 compared
to the first nine months of 2002. However, we do not expect this improvement
will reach the levels of our historical regulated returns in the near future due
in part to the current surplus of generating capacity in the ERCOT market and
changes to the economic conditions affecting our industry that have occurred
since our baseload facilities were originally constructed, including the
development of high efficiency gas-fired generating units.
In the capacity auctions held during January through September 2003, gas
generation capacity primarily sold in our contractually mandated auctions. On
September 25, 2003, we announced that we will mothball gas-fired generation in
two phases totaling 2,990 MW. Our decision was based on our July and September
capacity auction results combined with high forecasted reserve margins in the
ERCOT market. Three units totaling 777 MW will be seasonally mothballed from
October of 2003 through April of 2004. They include Webster Unit 3 (374 MW),
which is currently in mothball status, T.H. Wharton Unit 2 (229 MW) and
Deepwater Unit 7 (174 MW). In addition, all four P.H. Robinson units totaling
2,211 MW will be mothballed from October 2003 through April 2005. This includes
Unit 3 (552 MW), which is currently in mothball status. We expect this action
will reduce our operating costs. On October 13, 2003, we presented a letter
requesting ERCOT to determine if any of the mothballed units were necessary for
reliability purposes. As of the date of this report, we have not yet received a
response.
High reserve margins are expected to continue in the ERCOT market. With an
increasingly competitive wholesale energy market, the composition and level of
our operation and maintenance expense is likely to change as we continually
evaluate the value of various units based on their fuel source, heat rate and
dispatch type.
We have completed substantially all of the capacity auctions for 2003
capacity we are required to conduct. As a result, we have contracted for
approximately $737 million of total capacity revenue for 2003, compared to total
capacity revenue of $423 million for 2002. We have also auctioned capacity
entitlements to approximately 70% of our available 2004 baseload capacity and
27% of our available 2005 baseload capacity. As a result, we have contracted for
approximately $706 million of total capacity revenue with respect to our 2004
capacity and $216 million of total capacity revenue with respect to our 2005
capacity. We expect to conduct auctions to sell additional capacity entitlements
with respect to our 2004 and 2005 capacity during the fourth quarter of 2003. We
have been unable to sell some of the 2003 capacity that we have offered in our
state mandated auctions. However, we believe that we have complied with the
requirements under the applicable state mandated auction rules, including
re-offering the unsold capacity in subsequent auctions.
12
RECENT DEVELOPMENTS
In July 2003, a steam line ruptured at our W.A. Parish coal facility
damaging one of the facility's units and temporarily taking another unit
offline. The unit was returned to service in September 2003. A three-week
planned maintenance outage originally scheduled for November 2003 was advanced
and conducted concurrent with the unplanned outage.
In October 2003, the Federal Energy Regulatory Commission (FERC) granted
exempt wholesale generator (EWG) status to Texas Genco, LP, our wholly owned
subsidiary that owns and operates our electric generating plants. As a result,
we are now exempt from the 1935 Act and do not require SEC approval to issue and
sell securities or provide goods or services to CenterPoint Energy's utility
subsidiaries or to third parties.
CONSOLIDATED RESULTS OF OPERATIONS
For information regarding factors that may affect the future results of
operations of our business, please read "Risk Factors" in Item 5 of Part II of
this report, which is incorporated herein by reference. The following table sets
forth our consolidated results of operations for the three months and nine
months ended September 30, 2002 and 2003, followed by a discussion of our
consolidated results of operations.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2002 2003 2002 2003
------------- ------------- ------------- -------------
REVENUES:
Energy revenues ....................................... $ 346,855 $ 404,553 $ 893,664 $ 1,006,719
Capacity and other revenues ........................... 179,533 252,810 372,019 587,742
------------- ------------- ------------- -------------
Total ............................................ 526,388 657,363 1,265,683 1,594,461
------------- ------------- ------------- -------------
EXPENSES:
Fuel costs ............................................ 337,581 365,913 813,805 923,220
Purchased power ....................................... 34,593 20,259 87,217 55,227
Operation and maintenance ............................. 98,604 100,783 272,219 311,434
Depreciation and amortization ......................... 38,836 40,778 117,768 119,248
Taxes other than income taxes ......................... 10,062 5,084 48,840 27,858
------------- ------------- ------------- -------------
Total ............................................ 519,676 532,817 1,339,849 1,436,987
------------- ------------- ------------- -------------
OPERATING INCOME (LOSS) ................................. 6,712 124,546 (74,166) 157,474
OTHER INCOME ............................................ 434 919 3,338 2,208
INTEREST EXPENSE ........................................ (8,331) (1,298) (24,282) (6,923)
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE ........................... (1,185) 124,167 (95,110) 152,759
INCOME TAX BENEFIT (EXPENSE) ............................ 4,483 (41,761) 45,422 (47,942)
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE ..................................... 3,298 82,406 (49,688) 104,817
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX ...... -- -- -- 98,910
------------- ------------- ------------- -------------
NET INCOME (LOSS) ....................................... $ 3,298 $ 82,406 $ (49,688) $ 203,727
============= ============= ============= =============
BASIC AND DILUTED EARNINGS PER SHARE:
Income (Loss) Before Cumulative Effect of
Accounting Change .................................. $ 0.04 $ 1.03 $ (0.62) $ 1.31
Cumulative Effect of Accounting Change, net of tax .... -- -- -- 1.24
------------- ------------- ------------- -------------
Net Income (Loss) ..................................... $ 0.04 $ 1.03 $ (0.62) $ 2.55
============= ============= ============= =============
Power Sales (in GWh) .................................... 15,476 14,534 41,923 36,327
============= ============= ============= =============
13
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2002
We reported net income of $82 million ($1.03 per diluted share) for the
three months ended September 30, 2003 compared to net income of $3 million
($0.04 per diluted share) for the three months ended September 30, 2002. The $79
million improvement was primarily attributable to increased margins from higher
capacity and energy revenues as a result of higher capacity auction prices
driven by higher natural gas prices, partially offset by increased fuel costs
due to higher natural gas prices and lower sales volumes. Due to the operating
flexibility of some of the gas units, we were able to partially mitigate the
higher cost of natural gas by switching from natural gas to fuel oil.
Operation and maintenance expense increased $2 million for the three months
ended September 30, 2003 as compared to the same period in 2002. Approximately
$5 million was associated with higher pension and employee benefits, $3 million
with scheduled plant outages and $4 million with repairs to South Texas Project
Unit 1 and W.A. Parish Unit 8, partially offset by $8 million associated with
the timing of technical support costs.
Taxes other than income taxes decreased $5 million for the three months
ended September 30, 2003 as compared to the same period in 2002. This decrease
was primarily attributable to a reduction in property taxes due to lower
property valuations.
Interest expense decreased $7 million, or 84%, for the three months ended
September 30, 2003 from the comparable 2002 period primarily as a result of $6
million in intercompany interest allocated in 2002 prior to the Restructuring
and related to the remaining electric utility debt not specifically identified
with CenterPoint Energy's transmission and distribution utility upon
deregulation.
The effective tax rate for the three months ended September 30, 2003 was
33.6%. The decrease in the effective rate for the three months ended September
30, 2003 compared to the three months ended September 30, 2002 was primarily the
result of pre-tax income in 2003 compared to a pre-tax loss in 2002, offset by
reduced benefits from state taxes and the amortization of investment tax
credits.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2002
We reported income before cumulative effect of accounting change of $105
million ($1.31 per diluted share) for the nine months ended September 30, 2003
compared to a loss of $50 million ($0.62 per diluted share) for the nine months
ended September 30, 2002. The $155 million improvement was primarily
attributable to increased margins from higher capacity and energy revenues as a
result of higher capacity auction prices driven by higher natural gas prices,
partially offset by increased fuel costs due to higher natural gas prices and
lower sales volumes. Due to the operating flexibility of some of the gas units,
we were able to partially mitigate the higher cost of natural gas by switching
from natural gas to fuel oil.
