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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 SEPTEMBER 30, 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 incorporation or organization) (I.R.S. Employer Identification No.)
1111 LOUISIANA
HOUSTON, TEXAS 77002 (713) 207-1111
(Address and zip code of principal executive offices) (Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
As of November 1, 2004, CenterPoint Energy, Inc. had 307,821,461 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 SEPTEMBER 30, 2004
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................................................. 1
Statements of Consolidated Operations
Three Months and Nine Months Ended September 30, 2003 and 2004 (unaudited)....... 1
Consolidated Balance Sheets
December 31, 2003 and September 30, 2004 (unaudited)............................. 2
Statements of Consolidated Cash Flows
Nine Months Ended September 30, 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............................................................... 29
Item 3. Quantitative and Qualitative Disclosures about Market Risk........................ 47
Item 4. Controls and Procedures........................................................... 49
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................. 50
Item 6. Exhibits.......................................................................... 50
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, and any legal
proceeding relating thereto;
- - the successful consummation and the timing of the sale of our interest in
Texas Genco Holdings, Inc. (Texas Genco);
- - nonperformance by the counterparty to the master power purchase and sale
agreement that Texas Genco, LP, a subsidiary of Texas Genco, entered into
in connection with the sale of our interest in Texas Genco;
- - 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;
ii
- - inability of various counterparties 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;
- - 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 OPERATIONS
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2003 2004 2003 2004
------------ ----------- ----------- ------------
REVENUES......................................................... $ 1,607,934 $ 1,667,089 $ 5,672,592 $ 5,892,879
------------ ----------- ------------ ------------
EXPENSES:
Fuel and cost of gas sold...................................... 681,888 928,189 3,073,652 3,700,679
Operation and maintenance...................................... 298,814 317,486 910,274 928,556
Depreciation and amortization.................................. 119,472 125,528 350,547 361,820
Taxes other than income taxes.................................. 90,129 89,151 260,889 269,315
------------ ----------- ------------ ------------
Total...................................................... 1,190,303 1,460,354 4,595,362 5,260,370
------------ ----------- ------------ ------------
OPERATING INCOME................................................. 417,631 206,735 1,077,230 632,509
------------ ----------- ------------ ------------
OTHER INCOME (EXPENSE):
Gain (loss) on Time Warner investment.......................... (21,207) (31,161) 43,497 (40,033)
Gain (loss) on indexed debt securities......................... 17,040 34,117 (38,510) 43,240
Interest and other finance charges............................. (173,822) (182,701) (501,107) (554,658)
Interest on transition bonds................................... (9,811) (9,495) (29,495) (28,716)
Other, net..................................................... 2,688 1,310 11,846 15,243
------------ ----------- ------------ ------------
Total...................................................... (185,112) (187,930) (513,769) (564,924)
------------ ----------- ------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND
EXTRAORDINARY LOSS............................................. 232,519 18,805 563,461 67,585
Income Tax Expense............................................. (85,544) (2,174) (201,699) (24,781)
------------ ----------- ------------ ------------
INCOME FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY LOSS ..... 146,975 16,631 361,762 42,804
DISCONTINUED OPERATIONS:
Income from Texas Genco, net of tax............................ 51,753 108,768 104,580 240,689
Minority Interest in Income from Texas Genco................... (15,694) (21,852) (38,799) (48,707)
Loss on Disposal of Texas Genco, net of tax................... -- (346,127) -- (346,127)
Loss from Other Operations, net of tax......................... (1,212) -- (2,077) --
Loss on Disposal of Other Operations, net of tax.............. (97) -- (12,086) --
------------ ----------- ------------ ------------
Total...................................................... 34,750 (259,211) 51,618 (154,145)
EXTRAORDINARY LOSS, NET OF TAX .................................. -- (893,618) -- (893,618)
------------ ----------- ------------ ------------
NET INCOME (LOSS)................................................ $ 181,725 $ (1,136,198) $ 413,380 $ (1,004,959)
============ ============ ============ ============
BASIC EARNINGS PER SHARE:
Income from Continuing Operations.............................. $ 0.48 $ 0.05 $ 1.19 $ 0.14
Income (Loss) from Discontinued Operations..................... 0.12 (0.84) 0.17 (0.50)
Extraordinary Loss, net of tax................................. -- (2.90) -- (2.91)
------------ ----------- ------------ ------------
Net Income (Loss).............................................. $ 0.60 $ (3.69) $ 1.36 $ (3.27)
============ ============ ============ ============
DILUTED EARNINGS PER SHARE:
Income from Continuing Operations.............................. $ 0.48 $ 0.05 $ 1.18 $ 0.14
Income (Loss) from Discontinued Operations..................... 0.11 (0.83) 0.17 (0.50)
Extraordinary Loss, net of tax................................. -- (2.88) -- (2.89)
------------ ----------- ------------ ------------
Net Income (Loss).............................................. $ 0.59 $ (3.66) $ 1.35 $ (3.25)
============ ============ ============ ============
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, SEPTEMBER 30,
2003 2004
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents................................................ $ 86,922 $ 20,202
Investment in Time Warner common stock................................... 389,302 349,256
Accounts receivable, net................................................. 566,260 600,523
Accrued unbilled revenues................................................ 395,351 188,246
Fuel stock............................................................... 160,368 241,696
Materials and supplies................................................... 82,867 76,612
Non-trading derivative assets............................................ 45,897 89,677
Taxes receivable......................................................... 228,746 229,065
Prepaid expenses......................................................... 21,926 12,018
Other.................................................................... 77,227 100,991
Current assets of discontinued operations................................ 301,765 606,018
-------------- --------------
Total current assets................................................... 2,356,631 2,514,304
-------------- --------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment............................................ 10,569,517 10,830,910
Less accumulated depreciation and amortization........................... (2,484,593) (2,708,119)
-------------- --------------
Property, plant and equipment, net..................................... 8,084,924 8,122,791
-------------- --------------
OTHER ASSETS:
Goodwill, net............................................................ 1,740,510 1,740,510
Other intangibles, net................................................... 59,111 58,266
Regulatory assets........................................................ 4,930,793 3,227,201
Non-trading derivative assets............................................ 11,273 25,325
Other.................................................................... 335,552 323,048
Non-current assets of discontinued operations............................ 3,942,296 3,574,598
-------------- --------------
Total other assets..................................................... 11,019,535 8,948,948
-------------- --------------
TOTAL ASSETS......................................................... $ 21,461,090 $ 19,586,043
============== ==============
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, SEPTEMBER 30,
2003 2004
-------------- --------------
CURRENT LIABILITIES:
Short-term borrowings................................................... $ 63,135 $ 1,828
Current portion of transition bond long-term debt....................... 41,189 46,806
Current portion of other long-term debt................................. 119,603 488,586
Indexed debt securities derivative...................................... 321,352 278,103
Accounts payable........................................................ 588,883 445,183
Taxes accrued........................................................... 154,916 141,685
Interest accrued........................................................ 164,521 149,961
Non-trading derivative liabilities...................................... 8,036 9,299
Regulatory liabilities.................................................. 186,239 217,846
Accumulated deferred income taxes, net.................................. 345,870 365,125
Other................................................................... 276,392 274,343
Current liabilities of discontinued operations.......................... 332,125 353,947
-------------- --------------
Total current liabilities............................................. 2,602,261 2,772,712
-------------- --------------
OTHER LIABILITIES:
Accumulated deferred income taxes, net.................................. 2,166,032 1,851,670
Unamortized investment tax credits...................................... 61,197 55,567
Non-trading derivative liabilities...................................... 3,330 11,919
Benefit obligations..................................................... 818,061 749,250
Regulatory liabilities.................................................. 1,358,030 1,114,515
Other................................................................... 457,255 258,091
Non-current liabilities of discontinued operations...................... 1,277,760 1,461,097
-------------- --------------
Total other liabilities............................................... 6,141,665 5,502,109
-------------- --------------
LONG-TERM DEBT:
Transition bonds........................................................ 675,665 628,893
Other................................................................... 10,102,269 9,826,790
-------------- --------------
Total long-term debt.................................................. 10,777,934 10,455,683
-------------- --------------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 11)
MINORITY INTEREST IN DISCONTINUED OPERATIONS............................... 178,673 215,953
SHAREHOLDERS' EQUITY:
Common stock (305,385,434 shares and 307,771,218 shares outstanding
at December 31, 2003 and September 30, 2004, respectively)............ 3,063 3,078
Additional paid-in capital.............................................. 2,868,416 2,888,485
Unearned ESOP stock..................................................... (2,842) --
Retained deficit........................................................ (700,033) (1,797,041)
Accumulated other comprehensive loss.................................... (408,047) (454,936)
-------------- --------------
Total shareholders' equity............................................ 1,760,557 639,586
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.......................... $ 21,461,090 $ 19,586,043
============== ==============
See Notes to the Company's Interim Financial Statements
3
CENTERPOINT ENERGY, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------------
2003 2004
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)....................................................... $ 413,380 $ (1,004,959)
Discontinued operations................................................. (51,618) 154,145
Extraordinary loss...................................................... -- 893,618
-------------- --------------
Income from continuing operations before extraordinary loss............. 361,762 42,804
Adjustments to reconcile income from continuing operations to net
cash provided by operating activities:
Depreciation and amortization......................................... 350,547 361,820
Amortization of deferred financing costs.............................. 44,400 63,173
Deferred income taxes................................................. 317,070 105,186
Investment tax credit................................................. (3,919) (5,630)
Unrealized loss (gain) on Time Warner investment...................... (43,497) 40,033
Unrealized loss (gain) on indexed debt securities..................... 38,510 (43,240)
Changes in other assets and liabilities:
Accounts receivable and unbilled revenues, net...................... 230,822 345,217
Inventory........................................................... (76,550) (75,073)
Taxes receivable.................................................... (133,575) (319)
Accounts payable.................................................... (185,056) (143,846)
Fuel cost over (under) recovery/surcharge........................... 4,683 (10,812)
Non-trading derivatives, net........................................ (22,670) (19,486)
Interest and taxes accrued.......................................... (4,587) (27,829)
Net regulatory assets and liabilities............................... (667,796) (253,335)
Other current assets................................................ (10,202) (5,489)
Other current liabilities........................................... (42,086) 2,220
Other assets........................................................ 55,766 (11,968)
Other liabilities................................................... 32,486 (41,391)
Other, net............................................................ 22,507 17,268
-------------- --------------
Net cash provided by operating activities......................... 268,615 339,303
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.................................................... (352,178) (358,757)
Other, net.............................................................. 1,222 5,893
-------------- --------------
Net cash used in investing activities............................. (350,956) (352,864)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in short-term borrowings, net.................................. (292,000) (63,000)
Long-term revolving credit facility, net................................ (1,993,186) 358,500
Proceeds from long-term debt............................................ 3,381,529 231,564
Payments of long-term debt.............................................. (1,049,883) (545,080)
Debt issuance costs..................................................... (196,543) (13,441)
Payment of common stock dividends....................................... (91,609) (92,110)
Proceeds from issuance of common stock, net............................. 6,897 9,756
Other, net.............................................................. 4,568 --
-------------- --------------
Net cash used in financing activities............................... (230,227) (113,811)
-------------- --------------
NET CASH PROVIDED BY DISCONTINUED OPERATIONS.............................. 43,264 60,652
-------------- --------------
NET DECREASE IN CASH AND CASH EQUIVALENTS................................. (269,304) (66,720)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.......................... 303,704 86,922
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD................................ $ 34,400 $ 20,202
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest................................................................ $ 608,903 $ 571,553
Income taxes (refunds).................................................. (35,499) (16,752)
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, until the completion of the pending sale of the subsidiary owner,
electric generating stations. 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.
As of September 30, 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, a
wholesale gas company and gas gathering systems and provides various
ancillary services.
CenterPoint Energy also has an approximately 81% ownership interest in
Texas Genco Holdings, Inc. (Texas Genco), which owns and operates a portfolio of
generating assets located in Texas. On July 21, 2004, the Company and Texas
Genco entered into a definitive agreement for the sale of the Company's 81%
ownership interest in Texas Genco. For further discussion, see Note 2.
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) DISCONTINUED OPERATIONS
Texas Genco. As discussed in Note 1, on July 21, 2004, the Company and
Texas Genco entered into a definitive transaction agreement pursuant to which
Texas Genco has agreed to be acquired in a multi-step transaction by GC Power
Acquisition LLC (GC Power Acquisition), a newly formed entity owned in equal
parts by investment funds affiliated with The Blackstone Group, Hellman &
Friedman LLC, Kohlberg, Kravis Roberts & Co. L.P. and Texas Pacific Group, for
approximately $3.65 billion in cash.
The Interim Financial Statements present these 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 all
periods presented.
The transaction will be accomplished in two steps. In the first step,
expected to be completed in the fourth quarter of 2004, Texas Genco will
purchase the approximately 19% of its shares owned by the public (other than
shares held by shareholders who validly perfect their dissenters' rights under
Texas law) in a cash-out merger at a price of $47.00 per share, without interest
and less any applicable withholding taxes (Public Company Merger). In connection
with the anticipated Public Company Merger, Texas Genco has filed with the SEC a
Rule 13e-3 transaction statement and a preliminary information statement on
Schedule 14C containing information with respect to the transactions
contemplated by the definitive transaction agreement, including the Public
Company Merger, and related matters. Following the Public Company Merger, a
subsidiary of Texas Genco that will own Texas Genco's coal, lignite and
gas-fired generation plants will merge with a subsidiary of GC Power
Acquisition. The closing of the first step of the transaction is subject to
several conditions, including the mailing of a definitive information statement
to Texas Genco's shareholders at least 20 days prior to the closing of the
Public Company Merger, the receipt of debt financing under the financing
commitments described below, the expiration or termination of any applicable
waiting period under the antitrust laws (including the Hart Scott Rodino
Antitrust Improvement Act of 1976), which occurred on September 17, 2004, and
the Federal Energy Regulatory Commission's (FERC) certification of the entity
that will own Texas Genco's coal, lignite and gas-fired generation plants as an
"exempt wholesale generator," which occurred on September 24, 2004. The
definitive information statement will be mailed to Texas Genco's shareholders of
record as of October 21, 2004. Texas Genco's shareholders as of the effective
date of the Public Company Merger will have the right to either receive the cash
consideration for their shares described above or exercise dissenters' rights in
connection with the Public Company Merger by properly complying with the
requirements of the Texas Business Corporation Act. Within 10 days after the
effectiveness of
6
the Public Company Merger, Texas Genco must mail to all of its shareholders
written notice of the effectiveness of the Public Company Merger and of their
right to dissent from that transaction within 20 days after the date of Texas
Genco's mailing of the notice.
