EXHIBIT 99.3
ITEM 1. BUSINESS
RISK FACTORS
RISK FACTORS ASSOCIATED WITH FINANCIAL CONDITION AND OTHER RISKS
IF WE ARE UNABLE TO ARRANGE FUTURE FINANCINGS ON ACCEPTABLE TERMS, OUR ABILITY
TO FUND FUTURE CAPITAL EXPENDITURES AND REFINANCE EXISTING INDEBTEDNESS COULD
BE LIMITED.
As a result of events occurring in 2001 and 2002, including the September
11, 2001 terrorist attacks, the bankruptcy of Enron Corp., the downgrading of
our credit ratings and the credit ratings of several energy companies, the
general downturn in the utility industry and the unusual volatility in the U.S.
financial markets, the availability and cost of capital for our business have
been adversely affected. If we are unable to obtain external financing to meet
our future capital requirements on terms that are acceptable to us, our
financial condition and future results of operations could be materially
adversely affected. As of December 31, 2002, we had $3.7 billion of outstanding
indebtedness, including a $1.3 billion collateralized term loan that will expire
in 2005. In addition, the capital constraints currently impacting our business
may require our future indebtedness to include terms that are more restrictive
or burdensome than those of our current indebtedness. These terms may negatively
impact our ability to operate our business. The success of our future financing
efforts may depend, at least in part, on:
- general economic and capital market conditions;
- credit availability from financial institutions and other lenders;
- investor confidence in us and the market in which we operate;
- maintenance of acceptable credit ratings by us and by CenterPoint Energy;
- market expectations regarding our future earnings and probable cash
flows;
- market perceptions of our ability to access capital markets on reasonable
terms;
- our exposure to Reliant Resources as our customer and in connection with
its indemnification obligations arising in connection with its separation
from CenterPoint Energy;
- provisions of relevant tax and securities laws; and
- our ability to obtain approval of specific financing transactions under
the 1935 Act.
As of December 31, 2002, we had $1.8 billion of general mortgage bonds
outstanding. We may issue additional general mortgage bonds on the basis of
retired bonds, 70% of property additions or cash deposited with the trustee.
Although approximately $900 million of additional general mortgage bonds could
be issued on the basis of property additions as of December 31, 2002, we have
agreed contractually to limit incremental secured debt to $300 million. In
addition, we are contractually prohibited, subject to certain exceptions, from
issuing additional first mortgage bonds.
Our current credit ratings are discussed in "Management's Narrative
Analysis of Results of Operations -- Liquidity -- Impact on Liquidity of a
Downgrade in Credit Ratings" in Item 7 of this report. We cannot assure you that
these credit ratings will remain in effect for any given period of time or that
one or more of these ratings will not be lowered or withdrawn entirely by a
rating agency. We note that these credit ratings are not recommendations to buy,
sell or hold our securities. Each rating should be evaluated independently of
any other rating. Any future reduction or withdrawal of one or more of our
credit ratings could have a material adverse impact on our ability to access
capital on acceptable terms.
THE FINANCIAL CONDITION AND LIQUIDITY OF OUR PARENT COMPANY COULD AFFECT OUR
ACCESS TO CAPITAL, OUR CREDIT STANDING AND OUR FINANCIAL CONDITION.
Our ratings and credit may be impacted by CenterPoint Energy's credit
standing. CenterPoint Energy and its subsidiaries other than us have
approximately $1.0 billion of debt that must be refinanced in 2003. We cannot
assure you that CenterPoint Energy and its other subsidiaries will be able to
pay or refinance these
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amounts. If CenterPoint Energy were to experience a deterioration in its credit
standing or liquidity difficulties, our access to credit and our ratings could
be adversely affected and the repayment of $815 million demand notes receivable
from CenterPoint Energy could be adversely affected.
WE ARE A WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY. CENTERPOINT ENERGY CAN
EXERCISE SUBSTANTIAL CONTROL OVER OUR DIVIDEND POLICY AND BUSINESS AND
OPERATIONS AND COULD DO SO IN A MANNER THAT IS ADVERSE TO OUR INTERESTS.
We are managed by officers and employees of CenterPoint Energy. Our
management will make determinations with respect to the following:
- our payment of dividends;
- decisions on our financings and our capital raising activities;
- mergers or other business combinations; and
- our acquisition or disposition of assets.