Operation and maintenance expense increased $39 million for the nine months
ended September 30, 2003 as compared to the same period in 2002. The increase
was primarily due to repairs at South Texas Project Unit 1 and W.A. Parish Unit
8 ($8 million), an unplanned outage at South Texas Project Unit 2 ($4 million),
a planned refueling outage on South Texas Project Unit 1 without a comparable
outage in 2002 ($6 million), higher pension and benefit expenses ($9 million),
timing of technical support expenses ($2 million) and increased insurance and
other expenses ($8 million).
Taxes other than income taxes decreased $21 million for the nine months
ended September 30, 2003 as compared to the same period in 2002. This decrease
was attributable to a reduction in state franchise taxes that are no longer
applicable in 2003 ($12 million) and a reduction in property taxes due to lower
property valuations ($9 million).
Interest expense decreased $17 million, or 72%, for the nine months ended
September 30, 2003 from the comparable 2002 period primarily as a result of $25
million in intercompany interest allocated in 2002 prior to the Restructuring
and related to the remaining electric utility debt not specifically identified
with CenterPoint Energy's transmission and distribution utility upon
deregulation. This decrease was partially offset by an increase in interest
expense of $4 million on intercompany borrowings from CenterPoint Energy to fund
working capital requirements in the first nine months of 2003.
14
The effective tax rates for the nine months ended September 30, 2003 and
2002 were 31.4% and 47.8%, respectively. The decrease in the effective rate for
the nine months ended September 30, 2003 compared to the nine months ended
September 30, 2002 was primarily the result of pre-tax income in 2003 compared
to a pre-tax loss in 2002, offset by reduced benefits from state taxes and the
amortization of investment tax credits.
In connection with the adoption of Statement of Financial Accounting
Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations" (SFAS
No. 143), we have completed an assessment of the applicability and implications
of SFAS No. 143. As a result of the assessment, we have identified retirement
obligations for nuclear decommissioning at the South Texas Project and for
lignite mine operations at the mine supplying the Limestone electric generation
facility. The net difference between the amounts determined under SFAS No. 143
and the previous method of accounting for estimated mine reclamation costs was
$37 million and has been recorded as a cumulative effect of accounting change.
Upon adoption of SFAS No. 143, we reversed $115 million of previously recognized
removal costs as a cumulative effect of accounting change. Our operating results
for the nine months ended September 30, 2003 include a $99 million after-tax
($152 million pre-tax) non-cash gain ($1.24 per diluted share) from the adoption
of SFAS No. 143. For additional discussion of the adoption of SFAS No. 143,
please read Note 2 to our Interim Financial Statements.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Certain Factors Affecting
Future Earnings" in the Texas Genco Form 10-K and "Risk Factors" in Item 5 of
Part II of this report, each of which is incorporated herein by reference.
LIQUIDITY AND CAPITAL RESOURCES
HISTORICAL CASH FLOWS
The net cash provided by/used in our operating, investing and financing
activities for the nine months ended September 30, 2002 and 2003 is as follows
(in millions):
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2002 2003
------------- -------------
Cash provided by (used in):
Operating activities ............ $ (100) $ 234
Investing activities ............ (199) (117)
Financing activities ............ 300 (117)
CASH PROVIDED BY OPERATING ACTIVITIES
Net cash provided by operating activities for the nine months ended
September 30, 2003 increased $334 million as compared to the same period in
2002. This increase was primarily due to increased earnings as a result of
higher capacity auction prices, which were driven by higher gas prices. Changes
in accounts payable and accounts receivable also contributed to the increase in
cash flow. Additionally, in the first quarter of 2002, the Company paid higher
taxes associated with regulated revenues for 2001. These increases were
partially offset by an increase in inventory primarily related to timing of
deliveries in late 2001 and higher gas prices in 2003.
CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities for the nine months ended September
30, 2003 decreased $82 million as compared to the same period in 2002 primarily
due to the completion of a major portion of the required environmental capital
expenditures for emissions of oxides of nitrogen (NOx) during 2002.
CASH PROVIDED BY FINANCING ACTIVITIES
Net cash provided by financing activities for the nine months ended
September 30, 2003 decreased $417 million as compared to the same period in
2002. The decrease was primarily a result of reductions in transfers from
15
CenterPoint Energy to support various requirements for working capital and
capital expenditures, partially offset by a dividend on our common stock paid in
each of the first three quarters of 2003.
FUTURE SOURCES AND USES OF CASH
We expect to meet our future capital requirements with cash flows from
operations, as well as a combination of intercompany loans from our affiliates
and external financing. From time to time we may use the proceeds of our third
party borrowings to repay intercompany indebtedness, make dividend payments or
for other corporate purposes. We have obtained consent from Reliant Resources to
grant security interests in our assets to lenders under third party facilities.
We currently have no third-party borrowing arrangements in place, however, we
expect to enter into a $75 million senior secured revolving credit facility
during the fourth quarter of 2003. We believe that our cash flows from
operations, intercompany loans from our affiliates and our external borrowing
capability will be sufficient to meet the operational needs of our business for
the next twelve months.
In October 2003, CenterPoint Energy refinanced its bank facility with a
$2.35 billion credit facility. The new facility limits our incurrence of
indebtedness for borrowed money to an aggregate principal amount not to exceed
$250 million outstanding at any time. The new credit facility requires that
proceeds from the sale of any material portion of our assets, subject to certain
requirements, be used to prepay indebtedness under such credit facility.
Although we are not contractually bound by these limitations, it is expected
that CenterPoint Energy would likely cause its representatives on our board of
directors to direct our business so as not to breach the terms of the new
facility.
CenterPoint Energy is a registered public utility holding company under the
1935 Act. On October 23, 2003, the FERC granted EWG status to us. Upon receipt
of EWG status, we became exempt from the 1935 Act. Therefore, SEC approval is
not required for us to issue securities or provide goods or services to
CenterPoint Energy's utility subsidiaries or third parties. SEC approval will be
required, however, for CenterPoint Energy and its affiliates to continue to
provide goods and services to us after December 31, 2003. Except in an emergency
situation (in which CenterPoint Energy could provide funding pursuant to
applicable SEC rules), CenterPoint Energy would be required to obtain further
approval from the SEC to issue and sell securities for purposes of funding Texas
Genco's operations or for CenterPoint Energy to guarantee a security of Texas
Genco. Also, SEC policy precludes us from borrowing from CenterPoint Energy's
utility subsidiaries.
That portion of our stock which is owned by CenterPoint Energy secures any
obligations of CenterPoint Energy under its $2.35 billion credit facility
executed in October 2003.
Cash Flows From Operations -- Reliant Resources as a Significant Customer.
To date, we have sold a substantial portion of our auctioned capacity
entitlements to subsidiaries of Reliant Resources. For more information
regarding the impact that Reliant Resources' financial condition may have on our
cash flows, please read "Risk Factors" in Item 5 of Part II of this report.
Dividend Policy. We intend to pay regular quarterly cash dividends on our
common stock. Our board of directors will determine the amount of future
dividends in light of:
o any applicable contractual restrictions governing our ability to pay
dividends, including our agreements with CenterPoint Energy to ensure
its compliance with the terms of the Reliant Resources Option agreement;
o applicable legal requirements;
o our earnings and cash flows;
o our financial condition; and
o other factors our board of directors deems relevant.
On November 6, 2003, our board of directors declared a quarterly cash
dividend of $0.25 per share of common stock payable on December 19, 2003 to
shareholders of record as of the close of business on November 26, 2003. For a
description of certain contractual provisions governing our ability to pay
dividends, please read "Market for Common Stock and Related Stockholder Matters"
in Item 5 of the Texas Genco Form 10-K.
16
We expect our liquidity and capital requirements will be affected by our:
o capital requirements related to environmental compliance and other
maintenance projects;
o dividend policy;
o debt service requirements; and
o working capital requirements.
Intercompany Borrowings. At December 31, 2002 and September 30, 2003, we had
$86 million and $29 million respectively, borrowed from affiliates through the
CenterPoint Energy money pool. As a result of our certification by the FERC as
an "exempt wholesale generator" under the 1935 Act, we can no longer participate
in this money pool. CenterPoint Energy has established a second money pool in
which Texas Genco and certain other unregulated subsidiaries of CenterPoint
Energy can participate. It is anticipated that we will meet our cash needs with
a combination of funds from operations, borrowings from CenterPoint Energy and
funds obtained through the new money pool. Except in an emergency situation (in
which CenterPoint Energy could provide funding pursuant to applicable SEC
rules), CenterPoint Energy would be required to obtain approval from the SEC to
issue and sell securities for purposes of funding Texas Genco's operations or
for CenterPoint Energy to guarantee a security of Texas Genco. There is no
assurance that CenterPoint Energy will have sufficient funds to meet our cash
needs.
