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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
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,
executive offices) including 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 May 1, 2005, 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 MARCH 31, 2005
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................................. 1
Statements of Consolidated Income
Three Months Ended March 31, 2004 and 2005 (unaudited)............. 1
Consolidated Balance Sheets
December 31, 2004 and March 31, 2005 (unaudited)................... 2
Statements of Consolidated Cash Flows
Three Months Ended March 31, 2004 and 2005 (unaudited)............. 4
Notes to Unaudited Consolidated Financial Statements.................. 5
Item 2. Management's Narrative Analysis of the Results of Operations...... 14
Item 4. Controls and Procedures........................................... 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 21
Item 6. Exhibits.......................................................... 21
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), changes in or application of laws or regulations applicable to
other aspects of our business:
- allowed rates of return;
- rate structures;
- recovery of investments; and
- operation and construction of facilities;
- 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 financing
approvals under the 1935 Act, and the results of our financing and
refinancing efforts, including availability of funds in the debt
capital markets;
- actions by rating agencies;
- inability of various counterparties to meet their obligations to us;
- non-payment of our services due to financial distress of our
customers;
- our ability to control costs;
- the investment performance of CenterPoint Energy's employee benefit
plans;
- our internal restructuring or other restructuring options that may
be pursued;
- our potential business strategies, including acquisitions or
dispositions of assets or businesses, which cannot be assured to be
completed or beneficial to us; and
ii
- other factors we discuss in "Risk Factors" beginning on page 11 of
the CenterPoint Energy Resources Corp. Annual Report on Form 10-K
for the year ended December 31, 2004.
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 RESOURCES CORP. AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------------
2004 2005
-------------- --------------
REVENUES............................................................... $ 2,196,585 $ 2,415,090
-------------- --------------
EXPENSES:
Natural gas.......................................................... 1,762,240 1,948,335
Operation and maintenance............................................ 181,833 173,275
Depreciation and amortization........................................ 46,526 49,176
Taxes other than income taxes........................................ 45,394 42,411
-------------- --------------
Total............................................................ 2,035,993 2,213,197
-------------- --------------
OPERATING INCOME....................................................... 160,592 201,893
-------------- --------------
OTHER INCOME (EXPENSE):
Interest and other finance charges................................... (42,282) (45,454)
Other, net........................................................... 2,600 4,634
-------------- --------------
Total............................................................ (39,682) (40,820)
-------------- --------------
INCOME BEFORE INCOME TAXES............................................. 120,910 161,073
Income Tax Expense................................................... (46,719) (65,116)
-------------- --------------
NET INCOME............................................................. $ 74,191 $ 95,957
============== ==============
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, MARCH 31,
2004 2005
-------------- ------------
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 140,466 $ 253,927
Accounts and notes receivable, net........................................ 612,708 613,247
Accrued unbilled revenue.................................................. 502,163 316,298
Accounts and notes receivable - affiliated companies, net................. 11,987 145,561
Materials and supplies.................................................... 25,017 25,331
Natural gas inventory..................................................... 174,232 75,324
Non-trading derivative assets............................................. 50,219 85,664
Taxes receivable.......................................................... 155,155 141,371
Deferred tax asset........................................................ 12,256 --
Prepaid expenses.......................................................... 8,308 11,606
Other..................................................................... 92,160 46,304
-------------- ------------
Total current assets.................................................... 1,784,671 1,714,633
-------------- ------------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment............................................. 4,296,061 4,331,226
Less accumulated depreciation............................................. (461,978) (477,704)
-------------- ------------
Property, plant and equipment, net...................................... 3,834,083 3,853,522
-------------- ------------
OTHER ASSETS:
Goodwill.................................................................. 1,740,510 1,740,510
Other intangibles, net.................................................... 19,719 19,376
Non-trading derivative assets............................................. 17,682 44,153
Accounts and notes receivable - affiliated companies, net................. 18,197 17,240
Other..................................................................... 118,089 118,936
-------------- ------------
Total other assets...................................................... 1,914,197 1,940,215
-------------- ------------
TOTAL ASSETS................................................................ $ 7,532,951 $ 7,508,370
============== ============
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, MARCH 31,
2004 2005
-------------- ------------
CURRENT LIABILITIES:
Current portion of long-term debt......................................... $ 366,873 $ 361,000
Accounts payable.......................................................... 798,661 647,099
Taxes accrued............................................................. 77,802 75,795
Interest accrued.......................................................... 57,741 50,824
Customer deposits......................................................... 60,164 60,149
Non-trading derivative liabilities........................................ 26,323 21,169
Accumulated deferred income taxes, net.................................... -- 3,941
Other..................................................................... 272,996 302,685
-------------- ------------
Total current liabilities............................................. 1,660,560 1,522,662
-------------- ------------
OTHER LIABILITIES:
Accumulated deferred income taxes, net.................................... 640,780 644,463