In the second step of the transaction, expected to take place in the first
half of 2005 following receipt of approval by the Nuclear Regulatory Commission
(NRC), for which the application was filed on October 18, 2004, Texas Genco, the
principal remaining asset of which, at that time, will be Texas Genco's interest
in the South Texas Project Electric Generating Station (South Texas Project),
will merge with another subsidiary of GC Power Acquisition.
Cash proceeds to the Company are expected to be approximately $2.2 billion
from the first step of the transaction and $700 million from the second step of
the transaction, for total cash proceeds of approximately $2.9 billion for the
Company's 81% interest. The Company intends to use the anticipated net after-tax
proceeds of approximately $2.5 billion primarily to pay down outstanding debt,
including senior debt under its bank credit facility that is secured in part by
the Company's 81% ownership interest in Texas Genco, and for other general
corporate purposes, including additional pension contributions.
GC Power Acquisition has entered into a commitment letter with financing
sources, including Goldman Sachs Credit Partners, L.P., providing for up to $2.5
billion in the aggregate in debt financing for the transaction and a separate
overnight loan of $717 million to Texas Genco to fund the Public Company Merger
in the first step of the transaction, each subject to customary closing
conditions. This overnight loan is expected to be repaid with the proceeds of
the merger of a subsidiary of Texas Genco that will own Texas Genco's coal,
lignite and gas-fired generation plants with a subsidiary of GC Power
Acquisition. In addition, GC Power Acquisition's sponsor firms have committed
upon closing of the transaction to provide up to $1.08 billion in the aggregate
in equity funding for the transaction.
The transaction has been approved by the board of directors of the Company
and by the board of directors of Texas Genco acting upon the unanimous
recommendation of a special committee composed of independent members of Texas
Genco's board. The Company has signed a written consent that satisfies all state
law voting requirements applicable to the transaction.
In connection with the transaction, Texas Genco, LP, a subsidiary of Texas
Genco (Genco LP), entered into a master power purchase and sale agreement with a
member of the Goldman Sachs group. Under that agreement, Genco LP has sold
forward a substantial quantity of its available base-load capacity through 2008
and pledged $175 million of its first mortgage bonds as collateral for its
obligations. Genco LP's obligations under the power purchase agreement will
continue regardless of whether the transaction is completed.
On July 23, 2004, two plaintiffs filed substantially identical lawsuits in
Harris County, Texas state district court. The suits, purportedly brought on
behalf of holders of Texas Genco common stock, name Texas Genco Holdings, Inc.
and each of that company's directors as defendants. Both plaintiffs allege,
among other things, self-dealing and breach of fiduciary duty by the defendants
in entering into the transaction agreement. As part of their allegations of
self-dealing, both plaintiffs claim that Texas Genco's board of directors is
controlled by the Company, that the defendants improperly concealed Texas
Genco's results of operations for the second quarter of 2004 until after the
transaction agreement was announced, and that in order to aid the Company, Texas
Genco's board only searched for acquirers who would offer all-cash
consideration. Among other relief, the plaintiffs seek to enjoin the transaction
or, alternatively, rescind the transaction to the extent already implemented. In
August 2004, the cases were consolidated in state district court in Harris
County, Texas. Texas Genco intends to vigorously defend against the consolidated
suits.
The Company recorded an after-tax loss of approximately $253 million in
the third quarter of 2004 related to the sale of Texas Genco and an additional
after-tax loss of $93 million offsetting the Company's 81% interest in Texas
Genco's third quarter 2004 earnings. Until the sale of Texas Genco is complete,
the Company's interest in any Texas Genco earnings will be offset by an
increased loss on the pending sale. As a result of the reduction in retained
earnings caused by after-tax losses associated with the sale of Texas Genco and
the Company's true-up proceeding, the Company and Utility Holding, LLC may need
to obtain an order from the SEC under the 1935 Act to facilitate the payment of
dividends to transfer the proceeds from the sale of Texas Genco to the Company.
7
The following table summarizes the components of the income (loss) from
discontinued operations of Texas Genco for the three and nine months ended
September 30, 2003 and 2004:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
(IN MILLIONS)
Texas Genco net income (loss) as reported................. $ 82 $ (311) $ 204 $ (170)
Texas Genco write down of assets, net of tax of $223 (1).. -- 426 -- 426
----------- ----------- ----------- -----------
Texas Genco net income as adjusted for write down of
assets.................................................. 82 115 204 256
General corporate overhead reclassification, net of tax (2) 4 3 14 10
Interest expense reclassification, net of tax (3)......... (34) (9) (113) (25)
----------- ----------- ----------- -----------
Income from discontinued operations of Texas Genco, net
of tax.................................................. 52 109 105 241
Minority interest in discontinued operations of Texas
Genco................................................... (16) (22) (39) (49)
----------- ----------- ----------- -----------
Income from discontinued operations of Texas Genco, net
of tax and minority interest............................ 36 87 66 192
----------- ----------- ----------- -----------
Loss on sale of Texas Genco, net of tax................... -- (253) -- (253)
Loss offsetting 81% of Texas Genco's third quarter 2004
earnings, net of tax................................... -- (93) -- (93)
----------- ----------- ----------- -----------
Loss on disposal of Texas Genco, net of tax............... -- (346) -- (346)
----------- ----------- ----------- -----------
Total Discontinued Operations of Texas Genco........ $ 36 $ (259) $ 66 $ (154)
=========== =========== =========== ===========
(1) In September 2004, Texas Genco recorded an after-tax impairment charge of
$426 million ($649 million pre-tax) related to the sale of its coal,
lignite and gas-fired generation plants which occurs in the first step of
the transaction pursuant to which Texas Genco is being acquired. This
impairment loss is reversed by CenterPoint Energy to reflect its estimated
loss on the sale of Texas Genco.
(2) General corporate overhead previously allocated to Texas Genco from
CenterPoint Energy, which will not be eliminated by the sale of Texas
Genco, was excluded from income from discontinued operations and is
reflected as general corporate overhead of CenterPoint Energy in income
from continuing operations.
(3) Interest expense was reclassified to discontinued operations of Texas
Genco related to the applicable amounts of CenterPoint Energy's term loan
and revolving credit facility debt that would have been assumed to be paid
off with any proceeds from the sale of Texas Genco during those respective
periods.
Revenues related to Texas Genco included in discontinued operations for
the three months ended September 30, 2003 and 2004 were $657 million and $638
million, respectively. Income (loss) from these discontinued operations for the
three months ended September 30, 2003 and 2004 is reported net of income tax
(benefit) of $42 million and $(164) million, respectively.
Revenues related to Texas Genco included in discontinued operations for
both the nine months ended September 30, 2003 and 2004 were $1.6 billion. Income
(loss) from these discontinued operations for the nine months ended September
30, 2003 and 2004 is reported net of income tax expense (benefit) of $48 million
and $(94) million, respectively.
8
Summarized balance sheet information as of December 31, 2003 and September
30, 2004 related to discontinued operations of Texas Genco is as follows:
DECEMBER 31, SEPTEMBER 30,
2003 2004
------------ ------------
(IN MILLIONS)
CURRENT ASSETS:
Cash and cash equivalents.............................................. $ 45 $ 337
Accounts receivable, principally trade................................. 82 98
Other current assets................................................... 175 171
------------ ------------
Total current assets................................................ 302 606
OTHER NON-CURRENT ASSETS................................................ 3,942 3,575
------------ ------------
TOTAL ASSETS........................................................ 4,244 4,181
------------ ------------
CURRENT LIABILITIES:
Accounts payable, principally trade.................................... 109 120
Other current liabilities.............................................. 223 234
------------ ------------
Total current liabilities........................................... 332 354
OTHER LONG-TERM LIABILITIES............................................. 1,278 1,461
------------ ------------
TOTAL LIABILITIES................................................... 1,610 1,815
MINORITY INTEREST....................................................... 179 216
------------ ------------
NET ASSETS OF DISCONTINUED OPERATIONS................................... $ 2,455 $ 2,150
============ ============
On September 3, 2004, Genco LP signed an agreement to purchase a portion
of AEP Texas Central Company's (AEP) 25.2% interest in the South Texas Project
for approximately $174 million. Once the purchase is complete, Genco LP will own
an additional 13.2% interest in the South Texas Project for a total of 44%, or
approximately 1,100 MW. This purchase agreement was entered into pursuant to
Genco LP's right of first refusal to purchase this interest triggered by AEP's
previously announced agreement to sell this interest to a third party. In
addition to AEP's ownership interest and Genco LP's current 30.8% ownership, the
2,500 MW nuclear plant is currently 28%-owned by City Public Service of San
Antonio and 16%-owned by Austin Energy. City Public Service of San Antonio is
purchasing AEP's remaining 12% ownership interest under its right of first
refusal. The sale is subject to certain regulatory approvals, including filing
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, and action by
the NRC, the FERC, and the SEC. Texas Genco expects to fund the purchase of its
share of AEP's interest, including reimbursements of draws under letters of
credit, with existing cash balances and cash expected to be generated through
operations. Texas Genco expects to complete this transaction by the end of the
first quarter of 2005.
In September 2004, Genco LP amended its $75 million senior secured
revolving credit facility to increase the facility to $250 million. The facility
is secured by Genco LP's first mortgage bonds. The revolving credit facility
terminates on the earlier of March 2, 2005 or the date of the consummation of
the sale of Texas Genco's coal, lignite and gas-fired generation assets to GC
Power Acquisition. As of September 30, 2004, there were no borrowings
outstanding under the revolving credit facility. As of September 30, 2004,
letters of credit aggregating $182 million were issued under the facility in
favor of AEP, and are expected to be drawn upon in the first quarter of 2005 to
pay the purchase price of an additional interest in the South Texas Project as
discussed above. The expiration date of the letters of credit is August 29,
2005. Under the terms of the credit facility, the letters of credit will be cash
collateralized at 105% of their face amount upon Texas Genco's sale of its coal,
lignite and gas-fired generation assets to GC Power Acquisition.
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 provided district
cooling services in the Houston central business district and related
complementary energy services to district cooling customers and others. The
Company recorded an after-tax loss in discontinued operations of $16 million
($25 million pre-tax) during the second quarter of 2003 to record the impairment
of the long-lived asset based on the impending sale and to record one-time
employee termination benefits. 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 and nine months ended September 30, 2003.
Revenues related to CEMS included in discontinued operations for the three
and nine months ended September 30, 2003, were $3 million and $8 million,
respectively. The loss from these discontinued operations for the three and
9
nine months ended September 30, 2003 is reported net of income tax (expense)
benefit of $(1) million and $1 million, respectively.
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. In April 2003, the Company sold its final remaining
investment in Argentina, a 90 percent interest in Empresa Distribuidora de
Electricidad de Santiago del Estero S.A. The Company recorded an after-tax loss
of $3 million in the second quarter of 2003 related to its Latin America
operations. The Interim Financial Statements present these Latin America
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 and nine months ended September 30, 2003.
Revenues related to the Company's Latin America operations included in
discontinued operations for the three and nine months ended September 30, 2003
were $-0- and $2 million, respectively. Income from these discontinued
operations for the three and nine months ended September 30, 2003 is reported
net of income tax expense of $-0- and $2 million.
(3) REGULATORY MATTERS
(a) 2004 True-Up Proceeding.
On March 31, 2004, CenterPoint Houston, Genco LP and Reliant Energy Retail
Services LLC, a 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 a true-up balance composed of stranded power plant
costs, the cost of environmental controls and certain other costs associated
with the transition from a regulated to a competitive environment (2004 True-Up
Proceeding). CenterPoint Houston's requested true-up balance is $3.7 billion,
excluding interest and net of the retail clawback from RRI. CenterPoint Houston
has provided testimony and documentation to support the $3.7 billion it seeks to
recover in the 2004 True-Up Proceeding. CenterPoint Houston had recorded $3.3
billion of recoverable electric generation-related regulatory assets. The Texas
Utility Commission conducted hearings on the Company's true-up application and
has held six public meetings between August and October 2004. Based on the Texas
Utility Commission's deliberations at these public meetings, the Company
estimates that it will recover approximately $2.0 billion of its recorded
electric generation-related regulatory assets. The Texas Utility Commission acts
only through written orders and has not yet issued a written order on the
true-up application.
The Texas electric restructuring law specifies that a final order is to be
issued by the Texas Utility Commission 150 days after a proper filing is made by
the regulated utility, subject to an extension for good cause. The Company is
awaiting a decision and a written final order from the Texas Utility Commission.
It is possible that the Texas Utility Commission could modify the views
expressed in its public meetings prior to issuing its formal written decision.
However, based on its analysis of the Texas Utility Commission's deliberations,
the Company recorded an after-tax charge to earnings in the third quarter of
2004 of approximately $894 million, which is reflected as an extraordinary loss
in the Company's Statements of Consolidated Operations. Once a final order is
issued by the Texas Utility Commission, the extraordinary loss may be adjusted.
On June 18, 2004, the Texas Supreme Court ruled that interest on stranded
costs began to accrue as of January 1, 2002 and remanded the rule to the Texas
Utility Commission to review the interaction between the Supreme Court's
interest decision and the Texas Utility Commission's capacity auction true-up
rule and the extent to which the capacity auction true-up results in the
recovery of interest. The Texas Utility Commission held a hearing on this issue
on September 8, 2004. While the Texas Utility Commission has discussed this
issue, it has not reached a conclusion as to the calculation. Therefore, the
Company has not accrued interest income on stranded costs in its consolidated
financial statements.
The true-up proceeding will result in additional charges being assessed to
customers through the utility's non-bypassable delivery charges. 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
10
authorizes the Texas Utility Commission to permit utilities to issue transition
bonds based on the securitization of revenues associated with the transition
charges.
