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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-13265
RELIANT ENERGY RESOURCES CORP.
(Exact name of registrant as specified in its charter)
<Table>
DELAWARE
(State or other jurisdiction of incorporation 76-0511406
or organization) (I.R.S. Employer Identification Number)
1111 LOUISIANA
HOUSTON, TEXAS 77002 (713) 207-3000
(Address and zip code of principal executive (Registrant's telephone number, including
offices) area code)
</Table>
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
NorAm Financing I 6 1/4% Convertible Trust
Originated Preferred Securities New York Stock Exchange
6% Convertible Subordinated Debentures due 2012 New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
RELIANT ENERGY RESOURCES CORP. MEETS THE CONDITIONS SET FORTH IN
GENERAL INSTRUCTION I(1)(a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS
FORM 10-K WITH THE REDUCED DISCLOSURE FORMAT.
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates:
None
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TABLE OF CONTENTS
<Table>
PART I
Item 1. Business......................................................................................... 1
Item 2. Properties....................................................................................... 9
Item 3. Legal Proceedings................................................................................ 9
Item 4. Submission of Matters to a Vote of Security Holders.............................................. 9
PART II
Item 5. Market for Common Stock and
Related Stockholder Matters.................................................................... 10
Item 6. Selected Financial Data.......................................................................... 10
Item 7. Management's Narrative Analysis of Results of Operations......................................... 10
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....................................... 16
Item 8. Financial Statements and Supplementary Data...................................................... 19
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............. 48
PART III
Item 10. Directors and Executive Officers of the Registrant............................................... 48
Item 11. Executive Compensation........................................................................... 48
Item 12. Security Ownership of Certain Beneficial Owners and Management................................... 48
Item 13. Certain Relationships and Related Transactions................................................... 48
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................. 48
</Table>
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," "intend," "may," "plan," "potential," "predict,"
"should," "will," "forecast," "goal," "objective," "projection," 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.
The following list identifies some of the factors that could cause actual
results to differ from those expressed or implied by our forward-looking
statements:
o state, federal and international legislative and regulatory
developments and changes in, or application of environmental, siting
and other laws and regulations to which we are subject;
o timing of the implementation of our parent company's business
separation plan, including the receipt of necessary approvals from the
Securities and Exchange Commission (SEC) and an extension relating to
a private letter ruling from the Internal Revenue Service (IRS);
o the effects of competition, including the extent and timing of the
entry of additional competitors in our markets;
o industrial, commercial and residential growth in our service
territories;
o our pursuit of potential business strategies, including acquisitions
or dispositions of assets;
o state, federal and other rate regulations in the United States;
o the timing and extent of changes in commodity prices, particularly
natural gas;
o weather variations and other natural phenomena;
o political, legal and economic conditions and developments in the
United States;
o financial market conditions and the results of our financing efforts;
o any direct or indirect effect on our business resulting from the
September 11, 2001 terrorist attacks or any similar incidents or
responses to such incidents; and
o other factors we discuss in this Form 10-K, including those outlined
in "Management's Narrative Analysis of Results of Operations of
Reliant Energy Resources Corp. and its Consolidated Subsidiaries --
Certain Factors Affecting Our Future Earnings."
You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement, and we undertake no obligation to publicly update or revise any
forward-looking statements.
ii
PART I
ITEM 1. BUSINESS.
OUR BUSINESS
GENERAL
Reliant Energy Resources Corp., a Delaware corporation, was incorporated in
1996. In this Form 10-K, we refer to Reliant Energy Resources Corp. as "RERC
Corp." and to RERC Corp. and its subsidiaries as "we" or "us," unless the
context clearly indicates otherwise. RERC Corp. is a wholly owned subsidiary of
Reliant Energy, Incorporated, a diversified international energy company and
electric utility holding company. In this Form 10-K, we refer to Reliant Energy,
Incorporated as "Reliant Energy," unless the context clearly indicates
otherwise. The executive offices of RERC Corp. are located at 1111 Louisiana,
Houston, TX 77002 (telephone number 713-207-3000).
We conduct our operations primarily in the natural gas industry. We conduct
our operations through our Natural Gas Distribution, Pipelines and Gathering and
Other Operations business segments.
For information about the revenues, operating income, assets and other
financial information relating to our business segments, please read
"Management's Narrative Analysis of the Results of Operations of Reliant Energy
Resources Corp. and its Consolidated Subsidiaries" in Item 7 of this Form 10-K
and Note 13 to our consolidated financial statements, which, together with the
notes related to those statements, we refer to in this Form 10-K as our
"consolidated financial statements."
STATUS OF BUSINESS SEPARATION
Reliant Energy filed its initial business separation plan with the Public
Utility Commission of Texas (Texas Utility Commission) in January 2000 and filed
amended plans in April 2000 and August 2000. In December 2000, the Texas Utility
Commission approved Reliant Energy's amended business separation plan (Business
Separation Plan) providing for the separation of Reliant Energy's generation,
transmission and distribution, and retail operations into three different
companies and for the separation of Reliant Energy's regulated and unregulated
businesses into two unaffiliated publicly traded companies. In December 2000,
Reliant Energy transferred a significant portion of its unregulated businesses
to Reliant Resources, Inc. (Reliant Resources) which, at the time, was a wholly
owned subsidiary. In addition, in a merger, RERC transferred the businesses
conducted by Reliant Energy Services, Inc., which was a wholly owned subsidiary
of RERC's, to Reliant Resources in December 2000. Reliant Resources conducted an
initial public offering of approximately 20% of its common stock in May 2001. In
December 2001, Reliant Energy's shareholders approved an agreement and plan of
merger by which the following will occur (which we refer to as the
Restructuring):
o CenterPoint Energy, Inc. (CenterPoint Energy), currently a wholly
owned subsidiary of Reliant Energy, will become the holding company
for Reliant Energy and its subsidiaries;
o Reliant Energy and its subsidiaries will become subsidiaries of
CenterPoint Energy; and
o each share of Reliant Energy common stock will be converted into one
share of CenterPoint Energy common stock.
After the Restructuring, Reliant Energy plans, subject to further corporate
approvals, market and other conditions, to complete the separation of its
regulated and unregulated businesses by distributing the shares of common stock
of Reliant Resources that CenterPoint Energy will then own to its shareholders
(Distribution). Reliant Energy's goal is to complete the Restructuring and
subsequent Distribution as quickly as possible after all the necessary
conditions are fulfilled, including receipt of an order from the SEC granting
the required approvals under the Public Utility Holding Company Act of 1935
(1935 Act) and an extension from the IRS for a private letter ruling Reliant
Energy has obtained regarding the tax-free treatment of the Distribution.
Although receipt or timing of regulatory approvals cannot be assured, Reliant
Energy believes it meets the standards for such approvals. Reliant Energy
currently expects to complete the Restructuring and Distribution in the summer
of 2002.
RERC Corp. Restructuring
Following the Restructuring, CenterPoint Energy will be a utility holding
company under the 1935 Act and as such will be required to register under the
1935 Act unless it qualifies for an exemption. In order to enable CenterPoint
Energy to comply with the requirements in the exemption in Section 3(a)(1) of
the 1935 Act, Reliant Energy plans to divide the gas distribution businesses
conducted by RERC Corp.'s three unincorporated divisions, Reliant Energy Entex
(Entex), Reliant Energy Arkla (Arkla) and Reliant Energy Minnegasco
(Minnegasco), among three separate business entities. For more information
regarding Reliant Energy's application under the 1935 Act and regulation under
the 1935 Act, please read "Regulation -- Public Utility Holding Company Act of
1935" in Item 1 of this Form 10-K. The entity that will hold the Entex assets
will also hold RERC Corp.'s natural gas pipelines and gathering businesses. For
more information regarding RERC Corp.'s divisions and their operations, please
read "Natural Gas Distribution" and "Pipelines and Gathering" in Item 1 of this
Form 10-K. In addition to regulatory approvals Reliant Energy has obtained, this
restructuring will require approval of the public service commissions of
Louisiana, Oklahoma and Arkansas.
For additional information regarding the Restructuring, the Distribution
and the RERC Corp. separation described above, please read Note 2 to our
consolidated financial statements.
1
NATURAL GAS DISTRIBUTION
Our Natural Gas Distribution business segment consists of intrastate
natural gas sales to, and natural gas transportation for, residential,
commercial and industrial customers in Arkansas, Louisiana, Minnesota,
Mississippi, Oklahoma and Texas and some non-rate regulated retail gas marketing
operations.
We conduct intrastate natural gas sales to, and natural gas transportation
for, residential, commercial and industrial customers through three
unincorporated divisions of RERC Corp.: Arkla, Entex and Minnegasco. These
operations are regulated as gas utility operations in the jurisdictions served
by these divisions.
o Arkla. Arkla provides natural gas distribution services in over 245
communities in Arkansas, Louisiana, Oklahoma and Texas. The largest
metropolitan areas served by Arkla are Little Rock, Arkansas and
Shreveport, Louisiana. In 2001, approximately 65% of Arkla's total
throughput was attributable to retail sales of gas and approximately
35% was attributable to transportation services.
o Entex. Entex provides natural gas distribution services in over 500
communities in Louisiana, Mississippi and Texas. The largest
metropolitan area served by Entex is Houston, Texas. In 2001,
approximately 97% of Entex's total throughput was attributable to
retail sales of gas and approximately 3% was attributable to
transportation services.
o Minnegasco. Minnegasco provides natural gas distribution services in
over 240 communities in Minnesota. The largest metropolitan area
served by Minnegasco is Minneapolis, Minnesota. In 2001, approximately
97% of Minnegasco's total throughput was attributable to retail sales
of gas and approximately 3% was attributable to transportation
services.
The demand for intrastate natural gas sales to, and natural gas
transportation for, residential, commercial and industrial customers is
seasonal. In 2001, approximately 62% of our Natural Gas Distribution business
segment's total throughput occurred in the first and fourth quarters. These
patterns reflect the higher demand for natural gas for heating purposes during
those periods. For information about the plan to separate the operations of
Arkla, Entex and Minnegasco among different business entities, please read "Our
Business -- RERC Corp. Restructuring" above.
COMMERCIAL AND INDUSTRIAL MARKETING SALES
Our Natural Gas Distribution business segment's commercial and industrial
marketing sales group provides comprehensive natural gas products and services
to commercial and industrial customers in the region from Southern Texas to the
panhandle of Florida, as well as in the Midwestern United States. In 2001,
approximately 96% of total throughput was attributable to the sale of natural
gas and approximately 4% was attributable to transportation services. Typical
customer contract terms for natural gas sales range from one day to three years.
Our commercial and industrial marketing sales groups' operations may be affected
by seasonal weather changes and the relative price of natural gas. In 2000, the
commercial and industrial marketing sales group exited all retail gas markets in
non-strategic areas of the Northeast and Mid-Atlantic, allowing us to focus
resources and efforts in our core geographical areas of the Gulf South and
Midwest.
SUPPLY AND TRANSPORTATION
Arkla. In 2001, Arkla purchased approximately 53% of its natural gas supply
from Reliant Energy Services, 29% pursuant to third-party contracts, with terms
varying from three months to one year, and 18% on the spot market. Arkla's major
third-party natural gas suppliers in 2001 included Oneok Gas Marketing Company,
Tenaska Marketing Ventures, Marathon Oil Company and BP Energy Company. Arkla
transports substantially all of its natural gas supplies under contracts with
our pipeline subsidiaries.
Entex. In 2001, Entex purchased virtually all of its natural gas supply
pursuant to term contracts, with terms varying from one to five years. Entex's
major third-party natural gas suppliers in 2001 included AEP Houston Pipeline,
Kinder Morgan Texas Pipeline, L.P., Gulf Energy Marketing, Island Fuel Trading
and Koch Energy
2
Trading. Entex transports its natural gas supplies on both interstate and
intrastate pipelines under long-term contracts with terms varying from one to
five years.
Minnegasco. In 2001, Minnegasco purchased approximately 74% of its natural
gas supply pursuant to term contracts, with terms varying from one to ten years,
with more than 20 different suppliers. Minnegasco purchased the remaining 26% on
the daily or spot market. Most of the natural gas volumes under long-term
contracts are committed under terms providing for delivery during the winter
heating season, which extends from November through March. Minnegasco purchased
approximately 67% of its natural gas requirements from four suppliers in 2001:
Tenaska Marketing Ventures, Reliant Energy Services, Pan-Alberta Gas Ltd., and
TransCanada Gas Services Inc. Minnegasco transports its natural gas supplies on
various interstate pipelines under long-term contracts with terms varying from
one to five years.
For additional information regarding our ability to pass through changes in
natural gas prices to our customers, please read "Management's Narrative
Analysis of Results of Operations of Reliant Energy Resources Corp. and its
Consolidated Subsidiaries -- Certain Factors Affecting Our Future Earnings --
Competitive and Other Factors Affecting RERC Operations -- Natural Gas
Distribution" in Item 7 of this Form 10-K.
Arkla and Minnegasco use various leased or owned natural gas storage
facilities to meet peak-day requirements and to manage the daily changes in
demand due to changes in weather. Minnegasco also supplements contracted
supplies and storage from time to time with stored liquefied natural gas and
propane-air plant production.
Minnegasco owns and operates a 7.0 billion cubic feet (Bcf) underground
storage facility, having a working capacity of 2.1 Bcf available for use during
a normal heating season and a maximum daily withdrawal rate of 50 million cubic
feet (MMcf) per day. Minnegasco also owns ten propane-air plants with a total
capacity of 191 MMcf per day and on-site storage facilities for 11 million
gallons of propane (1.0 Bcf gas equivalent). Minnegasco owns a liquefied natural
gas facility with a 12 million-gallon liquefied natural gas storage tank (1.0
Bcf gas equivalent) with a send-out capability of 72 MMcf per day.
Although available natural gas supplies have exceeded demand for several
years, currently supply and demand appear to be more balanced. Our Natural Gas
Distribution business segment has sufficient supplies and pipeline capacity
under contract to meet its firm customer requirements. However, from time to
time, it is possible for limited service disruptions to occur due to weather
conditions, transportation constraints and other events. As a result of these
factors, supplies of natural gas may become unavailable from time to time or
prices may increase rapidly in response to temporary supply constraints or other
factors.
ASSETS
As of December 31, 2001, we owned approximately 61,000 linear miles of gas
distribution mains, varying in size from one-half inch to 24 inches in diameter.
Generally, in each of the cities, towns and rural areas served by our Natural
Gas Distribution business segment, we own the underground gas mains and service
lines, metering and regulating equipment located on customers' premises and the
district regulating equipment necessary for pressure maintenance. With a few
exceptions, the measuring stations at which we receive gas from our suppliers
are owned, operated and maintained by others, and our distribution facilities
begin at the outlet of the measuring equipment. These facilities, including
odorizing equipment, are usually located on the land owned by suppliers.
COMPETITION
Please read "Management's Narrative Analysis of Results of Operations of
Reliant Energy Resources Corp. and its Consolidated Subsidiaries -- Certain
Factors Affecting Our Future Earnings -- Competitive and Other Factors Affecting
RERC Operations -- Natural Gas Distribution" in Item 7 of this Form 10-K, which
section is incorporated herein by reference.
3
PIPELINES AND GATHERING
Our Pipelines and Gathering business segment operates two interstate
natural gas pipelines as well as gas gathering and pipeline services. Our
pipeline operations are primarily conducted by two wholly owned interstate
pipeline subsidiaries of RERC Corp., Reliant Energy Gas Transmission Company
(REGT) and Mississippi River Transmission Corporation (MRT). Our gathering and
pipeline services operations are conducted by a wholly owned gas gathering
subsidiary, Reliant Energy Field Services, Inc. (REFS), and a wholly owned
pipeline services subsidiary, Reliant Energy Pipeline Services, Inc. (REPS).
Through REFS, we provide natural gas gathering and related services,
including related liquids extraction and other well operating services. As of
December 31, 2001, REFS operated approximately 4,300 miles of gathering
pipelines, which collect natural gas from more than 300 separate systems located
in major producing fields in Arkansas, Louisiana, Oklahoma and Texas. Through
REPS, we provide pipeline project management and facility operation services to
affiliates and third parties.
In 2001, approximately 25% of our Pipelines and Gathering business
segment's total operating revenue was attributable to services provided by REGT
to Arkla, and approximately 10% of its total operating revenue was attributable
to services provided by MRT to Laclede Gas Company (Laclede), an unaffiliated
distribution company that provides natural gas utility service to the greater
St. Louis metropolitan area in Illinois and Missouri. An additional 20% of our
Pipelines and Gathering business segment's operating revenues was attributable
to the transportation of gas marketed by Reliant Energy Services. Our Pipelines
and Gathering business segment provides service to Arkla and Laclede under
several long-term firm storage and transportation agreements. REGT and Arkla
have entered into various contracts for firm transportation in Arkla's major
service areas that are currently scheduled to expire in 2005. In February 2002,
MRT negotiated an agreement to extend its existing service relationship with
Laclede for a five-year period subject to acceptance by the Federal Energy
Regulatory Commission (FERC).
The business and operations of our Pipelines and Gathering business segment
may be affected by seasonal changes in the demand for natural gas, the relative
price of natural gas in the Midcontinent and Gulf Coast natural gas supply
regions and, to a lesser extent, general economic conditions.
ASSETS
We own and operate approximately 8,100 miles of gas transmission lines. We
also own and operate six natural gas storage fields with a combined daily
deliverability of approximately 1.2 Bcf per day and a combined working gas
capacity of approximately 55.8 Bcf. REGT also owns a 10% interest, with Gulf
South Pipeline Company, LP, in the Bistineau storage facility with 68.8 Bcf of
working gas capacity and 1.1 Bcf per day of deliverability. REGT's storage
capacity in the Bistineau facility is 18 Bcf (8 Bcf of working gas) with 100
MMcf per day of deliverability. Most of our storage operations are in north
Louisiana and Oklahoma. We also own and operate approximately 4,300 miles of
gathering pipelines that collect gas from more than 300 separate systems located
in major producing fields in Arkansas, Louisiana, Oklahoma and Texas.
COMPETITION
Please read "Management's Narrative Analysis of Results of Operations of
Reliant Energy Resources Corp. and its Consolidated Subsidiaries -- Certain
Factors affecting Our Future Earnings -- Competitive and Other Factors Affecting
RERC Operations -- Pipelines and Gathering" in Item 7 of this Form 10-K, which
section is incorporated herein by reference.
OTHER OPERATIONS
In 2001, Other Operations included unallocated corporate costs and
inter-segment eliminations.
4
REGULATION
We are subject to regulation by various federal, state, local and foreign
governmental agencies, including the regulations described below.
PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
Current Status. Although RERC Corp. is a gas utility company as defined
under the 1935 Act, it is not a holding company within the meaning of the 1935
Act. RERC Corp. is currently subject to regulation under the 1935 Act with
respect to certain acquisitions of voting securities of other domestic public
utility companies and utility holding companies.