Non-trading derivative liabilities........................................ 6,412 4,425
Benefit obligations....................................................... 128,537 125,620
Other..................................................................... 556,819 535,641
-------------- ------------
Total other liabilities............................................... 1,332,548 1,310,149
-------------- ------------
LONG-TERM DEBT.............................................................. 2,000,696 1,999,999
-------------- ------------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 9)
STOCKHOLDER'S EQUITY:
Common stock.............................................................. 1 1
Paid-in capital........................................................... 2,231,906 2,262,589
Retained earnings......................................................... 305,291 401,248
Accumulated other comprehensive income.................................... 1,949 11,722
-------------- ------------
Total stockholder's equity............................................ 2,539,147 2,675,560
-------------- ------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY............................... $ 7,532,951 $ 7,508,370
============== ============
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)
THREE MONTHS ENDED MARCH 31,
-------------------------------
2004 2005
-------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................... $ 74,191 $ 95,957
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization.......................................... 46,526 49,176
Amortization of deferred financing costs............................... 2,814 2,266
Deferred income taxes.................................................. (10,770) 16,440
Changes in other assets and liabilities:
Accounts receivable and unbilled revenues, net....................... 176,189 185,461
Accounts receivable/payable, affiliates.............................. 1,626 (4,567)
Inventory............................................................ 91,570 98,594
Taxes receivable..................................................... 32,023 44,467
Accounts payable..................................................... (57,475) (151,562)
Fuel cost recovery................................................... 47,528 75,666
Interest and taxes accrued........................................... 61,115 (8,924)
Net non-trading derivative assets and liabilities.................... 6,487 (55,828)
Other current assets................................................. 26,099 42,557
Other current liabilities............................................ (25,216) (47,448)
Other assets......................................................... (3,667) 10,464
Other liabilities.................................................... (23,759) (36,367)
Other, net............................................................. (459) (697)
-------------- ------------
Net cash provided by operating activities.......................... 444,822 315,655
-------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................................... (52,126) (62,005)
Increase in notes receivable from affiliates, net........................ (175,065) (128,049)
Other, net............................................................... (2,416) (6,267)
-------------- ------------
Net cash used in investing activities.............................. (229,607) (196,321)
-------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in short-term borrowings, net................................... (63,000) --
Payments of long-term debt............................................... -- (5,873)
Debt issuance costs...................................................... (1,862) --
-------------- ------------
Net cash used in financing activities.............................. (64,862) (5,873)
-------------- ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS................................... 150,353 113,461
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD........................ 34,447 140,466
-------------- ------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD.............................. $ 184,800 $ 253,927
============== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest................................................................. $ 46,126 $ 51,728
Income taxes............................................................. 14,968 418
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. are the consolidated interim financial
statements and notes (Interim Financial Statements) of CenterPoint Energy
Resources Corp. and its subsidiaries (collectively, CERC Corp. or the Company).
The Interim Financial Statements are unaudited, omit certain financial statement
disclosures and should be read with the Annual Report on Form 10-K of CERC Corp.
for the year ended December 31, 2004 (CERC Corp. Form 10-K).
Background. The Company's operating subsidiaries own and operate natural
gas distribution facilities, interstate pipelines and natural gas gathering,
processing and treating facilities. The Company's operations of its local
distribution companies are conducted by three unincorporated divisions: Houston
Gas, Minnesota Gas and Southern Gas Operations. Through wholly owned
subsidiaries, the Company owns two interstate natural gas pipelines and gas
gathering systems, provides various ancillary services, and offers variable and
fixed price physical natural gas supplies to commercial and industrial customers
and natural gas distributors.
The Company is an indirect wholly owned subsidiary of CenterPoint Energy,
Inc. (CenterPoint Energy), a public utility holding company created on August
31, 2002, as part of a corporate restructuring of Reliant Energy, Incorporated
(Reliant Energy) that implemented certain requirements of the Texas Electric
Choice Plan. CenterPoint Energy is a registered public utility holding company
under the Public Utility Holding Company Act of 1935, as amended (1935 Act). The
1935 Act and related rules and regulations impose a number of restrictions on
the activities of CenterPoint Energy and those of its subsidiaries. The 1935
Act, among other things, limits the ability of CenterPoint Energy and its
subsidiaries to issue debt and equity securities without prior authorization,
restricts the source of dividend payments to current and retained earnings
without prior authorization, regulates sales and acquisitions of certain assets
and businesses and governs affiliated service, sales and construction contracts.
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 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(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 March 2005, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. (FIN) 47, "Accounting for Conditional Asset Retirement
Obligations" (FIN 47). FIN 47 clarifies that an entity must record a liability
for a "conditional" asset retirement obligation if the fair value of the
obligation can be reasonably estimated.
5
FIN 47 is effective no later than the end of fiscal years ending after December
15, 2005. The Company does not expect the adoption of this standard to have a
material effect on its financial position, results of operations or cash flows.
(3) REGULATORY MATTERS
(a) Rate Cases.