CenterPoint Houston expects to seek rehearing of certain Texas Utility
Commission's rulings once they have been reduced to a final written order, and,
to the extent sufficient relief is not obtained through rehearing, to contest
certain of the Texas Utility Commission's rulings through appeals to Texas state
courts. The Company and CenterPoint Houston believe that significant aspects of
the preliminary deliberations made to date by the Texas Utility Commission are
contrary to both the statute by which the legislature restructured the electric
industry in Texas and the regulations and orders the Texas Utility Commission
has issued in implementing that statute. Although the Company and CenterPoint
Houston believe they have meritorious arguments, no prediction can be made as to
the ultimate outcome or timing of rehearings or appeals.
(b) 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 $30 million of interest, in
the fourth quarter of 2003 reflecting the ALJ's recommendation. On April 15,
2004, the Texas Utility Commission affirmed the PFD's finding in part, reversed
in part, and remanded one issue back to the ALJ. On May 28, 2004, the Texas
Utility Commission approved a settlement of the remanded issue and issued a
final order which reduced the disallowance. As a result of the final order, the
Company reversed $23 million, including $8 million of interest, of the $117
million reserve recorded in the fourth quarter of 2003. The results of the Texas
Utility Commission's final decision will be a component of the 2004 True-Up
Proceeding. The Company has appealed certain portions of the Texas Utility
Commission's final order involving a disallowance of approximately $67 million
plus interest of $10 million.
(c) Rate Cases.
The City of Houston and the 28 other incorporated cities in CenterPoint
Energy Entex's (Entex) Houston Division have approved a rate settlement with
Entex. The Railroad Commission of Texas (Texas Railroad Commission), which has
original jurisdiction over Entex's rates in the unincorporated areas of the
Houston Division (the environs), approved the settlement in general but required
that approximately $8 million in franchise fees that had been allocated to the
environs customers be applied only to sales within the 28 incorporated cities.
Entex, which has historically allocated franchise fees across all customers
within its Houston Division, appealed this revision to the settlement agreement,
but a state district court has affirmed the Texas Railroad Commission's
decision. Entex is considering whether it will appeal the decision of the
district court. Pending the appeal, Entex has taken action to expedite the
changes that are necessary at the city level to conform the recovery of
franchise fees to the Texas Railroad Commission's ruling. The annualized effect
of this multi-jurisdictional rate increase will be approximately $14 million.
On July 2, 2004, CenterPoint Energy Arkla (Arkla) filed an application for
a general rate increase of $7 million with the Oklahoma Corporation Commission
(OCC). The OCC staff has begun its review of the request and a decision is
anticipated before the end of 2004.
On July 14, 2004, CenterPoint Energy Minnegasco filed an application for a
general rate increase of $22 million with the Minnesota Public Utility
Commission (MPUC). A final decision on this rate relief request is expected from
the MPUC in May 2005. Interim rates of $17 million on an annualized basis became
effective on October 1, 2004, subject to refund.
On July 15, 2004, Arkla filed with the Arkansas Public Service Commission a
notice that it intends to file for an application for a general rate increase in
late 2004. Arkla has not yet determined the amount of the rate increase to be
requested.
On July 21, 2004, the Louisiana Public Service Commission (LPSC) approved a
settlement which will increase base rate and service charge revenues for Arkla
by approximately $7 million annually.
11
On October 13, 2004, Entex filed an application for a general rate increase
of approximately $3 million with the Texas Railroad Commission for rate relief
in the unincorporated areas of its Beaumont, East Texas and South Texas
Divisions. The Texas Railroad Commission staff has begun its review of the
request, and a decision is anticipated in April 2005.
(d) 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 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 charged and collected for gas
service to its residential and commercial customers in its Tyler distribution
system in accordance with lawful filed tariffs during the period beginning
November 1, 1992, and ending October 31, 2002. In July 2004, Entex filed a
lawsuit in a Travis County district court challenging a ruling by the Texas
Railroad Commission in this proceeding that "to the extent raised by the City of
Tyler, issues related to a consideration of the reasonableness of Entex's gas
costs and purchase practices will be considered in this proceeding." In its
lawsuit, Entex contends that the Texas Railroad Commission ruling expands the
scope of review beyond whether it had properly followed its tariff to include a
review of its historical gas purchases. The Company believes such a review is
not permitted by law and is beyond what the parties requested in the joint
petition that initiated the proceeding at the Texas Railroad Commission. 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.
(4) 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 and nine months ended September 30,
2003 and 2004 is provided to reflect the amortization of stock-based
compensation as expense on a straight-line basis over the vesting period. If
compensation costs had 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2003 2004 2003 2004
------------ ------------ ------------ -----------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Net Income (Loss):
As reported.............................................. $ 182 $ (1,136) $ 413 $ (1,005)
Total stock-based employee compensation determined
under the fair value based method, net of tax.......... (2) (1) (8) (3)
------------ ------------ ------------ -----------
Pro forma................................................ $ 180 $ (1,137) $ 405 $ (1,008)
============ ============ ============ ===========
Basic Earnings Per Share:
As reported.............................................. $ 0.60 $ (3.69) $ 1.36 $ (3.27)
Pro forma................................................ $ 0.59 $ (3.70) $ 1.34 $ (3.28)
Diluted Earnings Per Share:
As reported.............................................. $ 0.59 $ (3.66) $ 1.35 $ (3.25)
Pro forma................................................ $ 0.58 $ (3.67) $ 1.33 $ (3.26)
12
(b) Employee Benefit Plans.
The Company's net periodic cost includes the following components relating
to pension and postretirement benefits:
THREE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------
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) (4)
Net amortization.................. 11 3 9 4
Curtailment....................... -- -- -- 17
-------- ----------- -------- -------------
Net periodic cost................. $ 23 $ 9 $ 19 $ 26
======== =========== ======== =============
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------
2003 2004
----------------------- ------------------------
PENSION POSTRETIREMENT PENSION POSTRETIREMENT
BENEFITS BENEFITS BENEFITS BENEFITS
-------- -------------- -------- --------------
(IN MILLIONS)
Service cost...................... $ 27 $ 3 $ 30 $ 3
Interest cost..................... 77 24 77 24
Expected return on plan assets.... (69) (9) (78) (10)
Net amortization.................. 33 10 28 10
Curtailment....................... -- -- -- 17
Other............................. -- -- 3 2
-------- ----------- -------- --------------
Net periodic cost................. $ 68 $ 28 $ 60 $ 46
======== =========== ======== ==============
Included in the net periodic cost for the three months ended
September 30, 2003 and 2004 is $5 million and $20 million, respectively, of
expense related to Texas Genco's participants, which is reflected in
discontinued operations in the Statements of Consolidated Operations. Included
in the net periodic cost for the nine months ended September 30, 2003 and 2004
is $16 million and $28 million, respectively, of expense related to Texas
Genco's participants, which is reflected in discontinued operations in the
Statements of Consolidated Operations. Included in the net periodic cost related
to Texas Genco's participants for both the three and nine months ended September
30, 2004, is $17 million of non-recurring curtailment costs attributable to the
discontinued participation of Texas Genco's workforce in the Company's
postretirement benefit plan as active employees.
The Company expects to contribute $28 million to its postretirement
benefits plan in 2004. As of September 30, 2004, $20 million of contributions
have been made. Although pension funding is not required during 2004, the
Company has made $56 million of contributions as of September 30, 2004, and is
considering additional contributions.
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 both the three months ended September 30, 2003 and
2004 was $2 million. The net periodic cost associated with this plan for the
nine months ended September 30, 2003 and 2004 was $6 million and $5 million,
respectively.
In connection with the Company's expected sale of its 81% interest in
Texas Genco, a separate pension plan was established for Texas Genco on
September 1, 2004 and the Company transferred a net pension liability of
approximately $68 million to Texas Genco. In October 2004, Texas Genco received
an allocation of assets from the Company's pension plan pursuant to rules and
regulations under the Employee Retirement Income Security Act of 1974.
(5) 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 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
13
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 4 to these Interim Financial Statements.
On May 19, 2004, the FASB issued a FASB Staff Position (FSP) addressing
the appropriate accounting and disclosure requirements for companies that
sponsor a postretirement health care plan that provides prescription drug
benefits. The new guidance from the FASB was deemed necessary as a result of the
2003 Medicare prescription law, which includes a federal subsidy for qualifying
companies. FSP FAS 106-2, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FAS
106-2)," requires that the effects of the federal subsidy be considered an
actuarial gain and treated like similar gains and losses and requires certain
disclosures for employers that sponsor postretirement health care plans that
provide prescription drug benefits. The FASB's related existing guidance, FSP
FAS 106-1, "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003," will be
superseded upon the effective date of FAS 106-2. The effective date of the new
FSP is the first interim or annual period beginning after June 15, 2004. The
Company adopted FAS 106-2 prospectively in July 2004 with no material effect on
its results of operations or financial condition.
In its October 13, 2004 meeting, the FASB ratified the consensus reached
by the Emerging Issues Task Force (EITF) at its September 29-30, 2004 meeting on
EITF Issue No. 04-8 "Accounting Issues Related to Certain Features of
Contingently Convertible Debt and the Effect on Diluted Earnings Per Share"
(EITF 04-8) that requires certain contingently convertible debt instruments with
a market price trigger to be treated the same as traditional convertible debt
instruments for earnings per share (EPS) purposes. The contingently convertible
debt instruments would be taken into consideration in the calculation of diluted
EPS using the "if-converted" method. The Company issued contingently convertible
debt instruments in 2003. The Company will be required to adopt the provisions
of this consensus for reporting periods ending after December 15, 2004, and will
restate prior period EPS amounts. The impact on the Company's diluted EPS for
the three and nine months ended September 30, 2003 would be $(0.05) per share.
There would be no impact on the Company's diluted EPS for the three and nine
months ended September 30, 2004 due to anti-dilution as a result of the net loss
recorded by the Company in these periods.
(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.
Cash Flow Hedges. During the nine months ended September 30, 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 September 30, 2004, the Company expects $75 million in accumulated other
comprehensive income to be reclassified into net income during the next twelve
months.
Other Derivative Financial Instruments. In the third quarter of 2004, the
Company entered into non-trading derivative instruments that were not designated
as cash flow hedges, but these financial instruments substantially offset
economic risk and the changes in value of these derivatives have been recognized
in earnings.
14
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 Operations.
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. Amortization
of amounts deferred in accumulated other comprehensive income for the nine
months ended September 30, 2004 was $19 million. As of September 30, 2004, the
Company expects $29 million in accumulated other comprehensive income to be
reclassified into net income during the next twelve months.
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 September 30, 2004.
Texas Genco Derivative Instrument. In connection with the definitive
agreement for the sale of Texas Genco entered into on July 21, 2004, Genco LP
entered into a master power purchase and sale agreement with a member of the
Goldman Sachs group. Under that agreement, Genco LP has sold forward a
substantial quantity of its available base-load capacity through 2008 and
pledged $175 million of its first mortgage bonds as collateral for its
obligations. Genco LP's obligations under the power purchase agreement will
continue regardless of whether the sale transaction is completed. Texas Genco
has designated the master power purchase and sale agreement as a cash flow hedge
of the forecasted sale of base-load capacity through 2008. During the three
months ended September 30, 2004, no hedge ineffectiveness was recognized in
earnings from derivatives that qualify for and are designated as cash flow
hedges. As of September 30, 2004, Texas Genco expects $5 million in accumulated
other comprehensive income to be reclassified into net income during the next
twelve months.
(7) GOODWILL AND INTANGIBLES
Goodwill as of December 31, 2003 and September 30, 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 SEPTEMBER 30, 2004
--------------------------- ---------------------------
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
------------ ------------ ------------ ------------
(IN MILLIONS)
Land use rights.................................... $ 55 $ (12) $ 55 $ (12)
Other.............................................. 20 (4) 20 (5)
------------ ------------ ------------ -------------
Total.......................................... $ 75 $ (16) $ 75 $ (17)
============ ============ ============ ============
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
September 30, 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
15
other intangibles.
Amortization expense for other intangibles for the three months ended
September 30, 2003 and 2004 was $0.5 million and $0.6 million, respectively.
Amortization expense for other intangibles for the nine months ended September
30, 2003 and 2004 was $1.6 million and $1.7 million, respectively. Estimated
amortization expense for the remainder of 2004 and the five succeeding fiscal
years is as follows (in millions):
2004........................................ $ 1
2005........................................ 3
2006........................................ 2
2007........................................ 1
2008........................................ 1
2009........................................ 1
-------
Total..................................... $ 9
=======
(8) COMPREHENSIVE INCOME (LOSS)
The following table summarizes the components of total comprehensive
income (loss):
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- --------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
(IN MILLIONS)
Net income (loss).................................... $ 182 $ (1,136) $ 413 $ (1,005)
Other comprehensive income:
Minimum benefits liability......................... -- 14 -- 14
Net deferred gain (loss) from cash flow hedges..... (26) 17 (19) 33
Reclassification of deferred loss (gain) from cash
flow hedges realized in net income............... 4 (2) 8 (1)
Other comprehensive income (loss) from
discontinued operations.......................... -- (93) 1 (93)
----------- ----------- ----------- -----------
Other comprehensive loss............................. (22) (64) (10) (47)
----------- ----------- ----------- -----------
Comprehensive income (loss).......................... $ 160 $ (1,200) $ 403 $ (1,052)
=========== =========== =========== ===========
(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 September 30, 2004,
307,771,384 shares of CenterPoint Energy common stock were issued and
307,771,218 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 September 30, 2004, respectively) and (b) treasury shares (166 at
both December 31, 2003 and September 30, 2004). CenterPoint Energy declared a
dividend of $0.10 per share in the first quarter of 2003 and $0.20 per share in
the second quarter of 2003, which included the third quarter dividend declared
on June 18, 2003 and paid on September 10, 2003. CenterPoint Energy declared a
dividend of $0.10 per share in each of the first, second and third quarters of
2004.
The Company's expected sale of its interest in Texas Genco described in
Note 2 resulted in an after-tax loss of approximately $253 million in the third
quarter of 2004. In addition, the Company recorded an after-tax extraordinary
loss of $894 million in the third quarter of 2004 related to the 2004 True-Up
Proceeding. These losses reduced the Company's earnings below the level required
for the Company to continue paying its current quarterly dividends out of
current earnings as required under the Company's SEC financing order. However,
in May 2004, the Company received an order from the SEC under the 1935 Act
authorizing it to continue to pay its current quarterly dividend in the second
and third quarters of 2004 out of capital or unearned surplus in the event the
Company had such losses. If the Company's earnings for the fourth quarter of
2004 or subsequent quarters are insufficient to pay dividends from current
earnings due to additional charges against the Company's earnings related to the
sale of its
16
interest in Texas Genco, the 2004 True-Up Proceeding or other factors,
additional authority would be required from the SEC for payment of the quarterly
dividend from capital or unearned surplus, but there can be no assurance that
the SEC would authorize such payments.