Pension Plan. As discussed in Note 6(a) to our 2002 Form 10-K, which is
incorporated herein by reference, we participate in CenterPoint Energy's
qualified non-contributory pension plan covering substantially all employees.
Pension expense for 2003 is estimated to be $17 million based on an expected
return on plan assets of 9.0% and a discount rate of 6.75% as of December 31,
2002. Future changes in plan asset returns, assumed discount rates and various
other factors related to the pension will impact our future pension expense and
liabilities. We cannot predict with certainty what these factors will be in the
future. Additionally, we expect that a separate pension plan will be established
for us prior to our disposition by CenterPoint Energy. We would receive an
allocation of assets from the CenterPoint Energy pension plan pursuant to rules
and regulations under the Employee Retirement Income Security Act of 1974 and
record our pension obligations in accordance with SFAS No. 87, "Employer's
Accounting for Pensions". It is anticipated that a plan established for us will
be underfunded and that such underfunding could be significant. Changes in
interest rates and the market values of the securities held by the CenterPoint
Energy pension plan during 2003 could materially, positively or negatively,
change the funding status of a plan established for us.
RELATED PARTY TRANSACTIONS
In connection with the Restructuring and the distribution by CenterPoint
Energy in January 2003 of 19% of our common stock, we entered into a number of
agreements with CenterPoint Energy. These agreements govern our interim and
ongoing relationships with CenterPoint Energy, including the provision by
CenterPoint Energy to us of various interim services. Pursuant to the
requirements of the 1935 Act, CenterPoint Energy is organizing a service company
through which these services will ultimately be delivered. For information
regarding our agreements and other relationships with CenterPoint Energy, the
terms of the option, exercisable in January 2004, under which Reliant Resources
has the right to purchase from CenterPoint Energy its 81% ownership of our
outstanding common stock, the terms of our technical services agreement with
Reliant Resources, and other matters, please read Note 3 to our Interim
Financial Statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Related Party Transactions" in our 2002
Form 10-K.
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one that is both important to the
presentation of our financial condition and results of operations and requires
management to make difficult, subjective or complex accounting estimates. An
accounting estimate is an approximation made by management of a financial
statement element, item or account in the financial statements. Accounting
estimates in our historical consolidated financial statements measure the
effects of past business transactions or events, or the present status of an
asset or liability. The accounting estimates described below require us to make
assumptions about matters that are highly uncertain at the time the estimate is
made. Additionally, different estimates that we could have used or changes in an
accounting estimate that are
17
reasonably likely to occur could have a material impact on the presentation of
our financial condition or results of operations. We base our estimates on
historical experience and on various other assumptions that we believe are
reasonable under the circumstances, the results of which form the basis for
making judgments. These estimates may change as new events occur, as more
experience is acquired, as additional information is obtained and as our
operating environment changes. We believe the following critical accounting
policies involve the application of accounting estimates for which a change in
the estimate is inseparable from the effect of a change in accounting principle.
Accordingly, these accounting policies have been reviewed and discussed with the
audit committee of the board of directors.
REVENUE RECOGNITION
Starting January 1, 2002, we have two primary components of revenue: (1)
capacity revenues, which entitle the owner to power, and (2) energy revenues,
which are intended to cover the costs of fuel for the actual electricity
produced. Capacity payments are billed and collected during the month prior to
actual energy deliveries and are recorded as deferred revenue until the month of
actual energy delivery. At that point, the deferred revenue is reversed, and
both capacity and energy payment revenues are recognized. As of December 31,
2002, and September 30, 2003, $49 million and $56 million, respectively, of
deferred capacity revenue was recorded in our Consolidated Balance Sheets.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets, which primarily include property, plant and equipment
(PP&E), comprise $4.1 billion or 89.3% of our total assets as of September 30,
2003. We make judgments and estimates in conjunction with the carrying value of
these assets, including amounts to be capitalized, depreciation and amortization
methods and useful lives. We evaluate our PP&E for impairment whenever
indicators of impairment exist. Accounting standards require that if the sum of
the undiscounted expected future cash flows from a company's asset is less than
the carrying value of the asset, an asset impairment must be recognized. The
amount of impairment recognized is calculated by subtracting the fair value of
the asset from the carrying value of the asset.
As a result of the distribution of approximately 19% of our common stock to
CenterPoint Energy's shareholders on January 6, 2003, we re-evaluated these
assets for impairment as of December 31, 2002 in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." As of December
31, 2002, no impairment had been indicated.
NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, we adopted SFAS No. 143. SFAS No. 143 requires
the fair value of an asset retirement obligation to be recognized as a liability
is incurred and capitalized as part of the cost of the related tangible
long-lived assets. Over time, the liability is accreted to its present value
each period, and the capitalized cost is depreciated over the useful life of the
related asset. Retirement obligations associated with long-lived assets included
within the scope of SFAS No. 143 are those for which a legal obligation exists
under enacted laws, statutes and written or oral contracts, including
obligations arising under the doctrine of promissory estoppel.
We have identified retirement obligations for nuclear decommissioning at the
South Texas Project and for lignite mine operations at the mine supplying the
Limestone electric generation facility. Prior to adoption of SFAS No. 143, we
had recorded liabilities for nuclear decommissioning and the reclamation of the
lignite mine. Liabilities were recorded for estimated decommissioning
obligations of $139.7 million and $39.7 million for reclamation of the lignite
at December 31, 2002. Upon adoption of SFAS No. 143 on January 1, 2003, we
reversed the $139.7 million previously accrued for the nuclear decommissioning
of the South Texas Project and recorded a plant asset of $99.1 million offset by
accumulated depreciation of $35.8 million as well as a retirement obligation of
$186.7 million. The $16.3 million difference between amounts previously recorded
and the amounts recorded upon adoption of SFAS No. 143 is being deferred as a
liability due to regulatory requirements. We also reversed the $39.7 million we
had previously recorded for the mine reclamation and recorded a plant asset of
$1.9 million offset by accumulated depreciation of $0.4 million as well as a
retirement obligation of $3.8 million. The $37.4 million difference between
amounts previously recorded and the amounts recorded upon adoption of SFAS No.
143 was recorded as a cumulative effect of accounting change. We have also
identified other asset retirement obligations that cannot be calculated because
the assets associated with the retirement obligations have an indeterminate
life.
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The following represents the balances of the asset retirement obligation as
of January 1, 2003 and the additions and accretion of the asset retirement
obligation for the nine months ended September 30, 2003:
BALANCE,
BALANCE, LIABILITIES LIABILITIES CASH FLOW SEPTEMBER 30,
JANUARY 1, 2003 INCURRED SETTLED ACCRETION REVISIONS 2003
--------------- ----------- ----------- --------- --------- -------------
(IN MILLIONS)
Nuclear decommissioning .... $ 186.7 -- -- $ 6.8 -- $ 193.5
Lignite mine ................ 3.8 -- -- 0.3 -- 4.1
--------------- ----------- ----------- --------- --------- -------------
$ 190.5 -- -- $ 7.1 -- $ 197.6
=============== =========== =========== ========= ========= =============
The following represents the pro-forma effect on our net income for the
three months and nine months ended September 30, 2002, as if we had adopted SFAS
No. 143 as of January 1, 2002:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
------------------ ------------------
(IN THOUSANDS)
Net loss as reported ........... $ 3,298 $ (49,688)
Pro-forma net loss ............. 6,585 (46,023)
DILUTED EARNINGS PER SHARE:
Net loss as reported ........... $ 0.04 $ (0.62)
Pro-forma net loss ............. 0.08 (0.58)
The following represents our asset retirement obligations on a pro-forma
basis as if we had adopted SFAS No. 143 as of December 31, 2002:
AS REPORTED PRO-FORMA
----------- -----------
(IN MILLIONS)
Nuclear decommissioning $ 139.7 $ 186.7
Lignite mine .......... 39.7 3.8
----------- -----------
Total ............... $ 179.4 $ 190.5
=========== ===========
We have previously recognized removal costs as a component of depreciation
expense. Upon adoption of SFAS No. 143, we reversed $115 million of previously
recognized removal costs as a cumulative effect of accounting change. The total
cumulative effect recognized upon adoption of SFAS No. 143 was $99 million
after-tax ($152 million pre-tax).
