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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 JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO _______________.
------------------------------
Commission file number 1-3187
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC
(Exact name of registrant as specified in its charter)
TEXAS 22-3865106
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1111 LOUISIANA
HOUSTON, TEXAS 77002
(Address of principal executive offices) (Zip Code)
(713) 207-1111
(Registrant's telephone number, including area code)
------------------------------
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]
As of August 4, 2003, 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 JUNE 30, 2003
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements......................................................... 1
Statements of Consolidated Income
Three and Six Months Ended June 30, 2002 and 2003 (unaudited)................. 1
Consolidated Balance Sheets
December 31, 2002 and June 30, 2003 (unaudited)............................... 2
Statements of Consolidated Cash Flows
Six Months Ended June 30, 2002 and 2003 (unaudited)........................... 4
Notes to Unaudited Consolidated Financial Statements............................. 5
Item 2. Management's Narrative Analysis of the Results of Operations of
CenterPoint Energy Houston Electric, LLC and Subsidiaries....................... 19
Item 4. Controls and Procedures..................................................... 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................................... 31
Item 5. Other Information........................................................... 31
Item 6. Exhibits and Reports on Form 8-K............................................ 37
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
the 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:
- state and federal legislative and regulatory actions or
developments, including deregulation, re-regulation and
restructuring of the electric utility industry, constraints placed
on our activities or business by the Public Utility Holding
Company Act of 1935, as amended (1935 Act), changes in or
application of laws or regulations applicable to other aspects of
our business and actions with respect to:
- recovery of stranded costs;
- allowed rates of return;
- rate structures;
- recovery of investments; and
- operation and construction of facilities;
- non-payment for our services due to financial distress of our
customers, including our largest customer, Reliant Resources,
Inc. (Reliant Resources);
- the successful and timely completion of our capital projects;
- industrial, commercial and residential growth in our service
territory and changes in market demand and demographic patterns;
- changes in business strategy or development plans;
- changes in interest rates or rates of inflation;
- unanticipated changes in operating expenses and capital
expenditures;
- weather variations and other natural phenomena, which can affect
the demand for power over our transmission and distribution
system;
- commercial bank and financial market conditions, our access to
capital, the cost of such capital, receipt of certain 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;
- legal and administrative proceedings and settlements;
- changes in tax laws;
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- inability of various counterparties to meet their obligations with
respect to our financial instruments;
- any lack of effectiveness of our disclosure controls and
procedures;
- changes in technology;
- significant changes in our relationship with our employees,
including the availability of qualified personnel and the
potential adverse effects if labor disputes or grievances were to
occur;
- significant changes in accounting policies;
- acts of terrorism or war, including any direct or indirect effect
on our business resulting from terrorist attacks such as occurred
on September 11, 2001 or any similar incidents or responses to
those incidents;
- the availability and price of insurance;
- the outcome of the pending lawsuits against Reliant Energy,
Incorporated and Reliant Resources;
- the ability of Reliant Resources to satisfy its indemnity
obligations to us;
- the reliability of the systems, procedures and other
infrastructure necessary to operate the retail electric business
in our service territory, including the systems owned and operated
by the independent system operator in the market served by the
Electric Reliability Council of Texas, Inc.;
- political, legal, regulatory and economic conditions and
developments in the United States; and
- other factors we discuss in this report, including those outlined
in Item 5 of Part II under "Risk Factors."
You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement, and we undertake no obligation to publicly update or revise any
forward-looking statements.
iii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
2002 2003 2002 2003
------------ ------------ ------------ ------------
REVENUES.......................................... $ 528,349 $ 481,772 $ 1,096,402 $ 929,175
------------ ------------ ------------ ------------
EXPENSES:
Purchased power................................. (3,648) -- 55,932 --
Operation and maintenance....................... 129,487 125,596 270,592 258,604
Depreciation and amortization................... 66,241 68,107 129,580 132,849
Taxes other than income taxes................... 61,465 53,435 111,921 97,487
------------ ------------ ------------ ------------
Total....................................... 253,545 247,138 568,025 488,940
------------ ------------ ------------ ------------
OPERATING INCOME.................................. 274,804 234,634 528,377 440,235
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense and distribution on trust
preferred securities........................ (67,569) (90,313) (127,666) (182,543)
Other, net...................................... 2,177 8,517 7,569 17,025
------------ ------------ ------------ ------------
Total....................................... (65,392) (81,796) (120,097) (165,518)
------------ ------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES.................................... 209,412 152,838 408,280 274,717
Income Tax Expense.............................. 70,997 53,455 138,140 95,159
------------ ------------ ------------ ------------
INCOME FROM CONTINUING OPERATIONS................. 138,415 99,383 270,140 179,558
Income (loss) from Discontinued Operations, net
of tax...................................... 97,230 -- (2,890) --
------------ ------------ ------------ ------------
NET INCOME ....................................... $ 235,645 $ 99,383 $ 267,250 $ 179,558
============ ============ ============ ============
See Notes to the Company's Interim Financial Statements
1
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, JUNE 30,
2002 2003
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents....................... $ 70,866 $ 27,588
Accounts and notes receivable, net.............. 99,304 126,624
Accrued unbilled revenues....................... 70,385 85,046
Materials and supplies.......................... 59,941 57,222
Taxes receivable................................ 40,997 73,730
Other........................................... 11,838 7,692
------------ ------------
Total current assets.......................... 353,331 377,902
------------ ------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment................... 5,959,843 6,016,187
Less accumulated depreciation and amortization.. (2,122,611) (2,194,737)
------------ ------------
Property, plant and equipment, net............ 3,837,232 3,821,450
------------ ------------
OTHER ASSETS:
Other intangibles, net.......................... 39,912 39,590
Regulatory assets............................... 3,970,007 4,507,973
Notes receivable -- affiliated companies........ 814,513 814,513
Other........................................... 66,049 91,648
------------ ------------
Total other assets............................ 4,890,481 5,453,724
------------ ------------
TOTAL ASSETS................................ $ 9,081,044 $ 9,653,076
------------ ------------
See Notes to the Company's Interim Financial Statements
2
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND MEMBER'S EQUITY
DECEMBER 31, JUNE 30,
2002 2003
------------ ------------
CURRENT LIABILITIES:
Current portion of long-term debt................. $ 18,758 $ 26,398
Accounts payable.................................. 32,362 21,152
Accounts payable -- affiliated companies, net..... 43,662 26,804
Notes payable -- affiliated companies, net........ 214,976 207,320
Taxes accrued..................................... 85,205 45,209
Interest accrued.................................. 78,355 86,213
Regulatory liabilities............................ 168,173 176,127
Other............................................. 57,731 61,503
------------ ------------
Total current liabilities....................... 699,222 650,726
------------ ------------
OTHER LIABILITIES:
Accumulated deferred income taxes, net............ 1,419,301 1,559,090
Unamortized investment tax credits................ 53,581 51,236
Benefit obligations............................... 61,671 61,710
Regulatory liabilities............................ 940,615 706,588
Notes payable -- affiliated companies............. 916,400 637,400
Accounts payable -- affiliated companies.......... -- 395,516
Other............................................. 24,987 12,342
------------ ------------
Total other liabilities......................... 3,416,555 3,423,882
------------ ------------
LONG-TERM DEBT....................................... 2,641,281 3,074,924
------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 8)
MEMBER'S EQUITY:
Common stock...................................... 1 1
Paid-in capital................................... 2,205,039 2,205,039
Retained earnings................................. 118,946 298,504
------------ ------------
Total member's equity........................... 2,323,986 2,503,544
------------ ------------
TOTAL LIABILITIES AND MEMBER'S EQUITY......... $ 9,081,044 $ 9,653,076
============ ============
See Notes to the Company's Interim Financial Statements
3
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(A WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
--------------------------
2002 2003
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................................................. $ 267,250 $ 179,558
Add: Loss from discontinued operations.................................. 2,890 --
------------ -----------
Income from continuing operations....................................... 270,140 179,558
Adjustments to reconcile income from continuing operations to net cash
used in operating activities:
Depreciation and amortization......................................... 129,580 132,849
Deferred income taxes................................................. 163,634 138,672
Investment tax credits................................................ (2,345) (2,345)
Changes in other assets and liabilities:
Accounts and notes receivable, net.................................. (264,943) (41,981)
Accounts receivable/payable, affiliates............................. (59,790) (16,857)
Taxes receivable.................................................... 52,755 (32,733)
Inventory........................................................... 6,542 2,719
Accounts payable.................................................... (20,435) (11,210)
Fuel cost over recovery............................................. 134,146 --
Interest and taxes accrued.......................................... (52,353) (32,138)
Net regulatory assets and liabilities............................... (371,431) (360,973)
Other current assets................................................ 1,594 5,583
Other current liabilities........................................... (60,267) 3,771
Other assets........................................................ 92,059 (17,653)
Other liabilities................................................... (120,758) (11,490)
Other, net............................................................ -- 753
------------ -----------
Net cash used in operating activities............................. (101,872) (63,475)
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net............................................... (142,932) (104,703)
Decrease (increase) in restricted cash.................................. 2,961 (1,437)
Other, net.............................................................. (6,985) (885)
------------ -----------
Net cash used in investing activities............................. (146,956) (107,025)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt................................ -- 958,500
Increase in short-term borrowing, net................................... 236,178 --
Increase (decrease) in notes with affiliates, net....................... (224,494) 142,344
Payments of long-term debt.............................................. (283) (518,649)
Decrease in long-term notes payable with affiliates..................... -- (429,000)
Debt issuance costs..................................................... -- (26,705)
Payment of common stock dividend........................................ (222,538) --
Other, net.............................................................. (22) 732
------------ -----------
Net cash provided by (used in) financing activities................. (211,159) 127,222
------------ -----------
NET CASH PROVIDED BY DISCONTINUED OPERATIONS.............................. 475,250 --
------------ -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS...................... 15,263 (43,278)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.......................... 3,428 70,866
------------ -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD................................ $ 18,691 $ 27,588
============ ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest................................................................ $ 43,982 $ 53,430
Income taxes............................................................ -- --
See Notes to the Company's Interim Financial Statements
4
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
Included in this Quarterly Report on Form 10-Q (Form 10-Q) of
CenterPoint Energy Houston Electric, LLC (CenterPoint Houston, together with its
subsidiaries, the Company), are the Company's consolidated interim financial
statements and notes (Interim Financial Statements) including its wholly owned
subsidiaries. The Company has filed a Current Report on Form 8-K dated May 15,
2003 (May 15 Form 8-K). The May 15 Form 8-K gives effect to certain
reclassifications that have been made to the Company's historical financial
statements as presented in the Annual Report on Form 10-K of CenterPoint Houston
(CenterPoint Houston Form 10-K) for the year ended December 31, 2002. The
Interim Financial Statements are unaudited, omit certain financial statement
disclosures and should be read with the May 15 Form 8-K, including the exhibits
thereto, and the Quarterly Report on Form 10-Q of CenterPoint Houston for the
quarter ended March 31, 2003 (First Quarter 10-Q).
ORGANIZATIONAL STRUCTURE AND RESTRUCTURING
CenterPoint Houston is a regulated utility engaged in the transmission
and distribution of electric energy in a 5,000 square mile area located along
the Texas Gulf Coast, including the City of Houston. CenterPoint Houston is an
indirect wholly owned subsidiary of CenterPoint Energy, Inc. (CenterPoint
Energy), a public utility holding company.
The Company's business includes:
- Transmission. The Company's transmission business transports
electricity from power plants to substations and from one substation
to another in locations in the control area managed by the Electric
Reliability Council of Texas, Inc. (ERCOT).
- Distribution. The Company's electric distribution business
distributes electricity for retail electric providers in its
certificated service area by carrying power from the substation to
the retail electric customer.
The Company's business also includes the stranded costs and regulatory
asset recovery associated with the Company's historical generating operations.
The Company operates its business as a single segment. In addition to the
electric transmission and distribution business, the consolidated financial
statements include the operations of one financing subsidiary.
The Company's business does not include:
- the generation or sale of electricity;
- the procurement, supply or delivery of fuel for the generation of
electricity; or
- the marketing to or billing of retail electric customers.
Effective August 31, 2002, Reliant Energy, Incorporated (Reliant
Energy) consummated a restructuring transaction (Restructuring) in which it,
among other things, (1) conveyed its Texas electric generation assets to Texas
Genco Holdings, Inc. (Texas Genco), (2) became an indirect, wholly owned
subsidiary of a new utility holding company, CenterPoint Energy, (3) was
converted into a Texas limited liability company named CenterPoint Energy
Houston Electric, LLC and (4) distributed the capital stock of its operating
subsidiaries, including Texas Genco, to CenterPoint Energy. As part of the
Restructuring, each share of Reliant Energy common stock was converted into one
share of CenterPoint Energy common stock.
CenterPoint Energy is a registered public utility holding company under
the Public Utility Holding Company Act of 1935, as amended (the 1935 Act). The
1935 Act and related rules and regulations impose a number of restrictions on
the activities of CenterPoint Energy and its subsidiaries. The 1935 Act, among
other things, limits the ability of the holding company and its subsidiaries to
issue debt and equity securities without prior authorization, restricts the
5
source of dividend payments to funds from current and retained earnings without
prior authorization, regulates sales and acquisitions of certain assets and
businesses and governs affiliate transactions.
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 Interim Financial Statements reflect all normal recurring
adjustments that are, in the opinion of management, necessary to present fairly
the financial position and results of operations for the respective periods.
Amounts reported in the Company's Statements of Consolidated Income are not
necessarily indicative of amounts expected for a full year period due to the
effects of, among other things, (a) fluctuations in demand for energy, (b)
timing of maintenance and other expenditures and (c) acquisitions and
dispositions of 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.