(10) LONG-TERM DEBT AND RECEIVABLES FACILITY
(a) Long-term Debt.
As of September 30, 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 September 30, 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 5, upon the
Company's adoption of FIN 46, the junior subordinated debentures discussed above
were included in long-term debt as of December 31, 2003 and September 30, 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.
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
17
any deferral or event of default, CenterPoint Energy may not pay dividends on
its capital stock. As of September 30, 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, SEPTEMBER 30, 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 8.257% Junior Subordinated
2037 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 5, upon the
Company's adoption of FIN 46, the junior subordinated debentures discussed above
were included in long-term debt as of December 31, 2003 and September 30, 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 September 30, 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
September 30, 2004, no interest payments on the convertible junior subordinated
debentures had been deferred.
(b) 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 September 30, 2004, CERC had $151 million
outstanding under its receivables facility.
18
(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 the Company 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,
several of which dismissals have been affirmed by the appellate courts, but most
of the lawsuits remain in early procedural stages. The Company's former
subsidiary, RRI, was a participant in the California markets, owning generating
plants in the state and participating in both electricity and natural gas
trading in that state and in western power markets generally. RRI, some of its
subsidiaries and in some cases, corporate officers of some of those companies,
have been named as defendants in these suits.
The Company, CenterPoint Houston or their predecessor, Reliant Energy,
have been named in approximately 25 of these lawsuits, which were instituted
between 2001 and 2004 and are pending in state courts in Alameda County, Los
Angeles County and San Diego County, in federal district courts in San
Francisco, San Diego, Los Angeles, Fresno, Sacramento and Nevada and before the
Ninth Circuit Court of Appeals. However, the Company, CenterPoint Houston and
Reliant Energy were not participants 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. On July 6, 2004 and
on October 12, 2004, the Ninth Circuit affirmed the Company's removal to federal
district court of two electric cases brought by the California Attorney General
and affirmed the federal court's dismissal of these cases based upon the filed
rate doctrine and federal preemption.
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
19
the registration statement issued in the RRI Offering remain. In June 2004, the
plaintiffs filed a motion for class certification, which the defendants have
asked the court to deny.
In February 2003, a lawsuit was filed by three individuals in federal
district court in Chicago against CenterPoint Energy and certain former officers
of RRI for alleged violations of federal securities laws. The plaintiffs in this
lawsuit allege that the defendants violated federal securities laws by issuing
false and misleading statements to the public, and that the defendants made
false and misleading statements as part of an alleged scheme to artificially
inflate trading volumes and revenues. In addition, the plaintiffs assert claims
of fraudulent and negligent misrepresentation and violations of Illinois
consumer law. In January 2004 the trial judge ordered dismissal of plaintiffs'
claims on the ground that they did not set forth a claim. The plaintiffs filed
an amended complaint in March 2004, which the defendants asked the court to
dismiss. On August 18, 2004, the court granted the defendants' motion to dismiss
with prejudice.
In May 2002, three class action lawsuits were filed in federal district
court in Houston on behalf of participants in various employee benefits plans
sponsored by Reliant Energy. Two of the lawsuits have been dismissed without
prejudice. Reliant Energy and certain current and former members of its benefits
committee are the remaining defendants in the third lawsuit. That lawsuit
alleges that the defendants breached their fiduciary duties to various employee
benefits plans, directly or indirectly sponsored by Reliant Energy, in violation
of the Employee Retirement Income Security Act of 1974. The plaintiffs allege
that the defendants permitted the plans to purchase or hold securities issued by
Reliant Energy when it was imprudent to do so, including after the prices for
such securities became artificially inflated because of alleged securities fraud
engaged in by the defendants. The complaint seeks monetary damages for losses
suffered on behalf of the plans and a putative class of plan participants whose
accounts held Reliant Energy or RRI securities, as well as equitable relief in
the form of restitution. In July 2004, another class action suit was filed in
federal court on behalf of the Reliant Energy Savings Plan and a class
consisting of participants in that plan against Reliant Energy and the Reliant
Energy Benefits Committee. The allegations and the relief sought in the new suit
are substantially similar to those in the previously pending suit; however, the
new suit also alleges that Reliant Energy and its Benefits Committee breached
their fiduciary duties to the Savings Plan and its participants by investing
plan funds in Reliant Energy stock when Reliant Energy or its subsidiaries were
allegedly manipulating the California energy market. On October 14, 2004, the
plaintiff voluntarily dismissed the newly filed lawsuit.
In October 2002, a derivative action was filed in the federal district
court in Houston, against the directors and officers of the Company. The
complaint set forth claims for breach of fiduciary duty, waste of corporate
assets, abuse of control and gross mismanagement. Specifically, the shareholder
plaintiff alleged that the defendants caused the Company to overstate its
revenues through so-called "round trip" transactions. The plaintiff also alleged
breach of fiduciary duty in connection with the spin-off of RRI and the RRI
Offering. The complaint sought monetary damages on behalf of the Company as well
as equitable relief in the form of a constructive trust on the compensation paid
to the defendants. The Company's board of directors investigated that demand and
similar allegations made in a June 28, 2002 demand letter sent on behalf of a
Company shareholder. The second letter demanded that the Company take several
actions in response to alleged round-trip trades occurring in 1999, 2000, and
2001. In June 2003, the board determined that these proposed actions would not
be in the best interests of the Company. In March 2003, the court dismissed this
case on the grounds that the plaintiff did not make an adequate demand on the
Company before filing suit. Thereafter, the plaintiff sent another demand
asserting the same claims.
The Company believes that none of the lawsuits described under Other Class
Action Lawsuits has merit because, among other reasons, the alleged
misstatements and omissions were not material and did not result in any damages
to the plaintiffs.
Other Legal Matters
Texas Antitrust Action. In July 2003, Texas Commercial Energy filed in
federal court in Corpus Christi, Texas a lawsuit against Reliant Energy, the
Company and CenterPoint Houston, as successors to Reliant Energy, Genco LP, 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. The plaintiff, a retail electricity provider in the Texas market served
by ERCOT, alleged that the defendants conspired to illegally fix and
artificially increase the price of electricity in violation of state and federal
antitrust laws and committed fraud and negligent misrepresentation. The lawsuit
sought damages in excess of $500 million, exemplary damages, treble damages,
20
interest, costs of suit and attorneys' fees. The plaintiff's principal
allegations had previously been investigated by the Texas Utility Commission and
found to be without merit. In June 2004, the federal court dismissed the
plaintiff's claims and in July 2004, the plaintiff filed a notice of appeal. The
Company intends to contest the appeal. The ultimate outcome of this matter
cannot be predicted at this time.
Municipal Franchise Fee Lawsuits. In February 1996, the cities of Wharton,
Galveston and Pasadena (Three Cities) filed suit in state district court in
Harris County, Texas for themselves and a proposed class of all similarly
situated cities in Reliant Energy's electric service area, against Reliant
Energy and Houston Industries Finance, Inc. (formerly a wholly owned subsidiary
of the Company's predecessor, Reliant Energy) alleging underpayment of municipal
franchise fees. The plaintiffs claimed that they were entitled to 4% of all
receipts of any kind for business conducted within these cities over the
previous four decades. After a jury trial involving the Three Cities' claims
(but not the class of cities), the trial court entered a judgment on the Three
Cities' breach of contract claims for $1.7 million, including interest, plus an
award of $13.7 million in legal fees. It also decertified the class. Following
this ruling, 45 cities filed individual suits against Reliant Energy in the
District Court of Harris County.
On February 27, 2003, a state court of appeals in Houston rendered an
opinion reversing the judgment against the Company and rendering judgment that
the Three Cities take nothing by their claims. The court of appeals held that
all of the Three Cities' claims were barred by the jury's finding of laches, a
defense similar to the statute of limitations, due to the Three Cities' having
unreasonably delayed bringing their claims during the more than 30 years since
the alleged wrongs began. The court also held that the Three Cities were not
entitled to recover any attorneys' fees. The Three Cities filed a petition for
review to the Texas Supreme Court, which declined to hear the case. Thus, the
Three Cities' claims have been finally resolved in the Company's favor, but the
individual claims of the 45 cities remain pending in the same court.
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 brought 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 certain non-affiliated companies 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 with respect to rates charged to certain consumers of natural gas
in the State of Texas. The plaintiffs allege that defendants inflated the prices
charged to certain consumers of natural gas. In February 2003, a similar suit
was filed in state court in Caddo Parish, Louisiana against CERC with respect to
rates charged to a purported class of certain consumers of natural gas and gas
service in the
21
State of Louisiana. In February 2004, another suit was filed in state court in
Calcasieu Parish, Louisiana against CERC seeking to recover alleged overcharges
for gas or gas services allegedly provided by Entex to a purported class of
certain consumers of natural gas and gas service without advance approval by the
LPSC. In October 2004, a similar case was filed in district court in Miller
County, Arkansas against the Company, CERC, Entex Gas Marketing Company,
CenterPoint Energy Gas Transmission Company, CenterPoint Energy Field Services,
CenterPoint Energy Pipeline Services, Inc., Mississippi River Transmission Corp.
and other non-affiliated companies alleging fraud, unjust enrichment and civil
conspiracy with respect to rates charged to certain consumers of natural gas in
at least the states of Arkansas, Louisiana, Mississippi, Oklahoma and Texas. At
the time of the filing of each of the Caddo and Calcasieu Parish cases, the
plaintiffs in those cases filed petitions with the LPSC relating to the same
alleged rate overcharges. The Caddo and Calcasieu Parish cases have been stayed
pending the resolution of the respective proceedings by the LPSC. The plaintiffs
in the Wharton County and Miller County cases seek class certification, but
neither proposed class has been certified. The range of relief sought by the
plaintiffs in these cases includes injunctive and declaratory relief,
restitution for the alleged overcharges, exemplary damages or trebling of actual
damages, civil penalties and attorney's fees. In these cases, the Company, CERC
and their affiliates 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.
(b) Environmental Matters.
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 Company believes the ultimate cost associated with resolving this
matter will not have a material impact on the financial condition or results of
operations of either the Company or CERC.
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 September 30, 2004, CERC had accrued $19 million for remediation of
certain Minnesota sites. At September 30, 2004, the estimated range of possible
remediation costs for these sites was $7 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
September 30, 2004 to be used for future 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
22
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
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 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. Although most existing claims relate to facilities owned by Texas
Genco, 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) Texas Genco Matters.
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 September 30, 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
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 reactor per year per
incident.
There can be no assurance that all potential losses or liabilities
associated with the South Texas Project will be insurable, or that the amount of
insurance will be sufficient to cover them. Any substantial losses not covered
by insurance would have a material effect on Texas Genco's financial condition,
results of operations and cash flows.
23
Nuclear Decommissioning. CenterPoint Houston, as collection agent for the
nuclear decommissioning charge assessed on its transmission and distribution
customers, 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
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 $200 million as of September 30, 2004, of which approximately 37% were
fixed-rate debt securities and the remaining 63% were equity securities. In May
2004, an outside consultant estimated Texas Genco's portion of decommissioning
costs to be approximately $456 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 were not recovered as of
January 1, 2002, will continue to be subject to cost-of-service rate regulation
and will be charged to transmission and distribution customers of CenterPoint
Houston or its successor.
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. Texas Genco is currently installing cost-effective controls at
its generating plants to comply with these requirements. Through September 30,
2004, Texas Genco has invested $689 million for NOx emission control, and plans
to make additional expenditures of up to approximately $106 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 in 2007, implementing the more stringent federal
eight-hour ozone standard.
24
(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 FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2003 2004 2003 2004
------------ ------------ ------------ ------------
(IN MILLIONS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Basic EPS Calculation:
Income from continuing operations before extraordinary
loss................................................. $ 147 $ 17 $ 362 $ 43
Income (loss) from discontinued operations............. 35 (259) 51 (154)
Extraordinary loss, net of tax......................... -- (894) -- (894)
------------ ------------ ------------ ------------
Net income (loss)...................................... $ 182 $ (1,136) $ 413 $ (1,005)
============ ============ ============ ============
Weighted average shares outstanding...................... 305,007,000 307,592,000 303,261,000 306,954,000
============ ============ ============ ============
Basic EPS:
Income from continuing operations before extraordinary
loss................................................. $ 0.48 $ 0.05 $ 1.19 $ 0.14
Income (loss) from discontinued operations............. 0.12 (0.84) 0.17 (0.50)
Extraordinary loss, net of tax......................... -- (2.90) -- (2.91)
------------ ------------ ------------ ------------
Net income (loss)...................................... $ 0.60 $ (3.69) $ 1.36 $ (3.27)
============ ============ ============ ============
Diluted EPS Calculation:
Net income (loss)...................................... $ 182 $ (1,136) $ 413 $ (1,005)
Plus: Income impact of assumed conversions:
Interest on 6 1/4% convertible trust preferred
securities........................................... -- -- -- --
------------ ------------ ------------ ------------
Total earnings effect assuming dilution................ $ 182 $ (1,136) $ 413 $ (1,005)
============ ============ ============ ============
Weighted average shares outstanding...................... 305,007,000 307,592,000 303,261,000 306,954,000
Plus: Incremental shares from assumed conversions (1):
Stock options........................................ 911,000 1,280,000 727,000 1,235,000
Restricted stock..................................... 1,409,000 1,276,000 1,409,000 1,276,000
6 1/4% convertible trust preferred securities........ 18,000 17,000 18,000 17,000
------------ ------------ ------------ ------------
Weighted average shares assuming dilution.............. 307,345,000 310,165,000 305,415,000 309,482,000
=========== =========== =========== ===========
Diluted EPS:
Income from continuing operations before extraordinary
loss................................................. $ 0.48 $ 0.05 $ 1.18 $ 0.14
Income (loss) from discontinued operations............. 0.11 (0.83) 0.17 (0.50)
Extraordinary loss, net of tax......................... -- (2.88) -- (2.89)
------------ ------------ ------------ ------------
Net income (loss)...................................... $ 0.59 $ (3.66) $ 1.35 $ (3.25)
============ ============ ============ ============
- -----------------
(1) For the three months ended September 30, 2003 and 2004, the computation of
diluted EPS excludes 10,120,798 and 10,005,605 purchase options,
respectively, for shares of common stock that have exercise prices
(ranging from $8.61 to $32.26 per share and $11.29 to $32.26 per share for
the third quarter 2003 and 2004, respectively) greater than the per share
average market price for the period and would thus be anti-dilutive if
exercised.
