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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 1-13265
CENTERPOINT ENERGY RESOURCES CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 76-0511406
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1111 LOUISIANA
HOUSTON, TEXAS 77002 (713) 207-1111
(Address and zip code of principal (Registrant's telephone number, including
executive offices) area code)
------------------------------------
CENTERPOINT ENERGY RESOURCES CORP. MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q
WITH THE REDUCED DISCLOSURE FORMAT.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of November 1, 2004, all 1,000 shares of CenterPoint Energy Resources Corp.
common stock were held by Utility Holding, LLC, a wholly owned subsidiary of
CenterPoint Energy, Inc.
CENTERPOINT ENERGY RESOURCES CORP.
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 Narrative Analysis of the Results of Operations............... 14
Item 4. Controls and Procedures.................................................... 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................... 20
Item 6. Exhibits................................................................... 20
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:
- state and federal legislative and regulatory actions or
developments, constraints placed on our activities or business by
the Public Utility Holding Company Act of 1935, as amended (1935
Act), and changes in or application of laws or regulations
applicable to other aspects of our business;
- timely rate increases, including recovery of costs;
- 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 costs of such capital, receipt of certain approvals
under the 1935 Act, and the results of our financing and refinancing
efforts, including availability of funds in the debt capital
markets;
- actions by rating agencies;
- inability of various counterparties to meet their obligations to us;
- non-payment of our services due to financial distress of our
customers; and
- other factors we discuss in "Risk Factors" beginning on page 9 of
the CenterPoint Energy Resources Corp. 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.
ii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CENTERPOINT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
STATEMENTS OF CONSOLIDATED OPERATIONS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2004 2003 2004
---- ---- ---- ----
REVENUES ................................. $ 950,178 $ 1,219,417 $ 4,075,794 $ 4,739,205
--------- ----------- ----------- -----------
EXPENSES:
Natural gas ............................ 681,889 928,189 3,072,667 3,700,679
Operation and maintenance .............. 164,585 184,255 504,045 536,235
Depreciation and amortization .......... 44,776 46,855 132,967 138,994
Taxes other than income taxes .......... 26,421 28,403 94,525 107,369
--------- ----------- ----------- -----------
Total .............................. 917,671 1,187,702 3,804,204 4,483,277
--------- ----------- ----------- -----------
OPERATING INCOME ......................... 32,507 31,715 271,590 255,928
--------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest and other finance charges...... (44,043) (45,080) (128,200) (133,893)
Other, net ............................. 851 3,873 4,290 9,927
--------- ----------- ----------- -----------
Total .............................. (43,192) (41,207) (123,910) (123,966)
--------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES ........ (10,685) (9,492) 147,680 131,962
Income Tax Expense (Benefit) .......... (452) (7,257) 55,083 49,254
--------- ----------- ----------- -----------
NET INCOME (LOSS) ........................ $ (10,233) $ (2,235) $ 92,597 $ 82,708
========= =========== =========== ===========
See Notes to the Company's Interim Financial Statements
1
CENTERPOINT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, SEPTEMBER 30,
2003 2004
---- ----
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 34,447 $ 16,466
Accounts and notes receivable, net........................................ 462,988 294,565
Accrued unbilled revenue.................................................. 323,844 95,896
Accounts and notes receivable - affiliated companies, net................. -- 124,396
Materials and supplies.................................................... 26,859 26,911
Natural gas inventory..................................................... 160,367 241,696
Non-trading derivative assets............................................. 45,897 89,677
Taxes receivable.......................................................... 32,023 10,935
Prepaid expenses.......................................................... 11,104 4,503
Other..................................................................... 71,597 97,682
-------------- --------------
Total current assets.................................................... 1,169,126 1,002,727
-------------- --------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment............................................. 4,086,750 4,222,530
Less accumulated depreciation............................................. (351,189) (444,791)
-------------- --------------
Property, plant and equipment, net...................................... 3,735,561 3,777,739
-------------- --------------
OTHER ASSETS:
Goodwill.................................................................. 1,740,510 1,740,510
Other intangibles, net.................................................... 20,101 19,736
Non-trading derivative assets............................................. 11,273 25,325
Accounts and notes receivable - affiliated companies, net................. 33,929 24,595
Other..................................................................... 142,162 141,580
-------------- --------------
Total other assets...................................................... 1,947,975 1,951,746
-------------- --------------
TOTAL ASSETS................................................................ $ 6,852,662 $ 6,732,212
============== ==============
See Notes to the Company's Interim Financial Statements
2
CENTERPOINT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDER'S EQUITY
DECEMBER 31, SEPTEMBER 30,
2003 2004
---- ----
CURRENT LIABILITIES:
Short-term borrowings..................................................... $ 63,000 $ --
Current portion of long-term debt......................................... -- 366,873
Accounts payable.......................................................... 528,394 385,739
Accounts and notes payable - affiliated companies, net.................... 23,351 --
Taxes accrued............................................................. 65,636 69,181
Interest accrued.......................................................... 58,505 51,930
Customer deposits......................................................... 58,372 57,789
