UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO _______________.
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Commission file number 1-3187
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC
(Exact name of registrant as specified in its charter)
TEXAS
(State or other jurisdiction of 22-3865106
incorporation or organization) (I.R.S. Employer Identification No.)
1111 LOUISIANA
HOUSTON, TEXAS 77002 (713) 207-1111
(Address and zip code of principal (Registrant's telephone number,
executive offices) including area code)
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CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC MEETS THE CONDITIONS SET FORTH IN
GENERAL INSTRUCTION H(1)(A) AND (B) OF FORM 10-Q AND IS THEREFORE FILING THIS
FORM 10-Q WITH THE REDUCED DISCLOSURE FORMAT.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
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Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
----- -----
As of November 1, 2005, all 1,000 common shares of CenterPoint Energy Houston
Electric, LLC were held by Utility Holding, LLC, a wholly owned subsidiary of
CenterPoint Energy, Inc.
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2005
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.......................................... 1
Statements of Consolidated Operations
Three Months and Nine Months Ended September 30, 2004 and
2005 (unaudited)........................................... 1
Consolidated Balance Sheets
December 31, 2004 and September 30, 2005 (unaudited)....... 2
Statements of Consolidated Cash Flows
Nine Months Ended September 30, 2004 and 2005 (unaudited).. 4
Notes to Unaudited Consolidated Financial Statements.......... 5
Item 2. Management's Narrative Analysis of the Results of
Operations................................................. 14
Item 4. Controls and Procedures....................................... 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 24
Item 5. Other Information............................................. 24
Item 6. Exhibits...................................................... 29
i
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
From time to time we make statements concerning our expectations, beliefs,
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are not historical facts. These
statements are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
from those expressed or implied by these statements. You can generally identify
our forward-looking statements by the words "anticipate," "believe," "continue,"
"could," "estimate," "expect," "forecast," "goal," "intend," "may," "objective,"
"plan," "potential," "predict," "projection," "should," "will," or other similar
words.
We have based our forward-looking statements on our management's beliefs
and assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, we cannot assure you that actual results will
not differ materially from those expressed or implied by our forward-looking
statements.
The following are some of the factors that could cause actual results to
differ materially from those expressed or implied in forward-looking statements:
- the timing and amount of our recovery of the true-up components;
- state and federal legislative and regulatory actions or developments,
including deregulation, re-regulation, constraints placed on our
activities or business by the Public Utility Holding Company Act of
1935, as amended (1935 Act), the impact of the repeal of the 1935 Act,
changes in or application of laws or regulations applicable to other
aspects of our business and actions with respect to:
- allowed rates of return;
- rate structures;
- recovery of investments; and
- operation and construction of facilities;
- industrial, commercial and residential growth in our service territory
and changes in market demand and demographic patterns;
- changes in interest rates or rates of inflation;
- weather variations and other natural phenomena;
- commercial bank and financial market conditions, our access to
capital, the cost of such capital, receipt of certain financing
approvals under the 1935 Act, and the results of our financing and
refinancing efforts, including availability of funds in the debt
capital markets;
- actions by rating agencies;
- non-payment for our services due to financial distress of our
customers, including Reliant Energy, Inc. (formerly named Reliant
Resources, Inc.) (RRI);
- the outcome of the pending securities lawsuits against us, Reliant
Energy, Incorporated and RRI;
- the ability of RRI to satisfy its obligations to us, including
indemnity obligations;
- our ability to control costs;
- the investment performance of CenterPoint Energy's employee benefit
plans;
ii
- our potential business strategies, including acquisitions or
dispositions of assets or businesses, which cannot be assured to be
completed or to have the anticipated benefits to us; and
- other factors we discuss in "Risk Factors" in Item 5 of Part II of
this report beginning on page 24.
Additional risk factors are described in other documents we file with the
Securities and Exchange Commission.
You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement.
iii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
STATEMENTS OF CONSOLIDATED OPERATIONS
(MILLIONS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2004 2005 2004 2005
----- ---- ------ ------
REVENUES ........................................... $ 448 $484 $1,153 $1,243
----- ---- ------ ------
EXPENSES:
Operation and maintenance ....................... 136 156 396 448
Depreciation and amortization ................... 74 90 209 247
Taxes other than income taxes ................... 60 55 158 163
----- ---- ------ ------
Total ........................................ 270 301 763 858
----- ---- ------ ------
OPERATING INCOME ................................... 178 183 390 385
----- ---- ------ ------
OTHER INCOME (EXPENSE):
Interest and other finance charges .............. (77) (78) (231) (230)
Interest on transition bonds .................... (9) (9) (29) (27)
Return on true-up balance ....................... -- 35 -- 104
Other, net ...................................... 8 13 34 36
----- ---- ------ ------
Total ........................................ (78) (39) (226) (117)
----- ---- ------ ------
INCOME BEFORE INCOME TAXES AND EXTRAORDINARY ITEM .. 100 144 164 268
Income Tax Expense .............................. (34) (49) (55) (90)
----- ---- ------ ------
INCOME BEFORE EXTRAORDINARY ITEM ................... 66 95 109 178
Extraordinary Item, net of tax .................. (894) -- (894) 30
----- ---- ------ ------
NET INCOME (LOSS) .................................. $(828) $ 95 $ (785) $ 208
===== ==== ====== ======
See Notes to the Company's Interim Financial Statements
1
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONSOLIDATED BALANCE SHEETS
(MILLIONS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, SEPTEMBER 30,
2004 2005
------------ -------------
CURRENT ASSETS:
Cash and cash equivalents .................................. $ 25 $ 14
Accounts and notes receivable, net ......................... 124 155
Accounts and notes receivable -- affiliated companies, net.. 58 41
Accrued unbilled revenues .................................. 74 124
Materials and supplies ..................................... 53 56
Taxes receivable ........................................... 62 58
Deferred tax asset ......................................... 79 --
Other ...................................................... 12 10
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Total current assets .................................... 487 458
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PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment .............................. 6,245 6,395
Less accumulated depreciation and amortization ............. (2,204) (2,331)
------- -------
Property, plant and equipment, net ...................... 4,041 4,064
------- -------
OTHER ASSETS:
Other intangibles, net ..................................... 38 38
Regulatory assets .......................................... 3,329 2,915
Notes receivable -- affiliated companies ................... 815 815
Other ...................................................... 73 65
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Total other assets ...................................... 4,255 3,833
------- -------
TOTAL ASSETS ......................................... $ 8,783 $ 8,355
======= =======
See Notes to the Company's Interim Financial Statements
2
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONSOLIDATED BALANCE SHEETS
(MILLIONS OF DOLLARS) -- (CONTINUED)
(UNAUDITED)
LIABILITIES AND MEMBER'S EQUITY
DECEMBER 31, SEPTEMBER 30,
2004 2005
------------ -------------
CURRENT LIABILITIES:
Current portion of transition bond long-term debt ....... $ 47 $ 54
Current portion of other long-term debt ................. 1,310 1,310
Accounts payable ........................................ 41 43
Taxes accrued ........................................... 105 67
Interest accrued ........................................ 68 51
Regulatory liabilities .................................. 225 --
Other ................................................... 58 46
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Total current liabilities ............................ 1,854 1,571
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OTHER LIABILITIES:
Accumulated deferred income taxes, net .................. 1,377 1,398
Unamortized investment tax credits ...................... 49 44
Benefit obligations ..................................... 128 135
Regulatory liabilities .................................. 648 302
Notes payable -- affiliated companies ................... 151 151
Accounts payable -- affiliated companies ................ 303 303
Other ................................................... 19 21
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Total other liabilities .............................. 2,675 2,354
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LONG-TERM DEBT:
Transition bonds ........................................ 629 575
Other ................................................... 1,592 1,591
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Total long-term debt ................................. 2,221 2,166
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COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 6)
MEMBER'S EQUITY:
Common stock............................................. -- --
Paid-in capital ......................................... 2,278 2,309
Retained deficit ........................................ (245) (45)
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Total member's equity ................................ 2,033 2,264
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TOTAL LIABILITIES AND MEMBER'S EQUITY ............. $8,783 $8,355
====== ======
See Notes to the Company's Interim Financial Statements
3
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
STATEMENTS OF CONSOLIDATED CASH FLOWS
(MILLIONS OF DOLLARS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2004 2005
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ....................................... $(785) $ 208
Extraordinary item, net of tax .......................... 894 (30)
----- -----
Income before extraordinary item ........................ 109 178
Adjustments to reconcile income before extraordinary
item to net cash provided by operating activities:
Depreciation and amortization ........................ 209 247
Amortization of deferred financing costs ............. 23 23
Deferred income taxes ................................ 84 96
Investment tax credits ............................... (5) (5)
Changes in other assets and liabilities:
Accounts and notes receivable, net ................ (50) (80)
Accounts receivable/payable, affiliates ........... 26 20
Inventory ......................................... 6 (3)
Accounts payable .................................. 2 (9)
Taxes receivable .................................. 132 28
Interest and taxes accrued ........................ (41) (54)
Net regulatory assets and liabilities ............. (254) (152)
Other current assets .............................. 7 (6)
Other current liabilities ......................... 12 (13)
Other assets ...................................... (17) (27)
Other liabilities ................................. 20 (6)
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Net cash provided by operating activities ...... 263 237
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CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures and other .......................... (164) (196)
Increase in notes receivable from affiliates ............ -- (3)
----- -----
Net cash used in investing activities .......... (164) (199)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ................ 229 --
Payments of long-term debt .............................. (42) (48)
Increase in short-term notes payable with affiliates .... 31 --
Decrease in long-term notes payable with affiliates ..... (229) --
Debt issuance costs ..................................... (15) (2)
Dividend to parent ...................................... (100) --
Other, net .............................................. -- 1
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Net cash used in financing activities .......... (126) (49)
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NET DECREASE IN CASH AND CASH EQUIVALENTS .................. (27) (11)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ........... 31 25
----- -----
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................. $ 4 $ 14
===== =====
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest ................................................ $ 267 $ 263
Income taxes (refunds) .................................. (53) 93
See Notes to the Company's Interim Financial Statements
4
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
General. Included in this Quarterly Report on Form 10-Q (Form 10-Q) of
CenterPoint Energy Houston Electric, LLC are the consolidated interim financial
statements and notes (Interim Financial Statements) of CenterPoint Energy
Houston Electric, LLC and its subsidiaries (collectively, CenterPoint Houston or
the Company). The Interim Financial Statements are unaudited, omit certain
financial statement disclosures and should be read with the Annual Report on
Form 10-K of CenterPoint Houston for the year ended December 31, 2004
(CenterPoint Houston Form 10-K).
Background. The Company owns and operates electric transmission and
distribution facilities. The Company is an indirect wholly owned subsidiary of
CenterPoint Energy, Inc. (CenterPoint Energy), a public utility holding company
created on August 31, 2002, as part of a corporate restructuring of Reliant
Energy, Incorporated (Reliant Energy) that implemented certain requirements of
the Texas Electric Choice Plan (Texas electric restructuring law).
CenterPoint Energy is a registered public utility holding company under the
Public Utility Holding Company Act of 1935, as amended (1935 Act). The 1935 Act
and related rules and regulations impose a number of restrictions on the
activities of CenterPoint Energy and those of its subsidiaries. The 1935 Act,
among other things, limits the ability of CenterPoint Energy and its
subsidiaries to issue debt and equity securities without prior authorization,
restricts the source of dividend payments to current and retained earnings
without prior authorization, regulates sales and acquisitions of certain assets
and businesses and governs affiliated service, sales and construction contracts.
On August 8, 2005, President Bush signed into law the Energy Policy Act of 2005
(Energy Act). Under that legislation, the 1935 Act is repealed effective
February 8, 2006. After the effective date of the repeal, CenterPoint Energy and
its subsidiaries will no longer be subject to restrictions imposed under the
1935 Act. Until the repeal is effective, CenterPoint Energy and its subsidiaries
remain subject to the provisions of the 1935 Act and the terms of orders issued
by the Securities and Exchange Commission (SEC) under the 1935 Act. The Energy
Act grants to the Federal Energy Regulatory Commission (FERC) authority to
require holding companies and their subsidiaries to maintain certain books and
records and make them available for review by FERC and state regulatory
authorities. The Energy Act requires FERC to issue regulations to implement its
jurisdiction under the Energy Act, and on September 16, 2005, FERC issued
proposed rules for public comment. It is presently unknown what, if any,
specific obligations under those rules may be imposed on CenterPoint Energy and
its subsidiaries as a result of that rulemaking.
Basis of Presentation. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America (GAAP) requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
The Company's Interim Financial Statements reflect all normal recurring
adjustments that are, in the opinion of management, necessary to present fairly
the financial position, results of operations and cash flows for the respective
periods. Amounts reported in the Company's Statements of Consolidated Operations
are not necessarily indicative of amounts expected for a full year period due to
the effects of, among other things, (a) seasonal fluctuations in demand for
energy, (b) timing of maintenance and other expenditures and (c) acquisitions
and dispositions of businesses, assets and other interests. In addition, certain
amounts from the prior year have been reclassified to conform to the Company's
presentation of financial statements in the current year. These
reclassifications do not affect net income.
Note 2(e) (Regulatory Assets and Liabilities), Note 4 (Regulatory Matters)
and Note 9 (Commitments and Contingencies) to the consolidated annual financial
statements in the CenterPoint Houston Form 10-K relate to certain contingencies.
These notes, as updated herein, are incorporated herein by reference.
For information regarding certain legal and regulatory proceedings and
environmental matters, see Note 6 to the Interim Financial Statements.
5
(2) NEW ACCOUNTING PRONOUNCEMENTS
In May 2005, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 154, "Accounting Changes
and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement
No. 3" (SFAS No. 154). SFAS No. 154 provides guidance on the accounting for and
reporting of accounting changes and error corrections. It establishes, unless
impracticable, retrospective application as the required method for reporting a
change in accounting principle in the absence of explicit transition
requirements specific to the newly adopted accounting principle. The correction
of an error in previously issued financial statements is not an accounting
change and must be reported as a prior-period adjustment by restating previously
issued financial statements. SFAS No. 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005.
In March 2005, the FASB issued FASB Interpretation No. (FIN) 47,
"Accounting for Conditional Asset Retirement Obligations" (FIN 47). FIN 47
clarifies that an entity must record a liability for a "conditional" asset
retirement obligation if the fair value of the obligation can be reasonably
estimated. FIN 47 is effective no later than the end of fiscal years ending
after December 15, 2005. The Company is evaluating the effect of adoption of
this new standard on its financial position, results of operations and cash
flows.
(3) REGULATORY MATTERS
(a) Recovery of True-Up Balance.
The Texas electric restructuring law provides for the Public Utility
Commission of Texas (Texas Utility Commission) to conduct a "true-up" proceeding
to determine CenterPoint Houston's stranded costs and certain other costs
resulting from the transition to a competitive retail electric market and to
provide for its recovery of those costs. In March 2004, the Company filed its
stranded cost true-up application with the Texas Utility Commission. The Company
had requested recovery of $3.7 billion, excluding interest. In December 2004,
the Texas Utility Commission issued its final order (True-Up Order) allowing the
Company to recover a true-up balance of approximately $2.3 billion, which
included interest through August 31, 2004, and providing for adjustment of the
amount to be recovered to include interest on the balance until recovery, the
principal portion of additional excess mitigation credits returned to customers
after August 31, 2004 and certain other matters. The Company and other parties
filed appeals of the True-Up Order to a district court in Travis County, Texas.
That court held a hearing on the appeal in early August 2005, and on August 26,
2005, the court issued its final judgment on the various appeals. In its
judgment, the court affirmed most aspects of the Texas Utility Commission's
order, but reversed two of the Texas Utility Commission's rulings, which would
have the effect of restoring approximately $620 million, plus interest, of the
$1.7 billion the Texas Utility Commission had disallowed from the Company's
initial request. First, the court reversed the Texas Utility Commission's
decision to prohibit the Company from recovering $180 million in credits through
August 2004 that the Company was ordered to provide to retail electric providers
as a result of a stranded cost estimate made by the Texas Utility Commission in
2000 that subsequently proved to be inaccurate. Second, the court reversed the
Texas Utility Commission's disallowance of $440 million in transition costs
which are recoverable under the Texas Utility Commission's regulations.
Additional credits of approximately $30 million paid after August 2004 and
interest would be added to these amounts. The Company and other parties appealed
the district court decision to the 3rd Court of Appeals in Austin in September
2005. The parties have agreed to a briefing schedule whereby briefs will be
filed by the parties on a schedule extending into February 2006. No amounts
related to the court's judgment have been recorded in the Company's consolidated
financial statements.
There are two ways for the Company to recover the true-up balance: by
issuing transition bonds to securitize the amounts due and/or by implementing a
competition transition charge (CTC). In March 2005, the Texas Utility Commission
issued a financing order that authorized the issuance of approximately $1.8
billion of transition bonds. In August 2005, the same Travis County District
Court considering the appeal of the True-Up Order affirmed the financing order
in all respects. The Company expects to complete the issuance of transition
bonds under that order in the fourth quarter of 2005, subject to, among other
matters, market conditions and the completion of documentation and rating agency
reviews.