For the nine months ended September 30, 2003 and 2004, the computation of
diluted EPS excludes 10,154,908 and 12,015,605 purchase options,
respectively, for shares of common stock that have exercise prices
(ranging from $7.86 to $32.26 per share and $10.92 to $32.26 per share for
the first nine months of 2003 and 2004, respectively) greater than the per
share average market price for the period and would thus be anti-dilutive
if exercised.
25
The Company's contingently convertible debt is not currently 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 (see Note
5 with respect to a change in this treatment pursuant to EITF 04-8).
(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. Texas Genco's
operations, which were previously reported in the Electric Generation business
segment, are presented as discontinued operations within these Interim Financial
Statements. 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, Natural Gas Distribution, Pipelines and
Gathering and Other Operations.
Financial data for the Company's reportable business segments are as
follows:
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003
---------------------------------------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME (LOSS)
-------------- ------------ ------------
(IN MILLIONS)
Electric Transmission & Distribution.......... $ 654 (1) $ -- $ 383
Natural Gas Distribution...................... 894 (2) 3 (5)
Pipelines and Gathering....................... 56 (3) 33 39
Other Operations.............................. 4 4 1
Eliminations.................................. -- (40) --
---------- ---------- ----------
Consolidated.................................. $ 1,608 $ -- $ 418
========== ========== ==========
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004
---------------------------------------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME (LOSS)
-------------- ------------ ------------
(IN MILLIONS)
Electric Transmission & Distribution.......... $ 446 (1) $ -- $ 178
Natural Gas Distribution...................... 1,146 (2) 3 (2)
Pipelines and Gathering....................... 73 (3) 35 35
Other Operations.............................. 2 -- (4)
Eliminations.................................. -- (38) --
---------- ---------- ----------
Consolidated.................................. $ 1,667 $ -- $ 207
========== ========== ==========
AS OF
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 DECEMBER 31, 2003
--------------------------------------------- -----------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME (LOSS) TOTAL ASSETS
-------------- ------------ ------------ -----------------
(IN MILLIONS)
Electric Transmission & Distribution......... $ 1,583 (1) $ -- $ 823 $ 10,326
Natural Gas Distribution..................... 3,885 (2) 28 146 4,661
Pipelines and Gathering...................... 191 (3) 129 124 2,519
Other Operations............................. 13 13 (16) 1,746
Discontinued Operations...................... -- -- -- 4,244
Eliminations................................. -- (170) -- (2,035)
---------- ---------- ---------- -------------
Consolidated................................. $ 5,672 $ -- $ 1,077 $ 21,461
========== ========== ========== =============
26
AS OF
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 SEPTEMBER 30, 2004
--------------------------------------------- -----------------
NET
REVENUES FROM INTERSEGMENT OPERATING
NON-AFFILIATES REVENUES INCOME (LOSS) TOTAL ASSETS
-------------- ------------ ------------ -----------------
(IN MILLIONS)
Electric Transmission & Distribution ........ $ 1,149 (1) $ -- $ 390 $ 8,682
Natural Gas Distribution..................... 4,522 (2) 3 137 4,346
Pipelines and Gathering...................... 217 (3) 107 123 2,552
Other Operations............................. 5 3 (17) 1,659
Discontinued Operations...................... -- -- -- 4,181
Eliminations................................. -- (113) -- (1,834)
---------- ---------- ---------- -------------
Consolidated................................. $ 5,893 $ -- $ 633 $ 19,586
========== ========== ========== =============
- -------------
(1) Included in CenterPoint Houston's transmission and distribution revenues
from non-affiliates are sales to subsidiaries of RRI of approximately $290
million and $265 million, respectively, for the three months ended
September 30, 2003 and 2004, and approximately $727 million and $666
million, respectively, for the nine months ended September 30, 2003 and
2004.
(2) Included in Natural Gas Distribution revenues from non-affiliates are
sales to Texas Genco of $14 million and $2 million, respectively, for the
three months ended September 30, 2003 and 2004, and $23 million and 18
million, respectively, for the nine months ended September 30, 2003 and
2004. Texas Genco has been presented as discontinued operations in these
Interim Financial Statements.
(3) Included in Pipelines and Gathering revenues from non-affiliates are sales
to Texas Genco of $1 million for both the three months ended September 30,
2003 and 2004, and $2 million for both the nine months ended September 30,
2003 and 2004. Texas Genco has been presented as discontinued operations
in these Interim Financial Statements.
27
(14) SUBSEQUENT EVENT
On October 22, 2004, the American Jobs Creation Act (the "Act") was signed
into law. The Act makes several sweeping changes to U.S. taxpayers engaged in
cross-border or manufacturing businesses, and some of the provisions of the Act
have retroactive effective dates. The Company is currently analyzing the impact
of this legislation, but believes that the Act has no material effect on its
financial position as of September 30, 2004. The Company presently estimates
that the majority of the reduction in federal tax related to relief for
manufacturers of domestic goods will inure to Texas Genco, which is reported as
discontinued operations as of September 30, 2004. Accordingly, this effect would
be reflected on Texas Genco's future financial statements when it is not
expected to be a part of the Company.
28
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 Item 1 of this Form 10-Q.
EXECUTIVE SUMMARY
UPDATE OF SIGNIFICANT EVENTS IN 2004
Resolution of our true-up proceeding (2004 True-Up Proceeding) and the
sale of our remaining interest in Texas Genco Holdings, Inc. (Texas Genco) are
the two most significant events facing us in 2004. We expect to use the proceeds
received from these two events to repay a portion of our indebtedness and for
other general corporate purposes, including additional pension contributions. We
recorded an after-tax loss of approximately $253 million in the third quarter of
2004 related to the sale of our interest in Texas Genco. See "Recent Event"
below. We also recorded an after-tax extraordinary loss of $894 million in the
third quarter of 2004 related to the 2004 True-Up Proceeding as discussed below.
These losses reduced 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. However, in May
2004, we received an order from the SEC under the Public Utility Holding Company
Act of 1935 (1935 Act) authorizing us to continue to pay our current quarterly
dividend in the second and third quarters of 2004 out of capital or unearned
surplus in the event we had such losses. If our earnings for the fourth quarter
of 2004 or subsequent quarters are insufficient to pay dividends from current
earnings due to additional charges against our earnings related to the sale of
our interest in Texas Genco, the 2004 True-Up Proceeding or other factors,
additional authority would be required from the SEC for payment of the quarterly
dividend from capital or unearned surplus, but there can be no assurance that
the SEC would authorize such payments. These losses will adversely affect our
ability to achieve a ratio of common equity to total capitalization of 30% by
the end of 2006, as had been projected in filings under the 1935 Act.
Accordingly, we may need to issue equity and/or take other action to achieve a
future equity capitalization of 30%.
Our requested true-up balance is $3.7 billion, excluding interest and net
of the retail clawback from Reliant Energy, Inc. (formerly Reliant Resources,
Inc.) (RRI). CenterPoint Energy Houston Electric, LLC (CenterPoint Houston) has
provided testimony and documentation to support the $3.7 billion it seeks to
recover in the 2004 True-Up Proceeding. CenterPoint Houston had recorded $3.3
billion of recoverable electric generation-related regulatory assets. The Public
Utility Commission of Texas (Texas Utility Commission) conducted hearings on our
true-up application and has held six public meetings between August and October
2004. Based on the Texas Utility Commission's deliberations at these public
meetings, we estimate that we will recover approximately $2.0 billion of our
recorded electric generation-related regulatory assets. Based on our analysis of
the Texas Utility Commission's deliberations, we recorded an after-tax charge to
earnings in the third quarter of 2004 of approximately $894 million to
write-down our electric generation-related regulatory assets to their realizable
value, which is reflected as an extraordinary loss in the Statements of
Consolidated Operations. The ultimate amount of such charge will depend upon the
final action of the Texas Utility Commission. The Texas Utility Commission acts
only through written orders and has not yet issued a written order on the
true-up application. Once a final order is issued by the Texas Utility
Commission, the extraordinary loss may be adjusted.
CenterPoint Houston expects to seek rehearing of certain Texas Utility
Commission's rulings once they have been reduced to a final written order, and,
to the extent sufficient relief is not obtained through rehearing, to contest
certain of the Texas Utility Commission's rulings through appeals to Texas state
courts. We and CenterPoint Houston believe that significant aspects of the
preliminary deliberations made to date by the Texas Utility Commission are
contrary to both the statute by which the legislature restructured the electric
industry in Texas and the regulations and orders the Texas Utility Commission
has issued in implementing that statute. Although we and CenterPoint Houston
believe we have meritorious arguments, no prediction can be made as to the
ultimate outcome or timing of rehearings or appeals.
After the issuance of the order in the 2004 True-Up Proceeding, we will
seek authority from the Texas Utility Commission to securitize all or a portion
of the true-up balance through the issuance of transition bonds and expect
29
to be in a position to issue those bonds in the first half of 2005. Appeals of
the true-up or securitization orders could delay the issuance of such bonds. 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 its
indebtedness to us or its external debt through either the payment of dividends
or the settlement of intercompany payables. The SEC must take action to permit
the issuance of any transition bonds and approve any dividends by CenterPoint
Houston in excess of its current and retained earnings. To maintain CenterPoint
Houston's capital structure at the appropriate levels, we may reinvest funds in
CenterPoint Houston in the form of equity contributions or intercompany loans.
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 June 18,
2004, the Texas Supreme Court ruled that interest on stranded costs began to
accrue as of January 1, 2002 and remanded the rule to the Texas Utility
Commission to review the interaction between the Supreme Court's interest
decision and the Texas Utility Commission's capacity auction true-up rule and
the extent to which the capacity auction true-up results in the recovery of
interest. The Texas Utility Commission held a hearing on this issue on September
8, 2004. While the Texas Utility Commission has discussed this issue, it has not
reached a conclusion as to the calculation. Therefore, we have not accrued
interest income on stranded costs in our consolidated financial statements.
RECENT EVENT
DEFINITIVE AGREEMENT FOR THE SALE OF TEXAS GENCO
On July 21, 2004, we and Texas Genco entered into a definitive transaction
agreement pursuant to which Texas Genco has agreed to be acquired in a
multi-step transaction by GC Power Acquisition LLC (GC Power Acquisition), a
newly formed entity owned in equal parts by investment funds affiliated with The
Blackstone Group, Hellman & Friedman LLC, Kohlberg, Kravis Roberts & Co. L.P.
and Texas Pacific Group, for approximately $3.65 billion in cash.
The transaction will be accomplished in two steps. In the first step,
expected to be completed in the fourth quarter of 2004, Texas Genco will
purchase the approximately 19% of its shares owned by the public (other than
shares held by shareholders who validly perfect their dissenters' rights under
Texas law) in a cash-out merger at a price of $47.00 per share, without interest
and less any applicable withholding taxes (Public Company Merger). In connection
with the anticipated Public Company Merger, Texas Genco has filed with the SEC a
Rule 13e-3 transaction statement and a preliminary information statement on
Schedule 14C containing information with respect to the transactions
contemplated by the definitive transaction agreement, including the Public
Company Merger, and related matters. Following the Public Company Merger, a
subsidiary of Texas Genco that will own Texas Genco's coal, lignite and
gas-fired generation plants will merge with a subsidiary of GC Power
Acquisition. The closing of the first step of the transaction is subject to
several conditions, including the mailing of a definitive information statement
to Texas Genco's shareholders at least 20 days prior to the closing of the
Public Company Merger, the receipt of debt financing under the financing
commitments described below, the expiration or termination of any applicable
waiting period under the antitrust laws (including the Hart Scott Rodino
Antitrust Improvement Act of 1976), which occurred on September 17, 2004, and
the Federal Energy Regulatory Commission's certification of the entity that will
own Texas Genco's coal, lignite and gas-fired generation plants as an "exempt
wholesale generator," which occurred on September 24, 2004. The definitive
information statement will be mailed to Texas Genco's shareholders of record as
of October 21, 2004. Texas Genco's shareholders as of the effective date of the
Public Company Merger will have the right to either receive the cash
consideration for their shares described above or exercise dissenters' rights in
connection with the Public Company Merger by properly complying with the
requirements of the Texas Business Corporation Act. Within 10 days after the
effectiveness of the Public Company Merger, Texas Genco must mail to all of its
shareholders written notice of the effectiveness of the Public Company Merger
and of their right to dissent from that transaction within 20 days after the
date of Texas Genco's mailing of the notice.
In the second step of the transaction, expected to take place in the
first half of 2005 following receipt of approval by the Nuclear Regulatory
Commission, for which the application was filed on October 18, 2004, Texas
30
Genco, the principal remaining asset of which, at that time, will be its
interest in the South Texas Project Electric Generating Station (South Texas
Project), will merge with another subsidiary of GC Power Acquisition.
Cash proceeds to us are expected to be approximately $2.2 billion from the
first step of the transaction and $700 million from the second step of the
transaction, for total cash proceeds of approximately $2.9 billion for our 81%
interest. We intend to use the net after-tax proceeds of approximately $2.5
billion primarily to pay down outstanding debt, including senior debt under our
bank credit facility that is secured in part by our 81% ownership interest in
Texas Genco, and for other general corporate purposes, including additional
pension contributions.
GC Power Acquisition has entered into a commitment letter with financing
sources, including Goldman Sachs Credit Partners, L.P., providing for up to $2.5
billion in the aggregate in debt financing for the transaction and a separate
overnight loan of $717 million to Texas Genco to fund the Public Company Merger
in the first step of the transaction, each subject to customary closing
conditions. This overnight loan is expected to be repaid with the proceeds of
the merger of a subsidiary of Texas Genco that will own Texas Genco's coal,
lignite and gas-fired generation plants with a subsidiary of GC Power
Acquisition. In addition, GC Power Acquisition's sponsor firms have committed
upon closing of the transaction to provide up to $1.08 billion in the aggregate
in equity funding for the transaction.