Section 33(a)(1) of the 1935 Act exempts foreign utility company affiliates
of RERC Corp. from regulation as a "public utility company," thereby permitting
RERC Corp. to invest in foreign utility companies without becoming subject to
registration under the 1935 Act as a registered holding company and without
approval by the SEC. The exemption, however, is subject to the SEC having
received certification from each state commission having jurisdiction over the
retail rates of any electric or gas utility company affiliated with RERC Corp.
that such commission has the authority and resources to protect ratepayers
subject to its jurisdiction and that it intends to exercise its authority. The
state regulatory commissions exercising jurisdiction over RERC Corp. (Arkansas,
Louisiana, Minnesota, Mississippi, Oklahoma and Texas) have provided a
certification to the SEC subject, however, to the right of such commissions to
revise or withdraw their certifications as to any future acquisitions of a
foreign utility company. The state regulatory commissions of Arkansas and
Minnesota have imposed limitations on the amount of investments that can be made
by utility companies (including RERC Corp.) in foreign utility companies and, in
some cases, foreign electric wholesale generating companies. These limitations
are based upon a utility company's consolidated net worth, retained earnings,
and debt and stockholders' equity. We currently do not plan to make any further
investments in foreign utility companies.
Subject to some limited exceptions, Section 33(f)(1) of the 1935 Act
prohibits us, as a public utility company, from issuing any security for the
purpose of financing the acquisition, ownership or operation of a foreign
utility company, or assuming any obligation or liability in respect of any
security of a foreign utility company.
Impact on the Restructuring. SEC approval is required for CenterPoint
Energy to acquire Reliant Energy and its subsidiary companies. As a result of
the Restructuring, CenterPoint Energy will be a holding company within the
meaning of the 1935 Act and, as such, required to register under the 1935 Act
unless it is able to qualify for exemption. Section 3(a)(1) of the 1935 Act
provides an exemption for a holding company if it and each of its material
public utility subsidiary companies carry on their utility operations
substantially and predominantly in a single state in which they are all
organized. While Reliant Energy believes that CenterPoint Energy will ultimately
be in compliance with the requirements for exemption under Section 3(a)(1), RERC
Corp. initially will be a material subsidiary with significant out-of-state
utility operations. As described in Reliant Energy's application to the SEC,
Reliant Energy plans to bring CenterPoint Energy into full compliance with the
standards of Section 3(a)(1) by separating the Entex, Arkla and Minnegasco
operations of RERC Corp. into separate business entities. One entity that will
hold the Entex assets will also held RERC Corp.'s natural gas pipelines and
gathering business. Reliant Energy is in the process of obtaining the necessary
state approvals for the RERC Corp. separation. Upon completion of the
Separation, Reliant Energy believes that CenterPoint Energy will be entitled to
an exemption under Section 3(a)(1) of the 1935 Act.
In the interim, CenterPoint Energy must either obtain a temporary exemption
from registration or else register under the 1935 Act until the separation of
RERC Corp. is completed. Reliant Energy has previously submitted a request for a
temporary exemption for CenterPoint Energy but believes that the new holding
company could also register and obtain the necessary authority under the 1935
Act to operate during this interim period consistent with its business plan. If
CenterPoint Energy becomes a registered public utility holding company, we will
be subject to regulation and additional restrictions as a "subsidiary company"
under the 1935 Act.
Following the Distribution, Reliant Resources and its subsidiaries would
not be subject to the provisions of the 1935 Act either as subsidiaries or
affiliates of CenterPoint Energy.
5
Proposals to Repeal the 1935 Act. In recent years, several bills have been
introduced in Congress that would repeal the 1935 Act. Repeal or significant
modification to the 1935 Act could have a significant impact on us and the
electric and gas utility industries. At this time, however, we are not able to
predict the outcome of any bills to repeal the 1935 Act or the outlook for
additional legislation in 2002.
FEDERAL ENERGY REGULATORY COMMISSION
Natural Gas. The transportation and sale for resale of natural gas in
interstate commerce is subject to regulation by the FERC under the Natural Gas
Act and the Natural Gas Policy Act of 1978, as amended. The FERC has
jurisdiction over, among other things, the construction of pipeline and related
facilities used in the transportation and storage of natural gas in interstate
commerce, including the extension, expansion or abandonment of these facilities.
The rates charged by interstate pipelines for interstate transportation and
storage services are also regulated by the FERC.
REGT and MRT periodically file applications with the FERC for changes in
their generally available maximum rates and charges designed to allow them to
recover their costs of providing service to customers (to the extent allowed by
prevailing market conditions), including a reasonable rate of return. These
rates are normally allowed to become effective after a suspension period, and in
some cases are subject to refund under applicable law, until such time as the
FERC issues an order on the allowable level of rates. REGT currently is
operating under such rates approved by the FERC that took effect in February
1995. MRT currently is operating under such rates that took effect in October
2001, pursuant to a rate case settlement approved by the FERC on January 16,
2002.
On February 9, 2000, the FERC issued Order No. 637, which introduces
several measures to increase competition for interstate pipeline transportation
services. Order No. 637 authorizes interstate pipelines to propose
term-differentiated and peak/off-peak rates, and requires pipelines, including
MRT and REGT, to make tariff filings to expand pipeline service options for
customers. REGT and MRT made Order No. 637 compliance filings in 2000. On March
29, 2002, the FERC issued an order accepting, subject to certain modifications,
a settlement agreement that would resolve REGT's Order No. 637 proceeding. On
November 21, 2001, MRT filed with the FERC for approval of a settlement intended
to resolve the MRT Order No. 637 compliance proceeding. The settlement was
uncontested. No action on the settlement has yet been taken by the FERC.
On May 31, 2001, the FERC issued an order on rehearing establishing hearing
procedures to evaluate MRT's request for authority to recover 4 Bcf of
undercollected lost and unaccounted for gas over a 3-year period. A settlement
resolving all issues in this case, among other things, was filed with the FERC
on November 5, 2001. The FERC approved the settlement on January 16, 2002.
STATE AND LOCAL REGULATIONS
Natural Gas Distribution. In almost all communities in which our Natural
Gas Distribution business segment provides service, RERC operates under
franchises, certificates or licenses obtained from state and local authorities.
The terms of the franchises, with various expiration dates, typically range from
10 to 30 years. None of our Natural Gas Distribution business segment's material
franchises expire before 2005. We expect to be able to renew expiring
franchises. In most cases, franchises to provide natural gas utility services
are not exclusive.
Substantially all of our Natural Gas Distribution business segment's retail
sales are subject to traditional cost-of-service regulation at rates regulated
by the relevant state public service commissions and, in Texas, by the Texas
Railroad Commission and municipalities we serve. For additional information
regarding our ability to recover increased costs of natural gas from our
customers, please read "Management's Narrative Analysis of Results of Operations
of Reliant Energy Resources Corp. and its Consolidated Subsidiaries -- Certain
Factors Affecting Our Future Earnings -- Factors Affecting the Results of
RERC Operations -- Natural Gas Distribution" in Item 7 of this Form 10-K.
On November 21, 2001, Arkla filed a rate case (Docket 01-243-U) with the
Arkansas Public Service Commission seeking an increase in rates for its Arkansas
customers of approximately $47 million on an annual
6
basis. Arkla's last rate increase was authorized in 1995. In the rate filing,
Arkla maintains that its rate base has grown by $183 million, and its operating
expenses have increased from $93 million to $106 million on an annual basis and,
therefore, Arkla's current rates for service to Arkansas customers do not
provide a reasonable opportunity for Arkla to cover its operating costs and earn
a fair return on its investment. A decision in the case is expected by the
fourth quarter of 2002.
ENVIRONMENTAL MATTERS
GENERAL ENVIRONMENTAL ISSUES
We are subject to numerous federal, state and local requirements relating
to the protection of the environment and the safety and health of personnel and
the public. These requirements relate to a broad range of our activities,
including the discharge of pollutants into water, and soil, the proper handling
of solid, hazardous, and toxic materials and waste, noise, and safety and health
standards applicable to the workplace. In order to comply with these
requirements, we will spend substantial amounts from time to time to construct,
modify and retrofit equipment, and to clean up or decommission disposal or fuel
storage areas and other locations as necessary.
Our facilities are subject to state and federal laws and regulations
governing the discharge of pollutants into the air and waterways. In many cases
we must obtain permits or other governmental authorizations that prescribe the
parameters for discharges from our facilities. There are ongoing efforts to
modify standards relating to both the discharge of pollutants into streams and
waterways and to air quality. These efforts may result in more restrictive
regulations and permit terms applicable to our facilities in the future.
We anticipate investing up to $6 million in capital and other special
project expenditures between 2002 and 2006 for environmental compliance. If we
do not comply with environmental requirements that apply to our operations,
regulatory agencies could seek to impose on us civil, administrative and/or
criminal liabilities as well as seek to curtail our operations. Under some
statutes, private parties could also seek to impose civil fines or liabilities
for property damage, personal injury and possibly other costs. For additional
information regarding environmental expenditures, please read "Management's
Narrative Analysis of the Results of Operations of Reliant Energy Resources
Corp. and its Consolidated Subsidiaries -- Certain Factors affecting Our Future
Earnings -- Environmental Expenditures" in Item 7 of this Form 10-K and Note
10(c) to our consolidated financial statements.
7
LIABILITY FOR PREEXISTING CONDITIONS AND REMEDIATION
Manufactured Gas Plant Sites. RERC and its predecessors operated a
manufactured gas plant adjacent until 1960 to the Mississippi River in Minnesota
formerly known as Minneapolis Gas Works. RERC has substantially completed
remediation of the main site other than ongoing water monitoring and treatment.
The manufactured gas was stored in separate holders. RERC is negotiating cleanup
of one such holder. There are six other former manufactured gas plant sites in
the Minnesota service territory. Remediation has been completed on one site. Of
the remaining five sites, RERC believes that two were neither owned nor operated
by RERC. RERC believes it has no liability with respect to the sites we neither
owned nor operated.
At December 31, 2000 and 2001, RERC had accrued $18 million and $23
million, respectively, for remediation of the Minnesota sites. At December 31,
2001, the estimated range of possible remediation costs was $11 million to $49
million. The cost estimates of the Minneapolis Gas Works site are based on
studies of that site. The remediation costs for the other sites are based on
industry average costs for remediation of sites of similar size. The actual
remediation costs will be dependent upon the number of sites remediated, the
participation of other potentially responsible parties, if any, and the
remediation methods used.
Issues relating to the identification and remediation of manufactured gas
plants are common in the natural gas distribution industry. RERC has received
notices from the United States Environmental Protection Agency and others
regarding its status as a potentially responsible party for other sites. Based
on current information, RERC has not been able to quantify a range of
environmental expenditures for potential remediation expenditures with respect
to other manufactured gas plant sites.
Hydrocarbon Contamination. In August 2001, a number of Louisiana residents
who live near the Wilcox Aquifer filed suit against RERC Corp., Reliant Energy
Pipeline Services, Inc., other Reliant Energy entities and third parties (Docket
No. 460, 916-Div. "B"), in the 1st Judicial District Court, Caddo Parish,
Louisiana. The suit alleges that we and the other defendants allowed or caused
hydrocarbon or chemical contamination of the Wilcox Aquifer, which lies beneath
property owned or leased by the defendants and is the sole or primary drinking
water aquifer in the area. The quantity of monetary damages sought is
unspecified. For additional information regarding this suit and the remediation
of the site, please read Note 10(c) to our consolidated financial statements.
Other Minnesota Matters. At December 31, 2000 and 2001, RERC had recorded
accruals of $4 million and $5 million, respectively, for other environmental
matters in Minnesota for which remediation may be required. At December 31,
2001, the estimated range of possible remediation costs was $4 million to $8
million.
MERCURY CONTAMINATION
Like similar companies, our pipeline and natural gas distribution
operations have in the past employed elemental mercury in measuring and
regulating equipment. It is possible that small amounts of mercury may have been
spilled in the course of normal maintenance and replacement operations and that
these spills may have contaminated the immediate area around the meters with
elemental mercury. We have found this type of contamination in the past, and we
have conducted remediation at sites found to be contaminated. Although we are
not aware of additional specific sites, it is possible that other contaminated
sites may exist and that remediation costs may be incurred for these sites.
Although the total amount of these costs cannot be known at this time, based on
our experience and that of others in the natural gas industry to date and on the
current regulations regarding remediation of these sites, we believe that the
cost of any remediation of these sites will not be material to our financial
position, results of operations or cash flows. For additional information
regarding environmental expenditures associated with mercury contamination,
please read "Management's Narrative Analysis of Results of Operations of Reliant
Energy Resources Corp. and its Consolidated Subsidiaries -- Certain Factors
Affecting our Future Earnings -- Environmental Expenditures -- Water, Mercury
and Other Expenditures" in Item 7 of this Form 10-K.
8
Under the federal Comprehensive Environmental Response, Compensation and
Liability Act of 1980, or CERCLA, owners and operators of facilities from which
there has been a release or threatened release of hazardous substances, together
with those who have transported or arranged for the disposal of those
substances, are liable for:
o The costs of responding to that release or threatened release, and
o The restoration of natural resources damaged by any such release.
We are not aware of any liabilities under CERCLA that would have a material
adverse effect on us, our financial position, results of operations or cash
flows.
EMPLOYEES
As of December 31, 2001, we had 5,564 full-time employees. The following
table sets forth the number of our employees by business segment as of December
31, 2001:
<Table>
<Caption>
SEGMENT NUMBER
------- ----------
Natural Gas Distribution ........ 4,943
Pipelines and Gathering ......... 614
Other Operations ................ 7
----------
Total ................. 5,564
==========
</Table>
As of December 31, 2001, 1,542 employees in the Natural Gas Distribution
Segment were represented by unions or other collective bargaining groups.
ITEM 2. PROPERTIES.
CHARACTER OF OWNERSHIP
We own our principal properties in fee. Also, most gas mains are located,
pursuant to easements and other rights, on public roads or on land owned by
others.
NATURAL GAS DISTRIBUTION
For information regarding the properties of our Natural Gas Distribution
business segment, please read "Natural Gas Distribution" in Item 1 of this Form
10-K, which information is incorporated herein by reference.
PIPELINES AND GATHERING
For information regarding the properties of our Pipelines and Gathering
business segment, please read "Pipelines and Gathering" in Item 1 of this Form
10-K, which information is incorporated herein by reference.
OTHER OPERATIONS
For information regarding the properties of our Other Operations business
segment, please read "Other Operations" in Item 1 of this Form 10-K, which
information is incorporated herein by reference.
ITEM 3. LEGAL PROCEEDINGS.
For a description of certain legal and regulatory proceedings affecting us,
see Notes 10(c) and 10(d) to our consolidated financial statements, which notes
are incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The information called for by Item 4 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly-Owned
Subsidiaries).
9
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
All of the 1,000 outstanding shares of RERC Corp.'s common stock are held
by Reliant Energy.
ITEM 6. SELECTED FINANCIAL DATA.
The information called for by Item 6 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly-Owned
Subsidiaries).
ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS OF RELIANT
ENERGY RESOURCES CORP. AND ITS CONSOLIDATED SUBSIDIARIES.
The following narrative and analysis should be read in combination with our
consolidated financial statements and notes contained in Item 8 of this Form
10-K.
Because Reliant Energy Resources Corp. (RERC Corp.) is a wholly owned
subsidiary of Reliant Energy, Incorporated (Reliant Energy) our determination of
reportable segments considers the strategic operating units under which Reliant
Energy manages sales, allocates resources and assesses performance of various
products and services to wholesale or retail customers in differing regulatory
environments. We have identified the following reportable segments: Natural Gas
Distribution, Pipelines and Gathering and Other Operations. Prior to 2001, we
also conducted business in the Wholesale Energy and European Energy segments.
Wholesale Energy included wholesale energy trading, marketing, power origination
and risk management services in North America but excluded the operations of
Reliant Energy Power Generation, Inc., an indirect wholly owned subsidiary of
Reliant Energy. European Energy included the energy trading and marketing
operations initiated in the fourth quarter of 1999 in the Netherlands and other
countries in Europe but excluded Reliant Energy Power Generation Benelux
N.V.(REPGB), a Dutch power company.
Reliant Energy is in the process of separating its regulated and
unregulated businesses into two publicly traded companies. In December 2000,
Reliant Energy transferred a significant portion of its unregulated businesses
to Reliant Resources, Inc. (Reliant Resources), which, at the time, was a wholly
owned subsidiary. Reliant Resources conducted an initial public offering
(Offering) of approximately 20% of its common stock in May 2001. In December
2001, Reliant Energy's shareholders approved an agreement and plan of merger by
which, subject to regulatory approvals, the following will occur (which we refer
to herein as the Restructuring):
o CenterPoint Energy will become the holding company for the Reliant
Energy group of companies;
o Reliant Energy and its subsidiaries will become subsidiaries of
CenterPoint Energy; and
o each share of Reliant Energy common stock will be converted into one
share of CenterPoint Energy common stock.
After the Restructuring, Reliant Energy plans, subject to further corporate
approvals, market and other conditions, to complete the separation of its
regulated and unregulated businesses by distributing the shares of common stock
of Reliant Resources that Reliant Energy owns to its shareholders (which we
refer to herein as the Distribution). Reliant Energy's goal is to complete the
Restructuring and subsequent Distribution as quickly as possible after all the
necessary conditions are fulfilled, including receipt of an order from the
Securities and Exchange Commission (SEC) granting the required approvals under
the Public Utility Holding Company Act of 1935 (1935 Act) and an extension from
the IRS of a private letter ruling that Reliant Energy has obtained regarding
the tax-free treatment of the Distribution. Reliant Energy currently expects to
complete the Restructuring and Distribution in the summer of 2002.
On December 31, 2000, RERC Corp. transferred all of the outstanding capital
stock of Reliant Energy Services International, Inc. (RESI), Arkla Finance
Corporation (Arkla Finance) and Reliant Energy Europe Trading &
10
Marketing, Inc. (RE Europe Trading), all of which were wholly owned subsidiaries
of RERC Corp., to Reliant Resources (collectively, Stock Transfer). Both RERC
Corp. and Reliant Resources are wholly owned subsidiaries of Reliant Energy. As
a result of the Stock Transfer, RESI, Arkla Finance and RE Europe Trading each
became a wholly owned subsidiary of Reliant Resources.
Also, on December 31, 2000, a wholly owned subsidiary of Reliant Resources
merged with and into Reliant Energy Services, Inc. (Reliant Energy Services), a
wholly owned subsidiary of RERC Corp., with Reliant Energy Services as the
surviving corporation (Merger). As a result of the Merger, Reliant Energy
Services became a wholly owned subsidiary of Reliant Resources. As consideration
for the Stock Transfer and the Merger, Reliant Resources paid $94 million to
RERC Corp.
Reliant Energy Services, together with RESI and RE Europe Trading, conducted
the Wholesale Energy segment's trading, marketing, power origination and risk
management business and operations of Reliant Energy. Arkla Finance is a company
that holds an investment in marketable equity securities.
The Stock Transfer and the Merger are part of Reliant Energy's previously
announced restructuring. We are reporting the results of RE Europe Trading as
discontinued operations for all periods presented in our consolidated financial
statements in accordance with Accounting Principles Board Opinion No. 30 (APB
Opinion No. 30). For additional information regarding the operating results of
the entities transferred to Reliant Resources, please read Note 14 to our
consolidated financial statements.
RERC Corp. meets the conditions specified in General Instruction I (1)(a)
and (b) to Form 10-K and is thereby permitted to use the reduced disclosure
format for wholly owned subsidiaries of reporting companies specified therein.