In April 2005, the Railroad Commission of Texas (Railroad Commission)
approved a settlement that increased Southern Gas Operations' base rate and
service charge revenues by a combined $2 million in its East Texas and South
Texas Divisions.
(b) City of Tyler, Texas Dispute.
In July 2002, the City of Tyler, Texas, asserted that Southern Gas
Operations 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 Railroad Commission by agreement of the parties for a
determination of whether Southern Gas Operations 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 December
2004, the Railroad Commission conducted a hearing on the matter. On April 15,
2005, the Railroad Commission hearing examiners issued a preliminary finding
that the Company had complied with its tariffs, acted prudently in entering into
its gas supply contracts, and prudently managed those contracts. The Railroad
Commission is expected to issue a final ruling in May 2005. In a parallel action
now in the Court of Appeals in Austin, Southern Gas Operations is challenging
the scope of the Railroad Commission's inquiry which goes beyond the issue of
whether Southern Gas Operations had properly followed its tariffs to include a
review of Southern Gas Operations' 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 Railroad
Commission. The Company believes that all costs for Southern Gas Operations'
Tyler distribution system have been properly included and recovered from
customers pursuant to Southern Gas Operations' filed tariffs.
(4) 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 three months ended March 31, 2004 and 2005,
hedge ineffectiveness was less than $1 million 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. If
it becomes probable that an anticipated transaction will not occur, the Company
realizes in net income the deferred gains and losses recognized in accumulated
other comprehensive income. Once the anticipated transaction occurs, the
accumulated deferred gain or loss recognized in accumulated other comprehensive
income is reclassified and included in the Company's Statements of Consolidated
Income under the caption "Natural Gas." Cash flows resulting from these
transactions in non-trading energy derivatives are included in the Statements of
Consolidated Cash Flows in the same category as the item being hedged. As of
March 31, 2005, the Company expects $14 million in accumulated other
comprehensive income to be reclassified into net income during the next twelve
months.
Other Derivative Financial Instruments. The Company also has natural gas
contracts that are derivatives which are not hedged. Load following services
that the Company offers its natural gas customers create an inherent tendency
for the Company to be either long or short natural gas supplies relative to
customer purchase commitments. The Company measures and values all of its
volumetric imbalances on a real-time basis to minimize its exposure to commodity
price and volume risk. The aggregate Value at Risk (VaR) associated with these
operations is calculated daily and averaged $0.3 million with a high of $1
million during the first quarter of 2005. The Company does not engage in
proprietary or speculative commodity trading. Unhedged positions are accounted
for by adjusting the carrying amount of the contracts to market and recognizing
any gain or loss in operating income, net. During the three months ended March
31, 2004 and 2005, the Company recognized net gains (losses)
6
related to unhedged positions amounting to $(1) million and $6 million,
respectively. As of December 31, 2004, the Company had recorded short-term risk
management assets and liabilities of $4 million and $5 million, respectively,
included in other current assets and other current liabilities, respectively. As
of March 31, 2005, the Company had recorded short-term risk management assets
and liabilities of $4 million and $3 million, respectively, included in other
current assets and other current liabilities, respectively.
(5) GOODWILL AND INTANGIBLES
Goodwill as of December 31, 2004 and March 31, 2005 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, 2005 and no impairment was indicated.
The components of the Company's other intangible assets consist of the
following:
DECEMBER 31, 2004 MARCH 31, 2005
------------------------- --------------------------
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------- ------------ -------- ------------
(IN MILLIONS)
Land use rights.......................... $ 7 $ (3) $ 7 $ (3)
Other.................................... 21 (5) 21 (6)
-------- ------------ -------- ------------
Total.................................... $ 28 $ (8) $ 28 $ (9)
======== ============ ======== ============
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 March
31, 2005. 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 the three months ended
March 31, 2004 and 2005 was $0.4 million and $0.5 million, respectively.
Estimated amortization expense for the remainder of 2005 is approximately $1.4
million and is approximately $2 million per year for each of the five succeeding
fiscal years.
(6) LONG-TERM DEBT AND RECEIVABLES FACILITY
(a) Long-Term Debt.
Credit Facilities. As of March 31, 2005, 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. Borrowings
under this facility may be made at the London interbank offered rate (LIBOR)
plus 137.5 basis points, including the facility fee, based on current credit
ratings and the applicable pricing grid. An additional utilization fee of 12.5
basis points applies to borrowings whenever more than 33% of the facility is
utilized. Changes in credit ratings would lower or raise the increment to LIBOR
depending on whether ratings improved or were lowered. As of March 31, 2005,
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
7
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. The junior subordinated debentures discussed above were included in
long-term debt as of December 31, 2004 and March 31, 2005.