In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" (SFAS No. 145). SFAS No. 145
eliminates the current requirement that gains and losses on debt extinguishment
must be classified as extraordinary items in the income statement. Instead, such
gains and losses will be classified as extraordinary items only if they are
deemed to be unusual and infrequent. SFAS No. 145 also requires that capital
leases that are modified so that the resulting lease agreement is classified as
an operating lease be accounted for as a sale-leaseback transaction. The changes
related to debt extinguishment are effective for fiscal years beginning after
May 15, 2002, and the changes related to lease accounting are effective for
transactions occurring after May 15, 2002. We have applied this guidance as it
relates to lease accounting and the accounting provisions related to debt
extinguishment. Upon adoption of SFAS No. 145, any gain or loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods presented is required to be reclassified. No such reclassification was
required in the three months or nine months ended September 30, 2002.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146 nullifies
Emerging Issues Task Force (EITF) No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)" (EITF No. 94-3). The principal
difference between SFAS No. 146 and EITF No. 94-3 relates to the requirements
for recognition of a liability for costs associated with an exit or disposal
activity. SFAS No. 146 requires that a liability be recognized for a cost
associated with an exit or disposal activity when it is incurred. A liability is
incurred when a transaction or event occurs that leaves an entity little or no
discretion to
19
avoid the future transfer or use of assets to settle the liability. Under EITF
No. 94-3, a liability for an exit cost was recognized at the date of an entity's
commitment to an exit plan. In addition, SFAS No. 146 also requires that a
liability for a cost associated with an exit or disposal activity be recognized
at its fair value when it is incurred. SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31, 2002. We adopted the
provisions of SFAS No. 146 on January 1, 2003. The adoption of SFAS No. 146 had
no effect on our consolidated financial statements.
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. In addition, FIN 45 requires disclosures about the guarantees that
an entity has issued. The provision for initial recognition and measurement of
the liability will be applied on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions of FIN 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of FIN 45 did not have a material impact on our
results of operations or financial condition.
In January 2003, the FASB issued FIN No. 46 "Consolidation of Variable
Interest Entities, an Interpretation of Accounting Research Bulletin No. 51"
(FIN 46). FIN 46 requires certain variable interest entities to be consolidated
by the primary beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. On October 9, 2003, the FASB deferred the application of FIN
46 until the end of the first interim or annual period ending after December 15,
2003 for variable interest entities created before February 1, 2003. The FASB is
currently considering several amendments to FIN 46, and we will analyze the
impact, if any, these changes may have on our consolidated financial statements
upon ultimate implementation of FIN 46. We do not expect the adoption of FIN 46
to have a material effect on our consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" (SFAS No. 149). SFAS No. 149 has
added additional criteria which were effective on July 1, 2003 for new,
acquired, or newly modified forward contracts. We engage in forward contracts
for the sale of power. The majority of these forward contracts are entered into
either through state mandated Texas Utility Commission auctions or auctions
mandated by an agreement with Reliant Resources. All of our contracts resulting
from these auctions specify the product types, the plant or group of plants from
which the auctioned products are derived, the delivery location and specific
delivery requirements, and pricing for each of the products. We have applied the
criteria from current accounting literature, including SFAS No. 133
Implementation Issue No. C-15 - "Scope Exceptions: Normal Purchases and Normal
Sales Exception for Option-Type Contracts and Forward Contracts in Electricity",
to both the state mandated and the contractually mandated auction contracts and
believe they meet the definition of capacity contracts. Accordingly, we consider
these contracts as normal sales contracts rather than as derivatives. We have
evaluated our forward commodity contracts under the new requirements of SFAS No.
149. The adoption of SFAS No. 149 did not change previous accounting conclusions
relating to forward power sales contracts entered into in connection with the
state mandated or contractually mandated auctions and the adoption did not have
a material effect on our consolidated financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
Beginning in 2002, we have contributed $2.9 million per year to trusts
established to fund our share of the decommissioning costs for the South Texas
Project. The securities held by the trusts for decommissioning costs had an
estimated fair value of $179 million as of September 30, 2003, of which
approximately 39% were debt securities that subject us 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 September 30, 2003, the fair value of the
fixed-rate debt securities would decrease by approximately $1 million. In
addition, the risk of an economic loss is mitigated because CenterPoint Energy
has agreed to indemnify us for any shortfall of the trust to cover
decommissioning costs.
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EQUITY MARKET VALUE RISK
As discussed above under "-- Interest Rate Risk," we contribute to trusts
established to fund our share of the decommissioning costs for the South Texas
Project, which held debt and equity securities as of September 30, 2003. The
equity securities expose us to losses in fair value. If the market prices of the
individual equity securities were to decrease by 10% from their levels at
September 30, 2003, the resulting loss in fair value of these securities would
be approximately $11 million. Currently, the risk of an economic loss is
mitigated as discussed above under "-- Interest Rate Risk."
COMMODITY PRICE RISK
Our gross margins are dependent upon the market price for power in the ERCOT
market. Our gross margins are primarily derived from the sale of capacity
entitlements associated with our large, solid fuel baseload generating units,
including our Limestone and W.A. Parish facilities and our interest in the South
Texas Project. The gross margins generated from payments associated with the
capacity of these units are directly impacted by natural gas prices. Since the
fuel costs for our baseload units are largely fixed under long-term contracts,
they are generally not subject to significant daily and monthly fluctuations.
However, the market price for power in the ERCOT market is directly affected by
the price of natural gas. Because natural gas is the marginal fuel of facilities
serving the ERCOT market during most hours, its price has a significant
influence on the price of electric power. As a result, the price customers are
willing to pay for entitlements to our solid fuel baseload capacity generally
rises and falls with natural gas prices.
ITEM 4. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an
evaluation, under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, of
the effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our principal executive
officer and principal financial officer concluded that our disclosure controls
and procedures were effective as of September 30, 2003 to provide assurance that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
There has been no change in our internal controls over financial reporting
that occurred during the three months ended September 30, 2003 that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are, from time to time, a party to litigation arising in the normal
course of our business, most of which involves contract disputes or claims for
personal injury and property damage incurred in connection with our operations.
We are not currently involved in any litigation that we expect will have a
material adverse effect on our financial condition, results of operations and
cash flows. For a description of a number of lawsuits involving claims of
asbestos exposure at properties owned by us, please read "Business --
Environmental Matters -- Asbestos" in Item 1 of our 2002 Form 10-K, which is
incorporated herein by reference. For a description of a lawsuit involving one
of our fuel suppliers, please read "Supplier Suits" in Note 4(a) to our Interim
Financial Statements, which is incorporated herein by reference.
ITEM 5. OTHER INFORMATION.
RISK FACTORS
PRINCIPAL RISK FACTORS AFFECTING OUR BUSINESS
OUR REVENUES AND RESULTS OF OPERATIONS ARE IMPACTED BY MARKET RISKS
THAT ARE BEYOND OUR CONTROL.
We sell electric generation capacity, energy and ancillary services in the
ERCOT market. The ERCOT market consists of the majority of the population
centers in the State of Texas and represents approximately 85% of the demand for
power in the state. Under the Texas electric restructuring law, we and other
power generators in Texas are not subject to traditional cost-based regulation
and, therefore, may sell electric generation capacity, energy and ancillary
services to wholesale purchasers at prices determined by the market. As a
result, we are not guaranteed any rate of return on our capital investments
through mandated rates, and our revenues and results of operations depend, in
large part, upon prevailing market prices for electricity in the ERCOT market.