On July 14, 2005, the Company received an order from the Texas Utility
Commission allowing it to implement a CTC to collect approximately $570 million
over 14 years plus interest at an annual rate of 11.075%. The CTC order
authorizes the Company to impose a charge on retail electric providers to
recover the portion of the true-up
6
balance not covered by the financing order. The CTC order also allows the
Company to collect approximately $24 million of rate case expenses over three
years through a separate tariff rider (Rider RCE). The Company implemented the
CTC and Rider RCE effective September 13, 2005 and began recovering
approximately $600 million and the rate case expenses. Certain other parties
appealed the CTC order to the Travis County District Court on September 27,
2005. Additionally, during the period from September 13, 2005, the date of
implementation of the CTC order, through September 30, 2005, the Company
recognized approximately $7 million in CTC revenue, which was partially offset
by $5 million in related amortization of the CTC regulatory asset.
Under the True-Up Order, the Company is allowed a return until the true-up
balance is recovered. The rate of return is based on the Company's cost of
capital, established in the Texas Utility Commission's final order issued in
October 2001, which is derived from the Company's cost to finance assets (debt
return) and an allowance for earnings on shareholders' investment (equity
return). Consequently, in accordance with SFAS No. 92, "Regulated Enterprises --
Accounting for Phase-in Plans," the rate of return has been bifurcated into a
debt return component and an equity return component. The Company was allowed a
return on the true-up balance of $62 million and $189 million for the three
months and nine months ended September 30, 2005, respectively. Effective
September 13, 2005, the date of implementation of the CTC order, the return on
the CTC portion of the true-up balance is included in the Company's tariff-based
revenues. The debt return of $35 million and $104 million for the three months
and nine months ended September 30, 2005, respectively, was accrued and included
in other income in the Company's Statements of Consolidated Operations. The debt
return will continue to be recognized as earned going forward. The equity return
of $27 million and $85 million for the three months and nine months ended
September 30, 2005, respectively, will be recognized in income as it is
recovered in the future. As of September 30, 2005, the Company has recorded a
regulatory asset of $331 million related to the debt return on its true-up
balance and has not recorded an allowed equity return of $232 million on its
true-up balance because such return will be recognized as it is recovered in the
future.
Net income for the nine months ended September 30, 2005 included an
after-tax extraordinary gain of $30 million reflecting an adjustment to the
extraordinary loss recorded in the last half of 2004 to write down
generation-related regulatory assets as a result of the final orders issued by
the Texas Utility Commission.
As a result of a settlement reached in a separate proceeding involving
Reliant Energy, Inc.'s (RRI) Price-to-Beat, excess mitigation credits were
terminated as of April 29, 2005. As a result of this settlement, the Company has
applied the remaining unrefunded excess mitigation credits of approximately $522
million to reduce the regulatory asset related to stranded costs.
(b) Final Fuel Reconciliation.
The results of the Texas Utility Commission's final decision related to the
Company's final fuel reconciliation are a component of the True-Up Order. The
Company has appealed certain portions of the True-Up Order involving a
disallowance of approximately $67 million relating to the final fuel
reconciliation plus interest of $10 million. A hearing on this issue was held
before a district court in Travis County on April 22, 2005 and a judgment was
entered from the district court on May 13, 2005 affirming the Texas Utility
Commission's decision. The Company filed an appeal to the Court of Appeals in
June 2005. The parties are briefing the issues before the court.
(c) City of Houston Franchise.
On June 27, 2005, the Company accepted an ordinance granting it a new
30-year franchise to use the public rights-of-way to conduct its business in the
City of Houston (New Franchise Ordinance). The New Franchise Ordinance took
effect on July 1, 2005, and replaced the prior electricity franchise ordinance,
which had been in effect since 1957. The New Franchise Ordinance clarifies
certain operational obligations of the Company and the City of Houston and
provides for streamlined payment and audit procedures and a two-year statute of
limitations on claims for underpayment or overpayment under the ordinance. Under
the prior electricity franchise ordinance, the Company paid annual franchise
fees of $76.6 million to the City of Houston for the year ended December 31,
2004. For the twelve-month period beginning July 1, 2005, the annual franchise
fee (Annual Franchise Fee) under the New Franchise Ordinance will include a base
amount of $88.1 million (Base Amount) and an additional payment of $8.5 million
(Additional Amount). The Base Amount and the Additional Amount will be adjusted
annually based on the increase, if any, in kWh delivered by the Company within
the City of Houston.
7
The Company began paying the new annual franchise fees on July 1, 2005.
Pursuant to the New Franchise Ordinance, the Annual Franchise Fee will be
reduced prospectively to reflect any portion of the Annual Franchise Fee that is
not included in the Company's base rates in any subsequent rate case. In
accordance with the Company's rights under the New Franchise Ordinance, the
Company filed a request with the City of Houston to implement a tariff rider to
collect the Additional Amount, but subsequently asked the City of Houston to
abate further consideration of that application.
(d) Texas Utility Commission Staff Report.
The Texas Utility Commission requires each electric utility to file, on
commission-prescribed forms, an annual Earnings Report providing certain
information to enable the Texas Utility Commission to monitor the electric
utilities' earnings and financial condition within the state. On May 16, 2005,
the Company filed its Earnings Report for the calendar year ended December 31,
2004. The Company's Earnings Report shows that it earned less than its
authorized rate of return on equity in 2004.
On October 21, 2005, the Texas Utility Commission Staff filed a memorandum
summarizing their review of the Earnings Reports filed by electric utilities.
Based on its review, the Texas Utility Commission Staff concluded that
continuation of the Company's existing rates could result in excess revenues of
as much as $105 million annually and recommended that the Texas Utility
Commission initiate a review of the reasonableness of existing rates. The Texas
Utility Commission Staff's analysis is based on an estimated 9.60% midpoint cost
of equity, which is more than 150 basis points lower than the approved return on
equity from the Company's last rate proceeding, the elimination of interest on
debt maturing in November 2005 and certain other adjustments to the Company's
reported information. Additionally, an assumed hypothetical capital structure of
60% debt and 40% equity was used which would vary materially from the projected
capital structure after the maturity of the Company's $1.31 billion term loan at
the end of 2005.
On October 28, 2005, the Texas Utility Commission considered the Staff
report and agreed to initiate a rate proceeding by December 1, 2005 if the
Company and other parties have not reached a settlement of the alleged excess
revenues.
The Company disagrees with several of the adjustments discussed in the
memorandum and believes the Texas Utility Commission should base any such
analysis on updated expense and revenue amounts and the appropriate capital
structure and cost of capital.
(4) LONG-TERM DEBT
In March 2005, the Company established a $200 million five-year revolving
credit facility. Borrowings may be made under the facility at the London
interbank offered rate (LIBOR) plus 75 basis points based on the Company's
current credit ratings. An additional utilization fee of 12.5 basis points
applies to borrowings whenever more than 50% of the facility is utilized.
Changes in credit ratings could lower or raise the increment to LIBOR depending
on whether ratings improved or were lowered. As of September 30, 2005, there
were no borrowings outstanding under the revolving credit facility.
The Company also established a $1.31 billion credit facility in March 2005.
The Company expects to utilize this facility to refinance its $1.31 billion term
loan maturing on November 11, 2005. Drawings may be made under this credit
facility until November 16, 2005, at which time any outstanding borrowings are
converted to term loans maturing in November 2007. Under this facility, (i) 100%
of the net proceeds from the issuance of transition bonds and (ii) the proceeds,
in excess of $200 million, from certain other new net indebtedness for borrowed
money incurred by the Company must be used to repay borrowings under the
facility. Based on the Company's current credit ratings, borrowings under the
facility may be made at LIBOR plus 75 basis points. The interest rate under the
term loan which this facility would replace is LIBOR plus 975 basis points.
Changes in credit ratings could lower or raise the increment to LIBOR depending
on whether ratings improved or were lowered. Any drawings under this facility
must be secured by the Company's general mortgage bonds in the same principal
amount and bearing the same interest rate as such drawings.
8
(5) RELATED PARTY TRANSACTIONS AND MAJOR CUSTOMERS
Related Party Transactions. The following table summarizes receivables
from, or payables to, CenterPoint Energy or its subsidiaries:
DECEMBER 31, SEPTEMBER 30,
2004 2005
------------ -------------
(IN MILLIONS)
Accounts receivable from affiliates ........................ $ 17 $ 9
Accounts payable to affiliates ............................. (32) (44)
Notes receivable -- affiliated companies (1) ............... 73 76
----- -----
Accounts and notes receivable -- affiliated companies,
net .................................................. $ 58 $ 41
===== =====
Long-term notes receivable -- affiliated companies ......... $ 815 $ 815
===== =====
Long-term notes payable -- affiliated companies ............ $(151) $(151)
===== =====
Long-term accounts payable -- affiliated companies ......... $(303) $(303)
===== =====
- ----------
(1) Represents money pool borrowings and investments.
For the three months ended September 30, 2004 and 2005, the Company had net
interest income related to affiliate borrowings of $5 million and $11 million,
respectively, and $11 million and $29 million for the nine months ended
September 30, 2004 and 2005, respectively.
The 1935 Act generally prohibits borrowings by CenterPoint Energy from its
subsidiaries, including the Company, either through the money pool or otherwise.
CenterPoint Energy provides some corporate services to the Company. The
costs of services have been charged directly to the Company using methods that
management believes are reasonable. These methods include negotiated usage
rates, dedicated asset assignment and proportionate corporate formulas based on
assets, operating margins, operating expenses and employees. These charges are
not necessarily indicative of what would have been incurred had the Company not
been an affiliate. Amounts charged to the Company for these services were $26
million and $30 million for the three months ended September 30, 2004 and 2005,
respectively, and $75 million and $84 million for the nine months ended
September 30, 2004 and 2005, respectively, and are included primarily in
operation and maintenance expenses.
Pursuant to the tax sharing agreement with CenterPoint Energy, the Company
received an allocation of CenterPoint Energy's tax benefits of $26 million and
$33 million for the three and nine months ended September 30, 2005,
respectively, which was recorded as an increase to additional paid-in capital.
Major Customers. During the three months ended September 30, 2004 and 2005,
revenues derived from energy delivery charges provided by the Company to a
subsidiary of RRI totaled $265 million and $249 million, respectively, and $666
million and $615 million during the nine months ended September 30, 2004 and
2005, respectively.
(6) COMMITMENTS AND CONTINGENCIES
(a) Legal Matters.
RRI Indemnified Litigation
The Company, CenterPoint Energy or their predecessor, Reliant Energy, and
certain of their former subsidiaries are named as defendants in several lawsuits
described below. Under a master separation agreement between CenterPoint Energy
and RRI, CenterPoint Energy and its subsidiaries are entitled to be indemnified
by RRI for any losses, including attorneys' fees and other costs, arising out of
the lawsuits described below under Electricity and Gas Market Manipulation Cases
and Other Class Action Lawsuits. Pursuant to the indemnification obligation, RRI
is defending CenterPoint Energy and its subsidiaries, including the Company, to
the extent named in these lawsuits. The ultimate outcome of these matters cannot
be predicted at this time.
9
Electricity and Gas Market Manipulation Cases. A large number of lawsuits
have been filed against numerous market participants and remain pending in both
federal and state courts in California and Nevada in connection with the
operation of the electricity and natural gas markets in California and certain
other western states in 2000-2001, a time of power shortages and significant
increases in prices. These lawsuits, many of which have been filed as class
actions, are based on a number of legal theories, including violation of state
and federal antitrust laws, laws against unfair and unlawful business practices,
the federal Racketeer Influenced Corrupt Organization Act, false claims statutes
and similar theories and breaches of contracts to supply power to governmental
entities. Plaintiffs in these lawsuits, which include state officials and
governmental entities as well as private litigants, are seeking a variety of
forms of relief, including recovery of compensatory damages (in some cases in
excess of $1 billion), a trebling of compensatory damages and punitive damages,
injunctive relief, restitution, interest due, disgorgement, civil penalties and
fines, costs of suit, attorneys' fees and divestiture of assets. To date,
several of the electricity complaints have been dismissed by the trial court and
are on appeal, and several of the dismissals have been affirmed by appellate
courts. Others remain in the early procedural stages. One of the gas complaints
has also been dismissed and is on appeal. The other gas cases remain in the
early procedural stages. CenterPoint Energy's former subsidiary, RRI, was a
participant in the California markets, owning generating plants in the state and
participating in both electricity and natural gas trading in that state and in
western power markets generally. RRI, some of its subsidiaries and, in some
cases, former corporate officers or employees of some of those companies have
been named as defendants in these suits.
CenterPoint Energy or its predecessor, Reliant Energy, has been named in
approximately 30 of these lawsuits, which were instituted between 2001 and 2005
and are pending in California state courts in San Diego County, in Kansas state
court in Wyandotte County and in federal district courts in San Francisco, San
Diego, Los Angeles, Fresno, Sacramento, San Jose, Kansas and Nevada and before
the Ninth Circuit Court of Appeals. However, the Company, CenterPoint Energy and
Reliant Energy were not participants in the electricity or natural gas markets
in California. CenterPoint Energy and Reliant Energy have been dismissed from
certain of the lawsuits, either voluntarily by the plaintiffs or by order of the
court, and CenterPoint Energy believes it is not a proper defendant in the
remaining cases and will continue to seek dismissal from such remaining cases.
On July 6, 2004 and on October 12, 2004, the Ninth Circuit affirmed CenterPoint
Energy's removal to federal district court of two electric cases brought by the
California Attorney General and affirmed the federal court's dismissal of these
cases based upon the filed rate doctrine and federal preemption. On April 18,
2005, the Supreme Court of the United States denied the Attorney General's
petition for certiorari in one of these cases. No petition for certiorari was
filed in the other case, and both of these cases are now finally resolved in
favor of the defendants. A third case filed by the California Attorney General
has been resolved in the settlement described in the following paragraph.
Several cases that are now pending in state court in San Diego County were
originally filed in several California state courts but were removed by the
defendants to federal district court. When the federal district court remanded
those cases, they were coordinated in front of one San Diego state court. In
July 2005, that San Diego state court refused to dismiss certain of those cases
based on defendants' claims of federal preemption and the filed rate doctrine.
On August 12, 2005, RRI reached a settlement with the states of California,
Washington and Oregon, California's three largest investor-owned utilities,
classes of consumers from California and other western states, and a number of
California city and county government entities that resolves their claims
against RRI related to the operation of the electricity markets in California
and certain other western states in 2000-2001. The settlement also resolves the
claims of the states and the investor-owned utilities related to the 2000-2001
natural gas markets. The settlement must be approved by FERC, the California
Public Utilities Commission and the courts in which the class action cases are
pending. Approvals are expected by the end of 2005. The Company is not a party
to the settlement, but may rely on the settlement as a defense to any claims
brought against it related to the time when the Company was an affiliate of RRI.
The terms of the settlement do not require payment by the Company.
Other Class Action Lawsuits. Fifteen class action lawsuits filed in May,
June and July 2002 on behalf of purchasers of securities of RRI and/or Reliant
Energy have been consolidated in federal district court in Houston. RRI and
certain of its former and current executive officers are named as defendants.
The consolidated complaint also names RRI, Reliant Energy, the underwriters of
the initial public offering of RRI's common stock in May 2001 (RRI Offering),
and RRI's and Reliant Energy's independent auditors as defendants. The
consolidated amended complaint seeks monetary relief purportedly on behalf of
purchasers of common stock of Reliant Energy or RRI during certain time periods
ranging from February 2000 to May 2002, and purchasers of common stock that can
be traced to the RRI Offering. The plaintiffs allege, among other things, that
the defendants misrepresented their
10
revenues and trading volumes by engaging in round-trip trades and improperly
accounted for certain structured transactions as cash-flow hedges, which
resulted in earnings from these transactions being accounted for as future
earnings rather than being accounted for as earnings in fiscal year 2001. In
January 2004, the trial judge dismissed the plaintiffs' allegations that the
defendants had engaged in fraud, but claims based on alleged misrepresentations
in the registration statement issued in the RRI Offering remain. In June 2004,
the plaintiffs filed a motion for class certification, which the court granted
in February 2005. The defendants appealed the court's order certifying the class
and asked the trial court to reconsider its ruling certifying the class. In July
2005, the parties announced that they had reached a settlement in this matter,
subject to court approval. The parties filed a stipulation and agreement of
settlement in September 2005, and in October 2005, filed a corrected and
supplemental submission at the court's request. Notice is being sent to
settlement class members and a settlement fairness hearing is set for January
2006. The terms of the settlement do not require a payment by CenterPoint Energy
or the Company.
In May 2002, three class action lawsuits were filed in federal district
court in Houston on behalf of participants in various employee benefits plans
sponsored by CenterPoint Energy. Two of the lawsuits have been dismissed without
prejudice. CenterPoint Energy and certain current and former members of its
benefits committee are the remaining defendants in the third lawsuit. That
lawsuit alleges that the defendants breached their fiduciary duties to various
employee benefits plans, directly or indirectly sponsored by CenterPoint Energy,
in violation of the Employee Retirement Income Security Act of 1974. The
plaintiffs allege that the defendants permitted the plans to purchase or hold
securities issued by CenterPoint Energy when it was imprudent to do so,
including after the prices for such securities became artificially inflated
because of alleged securities fraud engaged in by the defendants. The complaint
seeks monetary damages for losses suffered on behalf of the plans and a putative
class of plan participants whose accounts held CenterPoint Energy or RRI
securities, as well as restitution. Both the plaintiffs and the defendants have
pending motions for summary judgment before the court. Trial is set for January
2006.