Accordingly, RERC Corp. has omitted from this Form 10-K the information called
for by Item 4 (Submission of Matters to a Vote of Security Holders), Item 10
(Directors and Executive Officers of the Registrant), Item 11 (Executive
Compensation), Item 12 (Security Ownership of Certain Beneficial Owners and
Management) and Item 13 (Certain Relationships and Related Party Transactions)
of Form 10-K. In lieu of the information called for by Item 6 (Selected
Financial Data) and Item 7 (Management's Discussion and Analysis of Financial
Condition and Results of Operations) of Form 10-K, RERC Corp. has included the
following Management's Narrative Analysis of the Results of Operations to
explain material changes in the amount of revenue and expense items between
1999, 2000 and 2001.
11
CONSOLIDATED RESULTS OF OPERATIONS
Our results of operations are affected by seasonal fluctuations in the
demand for natural gas and price movements of energy commodities. Our results of
operations are also affected by, among other things, the actions of various
federal and state governmental authorities having jurisdiction over rates we
charge, competition in our various business operations, debt service costs and
income tax expense.
The following table sets forth selected financial and operating data for the
years ended December 31, 1999, 2000 and 2001, followed by a discussion of
significant variances in period-to-period results:
SELECTED FINANCIAL RESULTS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------------------
1999 2000 2001
---------- ---------- ----------
(IN MILLIONS)
Operating Revenues ............................... $ 10,532 $ 22,659 $ 5,044
Operating Expenses ............................... (10,231) (22,327) (4,778)
---------- ---------- ----------
Operating Income ................................. 301 332 266
Interest Expense ................................. (119) (143) (155)
Other Income, net ................................ 11 2 14
Income Tax Expense ............................... (89) (93) (58)
---------- ---------- ----------
Income from Continuing Operations ................ 104 98 67
Loss from Discontinued Operations, net of tax .... (4) (24) --
---------- ---------- ----------
Net Income ............................. $ 100 $ 74 $ 67
========== ========== ==========
</Table>
2001 Compared to 2000. Our net income for 2001 was $67 million compared to
net income of $74 million in 2000. The $7 million decrease was primarily due to:
o the absence of Reliant Energy Services trading and marketing results
in 2001, as a result of the Merger on December 31, 2000 as discussed
above;
o an increase in our Natural Gas Distribution segment's bad debt
expense, benefits expenses and changes in estimates of unbilled
revenues and recoverability of deferred gas accounts and other items;
and
o an increase in third-party interest primarily resulting from higher
levels of long-term debt during 2001.
The above items were partially offset by the following:
o increased operating margins (revenues less natural gas costs) in our
Natural Gas Distribution segment;
o an after-tax impairment loss of $17 million on marketable equity
securities classified as "available for sale" incurred during 2000 by
our Other Operations segment; and
o increased start-up costs of our European trading and marketing
operations in 2000 included in loss from discontinued operations.
Operating income decreased in 2001 by $66 million, or 20%, from 2000. The
decrease was primarily due to the transfer of Reliant Energy Services to Reliant
Resources pursuant to the Merger discussed above. This decrease was partially
offset by increased customer growth and usage and reduced operating expenses due
to exiting certain non-rate regulated retail gas markets outside of our
established areas during 2000 in our Natural Gas Distribution segment.
Our operating revenues for 2001 were $5.0 billion compared to $22.7 billion
for 2000. The $17.7 billion, or 78%, decrease was primarily due to the absence
of RESI trading and marketing results as a result of the Merger, as discussed
above, partially offset by an increase in revenues related to our Natural Gas
Distribution and Pipelines and Gathering segments resulting from an increase in
the cost of natural gas and, to a lesser extent, the effect of colder weather on
the operations of our Natural Gas Distribution segment in the first quarter of
2001.
12
Our operating expenses for 2001 were $4.8 billion compared to $22.3 billion
in 2000. The $17.5 billion, or 78%, decrease was primarily due to the same
reasons causing the decreases in revenues discussed above.
Our effective tax rate in 2001 was 46.4% compared to 48.7% in 2000. This
decrease was primarily due to a decrease in state income taxes.
2000 Compared to 1999. Our net income for 2000 was $74 million compared to
net income of $100 million in 1999. The $26 million decrease in net income was
primarily due to:
o a decline in operating income of our Natural Gas Distribution segment;
o an after-tax impairment loss of $17 million on marketable equity
securities classified as "available-for-sale" incurred in 2000 by our
Other Operations segment;
o increased third-party interest expense primarily resulting from higher
levels of short-term borrowings and long-term debt during 2000
compared to 1999; and
o increased start-up costs of our European trading and marketing
operations in 2000 included in loss from discontinued operations.
The above items were partially offset by improved operating results from
our Wholesale Energy segment's trading and marketing operations in North
America, increased operating income from our Pipelines and Gathering segment,
increased interest income earned on margin deposits on energy trading activities
and interest income related to a tax refund in 2000.
During 2000, we incurred a pre-tax impairment loss of $27 million on
marketable equity securities classified as "available-for-sale" by our Other
Operations segment. Management's determination to recognize this impairment
resulted from a combination of events occurring in 2000 related to this
investment. These events affecting the investment included changes occurring in
the investment's senior management, announcement of significant restructuring
charges and related downsizing for the entity, reduced earnings estimates for
this entity by brokerage analysts and the bankruptcy of a competitor of the
investment in the first quarter of 2000. These events, coupled with the stock
market value of our investment in these securities continuing to be below our
cost basis, caused management to believe the decline in fair value to be other
than temporary. This investment is held by Arkla Finance which was transferred
to Reliant Resources effective December 31, 2000.
Operating income increased in 2000 by $31 million, or 10%, from 1999. The
increase was primarily due to significantly improved operating margins (revenues
less natural gas and purchased power expenses) from our Wholesale Energy
segment's trading and marketing activity in the western U.S. market (primarily
California and Nevada), increased operating margins (revenues less natural gas
expenses) from our Natural Gas Distribution segment and increased gathering and
processing revenues from our Pipelines and Gathering segment. These items were
partially offset by increased operating expenses, including:
o costs incurred in connection with non-rate regulated retail natural
gas business activities outside our established market areas, which
have been discontinued;
o additional provisions against receivable balances resulting from the
implementation of a new billing system for Reliant Energy Arkla;
o increased costs associated with higher staffing levels to support
increased sales and expanded trading and marketing efforts;
o increased depreciation expenses of our Natural Gas Distribution
segment; and
o increased employee benefit costs.
13
Our operating revenues for 2000 were $22.7 billion compared to $10.5
billion for 1999. The $12.2 billion, or 116%, increase was primarily due to the
increase in our Wholesale Energy segment's trading and marketing revenues from
increased trading volumes for power and natural gas, as well as higher sale
prices for these commodities.
Our operating expenses for 2000 were $22.3 billion compared to $10.2
billion in 1999. The $12.1 billion, or 118%, increase was primarily due to an
increase in volumes and cost of purchased power and natural gas, as discussed
above. Other operating expenses also increased due to the increase in expenses
discussed above.
Our effective tax rate in 2000 was 48.7% compared to 46.1% in 1999. This
increase was primarily due to an increase in state income taxes in 2000 as
compared to 1999.
We are reporting the results of RE Europe Trading as discontinued
operations for all periods presented in our consolidated financial statements in
accordance with APB Opinion No. 30. For additional information, please read Note
14 to our consolidated financial statements. Our European Energy segment was
created in the fourth quarter of 1999 with the acquisition of REPGB by a
subsidiary of Reliant Energy. Beginning in the second half of 2000, our European
Energy segment's trading and marketing operations began participating in the
emerging wholesale energy trading and marketing industry in Northwest Europe.
Losses from discontinued operations in 1999 and 2000 are primarily related to
start-up costs for our European trading and marketing operations. For additional
information regarding the operating results of the other entities transferred to
Reliant Resources, please read Note 14 to our consolidated financial statements.
CERTAIN FACTORS AFFECTING OUR FUTURE EARNINGS
Our past earnings are not necessarily indicative of our future earnings and
results of operations. The magnitude of our future earnings and results of our
operations will depend on numerous factors including:
o state, federal and international legislative and regulatory
developments and changes in or application of environmental and other
laws and regulations to which we are subject and changes in or
application of laws or regulations applicable to other aspects of our
business;
o the timing of the implementation of our parent company's Business
Separation Plan;
o the effects of competition, including the extent and timing of the
entry of additional competitors in our markets;
o liquidity concerns in our markets;
o industrial, commercial and residential growth in our service
territories;
o our pursuit of potential business strategies, including acquisitions
or dispositions;
o state, federal and other rate regulations in the United States;
o the timing and extent of changes in interest rates and commodity
prices, particularly natural gas;
o weather variations and other natural phenomena;
o our ability to cost-effectively finance and refinance;
o financial market conditions, our access to capital and the results of
our financing efforts;
o the credit worthiness or bankruptcy or other financial distress of our
trading, marketing and risk management services counterparties;
o actions by rating agencies with respect to us or our competitors;
14
o acts of terrorism or war;
o the availability and price of insurance; and
o political, legal, regulatory and economic conditions and developments
in the United States.
In order to adapt to the increasingly competitive environment in our
industry, we continue to evaluate a wide array of potential business strategies,
including business combinations or acquisitions involving other utility or
non-utility businesses or properties and dispositions of currently owned
businesses.
FACTORS AFFECTING THE RESULTS OF RERC OPERATIONS
Natural Gas Distribution. Our Natural Gas Distribution business segment
competes primarily with alternate energy sources such as electricity and other
fuel sources. In some areas, intrastate pipelines, other gas distributors and
marketers also compete directly with our Natural Gas Distribution business
segment for gas sales to end-users. In addition, as a result of federal
regulatory changes affecting interstate pipelines, natural gas marketers
operating on these pipelines may be able to bypass our Natural Gas Distribution
business segment's facilities and market, sell and/or transport natural gas
directly to commercial and industrial customers.
Generally, the regulations of the states in which our Natural Gas
Distribution business segment operates allow us to pass through changes in the
costs of natural gas to our customers through purchased gas adjustment
provisions in rates. There is, however, an inherent timing difference between
our purchases of natural gas and the ultimate recovery of these costs.
Consequently, we may incur additional "carrying" costs as a result of this
timing difference and the resulting, temporary under-recovery of our purchased
gas costs. To a large extent, these additional carrying costs are not recovered
from our customers.
On November 21, 2001, Arkla filed a rate case (Docket 01-243-U) with the
Arkansas Public Service Commission seeking an increase in rates for its Arkansas
customers of approximately $47 million on an annual basis. Arkla's last rate
increase was authorized in 1995. In the rate filing, Arkla maintains that its
rate base has grown by $183 million, and its operating expenses have increased
from $93 million to $106 million on an annual basis and, therefore, Arkla's
current rates for service to Arkansas customers do not provide a reasonable
opportunity for Arkla to cover its operating costs and earn a fair return on its
investment. A decision in the case is expected in the fall of 2002.
Pipelines and Gathering. Our Pipelines and Gathering business segment
competes with other interstate and intrastate pipelines in the transportation
and storage of natural gas. The principal elements of competition among
pipelines are rates, terms of service, and flexibility and reliability of
service. Our Pipelines and Gathering business segment competes indirectly with
other forms of energy available to its customers, including electricity, coal
and fuel oils. The primary competitive factor is price. Changes in the
availability of energy and pipeline capacity, the level of business activity,
conservation and governmental regulations, the capability to convert to
alternative fuels, and other factors, including weather, affect the demand for
natural gas in areas we serve and the level of competition for transportation
and storage services. Since FERC Order No. 636, REGT's and MRT's commodity sales
activity has been minimal. Commodity transactions are usually related to system
management activity which we have been able to manage with little exposure. We
have not been nor do we anticipate being negatively impacted by higher price
levels and the tightening of supply experienced in the fourth quarter of 2000
and the first quarter of 2001. In addition, competition for our gathering
operations is impacted by commodity pricing levels in its markets because these
prices influence the level of drilling activity in those markets.
Natural Gas Pipeline Company of America has proposed, and is soliciting
customers for a 30" pipeline paralleling MRT's East Line in Illinois to a point
17 miles east of St. Louis Metro, with a proposed in-service date of June 2002.
This service would represent an alternative to that provided by MRT. MRT has
renewed or is engaged in negotiations to renew service agreements under
multi-year terms, including service and potential expansion needs along MRT's
existing East Line in Illinois. Our Pipelines and Gathering business segment
derives approximately 14% of its revenues from Laclede Gas Company, which has an
annual evergreen term provision. In February 2002, MRT negotiated an agreement
to extend its existing service relationship with Laclede for a five year period
subject
15
to acceptance by the FERC. However, the Pipeline and Gathering business
segment's financial results could be materially adversely affected after this
five year period if Laclede decides to engage another pipeline for the
transportation services currently provided by the Pipeline and Gathering
business segment.
FLUCTUATIONS IN COMMODITY PRICES AND DERIVATIVE INSTRUMENTS
For information regarding our exposure to risk as a result of fluctuations
in commodity prices and derivative instruments, please read "Quantitative and
Qualitative Disclosures About Market Risk" in Item 7A of this Form 10-K.
ENVIRONMENTAL EXPENDITURES
We are subject to numerous environmental laws and regulations, which
require us to incur substantial costs to operate existing facilities, construct
and operate new facilities, and mitigate or remove the effect of past operations
on the environment. Our facilities are subject to state and federal laws and
regulations governing the discharge of pollutants into the air and waterways. In
many cases we must obtain permits or other governmental authorizations that
prescribe the parameters for discharges from our facilities. There are ongoing
efforts to modify standards relating to both the discharge of pollutants into
streams and waterways and to air quality. These efforts may result in more
restrictive regulations and permit terms applicable to our facilities in the
future. For additional information regarding environmental contingencies, please
read Note 10(c) to our consolidated financial statements.
Site Remediation Expenditures. From time to time we have received notices
from regulatory authorities or others regarding our status as a potentially
responsible party in connection with sites found to require remediation due to
the presence of environmental contaminants. Based on currently available
information, we believe that remediation costs will not materially affect our
financial position, results of operations or cash flows. There can be no
assurance, however, that future developments, including additional information
about existing sites or the identification of new sites, will not require
material revisions to our estimates. For information about specific sites that
are the subject of remediation claims, please read Note 10(c) to our
consolidated financial statements.
Mercury and Other Expenditures. With regard to mercury remediation and
other environmental matters, such as the disposal of solid wastes, our
expenditures have not been, and are not expected to be material, based on our
experiences and that of others in our industries. Please read "Business --
Environmental Matters -- Mercury Contamination" in Item 1 of this Form 10-K.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
IMPACT OF CHANGES IN INTEREST RATES AND ENERGY COMMODITY PRICES
RERC is exposed to various market risks. These risks arise from
transactions entered into in the normal course of business and are inherent in
RERC's consolidated financial statements. Most of the revenues and income from
our business activities are impacted by market risks. Categories of market risk
include exposure to commodity prices through non-trading activities and interest
rates. A description of each market risk is set forth below:
o Commodity price risk results from exposures to changes in spot prices,
forward prices and price volatilities of commodities, such as natural
gas and other energy commodities risk.
o Interest rate risk primarily results from exposures to changes in the
level of borrowings and changes in interest rates.
Management has established comprehensive risk management policies to
monitor and manage these market risks. We seek to manage these risk exposures
through the implementation of our risk management policies and framework. We
seek to manage our exposures through the use of derivative financial instruments
and derivative
16
commodity instrument contracts. During the normal course of business, we review
our hedging strategies and determine the hedging approach we deem appropriate
based upon the circumstances of each situation.
Derivative instruments such as futures, forward contracts, swaps or
options, derive their value from underlying assets, indices, reference
rates or a combination of these factors. These derivative instruments include
negotiated contracts, which are referred to as over-the-counter derivatives, and
instruments that are listed and traded on an exchange.
Derivative transactions are entered into in our non-trading operations to
manage and hedge certain exposures, such as exposure to changes in gas prices.
We believe that the associated market risk of these instruments can best be
understood relative to the underlying assets or risk being hedged.
INTEREST RATE RISK
We have issued long-term debt, RERC obligated mandatorily redeemable
preferred securities of subsidiary trusts holding solely our junior subordinated
debentures (Trust Preferred Securities), bank facilities, and some lease
obligations which subject us to the risk of loss associated with movements in
market interest rates.
At December 31, 2000 and 2001, we had issued fixed-rate debt and Trust
Preferred Securities aggregating $1.5 billion and $1.9 billion, respectively, in
principal amount and having a fair value of $1.5 billion and $1.9 billion,
respectively. These instruments are fixed-rate and, therefore, do not expose us
to the risk of loss in earnings due to changes in market interest rates (please
read Notes 6 and 7 to our consolidated financial statements). However, the fair
value of these instruments would increase by approximately $59 million if
interest rates were to decline by 10% from their levels at December 31, 2001. In
general, such an increase in fair value would impact earnings and cash flows
only if we were to reacquire all or a portion of these instruments in the open
market prior to their maturity.
Our floating-rate obligations aggregated $0.6 billion and $0.3 billion at
December 31, 2000 and 2001, respectively, (please read Note 6 to our
consolidated financial statements), inclusive of (a) amounts borrowed under our
short-term credit facilities (including the issuance of commercial paper
supported by these facilities), (b) borrowings underlying a receivables facility
and (c) amounts subject to a master leasing agreement under which lease payments
vary depending on short-term interest rates. These floating-rate obligations
expose us to the risk of increased interest and lease expense in the event of
increases in short-term interest rates. If the floating rates were to increase
by 10% from December 31, 2001 levels, our consolidated interest expense and
expense under operating leases would increase by an immaterial amount.
As discussed in Note 6(b) to our consolidated financial statements, RERC
Corp.'s $500 million aggregate principal amount of 6 3/8% Term Enhanced
Remarketable Securities (TERM Notes) include an embedded option to remarket the
securities. The option is expected to be exercised in the event that the
ten-year Treasury rate in 2003 is below 5.66%. At December 31, 2001, we could
terminate the option at a cost of $21 million. A decrease of 10% in the December
31, 2001 level of interest rates would increase the cost of termination of the
option by approximately $16 million.
COMMODITY PRICE RISK
Non-Trading Activities
To reduce our commodity price risk from market fluctuations in the revenues
derived from the sale of natural gas and related transportation, we enter into
forward contracts, swaps and options (Non-Trading Energy Derivatives) in order
to hedge some expected purchases of natural gas and sales of natural gas (a
portion of which are firm commitments at the inception of the hedge).
Non-trading Energy Derivatives are also utilized to fix the price of compressor
fuel or other future operational gas requirements and to protect natural gas
distribution earnings against unseasonably warm weather during peak gas heating
months, although usage to date for this purpose has not been material.
Derivative instruments, which we use as economic hedges, create exposure to
commodity prices, which we use to offset the commodity exposure inherent in our
businesses. The stand-alone commodity risk created by these instruments, without
regard to the offsetting effect of the underlying exposure these instruments are
intended to
17
hedge, is described below. We measure the commodity risk of our Non-trading
Energy Derivatives using a sensitivity analysis. The sensitivity analysis
performed on our Non-trading Energy Derivatives measures the potential loss in
earnings based on a hypothetical 10% movement in energy prices. An increase of
10% in the market prices of energy commodities from their December 31, 2001
levels would have decreased the fair value of our Non-trading Energy Derivatives
by $14 million.