Market prices for electricity, generation capacity, energy and ancillary
services may fluctuate substantially. Our gross margins are primarily derived
from the sale of capacity entitlements associated with our large, solid fuel
baseload generating units, including our coal and lignite fueled generating
stations and the South Texas Project nuclear facility. The gross margins
generated from payments associated with the capacity of these units are directly
impacted by natural gas prices. Since the fuel costs for our baseload units are
largely fixed under long-term contracts, they are generally not subject to
significant daily and monthly fluctuations. However, the market price for power
in the ERCOT market is directly affected by the price of natural gas. Because
natural gas is the marginal fuel for facilities serving the ERCOT market during
most hours, its price has a significant influence on the price of electric
power. As a result, the price customers are willing to pay for entitlements to
our solid fuel-fired baseload capacity generally rises and falls with natural
gas prices.
Market prices in the ERCOT market may also fluctuate substantially due to
other factors. Such fluctuations may occur over relatively short periods of
time. Volatility in market prices may result from:
o oversupply or undersupply of generation capacity,
o power transmission or fuel transportation constraints or inefficiencies,
o weather conditions,
o seasonality,
o availability and market prices for natural gas, crude oil and refined
products, coal, enriched uranium and uranium fuels,
o changes in electricity usage,
o additional supplies of electricity from existing competitors or new
market entrants as a result of the development of new generation
facilities or additional transmission capacity,
22
o illiquidity in the ERCOT market,
o availability of competitively priced alternative energy sources,
o natural disasters, wars, embargoes, terrorist attacks and other
catastrophic events, and
o federal and state energy and environmental regulation and legislation.
THERE IS CURRENTLY A SURPLUS OF GENERATING CAPACITY IN THE ERCOT MARKET AND
WE EXPECT THE MARKET FOR WHOLESALE POWER TO BE HIGHLY COMPETITIVE.
The amount by which power generating capacity exceeds peak demand (reserve
margin) in the ERCOT market has exceeded 20% since 2001, and the Texas Utility
Commission and the ERCOT Independent System Operator (ISO) have forecasted the
reserve margin for 2004 to continue to exceed 20%. The commencement of
commercial operation of new power generation facilities in the ERCOT market has
increased and will continue to increase the competitiveness of the wholesale
power market, which could have a material adverse effect on our results of
operations, financial condition, cash flows and the market value of our assets.
Our competitors include generation companies affiliated with Texas-based
utilities, independent power producers, municipal and co-operative generators
and wholesale power marketers. The unbundling of vertically integrated utilities
into separate generation, transmission and distribution, and retail businesses
pursuant to the Texas electric restructuring law could result in a significant
number of additional competitors participating in the ERCOT market. Some of our
competitors may have greater financial resources, lower cost structures, more
effective risk management policies and procedures, greater ability to incur
losses, greater potential for profitability from ancillary services, and greater
flexibility in the timing of their sale of generating capacity and ancillary
services than we do.
WE ARE SUBJECT TO OPERATIONAL AND MARKET RISKS ASSOCIATED WITH OUR CAPACITY
AUCTIONS.
We are obligated to sell substantially all of our available capacity and
related ancillary services through 2003 pursuant to capacity auctions. In these
auctions, we sell firm entitlements on a forward basis to capacity and ancillary
services dispatched within specified operational constraints. Although we have
reserved a portion of our aggregate net generation capacity from our capacity
auctions for planned or forced outages at our facilities, unanticipated plant
outages or other problems with our generation facilities could result in our
firm capacity and ancillary services commitments exceeding our available
generation capacity. As a result, we could be required to obtain replacement
power from third parties in the open market to satisfy our firm commitments that
could result in significant additional costs. In addition, an unexpected outage
at one of our lower cost facilities could require us to run one of our higher
cost plants in order to satisfy our obligations even though the energy payments
for the dispatched power are based on the cost at the lower-cost facility.
The mechanics, regulations and agreements governing our capacity auctions
are complex. The state mandated auctions require, among other things, our
capacity entitlements to be sold in pre-determined amounts. The characteristics
of the capacity entitlements we sell in state mandated auctions are defined by
rules adopted by the Texas Utility Commission and, therefore, cannot be changed
to respond to market demands or operational requirements without approval by the
Texas Utility Commission.
THE OPERATION OF OUR POWER GENERATION FACILITIES INVOLVES RISKS THAT COULD
ADVERSELY AFFECT OUR REVENUES, COSTS, RESULTS OF OPERATIONS, FINANCIAL
CONDITION AND CASH FLOWS.
We are subject to various risks associated with operating our power
generation facilities, any of which could adversely affect our revenues, costs,
results of operations, financial condition and cash flows. These risks include:
o operating performance below expected levels of output or efficiency,
o breakdown or failure of equipment or processes,
o disruptions in the transmission of electricity,
o shortages of equipment, material or labor,
23
o labor disputes,
o fuel supply interruptions,
o limitations that may be imposed by regulatory requirements, including,
among others, environmental standards,
o limitations imposed by the ERCOT ISO,
o violations of permit limitations,
o operator error, and
o catastrophic events such as fires, hurricanes, explosions, floods,
terrorist attacks or other similar occurrences.
A significant portion of our facilities were constructed many years ago.
Older generation equipment, even if maintained in accordance with good
engineering practices, may require significant capital expenditures to keep it
operating at high efficiency and to meet regulatory requirements. This equipment
is also likely to require periodic upgrading and improvement. Any unexpected
failure to produce power, including failure caused by breakdown or forced
outage, could result in increased costs of operations and reduced earnings.
WE RELY ON POWER TRANSMISSION FACILITIES THAT WE DO NOT OWN OR CONTROL AND
THAT ARE SUBJECT TO TRANSMISSION CONSTRAINTS WITHIN THE ERCOT MARKET. IF
THESE FACILITIES FAIL TO PROVIDE US WITH ADEQUATE TRANSMISSION CAPACITY, WE
MAY NOT BE ABLE TO DELIVER WHOLESALE ELECTRIC POWER TO OUR CUSTOMERS AND WE
MAY INCUR ADDITIONAL COSTS.
We depend on transmission and distribution facilities owned and operated by
CenterPoint Houston and by others to deliver the wholesale electric power we
sell from our power generation facilities to our customers, who in turn deliver
power to the end users. If transmission is disrupted, or if transmission
capacity infrastructure is inadequate, our ability to sell and deliver wholesale
electric energy may be adversely impacted.
The single control area of the ERCOT market is currently organized into
four congestion zones. Transmission congestion between the zones could impair
our ability to schedule power for transmission across zonal boundaries, which
are defined by the ERCOT ISO, thereby inhibiting our efforts to match our
facility scheduled outputs with our customer scheduled requirements. In
addition, power generators participating in the ERCOT market could be liable for
congestion costs associated with transferring power between zones.
OUR RESULTS OF OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS COULD BE
ADVERSELY IMPACTED BY A DISRUPTION OF OUR FUEL SUPPLIES.
We rely primarily on natural gas, coal, lignite and uranium to fuel our
generation facilities. We purchase our fuel from a number of different suppliers
under long-term contracts and on the spot market. Under our capacity auctions,
we sell firm entitlements to capacity and ancillary services. Therefore, any
disruption in the delivery of fuel could prevent us from operating our
facilities, or force us to enter into alternative arrangements at higher than
prevailing market prices, to meet our auction commitments, which could adversely
affect our results of operations, financial condition and cash flows.
TO DATE, WE HAVE SOLD A SUBSTANTIAL PORTION OF OUR CAPACITY ENTITLEMENTS TO
SUBSIDIARIES OF RELIANT RESOURCES. ACCORDINGLY, OUR RESULTS OF OPERATIONS,
FINANCIAL CONDITION AND CASH FLOWS COULD BE ADVERSELY AFFECTED IF RELIANT
RESOURCES DECLINED TO PARTICIPATE IN OUR FUTURE AUCTIONS OR FAILED TO MAKE
PAYMENTS WHEN DUE UNDER RELIANT RESOURCES' PURCHASED ENTITLEMENTS.