In October 2002, a derivative action was filed in the federal district
court in Houston against the directors and officers of CenterPoint Energy. The
complaint set forth claims for breach of fiduciary duty, waste of corporate
assets, abuse of control and gross mismanagement. Specifically, the shareholder
plaintiff alleged that the defendants caused CenterPoint Energy to overstate its
revenues through so-called "round trip" transactions. The plaintiff also alleged
breach of fiduciary duty in connection with the spin-off of RRI and the RRI
Offering. The complaint sought monetary damages on behalf of CenterPoint Energy
as well as equitable relief in the form of a constructive trust on the
compensation paid to the defendants. CenterPoint Energy's board of directors
investigated that demand and similar allegations made in a June 28, 2002 demand
letter sent on behalf of a CenterPoint Energy shareholder. The second letter
demanded that CenterPoint Energy take several actions in response to alleged
round-trip trades occurring in 1999, 2000, and 2001. In June 2003, the board
determined that these proposed actions would not be in the best interests of
CenterPoint Energy. In March 2003, the court dismissed this case on the grounds
that the plaintiff did not make an adequate demand on CenterPoint Energy before
filing suit. Thereafter, the same party sent another demand asserting the same
claims, but there has been no further activity.
The Company believes that none of the lawsuits described under Other Class
Action Lawsuits has merit because, among other reasons, the alleged
misstatements and omissions were not material and did not result in any damages
to the plaintiffs.
Other Legal Matters
Texas Antitrust Actions. In July 2003, Texas Commercial Energy filed in
federal court in Corpus Christi, Texas a lawsuit against Reliant Energy, the
Company and CenterPoint Energy, as successors to Reliant Energy, Texas Genco, LP
(Genco LP), RRI, Reliant Energy Solutions, LLC, several other RRI subsidiaries
and a number of other participants in the Electric Reliability Council of Texas
(ERCOT) power market. The plaintiff, a retail electricity provider with the
ERCOT market, alleged that the defendants conspired to illegally fix and
artificially increase the price of electricity in violation of state and federal
antitrust laws and committed fraud and negligent misrepresentation. The lawsuit
sought damages in excess of $500 million, exemplary damages, treble damages,
interest, costs of suit and attorneys' fees. The plaintiff's principal
allegations had previously been investigated by the Texas Utility Commission and
found to be without merit. In June 2004, the federal court dismissed the
plaintiff's claims and the plaintiff appealed to the U.S. Fifth Circuit Court of
Appeals, which affirmed the dismissal. The plaintiff has now sought review by
the U.S. Supreme Court in a petition for certiorari. The Company is vigorously
contesting the appeal. The ultimate outcome of this matter cannot be predicted
at this time.
11
In February 2005, Utility Choice Electric filed in federal court in
Houston, Texas a lawsuit against the Company, CenterPoint Energy, CenterPoint
Energy Gas Services, Inc., CenterPoint Energy Alternative Fuels, Inc., Genco LP
and a number of other participants in the ERCOT power market. The plaintiff, a
retail electricity provider with the ERCOT market, alleged that the defendants
conspired to illegally fix and artificially increase the price of electricity in
violation of state and federal antitrust laws, intentionally interfered with
prospective business relationships and contracts, and committed fraud and
negligent misrepresentation. The plaintiff's principal allegations had
previously been investigated by the Texas Utility Commission and found to be
without merit. The Company intends to vigorously defend the case. The ultimate
outcome of this matter cannot be predicted at this time.
Municipal Franchise Fee Lawsuits. In February 1996, the cities of Wharton,
Galveston and Pasadena (Three Cities) filed suit in state district court in
Harris County, Texas for themselves and a proposed class of all similarly
situated cities in Reliant Energy's electric service area, against Reliant
Energy and Houston Industries Finance, Inc. (formerly a wholly owned subsidiary
of the Company's predecessor, Reliant Energy) alleging underpayment of municipal
franchise fees. The plaintiffs claimed that they were entitled to 4% of all
receipts of any kind for business conducted within these cities over the
previous four decades. After a jury trial involving the Three Cities' claims
(but not the class of cities), the trial court entered a judgment on the Three
Cities' breach of contract claims for $1.7 million, including interest, plus an
award of $13.7 million in legal fees. It also decertified the class. Following
this ruling, 45 cities filed individual suits against Reliant Energy in the
District Court of Harris County.
On February 27, 2003, a state court of appeals in Houston rendered an
opinion reversing the judgment against the Company and rendering judgment that
the Three Cities take nothing by their claims. The court of appeals held that
all of the Three Cities' claims were barred by the jury's finding of laches, a
defense similar to the statute of limitations, due to the Three Cities' having
unreasonably delayed bringing their claims during the more than 30 years since
the alleged wrongs began. The court also held that the Three Cities were not
entitled to recover any attorneys' fees. The Three Cities filed a petition for
review to the Texas Supreme Court, which declined to hear the case. Thus, the
Three Cities' claims have been finally resolved in the Company's favor, but the
individual claims of the remaining 45 cities remain pending in the same court.
There has been no activity in the claims of the 45 cities since the Texas
Supreme Court dismissed the claims of the Three Cities. The Company does not
expect the outcome of the remaining claims to have a material impact on its
financial condition, results of operations or cash flows.
(b) Environmental Matters.
Asbestos. A number of facilities owned by CenterPoint Energy contain
significant amounts of asbestos insulation and other asbestos-containing
materials. CenterPoint Energy or its subsidiaries have been named, along with
numerous others, as a defendant in lawsuits filed by a large number of
individuals who claim injury due to exposure to asbestos. Most claimants in such
litigation have been workers who participated in construction of various
industrial facilities, including power plants. Some of the claimants have worked
at locations owned by CenterPoint Energy, but most existing claims relate to
facilities previously owned by CenterPoint Energy but currently owned by Texas
Genco LLC. The Company anticipates that additional claims like those received
may be asserted in the future. Under the terms of the separation agreement
between CenterPoint Energy and Texas Genco Holdings, Inc. (Texas Genco),
ultimate financial responsibility for uninsured losses relating to these claims
has been assumed by Texas Genco, but under the terms of its agreement to sell
Texas Genco to Texas Genco LLC, CenterPoint Energy has agreed to continue to
defend such claims to the extent they are covered by insurance maintained by
CenterPoint Energy, subject to reimbursement of the costs of such defense from
Texas Genco LLC. Although their ultimate outcome cannot be predicted at this
time, the Company intends to continue vigorously contesting claims that it does
not consider to have merit and does not expect, based on its experience to date,
these matters, either individually or in the aggregate, to have a material
adverse effect on the Company's financial condition, results of operations or
cash flows.
(c) Other Proceedings.
The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management does not expect the disposition of these matters to have a material
adverse effect on the Company's financial condition, results of operations or
cash flows.
12
(d) Nuclear Decommissioning Trusts.
The Company, as collection agent for the nuclear decommissioning charge
assessed on its transmission and distribution customers, deposited $2.9 million
in 2004 to trusts established to fund Texas Genco's share of the decommissioning
costs for the South Texas Project, and expects to deposit approximately $2.9
million of collected charges in 2005. There are various investment restrictions
imposed upon Texas Genco by the Texas Utility Commission and the Nuclear
Regulatory Commission relating to Texas Genco's nuclear decommissioning trusts.
Pursuant to the provisions of both a separation agreement and the Texas Utility
Commission's final order, the Company and Texas Genco are presently jointly
administering the decommissioning funds through the Nuclear Decommissioning
Trust Investment Committee. Texas Genco and the Company have each appointed two
members to the Nuclear Decommissioning Trust Investment Committee which
establishes the investment policy of the trusts and oversees the investment of
the trusts' assets. As administrators of the decommissioning funds, the Company
and Texas Genco are jointly responsible for assuring that the funds are
prudently invested in a manner consistent with the rules of the Texas Utility
Commission. The Company and Texas Genco expect to file a request with the Texas
Utility Commission in 2005 to name Texas Genco as the sole fund administrator.
Pursuant to the Texas electric restructuring law, costs associated with nuclear
decommissioning that were not recovered as of January 1, 2002, will continue to
be subject to cost-of-service rate regulation and will be charged to
transmission and distribution customers of the Company or its successor.
(7) EMPLOYEE BENEFIT PLANS
The Company's employees participate in CenterPoint Energy's postretirement
benefit plan. The Company's net periodic cost includes the following components
relating to postretirement benefits:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2004 2005 2004 2005
---- ---- ---- ----
(IN MILLIONS)
Service cost .................... $-- $-- $ 1 $--
Interest cost ................... 4 4 12 13
Expected return on plan assets .. (2) (3) (7) (8)
Net amortization ................ 1 2 6 5
--- --- --- ---
Net periodic cost ............ $ 3 $ 3 $12 $10
=== === === ===
The Company expects to contribute $9 million to its postretirement benefits
plan in 2005. As of September 30, 2005, $6 million has been contributed.
13
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS
The following narrative analysis should be read in combination with our
Interim Financial Statements contained in this Form 10-Q.
We are an indirect wholly owned subsidiary of CenterPoint Energy, Inc.
(CenterPoint Energy), a public utility holding company created on August 31,
2002, as part of a corporate restructuring of Reliant Energy, Incorporated
(Reliant Energy). CenterPoint Energy is a registered public utility holding
company under the Public Utility Holding Company Act of 1935, as amended (1935
Act). For information about the 1935 Act, please read "-- Liquidity -- Certain
Contractual and Regulatory Limits on Our Ability to Issue Securities, Borrow
Money and Pay Dividends."
We meet the conditions specified in General Instruction H(1)(a) and (b) to
Form 10-Q and are therefore permitted to use the reduced disclosure format for
wholly owned subsidiaries of reporting companies. Accordingly, we have omitted
from this report the information called for by Item 2 (Management's Discussion
and Analysis of Financial Condition and Results of Operations), Item 3
(Quantitative and Qualitative Disclosures About Market Risk) of Part I and the
following Part II items of Form 10-Q: Item 2 (Unregistered Sales of Equity
Securities and Use of Proceeds), Item 3 (Defaults Upon Senior Securities) and
Item 4 (Submission of Matters to a Vote of Security Holders). The following
discussion explains material changes in our results of operations between the
three and nine months ended September 30, 2004 and the three and nine months
ended September 30, 2005. Reference is made to "Management's Narrative Analysis
of Results of Operations" in Item 7 of our Annual Report on Form 10-K for the
year ended December 31, 2004 (CenterPoint Houston Form 10-K).
RECENT EVENTS
RECOVERY OF TRUE-UP BALANCE
The Texas Electric Choice Plan (Texas electric restructuring law) provides
for the Public Utility Commission of Texas (Texas Utility Commission) to conduct
a "true-up" proceeding to determine our stranded costs and certain other costs
resulting from the transition to a competitive retail electric market and to
provide for our recovery of those costs. In March 2004, we filed our stranded
cost true-up application with the Texas Utility Commission. We had requested
recovery of $3.7 billion, excluding interest. In December 2004, the Texas
Utility Commission issued its final order (True-Up Order) allowing us to recover
a true-up balance of approximately $2.3 billion, which included interest through
August 31, 2004, and providing for adjustment of the amount to be recovered to
include interest on the balance until recovery, the principal portion of
additional excess mitigation credits returned to customers after August 31, 2004
and certain other matters. We and other parties filed appeals of the True-Up
Order to a district court in Travis County, Texas. That court held a hearing on
the appeal in early August 2005, and on August 26, 2005, the court issued its
final judgment on the various appeals. In its judgment, the court affirmed most
aspects of the Texas Utility Commission's order, but reversed two of the Texas
Utility Commission's rulings, which would have the effect of restoring
approximately $620 million, plus interest, of the $1.7 billion the Texas Utility
Commission had disallowed from our initial request. First, the court reversed
the Texas Utility Commission's decision to prohibit us from recovering $180
million in credits through August 2004 that we were ordered to provide to retail
electric providers as a result of a stranded cost estimate made by the Texas
Utility Commission in 2000 that subsequently proved to be inaccurate. Second,
the court reversed the Texas Utility Commission's disallowance of $440 million
in transition costs which are recoverable under the Texas Utility Commission's
regulations. Additional credits of approximately $30 million paid after August
2004 and interest would be added to these amounts. We and other parties appealed
the district court decision to the 3rd Court of Appeals in Austin in September
2005. The parties have agreed to a briefing schedule whereby briefs will be
filed by the parties on a schedule extending into February 2006. No amounts
related to the court's judgment have been recorded in our consolidated financial
statements.
There are two ways for us to recover the true-up balance: by issuing
transition bonds to securitize the amounts due and/or by implementing a
competition transition charge (CTC). In March 2005, the Texas Utility Commission
issued a financing order that authorized the issuance of approximately $1.8
billion of transition bonds. In August 2005, the same Travis County District
Court considering the appeal of the True-Up Order affirmed the financing order
in all respects. We expect to complete the issuance of transition bonds under
that order in the fourth quarter of 2005, subject to, among other matters,
market conditions and the completion of documentation and rating agency reviews.
14
On July 14, 2005, we received an order from the Texas Utility Commission
allowing us to implement a CTC to collect approximately $570 million over 14
years plus interest at an annual rate of 11.075%. The CTC order authorizes us to
impose a charge on retail electric providers to recover the portion of the
true-up balance not covered by the financing order. The CTC order also allows us
to collect approximately $24 million of rate case expenses over three years
through a separate tariff rider (Rider RCE). We implemented the CTC and Rider
RCE effective September 13, 2005 and began recovering approximately $600 million
and the rate case expenses. Certain other parties appealed the CTC order to the
Travis County District Court on September 27, 2005. Additionally, during the
period from September 13, 2005, the date of implementation of the CTC order,
through September 30, 2005, we recognized approximately $7 million in CTC
revenue, which was partially offset by $5 million in related amortization of the
CTC regulatory asset.
We are entitled to accrue a return on the true-up balance until it is fully
recovered.
CITY OF HOUSTON FRANCHISE
On June 27, 2005, we accepted an ordinance granting us a new 30-year
franchise to use the public rights-of-way to conduct our business in the City of
Houston (New Franchise Ordinance). The New Franchise Ordinance took effect on
July 1, 2005, and replaced the prior electricity franchise ordinance, which had
been in effect since 1957. The New Franchise Ordinance clarifies certain
operational obligations of ours and the City of Houston and provides for
streamlined payment and audit procedures and a two- year statute of limitations
on claims for underpayment or overpayment under the ordinance. Under the prior
electricity franchise ordinance, we paid annual franchise fees of $76.6 million
to the City of Houston for the year ended December 31, 2004. For the
twelve-month period beginning July 1, 2005, the annual franchise fee (Annual
Franchise Fee) under the New Franchise Ordinance will include a base amount of
$88.1 million (Base Amount) and an additional payment of $8.5 million
(Additional Amount). The Base Amount and the Additional Amount will be adjusted
annually based on the increase, if any, in kWh delivered by us within the City
of Houston.
We began paying the new annual franchise fees on July 1, 2005. Pursuant to
the New Franchise Ordinance, the Annual Franchise Fee will be reduced
prospectively to reflect any portion of the Annual Franchise Fee that is not
included in our base rates in any subsequent rate case. In accordance with our
rights under the New Franchise Ordinance, we filed a request with the City of
Houston to implement a tariff rider to collect the Additional Amount, but
subsequently asked the City of Houston to abate further consideration of that
application.
REPEAL OF THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
On August 8, 2005, President Bush signed into law the Energy Policy Act of
2005 (Energy Act). Under that legislation, the Public Utility Holding Company
Act of 1935 (1935 Act) is repealed effective February 8, 2006. After the
effective date of repeal, CenterPoint Energy and its subsidiaries will no longer
be subject to restrictions imposed under the 1935 Act. Until the repeal is
effective, CenterPoint Energy and its subsidiaries remain subject to the
provisions of the 1935 Act and the terms of orders issued by the Securities and
Exchange Commission (SEC) under the 1935 Act. The Energy Act grants to the
Federal Energy Regulatory Commission (FERC) authority to require holding
companies and their subsidiaries to maintain certain books and records and make
them available for review by FERC and state regulatory authorities. The Energy
Act requires FERC to issue regulations to implement its jurisdiction under the
Energy Act, and on September 16, 2005, FERC issued proposed rules for public
comment. It is presently unknown what, if any, specific obligations under those
rules may be imposed on CenterPoint Energy and its subsidiaries as a result of
that rulemaking.
CONSOLIDATED RESULTS OF OPERATIONS
Our results of operations are affected by, among other things, seasonal
fluctuations and other changes in the demand for electricity, the actions of
various governmental authorities having jurisdiction over the rates we charge,
debt service costs, income tax expense, our ability to collect receivables from
retail electric providers and our ability to recover our stranded costs and
regulatory assets. For more information regarding factors that may affect the
future results of operations of our business, please read "Risk Factors" in Item
5 of Part II of this report beginning on page 24 and "Management's Narrative
Analysis of Results of Operations -- Certain Factors Affecting Future Earnings"
in Item 7 of the CenterPoint Houston Form 10-K, which is incorporated herein by
reference.