The above analysis of the Non-trading Energy Derivatives utilized for
hedging purposes does not include the favorable impact that the same
hypothetical price movement would have on our physical purchases and sales of
natural gas to which the hedges relate. Furthermore, the Non-trading Energy
Derivative portfolio is managed to complement the physical transaction
portfolio, reducing overall risks within limits. Therefore, the adverse impact
to the fair value of the portfolio of Non-trading Energy Derivatives held for
hedging purposes associated with the hypothetical changes in commodity prices
referenced above would be offset by a favorable impact on the underlying hedged
physical transactions, assuming:
o the Non-trading Energy Derivatives are not closed out in advance of
their expected term;
o the Non-trading Energy Derivatives continue to function effectively as
hedges of the underlying risk; and
o as applicable, anticipated underlying transactions settle as expected.
If any of the above-mentioned assumptions ceases to be true, a loss on the
derivative instruments may occur, or the options might be worthless as
determined by the prevailing market value on their termination or maturity date,
whichever comes first. Non-trading Energy Derivatives intended as hedges, and
which are effective as hedges, may still have some percentage which is not
effective. The change in value of the Non-trading Energy Derivatives which
represents the ineffective component of the hedges, is recorded in our results
of operations. During 2001, we recognized a $3.6 million loss as a result of the
discontinuance of a cash flow hedge because it was no longer probable that the
forecasted transaction would occur due to credit problems of the customer.
Reliant Energy has established a Risk Oversight Committee comprised of
corporate and business segment officers that oversees all commodity price, and
credit risk activities, including Reliant Energy's trading, marketing, risk
management services and hedging activities. The committee's duties are to
establish Reliant Energy's commodity risk policies, allocate risk capital,
approve trading of new products and commodities, monitor risk positions and
ensure compliance with Reliant Energy's risk management policies and procedures
and trading limits established by Reliant Energy's board of directors.
Reliant Energy's policies prohibit the use of leveraged financial
instruments. A leveraged financial instrument, for this purpose, is a
transaction involving a derivative whose financial impact will be based on an
amount other than the notional amount or volume of the instrument.
18
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1999 2000 2001
------------ ------------ ------------
REVENUES .............................................. $ 10,531,849 $ 22,658,903 $ 5,044,419
EXPENSES:
Natural gas and purchased power ..................... 9,303,246 21,241,121 3,781,200
Operation and maintenance ........................... 625,392 758,824 657,515
Depreciation and amortization ....................... 198,664 214,259 207,203
Taxes other than income taxes ....................... 103,192 112,951 132,560
------------ ------------ ------------
10,230,494 22,327,155 4,778,478
------------ ------------ ------------
OPERATING INCOME ...................................... 301,355 331,748 265,941
------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense .................................... (119,500) (142,861) (154,965)
Distribution on trust preferred securities .......... (357) (29) (28)
Other, net .......................................... 11,154 2,642 14,583
------------ ------------ ------------
(108,703) (140,248) (140,410)
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES ............................................... 192,652 191,500 125,531
Income Tax Expense .................................. 88,781 93,272 58,287
------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS ..................... 103,871 98,228 67,244
Loss from Discontinued Operations ................... (3,670) (23,861) --
------------ ------------ ------------
NET INCOME ............................................ $ 100,201 $ 74,367 $ 67,244
============ ============ ============
</Table>
See Notes to RERC's Consolidated Financial Statements
19
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(THOUSANDS OF DOLLARS)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1999 2000 2001
------------ ------------ ------------
Net income ....................................................... $ 100,201 $ 74,367 $ 67,244
Other comprehensive (loss) income, net of tax:
Foreign currency translation adjustments from
discontinued operations, ( net of tax of $16 and
$1,340 in 1999 and 2000) .................................... 30 (2,490) --
Unrealized loss on available-for-sale securities (net
of tax of $373 and $1,492 in 1999 and 2000) ................. (1,224) (2,264) --
Reclassification adjustment for impairment loss on
available-for-sale securities realized in net income
(net of tax of $9,276) ...................................... -- 17,228 --
Additional minimum non-qualified pension liability
adjustment (net of tax of $6,068 and $4,703 in 2000
and 2001) ................................................... -- (9,747) 8,279
Cumulative effect of adoption of SFAS No. 133 ................. -- -- 38,092
Net deferred loss from cash flow hedges ....................... -- -- (11,826)
Reclassification of net deferred gains from cash flow
hedges realized in net income ............................... -- -- (61,449)
------------ ------------ ------------
Other comprehensive (loss) income ................................ (1,194) 2,727 (26,904)
------------ ------------ ------------
Comprehensive Income ............................................. $ 99,007 $ 77,094 $ 40,340
============ ============ ============
</Table>
See Notes to RERC's Consolidated Financial Statements
20
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
<Table>
<Caption>
DECEMBER 31,
-----------------------------
2000 2001
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ...................................... $ 22,576 $ 16,425
Accounts receivable, principally customers, net ................ 794,904 479,279
Unbilled revenue ............................................... 550,183 188,425
Accounts and notes receivable - affiliated companies, net ...... -- 39,393
Inventory ...................................................... 116,101 144,469
Non-trading derivative assets .................................. -- 6,996
Prepayments and other current assets ........................... 45,926 24,104
------------ ------------
Total current assets ................................ 1,529,690 899,091
------------ ------------
PROPERTY, PLANT AND EQUIPMENT, NET ............................... 3,029,357 3,158,885
------------ ------------
OTHER ASSETS:
Goodwill, net .................................................. 1,787,015 1,740,510
Prepaid pension asset .......................................... 141,882 94,022
Non-trading derivative assets .................................. -- 2,234
Other .......................................................... 87,821 94,221
------------ ------------
Total other assets .................................. 2,016,718 1,930,987
------------ ------------
TOTAL ASSETS ........................................ $ 6,575,765 $ 5,988,963
============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Short-term borrowings .......................................... $ 635,000 $ 345,527
Current portion of long-term debt .............................. 146,252 --
Accounts payable, principally trade ............................ 704,524 267,649
Accounts and notes payable -- affiliated companies, net ........ 134,707 --
Taxes accrued .................................................. 69,877 53,693
Interest accrued ............................................... 35,725 44,795
Customer deposits .............................................. 33,357 52,089
Non-trading derivative liabilities ............................. -- 59,075
Other .......................................................... 96,375 95,180
------------ ------------
Total current liabilities ........................... 1,855,817 918,008
------------ ------------
OTHER LIABILITIES:
Accumulated deferred income taxes, net ......................... 583,857 555,387
Non-trading derivative liabilities ............................. -- 9,826
Payable under capacity lease agreement ......................... 12,524 --
Benefit obligations ............................................ 175,144 177,559
Notes payable -- affiliated companies, net ..................... 21,718 27,311
Other .......................................................... 132,329 152,696
------------ ------------
Total other liabilities ............................. 925,572 922,779
------------ ------------
LONG-TERM DEBT ................................................... 1,392,798 1,927,039
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 10)
RERC OBLIGATED MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED
SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR
SUBORDINATED DEBENTURES OF RERC ................................ 608 555
------------ ------------
STOCKHOLDER'S EQUITY ............................................. 2,400,970 2,220,582
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY .......... $ 6,575,765 $ 5,988,963
============ ============
</Table>
See Notes to RERC's Consolidated Financial Statements
21
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------------------------
1999 2000 2001
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ....................................................... $ 100,201 $ 74,367 $ 67,244
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization .................................. 198,664 214,259 207,203
Deferred income taxes .......................................... 58,055 29,123 30,320
Impairment of marketable equity securities ..................... -- 26,504 --
Changes in other assets and liabilities:
Accounts and notes receivable, net .......................... (303,644) (1,984,240) 634,116
Accounts receivable/payable, affiliates ..................... (5,065) 15,016 17,497
Inventory ................................................... 79,776 (16,539) (22,048)
Accounts payable ............................................ 205,344 1,789,841 (436,875)
Fuel cost recovery .......................................... (16,940) 34,383 8,292
Interest and taxes accrued .................................. (15,381) 58,237 (7,114)
Margin deposits on energy trading activities ................ (59,468) (206,480) --
Federal tax refund .......................................... -- 26,278 --
Other current assets ........................................ (17,635) (118,836) 83,230
Other current liabilities ................................... (35,489) 4,242 17,537
Other assets ................................................ 14,708 47,831 (28,694)
Other liabilities ........................................... (51,416) (41,396) (9,673)
------------ ------------ ------------
Net cash provided by (used in) operating
activities ........................................... 151,710 (47,410) 561,035
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ............................................. (288,138) (290,565) (263,257)
Other, net ....................................................... (13,905) 31,475 (54,165)
------------ ------------ ------------
Net cash used in investing activities .................. (302,043) (259,090) (317,422)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt ....................................... (255,293) (221,500) (155,569)
Proceeds from long-term debt ..................................... -- 325,000 544,632
Increase (decrease) in short-term borrowings, net ................ 234,584 100,416 (289,473)
Increase (decrease) in notes with affiliates, net ................ 242,135 53,924 (186,004)
Dividends ........................................................ -- -- (400,000)
Capital contribution from Reliant Energy ......................... -- -- 241,352
Other, net ....................................................... (17,542) (8,891) (4,702)
------------ ------------ ------------
Net cash provided by (used in) financing
activities ........................................... 203,884 248,949 (249,764)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS .................................................... 53,551 (57,551) (6,151)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE
YEAR ........................................................... 26,576 80,127 22,576
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF THE YEAR ..................... $ 80,127 $ 22,576 $ 16,425
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest (net of amounts capitalized) .......................... $ 142,399 $ 138,365 $ 148,303
Income taxes ................................................... 85,415 62,144 116,272
</Table>
See Notes to RERC's Consolidated Financial Statements
22
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
STATEMENTS OF CONSOLIDATED STOCKHOLDER'S EQUITY
(THOUSANDS OF DOLLARS)
<Table>
<Caption>
ACCUMULATED
COMMON STOCK OTHER TOTAL
----------------------- PAID IN RETAINED COMPREHENSIVE STOCKHOLDER'S
SHARES AMOUNT CAPITAL EARNINGS INCOME (LOSS) EQUITY
---------- ---------- ------------ ---------- ------------- -------------
Balance at December 31, 1998 ............... 1,000 $ 1 $ 2,463,831 $ 114,671 $ (16,004) $ 2,562,499
---------- ---------- ------------ ---------- ---------- ------------
Net income ................................. 100,201 100,201
Other comprehensive loss, net of tax:
Foreign currency translation
adjustments from discontinued
operations ............................. 30 30
Unrealized loss on available-for-sale
securities ............................. (1,224) (1,224)
---------- ---------- ------------ ---------- ---------- ------------
Balance at December 31, 1999 ............... 1,000 1 2,463,831 214,872 (17,198) 2,661,506
---------- ---------- ------------ ---------- ---------- ------------
Net income ................................. 74,367 74,367
Other comprehensive income, net of tax:
Foreign currency translation
adjustments from discontinued
operations ............................. (2,490) (2,490)
Unrealized loss on available-for-sale
securities ............................. (2,264) (2,264)
Reclassification adjustment for
impairment loss on available-for-sale
securities realized in net income ...... 17,228 17,228
Additional minimum non-qualified
pension liability adjustment ........... (9,747) (9,747)
Transfer of subsidiaries to Reliant
Resources, Inc. .......................... (53,115) (289,239) 4,724 (337,630)
---------- ---------- ------------ ---------- ---------- ------------
Balance at December 31, 2000 ............... 1,000 1 2,410,716 -- (9,747) 2,400,970
---------- ---------- ------------ ---------- ---------- ------------
Net income ................................. 67,244 67,244
Dividend to parent ......................... (334,593) (65,407) (400,000)
Transfer of benefits to parent ............. (62,080) (62,080)
Contributions from parent .................. 241,352 241,352
Other comprehensive loss, net of tax:
Cumulative effect of adoption of SFAS
No. 133 ................................ 38,092 38,092
Net deferred loss from cash flow hedges .. (11,826) (11,826)
Reclassification of net deferred gains
from cash flow hedges realized in net
income ................................. (61,449) (61,449)
Additional minimum non-qualified
pension liability adjustment ........... 8,279 8,279
---------- ---------- ------------ ---------- ---------- ------------
Balance at December 31, 2001 ............... 1,000 $ 1 $ 2,255,395 $ 1,837 $ (36,651) $ 2,220,582
========== ========== ============ ========== ========== ============
</Table>
See Notes to RERC's Consolidated Financial Statements
23
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
Reliant Energy Resources Corp. (RERC Corp.), together with its subsidiaries
(collectively, RERC), distributes natural gas, transports natural gas through
its interstate pipelines and provides natural gas gathering and pipeline
services. Prior to 2001, RERC provided energy services including wholesale
energy trading, marketing, power origination and risk management services in
North America and Western Europe. RERC Corp. is a Delaware corporation and a
wholly owned subsidiary of Reliant Energy, Incorporated (Reliant Energy).
RERC's natural gas distribution operations (Natural Gas Distribution) are
conducted by three unincorporated divisions (Reliant Energy Entex (Entex),
Reliant Energy Minnegasco (Minnegasco) and Reliant Energy Arkla (Arkla)) and
other non-rate regulated retail gas marketing operations. RERC's pipelines and
gathering operations (Pipelines and Gathering) are primarily conducted by two
wholly owned pipeline subsidiaries, Reliant Energy Gas Transmission Company
(REGT) and Mississippi River Transmission Corporation (MRT) and a wholly owned
gas gathering subsidiary, Reliant Energy Field Services, Inc. (REFS). RERC's
principal operations are located in Arkansas, Louisiana, Minnesota, Mississippi,
Missouri, Oklahoma and Texas.
RERC's wholesale energy trading, marketing, power origination and risk
management activities in North America were conducted primarily by Reliant
Energy Services, Inc. (Reliant Energy Services), a wholly owned subsidiary of
RERC prior to January 1, 2001. RERC's European energy trading and marketing
activities were conducted by Reliant Energy Europe Trading & Marketing, Inc. (RE
Europe Trading), a wholly owned subsidiary of RERC Corp. prior to January 1,
2001. See Note 2 regarding Reliant Energy's separation plan.
(2) RELIANT ENERGY'S SEPARATION PLAN
Reliant Energy is in the process of separating its regulated and
unregulated businesses into two publicly traded companies. In December 2000,
Reliant Energy transferred a significant portion of its unregulated businesses
to Reliant Resources, Inc. (Reliant Resources), which, at the time, was a wholly
owned subsidiary. Reliant Resources conducted an initial public offering of
approximately 20% of its common stock in May 2001. In December 2001, Reliant
Energy's shareholders approved an agreement and plan of merger by which the
following will occur (which we refer to as the Restructuring):
o CenterPoint Energy, Inc. (CenterPoint Energy), currently a wholly
owned subsidiary of Reliant Energy, will become the holding company
for Reliant Energy and its subsidiaries;
o Reliant Energy and its subsidiaries will become subsidiaries of
CenterPoint Energy; and
o each share of Reliant Energy common stock will be converted into one
share of CenterPoint Energy common stock.
After the Restructuring, Reliant Energy plans, subject to further corporate
approvals, market and other conditions, to complete the separation of its
regulated and unregulated businesses by distributing its remaining equity
interest in the common stock of Reliant Resources to its shareholders
(Distribution). Reliant Energy's goal is to complete the Restructuring and
subsequent Distribution as quickly as possible after all the necessary
conditions are fulfilled, including receipt of an order from the Securities and
Exchange Commission (SEC) granting the required approvals under the Public
Utility Holding Company Act of 1935 (1935 Act) and an extension from the IRS of
a private letter ruling that Reliant Energy has obtained regarding the tax-free
treatment of the Distribution. Although receipt or timing of regulatory
approvals cannot be assured, Reliant Energy believes it meets the standards for
such approvals. RERC currently expects Reliant Energy to complete the
Restructuring and Distribution in the summer of 2002.
RERC Corp. Restructuring
Following the Restructuring, CenterPoint Energy will be a utility holding
company under the 1935 Act and as such will be required to register under the
1935 Act unless it qualifies for an exemption. In order to enable CenterPoint
Energy to comply with the requirements in the exemption in Section 3(a)(1) of
the 1935 Act, Reliant Energy plans to divide the gas distribution businesses
conducted by RERC Corp.'s three unincorporated divisions, Entex, Arkla and
Minnegasco, among three separate business entities. The entity that will hold
the Entex assets will also hold RERC Corp.'s natural gas pipelines and gathering
businesses. In addition to regulatory approvals Reliant Energy has obtained,
this restructuring will require approval of the public service commissions of
Louisiana, Oklahoma and Arkansas.
On December 31, 2000, RERC Corp. transferred all of the outstanding stock
of Reliant Energy Services
24
International, Inc. (RESI), Arkla Finance Corporation (Arkla Finance) and RE
Europe Trading, all wholly owned subsidiaries of RERC Corp., to Reliant
Resources (collectively, the Stock Transfer). Both RERC Corp. and Reliant
Resources are subsidiaries of Reliant Energy. As a result of the Stock Transfer,
RESI, Arkla Finance and RE Europe Trading each became a wholly owned subsidiary
of Reliant Resources.
Also, on December 31, 2000, a wholly owned subsidiary of Reliant Resources
merged with and into Reliant Energy Services, Inc. (Reliant Energy Services), a
wholly owned subsidiary of RERC Corp., with Reliant Energy Services as the
surviving corporation (Merger). As a result of the Merger, Reliant Energy
Services became a wholly owned subsidiary of Reliant Resources. As consideration
for the Merger, Reliant Resources paid $94 million to RERC Corp.
Prior to January 1, 2001, Reliant Energy Services, RESI and RE Europe
Trading conducted the trading, marketing, power origination and risk management
business and operations of RERC. Arkla Finance is a company that holds an
investment in marketable equity securities. The Stock Transfer and the Merger
are part of Reliant Energy's previously announced restructuring.
RERC is reporting the results of RE Europe Trading as discontinued
operations for all periods presented in RERC's consolidated financial statements
in accordance with Accounting Principles Board (APB) Opinion No. 30 (APB Opinion
No. 30).
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Reclassifications and Use of Estimates.
Some amounts from the previous years have been reclassified to conform to
the 2001 presentation of financial statements. These reclassifications do not
affect earnings.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
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.
(b) Market Risk and Uncertainties.
RERC is subject to the risk associated with price movements of energy
commodities and, historically, the credit risk associated with RERC's risk
management activities. For additional information regarding these risks, see
Note 5. RERC is also subject to risks relating to the supply and prices of
natural gas, seasonal weather patterns, technological obsolescence and
regulatory environment in the United States.
(c) Principles of Consolidation.
The accounts of RERC and its wholly owned and majority owned subsidiaries
are included in RERC's consolidated financial statements. All significant
intercompany transactions and balances are eliminated in consolidation. Other
investments, excluding marketable securities, are carried at cost.
(d) Revenues.
RERC records natural gas sales and services under the accrual method and
these revenues are generally recognized upon delivery. Natural gas sales and
services not billed by month-end are accrued based upon estimated purchased gas
volumes, estimated lost and unaccounted for gas and tariffed rates in effect.
Pipelines and Gathering records revenues as transportation services are
provided. RERC's energy trading and marketing operations were accounted for
under mark-to-market accounting, as discussed in Note 5.
25
(e) Long-lived Assets and Intangibles.