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 both December 31, 2004 and March 31, 2005, the
liquidation amount of convertible preferred securities outstanding was $0.3
million. The securities, and their underlying convertible junior subordinated
debentures, bear interest at 6.25% and mature in June 2026. Subject to some
limitations, CERC Corp. has the option of deferring payments of interest on the
convertible junior subordinated debentures. During any deferral or event of
default, CERC Corp. may not pay dividends on its common stock to CenterPoint
Energy. As of March 31, 2005, no interest payments on the convertible junior
subordinated debentures had been deferred.
(b) Receivables Facility.
In January 2005, the Company's $250 million receivables facility was
extended to January 2006 and temporarily increased, for the period from January
2005 to June 2005, to $375 million to provide additional liquidity to the
Company during the peak heating season of 2005, in view of recent levels of, and
volatility in, gas prices. As of March 31, 2005, the Company had $181 million of
advances under its receivables facility.
(7) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive
income (net of tax):
FOR THE THREE MONTHS
ENDED MARCH 31,
--------------------
2004 2005
-------- -------
(IN MILLIONS)
Net income......................................................................... $ 74 $ 96
-------- -------
Other comprehensive income:
Net deferred gain from cash flow hedges.......................................... 8 9
Reclassification of deferred loss (gain) from cash flow hedges realized in net
income......................................................................... (3) 1
-------- -------
Other comprehensive income......................................................... 5 10
-------- -------
Comprehensive income............................................................... $ 79 $ 106
======== =======
The following table summarizes the components of accumulated other
comprehensive income:
DECEMBER 31, MARCH 31,
2004 2005
------------ ---------
(IN MILLIONS)
Net deferred gain from cash flow hedges................................ $ 2 $ 12
============ =========
8
(8) RELATED PARTY TRANSACTIONS
The following table summarizes receivables from, or payables to,
CenterPoint Energy or its subsidiaries:
DECEMBER 31, MARCH 31,
2004 2005
------------ ---------
(IN MILLIONS)
Accounts receivable from affiliates......................................... $ 4 $ 4
Accounts payable to affiliates.............................................. (34) (29)
Note receivable from affiliates(1).......................................... 42 171
------------ ---------
Accounts and notes receivable - affiliated companies, net............... $ 12 $ 146
============ =========
Long-term accounts receivable from affiliates............................... $ 64 $ 64
Long-term accounts payable to affiliates.................................... (45) (46)
Long-term notes payable to affiliates....................................... (1) (1)
------------ ---------
Long-term accounts and notes receivable - affiliated companies, net.... $ 18 $ 17
============ =========
- ---------------
(1) This represents money pool investments.
For the three months ended March 31, 2004 and 2005, the Company had net
interest income related to affiliate borrowings of $1.6 million and $1.2
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 March 31, 2004, the sales and services provided
by the Company to Texas Genco Holdings, Inc. (Texas Genco), a former subsidiary
of CenterPoint Energy, totaled $7 million. For the three months ended March 31,
2005, the Company provided no sales or services to CenterPoint Energy or its
subsidiaries.
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 margins, operating expenses and employees. These charges are
not necessarily indicative of what would have been incurred had the Company not
been an affiliate. Amounts charged to the Company for these services were $27
million and $29 million for the three months ended March 31, 2004 and 2005,
respectively, and are included primarily in operation and maintenance expenses.
Pursuant to the tax sharing agreement with CenterPoint Energy, in the
first quarter of 2005, the Company received an allocation of CenterPoint
Energy's tax benefits totaling $31 million, which was recorded as an increase
to additional paid-in capital.
(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
9
claims against certain defendants (including two of the Company's 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 the ultimate outcome to have a material impact on its financial
condition, results of operations or cash flows.
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. Subsequently the plaintiffs added as
defendants CenterPoint Energy Marketing Inc., CenterPoint Energy Gas
Transmission Company, United Gas, Inc., Louisiana Unit Gas Transmission Company,
CenterPoint Energy Pipeline Services, Inc., and CenterPoint Energy Trading and
Transportation Group, Inc. 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 Southern Gas Operations to a purported class of certain consumers of
natural gas and gas service without advance approval by the Louisiana Public
Service Commission (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 Miller County case seek class
certification, but the proposed class has not been certified. In November 2004,
the Miller case was removed to federal district court in Texarkana, Arkansas. In
February 2005, the Wharton County case was removed to federal district court in
Houston, Texas, and in March 2005, the plaintiffs voluntarily moved to dismiss
the case and agreed not to refile the claims asserted unless the Miller County
case is not certified as a class action or is later decertified. 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, 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 and CenterPoint Energy do not expect
the outcome of these matters to have a material impact on the financial
condition , results of operations or cash flows of either the Company or
CenterPoint Energy.
(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
10
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 does not expect the ultimate cost associated with resolving this matter
to have a material impact on the financial condition, results of operations or
cash flows of the Company.
Manufactured Gas Plant Sites. The Company and its predecessors operated
manufactured gas plants (MGP) in the past. In Minnesota, the Company has
completed remediation on two sites, other than ongoing monitoring and water
treatment. There are five remaining sites in the Company's Minnesota service
territory. The Company believes that it has no liability with respect to two of
these sites.