The transaction has been approved by our board of directors and by the
board of directors of Texas Genco acting upon the unanimous recommendation of a
special committee composed of independent members of Texas Genco's board. We
have signed a written consent that satisfies all state law voting requirements
applicable to the transaction.
In connection with the transaction, Texas Genco, LP, a subsidiary of Texas
Genco (Genco LP), entered into a master power purchase and sale agreement with a
member of the Goldman Sachs group. Under that agreement, Genco LP has sold
forward a substantial quantity of its available base-load capacity through 2008
and pledged $175 million of its first mortgage bonds as collateral for its
obligations. Genco LP's obligations under the power purchase agreement will
continue regardless of whether the transaction is completed.
As a result of this transaction, the results of Texas Genco have been
presented in discontinued operations in this report for all periods in
accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets". We recorded an
after-tax loss of approximately $253 million in the third quarter of 2004
related to the sale of our interest in Texas Genco and an additional after-tax
loss of $93 million offsetting our 81% interest in Texas Genco's third quarter
2004 earnings. Until the sale of Texas Genco is complete, our interest in any
Texas Genco earnings will be offset by an increased loss on the pending sale. As
a result of the reduction in retained earnings caused by after-tax losses
associated with the sale of Texas Genco and our true-up proceeding, we and
Utility Holding, LLC may need to obtain an order from the SEC under the 1935 Act
to facilitate the payment of dividends to transfer the proceeds from the sale of
Texas Genco to us.
On July 23, 2004, two plaintiffs filed substantially identical lawsuits in
Harris County, Texas state district court. The suits, purportedly brought on
behalf of holders of Texas Genco common stock, name Texas Genco Holdings, Inc.
and each of that company's directors as defendants. Both plaintiffs allege,
among other things, self-dealing and breach of fiduciary duty by the defendants
in entering into the transaction agreement. As part of their allegations of
self-dealing, both plaintiffs claim that Texas Genco's board of directors is
controlled by us, that the defendants improperly concealed Texas Genco's results
of operations for the second quarter of 2004 until after the transaction
agreement was announced, and that in order to aid us, Texas Genco's board only
searched for acquirers who would offer all-cash consideration. Among other
relief, the plaintiffs seek to enjoin the transaction or, alternatively, rescind
the transaction to the extent already implemented. In August 2004, the cases
were consolidated in state district court in Harris County, Texas. Texas Genco
intends to vigorously defend against the consolidated suits.
3RD QUARTER 2004 HIGHLIGHTS
Excluding the extraordinary loss related to the 2004 True-Up Proceeding
and the loss related to the sale of Texas Genco as discussed above, our
operating performance and cash flow for the third quarter of 2004 compared to
the third quarter of 2003 were affected by:
- - the termination of revenues related to Excess Cost Over Market (ECOM) as
of January 1, 2004 compared to ECOM revenues of $222 million recorded in
the third quarter of 2003;
- - an increase of $28 million in capital expenditures related to our Electric
Transmission & Distribution business segment;
- - rate increases of $8 million in the third quarter of 2004 in our Natural
Gas Distribution business segment;
31
- - continued customer growth, with the addition of over 96,000 metered
electric and gas customers; and
- - an increase in operating income of $11 million from the sale of land by
our Electric Transmission & Distribution business segment.
32
CONSOLIDATED RESULTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Revenues........................................... $ 1,608 $ 1,667 $ 5,672 $ 5,893
Expenses........................................... 1,190 1,460 4,595 5,260
----------- ----------- ----------- -----------
Operating Income................................... 418 207 1,077 633
Interest and Other Finance Charges................. (184) (192) (531) (583)
Other, net......................................... (1) 4 17 18
----------- ----------- ----------- -----------
Income From Continuing Operations Before Income
Taxes and Extraordinary Loss..................... 233 19 563 68
Income Tax Expense................................. (86) (2) (201) (25)
----------- ----------- ----------- -----------
Income From Continuing Operations Before
Extraordinary Loss............................... 147 17 362 43
Discontinued Operations, net of tax................ 35 (259) 51 (154)
Extraordinary Loss, net of tax.................... -- (894) -- (894)
----------- ----------- ----------- -----------
Net Income (Loss).................................. $ 182 $ (1,136) $ 413 $ (1,005)
=========== =========== =========== ===========
BASIC EARNINGS PER SHARE:
Income From Continuing Operations................ $ 0.48 $ 0.05 $ 1.19 $ 0.14
Discontinued Operations, net of tax.............. 0.12 (0.84) 0.17 (0.50)
Extraordinary Loss, net of tax................... -- (2.90) -- (2.91)
----------- ----------- ----------- -----------
Net Income (Loss)................................ $ 0.60 $ (3.69) $ 1.36 $ (3.27)
=========== =========== =========== ===========
DILUTED EARNINGS PER SHARE:
Income From Continuing Operations................ $ 0.48 $ 0.05 $ 1.18 $ 0.14
Discontinued Operations, net of tax.............. 0.11 (0.83) 0.17 (0.50)
Extraordinary Loss, net of tax................... -- (2.88) -- (2.89)
----------- ----------- ----------- -----------
Net Income (Loss)................................ $ 0.59 $ (3.66) $ 1.35 $ (3.25)
=========== =========== =========== ===========
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
Income from Continuing Operations. We reported income from continuing
operations of $17 million ($0.05 per diluted share) for the three months ended
September 30, 2004 as compared to $147 million ($0.48 per diluted share) for the
same period in 2003. The decrease in income from continuing operations of $130
million was primarily due to the termination of revenues in our Electric
Transmission & Distribution business segment related to ECOM as of January 1,
2004, which had contributed $144 million of income in the third quarter of 2003.
This reduction in ECOM revenues was partially offset by a gain of $11 million on
the sale of land by our Electric Transmission & Distribution business segment.
Net loss for the three months ended September 30, 2004 included an
after-tax extraordinary loss of $894 million ($2.88 per diluted share) from a
write-down of regulatory assets based on our analysis of the Texas Utility
Commission's deliberations on the 2004 True-Up Proceeding. Additionally, net
loss for the three months ended September 30, 2004 included a net after-tax loss
from discontinued operations of Texas Genco of $259 million ($0.83 per diluted
share).
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
Income from Continuing Operations. We reported income from continuing
operations of $43 million ($0.14 per diluted share) for the nine months ended
September 30, 2004 as compared to $362 million ($1.19 per diluted share) for the
same period in 2003. The decrease in income from continuing operations of $319
million was primarily due to the termination of revenues in our Electric
Transmission & Distribution business segment related to ECOM as of January 1,
2004, which had contributed $296 million of income in the first nine months of
2003, a reduction of $20 million in operating income from our Electric
Transmission & Distribution and Natural Gas Distribution business
33
segments due to milder weather in the first nine months of 2004, an $8 million
charge for severance cost associated with staff reductions in our Natural Gas
Distribution business segment in 2004, higher net transmission costs of $6
million related to our Electric Transmission & Distribution business segment and
increased interest expense of $52 million related to continuing operations as
discussed below. These items were partially offset by a reversal of $23 million,
including $8 million of interest, of the $117 million reserve recorded in the
fourth quarter of 2003 by our Electric Transmission & Distribution business
segment related to the final fuel reconciliation, a $23 million increase in
operating income related to customer growth in our Electric Transmission &
Distribution business segment and a gain of $11 million on the sale of land by
our Electric Transmission & Distribution business segment.
Net loss for the nine months ended September 30, 2004 included an
after-tax extraordinary loss of $894 million ($2.89 per diluted share) from a
write-down of regulatory assets based on our analysis of the Texas Utility
Commission's deliberations on the 2004 True-Up Proceeding. Additionally, net
loss for the nine months ended September 30, 2004 included a net after-tax loss
from discontinued operations of Texas Genco of $154 million ($0.50 per diluted
share).
Net income for the nine months ended September 30, 2003 includes the
cumulative effect of an accounting change resulting from the adoption of SFAS
No. 143, "Accounting for Asset Retirement Obligations" ($80 million after-tax
gain, or $0.26 earnings per basic and diluted share), which is included in
discontinued operations related to Texas Genco.
INTEREST EXPENSE
In 2003, our $3.85 billion credit facility consisted of a revolver and a
term loan. This facility was amended in October 2003 to a $2.35 billion credit
facility, consisting of a revolver and a term loan. According to the terms of
the $3.85 billion credit facility, any net cash proceeds received from the sale
of Texas Genco were required to be applied to repay borrowings under the credit
facility. According to the terms of the $2.35 billion credit facility, until
such time as the facility has been reduced to $750 million, 100% of any net cash
proceeds received from the sale of Texas Genco are required to be applied to
repay borrowings under the credit facility and reduce the amount available under
the credit facility. In accordance with Emerging Issues Task Force Issue No.
87-24 "Allocation of Interest to Discontinued Operations", we have reclassified
interest to discontinued operations of Texas Genco based on net proceeds to be
received from the sale of Texas Genco of $2.5 billion, and have applied the
proceeds to the amount of debt assumed to be paid down in each respective period
according to the terms of the respective credit facilities in effect for those
periods. In periods where only the term loan was assumed to be repaid, the
actual interest paid was reclassified. In periods where a portion of the
revolver was assumed to be repaid, the percentage of that portion of the
revolver to the total outstanding balance was calculated, and that percentage
was applied to the actual interest paid in those periods to compute the amount
of interest reclassified.
Total interest expense incurred was $238 million and $206 million for the
three months ended September 30, 2003 and 2004, respectively, and $712 million
and $621 million for the nine months ended September 30, 2003 and 2004,
respectively. After reflecting the reclassification of interest expense to
discontinued operations and interest incurred by discontinued operations of $54
million and $14 million for the three months ended September 30, 2003 and 2004,
respectively, and $181 million and $38 million for the nine months ended
September 30, 2003 and 2004, respectively, interest expense related to
continuing operations was $184 million and $192 million for the three months
ended September 30, 2003 and 2004, respectively, and $531 million and $583
million for the nine months ended September 30, 2003 and 2004, respectively.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The following table presents operating income for each of our business
segments for the three months and nine months ended September 30, 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 (loss).
34
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
(IN MILLIONS)
Electric Transmission & Distribution............... $ 383 $ 178 $ 823 $ 390
Natural Gas Distribution........................... (5) (2) 146 137
Pipelines and Gathering............................ 39 35 124 123
Other Operations................................... 1 (4) (16) (17)
----------- ----------- ----------- -----------
Total Consolidated Operating Income.......... $ 418 $ 207 $ 1,077 $ 633
=========== =========== =========== ===========
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 and nine months ended
September 30, 2003 and 2004:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
(IN MILLIONS)
Revenues:
Electric transmission and distribution revenues.. $ 414 $ 425 $ 1,080 $ 1,095
ECOM revenues.................................... 222 -- 455 --
Transition bond revenues......................... 18 21 48 54
----------- ----------- ----------- -----------
Total revenues................................. 654 446 1,583 1,149
----------- ----------- ----------- -----------
Expenses:
Operation and maintenance........................ 139 134 398 390
Depreciation and amortization.................... 62 63 184 186
Taxes other than income taxes.................... 62 59 159 158
Transition bond expenses......................... 8 12 19 25
----------- ----------- ----------- -----------
Total expenses................................. 271 268 760 759
----------- ----------- ----------- -----------
Operating Income................................... $ 383 $ 178 $ 823 $ 390
=========== =========== =========== ===========
Actual gigawatt-hours (GWh) delivered:
Residential...................................... 8,134 8,512 19,183 18,714
Total (1)....................................... 20,896 22,568 54,770 56,634
- -----------
(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.
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
Our Electric Transmission & Distribution business segment reported
operating income of $178 million for the three months ended September 30, 2004,
consisting of $169 million for the regulated electric transmission and
distribution utility and $9 million for the transition bond company. For the
three months ended September 30, 2003, operating income totaled $383 million,
consisting of $151 million for the regulated electric transmission and
distribution utility, $10 million for the transition bond company and $222
million of non-cash income associated with ECOM. The amount of non-cash income
associated with ECOM was included in our 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 transmission and distribution utility continued
to benefit from solid customer growth, which contributed $9 million in operating
income from the
35
addition of nearly 51,000 metered customers since September 2003. Additionally,
we recorded an $11 million gain on the sale of land in the third quarter. These
amounts were offset by higher net transmission costs ($2 million) and
environmental remediation costs ($4 million).
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
Our Electric Transmission & Distribution business segment reported
operating income of $390 million for the nine months ended September 30, 2004,
consisting of $361 million for the regulated electric transmission and
distribution utility and $29 million for the transition bond company. For the
nine months ended September 30, 2003, operating income totaled $823 million,
consisting of $339 million for the regulated electric transmission and
distribution utility, $29 million for the transition bond company and $455
million of non-cash income associated with ECOM. Milder weather and decreased
usage negatively impacted the first nine months of 2004 by $25 million in
addition to higher net transmission costs of $6 million. These amounts were more
than offset by increased operating income from continued customer growth of $23
million and a gain of $11 million on the sale of land in the third quarter.
Additionally, operating income included $15 million due to a reversal of a
portion of an $87 million reserve, excluding interest, related to the final fuel
reconciliation recorded in the fourth quarter of 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.
The following table provides summary data of our Natural Gas Distribution
business segment for the three months and nine months ended September 30, 2003
and 2004:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
(IN MILLIONS)
Revenues........................................... $ 897 $ 1,149 $ 3,913 $ 4,525
----------- ----------- ----------- -----------
Expenses:
Natural gas...................................... 713 959 3,168 3,776
Operation and maintenance........................ 133 133 417 416
Depreciation and amortization.................... 34 36 101 106
Taxes other than income taxes.................... 22 23 81 90
----------- ----------- ----------- -----------
Total expenses................................. 902 1,151 3,767 4,388
----------- ----------- ----------- -----------
Operating Income (Loss)............................ $ (5) $ (2) $ 146 $ 137
=========== =========== =========== ===========
Throughput (in billion cubic feet (Bcf)):
Residential...................................... 15 15 129 121
Commercial and industrial........................ 39 39 167 171
Non-rate regulated commercial and industrial..... 120 113 365 419
Elimination...................................... (24) (32) (64) (105)
----------- ----------- ----------- -----------
Total Throughput............................... 150 135 597 606
=========== =========== =========== ===========
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
Our Natural Gas Distribution business segment reported an operating loss
of $2 million for the three months ended September 30, 2004 as compared to an
operating loss of $5 million for the same period in 2003. Higher revenues from
rate increases of $8 million and higher margins in our competitive commercial
and industrial sales business of $2 million were partially offset by a $6
million decrease in margins related to changes in estimates of unbilled revenues
and deferred gas costs which benefited 2003.