15
The following table sets forth our consolidated results of operations for
the three and nine months ended September 30, 2004 and 2005, followed by a
discussion of our consolidated results of operations based on operating income.
We have provided a reconciliation of consolidated operating income to net income
below.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2004 2005 2004 2005
---------- ---------- ---------- ----------
(IN MILLIONS, EXCEPT CUSTOMER DATA)
Electric transmission and distribution revenues .................... $ 427 $ 453 $ 1,099 $ 1,164
---------- ---------- ---------- ----------
Electric transmission and distribution expenses:
Operation and maintenance ....................................... 136 155 394 446
Depreciation and amortization ................................... 63 69 186 197
Taxes other than income taxes ................................... 59 55 158 163
---------- ---------- ---------- ----------
Total electric transmission and distribution expenses ........ 258 279 738 806
---------- ---------- ---------- ----------
Operating income - Electric transmission and distribution utility .. 169 174 361 358
Operating income - Transition bond company (1) ..................... 9 9 29 27
---------- ---------- ---------- ----------
Total operating income ....................................... 178 183 390 385
Interest and other finance charges .............................. (86) (87) (260) (257)
Return on true-up balance ....................................... -- 35 -- 104
Other income, net ............................................... 8 13 34 36
---------- ---------- ---------- ----------
Income before income taxes and extraordinary item .................. 100 144 164 268
Income tax expense .............................................. (34) (49) (55) (90)
---------- ---------- ---------- ----------
Income before extraordinary item ................................... 66 95 109 178
Extraordinary item, net of tax .................................. (894) -- (894) 30
---------- ---------- ---------- ----------
Net income (loss) .................................................. $ (828) $ 95 $ (785) $ 208
========== ========== ========== ==========
Actual gigawatt-hours (GWh) delivered:
Residential ..................................................... 8,512 8,871 18,714 19,607
Total ........................................................... 22,568 22,351 56,634 57,134
Average number of metered customers:
Residential ..................................................... 1,645,523 1,690,819 1,633,890 1,675,904
Total ........................................................... 1,870,128 1,921,594 1,856,551 1,904,235
- ----------
(1) Represents the amount necessary to pay interest on the transition bonds.
THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2004
We reported operating income of $183 million for the three months ended
September 30, 2005, consisting of $174 million for the regulated electric
transmission and distribution utility and $9 million for the transition bond
company. For the three months ended September 30, 2004, operating income totaled
$178 million, consisting of $169 million for the regulated electric transmission
and distribution utility and $9 million for the transition bond company.
Operating revenues increased primarily due to continued customer growth ($11
million) with the addition of 53,000 metered customers since September 2004,
competition transition charge (CTC) recovery of our 2004 true-up balance not
covered by the transition bond finance order ($7 million) and higher
transmission cost recovery ($5 million). The increase in operating revenues was
partially offset by higher transmission costs ($8 million), the absence of a
gain from a land sale recorded in the third quarter of 2004 ($11 million),
increased amortization related to the CTC regulatory asset resulting from the
2004 true-up balance ($5 million), partially offset by decreased state and local
taxes ($4 million).
NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2004
We reported operating income of $385 million for the nine months ended
September 30, 2005, consisting of $358 million for the regulated electric
transmission and distribution utility and $27 million for the transition bond
company. For the nine months ended September 30, 2004, operating income totaled
$390 million, consisting of $361 million for the regulated electric transmission
and distribution utility and $29 million for the transition bond
16
company. Operating revenues increased primarily due to increased usage resulting
from warmer weather ($10 million), continued customer growth ($26 million) with
the addition of 53,000 metered customers since September 2004, CTC recovery of
our 2004 true-up balance not covered by the transition bond finance order ($7
million) and higher transmission cost recovery ($13 million). The increase in
operating revenues was more than offset by higher transmission costs ($16
million), the absence of a gain from a land sale recorded in the third quarter
of 2004 ($11 million), the absence of a $15 million partial reversal of a
reserve related to the final fuel reconciliation recorded in 2004, higher
depreciation and amortization expense ($11 million, including $5 million of
amortization related to the CTC regulatory asset resulting from the 2004 true-up
balance) and increased state and local taxes ($5 million).
In September 2005, our service area in Texas was adversely affected by
Hurricane Rita. Although damage to our electric facilities was limited, over
700,000 customers lost power at the height of the storm. Power was restored to
over a half million customers within 36 hours and all power was restored in less
than five days. Our revenues lost as a result of the storm were more than offset
by warmer than normal weather during the quarter. We estimate restoration costs
in our service area to be in the range of $20 to $30 million, which will be
deferred for recovery in a future rate case.
EXTRAORDINARY ITEM
Net income for the nine months ended September 30, 2005 included an
after-tax extraordinary gain of $30 million reflecting an adjustment to the
extraordinary loss recorded in the last half of 2004 to write-down
generation-related regulatory assets as a result of the final orders issued by
the Texas Utility Commission.
Net loss for the three and nine months ended September 30, 2004 included an
after-tax extraordinary loss of $894 million from a write-down of regulatory
assets based on our analysis of the Texas Utility Commission's deliberations on
the 2004 True-Up Proceeding.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Management's Narrative Analysis of
Results of Operations -- Certain Factors Affecting Future Earnings" in Item 7 of
Part II of the CenterPoint Houston Form 10-K, which is incorporated herein by
reference, and "Risk Factors" in Item 5 of Part II of this report beginning on
page 24.
LIQUIDITY
Our liquidity and capital requirements are affected primarily by our
results of operations, capital expenditures, debt service requirements, working
capital needs, various regulatory actions and appeals relating to such
regulatory actions. Our principal cash requirements for the last three months of
2005 include the following:
- the maturity of our $1.31 billion term loan; and
- approximately $73 million of capital expenditures.
We expect that borrowings under our credit facilities, anticipated cash
flows from operations and intercompany borrowings under the money pool described
below will be sufficient to meet our cash needs for 2005. Our $1.31 billion term
loan, maturing in November 2005, requires the proceeds from the issuance of
transition bonds to be used to reduce the term loan unless refused by the
lenders. We expect to utilize our $1.31 billion credit facility to refinance the
$1.31 billion term loan at its maturity on November 11, 2005.
The 1935 Act currently regulates our financing ability, as more fully
described in "-- Certain Contractual and Regulatory Limits on Our Ability to
Issue Securities, Borrow Money and Pay Dividends" below.
Off-Balance Sheet Arrangements. Other than operating leases, we have no
off-balance sheet arrangements.
Credit Facilities. In March 2005, we established a $200 million five-year
revolving credit facility. Borrowings may be made under the facility at the
London interbank offered rate (LIBOR) plus 75 basis points based on our current
credit rating. An additional utilization fee of 12.5 basis points applies to
borrowings whenever more than
17
50% of the facility is utilized. Changes in credit ratings could lower or raise
the increment to LIBOR depending on whether ratings improved or were lowered.
We also established a $1.31 billion credit facility in March 2005. This
facility can be utilized only to refinance our $1.31 billion term loan maturing
on November 11, 2005. Drawings may be made under this credit facility until
November 16, 2005, at which time any outstanding borrowings are converted to
term loans maturing in November 2007. Under this facility, (i) 100% of the net
proceeds from the issuance of transition bonds and (ii) the proceeds, in excess
of $200 million, from certain other new net indebtedness for borrowed money
incurred by us must be used to repay borrowings under the facility. Based on our
current credit ratings, borrowings under the facility may be made at LIBOR plus
75 basis points. The interest rate under the term loan which this facility would
replace is LIBOR plus 975 basis points. Changes in credit ratings could lower or
raise the increment to LIBOR depending on whether ratings improved or were
lowered. Any drawings under this facility must be secured by our general
mortgage bonds in the same principal amount and bearing the same interest rate
as such drawings.
Our $200 million and $1.31 billion credit facilities each contain
covenants, including a debt (excluding transition bonds) to total capitalization
covenant of 68% and an earnings before interest, taxes, depreciation and
amortization (EBITDA) to interest covenant. Borrowings under our $200 million
credit facility and our $1.31 billion credit facility are available
notwithstanding that a material adverse change has occurred or litigation that
could be expected to have a material adverse effect has occurred, so long as
other customary terms and conditions are satisfied.
As of November 1, 2005, we had the following credit facilities (in
millions):
AMOUNT UTILIZED AT
DATE EXECUTED SIZE OF FACILITY NOVEMBER 1, 2005 TERMINATION DATE
- ------------- ---------------- ------------------ ----------------
March 7, 2005 $ 200 $-- March 7, 2010
March 7, 2005 1,310 -- (1)
- ----------
(1) Revolver until November 2005 with two-year term-out of borrowed moneys.
Long-term Debt. Our long-term debt consists of our obligations and the
obligations of our subsidiaries, including transition bonds issued by a wholly
owned subsidiary. The following table shows future maturity dates of long-term
debt issued by us to third parties and affiliates and expected future maturity
dates of transition bonds issued by our subsidiary, CenterPoint Energy
Transition Bond Company, LLC (Bond Company), as of November 1, 2005. Amounts are
expressed in millions.
TRANSITION
YEAR THIRD-PARTY AFFILIATE SUB-TOTAL BONDS TOTAL
- ---- ----------- --------- --------- ---------- ------
2005.... $1,310 $ -- $1,310 $ -- $1,310
2006.... -- -- -- 54 54
2007.... -- -- -- 60 60
2008.... -- -- -- 66 66
2009.... -- -- -- 73 73
2010.... -- -- -- 80 80
2011.... -- -- -- 88 88
2012.... 46 -- 46 99 145
2013.... 450 -- 450 109 559
2014.... 300 -- 300 -- 300
2015.... -- 151 151 -- 151
2017.... 128 -- 128 -- 128
2021.... 102 -- 102 -- 102
2023.... 200 -- 200 -- 200
2027.... 56 -- 56 -- 56
2033.... 312 -- 312 -- 312
------ ---- ------ ---- ------
Total... $2,904 $151 $3,055 $629 $3,684
====== ==== ====== ==== ======
18
As of November 1, 2005, outstanding first mortgage bonds and general
mortgage bonds aggregated approximately $3.6 billion as shown in the following
table. Amounts are expressed in millions.
ISSUED AS ISSUED AS COLLATERAL
ISSUED DIRECTLY COLLATERAL FOR THE FOR CENTERPOINT
TO THIRD PARTIES COMPANY'S DEBT ENERGY'S DEBT TOTAL
---------------- ------------------ -------------------- ------
First Mortgage Bonds .... $ 102 $ -- $151 $ 253
General Mortgage Bonds .. 1,262 1,539 527 3,328
------ ------ ---- ------
Total ................ $1,364 $1,539 $678 $3,581
====== ====== ==== ======
The lien of the general mortgage indenture is junior to that of the
mortgage, pursuant to which the first mortgage bonds are issued. The aggregate
amount of incremental general mortgage bonds and first mortgage bonds that could
be issued as of September 30, 2005 is approximately $650 million based on
estimates of the value of our property encumbered by the general mortgage, the
cost of such property, the amount of retired bonds that could be used as the
basis for issuing new bonds and the 70% bonding ratio contained in the general
mortgage. However, contractual limitations on us and CenterPoint Energy
contained in the $1.31 billion term loan maturing in November 2005 limit the
incremental aggregate amount of first mortgage bonds and general mortgage bonds
that may be issued to $200 million. Generally, first mortgage bonds and general
mortgage bonds can be issued to refinance outstanding first mortgage bonds or
general mortgage bonds in the same principal amount. Additionally, under our
$1.31 billion credit facility, (i) 100% of the net proceeds from the issuance of
transition bonds and (ii) the proceeds, in excess of $200 million, from certain
other new net indebtedness for borrowed money incurred by us must be used to
repay borrowings under the facility.
The following table shows the maturity dates of the $678 million of first
mortgage bonds and general mortgage bonds that we have issued as collateral for
long-term debt of CenterPoint Energy. These bonds are not reflected in the
financial statements of CenterPoint Houston because of the contingent nature of
the obligations. Amounts are expressed in millions.
FIRST MORTGAGE GENERAL MORTGAGE
YEAR BONDS BONDS TOTAL
---- -------------- ---------------- -----
2011....... $ -- $ 19 $ 19
2015....... 151 -- 151
2018....... -- 50 50
2019....... -- 200 200
2020....... -- 90 90
2026....... -- 100 100
2028....... -- 68 68
---- ---- ----
Total... $151 $527 $678
==== ==== ====
The Bond Company had $629 million aggregate principal amount of outstanding
transition bonds as of September 30, 2005, that were issued in 2001 in
accordance with the Texas electric restructuring law. The transition bonds are
secured by "transition property," as defined in the Texas electric restructuring
law, which includes the irrevocable right to recover, through non-bypassable
transition charges payable by retail electric customers, qualified costs
provided in the Texas electric restructuring law. The transition bonds are
reported as our long-term debt, although the holders of the transition bonds
have no recourse to any of our assets or revenues, and our creditors have no
recourse to any assets or revenues (including, without limitation, the
transition charges) of the Bond Company. We have no payment obligations with
respect to the transition bonds except to remit collections of transition
charges as set forth in a servicing agreement between us and the Bond Company
and in an intercreditor agreement among us, the Bond Company and other parties.
Money Pool. We participate in a "money pool" through which we and certain
of our affiliates can borrow or invest on a short-term basis. Funding needs are
aggregated and external borrowing or investing is based on the net cash
position. The money pool's net funding requirements are generally met by
borrowings of CenterPoint Energy. The terms of the money pool are in accordance
with requirements currently applicable to registered public utility holding
companies under the 1935 Act and under an order from the SEC relating to our
financing activities dated June 29, 2005 (June 2005 Financing Order). Our money
pool borrowing limit under the existing order is $600 million. At November 1,
2005, we had an investment in the money pool of $108 million. The money pool may
not provide sufficient funds to meet our cash needs.
19
Impact on Liquidity of a Downgrade in Credit Ratings. As of November 1,
2005, Moody's Investors Service, Inc. (Moody's), Standard & Poor's Ratings
Services, a division of The McGraw Hill Companies (S&P), and Fitch, Inc. (Fitch)
had assigned the following credit ratings to our senior debt:
MOODY'S S&P FITCH
------------------- -------------------- --------------------
COMPANY/INSTRUMENT RATING OUTLOOK(1) RATING OUTLOOK (2) RATING OUTLOOK (3)
------------------ ------ ---------- ------ ----------- ------ -----------
CenterPoint Houston Senior Secured
Debt (First Mortgage Bonds)....... Baa2 Stable BBB Stable BBB+ Stable
- ----------
(1) A "stable" outlook from Moody's indicates that Moody's does not expect to
put the rating on review for an upgrade or downgrade within 18 months from
when the outlook was assigned or last affirmed.
(2) An S&P rating outlook assesses the potential direction of a long-term
credit rating over the intermediate to longer term.
(3) A "stable" outlook from Fitch encompasses a one-to-two year horizon as to
the likely ratings direction.
We cannot assure you that these ratings will remain in effect for any given
period of time or that one or more of these ratings will not be lowered or
withdrawn entirely by a rating agency. We note that these credit ratings are not
recommendations to buy, sell or hold our securities and may be revised or
withdrawn at any time by the rating agency. Each rating should be evaluated
independently of any other rating. Any future reduction or withdrawal of one or
more of our credit ratings could have a material adverse impact on our ability
to obtain short- and long-term financing, the cost of such financings and the
execution of our commercial strategies.
A decline in credit ratings could increase borrowing costs under our $200
million credit facility and our $1.31 billion credit facility. A decline in
credit ratings would also increase the interest rate on long-term debt to be
issued in the capital markets and would negatively impact our ability to
complete capital market transactions.
Our $200 million credit facility and our $1.31 billion facility do not
contain material adverse change clauses with respect to borrowings.
Cross Defaults. Under CenterPoint Energy's revolving credit facility, a
payment default by us on, or a non-payment default by us that permits
acceleration of, any indebtedness exceeding $50 million will cause a default.
Pursuant to the indenture governing CenterPoint Energy's senior notes, a payment
default by us in respect of, or an acceleration of, borrowed money and certain
other specified types of obligations, in the aggregate principal amount of $50
million will cause a default. As of November 1, 2005, CenterPoint Energy had
issued six series of senior notes aggregating $1.4 billion in principal amount
under this indenture. A default by CenterPoint Energy would not trigger a
default under our debt instruments or bank credit facilities.
Other Factors that Could Affect Cash Requirements. In addition to the above
factors, our liquidity and capital resources could be affected by:
- increases in interest expense in connection with debt refinancings and
borrowings under our credit facilities;
- various regulatory actions;
- the ability of RRI and its subsidiaries to satisfy their obligations
as our principal customer and in respect of RRI's indemnity
obligations to us;
- restoration costs and revenue losses resulting from natural disasters
such as hurricanes; and
- various of the risks identified in "Risk Factors" in Item 5 of Part II
of this report beginning on page 24.
Certain Contractual and Regulatory Limits on Our Ability to Issue
Securities, Borrow Money and Pay Dividends. Our secured term loan and each of
our credit facilities limit our debt, excluding transition bonds, as a
20
percentage of our total capitalization to 68%. Additionally, our $1.31 billion
and $200 million credit facilities contain an EBITDA to interest covenant.