At March 31, 2005, the Company had accrued $18 million for remediation of
certain Minnesota sites. At March 31, 2005, the estimated range of possible
remediation costs for these sites was $7 million to $42 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. As of March 31, 2005, the
Company has collected or accrued $13 million from insurance companies and
ratepayers to be used for future environmental remediation.
In addition to the Minnesota sites, the United States Environmental
Protection Agency and other regulators have investigated MGP sites that were
owned or operated by the Company or may have been owned by one of its former
affiliates. The Company has been named as a defendant in two lawsuits under
which contribution is sought by private parties 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 has also been identified as a PRP by
the State of Maine for a site that is the subject of one of the lawsuits. In
March 2005, the court considering the other suit for contribution granted the
Company's motion to dismiss on the grounds that the Company was not an
"operator" of the site as had been alleged. The plaintiff in that case has filed
an appeal of the court's dismissal of the Company. The Company is investigating
details regarding these sites and the range of environmental expenditures for
potential remediation. However, the Company believes it is not liable as a
former owner or operator of those sites under the Comprehensive Environmental,
Response, Compensation and Liability Act of 1980, as amended, and applicable
state statutes, and is vigorously contesting those suits and its designation as
a PRP.
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 does not expect the costs of any remediation of these
sites to 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 from time to
time as a defendant in litigation related to such sites. Although the ultimate
outcome of such matters cannot be predicted at this time, the Company does not
expect, based on its experience to date, these matters, either individually or
in the aggregate, to have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
(c) Other Proceedings.
In 2005, the Company received a communication from the Minnesota Office of
Pipeline Safety indicating that the agency had ordered a predecessor company to
remove certain components from a portion of its distribution system prior to the
date the Company acquired it. Those components are not in compliance with
current state and federal codes, and it is possible that some of those
components remain in the Company's system. The Company has
11
not completed its analysis of the cost to locate and replace such components;
however, the Company does not expect the disposition of this matter to have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.
The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management does not expect the disposition of these matters to have a material
adverse effect on the Company's financial condition, results of operations or
cash flows.
(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 MARCH 31, 2004
----------------------------------------------
REVENUES FROM NET TOTAL ASSETS
EXTERNAL INTERSEGMENT OPERATING AS OF
CUSTOMERS REVENUES INCOME(LOSS) DECEMBER 31, 2004
------------- ------------ ------------ -----------------
(IN MILLIONS)
Natural Gas Distribution............... $ 2,130(1) $ 1 $ 117 $ 4,798
Pipelines and Gathering................ 66(2) 36 45 2,637
Other Operations....................... -- 3 (2) 792
Eliminations........................... -- (40) -- (694)
------------- ------------ --------- ------------
Consolidated........................... $ 2,196 $ -- $ 160 $ 7,533
============= ============ ========= ============
FOR THE THREE MONTHS ENDED MARCH 31, 2005
---------------------------------------------- TOTAL ASSETS
REVENUES FROM NET AS OF
EXTERNAL INTERSEGMENT OPERATING MARCH 31,
CUSTOMERS REVENUES INCOME(LOSS) 2005
------------- ------------ ------------ --------------
(IN MILLIONS)
Natural Gas Distribution............... $ 2,328 $ 2 $ 139 $ 4,889
Pipelines and Gathering................ 84 37 64 2,692
Other Operations....................... 3 1 (1) 907
Eliminations........................... -- (40) -- (980)
------------- ------------ --------- ------------
Consolidated........................... $ 2,415 $ -- $ 202 $ 7,508
============= ============ ========= ============
- ----------------
(1) Sales to Texas Genco for the three months ended March 31, 2004 of $6
million have been reclassified from sales to affiliates to revenues from
external customers due to the sale of Texas Genco by CenterPoint Energy.
(2) Sales to Texas Genco for the three months ended March 31, 2004 of $1
million have been reclassified from sales to affiliates to revenues from
external customers due to the sale of Texas Genco by CenterPoint Energy.
12
(11)EMPLOYEE BENEFIT PLANS
The Company's employees participate in CenterPoint Energy's postretirement
benefit plan. The Company's net periodic cost includes the following components
relating to postretirement benefits:
THREE MONTHS ENDED
MARCH 31,
------------------
2004 2005
------- -------
(IN MILLIONS)
Interest cost.................................... $ 2 $ 2
Net amortization................................. 1 1
Other ........................................... 1 --
------- -------
Net periodic cost.......................... $ 4 $ 3
======= =======
The Company previously disclosed in its financial statements for the year
ended December 31, 2004, that it expected to contribute $16 million to its
postretirement benefits plan in 2005. As of March 31, 2005, $4 million has been
contributed.