Non-trading derivative liabilities........................................ 6,537 9,299
Accumulated deferred income taxes, net.................................... 8,856 25,411
Other..................................................................... 125,132 121,579
-------------- --------------
Total current liabilities........................................... 937,783 1,087,801
-------------- --------------
OTHER LIABILITIES:
Accumulated deferred income taxes, net.................................... 645,125 646,694
Non-trading derivative liabilities........................................ 3,330 11,919
Benefit obligations....................................................... 130,980 128,712
Other..................................................................... 571,005 572,107
-------------- --------------
Total other liabilities............................................... 1,350,440 1,359,432
-------------- --------------
LONG-TERM DEBT.............................................................. 2,370,974 2,001,366
-------------- --------------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 9)
STOCKHOLDER'S EQUITY:
Common stock.............................................................. 1 1
Paid-in capital........................................................... 1,985,254 1,985,273
Retained earnings......................................................... 173,682 243,890
Accumulated other comprehensive income.................................... 34,528 54,449
-------------- --------------
Total stockholder's equity............................................ 2,193,465 2,283,613
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY............................... $ 6,852,662 $ 6,732,212
============== ==============
See Notes to the Company's Interim Financial Statements
3
CENTERPOINT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2003 2004
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................... $ 92,597 $ 82,708
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization.......................................... 132,967 138,994
Amortization of deferred financing costs............................... 3,091 7,349
Deferred income taxes.................................................. 31,433 9,198
Changes in other assets and liabilities:
Accounts and notes receivable and unbilled revenues, net............. 253,482 396,969
Accounts receivable/payable, affiliates.............................. (11,326) (3,521)
Inventory............................................................ (79,702) (81,381)
Taxes receivable..................................................... 17,780 21,088
Accounts payable..................................................... (175,553) (144,477)
Fuel cost recovery................................................... 3,835 (10,812)
Interest and taxes accrued........................................... 17,712 (3,030)
Net non-trading derivative assets and liabilities.................... (12,144) (17,987)
Other current assets................................................. (5,559) (11,116)
Other current liabilities............................................ (16,540) 131
Other assets......................................................... 4,760 (5,682)
Other liabilities.................................................... (9,745) (7,896)
Other, net............................................................. (13,118) (2,735)
-------------- --------------
Net cash provided by operating activities.......................... 233,970 367,800
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................................... (190,444) (170,163)
Decrease (increase) in notes receivable from affiliates, net............. 4,350 (134,872)
Other, net............................................................... (5,600) (3,561)
-------------- --------------
Net cash used in investing activities.............................. (191,694) (308,596)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt............................................... (367,008) --
Proceeds from long-term debt............................................. 768,525 --
Debt issuance costs...................................................... (68,916) (1,685)
Dividend to parent....................................................... -- (12,500)
Decrease in short-term borrowings, net................................... (292,000) (63,000)
Decrease in notes with affiliates, net................................... (74,096) --
-------------- --------------
Net cash used in financing activities.............................. (33,495) (77,185)
-------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS....................... 8,781 (17,981)
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD........................ 9,237 34,447
-------------- --------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD.............................. $ 18,018 $ 16,466
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest................................................................. $ 118,173 $ 136,839
Income taxes............................................................. 4,548 72,760
See Notes to the Company's Interim Financial Statements
4
CENTERPOINT ENERGY RESOURCES CORP. 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 Resources Corp. (CERC Corp., and together with its
subsidiaries, the Company), are the Company'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 CERC Corp. for the year ended December 31, 2003 (CERC
Corp. Form 10-K).
Background. The Company is an indirect wholly owned subsidiary of
CenterPoint Energy, Inc. (CenterPoint Energy), a public utility holding company
created on August 31, 2002, as part of a corporate restructuring of Reliant
Energy, Incorporated (Reliant Energy). CenterPoint Energy is a registered public
utility holding company under the Public Utility Holding Company Act of 1935, as
amended (1935 Act). The 1935 Act and related rules and regulations impose a
number of restrictions on the activities of CenterPoint Energy and those of its
subsidiaries. The 1935 Act, among other things, limits the ability of
CenterPoint Energy and its 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.
Basis of Presentation. The preparation of financial statements in
conformity with generally accepted accounting principles 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 Operations are not
necessarily indicative of amounts expected for a full-year period due to the
effects of, among other things, (a) seasonal fluctuations in demand for energy
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(e) (Regulatory Assets and Liabilities), Note 3 (Regulatory
Matters), Note 5 (Derivative Instruments) and Note 9 (Commitments and
Contingencies) to the consolidated annual financial statements in the CERC Corp.
Form 10-K (CERC Corp. 10-K Notes) relate to certain contingencies. These notes,
as updated herein, are incorporated herein by reference.