Notes 4 (Regulatory Matters), 3(e) (Regulatory Assets and Liabilities),
8(a) (Pension Plans) and 10 (Commitments and Contingencies) to the consolidated
financial statements in Exhibit 99.2 to the May 15 Form 8-K (CenterPoint Houston
8-K Notes) relate to certain contingencies. These notes, as updated herein, are
incorporated herein by reference.
For information regarding certain legal and regulatory proceedings, see
Note 8.
(2) DISCONTINUED OPERATIONS
The Interim Financial Statements have been prepared to reflect the
effect of the Restructuring as described above as it relates to CenterPoint
Houston and have been prepared based upon Reliant Energy's historical
consolidated financial statements.
The Interim Financial Statements present the regulated and unregulated
operations of Reliant Energy that were distributed to CenterPoint Energy in the
restructuring as discontinued operations, in accordance with Statement of
Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS No. 144). Included in discontinued
operations of CenterPoint Houston are Reliant Resources, Inc.'s (Reliant
Resources) unregulated operations previously reported in the Wholesale Energy,
European Energy and Retail Energy business segments of Reliant Energy. Also
included in discontinued operations are the regulated businesses conveyed to
CenterPoint Energy which have previously been reported in the Natural Gas
Distribution and Pipelines and Gathering business segments as well as the
Electric Generation business segment. Accordingly, the Interim Financial
Statements of CenterPoint Houston reflect these operations as discontinued
operations.
Total revenues included in discontinued operations for the three and
six months ended June 30, 2002 were $3.0 billion and $5.9 billion, respectively.
Income from discontinued operations for the three and six months ended June 30,
2002 is reported net of income tax expense of $71 million and $118 million,
respectively. These amounts have been restated to reflect Reliant Resources'
adoption of Emerging Issues Task Force (EITF) Issue No. 02-3, "Issues Related to
Accounting for Contracts Involved in Energy Trading and Risk Management
Activities."
(3) NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, the Company adopted SFAS No. 143,
"Accounting for Asset Retirement Obligations" (SFAS No. 143). SFAS No. 143
requires the fair value of an asset retirement obligation to be recognized as a
liability is incurred and capitalized as part of the cost of the related
tangible long-lived asset. Over time, the liability is accreted to its present
value each period, and the capitalized cost is depreciated over the useful life
of the related
6
asset. Retirement obligations associated with long-lived assets included within
the scope of SFAS No. 143 are those for which a legal obligation exists under
enacted laws, statutes and written or oral contracts, including obligations
arising under the doctrine of promissory estoppel.
The Company has not identified any asset retirement obligations;
however, the Company has previously recognized removal costs as a component of
depreciation expense in accordance with regulatory treatment. As of June 30,
2003, these previously recognized removal costs of $254 million do not represent
SFAS No. 143 asset retirement obligations, but rather embedded regulatory
liabilities.
In April 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections" (SFAS No. 145). SFAS No. 145
eliminates the current requirement that gains and losses on debt extinguishment
must be classified as extraordinary items in the income statement. Instead, such
gains and losses will be classified as extraordinary items only if they are
deemed to be unusual and infrequent. SFAS No. 145 also requires that capital
leases that are modified so that the resulting lease agreement is classified as
an operating lease be accounted for as a sale-leaseback transaction. The changes
related to debt extinguishment are effective for fiscal years beginning after
May 15, 2002, and the changes related to lease accounting are effective for
transactions occurring after May 15, 2002. The Company has applied this guidance
as it relates to lease accounting and the accounting provision related to debt
extinguishment. Upon adoption of SFAS No. 145, any gain or loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods is required to be reclassified. No such reclassification was required
for the six-month period ended June 30, 2002. The Company has reclassified the
$25 million loss on debt extinguishment related to the fourth quarter of 2002
from extraordinary item to interest expense.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)" (EITF No. 94-3). The principal difference
between SFAS No. 146 and EITF No. 94-3 relates to the requirements for
recognition of a liability for costs associated with an exit or disposal
activity. SFAS No. 146 requires that a liability be recognized for a cost
associated with an exit or disposal activity when it is incurred. A liability is
incurred when a transaction or event occurs that leaves an entity little or no
discretion to avoid the future transfer or use of assets to settle the
liability. Under EITF No. 94-3, a liability for an exit cost was recognized at
the date of an entity's commitment to an exit plan. In addition, SFAS No. 146
also requires that a liability for a cost associated with an exit or disposal
activity be recognized at its fair value when it is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002. The Company adopted the provisions of SFAS No. 146 on January 1, 2003.
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. In addition, FIN 45 requires disclosures about the guarantees that
an entity has issued. The provision for initial recognition and measurement of
the liability will be applied on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions of FIN 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of FIN 45 did not materially affect the
Company's consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" (SFAS No. 149). SFAS No.
149 has added additional criteria which were effective for new, acquired, or
newly modified forward contracts on July 1, 2003. The Company does not believe
the adoption of SFAS No. 149 will have a material effect on the Company's
financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity" (SFAS
No. 150). SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a
7
change in an accounting principle with no restatement of prior period
information permitted. The Company is currently assessing the impact that this
statement will have on its consolidated financial statements.
(4) REGULATORY MATTERS
(a) Excess Cost Over Market (ECOM) True-Up.
Our affiliate, Texas Genco, sells, through auctions, entitlements to
substantially all of its installed electric generation capacity, excluding
reserves for planned and forced outages. From September 2001, Texas Genco
conducted auctions, as required by the Public Utility Commission of Texas (Texas
Utility Commission) and by CenterPoint Energy's master separation agreement with
Reliant Resources.
The capacity auctions continue to be consummated at market-based prices
that are substantially below the estimate of those prices made by the Texas
Utility Commission in the spring of 2001. The Texas electric restructuring law
allows recovery, in a "true-up" proceeding in 2004 (2004 True-Up Proceeding), of
the difference between the prices for power sold in state mandated auctions and
earlier estimates of market power prices by the Texas Utility Commission. This
calculation (the ECOM Calculation) calculates the difference between (1) an
imputed margin that reflects the actual market power prices received in the
state mandated auctions, actual fuel expense and generation, and (2) the margin
included in the Texas Utility Commission's estimates of power prices, fuel
expense and generation in the ECOM model developed by the Texas Utility
Commission (the ECOM Margin). The difference is the ECOM True-Up amount.
The ECOM model from which the ECOM Margin is derived provides only
annual estimates of power prices, fuel expense and generation. Accordingly, the
Company must form its own quarterly allocation estimates during 2002-2003 for
the purpose of determining ECOM True-Up revenue.
Beginning January 1, 2002, the Company allocated the ECOM Margin in the
Company's ECOM Calculation based on annual estimated forecasts of power prices,
fuel expense and generation. In the second quarter of 2003, the Company began
using a cumulative methodology for allocating ECOM Margin. This methodology uses
revenue amounts based on the actual state mandated auction price results and
actual generation for historical periods, as well as forecasted amounts for the
balance of 2003, rather than forecasted amounts for the two-year period
allocated on an annual basis. Changes in estimates that affect the allocation of
ECOM Margin will have an effect on the amount of ECOM True-Up revenue recorded
in a specific period, but will not affect the total amount of ECOM True-Up
revenue recorded during the two-year period ending December 31, 2003.
In accordance with the Texas Utility Commission's rules regarding the
ECOM True-Up, for the three months ended June 30, 2002 and 2003, CenterPoint
Energy recorded approximately $170 million and $101 million, respectively, in
non-cash revenue related to the right to subsequent cost recovery of the
difference between the market power prices and the Texas Utility Commission's
earlier estimates. In accordance with the Texas Utility Commission's rules
regarding the ECOM True-Up, for the six months ended June 30, 2002 and 2003,
CenterPoint Energy recorded approximately $311 million and $233 million,
respectively, in non-cash revenue related to the right to subsequent cost
recovery of the difference between the market power prices and the Texas Utility
Commission's earlier estimates. For additional information regarding the
capacity auctions and the related true-up proceeding, please read Notes 3(e) and
4(a) to the CenterPoint Houston 8-K Notes, which are incorporated herein by
reference.
(b) Regulatory Assets Contingency.
As of June 30, 2003, in contemplation of the 2004 True-Up Proceeding,
the Company has recorded a regulatory asset of $2.5 billion representing the
estimated future recovery of previously incurred costs. This estimated recovery
is based upon current projections of the market value of the Company's Texas
generation assets to be covered by the 2004 True-Up Proceeding calculations.
This estimated recovery amount includes:
- $1.1 billion of previously recorded accelerated depreciation
(an amount equal to earnings above a stated overall annual rate of
return on invested capital that was used to recover the Company's
investment in generation assets);
- $841 million of redirected depreciation; and
- $396 million related to the Texas Genco distribution.
8
Offsetting this regulatory asset is an $880 million regulatory
liability relating to an order issued by the Texas Utility Commission in 2001 to
refund amounts relating to prior mitigation of anticipated stranded costs. The
Texas Utility Commission ruled that those amounts should be refunded based on
its conclusion that those amounts would result in an over-mitigation of stranded
costs unless they were refunded. The Company began refunding those amounts
(excess mitigation credits) with January 2002 bills and is scheduled to continue
to refund those credits over a seven-year period.
Because GAAP requires the Company to estimate fair market values in
advance of the final reconciliation, the financial impacts of the Texas electric
restructuring law with respect to the final determination of stranded costs in
the 2004 True-Up Proceeding are subject to material changes. Factors affecting
such changes may include estimation risk, uncertainty of future energy and
commodity prices and the economic lives of the plants. If events were to occur
that made the recovery of some of the remaining generation-related regulatory
assets no longer probable, the Company would write off the unrecoverable balance
of such assets as a charge against earnings.
On June 26, 2003, the Company filed a petition with the Texas Utility
Commission seeking to cease refunding excess mitigation credits on the ground
that continuation of that refund in light of current projections of stranded
costs only increases the amount of stranded costs that the Company will seek to
recover in the 2004 True-Up Proceeding. The excess mitigation credits amount to
approximately $19 million per month. This proceeding is currently pending before
the Texas Utility Commission.
(c) Fuel Reconciliation Contingency.
Texas Genco and the Company filed their joint application to reconcile
fuel revenues and expenses with the Texas Utility Commission on July 1, 2002.
This final fuel reconciliation filing covers reconcilable fuel revenue, fuel
expense and interest of approximately $8.5 billion incurred from August 1, 1997
through January 30, 2002. Also included in this amount is an under-recovery of
$94 million, which was the balance at July 31, 1997 as approved in the Company's
last fuel reconciliation. On March 3, 2003, a settlement agreement was filed
under which certain items totaling $24 million were written off during the
fourth quarter of 2002 and items totaling $203 million will be carried forward
for resolution by the Texas Utility Commission in late 2003 or early 2004. A
hearing is scheduled to begin in September 2003.
(d) 2004 True-Up Proceeding.
Under the Texas electric restructuring law, the Texas Utility
Commission is required to conduct true-up proceedings for each investor-owned
utility whose generation assets were "unbundled" from its transmission and
distribution assets in order to quantify and reconcile the amount of stranded
costs, ECOM True-Up, unreconciled fuel costs, "price to beat" clawback component
(See Note 8(b)) and other regulatory assets associated with electric generation
operations (true-up costs). On June 18, 2003, the Texas Utility Commission ruled
that the Company's filing for recovery of its true-up costs will be made on
March 31, 2004. The Company had requested, and the Texas Utility Commission had
initially proposed, a filing date of January 12, 2004. The law requires a final
order to be issued by the Texas Utility Commission not more than 150 days after
a proper filing is made by the regulated utility.
Any delay in the final order date will result in a delay in the
securitization of the Company's stranded costs and the start of recovery of
certain carrying costs through non-bypassable charges to the Company's
customers.
In addition, the delay in the Company's filing for recovery of its
true-up costs means that the calculation of the market value per share of the
Texas Genco common stock for purposes of the Texas Utility Commission's stranded
cost determination might be more or less than the purchase price per share
calculated under the option held by Reliant Resources to purchase CenterPoint
Energy's 81% ownership interest in Texas Genco. Under the option, the purchase
price will be based on market prices during the 120 trading days ending on
January 9, 2004, but under the filing schedule prescribed by the Texas Utility
Commission, the value of that ownership interest for the stranded cost
determination will be based on market prices during the 120 trading days ending
on March 30, 2004. If Reliant Resources exercises its option at a lower price
than the market value used by the Texas Utility Commission, the Company would be
unable to recover the difference.
We expect that upon completion of the 2004 True-Up Proceeding, the
Company will seek to securitize its
9
stranded costs, any regulatory assets not previously securitized by the October
2001 issuance of transition bonds and, to the extent permitted by the Texas
Utility Commission, the balance of the other true-up components. Under the Texas
electric restructuring law, the Company is entitled to recover any portion of
the true-up balance not securitized by transition bonds through a non-bypassable
competition transition charge assessed to its customers.
(5) LONG-TERM DEBT AND SHORT-TERM BORROWINGS
DECEMBER 31, 2002 JUNE 30, 2003
---------------------- ----------------------
LONG-TERM CURRENT(1) LONG-TERM CURRENT(1)
--------- ---------- --------- ----------
(IN MILLIONS)
Long-term debt:
Mortgage bonds 5.60% to 9.15% due 2013 to
2033................................................ $ 615 $ -- $ 1,065 $ --
Term loan, LIBOR plus 9.75%, due 2005(2)............... 1,310 -- 1,310 --
Series 2001-1 Transition Bonds 3.84% to 5.63%
due 2002 to 2013(3)................................. 717 19 703 26
Other.................................................. (1) -- (3) --
--------- ---------- --------- ---------
Long-term debt to third parties........................ 2,641 19 3,075 26
Notes payable to affiliate 4.90% to 6.70%(4)........... 916 167 637 17
Short-term borrowings from affiliates.................... -- 48 -- 190
--------- ---------- --------- ---------
Total borrowings.................................... $ 3,557 $ 234 $ 3,712 $ 233
========= ========== ========= =========
- --------------
(1) Includes amounts due within one year of the date noted.