36
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
Our Natural Gas Distribution business segment reported operating income of
$137 million for the nine months ended September 30, 2004 as compared to $146
million for the same period in 2003. Increases in operating income of $3 million
from continued customer growth and $11 million from rate increases were more
than offset by the $13 million impact of milder weather and reduced operating
income of $6 million from our competitive commercial and industrial sales
business due to less volatile market conditions than in 2003. Operations and
maintenance expense decreased $1 million for the nine months ended September 30,
2004 as compared to the same period in 2003. Excluding an $8 million charge
recorded in the first quarter of 2004 for severance costs associated with staff
reductions, which will reduce costs in future periods, operation and maintenance
expenses decreased by $9 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.
The following table provides summary data of our Pipelines and Gathering
business segment for the three months and nine months ended September 30, 2003
and 2004:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
(IN MILLIONS)
Revenues........................................... $ 89 $ 108 $ 320 $ 324
----------- ----------- ----------- -----------
Expenses:
Natural gas...................................... 5 6 62 33
Operation and maintenance........................ 31 52 90 122
Depreciation and amortization.................... 10 11 31 33
Taxes other than income taxes.................... 4 4 13 13
----------- ----------- ----------- -----------
Total expenses................................. 50 73 196 201
----------- ----------- ----------- -----------
Operating Income................................... $ 39 $ 35 $ 124 $ 123
=========== =========== =========== ===========
Throughput (in Bcf):
Natural Gas Sales................................ 1 1 9 8
Transportation................................... 159 181 630 658
Gathering........................................ 73 79 219 233
Elimination (1).................................. -- -- (4) (5)
----------- ----------- ----------- -----------
Total Throughput.............................. 233 261 854 894
=========== =========== =========== ===========
- -------------
(1) Elimination of volumes both transported and sold.
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
Our Pipelines and Gathering business segment reported operating income of
$35 million for the three months ended September 30, 2004 as compared to $39
million for the same period in 2003. Operating margins (revenues less natural
gas costs) increased $18 million primarily due to increased utilization of
certain pipeline transportation services, increased throughput and enhanced
services related to our gas gathering operations and higher third-party
project-related revenues. The increase in operating margin was offset by higher
operation and maintenance expenses of $21 million primarily due to compliance
with pipeline integrity regulations, third-party project-related costs, and
litigation settlement costs.
37
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
Our Pipelines and Gathering business segment reported operating income of
$123 million for the nine months ended September 30, 2004 compared to $124
million for the same period in 2003. Operating margins (revenues less natural
gas costs) increased $33 million primarily due to increased utilization of
certain pipeline transportation services, increased throughput and enhanced
services related to our gas gathering operations and higher third-party
project-related revenues. The increase in operating margin was offset by higher
operation and maintenance expenses of $32 million primarily due to compliance
with pipeline integrity regulations, third-party project-related costs and
litigation settlement costs.
OTHER OPERATIONS
The following table shows operating loss of our Other Operations business
segment for the three months and nine months ended September 30, 2003 and 2004:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2003 2004 2003 2004
----------- ----------- ----------- -----------
(IN MILLIONS)
Revenues........................................... $ 8 $ 2 $ 26 $ 8
Expenses........................................... 7 6 42 25
----------- ----------- ----------- -----------
Operating Income (Loss)............................ $ 1 $ (4) $ (16) $ (17)
=========== =========== =========== ===========
DISCONTINUED OPERATIONS
On July 21, 2004, we and Texas Genco entered into a definitive transaction
agreement pursuant to which Texas Genco has agreed to be acquired in a multistep
transaction by GC Power Acquisition LLC, a newly formed entity owned in equal
parts by investment funds affiliated with The Blackstone Group, Hellman &
Friedman LLC, Kohlberg, Kravis Roberts & Co. L.P. and Texas Pacific Group, for
approximately $3.65 billion in cash. We recorded an after-tax loss of
approximately $253 million in the third quarter of 2004 related to the sale of
Texas Genco and an additional after-tax loss of $93 million offsetting our 81%
interest in Texas Genco's third quarter 2004 earnings. Until the sale of Texas
Genco is complete, our interest in any Texas Genco earnings will be offset by an
increased loss on the pending sale. The Interim Financial Statements present
these operations as discontinued operations in accordance with SFAS No. 144 for
all periods presented.
In November 2003, we sold a component of our Other Operations business
segment, CenterPoint Energy Management Services, Inc. (CEMS), that provided
district cooling services in the Houston central business district and related
complementary energy services to district cooling customers and others. We
recorded an after-tax loss in discontinued operations of $16 million ($25
million pre-tax) during the second quarter of 2003 to record the impairment of
the CEMS long-lived assets based on the impending sale and to record one-time
employee termination benefits. The Interim Financial Statements present these
operations as discontinued operations in accordance with SFAS No. 144 for the
three months and nine months ended September 30, 2003.
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. In April
2003, we sold our final remaining investment in Argentina, a 90 percent interest
in Empresa Distribuidora de Electricidad de Santiago del Estero S.A. We recorded
an after-tax loss of $3 million in the second quarter of 2003 related to our
Latin America operations. 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
nine months ended September 30, 2003.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read the factors listed under "Cautionary
Statement Regarding Forward-Looking Information" on Page ii of this Form 10-Q,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations --
38
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.
The actual terms of the order issued by the Texas Utility Commission in the 2004
True-Up Proceeding will affect our results for the fourth quarter of 2004 to the
extent materially different from that assumed when we recorded the charge to
earnings in the third quarter for the assumed terms of the order. In addition to
these factors, the discontinuance of non-cash operating income associated with
ECOM will negatively impact our earnings in 2004 as compared to 2003.
Additionally, any future earnings of Texas Genco will be offset by an increase
in the loss on disposal associated with these discontinued operations.
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 nine months ended
September 30, 2003 and 2004:
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
2003 2004
-------------- --------------
(IN MILLIONS)
Cash provided by (used in):
Operating activities..................................................... $ 269 $ 339
Investing activities..................................................... (351) (353)
Financing activities..................................................... (230) (114)
CASH PROVIDED BY OPERATING ACTIVITIES
Cash provided by operating activities increased $70 million for the nine
months ended September 30, 2004 as compared to the same period in 2003
substantially due to decreased accounts receivable attributable to a higher
level of accounts receivable being sold under CERC Corp.'s receivables facility
($83 million). Additionally, other changes in working capital items, primarily
decreased net accounts receivable and accounts payable due to the impact of
colder weather and higher natural gas prices in December 2003 as compared to
December 2002 contributed to the overall increase in cash provided by operating
activities.
CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities increased $2 million for the nine
months ended September 30, 2004 as compared to the same period in 2003 due
primarily to increased capital expenditures in our Electric Transmission &
Distribution business segment, substantially offset by decreased capital
expenditures in our Natural Gas Distribution business segment.
CASH USED IN FINANCING ACTIVITIES
During the first nine months of 2004, debt payments exceeded net loan
proceeds by $31 million. During the first nine months of 2003, debt payments
exceeded net loan proceeds by $150 million.
FUTURE SOURCES AND USES OF CASH
Our liquidity and capital requirements will be affected by:
- the sale of our 81% ownership interest in Texas Genco;
- the amount and timing of the receipt of true-up proceeds, including
receipt of the retail clawback from RRI and the effects of any
appeal from the true-up proceeding and whether or not transition
bonds are issued;
- repayments of borrowings under our credit facilities and the
corresponding reduction in the size of our credit facilities upon
receipt of the proceeds from the sale of our interest in Texas Genco
and receipt of the retail clawback from RRI;
39
- capital expenditures;
- debt service requirements;
- pension plan contributions;
- various regulatory actions; and
- 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 September 30, 2004,
CERC Corp. had $151 million outstanding under 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 September 30, 2004, we had the following revolving credit facilities
(in millions):
SIZE OF FACILITY AT AMOUNT UTILIZED AT
DATE EXECUTED COMPANY SEPTEMBER 30, 2004 SEPTEMBER 30, 2004 TERMINATION DATE
- ---------------- ------------------ ------------------- -------------------- ----------------
March 23, 2004 CERC Corp. $ 250 $ -- March 23, 2007
October 7, 2003 CenterPoint Energy 1,425 928 October 7, 2006
September 3, 2004 Texas Genco 250 182 (1) (2)
- --------------
(1) Utilized in the form of letters of credit.
(2) Earlier of March 2, 2005 or the date of the consummation of the sale of
Texas Genco's coal, lignite and gas-fired generation assets to GC Power
Acquisition.
On September 30, 2004, we had temporary investments of $337 million, all
of which were held by Texas Genco.
In September 2004, Genco LP amended its $75 million senior secured
revolving credit facility to increase the facility to $250 million. The
revolving credit facility terminates on the earlier of March 2, 2005 or the date
of the consummation of the sale of Texas Genco's coal, lignite and gas-fired
generation assets to GC Power Acquisition. Proceeds from the revolving credit
facility will be used to meet ongoing working capital requirements and for other
general corporate purposes. Borrowings under the facility may be made at the
London interbank offered rate (LIBOR) plus 100 basis points. The facility is
secured by a series of Genco LP's first mortgage bonds in an aggregate principal
amount of $250 million. All of Texas Genco's real and tangible properties,
subject to certain exclusions, are currently subject to the lien of the first
mortgage. As of September 30, 2004, there were no borrowings outstanding under
the revolving credit facility. As of September 30, 2004, letters of credit
aggregating $182 million were issued under the facility in favor of AEP Texas
Central Company (AEP), and are expected to be drawn upon in the first quarter of
2005 to pay the purchase price of an additional interest in the South Texas
Project. The expiration date of the letters of credit is August 29, 2005. Texas
Genco's existing cash balances and cash expected to be generated through
operations are expected to be used to reimburse the draws under the letters of
credit. Under the terms of the credit facility, it is expected that the letters
of credit will be cash collateralized at 105% of their face amount upon the sale
of Texas Genco's coal, lignite and gas-fired generation assets to GC Power
Acquisition. Texas Genco expects to fund the cash collateral with a portion of
the net proceeds of the sale.
At September 30, 2004, CenterPoint Energy had filed with the SEC a shelf
registration statement covering senior debt securities, preferred stock and
common stock aggregating $1 billion, but such registration statement had not
been declared effective. At September 30, 2004, CERC Corp. had a shelf
registration statement covering $50 million principal amount of debt securities.
40
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 fourth quarter of 2004, excluding those related to Texas Genco,
include the following:
- approximately $199 million of capital expenditures;
- an estimated $56 million in refunds by CenterPoint Houston of excess
mitigation credits; and
- dividend payments on CenterPoint Energy common stock.
Our liquidity in the fourth quarter of 2004 was positively impacted by a
tax refund of $163 million received in October 2004. We also anticipate
receiving payment of the retail clawback of approximately $177 million from RRI.
Additionally, we may make a contribution to our pension plan in the fourth
quarter of 2004.
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, which consisted of a $915 million term loan and a $1.425
billion revolver at September 30, 2004, 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 or its external debt through either the payment
of dividends or the settlement of intercompany payables. The SEC must take
action to approve any dividends by CenterPoint Houston in excess of its current
and retained earnings. To maintain CenterPoint Houston's capital structure at
the appropriate levels, we may reinvest funds in CenterPoint Houston in the form
of equity contributions or intercompany loans. 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 September 30,
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.
41
(3) A "negative" outlook from Fitch encompasses a one-to-two year horizon as
to the likely ratings direction.
We cannot assure you that these ratings will remain in effect for any
given period of time or that one or more of these ratings will not be lowered or
withdrawn entirely by a rating agency. In the near term, our ratings may be
affected by the results of the 2004 True-Up Proceeding. 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 business 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 and reduce margins 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 September 30,
2004, the senior unsecured debt of CERC Corp. was rated BBB by S&P and Ba1 by
Moody's. We estimate that as of September 30, 2004, unsecured credit limits
related to hedge instruments extended to CEGS by counterparties could aggregate
$95 million; however, utilized credit capacity is significantly lower.
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 September 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
42
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.
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.
In connection with the expected sale of our 81% interest in Texas Genco, a
separate pension plan was established for Texas Genco on September 1, 2004 and
we transferred a net pension liability of approximately $68 million to Texas
Genco. In October 2004, Texas Genco received an allocation of assets from our
pension plan pursuant to rules and regulations under the Employee Retirement
Income Security Act of 1974.
During 2003 and 2004, we have not been required to make contributions to
our pension plan. We have made voluntary contributions of $23 million and $56
million in 2003 and 2004, respectively. Additionally, we are considering making
additional contributions during the fourth quarter of 2004.
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
September 30, 2003 and 2004, respectively. Pension costs were $68 million and
$60 million for the nine months ended September 30, 2003 and 2004, respectively.
Included in pension costs for the three months ended September 30, 2003 and 2004
is $4 million and $3 million, respectively, of expense related to Texas Genco's
participants, which is reflected in discontinued operations in the Statements of
Consolidated Operations. Included in pension costs for the nine months ended
September 30, 2003 and 2004 is $13 million and $9 million, respectively, of
expense related to Texas Genco's participants, which is reflected in
discontinued operations in the Statements of Consolidated Operations.
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 for both the three months ended September 30, 2003 and 2004. The expense
associated with this non-qualified plan was $6 million and $5 million for the
nine months ended September 30, 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 obligations
specific to the characteristics of our plan.
Pension expense for 2004, including the benefit restoration plan, is
estimated to be $85 million, including $3 million of non-recurring early
retirement expenses, based on an expected return on plan assets of 9.0% and a
43
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. Included in
estimated pension expense for 2004 is $12 million related to Texas Genco's
participants.
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 in respect of
RRI's indemnity obligations to us and our subsidiaries.