For information regarding environmental matters and legal proceedings, see
Note 9 to the Interim Financial Statements.
(2) 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
created before February 1, 2003, the Company applied the provisions of FIN 46 or
FIN 46-R as of December 31, 2003. The revised FIN 46-R is effective for all
other entities for financial periods ending after March 15, 2004. The Company
has a subsidiary trust that has Mandatorily Redeemable Preferred Securities
outstanding. The trust was determined to be a variable interest entity under FIN
46-R and the Company also determined that it is not the
5
primary beneficiary of the trust. As of December 31, 2003, the Company
deconsolidated the trust and instead reports its junior subordinated debentures
due to the trust as long-term debt.
On December 23, 2003, the FASB issued Statement of Financial Accounting
Standards (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 11 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.
(3) REGULATORY MATTERS
(a) 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.
6
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.
(b) 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) DERIVATIVE 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.
(5) 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.......................... $ 7 $ (3) $ 7 $ (3)
Other.................................... 20 (4) 21 (5)
----------- ---------- ----------- ----------
Total................................. $ 27 $ (7) $ 28 $ (8)
=========== ========== =========== ==========
The Company recognizes specifically identifiable intangibles when specific
rights and contracts are acquired.
7
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 47 to 75 years for land use rights and 4 to 25 years for
other intangibles.
Amortization expense for other intangibles for both the three months ended
September 30, 2003 and 2004 was $0.4 million. Amortization expense for other
intangibles for the nine months ended September 30, 2003 and 2004 was $1.1
million and $1.3 million, respectively. Estimated amortization expense for the
remainder of 2004 is approximately $0.5 million and is approximately $2 million
per year for the two succeeding fiscal years and $0.5 million per year for the
subsequent three succeeding fiscal years.
(6) LONG-TERM DEBT AND RECEIVABLES FACILITY
(a) Long-Term Debt.
Credit Facilities. As of September 30, 2004, the Company 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 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.
Junior Subordinated Debentures (Trust Preferred Securities). 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 2, 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, the Company 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, the Company
had $151 million outstanding under its receivables facility.
8
(7) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive
income:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
2003 2004 2003 2004
---- ---- ---- ----
(IN MILLIONS)
Net income (loss)............................................. $ (10) $ (2) $ 93 $ 83
-------- -------- -------- --------
Other comprehensive income:
Net deferred gain (loss) from cash flow hedges.............. (26) 17 (19) 34
Reclassification of deferred loss (gain) from cash flow
hedges realized in net income............................. 2 (6) 3 (14)
-------- -------- -------- --------
Other comprehensive income (loss)............................. (24) 11 (16) 20
-------- -------- -------- --------
Comprehensive income (loss)................................... $ (34) $ 9 $ 77 $ 103
======== ======== ======== ========
(8) RELATED PARTY TRANSACTIONS
The following table summarizes receivables from, or payables to,
CenterPoint Energy or its subsidiaries:
DECEMBER 31, SEPTEMBER 30,
2003 2004
------------ -------------
(IN MILLIONS)
Accounts receivable from affiliates......................................... $ 6 $ 2
Accounts payable to affiliates.............................................. (29) (22)
--------- ----------
Accounts payable -- affiliated companies, net............................. (23) (20)
--------- ----------
Note receivable from affiliates(1).......................................... -- 144
--------- ----------
Accounts and notes receivable/(payable) -- affiliated companies, net... $ (23) $ 124
========= ==========
Long-term accounts receivable from affiliates............................... $ -- $ 64
Long-term accounts payable to affiliates.................................... -- (44)
--------- ----------
Long-term accounts receivable -- affiliated companies, net................ -- 20
--------- ----------
Long-term notes receivable from affiliates.................................. 67 5
Long-term notes payable to affiliates....................................... (33) --
--------- ----------
Long-term notes receivable -- affiliated companies, net................... 34 5
--------- ----------
Long-term accounts and notes receivable -- affiliated companies, net... $ 34 $ 25
========= ==========
- ----------
(1) This note represents money pool investments.
For the three months ended September 30, 2003 and 2004, the Company had
net interest income related to affiliate borrowings of $0.6 million and $2.9
million, respectively. For the nine months ended September 30, 2003 and 2004,
the Company had net interest income related to affiliate borrowings of $3.0
million and $7.0 million, respectively.
The 1935 Act generally prohibits borrowings by CenterPoint Energy from its
subsidiaries, including the Company, either through the money pool or otherwise.
For the three months ended September 30, 2003 and 2004, sales and services
provided by the Company to Texas Genco Holdings, Inc. (Texas Genco) totaled $15
million and $3 million, respectively. For the nine months ended September 30,
2003 and 2004, sales and services provided by the Company to Texas Genco totaled
$25 million and $20 million, respectively.