RERC records property, plant and equipment at historical cost. RERC expenses
all repair and maintenance costs as incurred. The cost of utility plant and
equipment retirements is charged to accumulated depreciation. Property, plant
and equipment includes the following:
<Table>
<Caption>
DECEMBER 31,
ESTIMATED USEFUL ------------------------------
LIVES (YEARS) 2000 2001
---------------- ------------ ------------
(IN MILLIONS)
Natural gas distribution ................... 5-50 $ 1,809 $ 2,002
Pipelines and gathering .................... 5-75 1,582 1,627
Other property ............................. 3-20 38 56
------------ ------------
Total .................................. 3,429 3,685
Accumulated depreciation ................... (400) (526)
------------ ------------
Property, plant and equipment, net ..... $ 3,029 $ 3,159
============ ============
</Table>
RERC records goodwill for the excess of the purchase price over the fair
value assigned to the net assets of an acquisition. Goodwill is generally
amortized on a straight-line basis over 40 years. RERC had $170 million and $219
million accumulated goodwill amortization at December 31, 2000 and 2001,
respectively. RERC's goodwill is primarily related to Reliant Energy's merger
with RERC Corp. in 1997. The acquisition of RERC by Reliant Energy was recorded
under the purchase method of accounting. The purchase price was pushed down to
RERC.
RERC periodically evaluates long-lived assets, including property, plant
and equipment, goodwill and specifically identifiable intangibles, when events
or changes in circumstances indicate that the carrying value of these assets may
not be recoverable. The determination of whether an impairment has occurred is
based on an estimate of undiscounted cash flows attributable to the assets, as
compared to the carrying value of the assets. To date, no impairment has been
indicated. RERC adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142)
on January 1, 2002. RERC is in the process of determining the effect of adoption
of SFAS No. 142 on its consolidated financial statements. For additional
information related to SFAS No. 142, see Note 3(p).
(f) Regulatory Assets.
RERC applies the accounting policies established in SFAS No. 71 "Accounting
for the Effects of Certain Types of Regulation" (SFAS No. 71) to the accounts of
the utility operations of Natural Gas Distribution and MRT. As of December 31,
2000 and 2001, RERC had recorded $5 million and $3 million, respectively, of net
regulatory assets.
If, as a result of changes in regulation or competition, RERC's ability to
recover these assets and liabilities would not be assured, then pursuant to SFAS
No. 101, "Regulated Enterprises Accounting for the Discontinuation of
Application of SFAS No. 71" (SFAS No. 101) and SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
(SFAS No. 121), RERC would be required to write off or write down these
regulatory assets and liabilities. In addition, RERC would be required to
determine any impairment to the carrying costs of plant and inventory assets.
(g) Depreciation and Amortization Expense.
Depreciation is computed using the straight-line method based on economic
lives or a regulatory mandated method. Other amortization expense includes
amortization of regulatory assets and other intangibles.
26
The following table presents depreciation, goodwill amortization and other
amortization expense for 1999, 2000 and 2001.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------------------
1999 2000 2001
---------- ---------- ----------
(IN MILLIONS)
Depreciation expense ....................... $ 143 $ 153 $ 146
Goodwill amortization expense .............. 53 54 49
Other amortization expense ................. 3 7 12
---------- ---------- ----------
Total depreciation and amortization .... $ 199 $ 214 $ 207
========== ========== ==========
</Table>
(h) Capitalization of Interest.
Interest and allowance for funds used during construction (AFUDC) related
to debt for subsidiaries that apply SFAS No. 71 are capitalized as a component
of projects under construction and will be amortized over the assets' estimated
useful lives. During 1999, 2000 and 2001, RERC capitalized interest and AFUDC
related to debt of $1.9 million, $2.0 million and $0.2 million, respectively.
(i) Income Taxes.
RERC is included in the consolidated income tax returns of Reliant Energy.
RERC calculates its income tax provision on a separate return basis under a tax
sharing agreement with Reliant Energy. RERC uses the liability method of
accounting for deferred income taxes and measures deferred income taxes for all
significant income tax temporary differences. Investment tax credits were
deferred and are being amortized over the estimated lives of the related
property. Current federal and certain state income taxes are payable to or
receivable from Reliant Energy. For additional information regarding income
taxes, see Note 9.
(j) Accounts Receivable and Allowance for Doubtful Accounts.
Accounts and notes receivable, principally customers, net, are net of an
allowance for doubtful accounts of $33 million at December 31, 2000 and 2001.
The provisions for doubtful accounts in RERC's Statements of Consolidated Income
for 1999, 2000 and 2001 were $16 million, $32 million and $46 million,
respectively.
(k) Inventory.
Inventory consists principally of materials and supplies, natural gas and
heating oil and is valued at the lower of average cost or market. Inventory
includes the following components:
<Table>
<Caption>
DECEMBER 31,
-------------------------
2000 2001
---------- ----------
(IN MILLIONS)
Materials and supplies .......... $ 33 $ 33
Natural gas ..................... 83 111
---------- ----------
Total inventory ............. $ 116 $ 144
========== ==========
</Table>
(l) Investment in Other Debt and Equity Securities.
In accordance with SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" (SFAS No. 115), RERC reports "available-for-sale"
securities at estimated fair value in RERC's Consolidated Balance Sheets and any
unrealized gain or loss, net of tax, as a separate component of stockholder's
equity and accumulated other comprehensive income (loss).
During 2000, pursuant to SFAS No. 115, RERC incurred a pre-tax impairment
loss on marketable equity securities classified as "available-for-sale" equal to
$27 million of cumulative unrealized losses which was recorded in other income
(expense) in RERC's Statements of Consolidated Income. Management's
determination to recognize this impairment resulted from a combination of events
occurring in 2000 related to this investment. Such events affecting the
investment included changes occurring in the investment's senior management,
announcement of
27
significant restructuring charges and related downsizing for the entity, reduced
earnings estimates for this entity by brokerage analysts and the bankruptcy of a
competitor of the investment in the first quarter of 2000. These events, coupled
with the stock market value of RERC's investment in these securities continuing
to be below RERC's cost basis, caused management to believe the decline in fair
value of these "available-for-sale" securities to be other than temporary. On
December 31, 2000, RERC transferred all of the outstanding capital stock of
Arkla Finance, which holds this investment, to Reliant Resources as described in
Note 2. As of December 31, 2000 and 2001, RERC held no "available-for-sale"
securities.
(m) Environmental Costs.
RERC expenses or capitalizes environmental expenditures, as appropriate,
depending on their future economic benefit. RERC expenses amounts that relate to
an existing condition caused by past operations and that do not have future
economic benefit. RERC records undiscounted liabilities related to these future
costs when environmental assessments and/or remediation activities are probable
and the costs can be reasonably estimated. Subject to SFAS No. 71, a
corresponding regulatory asset is recorded in anticipation of recovery through
the rate making process by subsidiaries that apply SFAS No. 71 in some
circumstances.
(n) Foreign Currency Adjustments.
RERC considered the local currency the functional currency of RE Europe
Trading prior to its transfer as described in Note 2. Foreign subsidiaries'
assets and liabilities were translated into U.S. dollars using the exchange rate
at the balance sheet date. Revenues, expenses, gains and losses were translated
using the weighted average exchange rate for each year prevailing during the
periods reported. Cumulative adjustments resulting from translation were
recorded in stockholder's equity in other comprehensive income (loss).
(o) Statements of Consolidated Cash Flows.
For purposes of reporting cash flows, RERC considers cash equivalents to be
short-term, highly liquid investments with maturities of three months or less
from the date of purchase.
(p) Changes in Accounting Principles and New Accounting Pronouncements.
Staff Accounting Bulletin No. 101, "Revenue Recognition" (SAB No. 101), was
issued by the SEC on December 3, 1999. SAB No. 101 summarizes certain of the SEC
staff's views in applying generally accepted accounting principles to revenue
recognition in financial statements. The consolidated financial statements
reflect the accounting guidance provided in SAB No. 101.
For a discussion of the effect of the adoption of SFAS No. 133 on RERC's
consolidated financial statements, see Note 5.
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141 "Business Combinations" (SFAS No. 141) and SFAS No. 142. SFAS No. 141
requires business combinations initiated after June 30, 2001 to be accounted for
using the purchase method of accounting and broadens the criteria for recording
intangible assets separate from goodwill. Recorded goodwill and intangibles will
be evaluated against these new criteria and may result in certain intangibles
being transferred to goodwill, or alternatively, amounts initially recorded as
goodwill may be separately identified and recognized apart from goodwill. SFAS
No. 142 provides for a nonamortization approach, whereby goodwill and certain
intangibles with indefinite lives will not be amortized into results of
operations, but instead will be reviewed periodically for impairment and written
down and charged to results of operations only in the periods in which the
recorded value of goodwill and certain intangibles with indefinite lives is more
than its fair value. RERC adopted the provisions of each statement which apply
to goodwill and intangible assets acquired prior to June 30, 2001 on January 1,
2002. The adoption of SFAS No. 141 did not have a material impact on RERC's
historical results of operations or financial position. On January 1, 2002, RERC
discontinued amortizing goodwill into the results of operations pursuant to SFAS
No. 142. RERC recognized $49 million of goodwill amortization expense in the
Statements of Consolidated Income during 2001. RERC is in the process of
determining further effects of adoption of SFAS No. 142 on its consolidated
financial statements. RERC anticipates finalizing its review of goodwill and
certain intangible assets during 2002.
28
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations" (SFAS No. 143). SFAS No. 143 requires the fair value of
a liability for an asset retirement legal obligation to be recognized in the
period in which it is incurred. When the liability is initially recorded,
associated costs are capitalized by increasing the carrying amount of the
related long-lived asset. 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. SFAS No. 143 is effective for fiscal years beginning after
June 15, 2002, with earlier adoption encouraged. SFAS No. 143 requires entities
to record a cumulative effect of a change in accounting principle in the income
statement in the period of adoption. RERC plans to adopt SFAS No. 143 on January
1, 2003 and is in the process of determining the effect of adoption on its
consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets" (SFAS No. 144). SFAS No. 144 provides new
guidance on the recognition of impairment losses on long-lived assets to be held
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. SFAS No. 144 supercedes SFAS No. 121
and APB Opinion No. 30, while retaining many of the requirements of these two
statements. Under SFAS No. 144, assets held for sale that are a component of an
entity will be included in discontinued operations if the operations and cash
flows will be or have been eliminated from the ongoing operations of the entity
and the entity will not have any significant continuing involvement in the
operations prospectively. SFAS No. 144 is effective for fiscal years beginning
after December 15, 2001, with early adoption encouraged. SFAS No. 144 is not
expected to materially change the methods used by RERC to measure impairment
losses on long-lived assets, but may result in additional future dispositions
being reported as discontinued operations than was previously permitted. RERC
adopted SFAS No. 144 on January 1, 2002.
(4) RELATED PARTY TRANSACTIONS
From time to time, RERC has advanced to or borrowed money from Reliant
Energy or its subsidiaries. As of December 31, 2000, included in accounts and
notes payable-affiliated companies, RERC had net short-term borrowings of $59
million and net accounts payable of $76 million. As of December 31, 2001,
included in accounts and notes receivable-affiliated companies, RERC had net
short-term receivables of $132 million, partially offset by net accounts payable
of $93 million. As of December 31, 2000 and 2001, RERC had net long term
borrowings, included in notes payable-affiliated companies, totaling $22 million
and $27 million, respectively. Net interest income on these borrowings was $6
million, $3 million and $5 million in 1999, 2000 and 2001, respectively.
In 1999 and 2000, Reliant Energy Services supplied natural gas to,
purchased electricity for resale from, and provided marketing and risk
management services to unregulated power plants in deregulated markets acquired
or operated by Reliant Energy Power Generation, Inc., an indirect wholly owned
subsidiary of Reliant Energy, or its subsidiaries. In 2001, RERC supplied
natural gas to Reliant Energy Services, now a subsidiary of Reliant Resources
(see Note 2). During 1999, 2000 and 2001, the sales and services to Reliant
Energy and its affiliates totaled $197 million, $816 million and $181 million,
respectively. Purchases from Reliant Energy and its affiliates were $118
million, $391 million and $639 million in 1999, 2000 and 2001, respectively.
Reliant Energy provides some corporate services to RERC including various
corporate support services (including accounting, finance, investor relations,
planning, legal, communications, governmental and regulatory affairs and human
resources), information technology services and other shared services (such as
corporate security, facilities management, accounts receivable, accounts
payable, payroll, office support services, customer care services and purchasing
and logistics). The costs of services have been directly charged or allocated to
RERC 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 and allocations are not necessarily indicative of what would have been
incurred had RERC been a separate entity. Amounts charged and allocated to RERC
for these services were $34 million, $32 million and $31 million for 1999, 2000
and 2001, respectively, and are included primarily in operation and maintenance
expenses. Some
29
subsidiaries of RERC have entered into office rental agreements with Reliant
Energy. In 1999, 2000 and 2001, RERC paid $2 million, $3 million and $2 million,
respectively, of rent expense to Reliant Energy.
In February 2001, RERC Corp. paid a dividend to Reliant Energy from the
proceeds of a debt offering as discussed in Note 6(b). In May 2001, Reliant
Energy made a $236 million capital contribution to RERC Corp. and RERC Corp.
subsequently invested the $236 million with a financing subsidiary of Reliant
Energy, which is not a subsidiary of RERC.
(5) DERIVATIVE INSTRUMENTS
Effective January 1, 2001, RERC adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" as amended (SFAS No. 133), which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. This statement requires that derivatives be recognized at
fair value in the balance sheet and that changes in fair value be recognized
either currently in earnings or deferred as a component of other comprehensive
income, depending on the intended use of the derivative instrument as hedging
(a) the exposure to changes in the fair value of an asset or liability (Fair
Value Hedge) or (b) the exposure to variability in expected future cash flows
(Cash Flow Hedge) or (c) the foreign currency exposure of a net investment in a
foreign operation. For a derivative not designated as a hedging instrument, the
gain or loss is recognized in earnings in the period it occurs.
Adoption of SFAS No. 133 on January 1, 2001 resulted in a cumulative
after-tax increase in accumulated other comprehensive income of $38 million. The
adoption also increased current assets, long-term assets, current liabilities
and long-term liabilities by approximately $88 million, $5 million, $53 million
and $2 million, respectively, in RERC's Consolidated Balance Sheet. During the
year ended December 31, 2001, $34 million of the initial after-tax transition
adjustment recognized in other comprehensive income was recognized in net
income.
During the third quarter of 2001, the FASB cleared an issue related to
application of the normal purchases and normal sales exception to contracts that
combine forward and purchased option contracts. The effective date of this
guidance is April 1, 2002, and RERC is currently assessing the impact of this
cleared issue and does not believe it will have a material impact on RERC's
consolidated financial statements.
RERC is exposed to various market risks. These risks are inherent in RERC's
consolidated financial statements and arise from transactions entered into in
the normal course of business. RERC utilizes derivative financial instruments
such as physical forward contracts, swaps and options (Energy Derivatives) to
mitigate the impact of changes and cash flows of its natural gas on its
operating results and cash flows.
(a) Non-Trading Activities.
Cash Flow Hedges. To reduce the risk from market fluctuations in revenues
and the resulting cash flows derived from the sale of natural gas, RERC may
enter into Energy Derivatives in order to hedge certain expected purchases and
sales of natural gas (Non-trading Energy Derivatives). In 2001 these
transactions were entered into with Reliant Energy Services, an affiliated
company (See Note 2). The Non-trading Energy Derivative portfolios are managed
to complement the physical transaction portfolio, reducing overall risks within
authorized limits.
RERC applies hedge accounting for its Non-trading Energy Derivatives
utilized in non-trading activities only if there is a high correlation between
price movements in the derivative and the item designated as being hedged. This
correlation, a measure of hedge effectiveness, is measured both at the inception
of the hedge and on an ongoing basis, with an acceptable level of correlation of
at least 80% to 120% for hedge designation. If and when correlation ceases to
exist at an acceptable level, hedge accounting ceases and mark-to-market
accounting is applied. During 2001, the amount of hedge ineffectiveness
recognized in earnings from derivatives that are designated and qualify as Cash
Flow Hedges was immaterial. No component of the derivative instruments' loss was
excluded from the assessment of effectiveness. If it becomes probable that an
anticipated transaction will not occur, RERC realizes in net income the deferred
gains and losses recognized in accumulated other comprehensive loss. During the
year ended December 31, 2001, there was a $3.6 million deferred loss recognized
in earnings as a result of the discontinuance of cash flow hedges because it was
no longer probable that the forecasted transaction would occur due to credit
problems of a customer. Once the anticipated transaction occurs, the accumulated
deferred gain or loss
30
recognized in accumulated other comprehensive loss is reclassified and included
in RERC's Statements of Consolidated Income under the caption "Natural Gas and
Purchased Power." Cash flows resulting from these transactions in Non-trading
Energy Derivatives are included in the Statements of Consolidated Cash Flows in
the same category as the item being hedged. As of December 31, 2001, RERC's
current non-trading derivative assets and liabilities and corresponding amounts
in accumulated other comprehensive gain or loss were expected to be reclassified
into net income during the next twelve months.
The maximum length of time RERC is hedging its exposure to the variability
in future cash flows for forecasted transactions on existing financial
instruments is primarily two years with a limited amount of exposure up to three
years. RERC's policy is not to exceed five years in hedging its exposure.
(b) Energy Trading, Marketing and Price Risk Management Activities.
During 2000 and in prior years, RERC offered energy, price risk management
services through a subsidiary, Reliant Energy Services. In December 2000,
Reliant Energy Services was transferred to an affiliated company. Reliant Energy
Services offered energy price risk management services primarily related to
natural gas, electric power and other energy related commodities. Reliant Energy
Services provided these services by utilizing a variety of derivative financial
instruments, including (a) fixed and variable-priced physical forward contracts,
(b) fixed and variable-priced swap agreements, (c) options traded in the
over-the-counter financial markets and (d) exchange-traded energy futures and
option contracts (Trading Derivatives). Fixed-price swap agreements require
payments to, or receipts of payments from, counterparties based on the
differential between a fixed and variable price for the commodity.
Variable-price swap agreements require payments to, or receipts of payments
from, counterparties based on the differential between industry pricing
publications or exchange quotations.
RERC applied mark-to-market accounting for all of its energy trading,
marketing and price risk management operations. Accordingly, these Trading
Derivatives were recorded at fair value with realized and unrealized gains
(losses) recorded as a component of revenues prior to the Merger. There were no
recognized, unrealized balances (energy trading, marketing and price risk
management assets/liabilities) as of December 31, 2000 and 2001.
(c) Credit Risks.
In addition to the risk associated with price movements, credit risk is
also inherent in RERC's non-trading derivative activities. Credit risk relates
to the risk of loss resulting from non-performance of contractual obligations by
a counterparty. RERC enters into financial transactions to hedge purchases and
sales with Reliant Energy Services as the counterparty since December 2000.
Reliant Energy Services, an affiliated company, enters into financial
transactions with unaffiliated parties to complete the hedge transaction and
assumes the risk of loss from unaffiliated parties. As of December 31, 2001, the
counterparty for all of RERC's non-trading derivative assets and liabilities was
Reliant Energy Services.
(d) Trading and Non-trading - General Policy.
Reliant Energy has established a Risk Oversight Committee comprised of
corporate and business segment officers that oversees all commodity price and
credit risk activities, including Reliant Energy's trading, marketing, risk
management services and hedging activities. The committee's duties are to
establish Reliant Energy's commodity risk policies, allocate risk capital within
limits established by Reliant Energy's board of directors, approve trading of
new products and commodities, monitor risk positions and ensure compliance with
Reliant Energy's risk management policies and procedures and trading limits
established by Reliant Energy's board of directors.