(2) Under the term loan, the LIBOR rate is subject to a floor of 3%. This
collateralized term loan is secured by the Company's general mortgage
bonds.
(3) The Series 2001-1 Transition Bonds were issued by one of the Company's
subsidiaries, and are non-recourse to the Company. For further
discussion of the securitization financing, see Note 4(a) of the
CenterPoint Houston 8-K Notes.
(4) Of the total $654 million notes payable to affiliate at June 30, 2003,
$397 million has the same principal amounts and interest rates as
pollution control bond obligations of CenterPoint Energy that are
secured by first mortgage bonds of the Company.
Money Pool Borrowings
On June 30, 2003, the Company had borrowed approximately $190 million
from its affiliates, which had a weighted average interest rate of 6.14%. The
Company participates in a "money pool" through which it can borrow or invest on
a short-term basis. We are authorized to borrow up to a limit of $600 million
from the money pool. 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 with borrowings of CenterPoint Energy. The terms
of the money pool are in accordance with requirements applicable to registered
public utility holding company systems under the 1935 Act.
Long-Term Debt
On March 18, 2003, the Company issued $762.3 million aggregate
principal amount of general mortgage bonds composed of $450 million aggregate
principal amount of 10-year bonds with an interest rate of 5.7% and $312.3
million aggregate principal amount of 30-year bonds with an interest rate of
6.95%. Proceeds were used to redeem approximately $312.3 million aggregate
principal amount of the Company's first mortgage bonds and to repay $429 million
of intercompany notes payable to CenterPoint Energy. Proceeds from the note
repayment were ultimately used by CenterPoint Energy to repay $150 million
aggregate principal amount of medium-term notes maturing on April 21, 2003 and
to repay borrowings under its credit facility.
On May 23, 2003, the Company issued $200 million aggregate principal
amount of 20-year general mortgage
10
bonds with an interest rate of 5.6%. Proceeds were used to redeem, on July 1,
2003, $200 million aggregate principal amount of the Company's 7.5% first
mortgage bonds due 2023 at 103.51% of their principal amount. Funds for the
redemption were deposited in trust on May 23, 2003, and the first mortgage bonds
were legally extinguished.
The following table shows future maturity dates of long-term debt
issued by CenterPoint Houston and expected future maturity dates of the
transition bonds issued by CenterPoint Energy Transition Bond Company, LLC, a
subsidiary of the Company (Bond Company) as of June 30, 2003. Amounts are
expressed in thousands.
CENTERPOINT HOUSTON
------------------- TRANSITION
YEAR THIRD-PARTY AFFILIATE SUB-TOTAL BONDS TOTAL
---- ------------ ----------- ---------- --------- -----------
2003....................... $ -- $ 16,600 $ 16,600 $ 12,357 $ 28,957
2004....................... -- -- -- 41,189 41,189
2005....................... 1,310,000 -- 1,310,000 46,806 1,356,806
2006....................... -- -- -- 54,295 54,295
2007....................... -- -- -- 59,912 59,912
2008....................... -- -- -- 65,529 65,529
2009....................... -- -- -- 73,018 73,018
2010....................... -- -- -- 80,506 80,506
2011....................... -- -- -- 87,995 87,995
2012....................... -- 45,570 45,570 99,229 144,799
2013....................... 450,000 -- 450,000 108,590 558,590
2015....................... -- 150,850 150,850 -- 150,850
2017....................... -- 127,385 127,385 -- 127,385
2021....................... 102,442 -- 102,442 -- 102,442
2023....................... 200,000 -- 200,000 -- 200,000
2027....................... -- 56,095 56,095 -- 56,095
2028....................... -- 257,500 257,500 -- 257,500
2033....................... 312,275 -- 312,275 -- 312,275
------------ ----------- ---------- --------- -----------
Total. $ 2,374,717 $ 654,000 $3,028,717 $ 729,426 $ 3,758,143
============ =========== ========== ========= ===========
First mortgage bonds and general mortgage bonds in aggregate principal
amounts of $102 million and $962 million, respectively, have been issued
directly to third parties. External debt of $1.3 billion maturing in 2005 is
senior and secured by general mortgage bonds. The affiliate debt is senior and
unsecured.
Other than the affiliate note due 2028 set forth in the above table,
the amounts, maturities and interest rates of the intercompany debt payable to
CenterPoint Energy of $397 million effectively match the amounts, maturities and
interest rates of certain pollution control bond obligations of CenterPoint
Energy that are secured by the Company's first mortgage bonds in the same
amounts in the table below.
11
The following table shows the maturity dates of the $924 million of
first mortgage bonds and general mortgage bonds that the Company has issued as
collateral for long-term debt of CenterPoint Energy. These bonds are not
reflected on the financial statements of CenterPoint Houston because of the
contingent nature of the obligations. Amounts are expressed in thousands.
YEAR FIRST MORTGAGE BONDS GENERAL MORTGAGE BONDS TOTAL
---- -------------------- ---------------------- ---------
2003.................. $ 16,600 $ -- $ 16,600
2011.................. -- 19,200 19,200
2012.................. 45,570 -- 45,570
2015.................. 150,850 -- 150,850
2017.................. 127,385 -- 127,385
2018.................. -- 50,000 50,000
2019.................. -- 200,000 200,000
2020.................. -- 90,000 90,000
2026.................. -- 100,000 100,000
2027.................. 56,095 -- 56,095
2028.................. -- 68,000 68,000
----------- ----------- ---------
Total $ 396,500 $ 527,200 $ 923,700
=========== =========== =========
While the aggregate amount of additional general mortgage bonds and
first mortgage bonds that could be issued is approximately $680 million based on
estimates of the value of the Company's property encumbered by the general
mortgage, the cost of such property and the 70% bonding ratio contained in the
general mortgage, as a result of contractual limitations on the Company and
CenterPoint Energy expiring in November 2005, the aggregate amount of first
mortgage bonds and general mortgage bonds cannot be increased above current
levels. As of June 30, 2003, outstanding first mortgage bonds and general
mortgage bonds aggregated approximately $3.3 billion as shown in the following
table. Amounts are expressed in thousands.
ISSUED AS ISSUED AS COLLATERAL
ISSUED DIRECTLY TO COLLATERAL FOR FOR CENTERPOINT
THIRD PARTIES THE COMPANY'S DEBT ENERGY'S DEBT TOTAL
------------- ------------------ ------------- -----
First Mortgage Bonds $ 102,442 $ -- $ 396,500 $ 498,942
General Mortgage Bonds 962,275 1,310,000 527,200 2,799,475
------------- ------------ -------------- -------------
Total $ 1,064,717 $ 1,310,000 $ 923,700 $ 3,298,417
============= ============ ============== =============
The Bond Company has $729 million aggregate principal amount of
outstanding transition bonds. Classes of the transition bonds have final
maturity dates of September 15, 2007, September 15, 2009, September 15, 2011 and
September 15, 2015 and bear interest at rates of 3.84%, 4.76%, 5.16% and 5.63%,
respectively. 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 CenterPoint Houston's long-term debt,
although the holders of the transition bonds have no recourse to any of
CenterPoint Houston's assets or revenues, and CenterPoint Houston's creditors
have no recourse to any assets or revenues (including, without limitation, the
transition charges) of the Bond Company. CenterPoint Houston has no payment
obligations with respect to the transition bonds except to remit collections of
transition charges as set forth in a servicing agreement between CenterPoint
Houston and the Bond Company and in an intercreditor agreement among CenterPoint
Houston, the Bond Company and other parties.
Liens. The Company's assets are subject to liens securing approximately
$499 million of first mortgage bonds. Sinking or improvement fund and
replacement fund requirements on the first mortgage bonds may be satisfied by
certification of property additions. Sinking or improvement fund and replacement
fund requirements for 2001, 2002 and 2003 have been satisfied by certification
of property additions. The replacement fund requirement satisfied in 2003 was
approximately $354 million, and the sinking or improvement fund requirement
satisfied in 2003 was approximately $8 million. The Company's assets are subject
to liens securing approximately $2.8 billion of general mortgage bonds, which
are junior to the liens of the first mortgage bonds.
12
(6) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive
income:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------
2002 2003 2002 2003
-------------- --------------- -------------- ---------
(IN MILLIONS)
Net income........................................... $ 236 $ 99 $ 267 $ 180
Other comprehensive income:
Additional minimum non-qualified pension liability
adjustment....................................... -- -- 1 --
Other comprehensive income from discontinued
operations....................................... 46 -- 221 --
-------------- --------------- -------------- ---------
Other comprehensive income........................... 46 -- 222 --
--------------- --------------- -------------- ---------
Comprehensive income ................................ $ 282 $ 99 $ 489 $ 180
============== =============== ============== =========
(7) RELATED PARTY TRANSACTIONS
From time to time, the Company has receivables from, or payables to,
CenterPoint Energy or its subsidiaries. As of December 31, 2002, the Company had
net accounts payable-affiliated companies of $44 million and $215 million in
notes payable-affiliated companies. As of June 30, 2003, the Company had net
accounts payable-affiliated companies of $27 million, which included accounts
payable of $56 million, partially offset by accounts receivable of $29 million.
The Company had net short-term borrowings of $207 million in notes
payable-affiliated companies as of June 30, 2003, which included net short-term
notes payables of $190 million borrowed from the money pool as discussed in Note
5 and $17 million current portion of long-term notes payable. The Company had a
long-term note receivable from affiliate of $815 million, as of December 31,
2002 and June 30, 2003, as further discussed below. Long-term note payable to
affiliate was $1.1 billion as of December 31, 2002 and $654 million as of June
30, 2003. For more information on the long-term note payable to affiliate see
Note 5. The Company had net interest expense related to affiliate borrowings of
$20 million and $50 million for the three and six months ended June 30, 2002,
respectively and $4 million and $14 million for the three and six months ended
June 30, 2003, respectively. As of June 30, 2003, the Company had $396 million
in long-term accounts payable-affiliated companies, which related to the Texas
Genco distribution. In the first quarter of 2003, CenterPoint Energy recorded a
$396 million impairment related to the partial distribution of its investment in
Texas Genco. Since this amount is expected to be recovered in the 2004 True-Up
Proceeding, the Company has recorded a regulatory asset reflecting its right to
recover this amount and an associated payable to CenterPoint Energy. For more
information on the 2004 True-Up Proceeding see Notes 4(b) and 4(d).
The 1935 Act generally prohibits borrowings by CenterPoint Energy from
its subsidiaries, including the Company, either through the money pool or
otherwise.
Prior to August 31, 2002, the Company had $737 million invested in a
money fund through which the Company and certain of its affiliates could borrow
and/or invest on a short-term basis. At the time of the Restructuring, the
Company converted a money fund investment into a $750 million note receivable
from CenterPoint Energy payable on demand and bearing interest at the prime
rate, leaving $13 million borrowed from the money fund. Since August 31, 2002,
the Company has been a participant in the CenterPoint Energy money pool. The
$750 million note receivable is included in long-term notes receivable from
affiliate in the Consolidated Balance Sheets because CenterPoint Energy does not
plan to repay the note within the next twelve months.
For the three and six months ended June 30, 2002, revenues, excluding
transition charges, derived from energy delivery charges provided by the Company
to subsidiaries of Reliant Resources, a former affiliate, totaled $246 million
and $363 million, respectively.
Although the former retail sales business is no longer conducted by the
Company, retail customers remained regulated customers of the Company through
the date of their first meter reading in January 2002. During this transition
period, the Company purchased $56 million of power from Texas Genco as of June
30, 2002.
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 expenses and employees. These charges are not necessarily
indicative of what would have been incurred had the Company not
13
been an affiliate. Amounts charged to the Company for these services were $28
million and $25 million for the three months ended June 30, 2002 and 2003,
respectively, and are included primarily in operation and maintenance expenses.
For the six months ended June 30, 2002 and 2003 these costs are $58 million and
$57 million, respectively.
(8) COMMITMENTS AND CONTINGENCIES
(a) Legal Matters
The Company's predecessor, Reliant Energy, and certain of its former
subsidiaries are named as defendants in several lawsuits described below. Under
a master separation agreement between Reliant Energy and Reliant Resources,
CenterPoint Energy, the Company and each of their subsidiaries are entitled to
be indemnified by Reliant Resources for any losses, including attorneys' fees
and other costs, arising out of the lawsuits described under "California
Electricity and Gas Market Cases," "Western States Class Action," "Long-Term
Contract Class Action," "Washington and Oregon Class Actions," "Bustamante Price
Reporting Class Action," "Gas Trading Cases," "Trading and Marketing Activities"
and "Other Class Action Lawsuits." Pursuant to the indemnification obligation,
Reliant Resources is defending the Company and its subsidiaries to the extent
named in these lawsuits. The ultimate outcome of these matters cannot be
predicted at this time.
California Electricity and Gas Market Cases. Reliant Energy, Reliant
Resources, Reliant Energy Power Generation, Inc. (REPG) and several other
subsidiaries of Reliant Resources, as well as three former officers of some of
these companies, have been named as defendants in class action lawsuits and
other lawsuits filed against a number of companies that own generation plants in
California and other sellers of electricity in California markets. While the
plaintiffs allege various violations by the defendants of antitrust laws and
state laws against unfair and unlawful business practices, each of the lawsuits
is grounded on the central allegation that the defendants conspired to drive up
the wholesale price of electricity. In addition to injunctive relief, the
plaintiffs in these lawsuits seek treble the amount of damages alleged,
restitution of alleged overpayments, disgorgement of alleged unlawful profits
for sales of electricity, costs of suit and attorneys' fees. The first six of
these suits originally were filed in state courts in San Diego, San Francisco
and Los Angeles Counties. The suits in San Diego and Los Angeles Counties were
consolidated and removed to the federal district court in San Diego, but on
December 13, 2002, that court remanded the suits to the state courts. Prior to
the remand, Reliant Energy was voluntarily dismissed from two of the suits.
