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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 MARCH 31, 2004
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 1-31447
CENTERPOINT ENERGY, INC.
(Exact name of registrant as specified in its charter)
TEXAS 74-0694415
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1111 LOUISIANA
HOUSTON, TEXAS 77002 (713) 207-1111
(Address and zip code of principal (Registrant's telephone number, including
executive offices) area code)
_____________________
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of May 1, 2004, CenterPoint Energy, Inc. had 307,193,878 shares of common
stock outstanding, excluding 166 shares held as treasury stock.
CENTERPOINT ENERGY, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2004
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements............................................................. 1
Statements of Consolidated Income
Three Months Ended March 31, 2003 and 2004 (unaudited).......................... 1
Consolidated Balance Sheets
December 31, 2003 and March 31, 2004 (unaudited)................................ 2
Statements of Consolidated Cash Flows
Three Months Ended March 31, 2003 and 2004 (unaudited).......................... 4
Notes to Unaudited Consolidated Financial Statements............................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations of CenterPoint Energy and Subsidiaries..................................... 22
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................... 37
Item 4. Controls and Procedures.......................................................... 39
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................ 40
Item 2. Changes in Securities, Use of Proceeds and Issuer Repurchases of Equity
Securities............................................................................ 40
Item 6. Exhibits and Reports on Form 8-K................................................. 41
i
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
From time to time, we make statements concerning our expectations,
beliefs, plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements, that are not historical facts.
These statements are "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Actual results may differ
materially from those expressed or implied by these statements. You can
generally identify our forward-looking statements by the words "anticipate,"
"believe," "continue," "could," "estimate," "expect," "forecast," "goal,"
"intend," "may," "objective," "plan," "potential," "predict," "projection,"
"should," "will," or other similar words.
We have based our forward-looking statements on our management's beliefs
and assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, we cannot assure you that actual results will
not differ materially from those expressed or implied by our forward-looking
statements.
The following are some of the factors that could cause actual results to
differ materially from those expressed or implied in forward-looking statements:
- the timing and outcome of the regulatory process related to
the 1999 Texas Electric Choice Law leading to the
determination and recovery of the true-up components and the
securitization of these amounts;
- the timing and results of the monetization of our interest in
Texas Genco Holdings, Inc.;
- 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:
- allowed rates of return;
- rate structures;
- recovery of investments; and
- operation and construction of facilities;
- industrial, commercial and residential growth in our service
territory and changes in market demand and demographic
patterns;
- the timing and extent of changes in commodity prices,
particularly natural gas;
- changes in interest rates or rates of inflation;
- weather variations and other natural phenomena;
- the timing and extent of changes in the supply of natural gas;
- 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;
- inability of various counterparts to meet their obligations to
us;
- non-payment for our services due to financial distress of our
customers, including Reliant Energy, Inc. (formerly named
Reliant Resources, Inc.) (RRI);
- the outcome of the pending lawsuits against us, Reliant
Energy, Incorporated and RRI;
ii
- the ability of RRI to satisfy its obligations to us, including
indemnity obligations and obligations to pay the "price to
beat" clawback; and
- other factors we discuss in "Risk Factors" beginning on page
26 of the CenterPoint Energy, Inc. Annual Report on Form 10-K
for the year ended December 31, 2003.
Additional risk factors are described in other documents we file with the
Securities and Exchange Commission.
You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement.
iii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CENTERPOINT ENERGY, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
---------------------------
2003 2004
------------ ------------
REVENUES................................................................... $ 2,900,168 $ 2,959,187
------------ ------------
EXPENSES:
Fuel and cost of gas sold................................................ 1,859,145 1,942,258
Purchased power.......................................................... 11,994 8,270
Operation and maintenance................................................ 412,876 410,612
Depreciation and amortization............................................ 152,282 156,587
Taxes other than income taxes............................................ 102,844 106,245
------------ ------------
Total................................................................ 2,539,141 2,623,972
------------ ------------
OPERATING INCOME........................................................... 361,027 335,215
------------ ------------
OTHER INCOME (EXPENSE):
Loss on Time Warner investment.......................................... (48,474) (24,453)
Gain on indexed debt securities.......................................... 42,703 27,014
Interest and other finance charges....................................... (228,044) (194,752)
Interest on transition bonds............................................. (9,848) (9,674)
Other, net............................................................... 3,159 1,824
------------ ------------
Total................................................................ (240,504) (200,041)
------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, MINORITY INTEREST,
AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE .............................. 120,523 135,174
Income Tax Expense....................................................... (41,109) (49,997)
Minority Interest........................................................ 2,066 (11,590)
------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF ACCOUNTING
CHANGE .................................................................. 81,480 73,587
DISCONTINUED OPERATIONS:
Loss from Other Operations, net of tax................................. (462) -
Gain on Disposal of Other Operations, net of tax...................... 7,342 -
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAX........................ 80,072 -
------------ ------------
NET INCOME ................................................................ $ 168,432 $ 73,587
============ ============
BASIC EARNINGS PER SHARE:
Income from Continuing Operations Before Cumulative Effect of Accounting
Change................................................................. $ 0.27 $ 0.24
Discontinued Operations:
Loss from Other Operations, net of tax................................. - -
Gain on Disposal of Other Operations, net of tax...................... 0.02 -
Cumulative Effect of Accounting Change, net of tax....................... 0.27 -
------------ ------------
Net Income............................................................... $ 0.56 $ 0.24
============ ============
DILUTED EARNINGS PER SHARE:
Income from Continuing Operations Before Cumulative Effect of Accounting
Change................................................................. $ 0.27 $ 0.24
Discontinued Operations:
Loss from Other Operations, net of tax................................. - -
Gain on Disposal of Other Operations, net of tax...................... 0.02 -
Cumulative Effect of Accounting Change, net of tax....................... 0.27 -
------------ ------------
Net Income............................................................... $ 0.56 $ 0.24
============ ============
See Notes to the Company's Interim Financial Statements
1
CENTERPOINT ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, MARCH 31,
2003 2004
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents................................................ $ 131,480 $ 206,467
Investment in Time Warner common stock................................... 389,302 364,849
Accounts receivable, net................................................. 636,646 566,440
Accrued unbilled revenues................................................ 395,351 242,584
Fuel stock............................................................... 237,650 148,867
Materials and supplies................................................... 175,276 169,501
Non-trading derivative assets............................................ 45,897 48,993
Taxes receivable......................................................... 159,646 123,455
Prepaid expenses and other current assets................................ 101,457 79,176
-------------- --------------
Total current assets................................................... 2,272,705 1,950,332
-------------- --------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment............................................ 20,005,437 20,097,386
Less accumulated depreciation and amortization........................... (8,193,901) (8,307,335)
-------------- --------------
Property, plant and equipment, net..................................... 11,811,536 11,790,051
-------------- --------------
OTHER ASSETS:
Goodwill, net............................................................ 1,740,510 1,740,510
Other intangibles, net................................................... 79,936 79,111
Regulatory assets........................................................ 4,930,793 4,945,277
Non-trading derivative assets............................................ 11,273 11,391
Other.................................................................... 529,911 542,872
-------------- --------------
Total other assets..................................................... 7,292,423 7,319,161
-------------- --------------
TOTAL ASSETS......................................................... $ 21,376,664 $ 21,059,544
============== ==============
See Notes to the Company's Interim Financial Statements
2
CENTERPOINT ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY
DECEMBER 31, MARCH 31,
2003 2004
-------------- --------------
CURRENT LIABILITIES:
Short-term borrowings................................................... $ 63,000 $ --
Current portion of transition bond long-term debt....................... 41,189 43,099
Current portion of other long-term debt................................. 121,234 122,108
Indexed debt securities derivative...................................... 321,352 294,335
Accounts payable........................................................ 694,558 624,782
Taxes accrued........................................................... 193,273 115,320
Interest accrued........................................................ 164,669 155,957
Non-trading derivative liabilities...................................... 8,036 9,626
Regulatory liabilities.................................................. 186,239 187,218
Accumulated deferred income taxes, net.................................. 345,870 334,480
Deferred revenues....................................................... 88,740 88,781
Other................................................................... 290,176 228,906
-------------- --------------
Total current liabilities............................................. 2,518,336 2,204,612
-------------- --------------
OTHER LIABILITIES:
Accumulated deferred income taxes, net.................................. 3,010,577 3,043,093
Unamortized investment tax credits...................................... 211,731 206,969
Non-trading derivative liabilities...................................... 3,330 1,676
Benefit obligations..................................................... 836,459 851,622
Regulatory liabilities.................................................. 1,358,030 1,331,355
Other................................................................... 715,670 697,633
-------------- --------------
Total other liabilities............................................... 6,135,797 6,132,348
-------------- --------------
LONG-TERM DEBT:
Transition bonds........................................................ 675,665 659,762
Other................................................................... 10,107,399 10,046,251
-------------- --------------
Total long-term debt.................................................. 10,783,064 10,706,013
-------------- --------------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 11)
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES............................. 178,910 186,691
-------------- --------------
SHAREHOLDERS' EQUITY:
Common stock (305,385,434 shares and 307,072,860 shares outstanding
at December 31, 2003 and March 31, 2004, respectively)................ 3,063 3,071
Additional paid-in capital.............................................. 2,868,416 2,882,417
Unearned ESOP stock..................................................... (2,842) --
Retained deficit........................................................ (700,033) (657,012)
Accumulated other comprehensive loss.................................... (408,047) (398,596)
-------------- --------------
Total shareholders' equity............................................ 1,760,557 1,829,880
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.......................... $ 21,376,664 $ 21,059,544
============== ==============
See Notes to the Company's Interim Financial Statements
3
CENTERPOINT ENERGY, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
-----------------------------------
2003 2004
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................................................. $ 168,432 $ 73,587
Discontinued operations................................................. (6,880) -
Cumulative effect of accounting change.................................. (80,072) -
-------------- --------------
Income from continuing operations before cumulative effect of
accounting change..................................................... 81,480 73,587
Adjustments to reconcile income from continuing operations before
cumulative effect of accounting change to net cash provided by
operating activities:
Depreciation and amortization......................................... 152,282 156,587
Fuel-related amortization............................................. 6,535 6,916
Amortization of deferred financing costs.............................. 38,839 22,846
Deferred income taxes................................................. 101,945 17,061
Investment tax credit................................................. (4,342) (4,761)
Unrealized loss on Time Warner investment............................. 48,474 24,453
Unrealized gain on indexed debt securities............................ (42,703) (27,014)
Minority interest..................................................... (2,066) 11,590
Changes in other assets and liabilities:
Accounts receivable and unbilled revenues, net...................... (292,422) 223,241
Inventory........................................................... 59,473 94,558
Taxes receivable.................................................... (21,045) 36,191
Accounts payable.................................................... 216,341 (69,776)
Fuel cost over (under) recovery/surcharge........................... 10,702 31,280
Non-trading derivatives, net........................................ (3,826) 4,987
Interest and taxes accrued.......................................... (109,862) (86,665)
Net regulatory assets and liabilities............................... (198,022) (54,965)
Other current assets................................................ 7,854 22,281
Other current liabilities........................................... (79,136) (92,513)
Other assets........................................................ (4,323) (14,427)
Other liabilities................................................... 39,816 (3,773)
Other, net............................................................ (296) 21,136
-------------- --------------
Net cash provided by operating activities......................... 5,698 392,820
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.................................................... (143,373) (122,853)
Other, net.............................................................. (2,924) (4,745)
-------------- --------------
Net cash used in investing activities............................. (146,297) (127,598)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in short-term borrowing, net................................... (347,000) (63,000)
Long-term revolving credit facility, net................................ (53,000) 195,500
Proceeds from long-term debt............................................ 1,408,830 231,550
Payments of long-term debt.............................................. (729,138) (510,356)
Debt issuance costs..................................................... (124,893) (13,126)
Payment of common stock dividends....................................... (30,507) (30,657)
Payment of common stock dividends by subsidiary......................... (3,809) (3,808)
Proceeds from issuance of common stock, net............................. 814 3,658
Other, net.............................................................. 168 4
-------------- --------------
Net cash provided by (used in) financing activities................. 121,465 (190,235)
-------------- --------------
NET CASH PROVIDED BY DISCONTINUED OPERATIONS.............................. 19,322 -
-------------- --------------
NET INCREASE IN CASH AND CASH EQUIVALENTS................................. 188 74,987
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.......................... 304,281 131,480
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD................................ $ 304,469 $ 206,467
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest................................................................ $ 234,871 $ 202,587
Income taxes (refunds).................................................. (39,260) 1,997
See Notes to the Company's Interim Financial Statements
4
CENTERPOINT ENERGY, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
General. Included in this Quarterly Report on Form 10-Q (Form 10-Q) of
CenterPoint Energy, Inc., together with its subsidiaries (collectively,
CenterPoint Energy or the Company), are CenterPoint Energy's consolidated
interim financial statements and notes (Interim Financial Statements) including
its wholly owned and majority owned subsidiaries. The Interim Financial
Statements are unaudited, omit certain financial statement disclosures and
should be read with the Annual Report on Form 10-K of CenterPoint Energy for the
year ended December 31, 2003 (CenterPoint Energy Form 10-K).
Background. CenterPoint Energy, Inc. is a public utility holding company,
created on August 31, 2002 as part of a corporate restructuring of Reliant
Energy, Incorporated (Reliant Energy) that implemented certain requirements of
the 1999 Texas Electric Choice Law (Texas electric restructuring law).
The Company's operating subsidiaries own and operate electric transmission
and distribution facilities, natural gas distribution facilities, natural gas
pipelines and electric generating plants. 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 the Company and those of
its subsidiaries. The 1935 Act, among other things, limits the ability of the
Company and its regulated subsidiaries to issue debt and equity securities
without prior authorization, restricts the source of dividend payments to
current and retained earnings without prior authorization, regulates sales and
acquisitions of certain assets and businesses and governs affiliate
transactions.
Texas Genco, LP, the wholly owned subsidiary of Texas Genco Holdings, Inc.
(Texas Genco) that owns and operates its electric generating plants, is an
exempt wholesale generator pursuant to an order of the Federal Energy Regulatory
Commission. As a result, Texas Genco, LP is exempt from all provisions of the
1935 Act so long as it remains an exempt wholesale generator, and Texas Genco is
no longer a public utility holding company under the 1935 Act.
As of March 31, 2004, the Company's indirect wholly owned subsidiaries
included:
- CenterPoint Energy Houston Electric, LLC (CenterPoint
Houston), which engages in the electric transmission and
distribution business in a 5,000-square mile area of the Texas
Gulf Coast that includes Houston; and
- CenterPoint Energy Resources Corp. (CERC Corp., and, together
with its subsidiaries, CERC), which owns gas distribution
systems. Through wholly owned subsidiaries, CERC owns two
interstate natural gas pipelines and gas gathering systems and
provides various ancillary services.
CenterPoint Energy also has an approximately 81% ownership interest in
Texas Genco, which owns and operates a portfolio of generating assets located in
Texas. CenterPoint Energy distributed approximately 19% of the 80 million
outstanding shares of common stock of Texas Genco to its shareholders on January
6, 2003 (Texas Genco Distribution). As a result of the Texas Genco Distribution,
CenterPoint Energy recorded an impairment charge of $399 million, which is
reflected as a regulatory asset representing stranded costs in the Consolidated
Balance Sheets. This impairment charge represents the excess of the carrying
value of CenterPoint Energy's net investment in Texas Genco over the market
value of the Texas Genco common stock that was distributed. The financial impact
of this impairment was offset by recording a $399 million regulatory asset
reflecting CenterPoint Energy's expectation of stranded cost recovery of such
impairment. Additionally, in connection with the Texas Genco Distribution,
CenterPoint Energy recorded minority interest ownership in Texas Genco of $146
million in its Consolidated Balance Sheets in the first quarter of 2003.
CenterPoint Energy is actively pursuing a sale of its 81% ownership interest in
Texas Genco.
5
Basis of Presentation. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America (GAAP) requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
The Company's Interim Financial Statements reflect all normal recurring
adjustments that are, in the opinion of management, necessary to present fairly
the financial position 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) seasonal fluctuations in demand for energy
and energy services, (b) changes in energy commodity prices, (c) timing of
maintenance and other expenditures and (d) acquisitions and dispositions of
businesses, assets and other interests. In addition, certain amounts from the
prior year have been reclassified to conform to the Company's presentation of
financial statements in the current year. These reclassifications do not affect
net income.
Note 2(d) (Long-Lived Assets and Intangibles), Note 2(e) (Regulatory
Assets and Liabilities), Note 4 (Regulatory Matters), Note 5 (Derivative
Instruments), Note 7 (Indexed Debt Securities (ZENS) and Time Warner Securities)
and Note 12 (Commitments and Contingencies) to the consolidated annual financial
statements in the CenterPoint Energy Form 10-K relate to certain contingencies.