CenterPoint Energy provides some corporate services to the Company. The
costs of services have been directly charged to the Company using methods that
management believes are reasonable. These methods include negotiated usage
rates, dedicated asset assignment, and proportionate corporate formulas based on
assets, operating
9
expenses and employees. These charges are not necessarily indicative of what
would have been incurred had the Company not been an affiliate. Amounts charged
to the Company for these services were $26 million and $29 million for the three
months ended September 30, 2003 and 2004, respectively, and are included
primarily in operation and maintenance expenses. Amounts charged to the Company
for these services were $83 million and $84 million for the nine months ended
September 30, 2003 and 2004, respectively, and are included primarily in
operation and maintenance expenses.
In June 2004, the Company paid a dividend of $12.5 million to Utility
Holding, LLC.
(9) COMMITMENTS AND CONTINGENCIES
(a) Legal Matters.
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. The Company
believes that there has been no systematic mismeasurement of gas and that the
suits are without merit. The Company does not expect that their ultimate outcome
would have a material impact on the Company's financial condition or results of
operations.
Gas Cost Recovery Litigation. In October 2002, a suit was filed in state
district court in Wharton County, Texas against the Company, CenterPoint Energy,
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
the Company with respect to rates charged to a purported class of certain
consumers of natural gas and gas service in the State of Louisiana. In February
2004, another suit was filed in state court in Calcasieu Parish, Louisiana
against the Company 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, CenterPoint Energy, 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
10
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,
CenterPoint Energy 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 does not anticipate that the outcome of these matters
will have a material impact on the financial condition or results of operations
of the Company.
(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 the Company.
Manufactured Gas Plant Sites. The Company 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 the Company's Minnesota service territory, two of
which it believes were neither owned nor operated by the Company, and for which
it believes it has no liability.
At September 30, 2004, the Company 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. The Company has utilized an
environmental expense tracker mechanism in its rates in Minnesota to recover
estimated costs in excess of insurance recovery. The Company has collected or
accrued $12 million as of September 30, 2004 to be used for future environmental
remediation.
The Company has received notices from the United States Environmental
Protection Agency and others regarding its status as a PRP for other sites. The
Company has been named as a defendant in lawsuits under which contribution is
sought for the cost to remediate former MGP sites based on the previous
ownership of such sites by former affiliates of the Company 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
11
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. 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.
(10) REPORTABLE BUSINESS SEGMENTS
Because CERC Corp. is an indirect wholly owned subsidiary of CenterPoint
Energy, the Company's determination of reportable segments considers the
strategic operating units under which CenterPoint Energy manages sales,
allocates resources and assesses performance of various products and services to
wholesale or retail customers in differing regulatory environments.
The Company has identified the following reportable business segments:
Natural Gas Distribution, Pipelines and Gathering, and Other Operations. For
descriptions of the reportable business segments, see Note 12 to the CERC Corp.
10-K Notes, which is incorporated herein by reference.
The following table summarizes financial data for the Company's reportable
business segments:
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003
---------------------------------------------
REVENUES FROM NET
THIRD PARTIES INTERSEGMENT OPERATING
AND AFFILIATES REVENUES INCOME (LOSS)
-------------- -------- -------------
(IN MILLIONS)
Natural Gas Distribution............... $ 894 (1) $ 3 $ (5)
Pipelines and Gathering................ 56 (2) 33 39
Other Operations....................... -- 1 (1)
Eliminations........................... -- (37) --
----------- ----------- -----------
Consolidated........................... $ 950 $ -- $ 33
=========== =========== ===========
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004
---------------------------------------------
REVENUES FROM NET
THIRD PARTIES INTERSEGMENT OPERATING
AND AFFILIATES REVENUES INCOME (LOSS)
-------------- -------- -------------
(IN MILLIONS)
Natural Gas Distribution............... $ 1,146 (1) $ 3 $ (2)
Pipelines and Gathering................ 73 (2) 35 35
Other Operations....................... -- 1 (1)
Eliminations........................... -- (39) --
----------- ----------- -----------
Consolidated........................... $ 1,219 $ -- $ 32
=========== =========== ===========
12
AS OF
DECEMBER 31,
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 2003
-------------------------------------------- ------------
REVENUES FROM NET
THIRD PARTIES INTERSEGMENT OPERATING
AND AFFILIATES REVENUES INCOME TOTAL ASSETS
-------------- -------- ------ ------------
(IN MILLIONS)
Natural Gas Distribution............... $ 3,885 (1) $ 28 $ 146 $ 4,661
Pipelines and Gathering................ 191 (2) 129 124 2,519
Other Operations....................... -- 7 2 388
Eliminations........................... -- (164) -- (715)
----------- ----------- ----------- -----------
Consolidated........................... $ 4,076 $ -- $ 272 $ 6,853
=========== =========== =========== ===========
AS OF
SEPTEMBER 30,
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 2004
-------------------------------------------- -------------
REVENUES FROM NET
THIRD PARTIES INTERSEGMENT OPERATING
AND AFFILIATES REVENUES INCOME (LOSS) TOTAL ASSETS
-------------- -------- ------------- ------------
(IN MILLIONS)
Natural Gas Distribution............... $ 4,522 (1) $ 3 $ 137 $ 4,346
Pipelines and Gathering................ 217 (2) 107 123 2,552
Other Operations....................... -- 6 (4) 384
Eliminations........................... -- (116) -- (550)
----------- ----------- ----------- -----------
Consolidated........................... $ 4,739 $ -- $ 256 $ 6,732
=========== =========== =========== ===========
- -------------
(1) Included in Natural Gas Distribution revenues from third parties and
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.