Several parties, including the Reliant defendants, have appealed the judge's
remand decision. The United States court of appeals stayed the remand order
pending the appeal.
In March and April 2002, the California Attorney General filed three
complaints, two in state court in San Francisco and one in the federal district
court in San Francisco, against Reliant Energy, Reliant Resources, Reliant
Energy Services (a wholesale energy marketing subsidiary of Reliant Resources)
and other subsidiaries of Reliant Resources alleging, among other matters,
violations by the defendants of state laws against unfair and unlawful business
practices arising out of transactions in the markets for ancillary services run
by the California independent systems operator, charging unjust and unreasonable
prices for electricity, in violation of antitrust laws in connection with the
acquisition in 1998 of electric generating facilities located in California. The
complaints variously seek restitution and disgorgement of alleged unlawful
profits for sales of electricity, civil penalties and fines, injunctive relief
against unfair competition, divestment of Reliant Resources' generation capacity
and undefined equitable relief. Reliant Resources removed the two state court
cases to the federal district court in San Francisco. In August 2002, the
district court dismissed the two cases originally filed in state court and also
dismissed the damages claims asserted in the antitrust case. The Attorney
General has appealed the dismissal of these cases to the court of appeals.
Following the filing of the Attorney General cases, seven additional
class action cases were filed in state courts in Northern California. Each of
these purports to represent the same class of California ratepayers, assert the
same claims as asserted in the other California class action cases, and in some
instances repeat as well the allegations in the Attorney General cases. All of
these cases have been removed and consolidated in federal district court in San
Diego. The defendants have filed a motion to dismiss on grounds that the claims
are barred by federal preemption of regulation of wholesale rates by the Federal
Energy Regulatory Commission and the filed rate doctrine.
In July 2003, the City of Los Angeles Attorney filed suit against
CenterPoint Energy, Reliant Energy, Reliant Resources, Reliant Energy Services
and one of Reliant Resources' employees in federal court in Los Angeles. The
lawsuit alleges that the defendants conspired to manipulate the price for
natural gas in breach of Reliant Energy Services' contract to supply the Los
Angeles Department of Water and Power (LADWP) with natural gas in
14
violation of federal and state antitrust laws, the federal Racketeer Influenced
and Corrupt Organization Act and the California False Claims Act. The lawsuit
seeks treble damages for the alleged overcharges for gas purchased by LADWP of
an estimated $218 million, interest, costs of suit and attorneys' fees. The
Company has not yet been served with the complaint.
Western States Class Action. In May 2003, a class action lawsuit was
filed against Reliant Resources, Reliant Energy and various market participants
in state court in San Diego County, California. The plaintiffs allege that
Reliant Resources and Reliant Energy engaged in unfair, unlawful and fraudulent
business practices and violations of the California antitrust laws by
manipulating energy markets in California and the West. The action is brought on
behalf of all persons and businesses residing in Oregon, Washington, Utah,
Nevada, Idaho, New Mexico, Arizona and Montana. The lawsuit seeks injunctive
relief, treble damages, restitution, costs of suit and attorney's fees. In May
2003, the case was removed to federal court in San Diego. The plaintiffs have
moved to remand the case back to state court and the Reliant defendants have
filed a petition with the Federal Judicial Panel on Multidistrict Litigation to
transfer the case to San Francisco where certain of the cases described under
"California Electricity and Gas Market Cases" described above are already
pending and the judge is not a putative class member. Neither the remand motion
nor the motion to transfer has been heard.
Long-Term Contract Class Action. In October 2002, a class action was
filed in state court in Los Angeles against Reliant Energy and several
subsidiaries of Reliant Resources. The complaint in this case repeats the
allegations asserted in the California class actions as well as the Attorney
General cases and also alleges misconduct related to long-term contracts
purportedly entered into by the California Department of Water Resources. None
of the Reliant entities, however, has a long-term contract with the Department
of Water Resources. This case has been removed to federal district court in San
Diego. The Reliant defendants intend to file motions to dismiss on grounds that
the claims are barred by federal preemption and the filed rate doctrine.
Washington and Oregon Class Actions. In December 2002, a lawsuit was
filed in Circuit Court of the State of Oregon for the County of Multnomah on
behalf of a class of all Oregon purchasers of electricity and natural gas.
Reliant Energy, Reliant Resources and several Reliant Resources subsidiaries
were named as defendants, along with many other electricity generators and
marketers. Like the lawsuits filed in California, the plaintiffs claimed the
defendants manipulated wholesale power prices in violation of state and federal
law. The plaintiffs sought injunctive relief and payment of damages based on
alleged overcharges for electricity. Also in December 2002, a nearly identical
lawsuit on behalf of consumers in the State of Washington was filed in federal
district court in Seattle. Reliant Resources removed the Oregon suit to federal
district court in Portland. The plaintiffs in both cases voluntarily dismissed
their lawsuits.
Bustamante Price Reporting Class Action. In November 2002, California
Lieutenant Governor Cruz Bustamante filed a lawsuit in state court in Los
Angeles on behalf of a class of purchasers of gas and power alleging violations
of state antitrust laws and state laws against unfair and unlawful business
practices based on an alleged conspiracy to report and publish false and
fraudulent natural gas prices with an intent to affect the market prices of
natural gas and electricity in California. Reliant Energy, Reliant Resources and
several Reliant Resources subsidiaries were named as defendants, along with
other market participants and publishers of some of the price indices. The
complaint sought injunctive relief, compensatory and punitive damages,
restitution of alleged overpayment, disgorgement of all profits and funds
acquired by the alleged unlawful conduct, costs of suit and attorneys' fees. In
June 2003, the plaintiffs dismissed their claims against Reliant Energy.
Gas Trading Cases. CenterPoint Energy, Reliant Resources and Reliant
Energy have been named as defendants in two lawsuits filed on behalf of a class
of purchasers of natural gas alleging violations of state antitrust laws and
state laws against unfair and unlawful business practices based on an alleged
conspiracy with Enron Corp. to manipulate the California natural gas markets in
2000 and 2001. One lawsuit was filed in April 2003 in state court in Los Angeles
County, California, and the other was filed in May 2003 in state court in San
Diego County, California. The complaints are based on certain conclusions in a
report by the staff of the Federal Energy Regulatory Commission that has not
been subject to procedures designed to allow parties to either discover or test
the basis for the conclusions. The complaint seeks injunctive and declaratory
relief, compensatory and punitive damages, restitution, costs of suit and
attorneys' fees. The complaint alleges that there were "well over one billion
dollars in excess charges to California consumers during the 2000 through 2001
time period." The plaintiffs are seeking a trebling of any damages award.
Reliant Resources removed both cases to federal court and the plaintiffs in both
cases have moved to remand the cases back to state court. The plaintiffs in the
San Diego case have also filed a
15
petition with the Federal Judicial Panel on Multidistrict Litigation to transfer
the case to federal court in Nevada. The defendants have filed their own motion
with the Panel to transfer the case to the Southern District of New York.
Neither the remand nor the transfer motions have been heard. While Reliant
Resources has not yet filed an answer, the Company understands that Reliant
Resources intends to deny both the alleged violation of any laws and the
participation in a conspiracy with Enron. Neither CenterPoint Energy nor Reliant
Energy was a party in the proceedings in which the report was submitted. Only
former subsidiaries of the predecessor to the Company engaged in gas trading
activities in California; however, neither CenterPoint Energy nor any of its
current subsidiaries, including the Company, has ever engaged in gas trading in
California.
Trading and Marketing Activities. Reliant Energy has been named as a
party in several lawsuits and regulatory proceedings relating to the trading and
marketing activities of its former subsidiary, Reliant Resources.
In June 2002, the Securities and Exchange Commission (SEC) advised
Reliant Resources and Reliant Energy that it had issued a formal order in
connection with its investigation of Reliant Resources' and Reliant Energy's
financial reporting, internal controls and related matters. The investigation
was focused on Reliant Resources' same-day commodity trading transactions
involving purchases and sales with the same counterparty for the same volume at
substantially the same price and certain structured transactions. These matters
were previously the subject of an informal inquiry by the SEC. On May 12, 2003,
the SEC advised Reliant Resources and Reliant Energy that it had issued a formal
order in connection with this investigation. Reliant Energy, through the Company
as its successor, has entered into a settlement with the SEC that concludes this
investigation. Under the settlement, Reliant Resources and Reliant Energy
consented to the entry of an administrative cease-and-desist order with respect
to future violations of certain provisions of the Securities Act of 1933 and the
Securities Exchange Act of 1934, without admitting or denying the SEC's findings
that violations of these laws had occurred. The SEC did not assess monetary
penalties or fines against Reliant Energy, CenterPoint Energy or any of its
subsidiaries including the Company.
In connection with the Texas Utility Commission's industry-wide
investigation into potential manipulation of the ERCOT market on and after July
31, 2001, Reliant Energy and Reliant Resources have provided information to the
Texas Utility Commission concerning their scheduling and trading activities.
Other Class Action Lawsuits. Fifteen class action lawsuits filed in
May, June and July 2002 on behalf of purchasers of securities of Reliant
Resources and/or Reliant Energy have been consolidated in federal district court
in Houston. Reliant Resources and certain of its former and current executive
officers are named as defendants. Reliant Energy is also named as a defendant in
seven of the lawsuits. Two of the lawsuits also name as defendants the
underwriters of the May 2001 initial public offering of approximately 20% of the
common stock of Reliant Resources initial public offering (Reliant Resources
Offering). One lawsuit names Reliant Resources' and Reliant Energy's independent
auditors as a defendant. The consolidated amended complaint seeks monetary
relief purportedly on behalf of three classes: (1) purchasers of Reliant Energy
common stock from February 3, 2000 to May 13, 2002; (2) purchasers of Reliant
Resources common stock on the open market from May 1, 2001 to May 13, 2002; and
(3) purchasers of Reliant Resources common stock in the Reliant Resources
Offering or purchasers of shares that are traceable to the Reliant Resources
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 February 2003, a lawsuit was filed by three individuals in federal
district court in Chicago against CenterPoint Energy and certain former and
current officers of Reliant Resources 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 inflate artificially trading volumes and revenues. In
addition, the plaintiffs assert claims of fraudulent and negligent
misrepresentation and violations of Illinois consumer law.
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. Reliant Energy and its directors are named as
defendants in all of the lawsuits. Two of the lawsuits have been dismissed
without prejudice. The remaining 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. The plaintiffs allege that the defendants permitted the
plans to purchase or hold securities issued by Reliant Energy when it was
16
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 complaints seek monetary damages for losses suffered by a
putative class of plan participants whose accounts held Reliant Energy or
Reliant Resources securities, as well as equitable relief in the form of
restitution.
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 sets forth claims for breach of fiduciary duty, waste of corporate
assets, abuse of control and gross mismanagement. Specifically, the shareholder
plaintiff alleges that the defendants caused CenterPoint Energy to overstate its
revenues through so-called "round trip" transactions. The plaintiff also alleges
breach of fiduciary duty in connection with the spin-off of Reliant Resources
and the Reliant Resources Offering. The complaint seeks 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. In March, 2003,
the court dismissed this case on the ground that the plaintiff did not make an
adequate demand on CenterPoint Energy before filing suit. Thereafter, the
plaintiff sent another demand asserting the same claims.
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 latter 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.
The Company believes that none of these lawsuits has merit because,
among other reasons, the alleged misstatements and omissions were not material
and did not result in any damages to any of the plaintiffs.
Texas Action. In July 2003, Texas Commercial Energy filed a lawsuit
against Reliant Energy, Reliant Resources, Reliant Electric Solutions, LLC,
several other Reliant Resources subsidiaries and several other participants in
the ERCOT power market in federal court in Corpus Christi, Texas. The plaintiff,
a retail electricity provider in the Texas market served by ERCOT, alleges 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 seeks damages in excess of $500
million, exemplary damages, treble damages, interest, costs of suit and
attorneys' fees. The Company has not yet been served with the complaint.
Reliant Energy Municipal Franchise Fee Lawsuits. In February 1996, the
cities of Wharton, Galveston and Pasadena (Three Cities) filed suit, 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 Reliant Energy) alleging
underpayment of municipal franchise fees. The plaintiffs claim that they are
entitled to 4% of all receipts of any kind for business conducted within these
cities over the previous four decades. A jury trial of the original claimant
cities (but not the class of cities) in the 269th Judicial District Court for
Harris County, Texas, ended in April 2000 (the Three Cities case). Although the
jury found for Reliant Energy on many issues, it found in favor of the original
claimant cities on three issues, and assessed a total of $4 million in actual
and $30 million in punitive damages. However, the jury also found in favor of
Reliant Energy on the affirmative defense of laches, a defense similar to a
statute of limitations defense, due to the original claimant cities having
unreasonably delayed bringing their claims during the 43 years since the alleged
wrongs began. The trial court in the Three Cities case granted most of Reliant
Energy's motions to disregard the jury's findings. The trial court's rulings
reduced the judgment to $1.7 million, including interest, plus an award of $13.7
million in legal fees. In addition, the trial court granted Reliant Energy's
motion to decertify the class. Following this ruling, 45 cities filed individual
suits against Reliant Energy in the District Court of Harris County.
On February 27, 2003, the state court of appeals in Houston rendered an
opinion reversing the judgment against CenterPoint Energy and rendering judgment
that the Three Cities take nothing by their claims. The court of appeals found
that the jury's finding of laches barred all of the Three Cities' claims and
that the Three Cities were not entitled to recovery of any attorneys' fees. The
Three Cities have filed a petition for review at the Texas Supreme Court where
the matter remains pending.