These notes, as updated herein, are incorporated herein by reference.
For information regarding certain legal and regulatory proceedings and
environmental matters, see Note 11 to the Interim Financial Statements.
(2) STOCK-BASED INCENTIVE COMPENSATION PLANS AND EMPLOYEE BENEFIT PLANS
(a) Stock-Based Incentive Compensation Plans.
In accordance with SFAS No. 123, "Accounting for Stock-Based Compensation"
(SFAS No. 123), and SFAS No. 148, "Accounting for Stock-Based Compensation,
Transition and Disclosure -- an Amendment of SFAS No. 123," the Company applies
the guidance contained in Accounting Principles Board Opinion No. 25 and
discloses the required pro-forma effect on net income of the fair value based
method of accounting for stock compensation.
Pro-forma information for the three months ended March 31, 2003 and 2004
is provided to take into account the amortization of stock-based compensation to
expense on a straight-line basis over the vesting period. Had compensation costs
been determined as prescribed by SFAS No. 123, the Company's net income and
earnings per share would have been as follows:
THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2004
----------- -----------
(IN MILLIONS, EXCEPT PER SHARE
AMOUNTS)
Net Income:
As reported.............................................. $ 168 $ 74
Total stock-based employee compensation determined under
the fair value based method............................ (3) (2)
----------- -----------
Pro forma................................................ $ 165 $ 72
=========== ===========
Basic Earnings Per Share:
As reported.............................................. $ 0.56 $ 0.24
Pro forma................................................ $ 0.55 $ 0.24
Diluted Earnings Per Share:
As reported.............................................. $ 0.56 $ 0.24
Pro forma................................................ $ 0.54 $ 0.23
6
(b) Employee Benefit Plans.
The Company's net periodic cost includes the following components relating
to pension and postretirement benefits:
THREE MONTHS ENDED MARCH 31,
--------------------------------------------------------
2003 2004
-------------------------- --------------------------
PENSION POSTRETIREMENT PENSION POSTRETIREMENT
BENEFITS BENEFITS BENEFITS BENEFITS
-------- -------------- -------- --------------
(IN MILLIONS)
Service cost...................... $ 9 $ 1 $ 10 $ 1
Interest cost..................... 26 8 26 8
Expected return on plan assets.... (23) (3) (26) (3)
Net amortization.................. 11 3 9 3
Other............................. - - - 2
-------- ----------- -------- ------------
Net periodic cost................. $ 23 $ 9 $ 19 $ 11
======== =========== ======== ============
The Company previously disclosed in its financial statements for the year
ended December 31, 2003, that it expected to contribute $38 million to its
postretirement benefits plan in 2004. As of March 31, 2004, $8 million of
contributions have been made. Contributions to the pension plan are not required
or expected in 2004.
In addition to the Company's non-contributory pension plan, the Company
maintains a non-qualified benefit restoration plan. The net periodic cost
associated with this plan for the three months ended March 31, 2003 and 2004 was
$2 million and $1 million, respectively.
(3) DISCONTINUED OPERATIONS
Latin America. In February 2003, the Company sold its interest in Argener,
a cogeneration facility in Argentina, for $23 million. The carrying value of
this investment was approximately $11 million as of December 31, 2002. The
Company recorded an after-tax gain of $7 million from the sale of Argener in the
first quarter of 2003. The Interim Financial Statements present these Latin
America operations 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). Accordingly, the Interim
Financial Statements include the necessary reclassifications to reflect these
operations as discontinued operations for the three months ended March 31, 2003.
Revenues related to the Company's Latin America operations included in
discontinued operations for the three months ended March 31, 2003 were $2
million. Income from these discontinued operations for the three months ended
March 31, 2003 is reported net of income tax expense of $-0-.
CenterPoint Energy Management Services, Inc. In November 2003, the Company
completed the sale of a component of its Other Operations business segment,
CenterPoint Energy Management Services, Inc. (CEMS), that provides district
cooling services in the Houston central business district and related
complementary energy services to district cooling customers and others. The
Interim Financial Statements present these CEMS operations as discontinued
operations in accordance with SFAS No. 144. Accordingly, the Interim Financial
Statements include the necessary reclassifications to reflect these operations
as discontinued operations for the three months ended March 31, 2003.
Revenues related to CEMS included in discontinued operations for the three
months ended March 31, 2003, were $2 million. The loss from these discontinued
operations for the three months ended March 31, 2003 is reported net of income
tax benefit of $1 million.
(4) NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. (FIN) 46 "Consolidation of Variable Interest Entities,
an Interpretation of Accounting Research Bulletin No. 51" (FIN 46). FIN 46
requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from
7
other parties. On December 24, 2003, the FASB issued a revision to FIN 46 (FIN
46-R). For special-purpose entities (SPE's) created before February 1, 2003, the
Company applied the provisions of FIN 46 or FIN 46-R as of December 31, 2003.
The revised FIN 46-R is effective for all other entities for financial periods
ending after March 15, 2004. The Company has subsidiary trusts that have
Mandatorily Redeemable Preferred Securities outstanding. The trusts were
determined to be variable interest entities under FIN 46-R and the Company also
determined that it is not the primary beneficiary of the trusts. As of December
31, 2003, the Company deconsolidated the trusts and instead reports its junior
subordinated debentures due to the trusts as long-term debt. The Company also
evaluated two purchase power contracts with qualifying facilities as defined in
the Public Utility Regulatory Policies Act of 1978 related to its Electric
Generation business segment. The Company concluded it was not required to
consolidate the entities that own the qualifying facilities.
On December 23, 2003, the FASB issued SFAS No. 132 (Revised 2003),
"Employer's Disclosures about Pensions and Other Postretirement Benefits" (SFAS
No. 132(R)) which increases the existing disclosure requirements by requiring
more details about pension plan assets, benefit obligations, cash flows, benefit
costs and related information. Companies are required to segregate plan assets
by category, such as debt, equity and real estate, and to provide certain
expected rates of return and other informational disclosures. SFAS No. 132(R)
also requires companies to disclose various elements of pension and
postretirement benefit costs in interim-period financial statements for quarters
beginning after December 15, 2003. The Company has adopted the disclosure
requirements of SFAS No. 132(R) in Note 2 to these Interim Financial Statements.
In December 2003, Congress passed the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (the Act) which will become effective
in 2006. The Act contains incentives for the Company, if it continues to provide
prescription drug benefits for its retirees, through the provision of a
non-taxable reimbursement to the Company of specified costs. The Company has
many different alternatives available under the Act, and, until clarifying
regulations are issued with respect to the Act, the Company is unable to
determine the financial impact the Act will have on the Company. On January 12,
2004, the FASB issued FASB Staff Position (FSP) FAS 106-1, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 (FAS 106-1)." In accordance with FSP FAS 106-1,
the Company's postretirement benefits obligations and net periodic
postretirement benefit cost in the financial statements and accompanying notes
do not reflect the effects of the legislation. Specific authoritative guidance
on the accounting for the legislation is pending, and that guidance, when
issued, may require the Company to change previously reported information.
(5) REGULATORY MATTERS
(a) 2004 True-Up Proceeding.
On March 31, 2004, CenterPoint Houston, Texas Genco LP and Reliant Energy
Retail Services LLC, a former affiliate and current subsidiary of Reliant
Energy, Inc. (formerly named Reliant Resources, Inc.) (RRI), filed the final
true-up application required by the Texas electric restructuring law with the
Public Utility Commission of Texas (Texas Utility Commission). The Texas
electric restructuring law authorizes public utilities to recover in 2004 a
true-up balance composed of stranded power plant costs, the cost of
environmental controls and certain other costs associated with transition from a
regulated to a competitive environment (2004 True-Up Proceeding). The Company's
true-up balance is $3.8 billion. An additional $631 million in interest could be
added if approved in a proceeding pending before the Texas Supreme Court.
The Texas electric restructuring 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, although under its rules the Texas Utility
Commission can extend the 150-day deadline for good cause. The Texas Utility
Commission has scheduled hearings beginning June 21, 2004. The true-up
proceeding will result in either additional charges being assessed or credits
being issued through the utility's non-bypassable delivery charges. The Texas
electric restructuring law permits transmission and distribution utilities to
recover the true-up balance through transition charges on their non-bypassable
delivery charge, to the extent that such components are established in certain
regulatory proceedings. Non-bypassable delivery charges are those that must be
paid by essentially all customers and cannot, except in limited circumstances,
be avoided by switching to self-generation. The law also authorizes the Texas
Utility Commission to permit utilities to issue transition bonds based on the
securitization of revenues associated with the transition charges. Any delay in
the final order date will result in a delay in the securitization of the true-up
8
components and the implementation of the non-bypassable charges described above,
and could delay the recovery of carrying costs on the true-up components
determined by the Texas Utility Commission.
CenterPoint Houston will be required to establish and support the $3.8
billion it seeks to recover in the 2004 True-Up Proceeding. Third parties will
have the opportunity and are expected to challenge CenterPoint Houston's
calculation of these amounts. To the extent recovery of a portion of these
amounts is denied or if CenterPoint Houston agrees to forego recovery of a
portion of the request under a settlement agreement, CenterPoint Houston would
be unable to recover those amounts in the future.
Following adoption of the true-up rule by the Texas Utility Commission in
2001, CenterPoint Houston appealed the provisions of the rule that permitted
interest to be recovered on stranded costs only from the date of the Texas
Utility Commission's final order in the 2004 True-Up Proceeding, instead of from
January 1, 2002 as CenterPoint Houston contends is required by law. On January
30, 2004, the Texas Supreme Court granted CenterPoint Houston's petition for
review of the true-up rule. Oral arguments were heard on February 18, 2004. The
decision by the Court is pending. The Company has not accrued interest income on
stranded costs in its consolidated financial statements.
As of March 31, 2004, CenterPoint Houston has recorded net regulatory
assets totaling $3.3 billion, which are expected to be recovered in the 2004
True-Up Proceeding. If events were to occur during the 2004 True-Up Proceeding
that made the recovery of these regulatory assets no longer probable, the
Company would write off the unrecoverable balance of such assets as a charge
against earnings.
(b) Generation Asset Impairment Contingency.
The Company evaluates the recoverability of its long-lived assets in
accordance with SFAS No. 144. As of March 31, 2004, no impairment of its Texas
generation assets had been indicated. The Company anticipates that future
events, such as changes in the market value of Texas Genco common stock, a
change in the estimated holding period of the Texas generation assets, or a
change in market demand for electricity, will require the Company to re-evaluate
these assets for impairment. Changes in any of these assumptions could result in
a material impairment charge.
(c) Rate Cases.
On January 6, 2004, new rates went into effect in the City of Houston in
accordance with a rate settlement between CenterPoint Energy Entex (Entex) and
the City. These settlement rates were subsequently filed with the 28 remaining
cities in the Houston Division and with the Railroad Commission of Texas (Texas
Railroad Commission). The settlement rates went into effect in 12 of the 28
cities on February 1, 2004 and went into effect for ten additional cities on May
1, 2004. The Texas Railroad Commission is expected to render a decision
associated with the unincorporated environs in the near future. Once all
remaining regulatory approvals are received, the annualized effect of this
multi-jurisdictional rate increase will be approximately $14 million.
(d) Other Regulatory Proceedings.
Final Fuel Reconciliation. On March 4, 2004, an Administrative Law Judge
(ALJ) issued a Proposal for Decision (PFD) relating to CenterPoint Houston's
final fuel reconciliation. CenterPoint Houston reserved $117 million, including
interest, in the fourth quarter of 2003 reflecting the ALJ's recommendation. On
April 15, 2004, the Texas Utility Commission reviewed the PFD in CenterPoint
Houston's final fuel reconciliation case, affirmed the PFD's finding in part,
reversed in part, and remanded one issue back to the ALJ. The Texas Utility
Commission's decision is pending the outcome of the remanded issue. The results
of the Texas Utility Commission's final decision will be a component of the 2004
True-Up Proceeding.
City of Tyler, Texas Dispute. In July 2002, the City of Tyler, Texas,
asserted that Entex had overcharged residential and small commercial customers
in that city for excessive gas costs under supply agreements in effect since
1992. That dispute has been referred to the Texas Railroad Commission by
agreement of the parties for a determination of whether Entex has properly and
lawfully charged and collected for gas service to its residential and commercial
customers in its Tyler distribution system for the period beginning November 1,
1992, and ending
9
October 31, 2002. The Company believes that all costs for Entex's Tyler
distribution system have been properly included and recovered from customers
pursuant to Entex's filed tariffs.
(6) DERIVATIVE FINANCIAL INSTRUMENTS
The Company is exposed to various market risks. These risks arise from
transactions entered into in the normal course of business. The Company utilizes
derivative financial instruments such as physical forward contracts, swaps and
options to mitigate the impact of changes in cash flows of its natural gas
businesses on its operating results and cash flows.
During the three months ended March 31, 2004, no hedge ineffectiveness was
recognized in earnings from derivatives that qualify for and are designated as
cash flow hedges. No component of the derivative instruments' gain or loss was
excluded from the assessment of effectiveness. As of March 31, 2004, the Company
expects $54 million in accumulated other comprehensive income to be reclassified
into net income during the next twelve months.
Interest Rate Swaps. As of December 31, 2003, the Company had an
outstanding interest rate swap with a notional amount of $250 million to fix the
interest rate applicable to floating rate short-term debt. This swap, which
expired in January 2004, did not qualify as a cash flow hedge under SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No.
133), and was marked to market in the Company's Consolidated Balance Sheets with
changes in market value reflected in interest expense in the Statements of
Consolidated Income.
During 2002, the Company settled forward-starting interest rate swaps
having an aggregate notional amount of $1.5 billion at a cost of $156 million,
which was recorded in other comprehensive income and is being amortized into
interest expense over the life of the designated fixed-rate debt. No
amortization of this amount was recognized in the first three months of 2003.
Amortization of amounts deferred in accumulated other comprehensive income for
the three months ended March 31, 2004, was $6 million.
Embedded Derivative. The Company's $575 million of convertible senior
notes, issued May 19, 2003 and $255 million of convertible senior notes, issued
December 17, 2003, contain contingent interest provisions. The contingent
interest component is an embedded derivative as defined by SFAS No. 133, and
accordingly, must be split from the host instrument and recorded at fair value
on the balance sheet. The value of the contingent interest components was not
material at issuance or at March 31, 2004.
(7) GOODWILL AND INTANGIBLES
Goodwill as of December 31, 2003 and March 31, 2004 by reportable business
segment is as follows (in millions):
Natural Gas Distribution....... $ 1,085
Pipelines and Gathering........ 601
Other Operations............... 55
------------
Total........................ $ 1,741
============
The Company completed its annual evaluation of goodwill for impairment as
of January 1, 2004 and no impairment was indicated.
The components of the Company's other intangible assets consist of the
following:
DECEMBER 31, 2003 MARCH 31, 2004
--------------------------- ---------------------------
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
----------- ------------ ----------- ------------
(IN MILLIONS)
Land use rights.................................... $ 61 $ (14) $ 61 $ (14)
Other.............................................. 38 (5) 38 (6)
----------- ------------ ----------- ------------
Total.......................................... $ 99 $ (19) $ 99 $ (20)
=========== ============ =========== ============
The Company recognizes specifically identifiable intangibles, including
land use rights and permits, when specific rights and contracts are acquired.
The Company has no intangible assets with indefinite lives recorded as of
10
March 31, 2004. The Company amortizes other acquired intangibles on a
straight-line basis over the lesser of their contractual or estimated useful
lives that range from 40 to 75 years for land use rights and 4 to 25 years for
other intangibles.
Amortization expense for other intangibles for both the three months ended
March 31, 2003 and 2004 was $1 million. Estimated amortization expense for the
remainder of 2004 and the five succeeding fiscal years is as follows (in
millions):
2004........................................ $ 3
2005........................................ 3
2006........................................ 2
2007........................................ 2
2008........................................ 2
2009........................................ 2
-------
Total..................................... $ 14
=======
(8) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive
income:
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------
2003 2004
----------- -----------
(IN MILLIONS)
Net income......................................................................... $ 168 $ 74
----------- -----------
Other comprehensive income:
Net deferred gain (loss) from cash flow hedges................................... (1) 8
Reclassification of deferred loss from cash flow hedges realized in net income... 1 1
Other comprehensive income from discontinued operations.......................... 1 -
----------- -----------
Other comprehensive income......................................................... 1 9
----------- -----------
Comprehensive income .............................................................. $ 169 $ 83
=========== ===========
(9) CAPITAL STOCK
CenterPoint Energy has 1,020,000,000 authorized shares of capital stock,
comprised of 1,000,000,000 shares of $0.01 par value common stock and 20,000,000
shares of $0.01 par value preferred stock. At December 31, 2003, 306,297,147
shares of CenterPoint Energy common stock were issued and 305,385,434 shares of
CenterPoint Energy common stock were outstanding. At March 31, 2004, 307,073,026
shares of CenterPoint Energy common stock were issued and 307,072,860 shares of
CenterPoint Energy common stock were outstanding. Outstanding common shares
exclude (a) shares pledged to secure a loan to CenterPoint Energy's Employee
Stock Ownership Plan (911,547 and -0- at December 31, 2003 and March 31, 2004,
respectively) and (b) treasury shares (166 at both December 31, 2003 and March
31, 2004). CenterPoint Energy declared a dividend of $0.10 per share in the
first quarter of both 2003 and 2004.