(2) Included in Pipelines and Gathering revenues from third parties and
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.
(11) EMPLOYEE BENEFIT PLANS
The Company's employees participate in CenterPoint Energy's postretirement
benefits plan.
The Company's net periodic cost includes the following components relating
to postretirement benefits:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2004 2003 2004
---- ---- ---- ----
(IN MILLIONS)
Service cost...................................... $ -- $ -- $ 1 $ 1
Interest cost..................................... 2 3 7 8
Expected return on plan assets.................... -- -- (1) (1)
Net amortization.................................. 1 -- 2 1
Other ............................................ -- -- -- 1
---------- --------- ---------- ----------
Net periodic cost........................... $ 3 $ 3 $ 9 $ 10
========== ========= ========== ==========
The Company expects to contribute $15 million to CenterPoint Energy's
postretirement benefits plan in 2004. As of September 30, 2004, $11 million has
been contributed.
13
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS
The following narrative analysis should be read in combination with our
Interim Financial Statements contained in Item 1 of this Form 10-Q.
We are an indirect wholly owned subsidiary of CenterPoint Energy, Inc.
(CenterPoint Energy), a public utility holding company created on August 31,
2002, as part of a corporate restructuring of Reliant Energy, Incorporated
(Reliant Energy). CenterPoint Energy is a registered public utility holding
company under the Public Utility Holding Company Act of 1935, as amended (1935
Act). For information about the 1935 Act, please read " -- Liquidity -- Certain
Contractual and Regulatory Limits on Ability to Issue Securities and Pay
Dividends."
We meet the conditions specified in General Instruction H(1)(a) and (b) to
Form 10-Q and are therefore permitted to use the reduced disclosure format for
wholly owned subsidiaries of reporting companies. Accordingly, we have omitted
from this report the information called for by Item 2 (Management's Discussion
and Analysis of Financial Condition and Results of Operations) and Item 3
(Quantitative and Qualitative Disclosures About Market Risk) of Part I and the
following Part II items of Form 10-Q: Item 2 (Unregistered Sales of Equity
Securities and Use of Proceeds), Item 3 (Defaults Upon Senior Securities) and
Item 4 (Submission of Matters to a Vote of Security Holders). The following
discussion explains material changes in our revenue and expense items between
the three and nine months ended September 30, 2003 and the three and nine months
ended September 30, 2004. Reference is made to "Management's Narrative Analysis
of the Results of Operations" in Item 7 of the Annual Report on Form 10-K of
CERC Corp. for the year ended December 31, 2003 (CERC Corp. Form 10-K).
CONSOLIDATED RESULTS OF OPERATIONS
Our results of operations are affected by seasonal fluctuations in the
demand for natural gas and price movements of energy commodities. Our results of
operations are also affected by, among other things, the actions of various
federal, state and municipal governmental authorities having jurisdiction over
rates we charge, competition in our various business operations, debt service
costs and income tax expense. For more information regarding factors that may
affect the future results of operations of our business, please read "Business
- -- Risk Factors" in Item 1 of the CERC Corp. Form 10-K and "Management's
Narrative Analysis of the Results of Operations -- Certain Factors Affecting
Future Earnings" in Item 7 of the CERC Corp. Form 10-K, which are incorporated
herein by reference.
The following table sets forth our consolidated results of operations for
the three and nine months ended September 30, 2003 and 2004, followed by a
discussion of our consolidated results of operations based on operating income.
We have provided a reconciliation of consolidated operating income to net income
below.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2004 2003 2004
---- ---- ---- ----
(IN MILLIONS)
Revenues................................... $ 950 $ 1,219 $ 4,076 $ 4,739
------------ ------------ ------------ ------------
Expenses:
Natural gas............................. 682 928 3,073 3,701
Operation and maintenance............... 164 184 504 536
Depreciation and amortization........... 45 47 133 139
Taxes other than income taxes........... 26 28 94 107
------------ ------------ ------------ ------------
Total Expenses....................... 917 1,187 3,804 4,483
------------ ------------ ------------ ------------
Operating Income........................... 33 32 272 256
Interest and Other Finance Charges......... (44) (45) (128) (134)
Other Income, net.......................... 1 4 4 10
------------ ------------ ------------ ------------
Income (Loss) Before Income Taxes.......... (10) (9) 148 132
Income Tax Expense (Benefit)............... -- (7) 55 49
------------ ------------ ------------ ------------
Net Income (Loss).......................... $ (10) $ (2) $ 93 $ 83
============ ============ ============ ============
14
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
We reported operating income of $32 million for the three months ended
September 30, 2004 as compared to $33 million for the same period in 2003. The
decrease was primarily due to:
o decreased margins of $6 million related to changes in estimates of
unbilled revenues and deferred gas costs; and
o increased operations and maintenance expenses of $20 million
primarily due to compliance with pipeline integrity regulations,
third-party project-related costs and litigation settlement costs.