The extent to which issues in the Three Cities case may affect the
claims of the other cities served by Reliant Energy cannot be assessed until
judgments are final and no longer subject to appeal. However, the court of
appeals' ruling appears to be consistent with Texas Supreme Court opinions. The
Company estimates the range of possible outcomes for recovery by the plaintiffs
in the Three Cities case to be between $-0- and $18 million inclusive of
17
interest and attorneys' fees.
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.
(b) "Price to Beat" Clawback Component.
In connection with the implementation of the Texas electric
restructuring law, the Texas Utility Commission has set a "price to beat" that
retail electric providers affiliated or formerly affiliated with a former
integrated utility must charge residential and small commercial customers within
their affiliated electric utility's service area. The true-up provides for a
clawback of "price to beat" in excess of the market price of electricity if 40%
of the "price to beat" load is not served by a non-affiliated retail electric
provider by January 1, 2004. Pursuant to the Texas electric restructuring law
and the master separation agreement between Reliant Energy and Reliant
Resources, Reliant Resources is obligated to pay the Company for the clawback
component of the true-up. The clawback may not exceed $150 times the number of
customers served by the affiliated retail electric provider in the transmission
and distribution utility's service territory, less the number of customers
served by the affiliated retail electric provider outside the transmission and
distribution utility's service territory, on January 1, 2004.
18
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS OF
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
The following narrative analysis should be read in combination with our
Interim Financial Statements and notes contained in Item 1 of this report.
Effective August 31, 2002, Reliant Energy, Incorporated (Reliant
Energy) consummated a restructuring transaction (the Restructuring) in which it,
among other things, (1) conveyed its Texas electric generation assets to an
affiliated company, Texas Genco Holdings, Inc. (Texas Genco), (2) became an
indirect, wholly owned subsidiary of a new utility holding company, CenterPoint
Energy, Inc. (CenterPoint Energy), (3) was converted into a Texas limited
liability company named CenterPoint Energy Houston Electric, LLC (we, us,
CenterPoint Houston or the Company), and (4) distributed the capital stock of
its operating subsidiaries, including Texas Genco, to CenterPoint Energy. As
part of the Restructuring, each share of Reliant Energy common stock was
converted into one share of CenterPoint Energy common stock. Pursuant to the
provisions of certain of its existing debt agreements applicable when the
properties or assets of Reliant Energy were transferred to another entity
substantially as an entirety, CenterPoint Energy expressly assumed certain debt
and other obligations of Reliant Energy, and Reliant Energy was released as the
primary obligor on such debt. For additional information on the Restructuring,
see Note 1 to the Interim Financial Statements.
We operate Reliant Energy's electric transmission and distribution
business, which continues to be subject to cost-of-service rate regulation and
is responsible for the delivery of electricity sold to retail customers through
retail electric providers in the 5,000 square mile service area of Houston,
Texas and surrounding metropolitan areas as well as the transmission of bulk
power into and out of the Houston area.
CenterPoint Energy is a registered public utility holding company under
the Public Utility Holding Company Act of 1935, as amended (1935 Act). The 1935
Act and related rules and regulations impose a number of restrictions on the
activities of CenterPoint Energy and its subsidiaries. The 1935 Act, among other
things, limits the ability of the holding company and its subsidiaries to issue
debt and equity securities without prior authorization, restricts the source of
dividend payments to funds from current and retained earnings without prior
authorization, regulates sales and acquisitions of certain assets and businesses
and governs affiliate transactions. CenterPoint Energy and its subsidiaries,
including us, received an order from the Securities and Exchange Commission
(SEC) under the 1935 Act on June 30, 2003 (June 2003 Financing Order) relating
to financing and other activities, which is effective until June 30, 2005.
On August 1, 2003, the SEC issued a supplemental order which allows us
to issue an additional $250 million of external debt (August 2003 Financing
Order, together with the June 2003 Financing Order, the Orders). For more
information regarding the Orders, please read " - Liquidity - Capitalization."
The Interim Financial Statements have been prepared to reflect the
effect of the Restructuring as described above as it relates to us, and have
been prepared based upon Reliant Energy's historical consolidated financial
statements.
The Interim Financial Statements for the three months and six months
ended June 30, 2002, present the former subsidiaries of Reliant Energy that were
distributed to CenterPoint Energy in the Restructuring as discontinued
operations, in accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
(SFAS No. 144).
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 (Changes in Securities), 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 six months ended June 30, 2003 and
the three and six months ended June 30, 2002. Reference is made to "Management's
Narrative Analysis of Results of Operations" in Exhibit 99.1 to our Current
Report on Form 8-K dated May 15, 2003 (May 15, 2003 Form 8-K).
19
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 and "Management's Narrative Analysis of Results of
Operations -- Certain Factors Affecting Future Earnings" in Exhibit 99.1 to the
May 15, 2003 Form 8-K, each of which is incorporated herein by reference.
Beginning in the second quarter of 2003, we began to evaluate
performance on an operating income basis. Operating income is shown because it
is the measure used by the chief operating decision maker to evaluate
performance and allocate resources. Additionally, it is widely accepted measure
of financial performance prepared in accordance with accounting principles
generally accepted in the United States of America. Prior to the second quarter
of 2003, we evaluated performance on an earnings (loss) before interest expense,
distribution on trust preferred securities and income taxes (EBIT) basis.
Historically, the difference between EBIT and operating income has not been
material.
The following table sets forth our consolidated results of operations
for the three months and six months ended June 30, 2002 and 2003, followed by a
discussion of our consolidated results of operations.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2002 2003 2002 2003
---------- -------------- --------- --------------
(IN MILLIONS)
Operating Revenues:
Electric revenues.............................. $ 358 $ 381 $ 785 $ 696
ECOM true-up................................... 170 101 311 233
---------- -------------- --------- --------------
Total Operating Revenues...................... 528 482 1,096 929
---------- -------------- --------- --------------
Operating Expenses:
Purchased power................................ (4) -- 56 --
Operation and maintenance...................... 130 126 270 259
Depreciation and amortization.................. 66 68 130 133
Taxes other than income taxes.................. 61 53 112 97
---------- -------------- --------- --------------
Total Operating Expenses...................... 253 247 568 489
---------- -------------- --------- --------------
Operating Income................................. 275 235 528 440
Interest Expense and Distribution on Trust
Preferred Securities........................... (68) (90) (128) (183)
Other Income, net ............................... 2 8 8 18
---------- -------------- --------- --------------
Income from Continuing Operations Before Income
Taxes.......................................... 209 153 408 275
Income Tax Expense............................... (71) (54) (138) (95)
---------- -------------- --------- --------------
Income from Continuing Operations................ 138 99 270 180
Income (loss) from Discontinued Operations, net
of tax......................................... 98 -- (3) --
---------- -------------- --------- --------------
Net Income ...................................... $ 236 $ 99 $ 267 $ 180
========== ============== ========= ==============
Residential Throughput (in gigawatt-hours
(GWh)) (1)....................................... 6,296 6,490 10,769 11,049
- --------------
(1) This table no longer reflects usage volumes (KWh) for commercial and
industrial customers because the majority of these customers are billed
on a peak demand (KW) basis and, as a result, revenues do not vary
based on consumption.
20
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
We reported operating income of $235 million for the three months ended
June 30, 2003, consisting of $134 million for the regulated electric
transmission and distribution utility and non-cash operating income of $101
million associated with generation-related regulatory assets, or Excess Cost
Over Market (ECOM), as described below. For the three months ended June 30,
2002, operating income was $275 million, consisting of $105 million for the
regulated electric transmission and distribution utility and non-cash operating
income of $170 million associated with ECOM. Although our former retail sales
business is no longer conducted by us, retail customers remained regulated
customers of the regulated utility through the date of their first meter reading
in 2002. Purchased power activity of $4 million for the three months ended June
30, 2002 relates to operation of the regulated utility during this transition
period.
Our business, excluding ECOM and transition related operating income,
continues to benefit from solid customer growth. Revenues increased from the
addition of over 51,000 metered customers since June 2002 ($13 million) as well
as the positive impact of weather ($5 million).
Under the Texas electric restructuring law, a regulated utility may
recover, in its 2004 stranded cost true-up proceeding, any difference between
market prices received through the state mandated auctions and the Texas Utility
Commission's earlier estimates of those market prices. During 2002 and 2003,
this difference, referred to as ECOM, produced non-cash operating income and is
recorded as a regulatory asset. The reduction in ECOM of $69 million from 2002
to 2003 is primarily a result of lower margins derived from the ECOM model for
this period in 2003 compared to the same period in 2002.
Operation and maintenance expense decreased $4 million for the three
months ended June 30, 2003 as compared to the same period in 2002 primarily due
to reduced staffing levels as a result of process improvements ($4 million) and
decreased transmission cost of service ($2 million), partially offset by
increased pension expense ($4 million).
Depreciation and amortization expense increased $2 million for the
three months ended June 30, 2003 as compared to the same period in 2002 due to
increases in plant in service.
Taxes other than income taxes decreased $8 million for the three months
ended June 30, 2003 as compared to the same period in 2002 primarily due to
decreased city franchise fees ($6 million) and decreased state franchise taxes
($4 million), partially offset by increased property taxes ($2 million).
Other income, net increased $6 million for the three months ended June
30, 2003, compared to the same period in 2002. The increase was primarily due to
interest income partially offset by decreased interest on under recovery of
fuel.
Our effective tax rate for the three months ended June 30, 2002 and
2003 was 33.9% and 35.0%, respectively.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
We reported operating income of $440 million for the six months ended
June 30, 2003, consisting of $207 million for the regulated electric
transmission and distribution utility and non-cash operating income of $233
million associated with ECOM, as described below. For the six months ended June
30, 2002, operating income was $528 million, consisting of $217 million for the
regulated electric transmission and distribution utility and non-cash operating
income of $311 million associated with ECOM. The purchased power costs of $56
million for the six months ended June 30, 2002 relate to operation of the
regulated utility during the transition period discussed above.
Increased revenues from customer growth ($20 million) and positive
impacts of weather ($5 million) were more than offset by transition period
revenues in 2002 ($97 million) and decreased industrial demand.
The reduction in ECOM of $78 million from 2002 to 2003 primarily
resulted from lower margins derived from the ECOM model for this period in 2003
compared to the same period in 2002.
Operation and maintenance expense decreased $11 million for the six
months ended June 30, 2003 as compared to the same period in 2002. The decrease
was primarily due to a reduction in bad debt expense
21
related to the 2002 transition period revenues ($15 million), decreased
transmission cost of service ($4 million) and the termination of a factoring
program ($3 million). These decreases were partially offset by increased
employee benefit expenses primarily due to increased pension costs ($9 million)
and increased insurance expenses ($3 million).
Depreciation and amortization expense increased $3 million for the six
months ended June 30, 2003 as compared to the same period in 2002 primarily due
to increases in plant in service ($5 million) partially offset by decreased
amortization on securitized assets ($2 million).
Taxes other than income taxes decreased $15 million for the six months
ended June 30, 2003 as compared to the same period in 2002 primarily due to
gross receipts tax associated with transition period revenue in the first
quarter of 2002 ($9 million) and decreased state franchise taxes ($6 million).
Other income, net increased $10 million for the six months ended June
30, 2003, compared to the same period in 2002. The increase was primarily due to
interest income partially offset by decreased interest on under-recovery of
fuel.
Our effective tax rate for the six months ended June 30, 2002 and 2003
was 33.8% and 34.6%, respectively.
LIQUIDITY
Long-Term Debt.
On March 18, 2003, we issued $762.3 million aggregate principal amount
of general mortgage bonds composed of $450 million aggregate principal amount of
10-year bonds with an interest rate of 5.7% and $312.3 million aggregate
principal amount of 30-year bonds with an interest rate of 6.95%. Proceeds were
used to redeem approximately $312.3 million aggregate principal amount of our
first mortgage bonds and to repay $429 million of intercompany notes payable to
CenterPoint Energy. Proceeds from the note repayment were ultimately used by
CenterPoint Energy to repay $150 million aggregate principal amount of
medium-term notes maturing on April 21, 2003 and to repay borrowings under
CenterPoint Energy's credit facility.
On May 23, 2003, we issued $200 million aggregate principal amount of
20-year general mortgage bonds with an interest rate of 5.6%. Proceeds were used
to redeem, on July 1, 2003, $200 million aggregate principal amount of our 7.5%
first mortgage bonds due 2023 at 103.51% of their principal amount.
22
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 June 30, 2003. Amounts are expressed in
thousands.
CENTERPOINT HOUSTON
-------------------------- TRANSITION
YEAR THIRD-PARTY AFFILIATE SUB-TOTAL BONDS TOTAL
- ---- ----------- ------------ ----------- ---------- -----------
2003....................... $ -- $ 16,600 $ 16,600 $ 12,357 $ 28,957
2004....................... -- -- -- 41,189 41,189
2005....................... 1,310,000 -- 1,310,000 46,806 1,356,806
2006....................... -- -- -- 54,295 54,295
2007....................... -- -- -- 59,912 59,912
2008....................... -- -- -- 65,529 65,529
2009....................... -- -- -- 73,018 73,018
2010....................... -- -- -- 80,506 80,506
2011....................... -- -- -- 87,995 87,995
2012....................... -- 45,570 45,570 99,229 144,799
2013....................... 450,000 -- 450,000 108,590 558,590
2015....................... -- 150,850 150,850 -- 150,850
2017....................... -- 127,385 127,385 -- 127,385
2021....................... 102,442 -- 102,442 -- 102,442
2023....................... 200,000 -- 200,000 -- 200,000
2027....................... -- 56,095 56,095 -- 56,095
2028....................... -- 257,500 257,500 -- 257,500
2033....................... 312,275 -- 312,275 -- 312,275
----------- ------------ ----------- ---------- -----------
Total. $ 2,374,717 $ 654,000 $ 3,028,717 $ 729,426 $ 3,758,143
=========== ============ =========== ========== ===========
First mortgage bonds and general mortgage bonds in aggregate principal
amounts of $102 million and $962 million, respectively, have been issued
directly to third parties. External debt of $1.3 billion maturing in 2005 is
senior and secured by general mortgage bonds. The affiliate debt is senior and
unsecured.