Subsidiaries of Reliant Resources purchased entitlements to 63% of our
available 2002 capacity and through September 2003 had purchased 71% of our
available 2003 capacity. Reliant Resources made these purchases either through
the exercise of its contractual rights to purchase 50% of the entitlements we
auction in our contractually mandated auctions or through the submission of
bids. In the event Reliant Resources declined to participate in our future
auctions or failed to make payments when due, our results of operations,
financial condition and cash flows could be adversely affected. As of September
30, 2003, Reliant Resources' securities ratings are below investment
24
grade. We have been granted a security interest in accounts receivable and/or
notes associated with the accounts receivable of certain subsidiaries of Reliant
Resources to secure up to $250 million in purchase obligations.
WE MAY INCUR SUBSTANTIAL COSTS AND LIABILITIES AS A RESULT OF OUR OWNERSHIP
OF NUCLEAR FACILITIES.
We own a 30.8% interest in the South Texas Project, a nuclear powered
generation facility. As a result, we are subject to risks associated with the
ownership and operation of nuclear facilities. These risks include:
o the liabilities associated with potential harmful effects on the
environment and human health resulting from the operation of nuclear
facilities and the storage, handling and disposal of radioactive
materials,
o limitations on the amounts and types of insurance commercially available
to cover losses that might arise in connection with nuclear operations,
and
o uncertainties with respect to the technological and financial aspects of
decommissioning nuclear plants at the end of their licensed lives.
The NRC has broad authority under federal law to impose licensing and
safety-related requirements for the operation of nuclear generation facilities.
In the event of non-compliance, the NRC has the authority to impose fines, shut
down a unit, or both, depending upon its assessment of the severity of the
situation, until compliance is achieved. Revised safety requirements promulgated
by the NRC could necessitate substantial capital expenditures at nuclear plants.
In addition, although we have no reason to anticipate a serious nuclear incident
at the South Texas Project, if an incident did occur, it could have a material
adverse effect on our results of operations, financial condition and cash flows.
OTHER RISKS
WE MAY NOT HAVE ACCESS TO SUFFICIENT CAPITAL IN THE AMOUNTS AND AT THE TIMES
NEEDED TO FINANCE OUR BUSINESS.
To date, our capital has been provided by internally generated cash flows
and borrowings from the CenterPoint Energy money pool. At September 30, 2003, we
had borrowings of $29 million from this money pool. As a result of our
certification by the FERC as an "exempt wholesale generator" under the 1935 Act,
we can no longer participate in this money pool. CenterPoint Energy has
established a second money pool in which Texas Genco and certain other
unregulated subsidiaries of CenterPoint Energy can participate. It is
anticipated that we will meet our cash needs with a combination of funds from
operations, borrowings from CenterPoint Energy and funds obtained through the
new money pool. Except in an emergency situation (in which CenterPoint Energy
could provide funding pursuant to applicable SEC rules), CenterPoint Energy
would be required to obtain approval from the SEC to issue and sell securities
for purposes of funding Texas Genco's operations or for CenterPoint Energy to
guarantee a security of Texas Genco. There is no assurance that CenterPoint
Energy will have sufficient funds to meet our cash needs.
We can give no assurances that our current and future capital structure,
operating performance, financial condition and cash flows will permit us to
access the capital markets or to obtain other financing as needed to meet our
working capital requirements and projected future capital expenditures on
favorable terms. The amount of any debt issuance by us is expected to be
affected by the market's perception of our creditworthiness, market conditions
and factors affecting our industry. Our projected future capital expenditures
are substantial. Our ability to secure third party credit lines or other debt
financing may be adversely impacted by the factors described in this section,
including the nature of our business, which may lead to volatility in our
financial results and cash flows. CenterPoint Energy has agreed to lend funds to
us from time to time upon our request until the earlier of the closing date on
which Reliant Resources acquires our common stock from CenterPoint Energy
pursuant to the Reliant Resources Option or upon the expiration of the Reliant
Resources option. Please read "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources - Future
Sources and Uses of Cash."
25
In addition, our ability to raise capital is restricted under our
agreements with CenterPoint Energy. These restrictions limit our ability to:
o issue additional equity securities;
o encumber our assets; or
o incur indebtedness, except to satisfy requirements for operating and
maintenance expenditures and other capital expenditures contemplated
under our agreements with CenterPoint Energy, to meet our working
capital needs, or to refinance indebtedness incurred for the foregoing
purposes.
We are an 81% owned subsidiary of CenterPoint Energy. As a result of this
relationship, the financial condition of CenterPoint Energy could affect our
access to capital, our credit standing and our financial condition. On October
7, 2003, Moody's Investors Services, Inc. placed CenterPoint Energy's senior
unsecured credit rating on review for downgrade, reflecting concerns that may
lead to a downgrade. Similarly, if Reliant Resources were to exercise its option
to acquire CenterPoint Energy's interest in us, the financial condition of
Reliant Resources could affect our access to capital, our credit standing and
our financial condition. At September 30, 2003, Reliant Resources' securities
were rated below investment grade.
OUR OPERATIONS ARE SUBJECT TO EXTENSIVE REGULATION, INCLUDING ENVIRONMENTAL
REGULATION. IF WE FAIL TO COMPLY WITH APPLICABLE REGULATIONS OR OBTAIN OR
MAINTAIN ANY NECESSARY GOVERNMENTAL PERMIT OR APPROVAL, WE MAY BE SUBJECT TO
CIVIL, ADMINISTRATIVE AND/OR CRIMINAL PENALTIES THAT COULD ADVERSELY IMPACT
OUR RESULTS OF OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS.
Our operations are subject to complex and stringent energy, environmental
and other governmental laws and regulations. The acquisition, ownership and
operation of power generation facilities require numerous permits, approvals and
certificates from federal, state and local governmental agencies. These
facilities are subject to regulation by the Texas Utility Commission regarding
non-rate matters. Existing regulations may be revised or reinterpreted, new laws
and regulations may be adopted or become applicable to us or any of our
generation facilities or future changes in laws and regulations may have a
detrimental effect on our business.
Operation of the South Texas Project is subject to regulation by the NRC.
This regulation involves testing, evaluation and modification of all aspects of
plant operation in light of NRC safety and environmental requirements.
Continuous demonstrations to the NRC that plant operations meet applicable
requirements are also required. The NRC has the ultimate authority to determine
whether any nuclear powered generating unit may operate.
Water for certain of our facilities is obtained from public water
authorities. New or revised interpretations of existing agreements by those
authorities or changes in price or availability of water may have a detrimental
effect on our business.
Our business is subject to extensive environmental regulation by federal,
state and local authorities. We are required to comply with numerous
environmental laws and regulations and to obtain numerous governmental permits
in operating our facilities. We may incur significant additional costs to comply
with these requirements. If we fail to comply with these requirements or with
any other regulatory requirements that apply to our operations, we could be
subject to administrative, civil and/or criminal liability and fines, and
regulatory agencies could take other actions seeking to curtail our operations.
These liabilities or actions could adversely impact our results of operations,
financial condition and cash flows.
Existing environmental regulations could be revised or reinterpreted, new
laws and regulations could be adopted or become applicable to us or our
facilities, and future changes in environmental laws and regulations could
occur, including potential regulatory and enforcement developments related to
air emissions. If any of these events occurs, our business, results of
operations, financial condition and cash flows could be adversely affected.
We may not be able to obtain or maintain from time to time all required
environmental regulatory approvals. If there is a delay in obtaining any
required environmental regulatory approvals or if we fail to obtain and comply
with them, we may not be able to operate our facilities or we may be required to
incur additional costs. We are generally responsible for all on-site liabilities
associated with the environmental condition of our power generation facilities,
regardless of when the liabilities arose and whether the liabilities are known
or unknown. These liabilities may be substantial.
26
IF THE ERCOT MARKET DOES NOT FUNCTION IN THE MANNER CONTEMPLATED BY THE TEXAS
ELECTRIC RESTRUCTURING LAW, OUR BUSINESS PROSPECTS, RESULTS OF OPERATIONS,
FINANCIAL CONDITION AND CASH FLOWS COULD BE ADVERSELY IMPACTED.
The competitive electric market in Texas became fully operational in
January 2002, and none of us, the Texas Utility Commission, ERCOT or other
market participants has any significant operating history under the market
framework created by the Texas electric restructuring law. The initiatives under
the Texas electric restructuring law have had a significant impact on the nature
of the electric power industry in Texas and the manner in which participants in
the ERCOT market conduct their business. These changes are ongoing, and we
cannot predict the future development of the ERCOT market or the ultimate effect
that this changing regulatory environment will have on our business.