Both the 2004 True-Up Proceeding and the monetization of CenterPoint
Energy's remaining interest in Texas Genco could result in charges against our
earnings. If those charges are of sufficient magnitude, they could reduce our
earnings below the level required for us to continue paying our current
quarterly dividends out of current earnings as required under our SEC financing
order. We have filed an application with the SEC under the 1935 Act requesting
an order authorizing us to pay dividends in the second and third quarters of
2004 out of capital or unearned surplus in the event we take such a charge
against earnings.
11
(10) SHORT-TERM BORROWINGS, LONG-TERM DEBT AND RECEIVABLES FACILITY
(a) Short-term Borrowings.
As of March 31, 2004, Texas Genco had a revolving credit facility that
provided for an aggregate of $75 million of committed credit. The revolving
credit facility terminates on December 21, 2004. As of March 31, 2004, such
credit facility was not utilized.
(b) Long-term Debt.
As of March 31, 2004, CERC Corp. had a revolving credit facility that
provided for an aggregate of $250 million in committed credit. The revolving
credit facility terminates on March 23, 2007. Fully-drawn rates for borrowings
under this facility, including the facility fee, are the London interbank
offered rate (LIBOR) plus 150 basis points based on current credit ratings and
the applicable pricing grid. As of March 31, 2004, such credit facility was not
utilized.
In February 2004, $56 million aggregate principal amount of collateralized
5.6% pollution control bonds due 2027 and $44 million aggregate principal amount
of 4.25% collateralized insurance-backed pollution control bonds due 2017 were
issued on behalf of CenterPoint Houston. The pollution control bonds are
collateralized by general mortgage bonds of CenterPoint Houston with principal
amounts, interest rates and maturities that match the pollution control bonds.
The proceeds were used to extinguish two series of 6.7% collateralized pollution
control bonds with an aggregate principal amount of $100 million issued on
behalf of CenterPoint Energy. CenterPoint Houston's 6.7% first mortgage bonds
which collateralized CenterPoint Energy's payment obligations under the refunded
pollution control bonds were retired in connection with the extinguishment of
the refunded pollution control bonds. CenterPoint Houston's 6.7% notes payable
to CenterPoint Energy were also cancelled upon the extinguishment of the
refunded pollution control bonds.
In March 2004, $45 million aggregate principal amount of 3.625%
collateralized insurance-backed pollution control bonds due 2012 and $84 million
aggregate principal amount of 4.25% collateralized insurance-backed pollution
control bonds due 2017 were issued on behalf of CenterPoint Houston. The
pollution control bonds are collateralized by general mortgage bonds of
CenterPoint Houston with principal amounts, interest rates and maturities that
match the pollution control bonds. The proceeds were used to extinguish two
series of 6.375% collateralized pollution control bonds with an aggregate
principal amount of $45 million and one series of 5.6% collateralized pollution
control bonds with an aggregate principal amount of $84 million issued on behalf
of CenterPoint Energy. CenterPoint Houston's 6.375% and 5.6% first mortgage
bonds which collateralized CenterPoint Energy's payment obligations under the
refunded pollution control bonds were retired in connection with the
extinguishment of the refunded pollution control bonds. CenterPoint Houston's
6.375% and 5.6% notes payable to CenterPoint Energy were also cancelled upon the
extinguishment of the refunded pollution control bonds.
Junior Subordinated Debentures (Trust Preferred Securities). In February
1997, two Delaware statutory business trusts created by CenterPoint Energy (HL&P
Capital Trust I and HL&P Capital Trust II) issued to the public (a) $250 million
aggregate amount of preferred securities and (b) $100 million aggregate amount
of capital securities, respectively. In February 1999, a Delaware statutory
business trust created by CenterPoint Energy (REI Trust I) issued $375 million
aggregate amount of preferred securities to the public. Each of the trusts used
the proceeds of the offerings to purchase junior subordinated debentures issued
by CenterPoint Energy having interest rates and maturity dates that correspond
to the distribution rates and the mandatory redemption dates for each series of
preferred securities or capital securities. As discussed in Note 4, upon the
Company's adoption of FIN 46, the junior subordinated debentures discussed above
are included in long-term debt as of December 31, 2003 and March 31, 2004.
The junior subordinated debentures are the trusts' sole assets and their
entire operations. CenterPoint Energy considers its obligations under the
Amended and Restated Declaration of Trust, Indenture, Guaranty Agreement and,
where applicable, Agreement as to Expenses and Liabilities, relating to each
series of preferred securities or capital securities, taken together, to
constitute a full and unconditional guarantee by CenterPoint Energy of each
trust's obligations related to the respective series of preferred securities or
capital securities.
12
The preferred securities and capital securities are mandatorily redeemable
upon the repayment of the related series of junior subordinated debentures at
their stated maturity or earlier redemption. Subject to some limitations,
CenterPoint Energy has the option of deferring payments of interest on the
junior subordinated debentures. During any deferral or event of default,
CenterPoint Energy may not pay dividends on its capital stock. As of March 31,
2004, no interest payments on the junior subordinated debentures had been
deferred.
The outstanding aggregate liquidation amount, distribution rate and
mandatory redemption date of each series of the preferred securities or capital
securities of the trusts described above and the identity and similar terms of
each related series of junior subordinated debentures are as follows:
AGGREGATE LIQUIDATION
AMOUNTS AS OF
------------------------
DISTRIBUTION MANDATORY
RATE/ REDEMPTION
DECEMBER 31, MARCH 31, INTEREST DATE/
TRUST 2003 2004 RATE MATURITY DATE JUNIOR SUBORDINATED DEBENTURES
- --------------------------------- ------------ --------- ------------- ------------- --------------------------------
(IN MILLIONS)
REI Trust I...................... $ 375 $ 375 7.20% March 2048 7.20% Junior Subordinated
Debentures
HL&P Capital Trust I(1).......... $ 250 $ - 8.125% March 2046 8.125% Junior Subordinated
Deferrable Interest Debentures
Series A
HL&P Capital Trust II............ $ 100 $ 100 8.257% February 2037 8.257% Junior Subordinated
Deferrable Interest Debentures
Series B
- ------------
(1) The preferred securities issued by HL&P Capital Trust I having an
aggregate liquidation amount of $250 million were redeemed at 100% of
their aggregate liquidation amount in January 2004.
In June 1996, a Delaware statutory business trust created by CERC Corp.
(CERC Trust) issued $173 million aggregate amount of convertible preferred
securities to the public. CERC Trust used the proceeds of the offering to
purchase convertible junior subordinated debentures issued by CERC Corp. having
an interest rate and maturity date that correspond to the distribution rate and
mandatory redemption date of the convertible preferred securities. The
convertible junior subordinated debentures represent CERC Trust's sole asset and
its entire operations. CERC Corp. considers its obligation under the Amended and
Restated Declaration of Trust, Indenture and Guaranty Agreement relating to the
convertible preferred securities, taken together, to constitute a full and
unconditional guarantee by CERC Corp. of CERC Trust's obligations with respect
to the convertible preferred securities. As discussed in Note 4, upon the
Company's adoption of FIN 46, the junior subordinated debentures discussed above
are included in long-term debt as of December 31, 2003 and March 31, 2004.
The convertible preferred securities are mandatorily redeemable upon the
repayment of the convertible junior subordinated debentures at their stated
maturity or earlier redemption. Effective January 7, 2003, the convertible
preferred securities are convertible at the option of the holder into $33.62 of
cash and 2.34 shares of CenterPoint Energy common stock for each $50 of
liquidation value. As of December 31, 2003 and March 31, 2004, $0.4 million
liquidation amount of convertible preferred securities were outstanding. The
securities, and their underlying convertible junior subordinated debentures,
bear interest at 6.25% and mature in June 2026. Subject to some limitations,
CERC Corp. has the option of deferring payments of interest on the convertible
junior subordinated debentures. During any deferral or event of default, CERC
Corp. may not pay dividends on its common stock to CenterPoint Energy. As of
March 31, 2004, no interest payments on the convertible junior subordinated
debentures had been deferred.
(c) Receivables Facility.
On January 21, 2004, CERC replaced its $100 million receivables facility
with a $250 million receivables facility. The $250 million receivables facility
terminates on January 19, 2005. As of March 31, 2004, CERC had fully utilized
its receivables facility.
13
(11) COMMITMENTS AND CONTINGENCIES
(a) Legal Matters.
RRI Indemnified Litigation
The Company, CenterPoint Houston or their predecessor, Reliant Energy, and
certain of their former subsidiaries are named as defendants in several lawsuits
described below. Under a master separation agreement between Reliant Energy and
RRI, the Company and its subsidiaries are entitled to be indemnified by RRI for
any losses, including attorneys' fees and other costs, arising out of the
lawsuits described below under Electricity and Gas Market Manipulation Cases and
Other Class Action Lawsuits. Pursuant to the indemnification obligation, RRI is
defending the Company and its subsidiaries to the extent named in these
lawsuits. The ultimate outcome of these matters cannot be predicted at this
time.
Electricity and Gas Market Manipulation Cases. A large number of lawsuits
have been filed against numerous market participants and remain pending in both
federal and state courts in California and Nevada in connection with the
operation of the electricity and natural gas markets in California and certain
other western states in 2000-2001, a time of power shortages and significant
increases in prices. These lawsuits, many of which have been filed as class
actions, are based on a number of legal theories, including violation of state
and federal antitrust laws, laws against unfair and unlawful business practices,
the federal Racketeer Influenced Corrupt Organization Act, false claims statutes
and similar theories and breaches of contracts to supply power to governmental
entities. Plaintiffs in these lawsuits, which include state officials and
governmental entities as well as private litigants, are seeking a variety of
forms of relief, including recovery of compensatory damages (in some cases in
excess of $1 billion), a trebling of compensatory damages and punitive damages,
injunctive relief, restitution, interest due, disgorgement, civil penalties and
fines, costs of suit, attorneys' fees and divestiture of assets. To date, some
of these complaints have been dismissed by the trial court and are on appeal,
but most of the lawsuits remain in early procedural stages. Our former
subsidiary, RRI, was a participant in the California markets, owning generating
plants in the state and participating in both electricity and natural gas
trading in that state and in western power markets generally. RRI, some of its
subsidiaries and in some cases, corporate officers of some of those companies,
have been named as defendants in these suits.
The Company, CenterPoint Houston or their predecessor, Reliant Energy,
were named in approximately 25 of these lawsuits, which were instituted between
2001 and 2004 and are pending in state court in Los Angeles County, in federal
district courts in San Francisco, San Diego, Los Angeles and Nevada and before
the Ninth Circuit Court of Appeals. However, neither the Company nor Reliant
Energy was a participant in the electricity or natural gas markets in
California. The Company and Reliant Energy have been dismissed from certain of
the lawsuits, either voluntarily by the plaintiffs or by order of the court and
the Company believes it is not a proper defendant in the remaining cases and
will continue to seek dismissal from such remaining cases.
Other Class Action Lawsuits. Fifteen class action lawsuits filed in May,
June and July 2002 on behalf of purchasers of securities of RRI and/or Reliant
Energy have been consolidated in federal district court in Houston. RRI and
certain of its former and current executive officers are named as defendants.
The consolidated complaint also names RRI, Reliant Energy, the underwriters of
the initial public offering of RRI common stock in May 2001 (RRI Offering), and
RRI's and Reliant Energy's independent auditors as defendants. The consolidated
amended complaint seeks monetary relief purportedly on behalf of purchasers of
common stock of Reliant Energy or RRI during certain time periods ranging from
February 2000 to May 2002, and purchasers of common stock that can be traced to
the RRI Offering. The plaintiffs allege, among other things, that the defendants
misrepresented their revenues and trading volumes by engaging in round-trip
trades and improperly accounted for certain structured transactions as cash-flow
hedges, which resulted in earnings from these transactions being accounted for
as future earnings rather than being accounted for as earnings in fiscal year
2001. In January 2004 the trial judge dismissed the plaintiffs' allegations that
the defendants had engaged in fraud, but claims based on alleged
misrepresentations in the registration statement issued in the RRI Offering
remain.
In 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 RRI for alleged violations of federal securities laws. The
plaintiffs in this lawsuit allege that the defendants violated federal
securities laws by issuing false and misleading statements
14
to the public, and that the defendants made false and misleading statements as
part of an alleged scheme to artificially inflate trading volumes and revenues.
In addition, the plaintiffs assert claims of fraudulent and negligent
misrepresentation and violations of Illinois consumer law. In January 2004 the
trial judge ordered dismissal of plaintiffs' claims on the ground that they did
not set forth a claim. The plaintiffs filed an amended complaint in March 2004,
which the defendants are asking the court to dismiss.
In May 2002, three class action lawsuits were filed in federal district
court in Houston on behalf of participants in various employee benefits plans
sponsored by Reliant Energy. Two of the lawsuits have been dismissed without
prejudice. Reliant Energy and certain current and former members of its benefits
committee are the remaining defendants in the third lawsuit. That lawsuit
alleges that the defendants breached their fiduciary duties to various employee
benefits plans, directly or indirectly sponsored by Reliant Energy, in violation
of the Employee Retirement Income Security Act of 1974. The plaintiffs allege
that the defendants permitted the plans to purchase or hold securities issued by
Reliant Energy when it was imprudent to do so, including after the prices for
such securities became artificially inflated because of alleged securities fraud
engaged in by the defendants. The complaint seeks monetary damages for losses
suffered on behalf of the plans and a putative class of plan participants whose
accounts held Reliant Energy or RRI securities, as well as 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 the Company. 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 the Company 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 RRI and the RRI
Offering. The complaint seeks monetary damages on behalf of the Company as well
as equitable relief in the form of a constructive trust on the compensation paid
to the defendants. In March 2003, the court dismissed this case on the grounds
that the plaintiff did not make an adequate demand on the Company before filing
suit. Thereafter, the plaintiff sent another demand asserting the same claims.
The Company's board of directors investigated that demand and similar
allegations made in a June 28, 2002 demand letter sent on behalf of a Company
shareholder. The latter letter demanded that the Company take several actions in
response to alleged round-trip trades occurring in 1999, 2000, and 2001. In June
2003, the Board determined that these proposed actions would not be in the best
interests of the Company.
The Company believes that none of the lawsuits described under "Other
Class Action Lawsuits" has merit because, among other reasons, the alleged
misstatements and omissions were not material and did not result in any damages
to the plaintiffs.
Other Legal Matters
Texas Antitrust Action. In July 2003, Texas Commercial Energy filed a
lawsuit against Reliant Energy, RRI, Reliant Electric Solutions, LLC, several
other RRI subsidiaries and a number of other participants in the Electric
Reliability Council of Texas (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. In February 2004, this complaint
was amended to add the Company and CenterPoint Houston, as successors to Reliant
Energy, and Texas Genco, LP as defendants. The plaintiff's principal allegations
have previously been investigated by the Texas Utility Commission and found to
be without merit. The Company also believes the plaintiff's allegations are
without merit and will seek their dismissal.
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 the Company's predecessor, Reliant Energy) alleging
underpayment of municipal franchise fees. The plaintiffs claimed that they were
entitled to 4% of all receipts of any kind for business conducted within these
cities over the previous four decades. After a jury trial involving the Three
Cities claims (but not the class of cities), the trial court decertified the
class and entered a judgment for $1.7 million, including interest, plus an award
of $13.7 million in legal fees. Despite other jury findings for the plaintiffs,
the trial court's judgment was based on the jury's finding in
15
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. Following this ruling, 45 cities filed individual suits against
Reliant Energy in the District Court of Harris County.
On February 27, 2003, a state court of appeals in Houston rendered an
opinion reversing the judgment against the Company and rendering judgment that
the Three Cities take nothing by their claims. The court of appeals 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 filed a petition for review at the Texas Supreme Court, which declined to
hear the case. The Three Cities filed a motion for rehearing, which was denied
by the Supreme Court in April 2004. Now that the Three Cities case has been
favorably resolved, the Company intends to seek dismissal of the claims of the
other cities.