We have outstanding approximately $654 million aggregate principal
amount of affiliate notes, which represent borrowings from our parent.
On February 28, 2003, CenterPoint Energy reached agreement with a
syndicate of banks on a second amendment to its bank facility. The amendment
provides that proceeds from capital stock or indebtedness issued or incurred by
us must be applied (subject to a $200 million basket for CenterPoint Energy
Resources Corp. (CERC) and its subsidiaries and another $250 million basket for
borrowings by us and CenterPoint Energy's other subsidiaries and other limited
exceptions) to repay bank loans and reduce the bank facility. Cash proceeds from
issuances of indebtedness to refinance indebtedness existing on October 10, 2002
are not subject to this limitation.
We have outstanding approximately $499 million aggregate principal
amount of first mortgage bonds and approximately $2.8 billion aggregate
principal amount of general mortgage bonds, of which approximately $924 million
combined aggregate principal amount of first mortgage bonds and general mortgage
bonds collateralizes debt of CenterPoint Energy. The lien of the general
mortgage indenture is junior to that of the mortgage, pursuant to which the
first mortgage bonds are issued. While the aggregate amount of additional
general mortgage bonds and first mortgage bonds that could be issued is
approximately $680 million based on estimates of the value of our property
encumbered by the general mortgage, the cost of such property and the 70%
bonding ratio contained in the general mortgage, as a result of contractual
limitations on us and CenterPoint Energy expiring in November 2005, the
aggregate amount of first mortgage bonds and general mortgage bonds cannot be
increased above current levels.
23
The following table shows the maturity dates of the $924 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 on the financial statements of CenterPoint Houston because of the
contingent nature of the obligations. Amounts are expressed in thousands.
YEAR FIRST MORTGAGE BONDS GENERAL MORTGAGE BONDS TOTAL
- ------- -------------------- ---------------------- -------------
2003.................. $ 16,600 $ -- $ 16,600
2011.................. -- 19,200 19,200
2012.................. 45,570 -- 45,570
2015.................. 150,850 -- 150,850
2017.................. 127,385 -- 127,385
2018.................. -- 50,000 50,000
2019.................. -- 200,000 200,000
2020.................. -- 90,000 90,000
2026.................. -- 100,000 100,000
2027.................. 56,095 -- 56,095
2028.................. -- 68,000 68,000
----------- ----------- -------------
Total $ 396,500 $ 527,200 $ 923,700
=========== =========== =============
As of June 30, 2003, outstanding first mortgage bonds and general
mortgage bonds aggregated approximately $3.3 billion as shown in the following
table. Amounts are expressed in thousands.
ISSUED AS ISSUED AS COLLATERAL
ISSUED DIRECTLY TO COLLATERAL FOR FOR CENTERPOINT
THIRD PARTIES THE COMPANY'S DEBT ENERGY'S DEBT TOTAL
---------------- ------------------ -------------------- -----
First Mortgage Bonds $ 102,442 $ -- $ 396,500 $ 498,942
General Mortgage Bonds 962,275 1,310,000 527,200 2,799,475
------------------ ------------------ -------------------- -------------
Total $ 1,064,717 $ 1,310,000 $ 923,700 $ 3,298,417
================== ================== ==================== =============
The Texas electric restructuring law allows the former integrated
utility to recover its stranded costs in order to fully recover its generation
investment in a "true-up" proceeding to be held in 2004 (2004 True-Up
Proceeding). Following the unbundling of the integrated utility into its
components, we remain a regulated transmission and distribution utility through
which stranded investment is recovered. Since we do not own the once-regulated
generating assets, we are obligated to distribute recovery of stranded
investment to CenterPoint Energy, the ultimate owner of these generation assets.
In the first quarter of 2003 CenterPoint Energy recorded a $396 million
impairment related to the partial distribution of its investment in Texas Genco.
Since this amount is expected to be recovered in the 2004 True-Up Proceeding, we
have recorded a regulatory asset reflecting our right to recover this amount and
an associated payable to CenterPoint Energy. Any additional impairment or loss
that CenterPoint Energy incurs on its Texas Genco investment that we expect to
recover as stranded investment will be recorded in the same manner.
The Bond Company has $729 million aggregate principal amount of
outstanding transition bonds that were issued in 2001 in accordance with the
Texas electric restructuring law. Classes of the transition bonds have final
maturity dates of September 15, 2007, September 15, 2009, September 15, 2011 and
September 15, 2015 and bear interest at rates of 3.84%, 4.76%, 5.16% and 5.63%,
respectively. 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 transition 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.
Bank Facilities. As of June 30, 2003, we had no bank facilities
available to meet our short-term liquidity needs.
24
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. Under the
June 2003 Financing Order, we can borrow up to a limit of $600 million from the
money pool. 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 of the 1935 Act and the June 2003 Financing
Order. At June 30, 2003, we had borrowings of $190 million from the money pool.
The money pool may not provide sufficient funds to meet our cash needs.
Refunds to Our Customers. An order issued by the Texas Utility
Commission on October 3, 2001 established the transmission and distribution
rates that became effective in January 2002. The Texas Utility Commission
determined that we had overmitigated our stranded costs by redirecting
transmission and distribution depreciation and by accelerating depreciation of
generation assets (an amount equal to earnings above a stated overall rate of
return on rate base that was used to recover our investment in generation
assets) as provided under the 1998 transition plan and the Texas electric
restructuring law. In this final order, we were required to reverse the amount
of redirected depreciation and accelerated depreciation taken for regulatory
purposes as allowed under the transition plan and the Texas electric
restructuring law. In accordance with the October 3, 2001 order, we recorded a
regulatory liability to reflect the prospective refund of the accelerated
depreciation and in January 2002 we began refunding excess mitigation credits,
which are to be refunded over a seven-year period. The annual refund of excess
mitigation credits is approximately $237 million. Under the Texas electric
restructuring law, a final determination of these stranded costs will occur in
the 2004 True-Up Proceeding. We are currently seeking authority from the Texas
Utility Commission to terminate these refunds based on preliminary estimates of
what that final determination will be.
Cash Requirements in 2003. Our liquidity and capital requirements are
affected primarily by our results of operations, capital expenditures, debt
service requirements, and working capital needs. Our principal cash requirements
during the second half of 2003 include the following:
- approximately $153 million of capital expenditures;
- an estimated $126 million in refunds of excess mitigation credits
described above;
- dividend payments to CenterPoint Energy; and
- $17 million of maturing long-term debt to affiliate.
We expect that our anticipated cash flows from operations, money pool
borrowings and, to the extent permitted by our external debt agreements and
CenterPoint Energy's bank facility, proceeds from possible debt offerings, will
be sufficient to meet our cash needs for the remainder of 2003. Currently, these
agreements limit application of proceeds from debt offerings to the refinancing
of debt existing in November 2002. Limits on our ability to issue secured debt,
as described in this report, may adversely affect our ability to issue debt
securities. In addition, our future indebtedness may include terms that are more
restrictive or burdensome than those of our current indebtedness. Such terms may
negatively impact our ability to operate our business or may restrict dividends.
The amount of any debt security or any security having equity
characteristics, whether registered or unregistered, or whether debt is secured
or unsecured, is expected to be affected by:
- 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;
- market expectations regarding our future earnings and probable
cash flows;
- market perceptions of our ability to access capital markets on
reasonable terms;
25
- our exposure to Reliant Resources in connection with its
indemnification obligations arising in connection with its
separation from us;
- provisions of relevant tax and securities laws; and
- our ability to obtain approval of specific financing transactions
under the 1935 Act.
Sales of securities are expected to be used to refinance existing debt.
We may access the bank and capital markets to refinance debt that is not
scheduled to mature in the next twelve months.
Principal Factors Affecting Cash Requirements in 2004 and 2005. We
expect to issue securitization bonds in 2004 or 2005 to monetize and recover the
balance of stranded costs relating to previously owned electric generation
assets and other qualified costs as determined in the 2004 true-up proceeding.
The issuance will be done pursuant to a financing order to be issued by the
Texas Utility Commission. As with the debt of our existing transition bond
company, payments on these new securitization bonds would be made out of funds
from non-bypassable charges assessed to retail electric providers required to
take delivery service from us. The holders of the new securitization bonds would
have recourse to the assets and revenues of the issuer of the new securitization
bonds, and our other creditors would not have recourse to any assets or revenues
of that issuer. All or a portion of the proceeds from the issuance of
securitization bonds remaining after repayment of our $1.3 billion
collateralized term loan due in 2005 are expected to be utilized to retire other
debt and pay a dividend to our parent.
Impact on Liquidity of a Downgrade in Credit Ratings. As of July 31,
2003, 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 secured debt:
MOODY'S S&P FITCH
-------------------- -------------------- -------------------
SECURITY RATING OUTLOOK(1) RATING OUTLOOK(2) RATING OUTLOOK(3)
- ---------------------- -------- ---------- -------- ----------- -------- ----------
First Mortgage Bonds.. Baa2 Stable BBB Stable BBB+ Stable
General Mortgage Bonds Baa2 Stable BBB Stable BBB Stable
Debt secured by General
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) A "stable" outlook from S&P indicates that the rating is not likely to
change over the intermediate to longer term.
(3) A "stable" outlook from Fitch indicates the direction a rating is
likely to move over a one-to two-year period.
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 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.
Cross Defaults. The terms of our debt instruments generally provide
that a default on obligations by CenterPoint Energy does not cause a default
under our debt instruments. A payment default on debt for borrowed money and
certain other specified types of obligations by us exceeding $50 million will
cause a default under our $1.3 billion loan maturing in 2005. A payment default
on, or a non-payment default that permits acceleration of, any of our
indebtedness exceeding $50 million will cause a default under CenterPoint
Energy's $2.85 billion bank facility entered into on February 28, 2003. 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 on CenterPoint Energy's 3.75% senior
convertible notes due 2023, its 5.875% senior notes due 2008 and its 6.85%
senior notes due 2015.
Other Factors that Could Affect Cash Requirements. In addition to the
above factors, our liquidity and capital
26
resources could be affected by:
- various regulatory actions, including those under the 1935 Act;
and
- the ability of Reliant Resources and its subsidiaries to satisfy
their obligations to us as a principal customer and in respect of
its indemnity obligation to us.
Capitalization. Factors affecting our capitalization include:
- covenants in our borrowing agreements; and
- limitations imposed on us under the 1935 Act.
The Orders permit refinancings and authorize us to issue an additional
aggregate $500 million of external debt and an aggregate $250 million of
preferred stock and preferred securities in addition to amounts outstanding on
June 30, 2003.
The June 2003 Financing Order requires that if we issue any securities
that are rated by a nationally recognized statistical rating organization
(NRSRO), the security to be issued must obtain an investment grade rating from
at least one NRSRO and, as a condition to such issuance, all outstanding rated
securities of ours and of CenterPoint Energy must be so rated by at least one
NRSRO. The June 2003 Financing Order also contains certain requirements for
interest rates, maturities, issuance expenses and use of proceeds. Under the
June 2003 Financing Order, our common equity as a percentage of total
capitalization must be at least 30%.
Relationship to CenterPoint Energy. We are a 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.
Asset Sales. Factors affecting our ability to sell assets (including
assets of our subsidiaries) or to satisfy our cash requirements include the
following:
- the 1935 Act may require us to obtain prior approval of certain
assets sales; and
- obligations under existing credit facilities to use certain cash
received from asset sales and securities offerings to pay down
debt.
Pension Plan. As discussed in Note 8(a) of the notes to the
consolidated financial statements included in Exhibit 99.2 to the May 15 Form
8-K (CenterPoint Houston 8-K Notes), which is incorporated herein by reference,
we participate in CenterPoint Energy's qualified non-contributory pension plan
covering substantially all employees. Pension expense for 2003 is estimated to
be $26 million based on an expected return on plan assets of 9.0% and a discount
rate of 6.75% as of December 31, 2002. Pension expense for the three and six
months ended June 30, 2003 was $7 million and $13 million, respectively. Future
changes in plan asset returns, assumed discount rates and various other factors
related to the pension will impact our future pension expense. We cannot predict
with certainty what these factors will be in the future.
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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. We believe the following accounting policies involve the application of
critical accounting estimates.
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. 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 our 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. Regulatory assets reflected in our Consolidated Balance Sheets
aggregated $4.0 billion and $4.5 billion as of December 31, 2002 and June 30,
2003, respectively. Additionally, regulatory liabilities reflected in our
Consolidated Balance Sheets aggregated $1.1 billion and $0.9 billion at both
December 31, 2002 and June 30, 2003, respectively. Significant accounting
estimates embedded within the application of SFAS No. 71 relate to $2.5 billion
of recoverable electric generation plant mitigation assets (stranded costs) and
$929 million of ECOM true-up. The stranded costs are comprised of $1.1 billion
of previously recorded accelerated depreciation and $841 million of previously
redirected depreciation as well as $396 million associated with CenterPoint
Energy's distribution of approximately 19% of the 80 million outstanding shares
of common stock of Texas Genco to their shareholders on January 6, 2003. These
stranded costs are recoverable under the provisions of the Texas electric
restructuring law. The ultimate amount of stranded cost recovery is subject to a
final determination, which will occur in 2004, and is contingent upon the market
value of Texas Genco. Any significant changes in our accounting estimate of
stranded costs as a result of current market conditions or changes in the
regulatory recovery mechanism currently in place could result in a material
write-down of all or a portion of these regulatory assets.