Our parent, CenterPoint Energy, is a registered public utility holding
company under the 1935 Act. The 1935 Act and related rules and regulations
impose a number of restrictions on our parent's activities and those of its
subsidiaries, including us. The 1935 Act, among other things, limits our
parent's ability and the ability of its regulated subsidiaries, including us, to
issue debt and equity securities without prior authorization, restricts the
source of dividend payments to current and retained earnings without prior
authorization, regulates sales and acquisitions of certain assets and businesses
and governs affiliated service, sales and construction contracts. On August 8,
2005, President Bush signed into law the Energy Act. Under that legislation, the
1935 Act is repealed effective February 8, 2006. After the effective date of
repeal, CenterPoint Energy and its subsidiaries will no longer be subject to
restrictions imposed under the 1935 Act. Until the repeal is effective,
CenterPoint Energy and its subsidiaries remain subject to the provisions of the
1935 Act and the terms of orders issued by the SEC under the 1935 Act. The
Energy Act grants to FERC authority to require holding companies and their
subsidiaries to maintain certain books and records and make them available for
review by FERC and state regulatory authorities. The Energy Act requires FERC to
issue regulations to implement its jurisdiction under the Energy Act, and on
September 16, 2005, FERC issued proposed rules for public comment. It is
presently unknown what, if any, specific obligations under those rules may be
imposed on CenterPoint Energy and its subsidiaries as a result of that
rulemaking.
The June 2005 Financing Order establishes limits on the amount of external
debt and equity securities that can be issued by CenterPoint Energy and its
regulated subsidiaries, including us, without additional authorization but
generally permit CenterPoint Energy and its regulated subsidiaries, including
us, to refinance our existing obligations. We are in compliance with the
authorized limits. The order also generally permits utilization of our undrawn
credit facilities. Unless we obtain a further order from the SEC, as of October
31, 2005, we are authorized to issue an aggregate of $47 million of debt or
preferred securities.
In the June 2005 Financing Order, the SEC "reserved jurisdiction" over a
number of matters, meaning that an order will be required from the SEC before we
may conduct those activities. However, an order regarding the activities over
which the SEC has reserved jurisdiction generally can be issued by the SEC more
quickly than orders on other matters, although there is no assurance that a
release of jurisdiction will be granted on a given matter or the terms under
which such an order may be issued. In the June 2005 Financing Order, the SEC
reserved jurisdiction over all authority otherwise granted if the common equity
level of CenterPoint Energy falls below its level as of March 31, 2005 (11.4%
net of securitization debt) or if the common equity ratio of either us or
CenterPoint Energy Resources Corp., another wholly owned subsidiary of
CenterPoint Energy, falls below 30%. Among the other transactions over which the
SEC reserved jurisdiction are: (i) issuance of securities by CenterPoint Energy
or any of its subsidiaries, including us, unless our and the issuer's other
securities which are rated have an investment grade rating from at least one
nationally recognized statistical rating organization, (ii) further investment
in inactive subsidiaries and (iii) payment of dividends by us from capital or
unearned surplus. The June 2005 Financing Order also contains certain
requirements for interest rates, maturities, issuance expenses and use of
proceeds in connection with securities issued by CenterPoint Energy or any of
its subsidiaries, including us. So long as the common equity of CenterPoint
Energy is less than 30% of its capitalization, the SEC also reserved
jurisdiction over the use of proceeds from authorized financings for the
acquisition of additional energy-related or gas-related companies. Finally, the
SEC reserved jurisdiction over the issuance of $500 million in incremental debt
by us. The total authorized amount of debt and preferred securities that could
be outstanding during the authorization period, including the amounts over which
the SEC has reserved jurisdiction and undrawn amounts under our revolving credit
facilities, is $4.280 billion. The foregoing and the following restrictions
contained in the June 2005 Financing Order, along with other restrictions
contained in that order, will cease to apply to us on February 8, 2006.
The 1935 Act limits the payment of dividends to payment from current and
retained earnings unless specific authorization is obtained to pay dividends
from other sources. We expect to pay dividends out of current earnings. The June
2005 Financing Order also requires that we maintain a ratio of common equity to
total capitalization of 30%, although the SEC has permitted the percentage to be
below this level for other companies taking into account non-recourse
securitization debt as a component of capitalization. At September 30, 2005, our
ratio (excluding transition bonds) was 43%.
Other Factors Affecting the Upstreaming of Cash to Parent. Our $1.31
billion term loan maturing in November 2005, subject to certain exceptions,
limits the application of proceeds, in excess of $200 million, from capital
21
markets transactions and certain other borrowing transactions, by us to
repayment of debt existing as of November 2002. If the $1.31 billion credit
facility established in March 2005 is drawn in November 2005 to repay the term
loan, then (i) 100% of the net proceeds from the issuance of transition bonds
and (ii) the proceeds, in excess of $200 million, from certain other new net
indebtedness for borrowed money incurred by us must be used to repay borrowings
under the facility.
We plan to distribute recovery of the true-up components not used to repay
our indebtedness to CenterPoint Energy through the payment of dividends.
Specific approval has been obtained from the SEC to dividend to CenterPoint
Energy any net proceeds from the issuance of transition bonds. To maintain our
capital structure at the appropriate levels, CenterPoint Energy may reinvest
funds in us in the form of equity contributions or intercompany loans.
Relationship with CenterPoint Energy. We are an indirect wholly owned
subsidiary of CenterPoint Energy. As a result of this relationship, the
financial condition and liquidity of our parent company could affect our access
to capital, our credit standing and our financial condition.
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one that is both important to the
presentation of our financial condition and results of operations and requires
management to make difficult, subjective or complex accounting estimates. An
accounting estimate is an approximation made by management of a financial
statement element, item or account in the financial statements. Accounting
estimates in our historical consolidated financial statements measure the
effects of past business transactions or events, or the present status of an
asset or liability. The accounting estimates described below require us to make
assumptions about matters that are highly uncertain at the time the estimate is
made. Additionally, different estimates that we could have used or changes in an
accounting estimate that are reasonably likely to occur could have a material
impact on the presentation of our financial condition or results of operations.
The circumstances that make these judgments difficult, subjective and/or complex
have to do with the need to make estimates about the effect of matters that are
inherently uncertain. Estimates and assumptions about future events and their
effects cannot be predicted with certainty. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments. These estimates may change as new events occur, as more experience is
acquired, as additional information is obtained and as our operating environment
changes. Our significant accounting policies are discussed in Note 2 to the
consolidated financial statements in the CenterPoint Houston 10-K (CenterPoint
Houston 10-K Notes). We believe the following accounting policies involve the
application of critical accounting estimates. Accordingly, these accounting
estimates have been reviewed and discussed with the audit committee of the board
of directors of CenterPoint Energy.
ACCOUNTING FOR RATE REGULATION
SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation"
(SFAS No. 71), provides that rate-regulated entities account for and report
assets and liabilities consistent with the recovery of those incurred costs in
rates if the rates established are designed to recover the costs of providing
the regulated service and if the competitive environment makes it probable that
such rates can be charged and collected. Application of SFAS No. 71 to the
electric generation portion of our predecessor's business was discontinued as of
June 30, 1999. We continue to apply SFAS No. 71 which results in our accounting
for the regulatory effects of recovery of stranded costs and other regulatory
assets resulting from the unbundling of the transmission and distribution
business from the electric generation operations in our consolidated financial
statements. Certain expenses and revenues subject to utility regulation or rate
determination normally reflected in income are deferred on the balance sheet and
are recognized in income as the related amounts are included in service rates
and recovered from or refunded to customers. Significant accounting estimates
embedded within the application of SFAS No. 71 relate to $2.2 billion of
recoverable electric generation-related regulatory assets as of September 30,
2005. These costs are recoverable under the provisions of the Texas electric
restructuring law. Based on our analysis of the True-Up Order, we recorded an
after-tax charge to earnings in 2004 of approximately $977 million to write-down
our electric generation-related regulatory assets to their realizable value,
which was reflected as an extraordinary loss. Based on subsequent orders
received from the Texas Utility Commission, we recorded an extraordinary gain of
$30 million after-tax in the second quarter of 2005 related to the regulatory
asset.
22
IMPAIRMENT OF LONG-LIVED ASSETS AND INTANGIBLES
We review the carrying value of our long-lived assets, including
identifiable intangibles, whenever events or changes in circumstances indicate
that such carrying values may not be recoverable. Unforeseen events and changes
in circumstances and market conditions and material differences in the value of
long-lived assets and intangibles due to changes in estimates of future cash
flows, regulatory matters and operating costs could negatively affect the fair
value of our assets and result in an impairment charge.
Fair value is the amount at which the asset could be bought or sold in a
current transaction between willing parties and may be estimated using a number
of techniques, including quoted market prices or valuations by third parties,
present value techniques based on estimates of cash flows, or multiples of
earnings or revenue performance measures. The fair value of the asset could be
different using different estimates and assumptions in these valuation
techniques.
UNBILLED REVENUES
Revenues related to the delivery of electricity are generally recorded when
electricity is delivered to customers. However, the determination of electricity
deliveries to individual customers is based on the reading of their meters,
which is performed on a systematic basis throughout the month. At the end of
each month, amounts of electricity delivered to customers since the date of the
last meter reading are estimated and the corresponding unbilled revenue is
estimated. Unbilled electricity delivery revenue is estimated each month based
on daily supply volumes, applicable rates and analyses reflecting significant
historical trends and experience. As additional information becomes available,
or actual amounts are determinable, the recorded estimates are revised.
Consequently, operating results can be affected by revisions to prior accounting
estimates.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 2 to the Interim Financial Statements for a discussion of new
accounting pronouncements that affect us.
ITEM 4. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an
evaluation, under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, of
the effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our principal executive
officer and principal financial officer concluded that our disclosure controls
and procedures were effective as of September 30, 2005 to provide assurance that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
There has been no change in our internal controls over financial reporting
that occurred during the three months ended September 30, 2005 that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.
23
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a description of certain legal and regulatory proceedings affecting us,
please review Notes 3 and 6 to our Interim Financial Statements, "Business --
Regulation" and " -- Environmental Matters" in Item 1 of the CenterPoint Houston
Form 10-K, "Legal Proceedings" in Item 3 of the CenterPoint Houston Form 10-K
and Notes 4 and 9(b) to the CenterPoint Houston 10-K Notes, each of which is
incorporated herein by reference.
ITEM 5. OTHER INFORMATION
RISK FACTORS
PRINCIPAL RISK FACTORS ASSOCIATED WITH OUR BUSINESS
WE MAY NOT BE SUCCESSFUL IN TIMELY RECOVERING THE FULL VALUE OF OUR TRUE-UP
COMPONENTS, WHICH COULD HAVE AN ADVERSE IMPACT ON OUR RESULTS OF OPERATIONS,
FINANCIAL CONDITION AND CASH FLOWS.
In March 2004, we filed our stranded cost true-up application with the
Texas Utility Commission. We had requested recovery of $3.7 billion, excluding
interest. In December 2004, the Texas Utility Commission issued its final order
(True-Up Order) allowing us to recover a true-up balance of approximately $2.3
billion, which included interest through August 31, 2004, and providing for
adjustment of the amount to be recovered to include interest on the balance
until recovery, the principal portion of additional excess mitigation credits
returned to customers after August 31, 2004 and certain other matters. We and
other parties filed appeals of the True-Up Order to a district court in Travis
County, Texas. That court held a hearing on the appeal in early August 2005, and
on August 26, 2005, the court issued its final judgment on the various appeals.
In its judgment, the court affirmed most aspects of the Texas Utility
Commission's order, but reversed two of the Texas Utility Commission's rulings,
which would have the effect of restoring approximately $620 million, plus
interest, of the $1.7 billion the Texas Utility Commission had disallowed from
our initial request. First, the court reversed the Texas Utility Commission's
decision to prohibit us from recovering $180 million in credits through August
2004 that we were ordered to provide to retail electric providers as a result of
a stranded cost estimate made by the Texas Utility Commission in 2000 that
subsequently proved to be inaccurate. Second, the court reversed the Texas
Utility Commission's disallowance of $440 million in transition costs which are
recoverable under the Texas Utility Commission's regulations. Additional credits
of approximately $30 million paid after August 2004 and interest would be added
to these amounts. We and other parties appealed the district court decision to
the 3rd Court of Appeals in Austin in September 2005. The parties have agreed to
a briefing schedule whereby briefs will be filed by the parties on a schedule
extending into February 2006. No prediction can be made as to the ultimate
outcome or timing of such appeals. A failure by us to recover the full value of
our true-up components may have an adverse impact on our results of operations,
financial condition and cash flows.
OUR RECEIVABLES ARE CONCENTRATED IN A SMALL NUMBER OF RETAIL ELECTRIC PROVIDERS,
AND ANY DELAY OR DEFAULT IN PAYMENT COULD ADVERSELY IMPACT OUR RESULTS OF
OPERATIONS, FINANCIAL CONDITION AND CASH FLOWS.
Our receivables from the distribution of electricity are collected from
retail electric providers that supply the electricity we distribute to their
customers. Currently, we do business with approximately 65 retail electric
providers. Adverse economic conditions, structural problems in the market served
by ERCOT or financial difficulties of one or more retail electric providers
could impair the ability of these retail providers to pay for our services or
could cause them to delay such payments. We depend on these retail electric
providers to remit payments on a timely basis. Any delay or default in payment
could adversely affect our cash flows, financial condition and results of
operations. RRI, through its subsidiaries, is our largest customer.
Approximately 60% of our $175 million in billed receivables from retail electric
providers at September 30, 2005 was owed by subsidiaries of RRI.
RATE REGULATION OF OUR BUSINESS MAY DELAY OR DENY OUR ABILITY TO EARN A
REASONABLE RETURN AND FULLY RECOVER OUR COSTS.
Our rates are regulated by certain municipalities and the Texas Utility
Commission based on an analysis of our invested capital and our expenses in a
test year. Thus, the rates that we are allowed to charge may not match our
24
expenses at any given time. The regulatory process in which rates are determined
may not always result in rates that will produce full recovery of our costs and
enable us to earn a reasonable return on our invested capital.
DISRUPTIONS AT POWER GENERATION FACILITIES OWNED BY THIRD PARTIES COULD
INTERRUPT OUR SALES OF TRANSMISSION AND DISTRIBUTION SERVICES.
We depend on power generation facilities owned by third parties to provide
retail electric providers with electric power which we transmit and distribute
to customers of the retail electric providers. We do not own or operate any
power generation facilities. If power generation is disrupted or if power
generation capacity is inadequate, our services may be interrupted, and our
results of operations, financial condition and cash flows may be adversely
affected.
OUR REVENUES AND RESULTS OF OPERATIONS ARE SEASONAL.
A significant portion of our revenues is derived from rates that we collect
from each retail electric provider based on the amount of electricity we
distribute on behalf of such retail electric provider. Thus, our revenues and
results of operations are subject to seasonality, weather conditions and other
changes in electricity usage, with revenues being higher during the warmer
months.
RISK FACTORS ASSOCIATED WITH OUR CONSOLIDATED FINANCIAL CONDITION
IF WE ARE UNABLE TO ARRANGE FUTURE FINANCINGS ON ACCEPTABLE TERMS, OUR ABILITY
REFINANCE EXISTING INDEBTEDNESS COULD BE LIMITED.
As of September 30, 2005, we had $3.5 billion of outstanding indebtedness
on a consolidated basis. As of September 30, 2005, approximately $1.3 billion
principal amount of this debt must be paid through 2006, excluding principal
repayments of approximately $54 million on transition bonds. The success of our
future financing efforts may depend, at least in part, on:
- the timing and amount of our recovery of the true-up components;
- general economic and capital market conditions;
- credit availability from financial institutions and other lenders;
- investor confidence in us and the market in which we operate;
- maintenance of acceptable credit ratings by us and CenterPoint Energy;
- market expectations regarding our future earnings and probable cash
flows;
- market perceptions of our ability to access capital markets on
reasonable terms;
- our exposure to RRI as our customer and in connection with its
indemnification obligations arising in connection with its separation
from CenterPoint Energy;
- provisions of relevant tax and securities laws; and
- our ability to obtain approval of specific financing transactions
under the 1935 Act prior to the effective date of the repeal of the
1935 Act.
As of September 30, 2005, we had $3.3 billion principal amount of general
mortgage bonds outstanding and $253 million of first mortgage bonds outstanding.
We may issue additional general mortgage bonds on the basis of retired bonds,
70% of property additions or cash deposited with the trustee. Although
approximately $650 million of additional first mortgage bonds and general
mortgage bonds could be issued on the basis of retired bonds and 70% of property
additions as of September 30, 2005, we have agreed under the $1.3 billion
collateralized term loan maturing in November 2005 to not issue, subject to
certain exceptions, more than $200 million of any incremental
25
secured or unsecured debt. In addition, we are contractually prohibited, subject
to certain exceptions, from issuing additional first mortgage bonds. Our $1.3
billion credit facility requires that proceeds from the issuance of transition
bonds and certain new net indebtedness for borrowed money we issue in excess of
$200 million be used to repay borrowings under such facility.
Our capital structure and liquidity will be affected significantly by the
securitization of approximately $1.8 billion of costs authorized for recovery in
our proceeding regarding the transition to competitive retail markets in Texas.