These decreases were partially offset by:
o higher revenues from rate increases of $8 million;
o higher margins of $2 million in our competitive commercial and
industrial sales business;
o increased operating margins of $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.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
We reported operating income of $256 million for the nine months ended
September 30, 2004 as compared to $272 million for the same period in 2003. The
decrease was primarily due to:
o the $13 million impact of milder weather;
o reduced operating income from our competitive commercial and
industrial sales business of $6 million due to less volatile market
conditions than in 2003;
o increased operations and maintenance expenses of $32 million
primarily due compliance with pipeline integrity regulations,
third-party project-related costs and litigation settlement costs;
and
o an $8 million charge recorded in the first quarter of 2004 for
severance costs associated with staff reductions in our Natural Gas
Distribution business segment.
These decreases were partially offset by:
o increased operating income from continued customer growth of $3
million in our Natural Gas Distribution business segment;
o higher revenues from rate increases of $11 million; and
o increased operating margins of $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.
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 Narrative Analysis of Results of Operations -- Certain Factors
Affecting Future Earnings" in Item 7 of Part II of the CERC Corp. Form 10-K and
"Risk Factors" in Item 1 of Part I of the CERC Corp. Form 10-K, each of which is
incorporated herein by reference.
15
LIQUIDITY
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, we replaced our $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,
we had $151 million outstanding under our receivables facility.
Long-Term Debt. As of September 30, 2004, we had the following revolving
credit facility:
SIZE OF AMOUNT
FACILITY AT OUTSTANDING AT
SEPTEMBER 30, SEPTEMBER 30,
DATE EXECUTED COMPANY 2004 2004 TERMINATION DATE
- ------------- ------- ---- ---- ----------------
(IN MILLIONS)
March 23, 2004 CERC Corp. $ 250 $ -- March 23, 2007
As of September 30, 2004, we had no external temporary investments.
At September 30, 2004, we had a shelf registration statement covering $50
million principal amount of debt securities.
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 remaining cash
requirements during the fourth quarter of 2004 include approximately $122
million of capital expenditures.
We expect that revolving credit borrowings, anticipated cash flows from
operations and borrowings from affiliates will be sufficient to meet our cash
needs for 2004.
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 our senior unsecured debt:
MOODY'S S&P FITCH
------- --- -----
RATING OUTLOOK(1) RATING OUTLOOK(2) RATING OUTLOOK(3)
- ------ ---------- ------ ---------- ------ ----------
Ba1 Stable BBB Negative BBB Negative
- ----------
(1) A "stable" outlook from Moody's indicates that Moody's does not
expect to put the rating on review for an upgrade or downgrade
within 18 months from when the outlook was assigned or last
affirmed.
(2) An S&P rating outlook assesses the potential direction of a
long-term credit rating over the intermediate to longer term.
(3) A "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. 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, the
willingness of suppliers to extend credit lines to us on an unsecured basis and
the execution of our business strategies.
A decline in credit ratings would increase borrowing costs under our $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
as more fully described in " -- Certain Contractual and Regulatory Limits on
Ability to Issue Securities and Pay Dividends" below. Additionally, a
16
decline in credit ratings could increase cash collateral requirements and reduce
margins of our Natural Gas Distribution business segment.
Our revolving credit facility contains a "material adverse change" clause
that could impact our ability to make new borrowings under this facility. The
"material adverse change" clause in our revolving credit facility relates to any
material adverse change in the business, condition, operations, performance or
properties of the borrower or the borrower and its subsidiaries taken as a
whole.
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. Our debentures and borrowings generally provide that a
default on obligations by CenterPoint Energy does not cause a default under our
debentures, revolving credit facility or receivables facility. Under our
revolving credit facility, a payment default on, or a non-payment default that
permits acceleration of, any indebtedness exceeding $35 million by us or any of
our significant subsidiaries will cause a default. A payment default by us in
respect of, or an acceleration of, borrowed money and certain other specified
types of obligations, in the aggregate principal amount of $50 million will
cause a default on $922 million aggregate principal amount of our senior notes.
A payment default on, or a non-payment default that permits acceleration of, any
indebtedness at CERC Corp. exceeding $50 million will cause a default under
CenterPoint Energy's $2.3 billion credit facility entered into in October 2003.