Some restructured markets in other states have experienced supply problems
and extreme price volatility. If the ERCOT market does not function as intended
by the Texas electric restructuring law, our results of operations, financial
condition and cash flows could be adversely affected. In addition, any market
failures could lead to revisions or reinterpretations of the Texas electric
restructuring law, the adoption of new laws and regulations applicable to us or
our facilities and other future changes in laws and regulations that may have a
detrimental effect on our business.
OUR INSURANCE COVERAGE MAY NOT BE SUFFICIENT. INSUFFICIENT INSURANCE COVERAGE
AND INCREASED INSURANCE COSTS COULD ADVERSELY IMPACT OUR RESULTS OF
OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS.
We currently have general liability and property insurance in effect to
cover certain of our facilities in amounts that we consider appropriate. Such
policies are subject to certain limits and deductibles and do not include
business interruption coverage. We cannot assure you that insurance coverage
will be available in the future on commercially reasonable terms or that the
insurance proceeds received for any loss of or any damage to any of our
facilities will be sufficient to restore the loss or damage without negative
impact on our results of operations, financial condition and cash flows. The
costs of our insurance coverage have increased significantly in recent months
and may continue to increase in the future.
We 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.
Under the federal Price Anderson Act, the maximum liability to the public of
owners of nuclear power plants was $10.5 billion as of September 30, 2003.
Owners are required under the Price Anderson Act to insure their liability for
nuclear incidents and protective evacuations. We and the other owners of the
South Texas Project currently maintain the required nuclear liability insurance
and participate in the industry retrospective rating plan. In addition, the
security procedures at this facility have recently been enhanced to provide
additional protection against terrorist attacks. All potential losses or
liabilities associated with the South Texas Project may not be insurable, and
the amount of insurance may not be sufficient to cover them. In particular, our
insurance policies are subject to certain limits and deductibles and do not
include business interruption coverage.
CHANGES IN TECHNOLOGY MAY ADVERSELY AFFECT OUR REVENUES AND RESULTS OF
OPERATIONS.
A significant portion of our generation facilities were constructed many
years ago and rely on older technologies. Some of our competitors may have newer
generation facilities and technologies that allow them to produce and sell power
more efficiently, which could adversely affect our results of operations,
financial condition and cash flows. In addition, research and development
activities are ongoing to improve alternate technologies to produce electricity,
including fuel cells, microturbines, windmills and photovoltaic (solar) cells.
It is possible that advances in these or other technologies will reduce the
current costs of electricity production utilizing newer facilities to a level
that is below that of our generation facilities. If this occurs, our generation
facilities will be less competitive and the value of our power plants could be
significantly impaired. Also, electricity demand could be reduced by increased
conservation efforts and advances in technology that could likewise
significantly reduce the value of our power generation facilities.
27
OUR REVENUES AND RESULTS OF OPERATIONS ARE SUBJECT TO RISKS THAT ARE BEYOND
OUR CONTROL, INCLUDING BUT NOT LIMITED TO FUTURE TERRORIST ATTACKS OR RELATED
ACTS OF WAR.
The cost of repairing damage to our operating subsidiaries' facilities due
to storms, natural disasters, wars, terrorist acts and other catastrophic
events, in excess of reserves established for such repairs, may adversely impact
our results of operations, financial condition and cash flows. The occurrence or
risk of occurrence of future terrorist activity may impact our results of
operations, financial condition and cash flows in unpredictable ways. These
actions could also result in adverse changes in the insurance markets and
disruptions of power and fuel markets. In addition, our electric transmission
and distribution, electric generation, natural gas distribution and pipeline and
gathering facilities could be directly or indirectly harmed by future terrorist
activity. The occurrence or risk of occurrence of future terrorist attacks or
related acts of war could also adversely affect the United States economy. A
lower level of economic activity could result in a decline in energy
consumption, which could adversely affect our revenues and margins and limit our
future growth prospects. Also, these risks could cause instability in the
financial markets and adversely affect our ability to access capital.
RISKS RELATED TO OUR RELATIONSHIPS WITH CENTERPOINT ENERGY AND RELIANT RESOURCES
WE WILL BE CONTROLLED BY CENTERPOINT ENERGY AS LONG AS IT OWNS A MAJORITY OF
OUR COMMON STOCK, AND OUR MINORITY SHAREHOLDERS WILL BE UNABLE TO AFFECT THE
OUTCOME OF SHAREHOLDER VOTING DURING THAT TIME. IF RELIANT RESOURCES
EXERCISES ITS OPTION THAT IS EXERCISABLE IN JANUARY 2004 TO ACQUIRE OUR STOCK
OWNED BY CENTERPOINT ENERGY, WE WILL LIKEWISE BE CONTROLLED BY RELIANT
RESOURCES AND OUR MINORITY SHAREHOLDERS WILL BE UNABLE TO AFFECT THE OUTCOME
OF A SHAREHOLDER VOTE.
As a result of the January 6, 2003 distribution, CenterPoint Energy
indirectly owns approximately 81% of our outstanding common stock. As long as
CenterPoint Energy owns a majority of our outstanding common stock, it will
continue to be able to elect our entire board of directors, and our public
shareholders, by themselves, will not be able to affect the outcome of any
shareholder vote. Similarly, our public shareholders, by themselves, will not be
able to affect the outcome of any shareholder vote if Reliant Resources
exercises its option to acquire our common stock owned by CenterPoint Energy
that is exercisable in January 2004, as Reliant Resources would own
approximately 81% of our common stock in that event. For convenience, we
sometimes refer to CenterPoint Energy or Reliant Resources, as applicable, as
our "majority shareholder" when referring to either of them as the owner of 81%
or more of our common stock. In addition, CenterPoint Energy has stated that if
Reliant Resources does not exercise its option, CenterPoint Energy will consider
strategic alternatives for its interest in us, including a possible sale, which
could result in a third party becoming our majority shareholder. Reliant
Resources may choose not to exercise its option for a number of reasons,
including unfavorable market conditions or a lack of access to capital.
Our majority shareholder, subject to any fiduciary duty owed to our
minority shareholders under Texas law and restrictions under a master separation
agreement between CenterPoint Energy and Reliant Resources, will be able to
control all matters affecting us.
In addition, our majority shareholder may enter into credit agreements,
indentures or other contracts that limit the activities of its subsidiaries.
While we would not likely be contractually bound by these limitations, our
majority shareholder would likely cause its representatives on our board to
direct our business so as not to breach any of these agreements.
WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH CENTERPOINT ENERGY
WITH RESPECT TO OUR PAST AND ONGOING RELATIONSHIPS, AND BECAUSE OF
CENTERPOINT ENERGY'S CONTROLLING OWNERSHIP INTEREST, WE MAY NOT BE ABLE TO
RESOLVE THESE CONFLICTS ON TERMS POSSIBLE IN ARM'S LENGTH TRANSACTIONS.
Conflicts of interest may arise between CenterPoint Energy and us in a
number of areas relating to our past and ongoing relationships, including
proceedings, actions and decisions of legislative bodies and administrative
agencies, and our dividend policy. The agreements we have entered into with
CenterPoint Energy may be amended in the future upon agreement of the parties.
While we are controlled by CenterPoint Energy, CenterPoint Energy may be able to
require us to amend these agreements. We may not be able to resolve any
potential conflicts with CenterPoint Energy, and even if we do, the resolution
may be less favorable than if we were dealing with an unaffiliated party.
28
CONTRACTUAL RESTRICTIONS ON THE OPERATION OF OUR BUSINESS MAY ADVERSELY
AFFECT OUR ABILITY TO COMPETE WITH COMPANIES THAT ARE NOT SUBJECT TO SIMILAR
RESTRICTIONS.