Our current credit ratings are discussed in "Management's Narrative
Analysis of Results of Operations -- Liquidity -- Impact on Liquidity of a
Downgrade in Credit Ratings" in Item 2 of Part I of this report. These credit
ratings may not remain in effect for any given period of time and one or more of
these ratings may be lowered or withdrawn entirely by a rating agency. We note
that these credit ratings are not recommendations to buy, sell or hold our
securities. Each rating should be evaluated independently of any other rating.
Any future reduction or withdrawal of one or more of our credit ratings could
have a material adverse impact on our ability to access capital on acceptable
terms.
AN INCREASE IN SHORT-TERM INTEREST RATES COULD ADVERSELY AFFECT OUR CASH FLOWS
AND EARNINGS.
As of September 30, 2005, we had $1.3 billion of outstanding floating-rate
debt owed to third parties. The interest rate spreads on such debt are
substantially above our historical interest rate spreads. In addition, any
floating-rate debt issued by us in the future could be at interest rates
substantially above our historical borrowing rates. An increase in short-term
interest rates could result in higher interest costs and could adversely affect
our results of operations, financial condition and cash flows.
THE FINANCIAL CONDITION AND LIQUIDITY OF OUR PARENT COMPANY COULD AFFECT OUR
ACCESS TO CAPITAL, OUR CREDIT STANDING AND OUR FINANCIAL CONDITION.
Our ratings and credit may be impacted by CenterPoint Energy's credit
standing. As of September 30, 2005, CenterPoint Energy and its subsidiaries
other than us have approximately $152 million principal amount of debt required
to be paid through 2006. This amount excludes amounts related to capital leases,
securitization debt and indexed debt securities obligations. CenterPoint Energy
and its other subsidiaries may not be able to pay or refinance these amounts. If
CenterPoint Energy were to experience a deterioration in its credit standing or
liquidity difficulties, our access to credit and our ratings could be adversely
affected and the repayment of notes receivable from CenterPoint Energy in the
amount of $815 million as of September 30, 2005 could be adversely affected.
WE ARE AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY. CENTERPOINT
ENERGY CAN EXERCISE SUBSTANTIAL CONTROL OVER OUR BUSINESS AND OPERATIONS AND
COULD DO SO IN A MANNER THAT IS ADVERSE TO OUR INTERESTS.
We are managed by officers and employees of CenterPoint Energy. Our
management will make determinations with respect to the following:
- our payment of dividends;
- decisions on our financings and our capital raising activities;
- mergers or other business combinations; and
- our acquisition or disposition of assets.
There are no contractual restrictions on our ability to pay dividends to
CenterPoint Energy. Our management could decide to increase our dividends to
CenterPoint Energy to support its cash needs. This could adversely affect our
liquidity. Under the 1935 Act, our ability to pay dividends is restricted by the
SEC's requirement that common equity as a percentage of total capitalization
must be at least 30% after the payment of any dividend. Under our credit
facilities, our ability to pay dividends is restricted by a covenant that debt,
excluding transition bonds, as a percentage of total capitalization may not
exceed 68%.
26
OTHER RISKS
WE COULD INCUR LIABILITIES ASSOCIATED WITH BUSINESSES AND ASSETS THAT WE HAVE
TRANSFERRED TO OTHERS.
Under some circumstances, we could incur liabilities associated with assets
and businesses we no longer own. These assets and businesses were previously
owned by Reliant Energy directly or through subsidiaries and include:
- those transferred to RRI or its subsidiaries in connection with the
organization and capitalization of RRI prior to its initial public
offering in 2001; and
- those transferred to Texas Genco in connection with its organization
and capitalization.
In connection with the organization and capitalization of RRI, RRI and its
subsidiaries assumed liabilities associated with various assets and businesses
Reliant Energy transferred to them. RRI also agreed to indemnify, and cause the
applicable transferee subsidiaries to indemnify, CenterPoint Energy and its
subsidiaries, including us, with respect to liabilities associated with the
transferred assets and businesses. The indemnity provisions were intended to
place sole financial responsibility on RRI and its subsidiaries for all
liabilities associated with the current and historical businesses and operations
of RRI, regardless of the time those liabilities arose. If RRI is unable to
satisfy a liability that has been so assumed in circumstances in which Reliant
Energy has not been released from the liability in connection with the transfer,
we or CenterPoint Energy could be responsible for satisfying the liability.
RRI's unsecured debt ratings are currently below investment grade. If RRI
were unable to meet its obligations, it would need to consider, among various
options, restructuring under the bankruptcy laws, in which event RRI might not
honor its indemnification obligations and claims by RRI's creditors might be
made against us as its former owner.
Reliant Energy and RRI are named as defendants in a number of lawsuits
arising out of power sales in California and other West Coast markets and
financial reporting matters. Although these matters relate to the business and
operations of RRI, claims against Reliant Energy have been made on grounds that
include the effect of RRI's financial results on Reliant Energy's historical
financial statements and liability of Reliant Energy as a controlling
shareholder of RRI. We could incur liability if claims in one or more of these
lawsuits were successfully asserted against us or CenterPoint Energy and
indemnification from RRI were determined to be unavailable or if RRI were unable
to satisfy indemnification obligations owed with respect to those claims.
In connection with the organization and capitalization of Texas Genco,
Texas Genco assumed liabilities associated with the electric generation assets
Reliant Energy transferred to it. Texas Genco also agreed to indemnify, and
cause the applicable transferee subsidiaries to indemnify, CenterPoint Energy
and its subsidiaries, including us, with respect to liabilities associated with
the transferred assets and businesses. In many cases the liabilities assumed
were held by us and we were not released by third parties from these
liabilities. The indemnity provisions were intended generally to place sole
financial responsibility on Texas Genco and its subsidiaries for all liabilities
associated with the current and historical businesses and operations of Texas
Genco, regardless of the time those liabilities arose. In connection with the
sale of Texas Genco's fossil generation assets (coal, lignite and gas-fired
plants) to Texas Genco LLC, the separation agreement CenterPoint Energy entered
into with Texas Genco in connection with the organization and capitalization of
Texas Genco was amended to provide that all of Texas Genco's rights and
obligations under the separation agreement relating to its fossil generation
assets, including Texas Genco's obligation to indemnify us with respect to
liabilities associated with the fossil generation assets and related business,
were assigned to and assumed by Texas Genco LLC. In addition, under the amended
separation agreement, Texas Genco is no longer liable for, and CenterPoint
Energy has assumed and agreed to indemnify Texas Genco LLC against, liabilities
that Texas Genco originally assumed in connection with its organization to the
extent, and only to the extent, that such liabilities are covered by certain
insurance policies or other similar agreements held by CenterPoint Energy. If
Texas Genco or Texas Genco LLC were unable to satisfy a liability that had been
so assumed or indemnified against, and provided Reliant Energy had not been
released from the liability in connection with the transfer, we could be
responsible for satisfying the liability.
27
WE, AS A SUBSIDIARY OF CENTERPOINT ENERGY, A HOLDING COMPANY, ARE SUBJECT TO
REGULATION UNDER THE 1935 ACT. THE 1935 ACT AND RELATED RULES AND REGULATIONS
IMPOSE A NUMBER OF RESTRICTIONS ON OUR ACTIVITIES.
CenterPoint Energy and its subsidiaries, including us, are subject to
regulation by the SEC under the 1935 Act. The 1935 Act, among other things,
limits the ability of a holding company and its regulated subsidiaries to issue
debt and equity securities without prior authorization, restricts the source of
dividend payments to current and retained earnings without prior authorization,
regulates sales and acquisitions of certain assets and businesses and governs
affiliated service, sales and construction contracts.
CenterPoint Energy received an order from the SEC under the 1935 Act on
June 29, 2005 relating to its financing activities, which is effective until
June 30, 2008. Unforeseen events could result in capital needs in excess of
currently authorized amounts, necessitating further authorization from the SEC.
Approval of filings under the 1935 Act can take extended periods.
The Energy Policy Act of 2005 repeals the 1935 Act effective in 2006. We
cannot predict at this time the effect of the repeal on our business.
OUR INSURANCE COVERAGE MAY NOT BE SUFFICIENT. INSUFFICIENT INSURANCE COVERAGE
AND INCREASED INSURANCE COSTS COULD ADVERSELY IMPACT OUR RESULTS OF OPERATIONS,
FINANCIAL CONDITION AND CASH FLOWS.
In common with other companies in our line of business that serve coastal
regions, we do not have insurance covering our transmission and distribution
system because we believe it to be cost prohibitive. If we were to sustain any
loss of, or damage to, our transmission and distribution properties, we may not
be able to seek to recover such loss or damage through a change in our regulated
rates, and any such recovery may not be timely granted. Therefore, we may not be
able to restore any loss of, or damage to, any of our transmission and
distribution properties without negative impact on our results of operations,
financial condition and cash flows.
28
ITEM 6. EXHIBITS
The following exhibits are filed herewith:
Exhibits not incorporated by reference to a prior filing are designated by
a cross (+); all exhibits not so designated are incorporated by reference to a
prior filing of CenterPoint Energy Houston Electric, LLC or CenterPoint Energy,
Inc. as indicated.
Report or Registration SEC File or
Exhibit Number Description Statement Registration Number Exhibit References
- -------------- ----------- ---------------------- ------------------- ------------------
3.1 Articles of Organization of CenterPoint Houston's Form 1-3187 3(b)
CenterPoint Energy Houston 8-K dated August 31, 2002
Electric, LLC filed with the SEC on
September 3, 2002
3.2 Limited Liability Company CenterPoint Houston's Form 1-3187 3(c)
Regulations of CenterPoint 8-K dated August 31, 2002
Energy Houston Electric, LLC filed with the SEC on
September 3, 2002
4.1.1 $1,310,000,000 Credit CenterPoint Energy's Form 1-31447 4(g)(1)
Agreement dated as of 10-K for the year ended
November 12, 2002, among December 31, 2002
CenterPoint Houston and the
banks named therein
4.1.2 First Amendment to CenterPoint Energy's Form 1-31447 10.7
Exhibit 4.1.1, dated as of 10-Q for the quarter ended
September 3, 2003 September 30, 2003
4.1.3 Pledge Agreement, dated as CenterPoint Energy's Form 1-31447 4(g)(2)
of November 12, 2002 10-K for the year ended
executed in connection with December 31, 2002
Exhibit 4.1.1
4.2 $200,000,000 Credit CenterPoint Houston's Form 1-3187 4.2
Agreement dated as of March 8-K dated March 7, 2005
7, 2005 among CenterPoint
Houston and the banks named
therein
4.3 $1,310,000,000 Credit CenterPoint Houston's Form 1-3187 4.3
Agreement dated as of March 8-K dated March 7, 2005
7, 2005 among CenterPoint
Houston and the banks named
therein
+31.1 Rule 13a-14(a)/15d-14(a)
Certification of David M.
McClanahan
+31.2 Rule 13a-14(a)/15d-14(a)
Certification of Gary L.
Whitlock
+32.1 Section 1350 Certification
of David M. McClanahan
+32.2 Section 1350 Certification
of Gary L. Whitlock
29
Report or Registration SEC File or
Exhibit Number Description Statement Registration Number Exhibit References
- -------------- ----------- ---------------------- ------------------- ------------------
+99.1 Items incorporated by
reference from the
CenterPoint Houston Form
10-K. Item 1
"Business--Regulation,"
"--Environmental Matters,"
Item 3 "Legal Proceedings"
and Item 7 "Management's
Narrative Analysis of
Results of Operations --
Certain Factors Affecting
Future Earnings" and Notes
2(e) (Regulatory Assets and
Liabilities), 4 (Regulatory
Matters) and 9 (Commitments
and Contingencies).
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC
By: /s/ James S. Brian
------------------------------------
James S. Brian
Senior Vice President and Chief
Accounting Officer
Date: November 9, 2005
31
Exhibit Index
Exhibits not incorporated by reference to a prior filing are designated by
a cross (+); all exhibits not so designated are incorporated by reference to a
prior filing of CenterPoint Energy Houston Electric, LLC or CenterPoint Energy,
Inc. as indicated.
Report or Registration SEC File or
Exhibit Number Description Statement Registration Number Exhibit References
- -------------- ----------- ---------------------- ------------------- ------------------
3.1 Articles of Organization of CenterPoint Houston's Form 1-3187 3(b)
CenterPoint Energy Houston 8-K dated August 31, 2002
Electric, LLC filed with the SEC on
September 3, 2002
3.2 Limited Liability Company CenterPoint Houston's Form 1-3187 3(c)
Regulations of CenterPoint 8-K dated August 31, 2002
Energy Houston Electric, LLC filed with the SEC on
September 3, 2002
4.1.1 $1,310,000,000 Credit CenterPoint Energy's Form 1-31447 4(g)(1)
Agreement dated as of 10-K for the year ended
November 12, 2002, among December 31, 2002
CenterPoint Houston and the
banks named therein
4.1.2 First Amendment to CenterPoint Energy's Form 1-31447 10.7
Exhibit 4.1.1, dated as of 10-Q for the quarter ended
September 3, 2003 September 30, 2003
4.1.3 Pledge Agreement, dated as CenterPoint Energy's Form 1-31447 4(g)(2)
of November 12, 2002 10-K for the year ended
executed in connection with December 31, 2002
Exhibit 4.1.1
4.2 $200,000,000 Credit CenterPoint Houston's Form 1-3187 4.2
Agreement dated as of March 8-K dated March 7, 2005
7, 2005 among CenterPoint
Houston and the banks named
therein
4.3 $1,310,000,000 Credit CenterPoint Houston's Form 1-3187 4.3
Agreement dated as of March 8-K dated March 7, 2005
7, 2005 among CenterPoint
Houston and the banks named
therein
+31.1 Rule 13a-14(a)/15d-14(a)
Certification of David M.
McClanahan
+31.2 Rule 13a-14(a)/15d-14(a)
Certification of Gary L.
Whitlock
+32.1 Section 1350 Certification
of David M. McClanahan
+32.2 Section 1350 Certification
of Gary L. Whitlock
32
Report or Registration SEC File or
Exhibit Number Description Statement Registration Number Exhibit References
- -------------- ----------- ---------------------- ------------------- ------------------
+99.1 Items incorporated by
reference from the
CenterPoint Houston Form
10-K. Item 1
"Business--Regulation,"
"--Environmental Matters,"
Item 3 "Legal Proceedings"
and Item 7 "Management's
Narrative Analysis of
Results of Operations--
Certain Factors Affecting
Future Earnings" and Notes
2(e) (Regulatory Assets and
Liabilities), 4 (Regulatory
Matters) and 9 (Commitments
and Contingencies).
33
EXHIBIT 31.1
CERTIFICATIONS
I, David M. McClanahan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
CenterPoint Energy Houston Electric, LLC;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter (the registrant's
fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably
likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: November 9, 2005
/s/ David M. McClanahan
--------------------------------------
David M. McClanahan
Chairman (Principal Executive Officer)
EXHIBIT 31.2
CERTIFICATIONS
I, Gary L. Whitlock, certify that:
1. I have reviewed this quarterly report on Form 10-Q of
CenterPoint Energy Houston Electric, LLC;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a) Designed such disclosure controls and procedures, or caused
such disclosure controls and procedures to be designed under
our supervision, to ensure that material information relating
to the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred during
the registrant's most recent fiscal quarter (the registrant's
fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably
likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: November 9, 2005
/s/ Gary L. Whitlock
----------------------------------------------------
Gary L. Whitlock
Executive Vice President and Chief Financial Officer
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of CenterPoint Energy Houston
Electric, LLC (the "Company") on Form 10-Q for the period ended September 30,
2005 (the "Report"), as filed with the Securities and Exchange Commission on the
date hereof, I, David M. McClanahan, Chairman (Principal Executive Officer),
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that:
1. The Report fully complies with the requirements of section
13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
2. The information contained in the Report fairly presents, in
all material respects, the financial condition and results of operations of the
Company.
/s/ David M. McClanahan
- --------------------------------------------
David M. McClanahan
Chairman (Principal Executive Officer)
November 9, 2005
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of CenterPoint Energy Houston
Electric, LLC (the "Company") on Form 10-Q for the period ended September 30,
2005 (the "Report"), as filed with the Securities and Exchange Commission on the
date hereof, I, Gary L. Whitlock, Chief Financial Officer, certify, pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, to the best of my knowledge, that:
1. The Report fully complies with the requirements of
section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
2. The information contained in the Report fairly presents, in
all material respects, the financial condition and results of operations of the
Company.
/s/ Gary L. Whitlock
- ----------------------------------------------------
Gary L. Whitlock
Executive Vice President and Chief Financial Officer
November 9, 2005
EXHIBIT 99.1
ITEM 1. BUSINESS
REGULATION
We are subject to regulation by various federal, state and local
governmental agencies, including the regulations described below.
PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
As a subsidiary of a registered public utility holding company, we are
subject to a comprehensive regulatory scheme imposed by the SEC in order to
protect customers, investors and the public interest. Although the SEC does not
regulate rates and charges under the 1935 Act, it does regulate the structure,
financing, lines of business and internal transactions of public utility holding
companies and their system companies. In order to obtain financing, acquire
additional public utility assets or stock, or engage in other significant
transactions, we are generally required to obtain approval from the SEC under
the 1935 Act.