Reliant Energy's policies prohibit the use of leveraged financial
instruments. A leveraged financial instrument, for this purpose, is a
transaction involving a derivative whose financial impact will be based on an
amount other than the notional amount or volume of the instrument.
31
(6) LONG-TERM DEBT AND SHORT-TERM BORROWINGS
<Table>
<Caption>
DECEMBER 31, 2000 DECEMBER 31, 2001
------------------------- -------------------------
LONG-TERM CURRENT(1) LONG-TERM CURRENT(1)
---------- ---------- ---------- ----------
(IN MILLIONS)
Short-term borrowings:
Receivables facility ........................... $ 350 $ 346
Commercial paper ............................... 285 --
---------- ----------
Total short-term borrowings .................. 635 346
---------- ----------
Long-term debt(2):
Convertible debentures 6.0% due 2012 ........... $ 93 -- $ 82 --
Debentures 6.38% to 8.90% due 2003 to 2011 ..... 1,285 -- 1,833 --
Notes payable 8.77% to 9.23% paid 2001 ......... -- 146 -- --
Unamortized discount and premium ................. 15 -- 12 --
---------- ---------- ---------- ----------
Total long-term debt ......................... 1,393 146 1,927 --
---------- ---------- ---------- ----------
Total borrowings ............................. $ 1,393 $ 781 $ 1,927 $ 346
========== ========== ========== ==========
</Table>
- ----------
(1) Includes amounts due within one year of the date.
(2) Included in long term debt is additional unamortized premium related to
fair value adjustments of long-term debt of $12 million and $9 million at
December 31, 2000 and 2001, respectively. These fair value adjustments
resulted from Reliant Energy's acquisition of RERC and are being amortized
over the remaining term of the related long-term debt.
(a) Short-term Borrowings.
In 2001, RERC met its short-term financing needs primarily through a trade
receivables facility (Receivables Facility) and the issuance of commercial paper
in addition to advances from subsidiaries of Reliant Energy. RERC has a $350
million revolving credit facility (RERC Credit Facility) that expires in 2003.
The RERC Credit Facility is used to support RERC's issuance of up to $350
million of commercial paper and includes a $65 million sub-facility under which
letters of credit may be obtained. Borrowings under the RERC Credit Facility are
unsecured and bear interest at a rate based upon either the London interbank
offered rate (LIBOR) plus a margin, a base rate or a rate determined through a
bidding process. As of December 31, 2000, RERC had $285 million of commercial
paper outstanding with a weighted average interest rate of 8.38%. As of December
31, 2001, RERC had no commercial paper outstanding. Letters of credit
outstanding under the sub-facility aggregated $65 million and $2.5 million as of
December 31, 2000 and 2001, respectively.
Under the Receivables Facility, which expires in August 2002, RERC sells,
with limited recourse, an undivided interest (limited to a maximum of $350
million as of December 31, 2000 and 2001) in a designated pool of accounts
receivable. The amount advanced under the Receivables Facility was $350 million
and $346 million at December 31, 2000 and 2001, respectively. The weighted
average interest rate was approximately 6.58% and 2.03% at December 31, 2000 and
December 31, 2001, respectively. Fees and interest expense for 1999, 2000 and
2001 aggregated $19 million, $24 million and $15 million, respectively. The size
of the receivables facility was increased from $300 million to $350 million in
August 1999. For information on the reduction in the size of the facility in
2002, see Note 15.
32
(b) Long-term Debt.
Consolidated maturities of long-term debt and sinking fund requirements,
which are $7 million per year, for RERC are $-0- in 2002, $502 million in 2003,
$7 million in 2004, $332 million in 2005 and $152 million in 2006. The 2002 and
2003 amounts are net of accumulated sinking fund payments.
At December 31, 2000 and 2001, RERC Corp. had issued and outstanding $98
million and $86 million, respectively, aggregate principal amount ($93 million
and $82 million, respectively, carrying amount) of its 6% Convertible
Subordinated Debentures due 2012 (Subordinated Debentures). The holders of the
Subordinated Debentures receive interest quarterly and have the right at any
time on or before the maturity date thereof to convert each Subordinated
Debenture into 0.65 shares of Reliant Energy common stock and $14.24 in cash. At
Restructuring, each Subordinated Debenture is convertible into 0.65 shares of
CenterPoint Energy stock and $14.24 in cash. At Distribution, each Subordinated
Debenture is convertible into an increased number of CenterPoint Energy shares
based on a formula in the indenture governing the Subordinated Debentures, and
$14.24 in cash. During 2001, RERC Corp. purchased $11 million aggregate
principal amount of its Subordinated Debentures.
RERC Corp.'s $500 million aggregate principal amount of 6 3/8% Term
Enhanced ReMarketable Securities (TERM Notes) provide an investment bank with a
call option, which gives it the right to have the TERM Notes redeemed from the
investors on November 1, 2003 and then remarketed if it chooses to exercise the
option. The TERM Notes are unsecured obligations of RERC Corp. which bear
interest at an annual rate of 6 3/8% through November 1, 2003. On November 1,
2003, the holders of the TERM Notes are required to tender their notes at 100%
of their principal amount. The portion of the proceeds attributable to the call
option premium will be amortized over the stated term of the securities. If the
option is not exercised by the investment bank, RERC Corp. will repurchase the
TERM Notes at 100% of their principal amount on November 1, 2003. If the option
is exercised, the TERM Notes will be remarketed on a date, selected by RERC
Corp., within the 52-week period beginning November 1, 2003. During this period
and prior to remarketing, the TERM Notes will bear interest at rates, adjusted
weekly, based on an index selected by RERC Corp. If the TERM Notes are
remarketed, the final maturity date of the TERM Notes will be November 1, 2013,
subject to adjustment, and the effective interest rate on the remarketed TERM
Notes will be 5.66% plus RERC Corp.'s applicable credit spread at the time of
such remarketing.
In February 2001, RERC Corp. issued $550 million of unsecured notes that
bear interest at 7.75% per year and mature in February 2011. Net proceeds to
RERC Corp. were $545 million. RERC Corp. used the net proceeds from the sale of
the notes to pay a $400 million dividend to Reliant Energy, and for general
corporate purposes. Reliant Energy used the $400 million proceeds from the
dividend for general corporate purposes, including the repayment of short-term
borrowings.
(c) Restrictions on Debt.
RERC Corp.'s facilities contain various business and financial covenants
requiring RERC Corp. to, among other things, maintain leverage (as defined in
the credit facilities), below specified ratios. These covenants are not
anticipated to materially restrict RERC Corp. from borrowing funds or obtaining
letters of credit under these facilities. As of December 31, 2001, RERC Corp.
was in compliance with these debt covenants.
(7) TRUST PREFERRED SECURITIES
In June 1996, a Delaware statutory business trust created by RERC Corp.
(RERC Trust) issued $173 million aggregate amount of convertible preferred
securities to the public. RERC Corp. accounts for RERC Trust as a wholly owned
consolidated subsidiary. RERC Trust used the proceeds of the offering to
purchase convertible junior subordinated debentures issued by RERC Corp. having
an interest rate and maturity date that correspond to the distribution rate and
mandatory redemption date of the convertible preferred securities. The
convertible junior subordinated debentures represent RERC Trust's sole assets
and its entire operations. RERC Corp. considers its obligation under the Amended
and Restated Declaration of Trust, Indenture and Guaranty Agreement relating to
the convertible preferred securities, taken together, to constitute a full and
unconditional guarantee by RERC Corp. of RERC Trust's obligations with respect
to the convertible preferred securities.
33
The convertible preferred securities are mandatorily redeemable upon the
repayment of the convertible junior subordinated debentures at their stated
maturity or earlier redemption. Each convertible preferred security is
convertible at the option of the holder into $33.62 of cash and 1.55 shares of
Reliant Energy common stock. At Restructuring, each convertible preferred
security is convertible into 1.55 shares of CenterPoint Energy common stock and
$33.62 in cash. At Distribution, each convertible preferred security is
convertible into an increased number of shares of CenterPoint Energy common
stock based on a formula in the indenture governing the junior subordinated
debentures and $33.62 in cash. During 2000 and 2001, convertible preferred
securities of $0.3 million and $0.04 million, respectively, were converted. As
of December 31, 2000 and 2001, $0.4 million liquidation amount of convertible
preferred securities were outstanding. The securities, and their underlying
convertible junior subordinated debentures, bear interest at 6.25% and mature in
June 2026. Subject to some limitations, RERC Corp. has the option of deferring
payments of interest on the convertible junior subordinated debentures. During
any deferral or event of default, RERC Corp. may not pay dividends on its common
stock to Reliant Energy. As of December 31, 2001, no interest payments on the
convertible junior subordinated debentures had been deferred.
(8) STOCK-BASED INCENTIVE COMPENSATION PLANS AND EMPLOYEE BENEFIT PLANS
(a) Incentive Compensation Plans.
RERC participates in Reliant Energy's Long-Term Incentive Compensation
Plans (LICP) and other incentive compensation plans that provide for the
issuance of stock-based incentives, including performance-based shares,
performance-based units, restricted shares, stock options and stock appreciation
rights, to key employees of RERC, including officers. Stock-based incentive
expense information presented herein represents RERC's portion of the overall
plans. As of December 31, 2001, 138 current and 7 former employees of RERC
participate in the plans.
Performance-based shares, performance-based units and restricted shares are
granted to employees without cost to the participants. The performance shares
and units vest three years after the grant date based upon the performance of
Reliant Energy and its subsidiaries over a three-year cycle except as discussed
below. The restricted shares vest to the participants at various times ranging
from immediate vesting to vesting at the end of a three-year period. Upon
vesting, the shares are issued to the plans' participants. During 1999 and 2000,
RERC recorded compensation expense of $1 million and $4 million, respectively,
related to performance-based shares and restricted share grants. During 2001,
the amounts recorded for compensation expense were immaterial.
Assuming the Distribution occurs during calendar year 2002, Reliant
Energy's compensation committee will authorize the conversion of outstanding
Reliant Energy performance-based shares for the performance cycle ending
December 31, 2002 to a number of time-based restricted shares of Reliant
Energy's common stock equal to the number of performance-based shares that would
have vested if the performance objectives for the performance cycle were
achieved at the maximum level. These time-based restricted shares will vest if
the participant holding the shares remains employed with RERC or its affiliates
through December 31, 2002. At Distribution, holders of these time-based
restricted shares will receive shares of Reliant Resources common stock in the
same manner as other holders of Reliant Energy common stock, but these shares of
common stock will be subject to the same time-based vesting schedule as well as
the terms and conditions of the plan under which the original performance-based
shares were granted. Thus, following the Distribution, employees who held
performance-based shares under the LICP for the performance cycle ending
December 31, 2002 will hold time-based restricted shares of Reliant Energy
common stock and time-based restricted shares of Reliant Resources common stock
which will vest following continuous employment through December 31, 2002.
Reliant Energy stock options generally become exercisable in one-third
increments on each of the first through third anniversaries of the grant date.
The exercise price is the average of the high and low sales price of the common
stock on the New York Stock Exchange on the grant date. RERC applies APB Opinion
No. 25, "Accounting for Stock Issued to Employees" (APB Opinion No. 25), and
related interpretations in accounting for its stock option plans. Accordingly,
no compensation expense has been recognized for these fixed stock options.
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation"
(SFAS No. 123), RERC applies the guidance contained in APB Opinion No. 25 and
discloses the required pro forma effect on net income of the fair value based
method of accounting for stock compensation. The weighted average fair values at
date of grant for Reliant Energy options granted to RERC employees during 1999,
2000 and 2001 were $3.13, $5.07 and $9.25, respectively, and were estimated
using the Black-Scholes option valuation model with the following
weighted-average assumptions:
34
<Table>
<Caption>
1999 2000 2001
---------- ---------- ----------
Expected life in years ..................... 5 5 5
Interest rate .............................. 5.10% 6.57% 4.87%
Volatility ................................. 21.23% 24.00% 31.91%
Expected common stock dividend ............. $ 1.50 $ 1.50 $ 1.50
</Table>
Pro forma information for 1999, 2000 and 2001 is provided to take into
account the amortization of stock-based compensation to expense on a straight
line basis over the vesting period. Had compensation costs been determined as
prescribed by SFAS No. 123, RERC's net income would have been reduced by $1
million in 1999, and $2 million in 2000 and 2001, respectively.
(b) Pension.
RERC employees participate in Reliant Energy's pension plan which is a
noncontributory defined benefit plan covering substantially all employees in the
United States and certain employees in foreign countries. The benefit accrual is
in the form of a cash balance credit of 4% of annual pay. Prior to 1999, the
pension plan accrued benefits based on years of service, final average pay and
covered compensation. As a result, certain employees participating in the plan
as of December 31, 1998 are eligible for transition benefits through 2008.
Reliant Energy's funding policy is to review amounts annually in accordance
with applicable regulations in order to achieve adequate funding of projected
benefit obligations. The assets of the pension plan consist principally of
common stocks and interest-bearing obligations. Included in such assets are
RERC's proportionate share of 4.5 million shares of Reliant Energy common stock
contributed from Reliant Energy treasury stock during 2001. As of December 31,
2001, the fair value of Reliant Energy common stock was 8.7% of plan assets. The
net periodic pension benefits, prepaid pension costs and benefit obligation of
RERC have been determined based on the employees of RERC and their respective
compensation levels.
Net pension cost for RERC includes the following components:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------------------
1999 2000 2001
---------- ---------- ----------
(IN MILLIONS)
Service cost -- benefits earned during the period ..... $ 15 $ 12 $ 16
Interest cost on projected benefit obligation ......... 35 33 36
Expected return on plan assets ........................ (61) (62) (51)
Net amortization ...................................... (2) (4) --
---------- ---------- ----------
Net pension (benefit) cost ............................ $ (13) $ (21) $ 1
========== ========== ==========
</Table>
35
Reconciliations of RERC's beginning and ending balances of its retirement
plan benefit obligation, plan assets and funded status for 2000 and 2001 are set
forth below:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------
2000 2001
---------- ----------
(IN MILLIONS)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning of year ................. $ 447 $ 499
Service cost .......................................... 12 16
Interest cost ......................................... 33 36
Benefits paid ......................................... (41) (40)
Transfer to affiliate ................................. (1) --
Transfer of obligation to non-qualified plan .......... (10) --
Actuarial loss ........................................ 59 41
---------- ----------
Benefit obligation, end of year ....................... $ 499 $ 552
========== ==========
CHANGE IN PLAN ASSETS
Plan assets, beginning of year ........................ $ 620 $ 598
Employer contribution ................................. -- 39
Benefits paid ......................................... (41) (40)
Transfer to affiliate ................................. (1) (86)
Actual investment gain (loss) (1) ..................... 20 (11)
---------- ----------
Plan assets, end of year .............................. $ 598 $ 500
========== ==========
RECONCILIATION OF FUNDED STATUS
Funded status ......................................... $ 99 $ (52)
Unrecognized prior service cost ....................... (45) (35)
Unrecognized actuarial loss ........................... 88 181
---------- ----------
Net amount recognized at end of year .................. $ 142 $ 94
========== ==========
ACTUARIAL ASSUMPTIONS
Discount rate ......................................... 7.5% 7.25%
Rate of increase in compensation levels ............... 3.5-5.5% 3.5-5.5%
Expected long-term rate of return on assets ........... 10.0% 9.5%
</Table>
(1) Since RERC participates in Reliant Energy's defined benefit plan, RERC's
pension assets are allocated proportional to RERC's obligation in the plan.
Therefore, the investment gain (loss) may fluctuate due to the change in
obligations as well as investment performance.
RERC employees participate in Reliant Energy's non-qualified pension plans
which allowed participants to retain the benefits to which they would have been
entitled under its noncontributory pension plans except for the federally
mandated limits on these benefits or on the level of salary on which these
benefits may be calculated. The expense associated with these non-qualified
plans was $1 million, $13 million and $5 million in 1999, 2000 and 2001,
respectively. The accrued benefit liability for the nonqualified pension plan
was $49 million and $40 million at December 31, 2000 and December 31, 2001,
respectively. In addition, these accrued benefit liabilities include the
recognition of minimum liability adjustments of $19 million as of December 31,
2000 and $3 million as of December 31, 2001, which are reported as a component
of comprehensive income, net of income tax effects.
RERC's prepaid pension asset is presented in the Consolidated Balance
Sheets under the caption Other Assets - Prepaid Pension Asset.
(c) Savings Plan.
Employees of RERC participate in Reliant Energy's savings plans, which
qualify as cash or deferred arrangements under Section 401(k) of the Internal
Revenue Code of 1986, as amended (the Code). Under Reliant Energy's plans,
participating employees may contribute a portion of their compensation, pre-tax
or after-tax, generally up to a maximum of 16% of compensation. The Company
matches 75% to 125% (based on certain performance goals achieved) of the first
6% of each employee's compensation contributed, with most matching contributions
subject to a vesting schedule. Substantially all of Reliant Energy's match is
invested in Reliant Energy
36
common stock. Given the concentration of the investments in Reliant Energy's
common stock, the savings plan and its participants have vulnerability to
volatility of Reliant Energy's common stock. Reliant Energy allocates to RERC
the savings plan benefit expense related to the employees of RERC.
Savings plan benefit expense related to RERC was $10 million, $18 million
and $12 million in 1999, 2000 and 2001, respectively.
(d) Postretirement Benefits.
RERC employees participate in Reliant Energy's plans which provide certain
healthcare and life insurance benefits for retired employees on a contributory
and non-contributory basis. Employees become eligible for these benefits if they
have met certain age and service requirements at retirement, as defined in the
plans. Under plan amendments effective in early 1999, health care benefits for
future retirees were changed to limit employer contributions for medical
coverage. Such benefit costs are accrued over the active service period of
employees.
Reliant Energy is required to fund a portion of its obligations in
accordance with rate orders. All other obligations are funded on a pay-as-you-go
basis.
The net postretirement benefit cost includes the following components:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------------------
1999 2000 2001
---------- ---------- ----------
(IN MILLIONS)
Service cost -- benefits earned during the period ..... $ 2 $ 2 $ 2
Interest cost on projected benefit obligation ......... 9 9 9
Expected return on plan assets ........................ (1) (1) (1)
Net amortization ...................................... 2 1 2
---------- ---------- ----------
Net postretirement benefit cost ....................... $ 12 $ 11 $ 12
========== ========== ==========
</Table>
37
Following are reconciliations of RERC's beginning and ending balances of
its postretirement benefit plans benefit obligation, plan assets and funded
status for 2000 and 2001.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
---------------------------
2000 2001
---------- ----------
(IN MILLIONS)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning of year ................. $ 116 $ 130
Service cost .......................................... 2 2
Interest cost ......................................... 9 9
Benefits paid ......................................... (10) (12)
Participant contributions ............................. 1 2
Plan amendments ....................................... 3 --
Actuarial (gain) loss ................................. 9 --
---------- ----------
Benefit obligation, end of year ....................... $ 130 $ 131
========== ==========
CHANGE IN PLAN ASSETS
Plan assets, beginning of year ........................ $ 9 $ 12
Benefits paid ......................................... (10) (12)
Employer contributions ................................ 11 17
Participant contributions ............................. 1 2
Actual investment return .............................. 1 (1)
---------- ----------
Plan assets, end of year .............................. $ 12 $ 18
========== ==========
RECONCILIATION OF FUNDED STATUS
Funded status ......................................... $ (118) $ (113)
Unrecognized prior service cost ....................... 27 21
Unrecognized actuarial gain ........................... (12) (10)
---------- ----------
Net amount recognized at end of year .................. $ (103) $ (102)
========== ==========
ACTUARIAL ASSUMPTIONS
Discount rate ......................................... 7.5% 7.25%
Expected long-term rate of return on assets ........... 10.0% 9.5%
Health care cost trend rates -- Under 65 .............. 8.0% 7.5%
Health care cost trend rates -- 65 and over ........... 9.0% 8.5%
</Table>
The assumed health care rates gradually decline to 5.5% for both medical
categories by 2010. The actuarial gains and losses are due to changes in
actuarial assumptions.