There are no contractual restrictions on our ability to pay dividends to
CenterPoint Energy. Our management could decide to increase our dividends to
CenterPoint Energy to support its cash needs. This could adversely affect our
liquidity. Under the 1935 Act, our ability to pay dividends is restricted by the
SEC's requirement that common equity as a percentage of total capitalization
must be at least 30% after the payment of any dividend. In addition, the order
restricts our ability to pay dividends out of capital accounts to the extent
current or retained earnings are insufficient for those dividends. Under these
restrictions, we are permitted to pay dividends in excess of the respective
current or retained earnings in an amount up to $200 million.
AN INCREASE IN SHORT-TERM INTEREST RATES COULD ADVERSELY AFFECT OUR CASH FLOWS.
As of December 31, 2002, we had $1.3 billion of outstanding floating-rate
debt. Because of capital constraints impacting our business at the time this
floating-rate debt was entered into, the interest rates are substantially above
our historical borrowing rates. In addition, any floating-rate debt issued by us
in the future could be at interest rates substantially above our historical
borrowing rates. While we may seek to use interest rate swaps in order to hedge
portions of our floating-rate debt, we may not be successful in obtaining hedges
on acceptable terms. Any increase in short-term interest rates would result in
higher interest costs and could adversely affect our results of operations,
financial condition and cash flows.
OUR REVENUES AND RESULTS OF OPERATIONS ARE SUBJECT TO RISKS THAT ARE BEYOND
OUR CONTROL, INCLUDING BUT NOT LIMITED TO FUTURE TERRORIST ATTACKS OR RELATED
ACTS OF WAR.
The cost of repairing damage to our facilities due to storms, natural
disasters, wars, terrorist acts and other catastrophic events, in excess of
reserves established for such repairs, may adversely impact our results of
operations, financial condition and cash flows. The occurrence or risk of
occurrence of future terrorist activity may impact our results of operations,
financial condition and cash flows in unpredictable ways. These actions could
also result in adverse changes in the insurance markets and disruptions of power
and fuel markets. In addition, our transmission and distribution facilities
could be directly or indirectly harmed by future terrorist activity. The
occurrence or risk of occurrence of future terrorist attacks or related acts of
war could also adversely affect the United States economy. A lower level of
economic activity could result in a decline in energy consumption, which could
adversely affect our revenues and margins and limit our future growth prospects.
Also, these risks could cause instability in the financial markets and adversely
affect our ability to access capital.
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WE COULD INCUR LIABILITIES ASSOCIATED WITH BUSINESS AND ASSETS WE HAVE
TRANSFERRED TO OTHERS.
Under some circumstances, we could incur liabilities associated with assets
and businesses we no longer own. These assets and businesses include:
- those transferred to Reliant Resources or its subsidiaries in connection
with the organization and capitalization of Reliant Resources prior to
its initial public offering in 2001;
- those transferred to Texas Genco in connection with its organization and
capitalization; and
- those transferred to CenterPoint Energy in connection with the
Restructuring.
In connection with the organization and capitalization of Reliant
Resources, Reliant Resources and its subsidiaries assumed liabilities associated
with various assets and businesses Reliant Energy transferred to them. Reliant
Resources also agreed to indemnify, and cause the applicable transferee
subsidiaries to indemnify, CenterPoint Energy and its subsidiaries, including
us, with respect to liabilities associated with the transferred assets and
businesses. The indemnity provisions were intended to place sole financial
responsibility on Reliant Resources and its subsidiaries for all liabilities
associated with the current and historical businesses and operations of Reliant
Resources, regardless of the time those liabilities arose. If Reliant Resources
is unable to satisfy a liability that has been so assumed in circumstances in
which Reliant Energy has not been released from the liability in connection with
the transfer, we, as successor to Reliant Energy, could be responsible for
satisfying the liability.
Reliant Resources has reported that it is facing large maturities of its
debt over the next year. If Reliant Resources is unable to meet its obligations,
it would need to consider, among various options, restructuring under the
bankruptcy laws, in which event Reliant Resources might not honor its
indemnification obligations and claims by Reliant Resources' creditors might be
made against us as its former owner.