On January 21, 2005, the Department of Health and Human Services' Centers
for Medicare and Medicaid Services (CMS) released final regulations governing
the Medicare prescription drug benefit and other key elements of the Medicare
Modernization Act (MNA) that will go into effect January 1, 2006. Under the
final regulations, it has been determined that a greater portion of benefits
offered under the Company's plans meets the definition of actuarial equivalence
and therefore qualifies for federal subsidies equal to 28% of allowable drug
costs. As a result, the Company has remeasured its obligations and costs to take
into account the new regulations.
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 report.
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 months ended March 31, 2004 and the three months ended March 31, 2005.
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, 2004 (CERC Corp. Form 10-K).
CONSOLIDATED RESULTS OF OPERATIONS
Our results of operations are affected by, among other things, seasonal
fluctuations in the demand for natural gas and price movements of energy
commodities, 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 months ended March 31, 2004 and 2005, followed by a discussion of our
consolidated results of operations based on operating income. We have provided a
reconciliation of consolidated operating income to net income below.
THREE MONTHS ENDED MARCH 31,
----------------------------
2004 2005
------------ ----------
(IN MILLIONS)
Revenues............................................................... $ 2,196 $ 2,415
------------ ----------
Expenses:
Natural gas......................................................... 1,762 1,948
Operation and maintenance........................................... 182 173
Depreciation and amortization....................................... 47 49
Taxes other than income taxes....................................... 45 43
------------ ----------
Total Expenses............................................... 2,036 2,213
------------ ----------
Operating Income....................................................... 160 202
Interest and Other Finance Charges..................................... (42) (45)
Other Income, net...................................................... 3 4
------------ ----------
Income Before Income Taxes............................................. 121 161
Income Tax Expense..................................................... (47) (65)
------------ ----------
Net Income........................................................... $ 74 $ 96
============ ==========
THREE MONTHS ENDED MARCH 31, 2005 COMPARED TO THREE MONTHS ENDED MARCH 31, 2004
We reported net income of $96 million for the three months ended March 31,
2005 as compared to $74 million for the same period in 2004. The increase in net
income of $22 million was primarily due to increased operating
14
income of $22 million in our Natural Gas Distribution business segment primarily
due to rate increases and higher contributions from our competitive natural gas
sales business and increased operating income of $19 million in our Pipelines
and Gathering business segment primarily from increased demand for certain
transportation and ancillary services related to natural gas price volatility as
well as increased throughput and demand for services related to our core gas
gathering operations and increased income tax expense primarily driven by state
income taxes.
Income Tax Expense. During the three months ended March 31, 2005 and 2004,
our effective tax rates were 40.4% and 38.8%, respectively.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The following table presents operating income for our Natural Gas
Distribution and Pipelines and Gathering business segments for the three months
ended March 31, 2004 and 2005. Some amounts from the previous year have been
reclassified to conform to the 2005 presentation of the financial statements.
These reclassifications do not affect consolidated net income. For information
regarding factors that may affect the future results of operations of our
business segments, please read "Business -- Risk Factors -- Principal Risk
Factors Associated with Our Businesses," " -- Risk Factors Associated with Our
Consolidated Financial Condition" and " -- Other Risks" in Item 1 of the CERC
Corp. Form 10-K, each of which is incorporated herein by reference.
NATURAL GAS DISTRIBUTION
The following table provides summary data of our Natural Gas Distribution
business segment for the three months ended March 31, 2004 and 2005:
THREE MONTHS ENDED MARCH 31,
----------------------------
2004 2005
---------- -----------
(IN MILLIONS)
Revenues........................................................... $ 2,131 $ 2,330
---------- -----------
Expenses:
Natural gas...................................................... 1,790 1,975
Operation and maintenance........................................ 149 140
Depreciation and amortization.................................... 35 38
Taxes other than income taxes.................................... 40 38
---------- -----------
Total expenses................................................. 2,014 2,191
---------- -----------
Operating Income................................................... $ 117 $ 139
========== ===========
Throughput (in billion cubic feet (Bcf)):
Residential...................................................... 85 77
Commercial and industrial........................................ 83 77
Non-rate regulated............................................... 139 183
Eliminations(1).................................................. (10) (49)
---------- -----------
Total Throughput............................................... 297 288
========== ===========
- -----------------------
(1) Elimination of intrasegment sales.
Our Natural Gas Distribution business segment reported operating income of
$139 million for the three months ended March 31, 2005 as compared to $117
million for the same period in 2004. Increases in operating income of $2 million
from continued customer growth with the addition of approximately 43,000
customers since March 2004, $11 million from rate increases and increased
contributions of $3 million from our competitive natural gas sales business were
partially offset by the $7 million impact of milder weather and decreased usage.
Operation and maintenance expense decreased $9 million. Excluding an $8 million
charge recorded in the first quarter of 2004 for severance costs associated with
staff reductions, which has reduced costs in later periods, operation and
maintenance expenses decreased by $1 million.