If the health care cost trend rate assumptions were increased by 1%, the
accumulated postretirement benefit obligation as of December 31, 2001 would
increase by approximately 3.5%. The annual effect of the 1% increase on the
total of the service and interest costs would be an increase of approximately
2.9%. If the health care cost trend rate assumptions were decreased by 1%, the
accumulated postretirement benefit obligation as of December 31, 2001 would
decrease by approximately 3.6%. The annual effect of the 1% decrease on the
total of the service and interest costs would be a decrease of 3.0%.
RERC's postretirement obligation is presented as a liability in the
Consolidated Balance Sheet under the caption Benefit Obligations.
(e) Postemployment Benefits.
Net postemployment benefit costs for former or inactive employees, their
beneficiaries and covered dependents, after employment but before retirement
(primarily health care and life insurance benefits for participants in the
long-term disability plan), were $11 million, $1 million and $3 million in 1999,
2000 and 2001, respectively.
RERC's postemployment obligation is presented as a liability in the
Consolidated Balance Sheet under the caption Benefit Obligations.
38
(f) Other Non-qualified Plans.
RERC participates in Reliant Energy's deferred compensation plans which
permit eligible participants to elect each year to defer a percentage of up to
100% of that year's salary and that year's annual bonus. In general, employees
who attain the age of 60 during employment and participate in Reliant Energy's
deferred compensation plans may elect to have their deferred compensation
amounts repaid in (a) 15 equal annual installments commencing at the later of
age 65 or termination of employment or (b) a lump-sum distribution following
termination of employment. Interest generally accrues on deferrals at a rate
equal to the average Moody's Long-Term Corporate Bond Index plus 2%, determined
annually until termination when the rate is fixed at the greater of the rate in
effect at age 64 or at age 65. During 1999, 2000 and 2001, RERC recorded
interest expense related to its deferred compensation obligation of $1 million
each year. The discounted deferred compensation obligation recorded by RERC was
$10 million and $14 million as of December 31, 2000 and 2001, respectively.
RERC's obligations under other non-qualified plans are presented as a
liability in the Consolidated Balance Sheets under the caption Benefit
Obligations.
(g) Other Employee Matters.
As of December 31, 2001, approximately 28% of RERC's employees were subject
to collective bargaining arrangements, of which contracts covering 9% of RERC's
employees will expire prior to December 31, 2002.
(h) Transfer of Benefit Assets and Liabilities.
During the three months ended March 31, 2001, RERC Corp. had net
distributions to Reliant Energy related to various benefit assets and
obligations, net of deferred taxes, of $62 million.
(9) INCOME TAXES
The components of income from continuing operations before taxes are as
follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------------------
1999 2000 2001
---------- ---------- ----------
(IN MILLIONS)
United States .................................................... $ 193 $ 177 $ 126
Foreign .......................................................... -- 15 --
---------- ---------- ----------
Income from continuing operations before income taxes .......... $ 193 $ 192 $ 126
========== ========== ==========
</Table>
RERC's current and deferred components of income tax expense are as
follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------------------
1999 2000 2001
---------- ---------- ----------
(IN MILLIONS)
Current
Federal ....................... $ 27 $ 52 $ 31
State ......................... 4 9 (3)
Foreign ....................... -- 3 --
---------- ---------- ----------
Total current ............. 31 64 28
---------- ---------- ----------
Deferred
Federal ....................... 53 24 29
State ......................... 5 1 1
Foreign ....................... -- 4 --
---------- ---------- ----------
Total deferred ............ 58 29 30
---------- ---------- ----------
Income tax expense .............. $ 89 $ 93 $ 58
========== ========== ==========
</Table>
39
A reconciliation of the federal statutory income tax rate to the effective
income tax rate is as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1999 2000 2001
---------- ---------- ----------
(IN MILLIONS)
Income from continuing operations before income taxes ...... $ 193 $ 192 $ 126
Federal statutory rate ................................... 35% 35% 35%
---------- ---------- ----------
Income tax expense at statutory rate ....................... 68 67 44
---------- ---------- ----------
Increase (decrease) in tax resulting from:
State income taxes, net of valuation allowances and
federal income tax benefit(1) .......................... 5 6 (1)
Goodwill amortization .................................... 18 18 16
Other, net ............................................... (2) 2 (1)
---------- ---------- ----------
Total ................................................ 21 26 14
---------- ---------- ----------
Income tax expense ......................................... $ 89 $ 93 $ 58
========== ========== ==========
Effective Rate ............................................. 46.1% 48.7% 46.4%
</Table>
- ----------
(1) Calculation of the accrual for state income taxes at the end of each year
requires that RERC estimate the manner in which its income for that year
will be allocated and/or apportioned among the various states in which it
conducts business, where states have widely differing tax rules and rates.
These allocation/apportionment factors change from year to year and the
amount of taxes ultimately payable may differ from that estimated as a part
of the accrual process. For these reasons, the amount of state income tax
expense may vary significantly from year to year, even in the absence of
significant changes to state income tax valuation allowances or changes in
individual state income tax rates.
Following were RERC's tax effects of temporary differences between the
carrying amounts of assets and liabilities in the financial statements and their
respective tax bases:
<Table>
<Caption>
DECEMBER 31,
------------------------------
2000 2001
------------ ------------
(IN MILLIONS)
Deferred tax assets:
Current:
Non-trading derivative liabilities, net ...................... $ -- $ 19
Allowance for doubtful accounts .............................. 17 15
------------ ------------
Total current deferred tax assets .......................... 17 34
Non-current:
Employee benefits ............................................ 45 70
Operating loss carryforwards ................................. 63 28
Alternative minimum tax and other credit carryforwards ....... 25 --
Non-trading derivative liabilities, net ...................... -- 2
Other ........................................................ 37 43
Valuation allowance .......................................... (48) (15)
------------ ------------
Total non-current deferred tax assets ..................... 122 128
------------ ------------
Total deferred tax assets ................................. 139 162
------------ ------------
Deferred tax liabilities:
Non-current:
Depreciation ................................................. 574 584
Deferred gas costs ........................................... 58 28
Deferred state income taxes .................................. 69 69
Other ........................................................ 22 36
------------ ------------
Total deferred tax liabilities ............................. 723 717
------------ ------------
Accumulated deferred income taxes, net ..................... $ 584 $ 555
============ ============
</Table>
40
Tax Attribute Carryforwards. At December 31, 2001, RERC had $7 million and
$388 million of federal and state tax net operating loss carryforwards,
respectively. The loss carryforwards are available to offset future respective
federal and state taxable income through the year 2021.
The valuation allowance reflects a net increase of $29 million in 2000 and
a net decrease of $33 million in 2001. These net changes resulted from a
reassessment of RERC's future ability to use state tax net operating loss
carryforwards.
Tax Refund Case. In December 2000, RERC received a refund from the IRS of
$32 million in taxes and interest following an audit of its tax returns and
refund claims for the 1979 through 1993 tax years. Interest of $26 million
related to the period prior to the acquisition of RERC by Reliant Energy was
recorded as a reduction of goodwill. The income statement effect of $4 million
(after-tax) was recorded in RERC's Statement of Consolidated Income in 2000. All
of RERC Corp.'s consolidated federal income tax returns for tax years ending on
or prior to the date of Reliant Energy's acquisition of RERC have been audited
and settled.
(10) COMMITMENTS AND CONTINGENCIES
(a) Capital and Environmental Commitments.
RERC has various commitments for capital and environmental expenditures.
RERC anticipates investing up to $6 million in capital and other special project
expenditures between 2002 and 2006 for environmental compliance.
(b) Lease Commitments.
The following table sets forth information concerning RERC's obligations
under non-cancelable long-term operating leases principally consisting of rental
agreements for building space, data processing equipment and vehicles, including
major work equipment (in millions):
<Table>
2002 ........................ $ 14
2003 ........................ 12
2004 ........................ 7
2005 ........................ 6
2006 ........................ 5
2007 and beyond ............. 66
--------
Total ............. $ 110
========
</Table>
Total rental expense for all operating leases was $33 million, $33 million
and $32 million in 1999, 2000 and 2001, respectively.
(b) Transportation Agreement.
Prior to the merger of a subsidiary of Reliant Energy and RERC Corp., a
predecessor of Reliant Energy Services entered into a transportation agreement
(ANR Agreement) with ANR Pipeline Company (ANR) that contemplated a transfer to
ANR of an interest in some of RERC's pipelines and related assets. The interest
represented capacity of 250 million cubic feet (Mmcf)/day. Under the ANR
Agreement, an ANR affiliate advanced $125 million to RERC. Subsequently, the
parties restructured the ANR Agreement and RERC refunded in 1993 and 1995, $34
million and $50 million, respectively, to ANR. RERC has agreed to reimburse
Reliant Energy Services for any transportation payments made under the ANR
agreement and for the refund of the $41 million. In RERC's Consolidated Balance
Sheet, RERC has recorded a long-term notes payable to Reliant Energy Services of
$31 million and a deferred obligation to ANR of $10 million as of December 31,
2001.
(c) Environmental Matters.
Hydrocarbon Contamination. On August 24, 2001, 37 plaintiffs filed suit
against Reliant Energy Gas Transmission Company, Inc., Reliant Energy Pipeline
Services, Inc., RERC, Reliant Energy Services, Inc., and other Reliant Energy
entities and third parties (Docket No. 460, 916-Div. "B"), in the 1st Judicial
District Court, Caddo Parish,
41
Louisiana. The petition has now been supplemented five times. As of March 11,
2002, there were 628 plaintiffs, a majority of whom are Louisiana residents who
live near the Wilcox Aquifer. In addition to the Reliant Energy entities, the
plaintiffs have sued the State of Louisiana through its Department of
Environmental Quality, several individuals, some of whom are present employees
of the State of Louisiana, the Bayou South Gas Gathering Company, L.L.C., Martin
Timber Company, Inc., and several trusts.
The suit alleges that, at some unspecified date prior to 1985, the
defendants allowed or caused hydrocarbon or chemical contamination of the Wilcox
Aquifer which lies beneath property owned or leased by the defendants and which
is the sole or primary drinking water aquifer in the area. The primary source of
the contamination is alleged by the plaintiffs to be a gas processing facility
in Haughton, Bossier Parish, Louisiana known as the "Sligo Facility." This
facility was purportedly used for gathering natural gas from surrounding wells,
separating gasoline and hydrocarbons from the natural gas for marketing, and
transmission of natural gas for distribution. This site was originally leased
and operated by predecessors of Reliant Energy Gas Transmission Company in the
late 1940s and was operated until Arkansas Louisiana Gas Company ceased
operations of the plant in the late 1970s.
Beginning about 1985, the predecessors of certain Reliant Energy defendants
engaged in a voluntary remediation of any subsurface contamination of the
groundwater below the property they own or lease. This work has been done in
conjunction with and under the direction of the Louisiana Department of
Environmental Quality. The plaintiffs seek monetary damages for alleged damage
to the aquifer underlying their property, unspecified alleged personal injuries,
alleged fear of cancer, alleged property damage or dimunition of value of their
property, and in addition seek damages for trespass, punitive, and exemplary
damages. The quantity of monetary damages sought is unspecified. As of December
31, 2001, RERC is unable to estimate the monetary damages, if any, that
the plaintiffs may be awarded in this matter.
Manufactured Gas Plant Sites. RERC and its predecessors operated a
manufactured gas plant (MGP) until 1960 adjacent to the Mississippi River in
Minnesota formerly known as Minneapolis Gas Works (MGW). RERC has substantially
completed remediation of the main site other than ongoing water monitoring and
treatment. The manufactured gas was stored in separate holders. RERC is
negotiating cleanup of one such holder. There are six other former MGP sites in
the Minnesota service territory. Remediation has been completed on one site. Of
the remaining five sites, RERC believes that two were neither owned nor operated
by RERC. RERC believes it has no liability with respect to the sites it neither
owned nor operated.
At December 31, 2000 and 2001, RERC had accrued $18 million and $23
million, respectively, for remediation of the Minnesota sites. At December 31,
2001, the estimated range of possible remediation costs was $11 million to $49
million. The cost estimates of the MGW site are based on studies of that site.
The remediation costs for the other sites are based on industry average costs
for remediation of sites of similar size. The actual remediation costs will be
dependent upon the number of sites remediated, the participation of other
potentially responsible parties (PRP), if any, and the remediation methods used.
Issues relating to the identification and remediation of MGPs are common in
the natural gas distribution industry. RERC has received notices from the United
States Environmental Protection Agency and others regarding its status as a PRP
for other sites. Based on current information, RERC has not been able to
quantify a range of environmental expenditures for potential remediation
expenditures with respect to other MGP sites.
Other Minnesota Matters. At December 31, 2000 and 2001, RERC had recorded
accruals of $4 million and $5 million, respectively for other environmental
matters in Minnesota for which remediation may be required. At December 31,
2001, the estimated range of possible remediation costs was $4 million to $8
million.
Mercury Contamination. RERC's pipeline and distribution operations have in
the past employed elemental mercury in measuring and regulating equipment. It is
possible that small amounts of mercury may have been spilled in the course of
normal maintenance and replacement operations and that these spills may have
contaminated the immediate area with elemental mercury. This type of
contamination has been found by RERC at some sites in the past, and RERC has
conducted remediation at sites found to be contaminated. Although RERC is not
aware of additional specific sites, it is possible that other contaminated sites
may exist and that remediation costs may be incurred for these sites. Although
the total amount of these costs cannot be known at this time, based on
experience by RERC and that of others in the natural gas industry to date and on
the current regulations regarding remediation
42
of these sites, RERC believes that the costs of any remediation of these sites
will not be material to RERC's financial position, results of operations or cash
flows.
Potentially Responsible Party Notifications. From time to time RERC has
received notices from regulatory authorities or others regarding its status as a
PRP in connection with sites found to require remediation due to the presence of
environmental contaminants. Considering the information currently known about
such sites and the involvement of RERC in activities at these sites, RERC does
not believe that these matters will have a material adverse effect on RERC's
financial position, results of operations or cash flows.
(d) Other Legal Matters.
California Wholesale Market. Reliant Energy, Reliant Energy Services, Inc.
(a wholly owned subsidiary of Reliant Resources), Reliant Energy Power
Generation, Inc. (a wholly owned subsidiary of Reliant Resources) and several
other subsidiaries of Reliant Resources, as well as three officers of some of
these companies, have been named as defendants in class action lawsuits and
other lawsuits filed against a number of companies that own generation plants in
California and other sellers of electricity in California markets. RERC had also
been named as a defendant in one of these actions. Plaintiffs have voluntarily
dismissed Reliant Energy from two of the three class actions in which it was
named as a defendant. Plaintiffs have also voluntarily dismissed RERC from the
one action in which it was named as a defendant.
Natural Gas Measurement Lawsuits. In 1997, a suit was filed under the
Federal False Claim Act against RERC, REGT and REFS alleging mismeasurement of
natural gas produced from federal and Indian lands. The suit seeks undisclosed
damages, along with statutory penalties, interest, costs, and fees. The
complaint is part of a larger series of complaints filed against 77 natural gas
pipelines and their subsidiaries and affiliates. An earlier single action making
substantially similar allegations against the pipelines was dismissed by the
U.S. District Court for the District of Columbia on grounds of improper joinder
and lack of jurisdiction. As a result, the various individual complaints were
filed in numerous courts throughout the country. This case was consolidated,
together with the other similar False Claim Act cases filed and transferred to
the District of Wyoming. Motions to dismiss were denied. The defendants intend
to vigorously contest this case.
In addition, RERC, REGT, REFS and MRT have been named as defendants in a
class action filed in May 1999 against approximately 245 pipeline companies and
their affiliates. The plaintiffs in the case purport to represent a class of
natural gas producers and fee royalty owners who allege that they have been
subject to systematic gas mismeasurement by the defendants, including certain
Reliant Energy entities, for more than 25 years. The plaintiffs seek
compensatory damages, along with statutory penalties, treble damages, interest,
costs and fees. The action is currently pending in state court in Stevens
County, Kansas. Plaintiffs initially sued Reliant Energy Services, but that
company was dismissed without prejudice on June 8, 2001. Other Reliant Energy
entities that were misnamed or duplicative have also been dismissed. MRT and
REFS have filed motions to dismiss for lack of personal jurisdiction and are
currently responding to discovery on personal jurisdiction. All four Reliant
Energy defendants have joined in a motion to dismiss.
The defendants plan to raise significant affirmative defenses based on
the terms of the applicable contacts, as well as on the broad waivers and
releases in take or pay settlements that were granted by the producer-sellers
of natural gas who are putative class members.
Other. RERC is a party to other litigation (other than that specifically
noted) which arises in the normal course of business. Management regularly
analyzes current information and, as necessary, provides accruals for probable
liabilities on the eventual disposition of these matters. Management believes
that the effects, if any, from the disposition of these matters will not have a
material adverse effect on RERC's financial position, results of operations or
cash flows.
43
(11) ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of cash and cash equivalents, investments in debt and
equity securities classified as "available-for-sale" and "trading" in accordance
with SFAS No. 115, and short-term borrowings are estimated to be equivalent to
carrying amounts and have been excluded from the table below. The fair values of
non-trading derivative assets and liabilities are recognized in the Consolidated
Balance Sheets at December 31, 2001 (see Note 5). Therefore, these financial
instruments are stated at fair value and are excluded from the table below. The
fair values of non-trading derivative assets and liabilities as of December 31,
2000 have been determined using quoted market prices for the same or similar
instruments when available or other estimation techniques.
<Table>
<Caption>
DECEMBER 31, 2000
-------------------------
CARRYING FAIR
AMOUNT VALUE
---------- ----------
(IN MILLIONS)
Financial assets:
Energy derivatives -- non-trading ................... $ -- $ 93
Financial liabilities:
Long-term debt (excluding capital leases) ........... 1,539 1,543
Trust preferred securities .......................... 1 1
Energy derivatives -- non-trading ................... -- 34
</Table>
<Table>
<Caption>
DECEMBER 31, 2001
-------------------------
CARRYING FAIR
AMOUNT VALUE
---------- ----------
(IN MILLIONS)
Financial liabilities:
Long-term debt (excluding capital leases) ........... 1,927 1,948
Trust preferred securities .......................... 1 1
</Table>
(12) UNAUDITED QUARTERLY INFORMATION
Summarized quarterly financial data is as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31, 2000
----------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- ----------
(IN MILLIONS)
Operating revenues .................................... $ 3,093 $ 4,013 $ 7,263 $ 8,290
Operating income ...................................... 155 16 9 152
Income (loss) from continuing operations .............. 59 (9) (19) 67
Loss from discontinued operations, net of tax ......... (4) (4) (8) (8)
Net income (loss) ..................................... 55 (13) (27) 59
</Table>
<Table>
<Caption>
YEAR ENDED DECEMBER 31, 2001
----------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- ----------
(IN MILLIONS)
Operating revenues .................................... $ 2,423 $ 960 $ 669 $ 992
Operating income (loss) ............................... 174 (16) 5 103
Net income (loss) ..................................... 80 (34) (27) 48
</Table>
(13) REPORTABLE SEGMENTS
Because RERC Corp. is a wholly owned subsidiary of Reliant Energy, RERC's
determination of reportable segments considers the strategic operating units
under which Reliant Energy manages sales, allocates resources and assesses
performance of various products and services to wholesale or retail customers in
differing regulatory environments.