Natural Gas Measurement Lawsuits. CERC Corp. and certain of its
subsidiaries are defendants in a suit filed in 1997 under the Federal False
Claims Act alleging mismeasurement of natural gas produced from federal and
Indian lands. The suit seeks undisclosed damages, along with statutory
penalties, interest, costs, and fees. The complaint is part of a larger series
of complaints filed against 77 natural gas pipelines and their subsidiaries and
affiliates. An earlier single action making substantially similar allegations
against the pipelines was dismissed by the federal district court for the
District of Columbia on grounds of improper joinder and lack of jurisdiction. As
a result, the various individual complaints were filed in numerous courts
throughout the country. This case has been consolidated, together with the other
similar False Claims Act cases, in the federal district court in Cheyenne,
Wyoming.
In addition, CERC Corp. and certain of its subsidiaries are defendants in
two mismeasurement lawsuits against approximately 245 pipeline companies and
their affiliates pending in state court in Stevens County, Kansas. In one case
(originally filed in May 1999 and amended four times), the plaintiffs purport to
represent a class of royalty owners who allege that the defendants have engaged
in systematic mismeasurement of the volume of natural gas for more than 25
years. The plaintiffs amended their petition in this suit in July 2003 in
response to an order from the judge denying certification of the plaintiffs'
alleged class. In the amendment the plaintiffs dismissed their claims against
certain defendants (including two CERC subsidiaries), limited the scope of the
class of plaintiffs they purport to represent and eliminated previously asserted
claims based on mismeasurement of the Btu content of the gas. The same
plaintiffs then filed a second lawsuit, again as representatives of a class of
royalty owners, in which they assert their claims that the defendants have
engaged in systematic mismeasurement of the Btu content of natural gas for more
than 25 years. In both lawsuits, the plaintiffs seek compensatory damages, along
with statutory penalties, treble damages, interest, costs and fees. CERC and its
subsidiaries believe that there has been no systematic mismeasurement of gas and
that the suits are without merit. CERC does not expect that their ultimate
outcome would have a material impact on the financial condition or results of
operations of either the Company or CERC.
Gas Cost Recovery Litigation. In October 2002, a suit was filed in state
district court in Wharton County, Texas against the Company, CERC, Entex Gas
Marketing Company, and others alleging fraud, violations of the Texas Deceptive
Trade Practices Act, violations of the Texas Utilities Code, civil conspiracy
and violations of the Texas Free Enterprise and Antitrust Act. The plaintiffs
seek class certification, but no class has been certified. The plaintiffs allege
that defendants inflated the prices charged to certain consumers of natural gas.
In February 2003, a similar suit was filed against CERC in state court in Caddo
Parish, Louisiana purportedly on behalf of a class of residential or business
customers in Louisiana who allegedly have been overcharged for gas or gas
service provided by CERC. In February 2004, another suit was filed against CERC
in Calcasieu Parish, Louisiana, seeking to recover alleged overcharges for gas
or gas services allegedly provided by Entex without advance approval by the
Louisiana Public Service Commission. The plaintiffs in these cases seek
injunctive and declaratory relief, restitution for the alleged overcharges,
exemplary damages or trebling of actual damages and civil penalties. In these
cases, the Company, CERC and Entex Gas Marketing Company deny that they have
overcharged any of their customers for natural gas and believe that the amounts
recovered for purchased gas have been in accordance with what is permitted by
state regulatory authorities. The Company and CERC do not anticipate that the
outcome of these matters will have a material impact on the financial condition
or results of operations of either the Company or CERC.
16
(b) Environmental Matters.
Clean Air Standards. The Texas electric restructuring law and regulations
adopted by the Texas Commission on Environmental Quality (TCEQ) in 2001 require
substantial reductions in emission of oxides of nitrogen (NOx) from electric
generating units. The Company is currently installing cost-effective controls at
its generating plants to comply with these requirements. Through March 31, 2004,
the Company has invested $679 million for NOx emission control, and plans to
make additional expenditures of up to approximately $116 million during the
remainder of 2004 through 2007. Further revisions to these NOx requirements may
result from the EPA's ongoing review of these TCEQ rules and from the TCEQ's
future rules, expected by 2007, implementing more stringent federal eight-hour
ozone standards. The Texas electric restructuring law provides for stranded cost
recovery for expenditures incurred before May 1, 2003 to achieve the NOx
reduction requirements. Incurred costs include costs for which contractual
obligations have been made. The Texas Utility Commission has determined that the
Company's emission control plan is the most cost-effective option for achieving
compliance with applicable air quality standards for the Company's generating
facilities and the final amount for recovery will be determined in the 2004
True-Up Proceeding. The Company is limited to a maximum recovery of $699 million
excluding allowance for funds used during construction and capitalized interest,
as previously determined by the Texas Utility Commission.
Hydrocarbon Contamination. CERC Corp. and certain of its subsidiaries are
among the defendants in lawsuits filed beginning in August 2001 in Caddo Parish
and Bossier Parish, Louisiana. The suits allege that, at some unspecified date
prior to 1985, the defendants allowed or caused hydrocarbon or chemical
contamination of the Wilcox Aquifer, which lies beneath property owned or leased
by certain of the defendants and which is the sole or primary drinking water
aquifer in the area. The primary source of the contamination is alleged by the
plaintiffs to be a gas processing facility in Haughton, Bossier Parish,
Louisiana known as the "Sligo Facility," which was formerly operated by a
predecessor in interest of CERC Corp. This facility was purportedly used for
gathering natural gas from surrounding wells, separating gasoline and
hydrocarbons from the natural gas for marketing, and transmission of natural gas
for distribution.
Beginning about 1985, the predecessors of certain CERC Corp. defendants
engaged in a voluntary remediation of any subsurface contamination of the
groundwater below the property they owned or leased. This work has been done in
conjunction with and under the direction of the Louisiana Department of
Environmental Quality. The plaintiffs seek monetary damages for alleged damage
to the aquifer underlying their property, unspecified alleged personal injuries,
alleged fear of cancer, alleged property damage or diminution of value of their
property, and, in addition, seek damages for trespass, punitive, and exemplary
damages. The quantity of monetary damages sought is unspecified. The Company is
unable to estimate the monetary damages, if any, that the plaintiffs may be
awarded in these matters.
Manufactured Gas Plant Sites. CERC and its predecessors operated
manufactured gas plants (MGP) in the past. In Minnesota, remediation has been
completed on two sites, other than ongoing monitoring and water treatment. There
are five remaining sites in CERC's Minnesota service territory, two of which
CERC believes were neither owned nor operated by CERC, and for which CERC
believes it has no liability.
At March 31, 2004, CERC had accrued $19 million for remediation of certain
Minnesota sites. At March 31, 2004, the estimated range of possible remediation
costs for these sites was $8 million to $44 million based on remediation
continuing for 30 to 50 years. The cost estimates are based on studies of a site
or industry average costs for remediation of sites of similar size. The actual
remediation costs will be dependent upon the number of sites to be remediated,
the participation of other potentially responsible parties (PRP), if any, and
the remediation methods used. CERC has utilized an environmental expense tracker
mechanism in its rates in Minnesota to recover estimated costs in excess of
insurance recovery. CERC has collected or accrued $12 million as of March 31,
2004 to be used for environmental remediation.
CERC has received notices from the United States Environmental Protection
Agency and others regarding its status as a PRP for other sites. CERC has been
named as a defendant in lawsuits under which contribution is sought for the cost
to remediate former MGP sites based on the previous ownership of such sites by
former affiliates of CERC or its divisions. The Company is investigating details
regarding these sites and the range of environmental
17
expenditures for potential remediation. Based on current information, the
Company has not been able to quantify a range of potential environmental
expenditures for such sites.
Mercury Contamination. The Company's pipeline and distribution operations
have in the past employed elemental mercury in measuring and regulating
equipment. It is possible that small amounts of mercury may have been spilled in
the course of normal maintenance and replacement operations and that these
spills may have contaminated the immediate area with elemental mercury. This
type of contamination has been found by the Company at some sites in the past,
and the Company has conducted remediation at these sites. It is possible that
other contaminated sites may exist and that remediation costs may be incurred
for these sites. Although the total amount of these costs cannot be known at
this time, based on experience by the Company and that of others in the natural
gas industry to date and on the current regulations regarding remediation of
these sites, the Company believes that the costs of any remediation of these
sites will not be material to the Company's financial condition, results of
operations or cash flows.
Other Environmental. From time to time the Company has received notices
from regulatory authorities or others regarding its status as a PRP in
connection with sites found to require remediation due to the presence of
environmental contaminants. In addition, the Company has been named as a
defendant in litigation related to such sites and in recent years has been
named, along with numerous others, as a defendant in several lawsuits filed by a
large number of individuals who claim injury due to exposure to asbestos while
working at sites along the Texas Gulf Coast. Most of these claimants have been
workers who participated in construction of various industrial facilities,
including power plants, and some of the claimants have worked at locations owned
by the Company. The Company anticipates that additional claims like those
received may be asserted in the future and intends to continue vigorously
contesting claims that it does not consider to have merit. Although their
ultimate outcome cannot be predicted at this time, the Company does not believe,
based on its experience to date, that these matters, either individually or in
the aggregate, will have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
(c) Other Proceedings.
The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management 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.
(d) Nuclear Insurance.
Texas Genco and the other owners of the South Texas Project maintain
nuclear property and nuclear liability insurance coverage as required by law and
periodically review available limits and coverage for additional protection. The
owners of the South Texas Project currently maintain $2.75 billion in property
damage insurance coverage, which is above the legally required minimum, but is
less than the total amount of insurance currently available for such losses.
Under the Price Anderson Act, the maximum liability to the public of
owners of nuclear power plants was $10.8 billion as of March 31, 2004. Owners
are required under the Price Anderson Act to insure their liability for nuclear
incidents and protective evacuations. Texas Genco and the other owners of the
South Texas Project currently maintain the required nuclear liability insurance
and participate in the industry retrospective rating plan under which the owners
of the South Texas Project are subject to maximum retrospective assessments in
the aggregate per incident of up to $100.6 million per reactor. The owners are
jointly and severally liable at a rate not to exceed $10 million per incident
per year.
There can be no assurance that all potential losses or liabilities will be
insurable, or that the amount of insurance will be sufficient to cover them. Any
substantial losses not covered by insurance would have a material effect on the
Company's financial condition, results of operations and cash flows.
18
(e) Nuclear Decommissioning.
CenterPoint Houston contributed $2.9 million in 2003 to trusts established
to fund Texas Genco's share of the decommissioning costs for the South Texas
Project, and expects to contribute $2.9 million in 2004. There are various
investment restrictions imposed upon Texas Genco by the Texas Utility Commission
and the United States Nuclear Regulatory Commission (NRC) relating to Texas
Genco's nuclear decommissioning trusts. Texas Genco and CenterPoint Energy have
each appointed two members to the Nuclear Decommissioning Trust Investment
Committee which establishes the investment policy of the trusts and oversees the
investment of the trusts' assets. The securities held by the trusts for
decommissioning costs had an estimated fair value of $201 million as of March
31, 2004, of which approximately 36% were fixed-rate debt securities and the
remaining 64% were equity securities. In July 1999, an outside consultant
estimated Texas Genco's portion of decommissioning costs to be approximately
$363 million. While the funding levels currently exceed minimum NRC
requirements, no assurance can be given that the amounts held in trust will be
adequate to cover the actual decommissioning costs of the South Texas Project.
Such costs may vary because of changes in the assumed date of decommissioning
and changes in regulatory requirements, technology and costs of labor, materials
and equipment. Pursuant to the Texas electric restructuring law, costs
associated with nuclear decommissioning that have not been recovered as of
January 1, 2002, will continue to be subject to cost-of-service rate regulation
and will be included in a charge to transmission and distribution customers of
CenterPoint Houston or its successor.
19
(12) EARNINGS PER SHARE
The following table reconciles numerators and denominators of the
Company's basic and diluted earnings per share (EPS) calculations:
FOR THE THREE MONTHS ENDED
MARCH 31,
---------------------------------
2003 2004
-------------- --------------
(IN MILLIONS, EXCEPT SHARE AND
PER SHARE AMOUNTS)
Basic EPS Calculation:
Income from continuing operations before cumulative effect of accounting
change................................................................... $ 81 $ 74
Discontinued operations, net of tax........................................ 7 -
Cumulative effect of accounting change, net of tax......................... 80 -
-------------- --------------
Net income ................................................................ $ 168 $ 74
============== ==============
Weighted average shares outstanding.......................................... 301,664,000 306,012,000
============== ==============
Basic EPS:
Income from continuing operations before cumulative effect of accounting
change................................................................... $ 0.27 $ 0.24
Discontinued operations, net of tax........................................ 0.02 -
Cumulative effect of accounting change, net of tax......................... 0.27 -
-------------- --------------
Net income................................................................. $ 0.56 $ 0.24
============== ==============
Diluted EPS Calculation:
Net income................................................................. $ 168 $ 74
Plus: Income impact of assumed conversions:
Interest on 6 1/4% convertible trust preferred securities................ - -
-------------- --------------
Total earnings effect assuming dilution.................................... $ 168 $ 74
============== ==============
Weighted average shares outstanding.......................................... 301,664,000 306,012,000
Plus: Incremental shares from assumed conversions (1):
Stock options............................................................ 258,000 1,261,000
Restricted stock......................................................... 1,338,000 861,000
6 1/4% convertible trust preferred securities............................ 18,000 17,000
-------------- --------------
Weighted average shares assuming dilution.................................. 303,278,000 308,151,000
============== ==============
Diluted EPS:
Income from continuing operations before cumulative effect of
accounting change.......................................................... $ 0.27 $ 0.24
Discontinued operations, net of tax.......................................... 0.02 -
Cumulative effect of accounting change, net of tax........................... 0.27 -
-------------- --------------
Net income................................................................. $ 0.56 $ 0.24
============== ==============
- -----------------
(1) For the three months ended March 31, 2003 and 2004, the computation of
diluted EPS excludes 10,249,849 and 12,051,118 purchase options,
respectively, for shares of common stock that have exercise prices
(ranging from $7.86 to $34.17 per share and $10.92 to $32.26 per share for
the first quarter of 2003 and 2004, respectively) greater than the per
share average market price for the period and would thus be anti-dilutive
if exercised. The Company's contingently convertible debt is not
considered for purposes of diluted earnings per share because the required
conversion criteria had not been met as of the end of the reporting
period.
20
(13) REPORTABLE BUSINESS SEGMENTS
The Company's determination of reportable business segments considers the
strategic operating units under which the Company manages sales, allocates
resources and assesses performance of various products and services to wholesale
or retail customers in differing regulatory environments. The Company's Latin
America operations and its energy management services business, which were
previously reported in the Other Operations business segment, are presented as
discontinued operations within these Interim Financial Statements.
The Company has identified the following reportable business segments:
Electric Transmission & Distribution, Electric Generation, Natural Gas
Distribution, Pipelines and Gathering and Other Operations. Reportable business
segments for all prior periods have been restated to conform to the 2004
presentation.
Financial data for the Company's reportable business segments are as
follows:
AS OF
FOR THE THREE MONTHS ENDED MARCH 31, 2003 DECEMBER 31, 2003
---------------------------------------------- -----------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME TOTAL ASSETS
-------------- ------------ --------- -----------------
(IN MILLIONS)
Electric Transmission & Distribution............ $ 448 (1) $ - $ 206 $ 10,326
Electric Generation............................. 359 (2) - (17) 4,640
Natural Gas Distribution........................ 2,028 17 129 4,661
Pipelines and Gathering......................... 61 48 43 2,519
Other Operations................................ 4 5 - 1,347
Eliminations.................................... - (70) - (2,116)
-------------- ------------ --------- -----------------
Consolidated.................................... $ 2,900 $ - $ 361 $ 21,377
============== ============ ========= =================
AS OF
FOR THE THREE MONTHS ENDED MARCH 31, 2004 MARCH 31, 2004
--------------------------------------------- --------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME TOTAL ASSETS
-------------- ------------ --------- --------------
(IN MILLIONS)
Electric Transmission & Distribution ........... $ 329 (1) $ - $ 85 $ 10,234
Electric Generation............................. 439 (2) - 90 4,619
Natural Gas Distribution........................ 2,124 7 117 4,691
Pipelines and Gathering......................... 65 37 45 2,481
Other Operations................................ 2 1 (2) 1,423
Eliminations.................................... - (45) - (2,388)
-------------- ------------ --------- --------------
Consolidated.................................... $ 2,959 $ - $ 335 $ 21,060
============== ============ ========= ==============
- -------------
(1) Sales to subsidiaries of RRI for the three months ended March 31, 2003 and
2004 represented approximately $212 million and $199 million,
respectively, of CenterPoint Houston's transmission and distribution
revenues.