As described in Note 10(b) to our consolidated financial statements,
Reliant Energy and Reliant Resources are named as defendants in a number of
lawsuits arising out of power sales in California and other West Coast markets
and financial reporting matters. Although these matters relate to the business
and operations of Reliant Resources, claims against Reliant Energy have been
made on grounds that include the effect of Reliant Resources' financial results
on Reliant Energy's historical financial statements and liability of Reliant
Energy as a controlling shareholder of Reliant Resources. As Reliant Energy's
successor, we could incur liability if claims in one or more of these lawsuits
were successfully asserted against us and indemnification from Reliant Resources
were determined to be unavailable or if Reliant Resources were unable to satisfy
indemnification obligations owed to us with respect to those claims.
In connection with the organization and capitalization of Texas Genco,
Texas Genco and its subsidiaries assumed liabilities associated with the
electric generation assets Reliant Energy transferred to it. Texas Genco also
agreed to indemnify, and cause the applicable transferee subsidiaries to
indemnify, CenterPoint Energy and its subsidiaries, including us, with respect
to liabilities associated with the transferred assets and businesses. In many
cases the liabilities assumed were held by us and we were not released by third
parties from these liabilities. The indemnity provisions were intended to place
sole financial responsibility on Texas Genco and its subsidiaries for all
liabilities associated with the current and historical businesses and operations
of Texas Genco, regardless of the time those liabilities arose. If Texas Genco
were unable to satisfy a liability that had been so assumed or indemnified
against, and provided Reliant Energy had not been released from the liability in
connection with the transfer, we could be responsible for satisfying the
liability.
OUR HISTORICAL FINANCIAL RESULTS AS THE UNINCORPORATED ELECTRIC TRANSMISSION
AND DISTRIBUTION DIVISION OF RELIANT ENERGY ARE NOT REPRESENTATIVE OF OUR
EXPECTED FUTURE RESULTS AS CENTERPOINT HOUSTON.
We have limited experience operating as a transmission and distribution
utility in a deregulated electricity market in which we are subject to rate
regulation, Although our transmission and distribution business had a
significant operating history at the time of the Restructuring of Reliant
Energy, this business was operated until January 1, 2002 as part of a vertically
integrated utility company. Out historical costs and expenses reflect charges
from Reliant Energy for centralized corporate services and infrastructure costs.
These
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allocations have been determined based on what we and Reliant Energy considered
to be reasonable reflections of the utilization of services provided to us or
for the benefits received by us. We may experience significant changes in our
cost structure, funding and operations as a result of the restructuring of
Reliant Energy, including increased costs associated with reduced economies of
scale. In addition, since January 1, 2002, we have transmitted and distributed
electricity at rates regulated by the Texas Utility Commission. Therefore, the
historical financial information presented in or incorporated by reference into
this report prior to January 1, 2002 is not indicative of our future performance
and does not reflect what our results of operations, financial position, and
cash flows would have been had we operated as a separate stand-alone, rate-
regulated transmission and distribution utility in a deregulated market during
the periods presented.
IF CENTERPOINT ENERGY IS UNABLE TO OBTAIN AN EXTENSION OF ITS FINANCING ORDER
UNDER THE 1935 ACT, WE WILL NOT BE ABLE TO ENGAGE IN FINANCING TRANSACTIONS
AFTER JUNE 30, 2003.
In connection with CenterPoint Energy's registration as a public utility
holding company under the 1935 Act, the SEC issued a financing order which
authorizes us to enter into a wide range of financing transactions. This
financing order expires on June 30, 2003. If CenterPoint Energy is unable to
obtain an extension of the financing order, we would generally be unable to
engage in any financing transactions, including the refinancing of existing
obligations after June 30, 2003.
RISK FACTORS ASSOCIATED WITH OUR BUSINESS
WE MAY NOT BE SUCCESSFUL IN RECOVERING THE FULL VALUE OF OUR STRANDED COSTS
AND REGULATORY ASSETS RELATED TO GENERATION.
We are entitled to recover our stranded costs (the excess of regulatory net
book value of generation assets, as defined by the Texas electric restructuring
law, over the market value of those assets) and our regulatory assets related to
generation. We expect to make a filing in January 2004 in a true-up proceeding
provided for by the Texas electric restructuring law. The purpose of this
proceeding will be to quantify and reconcile:
- the amount of stranded costs;
- differences in the prices achieved in the auctions of Texas Genco's
generation capacity mandated by the Texas electric restructuring law and
Texas Utility Commission estimates (ECOM true-up);
- fuel over- or under-recovery;
- the "price to beat" clawback; and
- other regulatory assets associated with CenterPoint Energy's former
generation business that were not previously recovered through the
issuance of securitization bonds by a subsidiary.