Effective December 31, 2000, Reliant Resources and Reliant Energy entered
into a master separation agreement that now governs the rights and obligations
of CenterPoint Energy and Reliant Resources in connection with the business
separation plan of Reliant Energy adopted in response to the Texas electric
restructuring law. Reliant Resources also has an option to purchase the shares
of our stock owned by CenterPoint Energy that is exercisable in January 2004. We
have agreed to comply with certain restrictions governing our operations as
contemplated by the master separation agreement and option agreement. These
restrictions limit our ability to:
o merge or consolidate with another entity;
o sell assets;
o enter into long-term agreements and commitments for the purchase of fuel
or the purchase or sale of power outside the ordinary course of
business;
o engage in other businesses;
o construct or acquire new generation plants or capacity;
o engage in certain hedging transactions;
o encumber our assets;
o issue additional equity securities;
o pay special dividends; and
o make certain loans, investments or advances to, or engage in certain
transactions with, our affiliates.
IF RELIANT RESOURCES EXERCISES ITS OPTION TO ACQUIRE OUR STOCK OWNED BY
CENTERPOINT ENERGY IN 2004, THE TAX BASIS OF OUR ASSETS WILL BE ADJUSTED
UPWARDS OR DOWNWARDS TO REFLECT THE FAIR MARKET VALUE OF OUR BUSINESS AT THE
TIME OF THE PURCHASE.
We would be required to step up or step down the tax basis in all of our
assets following the date of the sale to be equivalent generally to the value of
the equity of our business, based upon the purchase price, plus the principal
amount of indebtedness at the time of the purchase. The resulting step-up or
step-down in the basis of our assets would impact our future tax liabilities. A
step-up would reduce our future tax liabilities, while a step-down would
increase our liabilities. We cannot currently project the impact of this tax
election because it is dependent on Reliant Resources' exercise of its option in
2004, and the purchase price to be paid by Reliant Resources in 2004, which is
not known at this time.
29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
The following exhibits are filed herewith:
Exhibits not incorporated by reference to a prior filing are designated
by a cross (+); all exhibits not so designated are incorporated by
reference to a prior filing as indicated.
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
------- ---------------------------------- ---------------------------------- ------------ ---------
3.1 -- Amended and Restated Articles of Texas Genco Holdings, Inc.'s 1-31449 3.1
Incorporation ("Texas Genco") Form 10-K for the
year ended December 31, 2002
3.2 -- Amended and Restated Bylaws Texas Genco's Form 10-K for the 1-31449 3.2
year ended December 31, 2002
4.1 -- Specimen Stock Certificate Texas Genco's registration 1-31449 4.1
statement on Form 10
10.1 -- Pledge Agreement, dated as of CenterPoint Energy, Inc.'s Form 1-31447 10.9
October 7, 2003, executed in 10-Q for the quarter ended
connection with Credit Agreement, September 30, 2003
dated as of October 7, 2003,
among CenterPoint Energy and the
banks named therein
10.2 -- CenterPoint Energy 1985 Deferred CenterPoint Energy, Inc.'s 1-31447 10.1
Compensation Plan, as amended and Form 10-Q for the quarter
restated effective January 1, 2003 ended September 30, 2003
10.3 -- CenterPoint Energy Deferred CenterPoint Energy, Inc.'s 1-31447 10.2
Compensation Plan, as amended and Form 10-Q for the quarter
restated ended September 30, 2003
effective January 1, 2003
10.4 -- CenterPoint Energy Short Term CenterPoint Energy, Inc.'s 1-31447 10.3
Incentive Plan, as amended and Form 10-Q for the quarter
restated effective January 1, 2003 ended September 30, 2003
10.5 -- CenterPoint Energy Executive CenterPoint Energy, Inc.'s 1-31447 10.4
Benefits Plan, as amended and Form 10-Q for the quarter
restated effective January 1, 2003 ended September 30, 2003
10.6 -- CenterPoint Energy Executive Life CenterPoint Energy, Inc.'s 1-31447 10.5
Insurance Plan, as amended and Form 10-Q for the quarter
restated effective June 18, 2003 ended September 30, 2003
+10.7 -- Texas Genco Holdings, Inc.
Performance Unit Plan effective as
of January 1, 2003
+31.1 -- Section 302 Certification of
David G. Tees
+31.2 -- Section 302 Certification of
Gary L. Whitlock
+32.1 -- Section 906 Certification of
David G. Tees
+32.2 -- Section 906 Certification of
Gary L. Whitlock
30
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
------- ---------------------------------- ---------------------------------- ------------ ---------
+99.1 -- Items incorporated by reference from
the Texas Genco Form 10-K:
"Business--Environmental
Matters--Asbestos" in Item 1,
"Market for Common Stock and
Related Stockholder Matters" in
Item 5, "Management's Discussion
and Analysis of Financial Condition
and Results of Operations --
Certain Factors Affecting Future
Earnings" in Item 7, and Notes 2(f),
2(h), 6(a) and 8.
(b) Reports on Form 8-K.
On July 29, 2003, we filed a Current Report on Form 8-K dated July 29,
2003, in which we furnished information under Item 12 of that form relating to
our second quarter 2003 earnings.
On September 25, 2003, we filed a Current Report on Form 8-K dated
September 25, 2003 announcing that we intend to mothball 2,990 MW of our
gas-fired generation capacity.
On October 21, 2003, we filed a Current Report on Form 8-K dated October
21, 2003 in which we furnished information under Item 12 of that form relating
to our third quarter 2003 earnings.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TEXAS GENCO HOLDINGS, INC.
By: /s/ James S. Brian
-----------------------------------------
James S. Brian
Senior Vice President and Chief
Accounting Officer
Date: November 12, 2003
32
INDEX TO EXHIBITS
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
------- ---------------------------------- ---------------------------------- ------------ ---------
3.1 -- Amended and Restated Articles of Texas Genco Holdings, Inc.'s 1-31449 3.1
Incorporation ("Texas Genco") Form 10-K for the
year ended December 31, 2002
3.2 -- Amended and Restated Bylaws Texas Genco's Form 10-K for the 1-31449 3.2
year ended December 31, 2002
4.1 -- Specimen Stock Certificate Texas Genco's registration 1-31449 4.1
statement on Form 10
10.1 -- Pledge Agreement, dated as of CenterPoint Energy, Inc.'s Form 1-31447 10.9
October 7, 2003, executed in 10-Q for the quarter ended
connection with Credit Agreement, September 30, 2003
dated as of October 7, 2003,
among CenterPoint Energy and the
banks named therein
10.2 -- CenterPoint Energy 1985 Deferred CenterPoint Energy, Inc.'s 1-31447 10.1
Compensation Plan, as amended and Form 10-Q for the quarter
restated effective January 1, 2003 ended September 30, 2003
10.3 -- CenterPoint Energy Deferred CenterPoint Energy, Inc.'s 1-31447 10.2
Compensation Plan, as amended and Form 10-Q for the quarter
restated ended September 30, 2003
effective January 1, 2003
10.4 -- CenterPoint Energy Short Term CenterPoint Energy, Inc.'s 1-31447 10.3
Incentive Plan, as amended and Form 10-Q for the quarter
restated effective January 1, 2003 ended September 30, 2003
10.5 -- CenterPoint Energy Executive CenterPoint Energy, Inc.'s 1-31447 10.4
Benefits Plan, as amended and Form 10-Q for the quarter
restated effective January 1, 2003 ended September 30, 2003
10.6 -- CenterPoint Energy Executive Life CenterPoint Energy, Inc.'s 1-31447 10.5
Insurance Plan, as amended and Form 10-Q for the quarter
restated effective June 18, 2003 ended September 30, 2003
+10.7 -- Texas Genco Holdings, Inc.
Performance Unit Plan effective as
of January 1, 2003
+31.1 -- Section 302 Certification of
David G. Tees
+31.2 -- Section 302 Certification of
Gary L. Whitlock
+32.1 -- Section 906 Certification of
David G. Tees
+32.2 -- Section 906 Certification of
Gary L. Whitlock
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
------- ---------------------------------- ---------------------------------- ------------ ---------
+99.1 -- Items incorporated by reference from
the Texas Genco Form 10-K:
"Business--Environmental
Matters--Asbestos" in Item 1,
"Market for Common Stock and
Related Stockholder Matters" in
Item 5, "Management's Discussion
and Analysis of Financial Condition
and Results of Operations --
Certain Factors Affecting Future
Earnings" in Item 7, and Notes 2(f),
2(h), 6(a) and 8.