44
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies except that some executive
benefit costs have not been allocated to segments. RERC evaluates performance
based on operating income, excluding some corporate costs not allocated to the
segments. RERC accounts for intersegment sales as if the sales were to third
parties, that is, at current market prices.
RERC's financial reporting segments include the following: Natural Gas
Distribution, Pipelines and Gathering, Wholesale Energy and Other Operations.
Natural Gas Distribution consists of intrastate natural gas sales to, and
natural gas transportation for, residential, commercial and industrial
customers, and some non-rate regulated retail gas marketing operations.
Pipelines and Gathering includes the interstate natural gas pipeline operations
and natural gas gathering and pipeline services. Reliant Energy Services was
previously reported within the Wholesale Energy segment. Other Operations
includes unallocated general corporate expenses and non-operating investments.
During 2000, Reliant Energy transferred RERC's non-rate regulated retail gas
marketing from Other Operations to Natural Gas Distribution and RERC's natural
gas gathering business from Wholesale Energy to Pipelines and Gathering. On
December 31, 2000, RERC Corp. transferred all of the outstanding stock of RESI,
Arkla Finance and RE Europe Trading, all wholly owned subsidiaries of RERC
Corp., to Reliant Resources. Also, on December 31, 2000, a wholly owned
subsidiary of Reliant Resources merged with and into Reliant Energy Services, a
wholly owned subsidiary of RERC Corp., with Reliant Energy Services as the
surviving corporation. As a result of the Merger, Reliant Energy Services became
a wholly owned subsidiary of Reliant Resources. Reportable segments from
previous years have been restated to conform to the 2001 presentation. All of
RERC's long-lived assets are in the United States.
Financial data for business segments and products and services are as
follows:
<Table>
<Caption>
SALES TO
PIPELINES NON-
NATURAL GAS AND WHOLESALE OTHER RECONCILING RERC
DISTRIBUTION GATHERING ENERGY OPERATIONS ELIMINATIONS AFFILIATES CONSOLIDATED
------------ ---------- ---------- ---------- ------------ ---------- ------------
(IN MILLIONS)
AS OF AND FOR THE YEAR ENDED
DECEMBER 31, 1999:
Revenues from external customers ... $ 2,735 $ 151 $ 7,441 $ 8 $ -- $ 197 $ 10,532
Intersegment revenues .............. 46 180 264 -- (490) -- --
Depreciation and amortization ...... 137 53 6 3 -- -- 199
Operating income (loss) ............ 159 131 27 (16) -- -- 301
Total assets ....................... 3,683 2,486 2,821 404 (1,841) -- 7,553
Expenditures for additions to
long-lived assets ................ 206 79 3 -- -- -- 288
AS OF AND FOR THE YEAR ENDED
DECEMBER 31, 2000:
Revenues from external customers ... 4,445 177 17,220 1 -- 816 22,659
Intersegment revenues .............. 34 202 578 -- (814) -- --
Depreciation and amortization ...... 145 55 11 3 -- -- 214
Operating income (loss) ............ 121 137 86 (12) -- -- 332
Total assets ....................... 4,518 2,358 -- 448 (748) -- 6,576
Expenditures for additions to
long-lived assets ................ 195 61 27 8 -- -- 291
AS OF AND FOR THE YEAR ENDED
DECEMBER 31, 2001:
Revenues from external customers ... 4,638 225 -- -- -- 181 5,044
Intersegment revenues .............. 5 108 -- -- (113) -- --
Depreciation and amortization ...... 147 58 -- 2 -- -- 207
Operating income (loss) ............ 130 137 -- (1) -- -- 266
Total assets ....................... 3,732 2,361 -- 495 (599) -- 5,989
Expenditures for additions to
long-lived assets ................ 209 54 -- -- -- -- 263
</Table>
45
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------------------------
1999 2000 2001
---------- ---------- ----------
(IN MILLIONS)
RECONCILIATION OF OPERATING INCOME TO NET INCOME:
Operating income ...................................... $ 301 $ 332 $ 266
Interest expense ...................................... (119) (143) (155)
Other, net ............................................ 11 2 14
Income taxes .......................................... (89) (93) (58)
Loss from discontinued operations ..................... (4) (24) --
---------- ---------- ----------
Net income ........................................ $ 100 $ 74 $ 67
========== ========== ==========
REVENUES BY PRODUCTS AND SERVICES:
Retail gas sales ...................................... $ 2,735 $ 4,358 $ 4,645
Wholesale energy and energy related sales ............. 7,638 18,031 --
Gas transport ......................................... 152 182 307
Energy products and services .......................... 7 88 92
---------- ---------- ----------
Total ............................................. $ 10,532 $ 22,659 $ 5,044
========== ========== ==========
REVENUES BY GEOGRAPHIC AREAS
U.S ................................................... $ 10,415 $ 21,609 $ 5,044
Canada ................................................ 117 1,050 --
---------- ---------- ----------
Total ............................................. $ 10,532 $ 22,659 $ 5,044
========== ========== ==========
</Table>
(14) DISCONTINUED OPERATIONS
As discussed in Note 2, on December 31, 2000, RERC transferred all of the
outstanding stock of RE Europe Trading to Reliant Resources. As a result of the
transfer, RERC is reporting the results of RE Europe Trading as discontinued
operations for all periods presented in RERC's consolidated financial statements
in accordance with APB Opinion No. 30. The undistributed earnings of foreign
subsidiaries, under existing tax law, will not be subject to U.S. income tax
until distributed. As the RE Europe Trading operations were transferred to a
related party, provisions for U.S. taxes have not been accrued as the
undistributed earnings have been and are intended to be permanently reinvested.
Below is a table of the operating results of RE Europe Trading for the years
ended December 31, 1999 and 2000.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
--------------------------
1999 2000
---------- ----------
(IN MILLIONS)
Revenues ........................ $ -- $ 37
Operating expenses .............. 4 61
Operating loss .................. (4) (24)
Net loss ........................ (4) (24)
</Table>
In addition to RE Europe Trading, RERC transferred its interests in RESI,
Arkla Finance and Reliant Energy Services to Reliant Resources as described in
Note 2. The transfer of these operations did not result in the disposal of a
segment of business as defined under APB No. 30. Revenues for these operations
were $8 billion and $19 billion for 1999 and 2000, respectively. Operations of
RESI, Arkla Finance and Reliant Energy Services had net income of $24 million
and $28 million in 1999 and 2000, respectively.
(15) SUBSEQUENT EVENTS
In January 2002, RERC reduced its trade receivables facility from $350
million to $150 million. Borrowings under the receivables facility aggregating
$196 million were repaid in January 2002 with proceeds from the issuance of
commercial paper under RERC's $350 million revolving credit facility and from
the liquidation of short-term investments.
During the first quarter of 2002, RERC purchased $6.6 million of its 6%
Convertible Subordinated Debentures due 2012 at a weighted average price of
95.4%.
46
INDEPENDENT AUDITORS' REPORT
Reliant Energy Resources Corp.:
We have audited the accompanying consolidated balance sheets of Reliant
Energy Resources Corp. and its subsidiaries (RERC) as of December 31, 2000 and
2001, and the related statements of consolidated income, consolidated
comprehensive income, consolidated stockholder's equity and consolidated cash
flows for each of the three years in the period ended December 31, 2001. Our
audits also included RERC's financial statement schedule listed in Item
14(a)(2). These financial statements and the financial statement schedule are
the responsibility of RERC's management. Our responsibility is to express an
opinion on these financial statements and the financial statement schedule based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of RERC at December 31, 2000 and
2001, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, such financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
As discussed in Note 5 to the financial statements, the Company changed its
method of accounting for derivative instruments and hedging activities in 2001.
DELOITTE & TOUCHE LLP
Houston, Texas
March 28, 2002
47
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS.
The information called for by Item 10 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly Owned
Subsidiaries).
ITEM 11. EXECUTIVE COMPENSATION.
The information called for by Item 11 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly Owned
Subsidiaries).
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information called for by Item 12 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly Owned
Subsidiaries).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information called for by Item 13 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly Owned
Subsidiaries).
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
<Table>
(a)(1) Financial Statements.
Statements of Consolidated Income for the Three Years Ended December 31, 2001............ 19
Statements of Consolidated Comprehensive Income for the Three Years Ended
December 31, 2001 ..................................................................... 20
Consolidated Balance Sheets at December 31, 2001 and 2000................................ 21
Statements of Consolidated Cash Flows for the Three Years Ended December 31, 2001........ 22
Statements of Consolidated Stockholder's Equity for the
Three Years Ended December 31, 2001.................................................... 23
Notes to Consolidated Financial Statements............................................... 24
Independent Auditors' Report............................................................. 47
(a)(2) Financial Statement Schedules for the Three Years Ended December 31, 2001.
Schedule II -- Reserves.................................................................. 49
</Table>
The following schedules are omitted because of the absence of the
conditions under which they are required or because the required
information is included in the financial statements:
I, III, IV and V.
(a)(3) Exhibits
See Index of Exhibits on page 51.
(b) Reports on Form 8-K.
None.
48
RELIANT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF RELIANT ENERGY, INCORPORATED)
SCHEDULE II -- RESERVES
FOR THE THREE YEARS ENDED DECEMBER 31, 2001
(THOUSANDS OF DOLLARS)
<Table>
<Caption>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- ------------------------------------------------------- ---------- -------------------------- ---------- ----------
ADDITIONS
--------------------------
BALANCE AT CHARGED CHARGED DEDUCTIONS BALANCE AT
BEGINNING TO TO OTHER FROM END OF
DESCRIPTION OF PERIOD INCOME ACCOUNTS(1) RESERVES PERIOD
- ----------- ---------- ---------- ----------- ---------- ----------
Year Ended December 31, 2001:
Accumulated provisions:
Uncollectible accounts receivable ................. $ 32,524 $ 43,419 -- $ 42,896 $ 33,047
Reserves for inventory ............................ 399 72 -- 348 123
Reserves for severance ............................ 11,028 244 -- 10,832 440
Deferred tax asset valuation allowance ............ 47,677 (32,678) -- -- 14,999
Year Ended December 31, 2000:
Accumulated provisions:
Uncollectible accounts receivable ................. 25,287 32,119 (7,803) 17,079 32,524
Reserves deducted from trading and marketing
assets .......................................... 11,511 54,621 (66,132) -- --
Reserves for inventory ............................ 90 372 -- 63 399
Reserves for severance ............................ 11,666 3,822 -- 4,460 11,028
Deferred tax asset valuation allowance ............ 19,139 28,538 -- -- 47,677
Year Ended December 31, 1999:
Accumulated provisions:
Uncollectible accounts receivable ................. 21,566 16,296 -- 12,575 25,287
Reserves deducted from trading and marketing
assets .......................................... 6,464 5,047 -- -- 11,511
Reserves for inventory ............................ 69 72 -- 51 90
Reserves for severance ............................ 32,812 -- -- 21,146 11,666
Deferred tax asset valuation allowance ............ 8,591 10,548 -- -- 19,139
</Table>
- ----------
(1) Charged to Other Accounts in 2000 relates to reserves that were transferred
to Reliant Resources, Inc.
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of
Houston, the State of Texas, on the 15th day of April, 2002.
RELIANT ENERGY RESOURCES CORP.
(Registrant)
By: /s/ R. STEVE LETBETTER
-----------------------------------
R. Steve Letbetter,
Chairman, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on April 15, 2002.
<Table>
<Caption>
SIGNATURE TITLE
--------- -----
/s/ R. STEVE LETBETTER Chairman, President and Chief Executive Officer
- --------------------------------------------- (Principal Executive Officer and Principal Financial
(R. Steve Letbetter) Officer)
/s/ MARY P. RICCIARDELLO Senior Vice President
- --------------------------------------------- (Principal Accounting Officer)
(Mary P. Ricciardello)
/s/ STEPHEN W. NAEVE Sole Director
- ---------------------------------------------
(Stephen W. Naeve)
</Table>
50
RELIANT ENERGY RESOURCES CORP.
EXHIBITS TO THE ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2001
INDEX OF EXHIBITS
Exhibits not incorporated by reference to a prior filing are designated by
a cross (+); all exhibits not so designated are incorporated herein by reference
to a prior filing as indicated.
<Table>
<Caption>
REPORT OR SEC FILE OR
EXHIBIT REGISTRATION REGISTRATION EXHIBIT
NUMBER DESCRIPTION STATEMENT NUMBER REFERENCE
------- ----------- ------------ ------------ ---------
2(a)(1) - Agreement and Plan of Merger among HI's Form 8-K dated August 11, 1-7629 2
the Company, HL&P, HI Merger, Inc. 1996
and NorAm dated August 11, 1996
2(a)(2) - Amendment to Agreement and Plan of Registration Statement on Form 333-11329 2(c)
Merger Among the Company, HL&P, HI S-4
Merger, Inc. and NorAm dated August
11, 1996
2(b) - Agreement and Plan of Merger dated Registration Statement on Form 333-54526 2
December 29, 2000 merging Reliant S-3
Resources Merger Sub, Inc. with
and into Reliant Energy Services,
Inc.
3(a)(1) - Certificate of Incorporation of Form 10-K for the year ended 1-3187 3(a)(1)
RERC Corp. December 31, 1997
3(a)(2) - Certificate of Merger merging Form 10-K for the year ended 1-3187 3(a)(2)
former NorAm Energy Corp. with and December 31, 1997
into HI Merger, Inc. dated August
6, 1997
3(a)(3) - Certificate of Amendment changing Form 10-K for the year ended 1-3187 3(a)(3)
the name to Reliant Energy December 31, 1998
Resources Corp.
3(b) - Bylaws of RERC Corp. Form 10-K for the year ended 1-3187 3(b)
December 31, 1997
4(a)(1) - Indenture, dated as of December 1, NorAm's Form 10-K for the year 1-13265 4.14
1986, between NorAm and Citibank, ended December 31, 1986
N.A., as Trustee
4(a)(2) - First Supplemental Indenture to Form 10-K for the year ended 1-3187 4(a)(2)
Exhibit 4(a)(1) dated as of December 31, 1997
September 30, 1988
4(a)(3) - Second Supplemental Indenture to Form 10-K for the year ended 1-3187 4(a)(3)
Exhibit 4(a)(1) dated as of December 31, 1997
November 15, 1989
4(a)(4) - Third Supplemental Indenture to Form 10-K for the year ended 1-3187 4(a)(4)
Exhibit 4(a)(1) dated as of August December 31, 1997
6, 1997
4(b)(1) - Indenture, dated as of March 31, NorAm's Registration Statement 33-14586 4.20
1987, between NorAm and Chase on Form S-3
Manhattan Bank, N.A., as Trustee,
authorizing 6% Convertible
Subordinated Debentures due 2012
4(b)(2) - Supplemental Indenture to Exhibit Form 10-K for the year ended 1-3187 4(b)(2)
4(b)(1) dated as of August 6, 1997 December 31, 1997
</Table>
51
<Table>
4(c)(1) - Indenture, dated as of April 15, NorAm's Registration Statement 33-23375 4.1
1990, between NorAm and Citibank, on Form S-3
N.A., as Trustee
4(c)(2) - Supplemental Indenture to Exhibit Form 10-K for the year ended 1-3187 4(c)(2)
4(c)(1) dated as of August 6, 1997 December 31, 1997
4(d)(1) - Form of Indenture between NorAm NorAm's Registration Statement 33-64001 4.8
and The Bank of New York as Trustee on Form S-3
4(d)(2) - Form of First Supplemental NorAm's Form 8-K dated June 10, 1-13265 4.01
Indenture to Exhibit 4(d)(1) 1996
4(d)(3) - Second Supplemental Indenture to Form 10-K for the year ended 1-3187 4(d)(3)
Exhibit 4(d)(1) dated as of August December 31, 1997
6, 1997
4(e) - Indenture, dated as of December 1, Registration Statement on Form 333-41017 4.1
1997, between RERC Corp. and Chase S-3
Bank of Texas, National Association
4(f)(1) - Indenture, dated as of February 1, Form 8-K dated February 5, 1998 1-13265 4.1
1998, between RERC Corp. and Chase
Bank of Texas, National
Association, as Trustee
4(f)(2) - Supplemental Indenture No. 1, Form 8-K dated February 5, 1998 1-13265 4.2
dated as of February 1, 1998,
providing for the issuance of RERC
Corp.'s 6 1/2% Debentures due
February 1, 2008
4(f)(3) - Supplemental Indenture No. 2, Form 8-K dated November 9, 1998 1-13265 4.1
dated as of November 1, 1998,
providing for the issuance of
RERC Corp.'s 6 3/8% Term Enhanced
ReMarketable Securities
4(f)(4) - Supplemental Indenture No. 3, Registration Statement on Form 333-49162 4.2
dated as of July 1, 2000, S-4
providing for the issuance of
RERC Corp.'s 8.125% Notes
due 2005
4(f)(5) - Supplemental Indenture No. 4, Form 8-K dated February 21, 2001 1-13265 4.1
dated as of February 15, 2001,
providing for the issuance of
RERC Corp.'s 7.75% Notes
due 2011
+4(g)(1) - Revolving Credit Agreement among
NorAm Energy Corp. and the Banks
party thereto and Citibank, N.A., as
Agent dated as of March 31, 1998
+4(g)(2) - Amendment Agreement dated as of
March 23, 1999 among RERC Corp., the
lenders parties thereto, The Bank
of Nova Scotia, as Issuing Bank and
Citibank, N.A., as Agent
+4(g)(3) - Second Amendment Agreement and
Consent dated as of August 22, 2000
among RERC Corp., the lenders party
thereto, The Bank of Nova Scotia, as
Issuing Bank, and Citibank, N.A., as
Agent
+4(g)(4) - Third Amendment Agreement and
Consent, dated as of July 13, 2001,
among RERC Corp., the lenders party
thereto, The Bank of Nova Scotia, as
Issuing Bank, and Citibank, N.A., as
Agent
</Table>
There have not been filed as exhibits to this Form 10-K certain long-term
debt instruments, including indentures, under which the total amount of
securities do not exceed 10% of the total assets of RERC. RERC hereby agrees to
furnish a copy of any such instrument to the SEC upon request.
<Table>
<Caption>
REPORT OR SEC FILE OR
EXHIBIT REGISTRATION REGISTRATION EXHIBIT
NUMBER DESCRIPTION STATEMENT NUMBER REFERENCE
------- ----------- ------------ ------------ ---------
10(a) - Service Agreement by and between NorAm's Form 10-K for the year 1-13265 10.20
Mississippi River Transmission ended December 31, 1989
Corporation and Laclede Gas Company
dated August 22, 1989
+12 - Computation of Ratios of Earnings
to Fixed Charges
+23 - Consent of Deloitte & Touche LLP
</Table>
52