Money Pools. 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 the 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 dated
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;
44
- 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 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
nine months of 2004. The orders also permit utilization of undrawn credit
facilities at CenterPoint Energy and CERC. As of September 30, 2004:
- CenterPoint Energy is authorized to issue an additional aggregate
$295 million of debt securities and $250 million of preferred stock
and preferred securities;
- CenterPoint Houston is authorized to issue an additional aggregate
$73 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 September
30, 2004, we had a retained deficit on our Consolidated Balance Sheets. We
recorded an after-tax loss of approximately $253 million in the third quarter of
2004 related to the sale of our remaining interest in Texas Genco. In addition,
we recorded an after-tax extraordinary loss of $894 million in
45
the third quarter of 2004 related to the 2004 True-Up Proceeding. These losses
reduced 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. However, in May 2004, we received an order from the SEC under
the 1935 Act authorizing us to continue to pay our current quarterly dividend in
the second and third quarters of 2004 out of capital or unearned surplus in the
event we had such losses. If our earnings for the fourth quarter of 2004 or
subsequent quarters are insufficient to pay dividends from current earnings due
to these or other factors, additional authority would be required from the SEC
for payment of the quarterly dividend from capital or unearned surplus, but
there can be no assurance that the SEC would authorize such payments. These
losses will adversely affect our ability to achieve a ratio of common equity to
total capitalization of 30% by the end of 2006, as had been projected in filings
under the 1935 Act. Accordingly, we may need to issue equity and/or take other
action to achieve a future equity capitalization of 30%. The June 2003 Financing
Order also requires that CenterPoint Houston and CERC maintain a ratio of common
equity to total capitalization of thirty percent.
On October 27, 2004, our board of directors authorized us to undertake
such accounting and legal review, valuation studies and other analyses as may be
deemed necessary in order to prepare an accounting reorganization
(quasi-reorganization) for presentation to the board. Such quasi-reorganization,
if approved, may be effective as of December 31, 2004.
A quasi-reorganization is an accounting procedure that eliminates an
accumulated deficit in retained earnings and permits the company to proceed on
much the same basis as if it had been legally reorganized. A
quasi-reorganization involves restating a company's assets and its liabilities
to their fair values. The balance in the retained earnings account is then
closed through a reduction in paid-in-capital accounts, giving the company a
"fresh start" with a zero balance in retained earnings.
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 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 $2.0 billion of recoverable electric generation-related
regulatory assets as of September 30, 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 is expected to occur in
2004. Based on our analysis of the Texas Utility Commission's deliberations, we
recorded an after-tax charge to earnings in the third quarter of 2004 of
approximately $894 million to write-down our electric generation-related
regulatory assets to their realizable value,
46
which is reflected as an extraordinary loss in the Statements of Consolidated
Operations. The ultimate amount of such charge will depend upon the final action
of the Texas Utility Commission.
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.
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 recorded an after-tax loss of approximately $253 million in the third
quarter of 2004 related to the expected sale of our remaining 81% interest in
Texas Genco.
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 5 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
Energy Derivative Instruments
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 September 30, 2004
levels would have decreased the fair value of our Energy Derivatives from their
levels on that date by $58 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.
Texas Genco Derivative Instrument
As discussed in Note 2 to the Interim Financial Statements, Genco LP
entered into a master power purchase and sale agreement with a member of the
Goldman Sachs group in connection with the definitive agreement for the sale of
Texas Genco entered into on July 21, 2004. Under that agreement, Genco LP has
sold forward a substantial quantity of its available base-load capacity through
2008. Texas Genco has designated the master power purchase and sale agreement as
a cash flow hedge of the forecasted sale of base-load capacity through 2008.
The sensitivity analysis performed on Genco LP's master power purchase
and sale agreement measures the potential loss based on a hypothetical 10%
movement in power prices. An increase of 10% in the market prices of electric
power from their September 30, 2004 levels would have decreased the fair value
of Genco LP's master power purchase and sale agreement from their levels on
that date by $196 million.
The above analysis of the Genco LP master power and sale agreement
utilized for hedging purposes does not include the favorable impact that the
same hypothetical price movement would have on Genco LP's forecasted sale of
base-load capacity to which the hedges relate. Therefore, the adverse impact to
the fair value of the Genco LP master power purchase and sale agreement held for
hedging purposes associated with the hypothetical changes in electric power
prices referenced above would be offset by a favorable impact to the underlying
hedged forecasted sale of base-load capacity.
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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), some lease obligations and our
obligations under the ZENS that subject us to the risk of loss associated with
movements in market interest rates.
Our floating-rate obligations to third parties aggregated $3 billion at
September 30, 2004. If the floating rates were to increase by 10% from September
30, 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 September 30, 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 $400 million if interest rates were
to decline by 10% from their levels at September 30, 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 11 (e) to the Interim Financial Statements,
CenterPoint Houston, as collection agent for the nuclear decommissioning charge
assessed on its transmission and distribution customers, contributed $2.9
million in 2003 and expects to contribute $2.9 million in 2004 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 $200 million as of September 30, 2004, of which
approximately 37% were debt securities that subject Texas Genco to risk of loss
of fair value with movements in market interest rates. If interest rates were to
increase by 10% from their levels at September 30, 2004, the fair value of the
fixed-rate debt securities would decrease by approximately $1 million. Any
unrealized gains or losses are accounted for by Texas Genco as a long-term
asset/liability as Texas Genco 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 September 30, 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 September 30, 2004. Changes
in the fair value of the derivative component will be recorded in our Statements
of Consolidated Operations 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 September 30, 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 Operations.
EQUITY MARKET VALUE RISK
We are exposed to equity market value risk through our ownership of 21.6
million shares of TW Common, 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 September 30, 2004 market value of TW Common would
result in a net loss of approximately $3 million, which would be recorded as a
loss in our Statements of Consolidated Operations.
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 approximately 63%
of total assets in equity securities as of September 30, 2004. The equity
securities expose Texas Genco to losses in fair value. If the market prices of
the individual equity securities were to decrease by 10% from their levels at
September
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30, 2004, the resulting loss to Texas Genco in fair value of these securities
would be approximately $12 million. Currently, the risk of an economic loss is
mitigated as discussed above under " -- Interest Rate Risk."
ITEM 4. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an
evaluation, under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, of
the effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our principal executive
officer and principal financial officer concluded that our disclosure controls
and procedures were effective as of September 30, 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 SEC's rules and forms.
There has been no change in our internal controls over financial reporting
that occurred during the three months ended September 30, 2004 that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.
49
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a description of certain legal and regulatory proceedings affecting
CenterPoint Energy, please read Notes 3 and 11 to our Interim Financial
Statements, "Business -- Regulation" and " -- Environmental Matters" in Item 1
of the CenterPoint Energy Form 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 6. EXHIBITS
The following exhibits are filed herewith:
Exhibits not incorporated by reference to a prior filing are designated by a
cross (+); all exhibits not so designated are incorporated by reference to a
prior filing of CenterPoint Energy, Inc. Pursuant to Item 601(b)(2) of
Regulation S-K, CenterPoint Energy has not filed the exhibits and schedules to
Exhibit 2.1. CenterPoint Energy hereby agrees to furnish a copy of any such
exhibit or schedule to the SEC upon request. 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
- ------ ----------- -------------------------------- ------ ---------
2.1 -- Transaction Agreement dated CenterPoint Energy's Current Report on 1-31447 10.1
July 21, 2004 among CenterPoint Form 8-K dated July 21, 2004
Energy, Inc., Utility Holding,
LLC, NN Houston Sub, Inc.,
Texas Genco Holdings, Inc., HPC
Merger Sub, Inc. and GC Power
Acquisition LLC (excluding
exhibits and schedules thereto)
3.1.1 -- Amended and Restated Articles CenterPoint Energy's Registration 3-69502 3.1
of Incorporation of CenterPoint Statement on Form S-4
Energy
3.1.2 -- Articles of Amendment to CenterPoint Energy's Form 10-K for the 1-31447 3.1.1
Amended and Restated Articles year ended December 31, 2001
of Incorporation of CenterPoint
Energy
3.2 -- Amended and Restated Bylaws of CenterPoint Energy's Form 10-K for the 1-31447 3.2
CenterPoint Energy year ended December 31, 2001
3.3 -- Statement of Resolution CenterPoint Energy's Form 10-K for the 1-31447 3.3
Establishing Series of Shares year ended December 31, 2001
designated Series A Preferred
Stock of CenterPoint Energy
4.1 -- Form of CenterPoint Energy CenterPoint Energy's Registration 3-69502 4.1
Stock Certificate Statement on Form S-4
4.2 -- Rights Agreement dated January CenterPoint Energy's Form 10-K for the 1-31447 4.2
1, 2002, between CenterPoint year ended December 31, 2001
Energy and JPMorgan Chase Bank,
as Rights Agent
4.3.1 -- $1,310,000,000 Credit Agreement CenterPoint Energy's Form 10-K for the 1-31447 4(g)(1)
dated as of November 12, 2002, year ended December 31, 2002
among CenterPoint Houston and
the banks named therein
4.3.2 -- First Amendment to Exhibit CenterPoint Energy's Form 10-Q for the 1-31447 10.7
4.3.1, dated as of September 3, quarter ended September 30, 2003
2003
50
4.3.3 -- Pledge Agreement, dated as of CenterPoint Energy's Form 10-K for the 1-31447 4(g)(2)
November 12, 2002 executed in year ended December 31, 2002
connection with Exhibit 4.3.1
4.4 -- $250,000,000 Credit Agreement, CenterPoint Energy's Form 8-K dated 1-31447 4.1
dated as of March 23, 2004, March 31, 2004
among CERC Corp., as Borrower,
and the Initial Lenders named
therein, as Initial Lenders
4.5.1 -- Credit Agreement, dated as of CenterPoint Energy's Form 10-Q for the 1-31447 10.8
October 7, 2003 among quarter ended September 30, 2003
CenterPoint Energy and the
banks named therein
4.5.2 -- Pledge Agreement, dated as of CenterPoint Energy's Form 10-Q for the 1-31447 10.9
October 7, 2003, executed in quarter ended September 30, 2003
connection with Exhibit 4.5.1
4.6.1 -- $75,000,000 revolving credit CenterPoint Energy's Form 10-K for the 1-31447 10(pp)(1)
facility dated as of December year ended December 31, 2003
23, 2003 among Texas Genco, LP
and the banks named therein
+4.6.2 -- First Amendment to Exhibit
4.6.1, dated as of September 3,
2004
10.1 -- Centerpoint Energy, Inc. CenterPoint Energy's Registration 333-120306 4.6
Second Amended and Restated Statement on Form S-3
Investor's Choice Plan
+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)
51
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: November 9, 2004
52
EXHIBIT INDEX
Exhibits not incorporated by reference to a prior filing are designated by a
cross (+); all exhibits not so designated are incorporated by reference to a
prior filing of CenterPoint Energy, Inc. Pursuant to Item 601(b)(2) of
Regulation S-K, CenterPoint Energy has not filed the exhibits and schedules to
Exhibit 2.1. CenterPoint Energy hereby agrees to furnish a copy of any such
exhibit or schedule to the SEC upon request. 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
- ------ ----------- -------------------------------- ------ ---------
2.1 -- Transaction Agreement dated CenterPoint Energy's Current Report on 1-31447 10.1
July 21, 2004 among CenterPoint Form 8-K dated July 21, 2004
Energy, Inc., Utility Holding,
LLC, NN Houston Sub, Inc.,
Texas Genco Holdings, Inc., HPC
Merger Sub, Inc. and GC Power
Acquisition LLC (excluding
exhibits and schedules thereto)
3.1.1 -- Amended and Restated Articles CenterPoint Energy's Registration 3-69502 3.1
of Incorporation of CenterPoint Statement on Form S-4
Energy
3.1.2 -- Articles of Amendment to CenterPoint Energy's Form 10-K for the 1-31447 3.1.1
Amended and Restated Articles year ended December 31, 2001
of Incorporation of CenterPoint
Energy
3.2 -- Amended and Restated Bylaws of CenterPoint Energy's Form 10-K for the 1-31447 3.2
CenterPoint Energy year ended December 31, 2001
3.3 -- Statement of Resolution CenterPoint Energy's Form 10-K for the 1-31447 3.3
Establishing Series of Shares year ended December 31, 2001
designated Series A Preferred
Stock of CenterPoint Energy
4.1 -- Form of CenterPoint Energy CenterPoint Energy's Registration 3-69502 4.1
Stock Certificate Statement on Form S-4
4.2 -- Rights Agreement dated January CenterPoint Energy's Form 10-K for the 1-31447 4.2
1, 2002, between CenterPoint year ended December 31, 2001
Energy and JPMorgan Chase Bank,
as Rights Agent
4.3.1 -- $1,310,000,000 Credit Agreement CenterPoint Energy's Form 10-K for the 1-31447 4(g)(1)
dated as of November 12, 2002, year ended December 31, 2002
among CenterPoint Houston and
the banks named therein
4.3.2 -- First Amendment to Exhibit CenterPoint Energy's Form 10-Q for the 1-31447 10.7
4.3.1, dated as of September 3, quarter ended September 30, 2003
2003
4.3.3 -- Pledge Agreement, dated as of CenterPoint Energy's Form 10-K for the 1-31447 4(g)(2)
November 12, 2002 executed in year ended December 31, 2002
connection with Exhibit 4.3.1
4.4 -- $250,000,000 Credit Agreement, CenterPoint Energy's Form 8-K dated 1-31447 4.1
dated as of March 23, 2004, March 31, 2004
among CERC Corp., as Borrower,
and the Initial Lenders named
therein, as Initial Lenders
4.5.1 -- Credit Agreement, dated as of CenterPoint Energy's Form 10-Q for the 1-31447 10.8
October 7, 2003 among quarter ended September 30, 2003
CenterPoint Energy and the
banks named therein
4.5.2 -- Pledge Agreement, dated as of CenterPoint Energy's Form 10-Q for the 1-31447 10.9
October 7, 2003, executed in quarter ended September 30, 2003
connection with Exhibit 4.5.1
4.6.1 -- $75,000,000 revolving credit CenterPoint Energy's Form 10-K for the 1-31447 10(pp)(1)
facility dated as of December year ended December 31, 2003
23, 2003 among Texas Genco, LP
and the banks named therein
+4.6.2 -- First Amendment to Exhibit
4.6.1, dated as of September 3,
2004
10.1 -- Centerpoint Energy, Inc. CenterPoint Energy's Registration 333-120306 4.6
Second Amended and Restated Statement on Form S-3
Investor's Choice Plan
+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)