15
PIPELINES AND GATHERING
The following table provides summary data of our Pipelines and Gathering
business segment for the three months ended March 31, 2004 and 2005:
THREE MONTHS ENDED MARCH 31,
----------------------------
2004 2005
---------- -----------
(IN MILLIONS)
Revenues........................................................... $ 102 $ 121
---------- -----------
Expenses:
Natural gas...................................................... 9 7
Operation and maintenance........................................ 33 34
Depreciation and amortization.................................... 11 11
Taxes other than income taxes.................................... 4 5
---------- -----------
Total expenses................................................. 57 57
---------- -----------
Operating Income................................................... $ 45 $ 64
========== ===========
Throughput (in Bcf):
Natural Gas Sales................................................ 2 1
Transportation................................................... 270 271
Gathering........................................................ 75 83
Eliminations (1)................................................. (2) (1)
---------- -----------
Total Throughput............................................... 345 354
========== ===========
- ---------
(1) Elimination of volumes both transported and sold.
Our Pipelines and Gathering business segment reported operating income of
$64 million for the three months ended March 31, 2005 compared to $45 million
for the same period in 2004. Operating margins (revenues less fuel costs)
increased by $21 million primarily due to increased demand for certain
transportation and ancillary services related to natural gas price volatility
($13 million) and increased throughput and demand for services related to our
core gas gathering operations ($5 million).
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Management's Narrative Analysis of
Results of Operations -- Certain Factors Affecting Future Earnings" in Item 7 of
Part II of the 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.
LIQUIDITY
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 for the remainder of 2005
are approximately $295 million of capital expenditures and $361 million
principal amount of maturing debt. We expect that borrowings under our credit
facility, anticipated cash flows from operations and borrowings from affiliates
under the money pool described below will be sufficient to meet our cash needs
for 2005. Cash needs may also be met by issuing securities in the capital
markets.
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" 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. We have a bankruptcy remote subsidiary, which we
consolidate, which was formed for the sole purpose of buying receivables created
by us and selling those
16
receivables to an unrelated third-party. This transaction is accounted for as a
sale of receivables under the provisions of SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,"
and, as a result, the related receivables are excluded from the Consolidated
Balance Sheet. In January 2005, the $250 million facility was extended to
January 2006 and temporarily increased, for the period from January 2005 to June
2005, to $375 million. As of March 31, 2005, we had $181 million of advances
under our receivables facility.
Credit Facilities. As of March 31, 2005, we had a $250 million credit
facility under which no borrowings had been made. The credit facility terminates
on March 23, 2007.
Securities Registered with the SEC. At March 31, 2005, we had a shelf
registration statement covering $50 million of debt securities.
Temporary Investments. On March 31, 2005, we had temporary external
investments of $230 million.
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. The order expires in
June 2005; however, CenterPoint Energy and its subsidiaries, including us, are
seeking a new order providing appropriate approval for participation in the
money pool by the end of June 2005. Our money pool borrowing limit under
existing orders is $600 million. At March 31, 2005, we had $171 million invested
in the money pool. The money pool may not provide sufficient funds to meet our
cash needs.
Impact on Liquidity of a Downgrade in Credit Ratings. As of May 1, 2005,
Moody's Investors Service, Inc. (Moody's), Standard & Poor's Ratings Services, a
division of The McGraw Hill Companies (S&P) and Fitch, Inc. (Fitch) had assigned
the following credit ratings to our senior unsecured debt:
MOODY'S S&P FITCH
- ------------------------ -------------------- --------------------
RATING REVIEW(1) RATING OUTLOOK(2) RATING OUTLOOK(3)
- ------ --------- ------ ---------- ------ ----------
Ba1 Possible Upgrade BBB Negative BBB Stable
- -------------------
(1) A "review for possible upgrade" from Moody's indicates that a rating is
under review for possible change in the short-term, usually within 90
days.
(2) An S&P rating outlook assesses the potential direction of a long-term
credit rating over the intermediate to longer term.
(3) A "stable" outlook from Fitch encompasses a one-to-two year horizon as to
the likely ratings direction.
We cannot assure you that these ratings will remain in effect for any
given period of time or that one or more of these ratings will not be lowered or
withdrawn entirely by a rating agency. We note that these credit ratings are not
recommendations to buy, sell or hold our securities and may be revised or
withdrawn at any time by the rating agency. Each rating should be evaluated
independently of any other rating. Any future reduction or withdrawal of one or
more of our credit ratings could have a material adverse impact on our ability
to obtain short- and long-term financing, the cost of such financings, the
willingness of suppliers to extend credit lines to us on an unsecured basis and
the execution of our commercial 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 decline in
credit ratings could increase cash collateral requirements and reduce margins of
our Natural Gas Distribution business segment.
Our credit facility contains a "material adverse change" clause which
relates to our ability to perform our obligations under the credit agreement.