The Texas electric restructuring law allows recovery of the difference
between the prices for power sold in state mandated auctions and earlier
estimates of market power prices by the Texas Utility Commission. This
calculation (the ECOM Calculation) compares (1) an imputed margin that reflects
the difference between actual market power prices received in the state mandated
auctions, actual fuel expense and generation, and (2) the margin resulting
from the Texas Utility Commission's estimates of power prices, fuel expense and
generation in the ECOM model developed by the Texas Utility Commission (the ECOM
Margin). The difference between those two amounts is the ECOM True-Up amount,
which is the non-cash revenue related to the cost recovery.
The ECOM model from which the ECOM Margin is derived provides only
annual estimates of power prices and fuel expense and generation. Accordingly,
we must form our own quarterly allocation estimates during 2002-2003 for the
purpose of determining ECOM True-Up revenue.
Beginning January 1, 2002, we allocated the ECOM Margin in our ECOM
Calculation based on annual estimated forecasts of power prices, fuel expense
and generation. In the second quarter of 2003, we began using a cumulative
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methodology for allocating ECOM Margin. This methodology uses revenue amounts
based on the actual state mandated auction price results and actual generation
for historical periods, as well as forecasted amounts for the balance of 2003,
rather than forecasted amounts for the two-year period allocated on an annual
basis. Changes in estimates that affect the allocation of ECOM Margin will have
an affect on the total amount of ECOM True-Up revenue recorded in a specific
period, but will not affect the total amount of ECOM True-Up revenue recorded
during the two-year period ending December 31, 2003.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets recorded in our Consolidated Balance Sheets primarily
consist of property, plant and equipment (PP&E). Net PP&E comprises $3.8 billion
or 40% of our total assets as of June 30, 2003. We make judgments and estimates
in conjunction with the carrying value of these assets, including amounts to be
capitalized, depreciation and amortization methods and useful lives. We evaluate
our PP&E for impairment whenever indicators of impairment exist. During 2003, no
such indicators of impairment existed. Accounting standards require that if the
sum of the undiscounted expected future cash flows from a company's asset is
less than the carrying value of the asset, an asset impairment must be
recognized in the financial statements. The amount of impairment recognized is
calculated by subtracting the fair value of the asset from the carrying value of
the asset.
UNBILLED REVENUES
Revenues related to the sale and/or delivery of electricity are
generally recorded when electricity is delivered to customers. However, the
determination of 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 electric delivery revenue is estimated each month
based on daily supply volumes, applicable rates and analyses reflecting
significant historical trends and experience. Accrued unbilled revenues recorded
in the Consolidated Balance Sheets as of December 31, 2002 and June 30, 2003
were $70 million and $85 million, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2003, we adopted SFAS No. 143, "Accounting for
Asset Retirement Obligations" (SFAS No. 143). SFAS No. 143 requires the fair
value of an asset retirement obligation to be recognized as a liability is
incurred and capitalized as part of the cost of the related tangible long-lived
asset. Over time, the liability is accreted to its present value each period,
and the capitalized cost is depreciated over the useful life of the related
asset. Retirement obligations associated with long-lived assets included within
the scope of SFAS No. 143 are those for which a legal obligation exists under
enacted laws, statutes and written or oral contracts, including obligations
arising under the doctrine of promissory estoppel.
We have not identified any asset retirement obligations; however, we
have previously recognized removal costs as a component of depreciation expense
in accordance with regulatory treatment. As of June 30, 2003, these previously
recognized removal costs of $254 million do not represent SFAS No. 143 asset
retirement obligations, but rather embedded regulatory liabilities.
In April 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections" (SFAS No. 145). SFAS No. 145
eliminates the current requirement that gains and losses on debt extinguishment
must be classified as extraordinary items in the income statement. Instead, such
gains and losses will be classified as extraordinary items only if they are
deemed to be unusual and infrequent. SFAS No. 145 also requires that capital
leases that are modified so that the resulting lease agreement is classified as
an operating lease be accounted for as a sale-leaseback transaction. The changes
related to debt extinguishment are effective for fiscal years beginning after
May 15, 2002, and the changes related to lease accounting are effective for
transactions occurring after May 15, 2002. We have applied this guidance
prospectively as it relates to lease accounting and the accounting provision
related to debt extinguishment. Upon adoption of SFAS No. 145, any gain or loss
on extinguishment of debt that was classified as an extraordinary item in prior
periods is required to be reclassified. No such reclassification was required
for the three month and six month period ended June 30, 2002. We have
reclassified the $25 million loss on debt extinguishment related to the fourth
quarter of 2002 from an extraordinary item to interest expense.
29
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)" (EITF No. 94-3). The principal difference
between SFAS No. 146 and EITF No. 94-3 relates to the requirements for
recognition of a liability for costs associated with an exit or disposal
activity. SFAS No. 146 requires that a liability be recognized for a cost
associated with an exit or disposal activity when it is incurred. A liability is
incurred when a transaction or event occurs that leaves an entity little or no
discretion to avoid the future transfer or use of assets to settle the
liability. Under EITF No. 94-3, a liability for an exit cost was recognized at
the date of an entity's commitment to an exit plan. In addition, SFAS No. 146
also requires that a liability for a cost associated with an exit or disposal
activity be recognized at its fair value when it is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002. We adopted the provisions of SFAS No. 146 on January 1, 2003.
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. In addition, FIN 45 requires disclosures about the guarantees that
an entity has issued. The provision for initial recognition and measurement of
the liability will be applied on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions of FIN 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of FIN 45 did not materially affect our
consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" (SFAS No. 149). SFAS No.
149 has added additional criteria which were effective on July 1, 2003 for new,
acquired, or newly modified forward contracts. We do not believe the adoption of
SFAS No. 149 will have a material effect on our financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity" (SFAS
No. 150). SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a change in an accounting principle with no restatement of
prior period information permitted. We are currently assessing the impact that
this statement will have on our consolidated financial statements.
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 June 30, 2003 to provide assurance that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
There has been no change in our internal controls over financial
reporting that occurred during the three months ended June 30, 2003 that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.
30
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
For a description of certain legal and regulatory proceedings affecting
us, please review Note 8 to our Interim Financial Statements, "Legal
Proceedings" in Item 3 of the CenterPoint Houston Form 10-K and Note 10(b) to
the CenterPoint Houston 8-K Notes, each of which are incorporated herein by
reference.
ITEM 5. OTHER INFORMATION.
RISK FACTORS
PRINCIPAL RISK FACTORS ASSOCIATED WITH OUR BUSINESS
WE MAY NOT BE SUCCESSFUL IN RECOVERING THE FULL VALUE OF OUR STRANDED COSTS AND
REGULATORY ASSETS RELATED TO GENERATION.
We are entitled to recover our stranded costs (the excess of regulatory
net book value of generation assets, as defined by the Texas electric
restructuring law, over the market value of those assets) and our regulatory
assets related to generation. We expect to make a filing on March 31, 2004 in a
true-up proceeding provided for by the Texas electric restructuring law. The
purpose of this proceeding will be to quantify and reconcile:
- the amount of stranded costs;
- regulatory assets that were not previously recovered through the
issuance of securitization bonds by a subsidiary;
- differences in the prices achieved in the state-mandated auctions
of Texas Genco's generation capacity and Texas Utility Commission
estimates;
- fuel over- or under-recovery; and
- the "price to beat" clawback.
We will be required to establish and support the amounts of these costs
in order to recover them. We expect these costs to be substantial. We cannot
assure you that we will be able to successfully establish and support our
estimates of the amount of these costs. Our $1.3 billion collateralized term
loan that matures in November 2005 is expected to be repaid or refinanced with
the proceeds from the issuance of securitization bonds to recover our stranded
costs and the balance of our regulatory assets. If we do not receive the
proceeds on or before the maturity date, our ability to repay or refinance this
term loan will be adversely affected.
The Texas Utility Commission's ruling that the true-up proceeding
filing will be made on March 31, 2004 means that the calculation of the market
value of the Texas Genco common stock for purposes of the Texas Utility
Commission's stranded cost determination might be more or less than the purchase
price calculated under the option held by Reliant Resources to purchase our 81%
ownership interest in Texas Genco. The purchase price under the option will be
based on market prices during the 120 trading days ending on January 9, 2004,
but under the filing schedule prescribed by the Texas Utility Commission, the
value of that ownership interest for the stranded cost determination will be
based on market prices during the 120 trading days ending on March 30, 2004. If
Reliant Resources exercises its option at a lower price than the market value
used by the Texas Utility Commission, we would be unable to recover the
difference.
OUR RECEIVABLES ARE CONCENTRATED IN A SMALL NUMBER OF RETAIL ELECTRIC PROVIDERS.
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 31 retail electric
31
providers. Adverse economic conditions, structural problems in the new ERCOT
market 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 timely to us. Any delay or default in payment could adversely
affect our cash flows, financial condition and results of operations.
Approximately 78% of our $119 million in receivables from retail electric
providers at June 30, 2003 was owed by subsidiaries of Reliant Resources. Our
financial condition may be adversely affected if Reliant Resources is unable to
meet these obligations. Reliant Resources, through its subsidiaries, is our
largest customer. Pursuant to the Texas electric restructuring law, Reliant
Resources may be obligated to make a large "price to beat" clawback payment to
us in 2004. We expect the clawback, if any, to be applied against any stranded
cost recovery to which we are entitled or, if no stranded costs are recoverable,
to be refunded to retail electric providers.
RATE REGULATION OF OUR BUSINESS MAY DELAY OR DENY OUR FULL RECOVERY OF OUR
COSTS.
Our rates are regulated by certain municipalities and the Texas Utility
Commission based on an analysis of our invested capital and expenses incurred in
a test year. Thus, the rates we are allowed to charge may not match our expenses
at any given time. While rate regulation in Texas is premised on providing a
reasonable opportunity to recover reasonable and necessary operating expenses
and to earn a reasonable return on our invested capital, there can be no
assurance that the Texas Utility Commission will judge all of our costs to be
reasonable or necessary or that the regulatory process in which rates are
determined will always result in rates that will produce full recovery of our
costs.
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 our customers. 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 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 each 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 FINANCIAL CONDITION
IF WE ARE UNABLE TO ARRANGE FUTURE FINANCINGS ON ACCEPTABLE TERMS, OUR
ABILITY TO FUND FUTURE CAPITAL EXPENDITURES AND FINANCE EXISTING INDEBTEDNESS
COULD BE LIMITED.
As of June 30, 2003, we had $3.7 billion of outstanding indebtedness,
including approximately $17 million of debt that must be refinanced in 2003. In
addition, the capital constraints and other factors currently impacting our
business may require our future indebtedness to include terms that are more
restrictive or burdensome than those of our current indebtedness. These terms
may negatively impact our ability to operate our business or adversely affect
our financial condition and results of operations. The success of our future
financing efforts may depend, at least in part, on:
- 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 by
CenterPoint Energy;
32
- 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 Reliant Resources as our customer and in
connection with Reliant Resources' 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 financing transactions
under the 1935 Act.
As of June 30, 2003, we had $2.8 billion principal amount of general
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 $680 million of additional general mortgage
bonds could be issued on the basis of property additions as of June 30, 2003, we
have agreed under the $1.3 billion collateralized term loan maturing in 2005 to
not issue, subject to certain exceptions, any incremental secured debt. In
addition, we are contractually prohibited, subject to certain exceptions, from
issuing additional first mortgage bonds.
Our current credit ratings are discussed in "Management's Narrative
Analysis of Results of Operations of CenterPoint Energy Houston Electric, LLC
and Subsidiaries--Liquidity--Impact on Liquidity of a Downgrade in Credit
Ratings" in Item 2 of Part I of this report. We cannot assure you that these
credit 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. 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.
As of June 30, 2003, we had $1.5 billion of outstanding floating-rate
debt owed to third parties. Because of capital constraints impacting our
business at the time $1.3 billion of this floating-rate debt was entered into,
the interest rates are substantially above our historical borrowing rates. In
addition, any floating-rate debt issued by us in the future could be at interest
rates substantially above our historical borrowing rates. While we may seek to
use interest rate swaps in order to hedge portions of our floating-rate debt, we
may not be successful in obtaining hedges on acceptable terms. Any increase in
short-term interest rates would 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. CenterPoint Energy and its subsidiaries other than us have
approximately $140 million of debt, including capital leases, required to be
paid in 2003. We cannot assure you that CenterPoint Energy and its other
subsidiaries will 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 a note receivable from CenterPoint Energy in the amount of
$815 million as of June 30, 2003 could be adversely affected.
WE ARE A 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:
- decisions on our financings and our capital raising
activities;
- mergers or other business combinations; and
33
- 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.
OTHER RISKS
WE COULD INCUR LIABILITIES ASSOCIATED WITH BUSINESSES AND ASSETS 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 Reliant Resources or its subsidiaries in
connection with the organization and capitalization of Reliant
Resources prior to its initial public offering in 2001;
- those transferred to Texas Genco in connection with its
organization and capitalization; and
- those transferred to CenterPoint Energy in connection with the
Restructuring.
In connection with the organization and capitalization of Reliant
Resources, Reliant Resources and its subsidiaries assumed liabilities associated
with various assets and businesses Reliant Energy transferred to them. Reliant
Resources 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 Reliant Resources and its subsidiaries for all liabilities
associated with the current and historical businesses and operations of Reliant
Resources, regardless of the time those liabilities arose. If Reliant Resources
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 could be responsible for satisfying the liability.
Reliant Resources reported in its Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 2003 that as of March 31, 2003 it had $7.9
billion of total debt and its unsecured debt ratings are currently below
investment grade. If Reliant Resources is unable to meet its obligations, it
would need to consider, among various options, restructuring under the
bankruptcy laws, in which event Reliant Resources might not honor its
indemnification obligations and claims by Reliant Resources' creditors might be
made against us as its former owner.