A payment default by us in respect of, or an acceleration of, borrowed money and
certain other specified types of obligations, in the aggregate principal amount
of $50 million, will cause a default on senior debt of CenterPoint Energy
aggregating $1.4 billion.
Pension Plan. As discussed in Note 7(a) to the consolidated annual
financial statements in the CERC Corp. Form 10-K (CERC Corp. 10-K Notes), which
is incorporated herein by reference, we participate in CenterPoint Energy's
qualified non-contributory pension plan covering substantially all employees.
Pension expense for 2004 is estimated to be $34 million, including $3 million of
non-recurring early retirement expenses, based on an expected return on plan
assets of 9.0% and a discount rate of 6.25% as of December 31, 2003. Future
changes in plan asset returns, assumed discount rates and various other factors
related to the pension plan will impact our future pension expense. 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:
o 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;
o acceleration of payment dates on certain gas supply contracts under
certain circumstances, as a result of increased gas prices and
concentration of suppliers;
o increased costs related to the acquisition of gas for storage; and
o various regulatory actions.
Money Pool. We participate in a "money pool" through which we and certain
of our affiliates can borrow or invest on a short-term basis. Funding needs are
aggregated and external borrowing or investing is based on the net cash
position. The money pool's net funding requirements are generally met by
borrowings of CenterPoint Energy. The terms of the money pool are in accordance
with requirements applicable to registered public utility holding companies
under the 1935 Act and under an order from the SEC dated June 30, 2003 (June
2003 Financing Order) relating to our financing activities. Our money pool
borrowing limit under such financing order is $600 million. At
17
September 30, 2004, we had $144 million invested in the money pool. The money
pool may not provide sufficient funds to meet our cash needs.
Certain Contractual and Regulatory Limits on Ability to Issue Securities
and Pay Dividends. Factors affecting our ability to issue securities, pay
dividends on our common stock or take other actions to adjust our capitalization
include:
o covenants and other provisions in our credit facility and
receivables facility; and
o limitations imposed on us under the 1935 Act.
Our bank facility and our receivables facility limit our debt as a
percentage of our total capitalization to 60% and contain an earnings before
interest, taxes, depreciation and amortization to interest covenant. We are in
compliance with such covenants.
Our parent, CenterPoint Energy, is a registered public utility holding
company under the 1935 Act. The 1935 Act and related rules and regulations
impose a number of restrictions on our parent's activities and those of its
subsidiaries, including us. The 1935 Act, among other things, limits our
parent's ability and the ability of its regulated subsidiaries, including us, to
issue debt and equity securities without prior authorization, restricts the
source of dividend payments to current and retained earnings without prior
authorization, regulates sales and acquisitions of certain assets and businesses
and governs affiliate transactions.
The June 2003 Financing Order is effective until June 30, 2005.
Additionally, CenterPoint Energy has 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 CenterPoint
Energy and its regulated subsidiaries, including us, without additional
authorization but generally permit CenterPoint Energy and its subsidiaries,
including us, to refinance our existing obligations. We are in compliance with
the authorized limits. The orders also permit our utilization of undrawn credit
facilities. As of September 30, 2004, we are 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 $430 million of additional debt by us.
The orders require that if CenterPoint Energy or any of its regulated
subsidiaries, including us, issue any securities that are rated by a nationally
recognized statistical rating organization (NRSRO), the security to be issued
must obtain an investment grade rating from at least one NRSRO and, as a
condition to such issuance, all outstanding rated securities of 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 June 2003 Financing Order requires us to maintain a
ratio of common equity to total capitalization of at least 30%.
Relationship with CenterPoint Energy. We are an indirect wholly owned
subsidiary of CenterPoint Energy. As a result of this relationship, the
financial condition and liquidity of our parent company could affect our access
to capital, our credit standing and our financial condition.
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one that is both important to the
presentation of our financial condition and results of operations and requires
management to make difficult, subjective or complex accounting estimates. An
accounting estimate is an approximation made by management of a financial
statement element, item or account in the financial statements. Accounting
estimates in our historical consolidated financial statements measure the
effects of past business transactions or events, or the present status of an
asset or liability. The accounting estimates described below require us to make
assumptions about matters that are highly uncertain at the time the estimate is
made. Additionally, different estimates that we could have used or changes in an
accounting estimate that are
18
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 CERC Corp. 10-K
Notes. We believe the following accounting policies involve the application of
critical accounting estimates. Accordingly, these accounting estimates have been
reviewed and discussed with the audit committee of the board of directors of
CenterPoint Energy.
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 Statement of Financial Accounting Standards 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.
UNBILLED REVENUES
Revenues related to the sale and/or delivery of natural gas are generally
recorded when natural gas is delivered to customers. However, the determination
of 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 natural gas delivered to customers since the date of the last
meter reading are estimated and the corresponding unbilled revenue is estimated.