(2) Sales to subsidiaries of RRI for the three months ended March 31, 2003 and
2004 represented approximately 68% and 58%, respectively, of Texas Genco's
total revenues. Sales to another major customer for the three months ended
March 31, 2003 and 2004 represented approximately 10% and 19%,
respectively, of Texas Genco's total revenues.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF CENTERPOINT ENERGY AND SUBSIDIARIES
The following discussion and analysis should be read in combination with
our Interim Financial Statements contained in this Form 10-Q.
EXECUTIVE SUMMARY
1ST QUARTER 2004 HIGHLIGHTS
Our operating performance and cash flow for the first quarter of 2004
compared to the first quarter of 2003 were affected by:
- improved operating income from Texas Genco Holdings, Inc. (Texas
Genco) of $107 million;
- continued customer growth, with the addition of nearly 87,000
metered electric and gas customers;
- a decrease in interest expense of $33 million;
- a reduction of $21 million in capital expenditures;
- the termination of revenues related to Excess Cost Over Market
(ECOM) as of January 1, 2004 compared to ECOM revenues of $132
million recorded in the first quarter of 2003;
- milder weather in 2004, impacting the quarter by $16 million; and
- a charge of $8 million related to staff reductions in the Natural
Gas Distribution business segment.
SIGNIFICANT EVENTS IN 2004
The 1999 Texas Electric Choice Law (Texas electric restructuring law)
contains provisions that allow our transmission and distribution utility,
CenterPoint Energy Houston Electric, LLC (CenterPoint Houston), to recover the
amount by which the market value of our generating assets, as determined by the
Public Utility Commission of Texas (Texas Utility Commission) under a formula
prescribed in the law, is below the regulatory net book value of those assets as
of the end of 2001. It also allows CenterPoint Houston to recover certain other
transition costs, such as a final fuel reconciliation balance, regulatory assets
and the difference between the Texas Utility Commission's projected market
prices for generation during 2002 and 2003 and actual market prices for
generation as determined in the state-mandated capacity auctions during that
period (called the ECOM true-up). Those amounts, and certain other adjustments
(the true-up balance), are to be determined by the Texas Utility Commission in a
proceeding that began on March 31, 2004 (2004 True-Up Proceeding). Our true-up
balance is $3.8 billion, excluding interest. 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, although, under its rules the Texas
Utility Commission can extend the 150-day deadline for good cause. The Texas
Utility Commission has scheduled hearings beginning June 21, 2004. Various
parties have intervened in our true-up proceeding, and we expect intervenors to
vigorously oppose recovery of the amounts we are seeking. After the Texas
Utility Commission determines the amount of the true-up balance that the utility
may recover, the utility will recover those amounts through a transition charge
added to its non-bypassable delivery charge. An ultimate determination or a
settlement at an amount less than that recorded in our financial statements
could lead to a charge that would materially adversely affect our results of
operations, financial condition and cash flows. Assuming receipt of a timely
final order from the Texas Utility Commission, we expect to begin earning a rate
of return on the true-up balance in the third quarter of 2004. We intend to seek
authority from the Texas Utility Commission to securitize all or a portion of
the true-up balance as early as the fourth quarter of 2004 through the issuance
of transition bonds and to be in a position to issue those bonds by early 2005.
Transition bonds would be issued through a special purpose entity that would be
a subsidiary of CenterPoint Houston, but they would be non-recourse to
CenterPoint Houston. Any portion of the true-up balance not securitized by
transition bonds will be recovered through a non-bypassable competition
transition charge. CenterPoint Houston will distribute recovery of the true-up
components not used to repay indebtedness to us through either the payment of
dividends or the
22
settlement of intercompany payables. We can then move funds back to CenterPoint
Houston, either through equity or intercompany debt, in order to maintain
CenterPoint Houston's capital structure at the appropriate levels.
In January 2004, Reliant Energy, Inc. (formerly named Reliant Resources,
Inc.) (RRI) did not exercise its option to purchase our 81% interest in Texas
Genco. We have engaged a financial advisor to assist us in the sale of our
interest in Texas Genco. We are currently providing interested parties
information about Texas Genco and its operations. There can be no assurance that
we will receive any definitive bids for our interest in Texas Genco or that any
bids we do receive will be acceptable to us. Any proceeds from the monetization
of Texas Genco are expected to be used to repay indebtedness. We expect to have
determined our best course of action regarding the possible disposition of our
interest in Texas Genco in 2004.
The alternatives for monetization of our remaining interest in Texas Genco
may not be completed in 2004 and may result in receipt of proceeds in an amount
different from the market valuation placed on Texas Genco in the 2004 True-Up
Proceeding. To the extent that the Texas Utility Commission uses a market value
higher than the amount ultimately realized from the sale of Texas Genco, a loss
would be recognized. The completion of the 2004 True-Up Proceeding and recovery
of stranded costs is not dependent on the sale of Texas Genco.
Resolution of the 2004 True-Up Proceeding and the monetization of our
remaining interest in Texas Genco are the two most significant events facing the
company in 2004. These events are expected to result in aggregate proceeds of
over $5 billion based on the Texas Utility Commission rules and our estimate of
the ultimate sales price of our interest in Texas Genco. We expect to use these
proceeds to repay our indebtedness. Either or both events could, however, lead
to charges against earnings. If those charges are of sufficient magnitude, they
could reduce our earnings below the level required for us to continue paying our
current quarterly dividends out of current earnings as required under our
Securities and Exchange Commission (SEC) financing order. We have filed an
application with the SEC under the 1935 Act requesting an order authorizing us
to pay dividends in the second and third quarters of 2004 out of capital or
unearned surplus in the event we are required to take such a charge against
earnings.
Following adoption of the true-up rule by the Texas Utility Commission in
2001, CenterPoint Houston appealed the provisions of the rule that permitted
interest to be recovered on stranded costs only from the date of the Texas
Utility Commission's final order in the 2004 True-Up Proceeding, instead of from
January 1, 2002 as CenterPoint Houston contends is required by law. On January
30, 2004, the Texas Supreme Court granted our petition for review of the true-up
rule. Oral arguments were heard on February 18, 2004. The decision by the Court
is pending. We have not accrued interest income on stranded costs of
approximately $631 million in our consolidated financial statements.
RECENT DEVELOPMENTS
In March 2004, AEP Central Texas Company (AEP), one of Texas Genco's
co-owners in the South Texas Project Electric Generating Station (South Texas
Project), notified Texas Genco that it has received an offer by a third party to
purchase its entire 25.2 percent ownership interest in the South Texas Project
for $332.6 million, subject to certain adjustments at closing. Under the terms
of the agreements among the owners of the South Texas Project, Texas Genco and
each of the other two co-owners have the right to purchase AEP's interest for
the cash price offered by the third party. To exercise the right of first
refusal, Texas Genco must give notice to AEP within three months of their notice
to Texas Genco. If more than one owner elects to purchase all or a portion of
the interest being sold, the interest will be prorated among the owners seeking
to purchase AEP's interest in proportion to their ownership interests in the
South Texas Project. Texas Genco is currently evaluating the offer received, but
has not made a decision whether to exercise its rights.
23
CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31,
------------------------------------
2003 2004
-------- --------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Revenues ......................................................................... $ 2,900 $ 2,959
Expenses ......................................................................... (2,539) (2,624)
------- -------
Operating Income ................................................................. 361 335
Interest and Other Finance Charges ............................................... (238) (205)
Other Income, net ................................................................ (3) 5
------- -------
Income From Continuing Operations Before Income Taxes, Minority Interest and
Cumulative Effect of Accounting Change ......................................... 120 135
Income Tax Expense ............................................................... (41) (50)
Minority Interest ................................................................ 2 (11)
------- -------
Income From Continuing Operations Before Cumulative Effect of Accounting Change .. 81 74
Discontinued Operations, net of tax .............................................. 7 --
Cumulative Effect of Accounting Change, net of tax ............................... 80 --
------- -------
Net Income ....................................................................... $ 168 $ 74
======= =======
BASIC EARNINGS PER SHARE:
Income From Continuing Operations Before Cumulative Effect of Accounting
Change ....................................................................... $ 0.27 $ 0.24
Discontinued Operations, net of tax ............................................ 0.02 --
Cumulative Effect of Accounting Change, net of tax ............................. 0.27 --
------- -------
Net Income ..................................................................... $ 0.56 $ 0.24
======= =======
DILUTED EARNINGS PER SHARE:
Income From Continuing Operations Before Cumulative Effect of Accounting
Change ....................................................................... $ 0.27 $ 0.24
Discontinued Operations, net of tax ............................................ 0.02 --
Cumulative Effect of Accounting Change, net of tax ............................. 0.27 --
------- -------
Net Income ..................................................................... $ 0.56 $ 0.24
======= =======
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
Income from Continuing Operations. We reported income from continuing
operations of $74 million ($0.24 per diluted share) for the three months ended
March 31, 2004 as compared to $81 million ($0.27 per diluted share) for the same
period in 2003 before cumulative effect of accounting change. The decrease in
income from continuing operations of $7 million was primarily due to the
termination of revenues in our Electric Transmission & Distribution business
segment related to ECOM as of January 1, 2004 compared to ECOM revenues of $132
million recorded in the first quarter of 2003, a reduction of $16 million in
revenues from our Electric Transmission & Distribution and Natural Gas
Distribution business segments due to milder weather in the first quarter of
2004 and an $8 million charge for severance cost associated with staff
reductions in our Natural Gas Distribution business segment. These decreases
were substantially offset by a $107 million increase in operating income from
our Electric Generation business segment and a $33 million decrease in interest
expense due to lower borrowing costs.
Cumulative Effect of Accounting Change. In connection with the adoption of
Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for
Asset Retirement Obligations" (SFAS No. 143), effective January 1, 2003, we
completed an assessment of the applicability and implications of SFAS No. 143.
As a result of the assessment, we identified retirement obligations for nuclear
decommissioning at the South Texas Project and for lignite mine operations at
the Jewett mine supplying the Limestone electric generation facility. The net
difference between the amounts determined under SFAS No. 143 and the previous
method of accounting for estimated mine reclamation costs was $37 million and
has been recorded as a cumulative effect of accounting change. Upon adoption of
SFAS No. 143, we reversed $115 million of previously recognized removal costs
with respect to our non-rate regulated businesses as a cumulative effect of
accounting change. The total cumulative effect of accounting
24
change from adoption of SFAS No. 143 was $80 million after-tax ($152 million
pre-tax). Excluded from the $80 million after-tax cumulative effect of
accounting change recorded for the three months ended March 31, 2003, is
minority interest of $19 million related to the Texas Genco stock not owned by
CenterPoint Energy.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The following table presents operating income for each of our business
segments for the three months ended March 31, 2003 and 2004. Some amounts from
the previous year have been reclassified to conform to the 2004 presentation of
the financial statements. These reclassifications do not affect consolidated net
income.
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2004
---- ----
(IN MILLIONS)
Electric Transmission & Distribution ......... $ 206 $ 85
Electric Generation .......................... (17) 90
Natural Gas Distribution ..................... 129 117
Pipelines and Gathering ...................... 43 45
Other Operations ............................. -- (2)
----- -----
Total Consolidated Operating Income..... $ 361 $ 335
===== =====
ELECTRIC TRANSMISSION & DISTRIBUTION
For information regarding factors that may affect the future results of
operations of our Electric Transmission & Distribution business segment, please
read "Business -- Risk Factors -- Principal Risk Factors Associated with Our
Businesses -- Risk Factors Affecting Our Electric Transmission & Distribution
Business," " -- Risk Factors Associated with Our Consolidated Financial
Condition" and " -- Other Risks" in Item 1 of the Annual Report on Form 10-K of
CenterPoint Energy for the year ended December 31, 2003 (CenterPoint Energy Form
10-K), each of which is incorporated herein by reference.
The following tables provide summary data of our Electric Transmission &
Distribution business segment for the three months ended March 31, 2003 and
2004:
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2004
------- -------
(IN MILLIONS)
Revenues:
Electric transmission and distribution revenues..... $ 303 $ 314
ECOM revenues ...................................... 132 --
Transition bond revenues ........................... 13 15
------- -------
Total revenues ................................... 448 329
------- -------
Expenses:
Operation and maintenance .......................... 133 132
Depreciation and amortization ...................... 62 60
Taxes other than income taxes ...................... 44 47
Transition bond expenses ........................... 3 5
------- -------
Total expenses ................................... 242 244
------- -------
Operating Income ..................................... $ 206 $ 85
======= =======
Actual gigawatt-hours (GWh) delivered:
Residential ........................................ 4,558 4,402
Total (1) .......................................... 14,788 15,520
- ------------
(1) Usage volumes for commercial and industrial customers are included in
total GWh delivered; however, the majority of these customers are billed
on a peak demand (KW) basis and, as a result, revenues do not vary based
on consumption.
25
Our Electric Transmission & Distribution business segment reported
operating income of $85 million for the three months ended March 31, 2004,
consisting of $75 million for the regulated electric transmission and
distribution utility and $10 million for the transition bond company. For the
three months ended March 31, 2003, operating income totaled $206 million,
consisting of $64 million for the regulated electric transmission and
distribution utility, $10 million for the transition bond company and $132
million of non-cash income associated with ECOM. ECOM is recoverable under the
Texas electric restructuring law and is included in our recently filed true-up
application. Beginning in 2004, there is no ECOM contribution to earnings. The
transition bond company's operating income represents the amount necessary to
pay interest on the transition bonds. The regulated electric transmission and
distribution utility continues to benefit from solid customer growth. Revenues
increased $9 million for the three months ended March 31, 2004 as compared to
the same period in 2003 from the addition of 48,000 metered customers since
March 2003. This increase was partially offset by milder weather which
negatively impacted the quarter by $6 million.
ELECTRIC GENERATION
For information regarding factors that may affect the future results of
operations of our Electric Generation business segment, please read "Business --
Risk Factors -- Principal Risk Factors Associated with Our Businesses -- Risk
Factors Affecting Our Electric Generation Business," " -- Risk Factors
Associated with Our Consolidated Financial Condition" and " -- Other Risks" in
Item 1 of the CenterPoint Energy Form 10-K, each of which is incorporated herein
by reference.
The following tables provide summary data of our Electric Generation
business segment for the three months ended March 31, 2003 and 2004:
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2004
-------- -------
(IN MILLIONS)
Revenues ......................................... $ 359 $ 439
------- -------
Expenses:
Fuel ........................................... 208 187
Purchased power ................................ 12 8
Operation and maintenance ...................... 106 102
Depreciation and amortization .................. 39 40
Taxes other than income taxes .................. 11 12
------- -------
Total expenses ............................... 376 349
------- -------
Operating Income (Loss) .......................... $ (17) $ 90
======= =======
Sales (in GWh) ................................... 9,276 10,721
Generation (in GWh) .............................. 8,995 10,149
Our Electric Generation business segment's operating income for the three
months ended March 31, 2004 was $90 million compared to a loss of $17 million
for the same period in 2003. Revenues increased $80 million in the first quarter
of 2004 as compared to the same period in 2003 due to higher capacity revenue
for base-load products driven by continued high natural gas prices. Most of
these base-load products were sold in capacity auctions held when natural gas
prices were higher than when we sold our capacity for 2003. Additionally, the
sale of surplus air emission allowances contributed $4 million to the increase
in revenues. Fuel and purchased power costs declined $25 million in the first
quarter of 2004 as compared to the same period in 2003 reflecting the increase
in availability of our lower-cost base-load units in 2004, lower gas prices in
2004 and lower demand for gas-fired generation products. Operation and
maintenance expenses decreased $4 million primarily due to a reduction in
planned and unplanned outages in the first quarter of 2004 as compared to the
same period in 2003.
NATURAL GAS DISTRIBUTION
For information regarding factors that may affect the future results of
operations of our Natural Gas Distribution business segment, please read
"Business -- Risk Factors -- Principal Risk Factors Associated with Our
Businesses -- Risk Factors Affecting Our Natural Gas Distribution and Pipelines
and Gathering Businesses," " -- Risk Factors Associated with Our Consolidated
Financial Condition" and " -- Other Risks" in Item 1 of the CenterPoint Energy
Form 10-K, each of which is incorporated herein by reference.