Reliant Energy and Reliant Resources 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 Reliant Resources, claims against Reliant Energy have
been made on grounds that include the effect of Reliant Resources' financial
results on Reliant Energy's historical financial statements and liability of
Reliant Energy as a controlling shareholder of Reliant Resources. We could incur
liability if claims in one or more of these lawsuits were successfully asserted
against us and indemnification from Reliant Resources were determined to be
unavailable or if Reliant Resources were unable to satisfy indemnification
obligations owed to us 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. If Texas Genco 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.
34
IF THE ERCOT MARKET DOES NOT FUNCTION IN THE MANNER CONTEMPLATED BY THE TEXAS
ELECTRIC RESTRUCTURING LAW, OUR BUSINESS, PROSPECTS, RESULTS OF OPERATIONS,
FINANCIAL CONDITION AND CASH FLOWS COULD BE ADVERSELY IMPACTED.
The competitive electric market in Texas became fully operational in
January 2002, and none of the Texas Utility Commission, ERCOT, other market
participants or us has any significant operating history under the market
framework created by the Texas electric restructuring law. The initiatives under
the Texas electric restructuring law have had a significant impact on the nature
of the electric power industry in Texas and the manner in which participants in
the ERCOT market conduct their business. These changes are ongoing, and we
cannot predict the future development of the ERCOT market or the ultimate effect
that this changing regulatory environment will have on our business.
Some restructured markets in other states have experienced supply
problems and extreme price volatility. If the ERCOT market does not function as
intended by the Texas electric restructuring law, our results of operations,
financial condition and cash flows could be adversely affected. In addition, any
market failures could lead to revisions or reinterpretations of the Texas
electric restructuring law, the adoption of new laws and regulations applicable
to us or our facilities and other future changes in laws and regulations that
may have a detrimental effect on our business.
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 subsidiaries to issue debt and
equity securities without prior authorization, restricts the source of dividend
payments to funds from current and retained earnings without prior
authorization, regulates sales and acquisitions of certain assets and businesses
and governs affiliate transactions. Approval of filings under the 1935 Act can
take extended periods.
The Orders relating to financing activities, are effective until
June 30, 2005. Although authorized levels of financing, together with current
levels of liquidity, are believed to be adequate during the period the order is
effective, unforeseen events could result in capital needs in excess of
authorized amounts, necessitating further authorization from the SEC.
The United States Congress is currently considering legislation which
has a provision 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.
WE DO NOT MAINTAIN INSURANCE COVERAGE ON OUR TRANSMISSION AND DISTRIBUTION
SYSTEM. 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 would be entitled to seek to recover such loss or damage through a change in
our regulated rates, although there is no assurance that we would ultimately
obtain any such rate recovery or that any such rate recovery would be timely
granted. Therefore, we cannot assure you that we will 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.
TECHNOLOGICAL CHANGE MAY MAKE ALTERNATIVE ENERGY SOURCES MORE ATTRACTIVE AND MAY
ADVERSELY AFFECT OUR REVENUES AND RESULTS OF OPERATIONS.
The continuous process of technological development may result in the
introduction to retail customers of economically attractive alternatives to
purchasing electricity through our distribution facilities. Manufacturers of
self-generation facilities continue to develop smaller-scale,
more-fuel-efficient generating units that can be cost-effective options for some
retail customers with smaller electric energy requirements. Any reduction in the
amount of electric energy we distribute as a result of these technologies may
have an adverse impact on our results of operations, financial condition and
cash flows in the future.
OUR REVENUES AND RESULTS OF OPERATIONS ARE SUBJECT TO RISKS THAT ARE BEYOND OUR
CONTROL, INCLUDING BUT NOT LIMITED TO FUTURE TERRORIST ATTACKS OR RELATED ACTS
OF WAR.
35
The cost of repairing damage to our facilities due to storms, natural
disasters, wars, terrorist acts and other catastrophic events, in excess of
reserves established for such repairs, may adversely impact our results of
operations, financial condition and cash flows. The occurrence or risk of
occurrence of future terrorist activity may impact our results of operations,
financial condition and cash flows in unpredictable ways. These actions could
also result in adverse changes in the insurance markets and disruptions of power
and fuel markets. In addition, our transmission and distribution facilities
could be directly or indirectly harmed by future terrorist activity. The
occurrence or risk of occurrence of future terrorist attacks or related acts of
war could also adversely affect the United States economy. A lower level of
economic activity could result in a decline in energy consumption, which could
adversely affect our revenues and margins and limit our future growth prospects.
Also, these risks could cause instability in the financial markets and adversely
affect our ability to access capital.
36
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
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 Form 8-K dated 1-3187 3(a)
Conversion of REI August 31, 2002
filed with the SEC
on September 3, 2002
3.2 -- Articles of Form 8-K dated 1-3187 3(b)
Organization of August 31, 2002
CenterPoint filed with the SEC
Energy Houston on September 3, 2002
Electric, LLC
3.3 -- Limited Form 8-K dated 1-3187 3(c)
Liability August 31, 2002
Company filed with the SEC
Regulations of on September 3, 2002
CenterPoint
Energy Houston
Electric, LLC
4.1.1 -- General Mortgage CenterPoint 1-3187 4(j)(1)
Indenture, dated Houston's Form 10-Q
as of October for the quarter
10, 2002, ended September 30,
between 2002
CenterPoint
Houston and
JPMorgan Chase
Bank, as Trustee
4.1.2 -- First CenterPoint 1-3187 4(j)(2)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.3 -- Second CenterPoint 1-3187 4(j)(3)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.4 -- Third CenterPoint 1-3187 4(j)(4)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.5 -- Fourth CenterPoint 1-3187 4(j)(5)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.6 -- Fifth CenterPoint 1-3187 4(j)(6)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.7 -- Sixth CenterPoint 1-3187 4(j)(7)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.8 -- Seventh CenterPoint 1-3187 4(j)(8)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
37
4.1.9 -- Eighth CenterPoint 1-3187 4(j)(9)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.10 -- Ninth CenterPoint Energy's 1-31447 4(e)(10)
Supplemental Form 10-K for the
Indenture to year ended December
Exhibit 4.1.1, 31, 2002
dated as of
November 12, 2002
4.1.11 -- Tenth CenterPoint Energy's 1-31447 4.1
Supplemental Form 8-K dated March
Indenture to 13, 2003
Exhibit 4.1.1,
dated as of
March 18, 2003
4.1.12 -- Eleventh CenterPoint Energy's 1-31447 4.1
Supplemental Form 8-K dated May
Indenture to 16, 2003
Exhibit 4.1.1,
dated as of May
23, 2003
4.2.1 -- Officer's CenterPoint Energy's 1-31447 4.2
Certificate Form 8-K dated March
dated March 18, 13, 2003
2003 setting forth
the form, terms
and provisions of
the Tenth Series
and Eleventh
Series of general
mortgage bonds
4.2.2 -- Registration CenterPoint Energy's 1-31447 4.2.2
Rights Form 10-Q for the
Agreement, dated quarter ended June
as of March 18, 30, 2003
2003, among
CenterPoint
Houston and the
representatives of
the initial
purchasers named
therein relating
to Tenth Series
and Eleventh Series
of general mortgage
bonds.
4.2.3 -- Officer's CenterPoint Energy's 1-31447 4.2
Certificate Form 8-K dated May
dated May 23, 16, 2003
2003 setting
forth the form,
terms and
provisions of
the Twelfth
Series of
general mortgage
bonds
4.2.4 -- Registration CenterPoint Energy's 1-31447 4.2.4
Rights Form 10-Q for the
Agreement, dated quarter ended June
as of May 23, 2003 30, 2003
among CenterPoint
Houston and the
representatives of
the initial
purchasers named
therein relating
to Twelfth Series
of general mortgage
bonds
+31.1 -- Section 302
Certification of
David M.
McClanahan
38
+31.2 -- Section 302
Certification of
Gary L. Whitlock
+32.1 -- Section 906
Certification of
David M. McClanahan
+32.2 -- Section 906
Certification of
Gary L. Whitlock
+99.1 -- Items incorporated
by reference from
the CenterPoint
Houston Form 10-K.
Item 3 "Legal
Proceedings"
+99.2 -- Items
incorporated by
reference from
CenterPoint
Houston's
Current Report
on Form 8-K
dated May 15,
2003. Exhibit
99.1,
"Management's
Narrative
Analysis of
Results of
Operations
--Certain Factors
Affecting Future
Earnings," and
the following
Notes from
Exhibit 99.2:
Notes 3(e)
(Regulatory
Assets and
Liabilities), 4
(Regulatory
Matters), 8(a)
(Pension Plans)
and 10
(Commitments and
Contingencies).
(b) Reports on Form 8-K.
On April 8, 2003, we filed a Current Report on Form 8-K to furnish
information under Item 9 of that form regarding our external debt balances as of
March 31, 2003.
On May 16, 2003, we filed a Current Report on Form 8-K dated May 15,
2003, to provide information giving effect to certain reclassifications within
our historical consolidated financial statements, and Management's Narrative
Analysis of Results of Operations as reported on our Annual Report on Form 10-K
for the year ended December 31, 2002.
On June 20, 2003, we filed a Current Report on Form 8-K dated May 16,
2003, to report the pricing and closing of $200 million of general mortgage
bonds in a private placement with institutions pursuant to Rule 144A under the
Securities Act of 1933, as amended.
On June 20, 2003, we filed a Current Report on Form 8-K dated May 16,
2003, to report that the Public Utility Commission of Texas ruled that our
filing for recovery of our stranded costs an regulatory assets as provide by the
Texas electric restructuring law will be made on March 31, 2004.
39
SIGNATURE
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: August 13, 2003
40
INDEX TO EXHIBITS
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 Form 8-K dated 1-3187 3(a)
Conversion of REI August 31, 2002
filed with the SEC
on September 3, 2002
3.2 -- Articles of Form 8-K dated 1-3187 3(b)
Organization of August 31, 2002
CenterPoint filed with the SEC
Energy Houston on September 3, 2002
Electric, LLC
3.3 -- Limited Form 8-K dated 1-3187 3(c)
Liability August 31, 2002
Company filed with the SEC
Regulations of on September 3, 2002
CenterPoint
Energy Houston
Electric, LLC
4.1.1 -- General Mortgage CenterPoint 1-3187 4(j)(1)
Indenture, dated Houston's Form 10-Q
as of October for the quarter
10, 2002, ended September 30,
between 2002
CenterPoint
Houston and
JPMorgan Chase
Bank, as Trustee
4.1.2 -- First CenterPoint 1-3187 4(j)(2)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.3 -- Second CenterPoint 1-3187 4(j)(3)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.4 -- Third CenterPoint 1-3187 4(j)(4)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.5 -- Fourth CenterPoint 1-3187 4(j)(5)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.6 -- Fifth CenterPoint 1-3187 4(j)(6)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.7 -- Sixth CenterPoint 1-3187 4(j)(7)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.8 -- Seventh CenterPoint 1-3187 4(j)(8)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.9 -- Eighth CenterPoint 1-3187 4(j)(9)
Supplemental Houston's Form 10-Q
Indenture to for the quarter
Exhibit 4.1.1, ended September 30,
dated as of 2002
October 10, 2002
4.1.10 -- Ninth CenterPoint Energy's 1-31447 4(e)(10)
Supplemental Form 10-K for the
Indenture to year ended December
Exhibit 4.1.1, 31, 2002
dated as of
November 12, 2002
4.1.11 -- Tenth CenterPoint Energy's 1-31447 4.1
Supplemental Form 8-K dated March
Indenture to 13, 2003
Exhibit 4.1.1,
dated as of
March 18, 2003
4.1.12 -- Eleventh CenterPoint Energy's 1-31447 4.1
Supplemental Form 8-K dated May
Indenture to 16, 2003
Exhibit 4.1.1,
dated as of May
23, 2003
4.2.1 -- Officer's CenterPoint Energy's 1-31447 4.2
Certificate Form 8-K dated March
dated March 18, 13, 2003
2003 setting forth
the form, terms
and provisions of
the Tenth Series
and Eleventh
Series of general
mortgage bonds
4.2.2 -- Registration CenterPoint Energy's 1-31447 4.2.2
Rights Form 10-Q for the
Agreement, dated quarter ended June
as of March 18, 30, 2003
2003, among
CenterPoint
Houston and the
representatives of
the initial
purchasers named
therein relating
to Tenth Series
and Eleventh Series
of general mortgage
bonds.
4.2.3 -- Officer's CenterPoint Energy's 1-31447 4.2
Certificate Form 8-K dated May
dated May 23, 16, 2003
2003 setting
forth the form,
terms and
provisions of
the Twelfth
Series of
general mortgage
bonds
4.2.4 -- Registration CenterPoint Energy's 1-31447 4.2.4
Rights Form 10-Q for the
Agreement, dated quarter ended June
as of May 23, 2003 30, 2003
among CenterPoint
Houston and the
representatives of
the initial
purchasers named
therein relating
to Twelfth Series
of general mortgage
bonds
+31.1 -- Section 302
Certification of
David M.
McClanahan
+31.2 -- Section 302
Certification of
Gary L. Whitlock
+32.1 -- Section 906
Certification of
David M. McClanahan
+32.2 -- Section 906
Certification of
Gary L. Whitlock
+99.1 -- Items incorporated
by reference from
the CenterPoint
Houston Form 10-K.
Item 3 "Legal
Proceedings"
+99.2 -- Items
incorporated by
reference from
CenterPoint
Houston's
Current Report
on Form 8-K
dated May 15,
2003. Exhibit
99.1,
"Management's
Narrative
Analysis of
Results of
Operations," and
the following
Notes from
Exhibit 99.2:
Notes 3(e)
(Regulatory
Assets and
Liabilities), 4
(Regulatory
Matters), 8(a)
(Pension Plans)
and 10
(Commitments and
Contingencies).