CenterPoint Energy received an order from the SEC under the 1935 Act on
June 30, 2003 and supplemental orders thereafter relating to its financing
activities and those of its regulated subsidiaries, including us, as well as
other matters. The orders are effective until June 30, 2005. As of December 31,
2004, the orders generally permitted CenterPoint Energy and its subsidiaries,
including us, to issue securities to refinance indebtedness outstanding at June
30, 2003, and authorized CenterPoint Energy and its subsidiaries, including us,
to issue certain incremental external debt securities and common and preferred
stock through June 30, 2005 in specified amounts, without prior authorization
from the SEC. The orders also contain certain requirements regarding ratings of
CenterPoint Energy's securities, interest rates, maturities, issuance expenses
and use of proceeds. The orders require that we maintain a ratio of common
equity to total capitalization of at least 30%. We intend to file an application
for approval of our post-June 30, 2005 financing activities.
The United States Congress from time to time considers legislation that
would repeal the 1935 Act. We cannot predict at this time whether this
legislation or any variation thereof will be adopted or, if adopted, the effect
of any such law on our business.
FEDERAL ENERGY REGULATORY COMMISSION
We are not a "public utility" under the Federal Power Act and therefore
are not generally regulated by the Federal Energy Regulatory Commission (FERC),
although certain of our transactions are subject to limited FERC jurisdiction.
STATE AND LOCAL REGULATION
We conduct operations pursuant to a certificate of convenience and
necessity issued by the Texas Utility Commission that covers our present service
area and facilities. In addition, we hold non-exclusive franchises, typically
having a term of 50 years, from the incorporated municipalities in our service
territory. These franchises give us the right to construct, operate and maintain
our transmission and distribution system within the streets and public ways of
these municipalities for the purpose of delivering electric service to the
municipality, its residents and businesses in exchange for payment of a fee. The
franchise for the City of Houston is scheduled to expire in 2007.
All retail electric providers in our service area pay the same rates and
other charges for transmission and distribution services.
Our distribution rates charged to retail electric providers for
residential customers are based on amounts of energy delivered, whereas
distribution rates for a majority of commercial and industrial customers are
based on peak demand. Transmission rates charged to other distribution companies
are based on amounts of energy transmitted under "postage stamp" rates that do
not vary with the distance the energy is being transmitted. All distribution
companies in ERCOT pay us the same rates and other charges for transmission
services. Our transmission and distribution rates have been in effect since
January 1, 2002, when electric competition began. This regulated delivery charge
includes the transmission and distribution rate (which includes costs for
nuclear decommissioning and
1
municipal franchise fees), a system benefit fund fee imposed by the Texas
electric restructuring law, a transition charge associated with securitization
of regulatory assets and an excess mitigation credit imposed by the Texas
Utility Commission.
ENVIRONMENTAL MATTERS
Our operations are subject to stringent and complex laws and regulations
pertaining to health, safety and the environment. As an owner or operator of
electric transmission and distribution systems we must comply with these laws
and regulations at the federal, state and local levels. These laws and
regulations can restrict or impact our business activities in many ways, such
as:
- restricting the way we can handle or dispose of our wastes;
- limiting or prohibiting construction activities in sensitive areas
such as wetlands, coastal regions, or areas inhabited by endangered
species;
- requiring remedial action to mitigate pollution conditions caused by
our operations, or attributable to former operations; and
- enjoining the operations of facilities deemed in non-compliance with
permits issued pursuant to such environmental laws and regulations.
In order to comply with these requirements, we may need to spend
substantial amounts and devote other resources from time to time to:
- construct or acquire new equipment; and
- modify or replace existing and proposed equipment.
Failure to comply with these laws and regulations may trigger a variety of
administrative, civil and criminal enforcement measures, including the
assessment of monetary penalties, the imposition of remedial requirements, and
the issuance of orders enjoining future operations. Certain environmental
statutes impose strict, joint and several liability for costs required to clean
up and restore sites where hazardous substances have been disposed or otherwise
released. Moreover, it is not uncommon for neighboring landowners and other
third parties to file claims for personal injury and property damage allegedly
caused by the release of hazardous substances or other waste products into the
environment.
The trend in environmental regulation is to place more restrictions and
limitations on activities that may affect the environment, and thus there can be
no assurance as to the amount or timing of future expenditures for environmental
compliance or remediation, and actual future expenditures may be different from
the amounts we currently anticipate. We try to anticipate future regulatory
requirements that might be imposed and plan accordingly to remain in compliance
with changing environmental laws and regulations and to minimize the costs of
such compliance.
We do not believe that compliance with federal, state or local
environmental laws and regulations will have a material adverse effect on our
business, financial position or results of operations. In addition, we believe
that the various environmental remediation activities in which we are presently
engaged will not materially interrupt or diminish our operational ability. We
cannot assure you, however, that future events, such as changes in existing
laws, the promulgation of new laws, or the development or discovery of new facts
or conditions will not cause us to incur significant costs. The following is a
discussion of all material environmental and safety laws and regulations that
relate to our operations. We believe that we are in substantial compliance with
all of these environmental laws and regulations.
2
AIR EMISSIONS
Our operations are subject to the federal Clean Air Act and comparable
state laws and regulations. These laws and regulations regulate emissions of air
pollutants from various industrial sources and also impose various monitoring
and reporting requirements. Such laws and regulations may require that we obtain
pre-approval for the construction or modification of certain projects or
facilities expected to produce air emissions or result in the increase of
existing air emissions, obtain and strictly comply with air permits containing
various emissions and operational limitations, or utilize specific emission
control technologies to limit emissions. Our failure to comply with these
requirements could subject us to monetary penalties, injunctions, conditions or
restrictions on operations, and potentially criminal enforcement actions. We may
be required to incur certain capital expenditures in the future for air
pollution control equipment in connection with obtaining and maintaining
operating permits and approvals for air emissions. We believe, however, that our
operations will not be materially adversely affected by such requirements, and
the requirements are not expected to be any more burdensome to us than to any
other similarly situated companies.
WATER DISCHARGES
Our operations are subject to the Federal Water Pollution Control Act of
1972, as amended, also known as the Clean Water Act, and analogous state laws
and regulations. These laws and regulations impose detailed requirements and
strict controls regarding the discharge of pollutants into waters of the United
States. The unpermitted discharge of pollutants, including discharges resulting
from a spill or leak incident, is prohibited. The Clean Water Act and
regulations implemented thereunder also prohibit discharges of dredged and fill
material in wetlands and other waters of the United States unless authorized by
an appropriately issued permit. Any unpermitted release of petroleum or other
pollutants from our pipelines or facilities could result in fines or penalties
as well as significant remedial obligations.
HAZARDOUS WASTE
Our operations generate wastes, including some hazardous wastes, that are
subject to the federal Resource Conservation and Recovery Act (RCRA), and
comparable state laws, which impose detailed requirements for the handling,
storage, treatment and disposal of hazardous and solid waste. RCRA currently
exempts many natural gas gathering and field processing wastes from
classification as hazardous waste. Specifically, RCRA excludes from the
definition of hazardous waste produced waters and other wastes associated with
the exploration, development, or production of crude oil and natural gas.
However, these oil and gas exploration and production wastes are still regulated
under state law and the less stringent non-hazardous waste requirements of RCRA.
Moreover, ordinary industrial wastes such as paint wastes, waste solvents,
laboratory wastes, and waste compressor oils may be regulated as hazardous
waste. The transportation of natural gas in pipelines may also generate some
hazardous wastes that are subject to RCRA or comparable state law requirements.
LIABILITY FOR REMEDIATION
The Comprehensive Environmental Response, Compensation and Liability Act
of 1980, as amended (CERCLA), also known as "Superfund," and comparable state
laws impose liability, without regard to fault or the legality of the original
conduct, on certain classes of persons responsible for the release of hazardous
substances into the environment. Such classes of persons include the current and
past owners or operators of sites where a hazardous substance was released, and
companies that disposed or arranged for disposal of hazardous substances at
offsite locations such as landfills. In the course of our ordinary operations we
generate wastes that may fall within the definition of a "hazardous substance."
CERCLA authorizes the United States Environmental Protection Agency (EPA) and,
in some cases, third parties to take actions in response to threats to the
public health or the environment and to seek to recover from the responsible
classes of persons the costs they incur. Under CERCLA, we could be subject to
joint and several liability for the costs of cleaning up and restoring sites
where hazardous substances have been released, for damages to natural resources,
and for the costs of certain health studies.
3
LIABILITY FOR PREEXISTING CONDITIONS
Asbestos. A number of facilities owned by CenterPoint Energy contain
significant amounts of asbestos insulation and other asbestos-containing
materials. CenterPoint Energy or its subsidiaries, including us, have been
named, along with numerous others, as a defendant in lawsuits filed by a large
number of individuals who claim injury due to exposure to asbestos. Most
claimants in such litigation have been workers who participated in construction
of various industrial facilities, including power plants. Some of the claimants
have worked at locations owned by CenterPoint Energy, but most existing claims
relate to facilities previously owned by CenterPoint Energy but currently owned
by Texas Genco LLC. We anticipate that additional claims like those received may
be asserted in the future. Under the terms of the separation agreement between
CenterPoint Energy and Texas Genco, ultimate financial responsibility for
uninsured losses relating to these claims has been assumed by Texas Genco, but
under the terms of its agreement to sell Texas Genco to Texas Genco LLC,
CenterPoint Energy has agreed to continue to defend such claims to the extent
they are covered by insurance maintained by CenterPoint Energy, subject to
reimbursement of the costs of such defense from Texas Genco LLC. Although their
ultimate outcome cannot be predicted at this time, we intend to continue
vigorously contesting claims that we do not consider to have merit and do not
believe, based on our experience to date, that these matters, either
individually or in the aggregate, will have a material adverse effect on our
financial condition, results of operations or cash flows.
4
ITEM 3. LEGAL PROCEEDINGS
For a brief description of certain legal and regulatory proceedings
affecting us, please read "Regulation" and "Environmental Matters" in Item 1 of
this report and Notes 4 and 9(b) to our consolidated financial statements, which
information is incorporated herein by reference.
ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS -
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
Our past earnings and results of operations 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 or be affected by numerous
factors including:
- the timing and amount of our recovery of the true-up components;
- state and federal legislative and regulatory actions or
developments, including deregulation, re-regulation, constraints
placed on our activities or business by the 1935 Act, changes in or
application of laws or regulations applicable to other aspects of
our business and actions with respect to:
- allowed rates of return;
- rate structures;
- recovery of investments; and
- operation and construction of facilities;
- industrial, commercial and residential growth in our service
territory and changes in market demand and demographic patterns;
- changes in interest rates or rates of inflation;
- weather variations and other natural phenomena;
- commercial bank and financial market conditions, our access to
capital, the cost of such capital, receipt of certain financing
approvals under the 1935 Act, and the results of our financing and
refinancing efforts, including availability of funds in the debt
capital markets;
- actions by rating agencies;
- non-payment for our services due to financial distress of our
customers, including RRI;
- the outcome of the pending securities lawsuits against us, Reliant
Energy and RRI;
- the ability of RRI to satisfy its obligations to us, including
indemnity obligations;
- our ability to control costs;
- the investment performance of CenterPoint Energy's employee benefit
plans;
- our internal restructuring or other restructuring options that may
be pursued;
- our potential business strategies, including acquisitions or
dispositions of assets or businesses, which cannot be assured to be
completed or beneficial to us; and
- other factors discussed in Item 1 of this report under "Risk
Factors."
5
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(e) REGULATORY ASSETS AND LIABILITIES
The Company applies the accounting policies established in SFAS No. 71,
"Accounting for the Effects of Certain Types of Regulation" (SFAS No. 71). The
following is a list of regulatory assets/liabilities reflected on the Company's
Consolidated Balance Sheets as of December 31, 2003 and 2004:
DECEMBER 31,
-----------------
2003 2004
------- -------
(IN MILLIONS)
Recoverable electric generation-related regulatory assets........... $ 3,226 $ 1,946
Securitized regulatory asset........................................ 682 647
Unamortized loss on reacquired debt................................. 80 80
Estimated removal costs............................................. (232) (249)
Other long-term regulatory assets/liabilities....................... 32 32
------- -------
Total............................................................. $ 3,788 $ 2,456
======= =======
If events were to occur that would make the recovery of these assets and
liabilities no longer probable, the Company would be required to write-off or
write-down these regulatory assets and liabilities. During 2004, the Company
wrote-off net regulatory assets of $1.5 billion in response to the Public
Utility Commission of Texas' (Texas Utility Commission) order on the Company's
final true-up application. For further discussion of regulatory assets, see Note
4.
The Company's rate-regulated businesses recognize removal costs as a
component of depreciation expense in accordance with regulatory treatment. As of
December 31, 2003 and 2004, these removal costs of $232 million and $249
million, respectively, are classified as regulatory liabilities in the
Consolidated Balance Sheets. The Company has also identified other asset
retirement obligations that cannot be estimated because the assets associated
with the retirement obligations have an indeterminate life.
6
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) REGULATORY MATTERS
(a) 2004 TRUE-UP PROCEEDING
In March 2004, the Company filed the final true-up application required by
the Texas electric restructuring law with the Texas Utility Commission (2004
True-Up Proceeding). The Company's requested true-up balance was $3.7 billion,
excluding interest and net of the retail clawback from RRI described below. In
June, July and September 2004, the Texas Utility Commission conducted hearings
on, and held public meetings addressing, the Company's true-up application. In
December 2004, the Texas Utility Commission approved a final order in the
Company's true-up proceeding (2004 Final Order) authorizing the Company to
recover $2.3 billion including interest through August 31, 2004, subject to
adjustments to reflect the benefit of certain deferred taxes and the accrual of
interest and payment of excess mitigation credits after August 31, 2004. As a
result of the 2004 Final Order, the Company wrote-off net regulatory assets of
$1.5 billion and recorded a related income tax benefit of $526 million,
resulting in an after-tax charge of $977 million, which is reflected as an
extraordinary loss in the Company's Statements of Consolidated Operations. The
Company recorded an expected loss of $894 million in the third quarter of 2004
and increased this amount by $83 million in the fourth quarter of 2004 based on
the Company's assessment of the amounts ultimately recoverable. In January 2005,
the Company appealed certain aspects of the final order seeking to increase the
true-up balance ultimately recovered by the Company. Other parties have also
appealed the order, seeking to reduce the amount authorized for the Company's
recovery. Although the Company believes it has meritorious arguments and that
the other parties' appeals are without merit, no prediction can be made as to
the ultimate outcome or timing of such appeals.
The Company has recorded as a regulatory asset a return of $374 million on
the true-up balance for the period from January 1, 2002 through December 31,
2004 as allowed by the Texas Utility Commission's 2004 Final Order. The Company,
under the 2004 Final Order, will continue to accrue a return until the true-up
balance is recovered by the Company, either from rate payers or through a
securitization offering as discussed below. The rate of return is based on the
Company's cost of capital, established in the Texas Utility Commission's final
order issued in October 2001 (2001 Final Order), which is derived from the
Company's cost to finance assets and an allowance for earnings on shareholders'
investment. Accordingly, in accordance with SFAS No. 92, "Regulated Enterprises
- - Accounting for Phase-in Plans," the rate of return has been bifurcated into
components representing a return of costs to finance assets and an allowance for
earnings on shareholders' investment. The component representing a return of
costs to finance assets of $226 million has been recognized in the fourth
quarter of 2004 and is included in other income in the Company's Statements of
Consolidated Operations. The component representing a return of costs to finance
assets will continue to be recognized as earned going forward. The component
representing an allowance for earnings on shareholders' investment of $148
million has been deferred and will be recognized as it is collected through
rates in the future.
In November 2004, RRI paid $177 million to the Company, representing the
"retail clawback" determined by the Texas Utility Commission in the 2004 True-Up
Proceeding. The Texas electric restructuring law requires the Texas Utility
Commission to determine the retail clawback if the formerly integrated utility's
affiliated retail electric provider retained more than 40 percent of its
residential price-to-beat customers within the utility's service area as of
January 1, 2004 (offset by new customers added outside the service territory).
That retail clawback is a credit against the stranded costs the utility is
entitled to recover and was reflected in the $2.3 billion recovery authorized.
Under the terms of a master separation agreement between RRI and the Company,
RRI agreed to pay the Company the amount of the retail clawback determined by
the Texas Utility Commission. The payment was used by the Company to reduce
outstanding indebtedness.
7
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Texas electric restructuring law provides for the use of special
purpose entities to issue transition bonds for the economic value of
generation-related regulatory assets and stranded costs. These transition bonds
will be amortized over a period not to exceed 15 years through non-bypassable
transition charges. In October 2001, a special purpose subsidiary of the Company
issued $749 million of transition bonds to securitize certain generation-related
regulatory assets. These transition bonds have a final maturity date of
September 15, 2015 and are non-recourse to the Company and its subsidiaries
other than to the special purpose issuer. Payments on the transition bonds are
made solely out of funds from non-bypassable transition charges.