26
The following table provides summary data of our Natural Gas Distribution
business segment for the three months ended March 31, 2003 and 2004:
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2004
-------- --------
(IN MILLIONS)
Revenues ................................................... $ 2,045 $ 2,131
------- -------
Expenses:
Natural gas .............................................. 1,694 1,790
Operation and maintenance ................................ 148 149
Depreciation and amortization ............................ 33 35
Taxes other than income taxes ............................ 41 40
------- -------
Total expenses ......................................... 1,916 2,014
------- -------
Operating Income ........................................... $ 129 $ 117
======= =======
Throughput (in billion cubic feet (Bcf)):
Residential .............................................. 94 85
Commercial and industrial ................................ 89 83
Non-rate regulated commercial and industrial ............. 129 139
Elimination .............................................. (15) (10)
------- -------
Total Throughput ....................................... 297 297
======= =======
Our Natural Gas Distribution business segment reported operating income of
$117 million for the three months ended March 31, 2004 as compared to $129
million for the same period in 2003. Continued customer growth, with the
addition of over 38,000 customers since March 2003, and higher revenues of $3
million from rate increases were more than offset by the impact of milder
weather of $10 million and reduced contributions from our competitive commercial
and industrial sales business. Operations and maintenance expense increased $1
million for the three months ended March 31, 2004 as compared to the same period
in 2003. The increase was primarily due to an $8 million charge for severance
cost associated with staff reductions, which will reduce costs in future
periods. Excluding this charge, operation and maintenance expenses decreased by
$7 million.
PIPELINES AND GATHERING
For information regarding factors that may affect the future results of
operations of our Pipelines and Gathering business segment, please read
"Business -- Risk Factors -- Principal Risk Factors Associated with Our
Businesses -- Risk Factors Affecting Our Natural Gas Distribution and Pipelines
and Gathering Businesses," " -- Risk Factors Associated with Our Consolidated
Financial Condition" and " -- Other Risks" in Item 1 of the CenterPoint Energy
Form 10-K, each of which is incorporated herein by reference.
27
The following table provides summary data of our Pipelines and Gathering
business segment for the three months ended March 31, 2003 and 2004:
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2004
-------- --------
(IN MILLIONS)
Revenues ................................... $ 109 $ 102
----- -----
Expenses:
Natural gas .............................. 21 9
Operation and maintenance ................ 30 33
Depreciation and amortization ............ 11 11
Taxes other than income taxes ............ 4 4
----- -----
Total expenses ......................... 66 57
----- -----
Operating Income ........................... $ 43 $ 45
===== =====
Throughput (in Bcf):
Natural Gas Sales ........................ 4 2
Transportation ........................... 268 270
Gathering ................................ 72 75
Elimination (1) .......................... (2) (2)
----- -----
Total Throughput ....................... 342 345
===== =====
- -------------
(1) Elimination of volumes both transported and sold.
Our Pipelines and Gathering business segment reported operating income of
$45 million for the three months ended March 31, 2004 compared to $43 million
for the same period in 2003. The improvement was primarily due to higher
utilization of storage services, higher interruptible transportation margins,
increased throughput and enhanced services related to our gas gathering
operations and lower natural gas prices. Operation and maintenance expenses
increased $3 million for the three months ended March 31, 2004 compared to the
same period in 2003 primarily due to spending related to pipeline integrity and
higher employee-related costs.
OTHER OPERATIONS
The following table shows operating income of our Other Operations
business segment for the three months ended March 31, 2003 and 2004:
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2004
----- ------
(IN MILLIONS)
Revenues....................... $ 9 $ 3
Expenses....................... 9 5
----- -----
Operating Income (Loss)........ $ -- $ (2)
===== =====
DISCONTINUED OPERATIONS
In February 2003, we sold our interest in Argener, a cogeneration facility
in Argentina, for $23 million. The carrying value of this investment was
approximately $11 million as of December 31, 2002. We recorded an after-tax gain
of $7 million from the sale of Argener in the first quarter of 2003. We have
completed our strategy of exiting all of our international investments. The
Interim Financial Statements present these operations as discontinued operations
in accordance with SFAS No. 144 for the three months ended March 31, 2003.
In November 2003, we sold a component of our Other Operations business
segment, CenterPoint Energy Management Services, Inc. (CEMS), that provides
district cooling services in the Houston central business district and related
complementary energy services to district cooling customers and others. The
Interim Financial Statements present these operations as discontinued operations
in accordance with SFAS No. 144 for the three months ended March 31, 2003.
28
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Certain Factors Affecting
Future Earnings" in Item 7 of Part II of the CenterPoint Energy Form 10-K and
"Risk Factors" in Item 1 of Part I of the CenterPoint Energy Form 10-K, each of
which is incorporated herein by reference. In addition to these factors, the
discontinuation of non-cash operating income associated with ECOM is expected to
negatively impact our earnings in 2004.
LIQUIDITY AND CAPITAL RESOURCES
HISTORICAL CASH FLOWS
The following table summarizes the net cash provided by (used in)
operating, investing and financing activities for the three months ended March
31, 2003 and 2004:
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2004
------ ------
(IN MILLIONS)
Cash provided by (used in):
Operating activities ................. $ 6 $ 393
Investing activities ................. (146) (128)
Financing activities ................. 121 (190)
CASH PROVIDED BY OPERATING ACTIVITIES
Cash provided by operating activities increased $387 million for the three
months ended March 31, 2004 as compared to the same period in 2003 primarily due
to increased cash flow from Texas Genco substantially due to higher capacity
revenues driven by continued high natural gas prices ($88 million), and
decreased accounts receivable attributable to a higher level of accounts
receivable being sold under CERC Corp.'s factoring agreement ($100 million).
Additionally, other changes in working capital items, primarily decreased net
accounts receivable and accounts payable due to the impact of lower natural gas
prices and milder weather in the first quarter of 2004 as compared to the same
period in 2003 ($130 million), contributed to the overall increase in cash
provided by operating activities.
CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities decreased $18 million for the three
months ended March 31, 2004 as compared to the same period in 2003 due primarily
to decreased environmental-related capital expenditures in our Electric
Generation business segment and decreased capital expenditures in our Electric
Transmission & Distribution business segment primarily resulting from delayed
spending due to inclement weather.
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
During the first three months of 2004, debt payments exceeded net loan
proceeds by $159 million. During the first three months of 2003, net loan
proceeds exceeded debt payments by $155 million.
FUTURE SOURCES AND USES OF CASH
Our liquidity and capital requirements will be affected by:
- capital expenditures;
- debt service requirements;
- various regulatory actions; and
29
- working capital requirements.
The 1935 Act regulates our financing ability, as more fully described in "
- -- Certain Contractual and Regulatory Limits on Ability to Issue Securities and
Pay Dividends on Our Common Stock" below.
Off-Balance Sheet Arrangements. Other than operating leases, we have no
off-balance sheet arrangements. However, we do participate in a receivables
factoring arrangement. On January 21, 2004, CERC Corp. replaced its $100 million
receivables facility with a $250 million receivables facility. The $250 million
receivables facility terminates on January 19, 2005. As of March 31, 2004, CERC
Corp. had fully utilized its receivables facility.
Long-term and Short-term Debt. Our long-term debt consists of our
obligations and the obligations of our subsidiaries, including transition bonds
issued by an indirect wholly owned subsidiary (transition bonds).
As of March 31, 2004, we had the following revolving credit facilities (in
millions):
SIZE OF AMOUNT
FACILITY AT OUTSTANDING AT
MARCH 31, MARCH 31,
DATE EXECUTED COMPANY 2004 2004 TERMINATION DATE
------------- ------- ---- ---- ----------------
March 23, 2004 CERC Corp. $ 250 $ -- March 23, 2007
October 7, 2003 CenterPoint Energy 1,425 735 October 7, 2006
December 23, 2003 Texas Genco, LP 75 -- December 21, 2004
On March 23, 2004, CERC Corp. replaced its $200 million revolving credit
facility with a $250 million revolving credit facility that terminates on March
23, 2007. Fully-drawn rates for borrowings under this facility, including the
facility fee, are LIBOR plus 150 basis points based on current credit ratings
and the applicable pricing grid.
In February 2004, $56 million aggregate principal amount of collateralized
5.60% pollution control bonds due 2027 and $44 million aggregate principal
amount of 4.25% collateralized insurance-backed pollution control bonds due 2017
were issued on behalf of CenterPoint Houston. The pollution control bonds are
collateralized by general mortgage bonds of CenterPoint Houston with principal
amounts, interest rates and maturities that match the pollution control bonds.
The proceeds were used to extinguish two series of 6.7% collateralized pollution
control bonds with an aggregate principal amount of $100 million issued on our
behalf. CenterPoint Houston's 6.7% first mortgage bonds, which collateralized
our payment obligations under the refunded pollution control bonds, were retired
in connection with the extinguishment of the refunded pollution control bonds.
CenterPoint Houston's 6.7% notes payable to us were cancelled upon the
extinguishment of the refunded pollution control bonds.
In March 2004, $45 million aggregate principal amount of 3.625%
collateralized insurance-backed pollution control bonds due 2012 and $84 million
aggregate principal amount of 4.25% collateralized insurance-backed pollution
control bonds due 2017 were issued on behalf of CenterPoint Houston. The
pollution control bonds are collateralized by general mortgage bonds of
CenterPoint Houston with principal amounts, interest rates and maturities that
match the pollution control bonds. The proceeds were used to extinguish two
series of 6.375% collateralized pollution control bonds with an aggregate
principal amount of $45 million and one series of 5.6% collateralized pollution
control bonds with an aggregate principal amount of $84 million issued on our
behalf. CenterPoint Houston's 6.375% and 5.6% first mortgage bonds which
collateralized our payment obligations under the refunded pollution control
bonds were retired in connection with the extinguishment of the refunded
pollution control bonds. CenterPoint Houston's 6.375% and 5.6% notes payable to
us were cancelled upon the extinguishment of the refunded pollution control
bonds.
On March 31, 2004, we had temporary external investments of $160 million.
At March 31, 2004, CenterPoint Energy had a shelf registration statement
covering 15 million shares of common stock and CERC Corp. had a shelf
registration statement covering $50 million principal amount of debt securities.
30
Cash Requirements in 2004. 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 remainder of 2004, assuming we continue to own our interest in Texas
Genco for the full year, include the following:
- approximately $571 million of capital expenditures;
- an estimated $183 million in refunds by CenterPoint Houston of
excess mitigation credits through December 31, 2004;
- dividend payments on CenterPoint Energy common stock; and
- $35 million of maturing long-term debt, including $27 million of
transition bonds.
We expect that revolving credit borrowings and anticipated cash flows from
operations will be sufficient to meet our cash needs for 2004. Our $2.3 billion
credit facility provides that, until such time as the credit facility has been
reduced to $750 million, all of the net cash proceeds from any securitizations
relating to the recovery of the true-up components, after making any payments
required under CenterPoint Houston's term loan, and the net cash proceeds of any
sales of the common stock of Texas Genco that we own, or of material portions of
Texas Genco's assets, shall be applied to repay borrowings under our credit
facility and reduce the amount available under the credit facility. Our $2.3
billion credit facility contains no other restrictions with respect to our use
of proceeds from financing activities. CenterPoint Houston's term loan requires
the proceeds from the issuance of transition bonds to be used to reduce the term
loan unless refused by the lenders. CenterPoint Houston's term loan, subject to
certain exceptions, limits the application of proceeds from capital markets
transactions by CenterPoint Houston over $200 million to repayment of debt
existing in November 2002.
CenterPoint Houston will distribute recovery of the true-up components not
used to repay indebtedness to us through either the payment of dividends or the
settlement of intercompany payables. We can then move funds back to CenterPoint
Houston, either through equity or intercompany debt, in order to maintain
CenterPoint Houston's capital structure at the appropriate levels. Under the
orders described under " -- Certain Contractual and Regulatory Limits on Ability
to Issue Securities and Pay Dividends on Our Common Stock," CenterPoint
Houston's member's equity as a percentage of total capitalization must be at
least 30%, although the SEC has permitted the percentage to be below this level
for other companies taking into account non-recourse securitization debt as a
component of capitalization.
Impact on Liquidity of a Downgrade in Credit Ratings. As of May 1, 2004,
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 senior debt of CenterPoint Energy and
certain subsidiaries:
MOODY'S S&P FITCH
------------------- --------------------- --------------------
COMPANY/INSTRUMENT RATING OUTLOOK(1) RATING OUTLOOK(2) RATING OUTLOOK(3)
------------------ ------- ---------- -------- ---------- -------- ----------
CenterPoint Energy Senior Unsecured Debt... Ba2 Negative BBB- Negative BBB- Negative
CenterPoint Houston Senior Secured Debt
(First Mortgage Bonds)................... Baa2 Negative BBB Negative BBB+ Negative
CERC Corp. Senior Debt..................... Ba1 Stable BBB Negative BBB Negative
- ------------
(1) A "negative" outlook from Moody's reflects concerns over the next 12 to 18
months which will either lead to a review for a potential downgrade or a
return to a stable outlook. A "stable" outlook from Moody's indicates that
Moody's does not expect to put the rating on review for an upgrade or
downgrade within 18 months from when the outlook was assigned or last
affirmed.
(2) An S&P rating outlook assesses the potential direction of a long-term
credit rating over the intermediate to longer term.
(3) A "negative" outlook from Fitch encompasses a one-to-two year horizon as
to the likely ratings direction.
31
On February 27, 2004, Moody's announced that it was downgrading our senior
unsecured debt to Ba2 from Ba1. Moody's explained in its announcement that the
action was to reflect the structural differences in rights and claims afforded
to our senior secured bank lenders, who benefit from their priority claim on
proceeds from the monetization of Texas Genco and from the up-streaming of
proceeds resulting from securitization of the true-up components at CenterPoint
Houston. Moody's announced that its action concluded a review for possible
downgrade of us that it initiated in October 2003.
On April 30, 2004, Moody's announced that it had changed the CERC outlook
to stable from negative. Moody's explained in its announcement that the action
was to reflect the mitigation of concerns that underlay its negative outlook
including CERC 's establishment of a steady operating track record as a
subsidiary of CenterPoint Energy, CERC's establishment of adequate stand-alone
liquidity, CERC's progress made in addressing certain regulatory issues and
greater comfort with the ringfencing protections provided to CERC by the 1935
Act.
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 increase borrowing costs under CERC's
$250 million revolving credit facility. A decline in credit ratings would also
increase the interest rate on long-term debt to be issued in the capital markets
and would negatively impact our ability to complete capital market transactions.
If we were unable to maintain an investment-grade rating from at least one
rating agency, as a registered public utility holding company we would be
required to obtain further approval from the SEC for any additional capital
markets transactions as more fully described in " -- Certain Contractual and
Regulatory Limits on Ability to Issue Securities and Pay Dividends on Our Common
Stock" below. Additionally, a decline in credit ratings could increase cash
collateral requirements that could exist in connection with certain contracts
relating to gas purchases, gas price hedging and gas storage activities of our
Natural Gas Distribution business segment.
Our revolving credit facilities contain "material adverse change" clauses
that could impact our ability to make new borrowings under these facilities. The
"material adverse change" clauses in our revolving credit facilities generally
relate to an event, development or circumstance that has or would reasonably be
expected to have a material adverse effect on (a) the business, financial
condition or operations of the borrower and its subsidiaries taken as a whole,
or (b) the legality, validity or enforceability of the loan documents.
In September 1999, we issued 2.0% Zero-Premium Exchangeable Subordinated
Notes due 2029 (ZENS) having an original principal amount of $1.0 billion. Each
ZENS note is exchangeable at the holder's option at any time for an amount of
cash equal to 95% of the market value of the reference shares of Time Warner
Inc. (TW Common) attributable to each ZENS note. If our creditworthiness were to
drop such that ZENS note holders thought our liquidity was adversely affected or
the market for the ZENS notes were to become illiquid, some ZENS noteholders
might decide to exchange their ZENS notes for cash. Funds for the payment of
cash upon exchange could be obtained from the sale of the shares of TW Common
that we own or from other sources. We own shares of TW Common equal to 100% of
the reference shares used to calculate our obligation to the holders of the ZENS
notes. ZENS note exchanges result in a cash outflow because deferred tax
liabilities related to the ZENS notes and TW Common shares become current tax
obligations when ZENS notes are exchanged and TW Common shares are sold.
CenterPoint Energy Gas Services, Inc. (CEGS), a wholly owned subsidiary of
CERC Corp., provides comprehensive natural gas sales and services to industrial
and commercial customers, which are primarily located within or near the
territories served by our pipelines and natural gas distribution subsidiaries.
In order to hedge its exposure to natural gas prices, CEGS has agreements with
provisions standard for the industry that establish credit thresholds and
require a party to provide additional collateral on two business days' notice
when that party's rating or the rating of a credit support provider for that
party (CERC Corp. in this case) falls below those levels. As of March 31, 2004,
the senior unsecured debt of CERC Corp. was rated BBB by S&P and Ba1 by Moody's.
We estimate that as of March 31, 2004, unsecured credit limits related to hedge
instruments extended to CEGS by counterparties could aggregate $82 million;
however, utilized credit capacity is significantly lower.