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 2 to the Interim Financial Statements for a discussion of new
accounting pronouncements that affect us.
ITEM 4. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an
evaluation, under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, of
the effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our principal executive
officer and principal financial officer concluded that our disclosure controls
and procedures were effective as of September 30, 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.
19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a description of certain legal and regulatory proceedings affecting
us, please review Notes 3 and 9 to our Interim Financial Statements, "Business
- -- Regulation" and " -- Environmental Matters" in Item 1 of the CERC Corp. Form
10-K, "Legal Proceedings" in Item 3 of the CERC Corp. Form 10-K and Notes 3,
9(c) and (d) to the CERC Corp. 10-K 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 as indicated.
REPORT OR SEC FILE OR
EXHIBIT REGISTRATION REGISTRATION EXHIBIT
NUMBER DESCRIPTION STATEMENT NUMBER REFERENCE
- ------ ----------- --------- ------ ---------
3.1.1 - Certificate of Incorporation of Form 10-K for the year ended 1-13265 3(a)(1)
RERC Corp. December 31, 1997
3.1.2 - Certificate of Merger merging Form 10-K for the year ended 1-13265 3(a)(2)
former NorAm Energy Corp. with and December 31, 1997
into HI Merger, Inc. dated August
6, 1997
3.1.3 - Certificate of Amendment changing Form 10-K for the year ended 1-13265 3(a)(3)
the name to Reliant Energy December 31, 1998
Resources Corp.
3.1.4 - Certificate of Amendment changing Form 10-Q for the quarter ended 1-13265 3(a)(4)
the name to CenterPoint Energy June 30,2003
Resources Corp.
3.2 - Bylaws of RERC Corp. Form 10-K for the year ended 1-13265 3(b)
December 31, 1997
4.1 - $250,000,000 Credit Agreement, Form 8-K dated March 31, 2004 1-13265 4.1
dated as of March 23, 2004, among
CERC Corp., as Borrower, and the
Initial Lenders named therein, as
Initial Lenders
+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
20
REPORT OR SEC FILE OR
EXHIBIT REGISTRATION REGISTRATION EXHIBIT
NUMBER DESCRIPTION STATEMENT NUMBER REFERENCE
- ------ ----------- --------- ------ ---------
+99.1 - Items incorporated by reference
from the CERC Corp. Form 10-K.
Item 1 "Business -- Regulation,"
" -- Environmental Matters," and
" -- Risk Factors," Item 3 "Legal
Proceedings" and Item 7
"Management's Narrative Analysis of
the Results of Operations --
Certain Factors Affecting Future
Earnings" and Notes 2(e)
(Regulatory Assets and
Liabilities), 3 (Regulatory
Matters), 5 (Derivative
Instruments), 7(a) (Pension Plans),
9 (Commitments and Contingencies)
and 12 (Reportable Segments).
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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 RESOURCES CORP.
By: /s/ James S. Brian
---------------------------------------
James S. Brian
Senior Vice President and Chief Accounting Officer
Date: November 9, 2004
22
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 as indicated.
REPORT OR SEC FILE OR
EXHIBIT REGISTRATION REGISTRATION EXHIBIT
NUMBER DESCRIPTION STATEMENT NUMBER REFERENCE
- ------ ----------- --------- ------ ---------
3.1.1 - Certificate of Incorporation of Form 10-K for the year ended 1-13265 3(a)(1)
RERC Corp. December 31, 1997
3.1.2 - Certificate of Merger merging Form 10-K for the year ended 1-13265 3(a)(2)
former NorAm Energy Corp. with and December 31, 1997
into HI Merger, Inc. dated August
6, 1997
3.1.3 - Certificate of Amendment changing Form 10-K for the year ended 1-13265 3(a)(3)
the name to Reliant Energy December 31, 1998
Resources Corp.
3.1.4 - Certificate of Amendment changing Form 10-Q for the quarter ended 1-13265 3(a)(4)
the name to CenterPoint Energy June 30,
2003 Resources Corp.
3.2 - Bylaws of RERC Corp. Form 10-K for the year ended 1-13265 3(b)
December 31, 1997
4.1 - $250,000,000 Credit Agreement, Form 8-K dated March 31, 2004 1-13265 4.1
dated as of March 23, 2004, among
CERC Corp., as Borrower, and the
Initial Lenders named therein, as
Initial Lenders
+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 CERC Corp. Form 10-K.
Item 1 "Business -- Regulation,"
" -- Environmental Matters," and
" -- Risk Factors," Item 3 "Legal
Proceedings" and Item 7
"Management's Narrative Analysis of
the Results of Operations --
Certain Factors Affecting Future
Earnings" and Notes 2(e)
(Regulatory Assets and
Liabilities), 3 (Regulatory
Matters), 5 (Derivative
Instruments), 7(a) (Pension Plans),
9 (Commitments and Contingencies)
and 12 (Reportable Segments).