In December 2004, the Company filed for approval of a financing order to
issue transition bonds to securitize its true-up balance. On March 9, 2005, the
Texas Utility Commission issued a financing order allowing the Company to
securitize approximately $1.8 billion and requiring that the benefit of certain
deferred taxes be reflected as a reduction in the competition transition charge.
The Company anticipates that a new special purpose subsidiary of the Company
will issue bonds in one or more series through an underwritten offering.
Depending on market conditions and the impact of possible appeals of the
financing order, among other factors, the Company anticipates completing such an
offering in 2005.
In January 2005, the Company filed an application for a competition
transition charge to recover its true-up balance. The Company will adjust the
amount sought through that charge to the extent that it is able to securitize
any of such amount. Under the Texas Utility Commission's rules, the unrecovered
true-up balance to be recovered through the competition transition charge earns
a return until fully recovered.
In the 2001 Final Order, the Texas Utility Commission established the
transmission and distribution rates that became effective in January 2002. Based
on its 2001 revision of the 1998 stranded cost estimates, the Texas Utility
Commission determined that the Company had over-mitigated its stranded costs by
redirecting transmission and distribution depreciation and by accelerating
depreciation of generation assets as provided under its 1998 transition plan and
the Texas electric restructuring law. In the 2001 Final Order, the Company was
required to reverse the amount of redirected depreciation and accelerated
depreciation taken for regulatory purposes as allowed under the 1998 transition
plan and the Texas electric restructuring law. In accordance with the 2001 Final
Order, the Company recorded a regulatory liability to reflect the prospective
refund of the accelerated depreciation, and in January 2002 the Company began
paying excess mitigation credits, which were to be paid over a seven-year period
with interest at 7 1/2% per annum. The annual payment of excess mitigation
credits is approximately $264 million. In its December 2004 final order in the
2004 True-Up Proceeding, the Texas Utility Commission found that the Company
did, in fact, have stranded costs (as originally estimated in 1998). Despite
this ruling, the Texas Utility Commission denied the Company recovery of
approximately $180 million of the interest portion of the excess mitigation
credits already paid by the Company and refused to terminate future excess
mitigation credits. In January 2005, the Company filed a writ of mandamus
petition with the Texas Supreme Court asking that court to order the Texas
Utility Commission to terminate immediately the payment of all excess mitigation
credits and to ensure full recovery of all excess mitigation credits. Although
the Company believes it has meritorious arguments, a writ of mandamus is an
extraordinary remedy and no prediction can be made as to the ultimate outcome or
timing of the mandamus petition. If the Supreme Court denies the Company's
mandamus petition, it will continue to pursue this issue through regular
appellate mechanisms. On March 1, 2005, a non-unanimous settlement was filed in
Docket No. 30774, which involves the adjustment of RRI's Price-to-Beat. Under
the terms of that settlement, the excess mitigation credits being paid by the
Company would be terminated as of April 29, 2005. The Texas Utility Commission
approved the settlement on March 9, 2005.
8
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(b) FINAL FUEL RECONCILIATION
On March 4, 2004, an Administrative Law Judge (ALJ) issued a Proposal for
Decision (PFD) relating to the Company's final fuel reconciliation. The Company
reserved $117 million, including $30 million of interest, in the fourth quarter
of 2003 reflecting the ALJ's recommendation. On April 15, 2004, the Texas
Utility Commission affirmed the PFD's finding in part, reversed in part, and
remanded one issue back to the ALJ. On May 28, 2004, the Texas Utility
Commission approved a settlement of the remanded issue and issued a final order
which reduced the disallowance. As a result of the final order, the Company
reversed $23 million, including $8 million of interest, of the $117 million
reserve recorded in the fourth quarter of 2003. The results of the Texas Utility
Commission's final decision are a component of the 2004 True-Up Proceeding. The
Company has appealed certain portions of the Texas Utility Commission's final
order involving a disallowance of approximately $67 million relating to the
final fuel reconciliation plus interest of $10 million. Briefs on this issue
were filed on January 5, 2005, and a hearing on this issue is scheduled for
April 22, 2005.
9
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) COMMITMENTS AND CONTINGENCIES
(a) LEASE COMMITMENTS
The following table sets forth information concerning the Company's
obligations under non-cancelable long-term operating leases at December 31,
2004, which primarily consist of rental agreements for building space, data
processing equipment and vehicles, including major work equipment (in millions).
2005.................. $ 5
2006.................. 6
2007.................. 5
2008.................. 3
2009.................. -
----
Total................ $ 19
====
Total lease expense for all operating leases was approximately $5 million,
$5 million and $4 million for the years ended December 31, 2002, 2003 and 2004,
respectively.
(b) LEGAL AND ENVIRONMENTAL MATTERS
Legal Matters
RRI Indemnified Litigation
The Company, CenterPoint Energy or their predecessor, Reliant Energy, and
certain of their former subsidiaries are named as defendants in several lawsuits
described below. Under a master separation agreement between CenterPoint Energy
and RRI, CenterPoint Energy and its subsidiaries, including the Company, are
entitled to be indemnified by RRI for any losses, including attorneys' fees and
other costs, arising out of the lawsuits described below under Electricity and
Gas Market Manipulation Cases and Other Class Action Lawsuits. Pursuant to the
indemnification obligation, RRI is defending CenterPoint Energy and its
subsidiaries, including the Company, to the extent named in these lawsuits. The
ultimate outcome of these matters cannot be predicted at this time.
Electricity and Gas Market Manipulation Cases. A large number of lawsuits
have been filed against numerous market participants and remain pending in both
federal and state courts in California and Nevada in connection with the
operation of the electricity and natural gas markets in California and certain
other western states in 2000-2001, a time of power shortages and significant
increases in prices. These lawsuits, many of which have been filed as class
actions, are based on a number of legal theories, including violation of state
and federal antitrust laws, laws against unfair and unlawful business practices,
the federal Racketeer Influenced Corrupt Organization Act, false claims statutes
and similar theories and breaches of contracts to supply power to governmental
entities. Plaintiffs in these lawsuits, which include state officials and
governmental entities as well as private litigants, are seeking a variety of
forms of relief, including recovery of compensatory damages (in some cases in
excess of $1 billion), a trebling of compensatory damages and punitive damages,
injunctive relief, restitution, interest due, disgorgement, civil penalties and
fines, costs of suit, attorneys' fees and divestiture of assets. To date, some
of these complaints have been dismissed by the trial court and are on appeal,
several of which dismissals have been affirmed by the appellate courts, but most
of the lawsuits remain in early procedural stages. The Company's former
subsidiary, RRI, was a participant in the California markets, owning generating
plants in the state and participating in both electricity and natural gas
trading in that state and in western power markets generally. RRI, some of its
subsidiaries and, in some cases, corporate officers of some of those companies
have been named as defendants in these suits.
CenterPoint Energy or its and the Company's predecessor, Reliant Energy,
have been named in approximately 30 of these lawsuits, which were instituted
between 2001 and 2004 and are pending in California state courts in Alameda
County, Los Angeles County, San Francisco County, San Mateo County and San Diego
County, in Nevada state court in Clark County, in federal district courts in San
Francisco, San Diego, Los Angeles, Fresno, Sacramento and Nevada and before the
Ninth Circuit Court of Appeals. However, the Company, CenterPoint Energy and
Reliant Energy were not participants in the electricity or natural gas markets
in California. CenterPoint Energy and Reliant Energy have been dismissed from
certain of the lawsuits, either voluntarily by the plaintiffs or by order of the
court and CenterPoint Energy believes it is not a proper defendant in the
remaining cases and will continue to seek dismissal from such remaining cases.
On July 6, 2004 and on October 12, 2004, the Ninth Circuit affirmed CenterPoint
Energy's removal to federal district court of two electric cases brought by the
California Attorney General and affirmed the federal court's dismissal of these
cases based upon the filed rate doctrine and federal preemption.
10
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other Class Action Lawsuits. Fifteen class action lawsuits filed in May,
June and July 2002 on behalf of purchasers of securities of RRI and/or Reliant
Energy have been consolidated in federal district court in Houston. RRI and
certain of its former and current executive officers are named as defendants.
The consolidated complaint also names RRI , Reliant Energy, the underwriters of
the initial public offering of RRI's common stock in May 2001 (RRI Offering),
and RRI's and Reliant Energy's independent auditors as defendants. The
consolidated amended complaint seeks monetary relief purportedly on behalf of
purchasers of common stock of Reliant Energy or RRI during certain time periods
ranging from February 2000 to May 2002, and purchasers of common stock that can
be traced to the RRI Offering. The plaintiffs allege, among other things, that
the defendants misrepresented their revenues and trading volumes by engaging in
round-trip trades and improperly accounted for certain structured transactions
as cash-flow hedges, which resulted in earnings from these transactions being
accounted for as future earnings rather than being accounted for as earnings in
fiscal year 2001. In January 2004 the trial judge dismissed the plaintiffs'
allegations that the defendants had engaged in fraud, but claims based on
alleged misrepresentations in the registration statement issued in the RRI
Offering remain. In June 2004, the plaintiffs filed a motion for class
certification, which the court granted in February 2005. The defendants have
appealed the court's order certifying the class.
In February 2003, a lawsuit was filed by three individuals in federal
district court in Chicago against CenterPoint Energy and certain former officers
of RRI for alleged violations of federal securities laws. The plaintiffs in this
lawsuit allege that the defendants violated federal securities laws by issuing
false and misleading statements to the public, and that the defendants made
false and misleading statements as part of an alleged scheme to artificially
inflate trading volumes and revenues. In addition, the plaintiffs assert claims
of fraudulent and negligent misrepresentation and violations of Illinois
consumer law. In January 2004 the trial judge ordered dismissal of plaintiffs'
claims on the ground that they did not set forth a claim. The plaintiffs filed
an amended complaint in March 2004, which the defendants asked the court to
dismiss. On August 18, 2004, the court granted the defendants' motion to dismiss
with prejudice.
In May 2002, three class action lawsuits were filed in federal district
court in Houston on behalf of participants in various employee benefits plans
sponsored by Reliant Energy. Two of the lawsuits have been dismissed without
prejudice. Reliant Energy and certain current and former members of its benefits
committee are the remaining defendants in the third lawsuit. That lawsuit
alleges that the defendants breached their fiduciary duties to various employee
benefits plans, directly or indirectly sponsored by Reliant Energy, in violation
of the Employee Retirement Income Security Act of 1974. The plaintiffs allege
that the defendants permitted the plans to purchase or hold securities issued by
Reliant Energy when it was imprudent to do so, including after the prices for
such securities became artificially inflated because of alleged securities fraud
engaged in by the defendants. The complaint seeks monetary damages for losses
suffered on behalf of the plans and a putative class of plan participants whose
accounts held Reliant Energy or RRI securities, as well as restitution. In July
2004, another class action suit was filed in federal court on behalf of the
Reliant Energy Savings Plan and a class consisting of participants in that plan
against Reliant Energy and the Reliant Energy Benefits Committee. The
allegations and the relief sought in the new suit are substantially similar to
those in the previously pending suit; however, the new suit also alleges that
Reliant Energy and its Benefits Committee breached their fiduciary duties to the
Savings Plan and its participants by investing plan funds in Reliant Energy
stock when Reliant Energy or its subsidiaries were allegedly manipulating the
California energy market. On October 14, 2004, the plaintiff voluntarily
dismissed the newly filed lawsuit.
11
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In October 2002, a derivative action was filed in the federal district
court in Houston against the directors and officers of the Company. The
complaint set forth claims for breach of fiduciary duty, waste of corporate
assets, abuse of control and gross mismanagement. Specifically, the shareholder
plaintiff alleged that the defendants caused the Company to overstate its
revenues through so-called "round trip" transactions. The plaintiff also alleged
breach of fiduciary duty in connection with the spin-off of RRI and the RRI
Offering. The complaint sought monetary damages on behalf of the Company as well
as equitable relief in the form of a constructive trust on the compensation paid
to the defendants. The Company's board of directors investigated that demand and
similar allegations made in a June 28, 2002 demand letter sent on behalf of a
Company shareholder. The second letter demanded that the Company take several
actions in response to alleged round-trip trades occurring in 1999, 2000, and
2001. In June 2003, the board determined that these proposed actions would not
be in the best interests of the Company. In March 2003, the court dismissed this
case on the grounds that the plaintiff did not make an adequate demand on the
Company before filing suit. Thereafter, the plaintiff sent another demand
asserting the same claims.
The Company believes that none of the lawsuits described under Other Class
Action Lawsuits has merit because, among other reasons, the alleged
misstatements and omissions were not material and did not result in any damages
to the plaintiffs.
Other Legal Matters
Texas Antitrust Actions. In July 2003, Texas Commercial Energy filed in
federal court in Corpus Christi, Texas a lawsuit against Reliant Energy, the
Company and CenterPoint Energy, as successors to Reliant Energy, Genco LP, RRI,
Reliant Energy Solutions, LLC, several other RRI subsidiaries and a number of
other participants in the Electric Reliability Council of Texas (ERCOT) power
market. The plaintiff, a retail electricity provider with the ERCOT market,
alleged that the defendants conspired to illegally fix and artificially increase
the price of electricity in violation of state and federal antitrust laws and
committed fraud and negligent misrepresentation. The lawsuit sought damages in
excess of $500 million, exemplary damages, treble damages, interest, costs of
suit and attorneys' fees. The plaintiff's principal allegations had previously
been investigated by the Texas Utility Commission and found to be without merit.
In June 2004, the federal court dismissed the plaintiff's claims and in July
2004, the plaintiff filed a notice of appeal. The Company is vigorously
contesting the appeal. The ultimate outcome of this matter cannot be predicted
at this time.
In February 2005, Utility Choice Electric filed in federal court in
Houston, Texas a lawsuit against the Company, CenterPoint Energy, CenterPoint
Energy Gas Services, Inc., CenterPoint Energy Alternative Fuels, Inc., Genco LP
and a number of other participants in the ERCOT power market. The plaintiff, a
retail electricity provider with the ERCOT market, alleged that the defendants
conspired to illegally fix and artificially increase the price of electricity in
violation of state and federal antitrust laws, intentionally interfered with
prospective business relationships and contracts, and committed fraud and
negligent misrepresentation. The plaintiff's principal allegations had
previously been investigated by the Texas Utility Commission and found to be
without merit. The Company intends to vigorously defend the case. The ultimate
outcome of this matter cannot be predicted at this time.
Municipal Franchise Fee Lawsuits. In February 1996, the cities of Wharton,
Galveston and Pasadena (Three Cities) filed suit in state district court in
Harris County, Texas for themselves and a proposed class of all similarly
situated cities in Reliant Energy's electric service area, against Reliant
Energy and Houston Industries Finance, Inc. (formerly a wholly owned subsidiary
of the Company's predecessor, Reliant Energy) alleging underpayment of municipal
franchise fees. The plaintiffs claimed that they were entitled to 4% of all
receipts of any kind for business conducted within these cities over the
previous four decades. After a jury trial involving the Three Cities' claims
(but not the class of cities), the trial court entered a judgment on the Three
Cities' breach of contract claims for $1.7 million, including interest, plus an
award of $13.7 million in legal fees. It also decertified the class. Following
this ruling, 45 cities filed individual suits against Reliant Energy in the
District Court of Harris County.
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CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On February 27, 2003, a state court of appeals in Houston rendered an
opinion reversing the judgment against the Company and rendering judgment that
the Three Cities take nothing by their claims. The court of appeals held that
all of the Three Cities' claims were barred by the jury's finding of laches, a
defense similar to the statute of limitations, due to the Three Cities' having
unreasonably delayed bringing their claims during the more than 30 years since
the alleged wrongs began. The court also held that the Three Cities were not
entitled to recover any attorneys' fees. The Three Cities filed a petition for
review to the Texas Supreme Court, which declined to hear the case. Thus, the
Three Cities' claims have been finally resolved in the Company's favor, but the
individual claims of the 45 cities remain pending in the same court.
ENVIRONMENTAL MATTERS
Asbestos. A number of facilities owned by CenterPoint Energy contain
significant amounts of asbestos insulation and other asbestos-containing
materials. CenterPoint Energy or its subsidiaries, including the Company, have
been named, along with numerous others, as a defendant in lawsuits filed by a
large number of individuals who claim injury due to exposure to asbestos. Most
claimants in such litigation have been workers who participated in construction
of various industrial facilities, including power plants. Some of the claimants
have worked at locations owned by CenterPoint Energy, but most existing claims
relate to facilities previously owned by CenterPoint Energy but currently owned
by Texas Genco LLC. The Company anticipates that additional claims like those
received may be asserted in the future. Under the terms of the separation
agreement between CenterPoint Energy and Texas Genco, ultimate financial
responsibility for uninsured losses relating to these claims has been assumed by
Texas Genco, but under the terms of its agreement to sell Texas Genco to Texas
Genco LLC, CenterPoint Energy has agreed to continue to defend such claims to
the extent they are covered by insurance maintained by CenterPoint Energy,
subject to reimbursement of the costs of such defense from Texas Genco LLC.
Although their ultimate outcome cannot be predicted at this time, the Company
intends to continue vigorously contesting claims that it does not consider to
have merit and does not believe, based on its experience to date, that these
matters, either individually or in the aggregate, will have a material adverse
effect on the Company's financial condition, results of operations or cash
flows.
Other Proceedings
The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management believes that the disposition of these matters will not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.
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