32
Cross Defaults. Under our revolving credit facility and our term loan, a
payment default on, or a non-payment default that permits acceleration of, any
indebtedness exceeding $50 million by us or any of our significant subsidiaries
will cause a default. Pursuant to the indenture governing our senior notes, a
payment default by us, CERC Corp. or CenterPoint Houston in respect of, or an
acceleration of, borrowed money and certain other specified types of
obligations, in the aggregate principal amount of $50 million will cause a
default. As of April 30, 2004, we had issued five series of senior notes
aggregating $1.4 billion in principal amount under this indenture. A default by
CenterPoint Energy would not trigger a default under our subsidiaries' debt
instruments.
Pension Plan. As discussed in Note 10(b) to the consolidated annual
financial statements in the CenterPoint Energy Form 10-K (CenterPoint Energy
Notes), which is incorporated herein by reference, we maintain a
non-contributory pension plan covering substantially all employees. Employer
contributions are based on actuarial computations that establish the minimum
contribution required under the Employee Retirement Income Security Act of 1974
(ERISA) and the maximum deductible contribution for income tax purposes. At
December 31, 2003, the projected benefit obligation exceeded the market value of
plan assets by $498 million. In September 2003, we elected to make a $22.7
million contribution to our pension plan. As a result, we will not be required
to make any contributions to our pension plan prior to 2005. Changes in interest
rates and the market values of the securities held by the plan during 2004 could
materially, positively or negatively, change our under-funded status and affect
the level of pension expense and required contributions in 2005 and beyond. Plan
assets used to satisfy pension obligations have been adversely impacted by the
decline in equity market values prior to 2003.
Under the terms of our pension plan, we reserve the right to change,
modify or terminate the plan. Our funding policy is to review amounts annually
and contribute an amount at least equal to the minimum contribution required
under ERISA and the Internal Revenue Code (Code).
In accordance with SFAS No. 87, "Employers' Accounting for Pensions,"
changes in pension obligations and assets may not be immediately recognized as
pension costs in the income statement, but generally are recognized in future
years over the remaining average service period of plan participants. As such,
significant portions of pension costs recorded in any period may not reflect the
actual level of benefit payments provided to plan participants.
Pension costs were $23 million and $19 million for the three months ended
March 31, 2003 and 2004, respectively. Additionally, we maintain a non-qualified
benefit restoration plan which allows participants to retain the benefits to
which they would have been entitled under our non-contributory pension plan
except for the Code mandated limits on these benefits or on the level of
compensation on which these benefits may be calculated. The expense associated
with this non-qualified plan was $2 million and $1 million for the three months
ended March 31, 2003 and 2004, respectively.
The calculation of pension expense and related liabilities requires the
use of assumptions. Changes in these assumptions can result in different expense
and liability amounts, and future actual experience can differ from the
assumptions. Two of the most critical assumptions are the expected long-term
rate of return on plan assets and the assumed discount rate.
As of December 31, 2003, the expected long-term rate of return on plan
assets was 9.0%. We believe that our actual asset allocation on average will
approximate the targeted allocation and the estimated return on net assets. We
regularly review our actual asset allocation and periodically rebalance plan
assets as appropriate.
As of December 31, 2003, the projected benefit obligation was calculated
assuming a discount rate of 6.25%, which is a 0.5% decline from the 6.75%
discount rate assumed in 2002. The discount rate was determined by reviewing
yields on high-quality bonds that receive one of the two highest ratings given
by a recognized rating agency and the expected duration of pension obligation
specific to the characteristics of our plan.
Pension expense for 2004, including the benefit restoration plan, is
estimated to be $82 million based on an expected return on plan assets of 9.0%
and a discount rate of 6.25% as of December 31, 2003. If the expected return
assumption were lowered by 0.5% (from 9.0% to 8.5%), 2004 pension expense would
increase by approximately $6 million. Similarly, if the discount rate were
lowered by 0.5% (from 6.25% to 5.75%), this assumption change would increase our
projected benefit obligation, pension liabilities and 2004 pension expense by
approximately $121 million, $111 million and $10 million, respectively. In
addition, the assumption change would result in an additional charge to
comprehensive income during 2004 of $72 million, net of tax.
33
Primarily due to the decline in the market value of the pension plan's
assets and increased benefit obligations associated with a reduction in the
discount rate, the value of the plan's assets is less than our accumulated
benefit obligation. In December 2003, we recorded a minimum liability adjustment
in the Consolidated Balance Sheet ($72 million decrease in pension liability) to
reflect a liability equal to the unfunded accumulated benefit obligation, with
an offsetting credit of $47 million to equity, net of a $25 million deferred tax
effect.
Future changes in plan asset returns, assumed discount rates and various
other factors related to the pension plan will impact our future pension expense
and liabilities. We cannot predict with certainty what these factors will be in
the future.
Other Factors that Could Affect Cash Requirements. In addition to the
above factors, our liquidity and capital resources could be affected by:
- cash collateral requirements that could exist in connection with
certain contracts, including gas purchases, gas price hedging and
gas storage activities of our Natural Gas Distribution business
segment, particularly given gas price levels and volatility;
- acceleration of payment dates on certain gas supply contracts under
certain circumstances, as a result of increased gas prices and
concentration of suppliers;
- increased costs related to the acquisition of gas for storage;
- various regulatory actions; and
- the ability of RRI and its subsidiaries to satisfy their obligations
as the principal customers of CenterPoint Houston and Texas Genco
and in respect of RRI's indemnity obligations to us and our
subsidiaries.
Money Pool. We have two "money pools" through which our participating
subsidiaries can borrow or invest on a short-term basis. Funding needs are
aggregated and external borrowing or investing is based on the net cash
position. Prior to October 2003, we had only one money pool. Following Texas
Genco's certification by FERC as an "exempt wholesale generator" under the 1935
Act in October 2003, it could no longer participate with our regulated
subsidiaries in the same money pool. In October 2003, we established a second
money pool in which Texas Genco and certain of our other unregulated
subsidiaries can participate.
The net funding requirements of the money pool in which our regulated
subsidiaries participate are expected to be met with borrowings under credit
facilities. Except in an emergency situation (in which case we could provide
funding pursuant to applicable SEC rules), we would be required to obtain
approval from the SEC to issue and sell securities for purposes of funding Texas
Genco's operations via the money pool established in October 2003. The terms of
both money pools are in accordance with requirements applicable to registered
public utility holding companies under the 1935 Act and under an order from the
SEC relating to our financing activities and those of our subsidiaries on June
30, 2003 (June 2003 Financing Order).
Certain Contractual and Regulatory Limits on Ability to Issue Securities
and Pay Dividends on Our Common Stock. Factors affecting our ability to issue
securities, pay dividends on our common stock or take other actions that affect
our capitalization include:
- a $0.10 per share per quarter limitation on common stock dividend
payments under our $2.3 billion revolving credit and term loan
facility;
- covenants and other provisions in our credit or loan facilities and
the credit facilities and receivables facility of our subsidiaries
and other borrowing agreements; and
- limitations imposed on us as a registered public utility holding
company under the 1935 Act.
The collateralized term loan of CenterPoint Houston limits CenterPoint
Houston's debt, excluding transition bonds, as a percentage of its total
capitalization to 68%. CERC Corp.'s bank facility and its receivables facility
limit
34
CERC's debt as a percentage of its total capitalization to 60% and contain an
earnings before interest, taxes, depreciation and amortization (EBITDA) to
interest covenant. Our $2.3 billion credit facility: limits dividend payments as
described above; contains a debt to EBITDA covenant; contains an EBITDA to
interest covenant; and provides that, until such time as the credit facility has
been reduced to $750 million, all of the net cash proceeds from any
securitizations relating to the recovery of the true-up components, after making
any payments required under CenterPoint Houston's term loan, and the net cash
proceeds of any sales of the common stock of Texas Genco that we own, or of
material portions of Texas Genco's assets, shall be applied to repay borrowings
under our credit facility and reduce the amount available under the credit
facility. These facilities include certain restrictive covenants. We and our
subsidiaries are in compliance with such covenants.
We are a registered public utility holding company under the 1935 Act. The
1935 Act and related rules and regulations impose a number of restrictions on
our activities and those of our subsidiaries. The 1935 Act, among other things,
limits our ability and the ability of our regulated subsidiaries to issue debt
and equity securities without prior authorization, restricts the source of
dividend payments to current and retained earnings without prior authorization,
regulates sales and acquisitions of certain assets and businesses and governs
affiliate transactions.
The June 2003 Financing Order is effective until June 30, 2005.
Additionally, we have received several subsequent orders which provide
additional financing authority. These orders establish limits on the amount of
external debt and equity securities that can be issued by us and our regulated
subsidiaries without additional authorization but generally permit us to
refinance our existing obligations and those of our subsidiaries. Each of us and
our subsidiaries is in compliance with the authorized limits. Discussed below
are the incremental amounts of debt and equity that we are authorized to issue
after giving effect to our capital markets transactions in 2003 and the first
four months of 2004. The orders also permit utilization of undrawn credit
facilities at CenterPoint Energy and CERC. As of April 30, 2004:
- CenterPoint Energy is authorized to issue an additional aggregate
$250 million of preferred stock, preferred securities and
equity-linked securities, $291 million of debt and 198 million
shares of common stock;
- CenterPoint Houston is authorized to issue an additional aggregate
$46 million of debt and an aggregate $250 million of preferred stock
and preferred securities; and
- CERC is authorized to issue an additional $2 million of debt and an
additional aggregate $250 million of preferred stock and preferred
securities.
The SEC has reserved jurisdiction over, and must take further action to
permit, the issuance of $478 million of additional debt at CenterPoint Energy,
$430 million of additional debt at CERC and $250 million of additional debt at
CenterPoint Houston.
The orders require that if we or any of our regulated subsidiaries issue
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 the issuer and of CenterPoint Energy must be
rated investment grade by at least one NRSRO. The orders also contain certain
requirements for interest rates, maturities, issuance expenses and use of
proceeds.
The 1935 Act limits the payment of dividends to payment from current and
retained earnings unless specific authorization is obtained to pay dividends
from other sources. The SEC has reserved jurisdiction over payment of $500
million of dividends from CenterPoint Energy's unearned surplus or capital.
Further authorization would be required to make those payments. As of March 31,
2004, we had a retained deficit on our Consolidated Balance Sheets. We expect to
pay dividends out of current earnings. If as a result of the 2004 True-Up
Proceeding or the monetization of our remaining interest in Texas Genco we are
required to take a charge against our net income, our current earnings could be
reduced below the level that would enable us to pay the quarterly dividend on
our common stock under our current SEC financing order. We have filed an
application with the SEC under the 1935 Act requesting an order authorizing us
to pay dividends in the second and third quarters of 2004 out of capital or
unearned surplus in the event that we are required to take such a charge against
earnings. The June 2003 Financing Order requires that CenterPoint Houston and
CERC maintain a ratio of common equity to total capitalization of thirty percent
(30%).
35
Security Interests in Receivables of RRI. Pursuant to a Master Power
Purchase and Sale Agreement with a subsidiary of RRI related to power sales in
the Electric Reliability Council of Texas (ERCOT) market, Texas Genco has been
granted a security interest in accounts receivable and/or notes associated with
the accounts receivable of certain subsidiaries of RRI to secure up to $250
million in purchase obligations.
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one that is both important to the
presentation of our financial condition and results of operations and requires
management to make difficult, subjective or complex accounting estimates. An
accounting estimate is an approximation made by management of a financial
statement element, item or account in the financial statements. Accounting
estimates in our historical consolidated financial statements measure the
effects of past business transactions or events, or the present status of an
asset or liability. The accounting estimates described below require us to make
assumptions about matters that are highly uncertain at the time the estimate is
made. Additionally, different estimates that we could have used or changes in an
accounting estimate that are reasonably likely to occur could have a material
impact on the presentation of our financial condition or results of operations.
The circumstances that make these judgments difficult, subjective and/or complex
have to do with the need to make estimates about the effect of matters that are
inherently uncertain. Estimates and assumptions about future events and their
effects cannot be predicted with certainty. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments. These estimates may change as new events occur, as more experience is
acquired, as additional information is obtained and as our operating environment
changes. Our significant accounting policies are discussed in Note 2 to the
CenterPoint Energy Notes. We believe the following accounting policies involve
the application of critical accounting estimates. Accordingly, these accounting
estimates have been reviewed and discussed with the audit committee of the board
of directors.
ACCOUNTING FOR RATE REGULATION
SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation"
(SFAS No. 71), provides that rate-regulated entities account for and report
assets and liabilities consistent with the recovery of those incurred costs in
rates if the rates established are designed to recover the costs of providing
the regulated service and if the competitive environment makes it probable that
such rates can be charged and collected. Application of SFAS No. 71 to the
electric generation portion of our business was discontinued as of June 30,
1999. Our Electric Transmission & Distribution business continues 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. Significant accounting estimates embedded within the application of
SFAS No. 71 with respect to our Electric Transmission & Distribution business
segment relate to $3.3 billion of recoverable electric generation-related
regulatory assets as of March 31, 2004. These costs are recoverable under the
provisions of the Texas electric restructuring law. The ultimate amount of 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 the
regulatory recovery mechanism currently in place could result in a material
write-down of these regulatory assets.
IMPAIRMENT OF LONG-LIVED ASSETS AND INTANGIBLES
We review the carrying value of our long-lived assets, including goodwill
and identifiable intangibles, whenever events or changes in circumstances
indicate that such carrying values may not be recoverable, and annually for
goodwill as required by SFAS No. 142, "Goodwill and Other Intangible Assets." No
impairment of goodwill was indicated based on our analysis as of January 1,
2004. Unforeseen events and changes in circumstances and market conditions and
material differences in the value of long-lived assets and intangibles due to
changes in estimates of future cash flows, regulatory matters and operating
costs could negatively affect the fair value of our assets and result in an
impairment charge.
36
Fair value is the amount at which the asset could be bought or sold in a
current transaction between willing parties and may be estimated using a number
of techniques, including quoted market prices or valuations by third parties,
present value techniques based on estimates of cash flows, or multiples of
earnings or revenue performance measures. The fair value of the asset could be
different using different estimates and assumptions in these valuation
techniques.
We have engaged a financial advisor to assist in exploring alternatives
for monetizing our 81% interest in Texas Genco, including possible sale of our
ownership interest in Texas Genco. As a result of our intention to monetize our
interest in Texas Genco, we performed an impairment analysis of Texas Genco's
assets as of December 31, 2003 in accordance with the provisions of SFAS No.
144. As of December 31, 2003 no impairment had been indicated. The fair value of
our Texas Genco assets could be materially affected by a change in the estimated
future cash flows for these assets. We estimate future cash flows for Texas
Genco using a probability-weighted approach based on the fair value of its
common stock, operating projections and estimates of how long we will retain
these assets. Changes in any of these assumptions, including the timing of a
possible sale, could result in an impairment charge.
UNBILLED ENERGY REVENUES
Revenues related to the sale and/or delivery of electricity or natural gas
(energy) are generally recorded when energy is delivered to customers. However,
the determination of energy sales 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 energy 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. Unbilled natural gas sales are
estimated based on estimated purchased gas volumes, estimated lost and
unaccounted for gas and tariffed rates in effect. As additional information
becomes available, or actual amounts are determinable, the recorded estimates
are revised. Consequently, operating results can be affected by revisions to
prior accounting estimates.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 4 to the Interim Financial Statements for a discussion of new
accounting pronouncements that affect us.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
COMMODITY PRICE RISK
We assess the risk of our non-trading derivatives (Energy Derivatives)
using a sensitivity analysis method.
The sensitivity analysis performed on our Energy Derivatives measures the
potential loss based on a hypothetical 10% movement in energy prices. A decrease
of 10% in the market prices of energy commodities from their March 31, 2004
levels would have decreased the fair value of our Energy Derivatives from their
levels on that date by $34 million.
The above analysis of the Energy Derivatives utilized for hedging purposes
does not include the favorable impact that the same hypothetical price movement
would have on our physical purchases and sales of natural gas to which the
hedges relate. The Energy Derivative portfolio is managed to complement the
physical transaction portfolio, reducing overall risks within limits. Therefore,
the adverse impact to the fair value of the portfolio of Energy Derivatives held
for hedging purposes associated with the hypothetical changes in commodity
prices referenced above would be offset by a favorable impact on the underlying
hedged physical transactions.
INTEREST RATE RISK
We have outstanding long-term debt, bank loans, mandatory redeemable
preferred securities of subsidiary trusts holding solely our junior subordinated
debentures (Trust Preferred Securities), securities held in our nuclear
decommissioning trusts, some lease obligations and our obligations under the
ZENS that subject us to the risk of loss associated with movements in market
interest rates.
37
Our floating-rate obligations to third parties aggregated $3 billion at
March 31, 2004. If the floating rates were to increase by 10% from March 31,
2004 rates, our combined interest expense to third parties would increase by a
total of $2 million each month in which such increase continued.