17
CenterPoint Energy Gas Services, Inc.(CEGS), one of our wholly owned
subsidiaries, provides comprehensive natural gas sales and services to
industrial and commercial customers, electric generators and natural gas
utilities throughout the central United States. 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. We estimate that as of March 31, 2005, unsecured
credit limits extended to CEGS by counterparties could aggregate $100 million;
however, utilized credit capacity is significantly lower. In addition, we
purchase natural gas under supply agreements that contain an aggregate credit
threshold of $100 million based on our S&P Senior Unsecured Long-Term Debt
rating of BBB. Upgrades and downgrades from this BBB rating will increase and
decrease the aggregate credit threshold accordingly.
Cross Defaults. Under CenterPoint Energy's revolving credit facility, a
payment default by us on, or a non-payment default by us that permits
acceleration of, any indebtedness exceeding $50 million will cause a default.
Pursuant to the indenture governing CenterPoint Energy's senior notes, a payment
default by us in respect of, or an acceleration of, borrowed money and certain
other specified types of obligations, in the aggregate principal amount of $50
million will cause a default. As of May 1, 2005, CenterPoint Energy 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 debt instruments or bank credit facilities.
Other Factors that Could Affect Cash Requirements. In addition to the
above factors, our liquidity and capital resources could be affected by:
- 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;
- increases in interest expense in connection with debt refinancings
and borrowings under our credit facility;
- various regulatory actions; and
- various of the risks identified in "Risk Factors" in Item 1 of the
CERC Corp. Form 10-K.
Certain Contractual and Regulatory Limits on Ability to Issue Securities
and Pay Dividends. Limitations imposed on us under the 1935 Act affect our
ability to issue securities, pay dividends on our common stock or take other
actions to adjust our capitalization.
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 (EBITDA) to interest covenant.
Our parent, CenterPoint Energy, is a registered public utility holding
company under the 1935 Act. The 1935 Act and related rules and regulations
impose a number of restrictions on our parent's activities and those of its
subsidiaries, including us. The 1935 Act, among other things, limits our
parent's ability and the ability of its regulated subsidiaries, including us, to
issue debt and equity securities without prior authorization, restricts the
source of dividend payments to current and retained earnings without prior
authorization, regulates sales and acquisitions of certain assets and businesses
and governs affiliated service, sales and construction contracts.
The June 2003 Financing Order and the several subsequent orders we have
received that provide additional financing authority are effective until June
30, 2005. 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 regulated subsidiaries, including us, to
refinance our existing obligations. We are in compliance with the authorized
limits. The orders also permit our
18
utilization of undrawn credit facilities. As of April 30, 2005, we are
authorized to issue an additional $7 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.
CenterPoint Energy and certain of its subsidiaries, including us, have an
application currently pending with the SEC for a new financing order which would
govern financing by CenterPoint Energy and its subsidiaries after the expiration
of the June 2003 Financing Order. We anticipate that the new order will be
issued at or before the expiration of the existing order.
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 30%. At March 31, 2005, our
ratio was 53%.
Relationship with CenterPoint Energy. We are an indirect wholly owned
subsidiary of CenterPoint Energy. As a result of this relationship, the
financial condition and liquidity of our parent company could affect our access
to capital, our credit standing and our financial condition.
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one that is both important to the
presentation of our financial condition and results of operations and requires
management to make difficult, subjective or complex accounting estimates. An
accounting estimate is an approximation made by management of a financial
statement element, item or account in the financial statements. Accounting
estimates in our historical consolidated financial statements measure the
effects of past business transactions or events, or the present status of an
asset or liability. The accounting estimates described below require us to make
assumptions about matters that are highly uncertain at the time the estimate is
made. Additionally, different estimates that we could have used or changes in an
accounting estimate that are reasonably likely to occur could have a material
impact on the presentation of our financial condition or results of operations.
The circumstances that make these judgments difficult, subjective and/or complex
have to do with the need to make estimates about the effect of matters that are
inherently uncertain. Estimates and assumptions about future events and their
effects cannot be predicted with certainty. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments. These estimates may change as new events occur, as more experience is
acquired, as additional information is obtained and as our operating environment
changes. Our significant accounting policies are discussed in Note 2 to the
consolidated financial statements in the CERC Form 10-K (CERC 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 SFAS No. 142, "Goodwill and Other Intangible Assets." No
impairment of goodwill was indicated based on our analysis as of January 1,
2005. 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
19
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 March 31, 2005 to provide assurance that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.
There has been no change in our internal controls over financial reporting
that occurred during the three months ended March 31, 2005 that has materially
affected, or is reasonably likely to materially affect, our internal controls
over financial reporting.
20
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, 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
+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), 9 (Commitments and
Contingencies) and 12 (Reportable
Business Segments).
21
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: May 11, 2005
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 Resource December 31, 1998
Corp.
3.1.4 - Certificate of Amendment changing Form 10-Q for the quarter 1-13265 3(a)(4)
the name to CenterPoint 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 CERE Corp. From 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), 9 (Commitements and
Contingencies) and 12 (Reportable
Business Segments).