At March 31, 2004, we had outstanding fixed-rate debt (excluding indexed
debt securities) and trust preferred securities aggregating $8 billion in
principal amount and having a fair value of $8 billion. These instruments are
fixed-rate and, therefore, do not expose us to the risk of loss in earnings due
to changes in market interest rates. However, the fair value of these
instruments would increase by approximately $405 million if interest rates were
to decline by 10% from their levels at March 31, 2004. In general, such an
increase in fair value would impact earnings and cash flows only if we were to
reacquire all or a portion of these instruments in the open market prior to
their maturity.
As discussed in Note 12(e) to the CenterPoint Energy Notes, which note is
incorporated herein by reference, CenterPoint Houston contributes $2.9 million
per year to trusts established to fund Texas Genco's share of the
decommissioning costs for the South Texas Project. The securities held by the
trusts for decommissioning costs had an estimated fair value of $201 million as
of March 31, 2004, of which approximately 36% were debt securities that subject
us to risk of loss of fair value with movements in market interest rates. If
interest rates were to increase by 10% from their levels at March 31, 2004, the
fair value of the fixed-rate debt securities would decrease by approximately $1
million. Any unrealized gains or losses are accounted for as a long-term
asset/liability as we will not benefit from any gains, and losses will be
recovered through the rate making process. For further discussion regarding the
recovery of decommissioning costs pursuant to the Texas electric restructuring
law, please read Note 4(a) to the CenterPoint Energy Notes, which is
incorporated herein by reference.
As discussed in Note 7 to the CenterPoint Energy Notes, which note is
incorporated herein by reference, upon adoption of SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS No. 133), effective January
1, 2001, the ZENS obligation was bifurcated into a debt component and a
derivative component. The debt component of $106 million at March 31, 2004 is a
fixed-rate obligation and, therefore, does not expose us to the risk of loss in
earnings due to changes in market interest rates. However, the fair value of the
debt component would increase by approximately $16 million if interest rates
were to decline by 10% from levels at March 31, 2004. Changes in the fair value
of the derivative component will be recorded in our Statements of Consolidated
Income and, therefore, we are exposed to changes in the fair value of the
derivative component as a result of changes in the underlying risk-free interest
rate. If the risk-free interest rate were to increase by 10% from March 31, 2004
levels, the fair value of the derivative component would increase by
approximately $5 million, which would be recorded as a loss in our Statements of
Consolidated Income.
EQUITY MARKET VALUE RISK
We are exposed to equity market value risk through our ownership of 21.6
million shares of TW common stock, which we hold to facilitate our ability to
meet our obligations under the ZENS. Please read Note 7 to the CenterPoint
Energy Notes for a discussion of the effect of adoption of SFAS No. 133 on our
ZENS obligation and our historical accounting treatment of our ZENS obligation.
A decrease of 10% from the March 31, 2004 market value of Time Warner common
stock would result in a net loss of approximately $3 million, which would be
recorded as a loss in our Statements of Consolidated Income.
As discussed above under " -- Interest Rate Risk," CenterPoint Houston
contributes to trusts established to fund Texas Genco's share of the
decommissioning costs for the South Texas Project, which held debt (36%) and
equity (64%) securities as of March 31, 2004. The equity securities expose us to
losses in fair value. If the market prices of the individual equity securities
were to decrease by 10% from their levels at March 31, 2004, the resulting loss
in fair value of these securities would be approximately $13 million. Currently,
the risk of an economic loss is mitigated as discussed above under " -- Interest
Rate Risk."
38
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 March 31, 2004 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 March 31, 2004 that has materially
affected, or is reasonably likely to materially affect, our internal controls
over financial reporting.
39
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a description of certain legal and regulatory proceedings affecting
CenterPoint Energy, please read Notes 5 and 11 to our Interim Financial
Statements, "Business -- Regulation" and " -- Environmental Matters" in Item 1
of the CenterPoint Energy 10-K, "Legal Proceedings" in Item 3 of the CenterPoint
Energy Form 10-K and Notes 4 and 12 to the CenterPoint Energy Notes, each of
which is incorporated herein by reference.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER REPURCHASES OF EQUITY
SECURITIES
The following table provides information about purchases by or on behalf
of CenterPoint Energy and its affiliated purchasers during the quarter ended
March 31, 2004 of its common stock. These purchases are related to CenterPoint
Energy's discretionary matching contributions under the CenterPoint Energy, Inc.
Savings Plan.
(a) (b) (c) (d)
TOTAL NUMBER MAXIMUM
OF SHARES (OR NUMBER (OR
UNITS) APPROXIMATE
PURCHASED AS DOLLAR VALUE) OF
TOTAL PART OF SHARES (OR UNITS)
NUMBER OF AVERAGE PRICE PUBLICLY THAT MAY YET BE
SHARES (OR PAID PER ANNOUNCED PURCHASED
UNITS) SHARE (OR PLANS OR UNDER THE PLANS
PERIOD PURCHASED UNIT) PROGRAMS OR PROGRAMS
- ---------- ---------- ------------- ------------- ----------------
01/01/04 -
01/31/04 -- -- -- --
02/01/04 -
02/29/04 -- -- -- --
03/01/04 -
03/31/04 850,877(1) $11.0613 -- --
- ----------
(1) The shares indicated were purchased by the trustee of the Savings Plan in
open-market transactions and are included because they were purchased to
fund benefits to employees established by CenterPoint Energy on a
discretionary basis. An additional 576,317 shares for the discretionary
matching contributions were allocated to plan participants as a result of
the repayment of a loan to a related leveraged Employee Stock Ownership Plan
using cash contributions from CenterPoint Energy at an average price per
share of $10.3751. Shares purchased to fund acquisitions from employee
contributions and non-discretionary matching contributions have been
regarded as purchased on behalf of plan participants and are not included in
the table.
40
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
The following exhibits are filed herewith:
Exhibits not incorporated by reference to a prior filing are designated by
a cross (+); all exhibits not so designated are incorporated by reference
to a prior filing of CenterPoint Energy, Inc.
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
- ------ ----------- -------------------------------- ------ ---------
3.1.1 -- Amended and Restated Articles of CenterPoint Energy's Registration Statement 3-69502 3.1
Incorporation of CenterPoint Energy on Form S-4
3.1.2 -- Articles of Amendment to Amended and
Restated Articles of Incorporation of CenterPoint Energy's Form 10-K for the year 1-31447 3.1.1
CenterPoint Energy ended December 31, 2001
3.2 -- Amended and Restated Bylaws of CenterPoint Energy's Form 10-K for the year 1-31447 3.2
CenterPoint Energy ended December 31, 2001
3.3 -- Statement of Resolution Establishing
Series of Shares designated Series A CenterPoint Energy's Form 10-K for the year 1-31447 3.3
Preferred Stock of CenterPoint Energy ended December 31, 2001
4.1 -- Form of CenterPoint Energy Stock CenterPoint Energy's Registration Statement 3-69502 4.1
Certificate on Form S-4
4.2 -- Rights Agreement dated January 1,
2002, between CenterPoint Energy and CenterPoint Energy's Form 10-K for the year 1-31447 4.2
JPMorgan Chase Bank, as Rights Agent ended December 31, 2001
Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, CenterPoint Energy
has not filed as exhibits to this Form 10-Q certain long-term debt instruments,
including indentures, under which the total amount of securities authorized does
not exceed 10% of the total assets of CenterPoint Energy and its subsidiaries on
a consolidated basis. CenterPoint Energy hereby agrees to furnish a copy of any
such instrument to the SEC upon request.
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
- ------ ----------- -------------------------------- ------ ---------
10.1.1 -- $1,310,000,000 Credit Agreement dated CenterPoint Energy's Form 10-K for the year
as of November 12, 2002, among ended December 31, 2002 1-31447 4(g)(1)
CenterPoint Houston and the banks named
therein
10.1.2 -- First Amendment to Exhibit 10.1.1, CenterPoint Energy's Form 10-Q for the 1-31447 10.7
dated as of September 3, 2003 quarter ended September 30, 2003
41
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
- ------ ----------- -------------------------------- ------ ---------
10.1.3 -- Pledge Agreement, dated as of November
12, 2002 executed in connection with CenterPoint Energy's Form 10-K for the year
Exhibit 10.1.1 ended December 31, 2002 1-31447 4(g)(2)
10.2 -- $250,000,000 Credit Agreement, dated as
of March 23, 2004, among CERC Corp., as CenterPoint Energy's Form 8-K dated March 31,
Borrower, and the Initial Lenders named 2004 1-31447 4.1
therein, as Initial Lenders
10.3.1 -- Credit Agreement, dated as of October
7, 2003 among CenterPoint Energy and CenterPoint Energy's Form 10-Q for the 1-31447 10.8
the banks named therein quarter ended September 30, 2003
10.3.2 -- Pledge Agreement, dated as of October
7, 2003, executed in connection with CenterPoint Energy's Form 10-Q for the 1-31447 10.9
Exhibit 10.3.1 quarter ended September 30, 2003
10.4.1 -- $75,000,000 revolving credit facility
dated as of December 23, 2003 among CenterPoint Energy's Form 10-K for the year
Texas Genco, LP and the banks named ended December 31, 2003 1-31447 10(pp)(1)
therein
+31.1 -- Rule 13a-14(a)/15d-14(a) Certification
of David M. McClanahan
+31.2 -- Rule 13a-14(a)/15d-14(a) Certification
of Gary L. Whitlock
+32.1 -- Section 1350 Certification of David M.
McClanahan
+32.2 -- Section 1350 Certification of Gary L.
Whitlock
+99.1 -- Items incorporated by reference from
the CenterPoint Energy Form 10-K. Item
1 "Business -- Regulation," " --
Environmental Matters," " -- Risk
Factors," Item 3 "Legal Proceedings,"
Item 7 "Management's Discussion and
Analysis of Financial Condition and
Results of Operations -- Certain
Factors Affecting Future Earnings" and
Notes 2(d) (Long-Lived Assets and
Intangibles), 2(e) (Regulatory Assets
and Liabilities), 4 (Regulatory
Matters), 5 (Derivative Instruments), 7
(Indexed Debt Securities (ZENS) and
Time Warner Securities), 10(b) (Pension
and Postretirement Benefits) and 12
(Commitments and Contingencies)
(b) Reports on Form 8-K.
On January 29, 2004, we filed a Current Report on Form 8-K dated January
23, 2004 to report that Reliant Energy, Inc. (formerly named Reliant Resources,
Inc. (RRI)) notified us it would not exercise its option to purchase our 81%
interest in Texas Genco.
42
On February 12, 2004, we filed a Current Report on Form 8-K dated February
12, 2004, in which we reported certain fourth quarter and full year 2003
earnings information and furnished a press release under Item 12 of that form.
On March 3, 2004, we filed a Current Report on Form 8-K dated March 3,
2004 to furnish under Item 9 of that form a slide presentation we expect will be
presented to various members of the financial and investment community from time
to time.
On March 10, 2004, we filed a Current Report on Form 8-K dated March 4,
2004 to report the administrative law judge's recommendation regarding
CenterPoint Houston's final fuel reconciliation proceeding and its effect on our
previously reported 2003 earnings.
On April 1, 2004, we filed a Current Report on Form 8-K dated March 31,
2004 to report that CERC Corp. had entered into a new three-year, $250 million
credit agreement with a group of lenders.
On April 1, 2004, we filed a Current Report on Form 8-K dated April 1,
2004 to report that CenterPoint Houston, Texas Genco LP and Reliant Energy
Retail Services LLC filed the final true-up application required by the 1999
Texas Electric Choice Law with the Texas Utility Commission. A slide showing the
components of the true-up balance for CenterPoint Energy was furnished under
Item 9 of that form.
On April 1, 2004, we filed a Current Report on Form 8-K dated April 1,
2004 to furnish under Item 9 of that form a slide presentation we expect will be
presented to various members of the financial and investment community from time
to time.
On April 22, 2004, we filed a Current Report on Form 8-K dated April 22,
2004, in which we reported certain first quarter 2004 earnings information and
furnished a press release under Item 12 of that form.
43
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CENTERPOINT ENERGY, INC.
By: /s/ James S. Brian
-------------------------------
James S. Brian
Senior Vice President and Chief
Accounting Officer
Date: May 7, 2004
44
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, Inc.
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
- ------ ----------- -------------------------------- ------ ---------
3.1.1 -- Amended and Restated Articles of CenterPoint Energy's Registration Statement 3-69502 3.1
Incorporation of CenterPoint Energy on Form S-4
3.1.2 -- Articles of Amendment to Amended and
Restated Articles of Incorporation of CenterPoint Energy's Form 10-K for the year 1-31447 3.1.1
CenterPoint Energy ended December 31, 2001
3.2 -- Amended and Restated Bylaws of CenterPoint Energy's Form 10-K for the year 1-31447 3.2
CenterPoint Energy ended December 31, 2001
3.3 -- Statement of Resolution Establishing
Series of Shares designated Series A CenterPoint Energy's Form 10-K for the year 1-31447 3.3
Preferred Stock of CenterPoint Energy ended December 31, 2001
4.1 -- Form of CenterPoint Energy Stock CenterPoint Energy's Registration Statement 3-69502 4.1
Certificate on Form S-4
4.2 -- Rights Agreement dated January 1,
2002, between CenterPoint Energy and CenterPoint Energy's Form 10-K for the year 1-31447 4.2
JPMorgan Chase Bank, as Rights Agent ended December 31, 2001
Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, CenterPoint Energy
has not filed as exhibits to this Form 10-Q certain long-term debt instruments,
including indentures, under which the total amount of securities authorized does
not exceed 10% of the total assets of CenterPoint Energy and its subsidiaries on
a consolidated basis. CenterPoint Energy hereby agrees to furnish a copy of any
such instrument to the SEC upon request.
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
- ------ ----------- -------------------------------- ------ ---------
10.1.1 -- $1,310,000,000 Credit Agreement dated CenterPoint Energy's Form 10-K for the year
as of November 12, 2002, among ended December 31, 2002 1-31447 4(g)(1)
CenterPoint Houston and the banks named
therein
10.1.2 -- First Amendment to Exhibit 10.1.1, CenterPoint Energy's Form 10-Q for the 1-31447 10.7
dated as of September 3, 2003 quarter ended September 30, 2003
SEC FILE
OR
EXHIBIT REGISTRATION EXHIBIT
NUMBER DESCRIPTION REPORT OR REGISTRATION STATEMENT NUMBER REFERENCE
- ------ ----------- -------------------------------- ------ ---------
10.1.3 -- Pledge Agreement, dated as of November
12, 2002 executed in connection with CenterPoint Energy's Form 10-K for the year
Exhibit 10.1.1 ended December 31, 2002 1-31447 4(g)(2)
10.2 -- $250,000,000 Credit Agreement, dated as
of March 23, 2004, among CERC Corp., as CenterPoint Energy's Form 8-K dated March 31,
Borrower, and the Initial Lenders named 2004 1-31447 4.1
therein, as Initial Lenders
10.3.1 -- Credit Agreement, dated as of October
7, 2003 among CenterPoint Energy and CenterPoint Energy's Form 10-Q for the 1-31447 10.8
the banks named therein quarter ended September 30, 2003
10.3.2 -- Pledge Agreement, dated as of October
7, 2003, executed in connection with CenterPoint Energy's Form 10-Q for the 1-31447 10.9
Exhibit 10.3.1 quarter ended September 30, 2003
10.4.1 -- $75,000,000 revolving credit facility
dated as of December 23, 2003 among CenterPoint Energy's Form 10-K for the year
Texas Genco, LP and the banks named ended December 31, 2003 1-31447 10(pp)(1)
therein
+31.1 -- Rule 13a-14(a)/15d-14(a) Certification
of David M. McClanahan
+31.2 -- Rule 13a-14(a)/15d-14(a) Certification
of Gary L. Whitlock
+32.1 -- Section 1350 Certification of David M.
McClanahan
+32.2 -- Section 1350 Certification of Gary L.
Whitlock
+99.1 -- Items incorporated by reference from
the CenterPoint Energy Form 10-K. Item
1 "Business -- Regulation," " --
Environmental Matters," " -- Risk
Factors," Item 3 "Legal Proceedings,"
Item 7 "Management's Discussion and
Analysis of Financial Condition and
Results of Operations -- Certain
Factors Affecting Future Earnings" and
Notes 2(d) (Long-Lived Assets and
Intangibles), 2(e) (Regulatory Assets
and Liabilities), 4 (Regulatory
Matters), 5 (Derivative Instruments), 7
(Indexed Debt Securities (ZENS) and
Time Warner Securities), 10(b) (Pension
and Postretirement Benefits) and 12
(Commitments and Contingencies)