We will be required to establish and support the amounts of these costs in
order to recover them. We expect these costs to be substantial. We cannot assure
you that we will be able to successfully establish and support our estimates of
the amount of these costs. For more information about the true-up proceeding,
please read "-- Electric Transmission and Distribution -- Stranded Costs and
Regulatory Assets Recovery" above and Note 4 to our consolidated financial
statements.
In addition, our $1.3 billion collateralized term loan matures on November
11, 2005 and is expected to be repaid or refinanced with the proceeds from the
recovery of these costs. To the extent we have not received the proceeds by
November 11, 2005, our ability to repay or refinance our $1.3 billion term loan
will be adversely affected.
OUR RECEIVABLES ARE CONCENTRATED IN A SMALL NUMBER OF RETAIL ELECTRIC
PROVIDERS.
Our receivables from the distribution of electricity are collected from
retail electric providers that supply the electricity we distribute to their
customers. Currently, we do business with approximately 31 retail electric
providers. Adverse economic conditions, structural problems in the new ERCOT
market or financial
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difficulties of one or more retail electric providers could impair the ability
of these retail providers to pay for our services or could cause them to delay
such payments. We depend on these retail electric providers to remit payments
timely to us. Any delay or default in payment could adversely affect our cash
flows, financial condition and results of operations. Our receivables balance
from retail electric providers at December 31, 2002 was $85 million.
Approximately 72% of our receivables from retail electric providers at December
31, 2002, was owed by subsidiaries of Reliant Resources. Our financial condition
may be adversely affected if Reliant Resources is unable to meet its obligations
to us.
Reliant Resources, through its subsidiaries, is our largest customer.
Pursuant to the Texas electric restructuring law, Reliant Resources may be
obligated to make a large "price to beat" clawback payment to us in 2004. We
expect the clawback, if any, to be applied against any stranded cost recovery to
which we are entitled or, if no stranded costs are recoverable, to be refunded
to retail electric providers. Also, as discussed in "Risk Factors Associated
with Financial Condition and Other Risks -- We could incur liabilities
associated with business and assets we have transferred to others," Reliant
Resources is obligated to indemnify us for other potential liabilities. Reliant
Resources has reported that it is facing large maturities of its debt over the
next year and thus its ability to satisfy its obligations to us cannot be
assured.
RATE REGULATION OF OUR BUSINESS MAY DELAY OR DENY OUR FULL RECOVERY OF OUR
COSTS.
Our rates are regulated by certain municipalities and the Texas Utility
Commission based on an analysis of our invested capital and expenses incurred in
a test year. Thus, the rates we are allowed to charge may not match our expenses
at any given time. While rate regulation in Texas is premised on providing a
reasonable opportunity to recover reasonable and necessary operating expenses
and to earn a reasonable return on invested capital, there can be no assurance
that the Texas Utility Commission will judge all of our costs to be reasonable
or necessary or that the regulatory process in which rates are determined will
always result in rates that will produce full recovery of our costs.
WE ARE OPERATING IN A RELATIVELY NEW MARKET ENVIRONMENT IN WHICH WE AND OTHERS
HAVE LITTLE OPERATING EXPERIENCE.
The competitive electric market in Texas became fully operational in
January 2002. Neither we nor any of the Texas Utility Commission, ERCOT or other
market participants has any significant operating history under the market
framework created by the Texas electric restructuring law. Some operational
difficulties were encountered in the pilot program conducted in 2001 and
continue to be experienced now. These difficulties include delays in the
switching of some customers from one retail electric provider to another. These
difficulties create uncertainty as to the amount of transmission and
distribution charges owed by each retail electric provider, which may cause
payment of those amounts to be delayed. While to date these difficulties have
not been material, these operating difficulties could become material or
structural changes adopted to address these difficulties could materially
adversely affect our results of operations, financial condition and cash flows.
DISRUPTIONS AT POWER GENERATION FACILITIES OWNED BY THIRD PARTIES COULD
INTERRUPT OUR SALES OF TRANSMISSION AND DISTRIBUTION SERVICES.
We depend on power generation facilities owned by third parties to provide
retail electric providers with electric power which we transmit and distribute
to their customers. We do not own or operate any power generation facilities. If
power generation is disrupted or if power generation capacity is inadequate, our
services may be interrupted, and our results of operations, financial condition
and cash flows may be adversely affected.
OUR REVENUES AND RESULTS OF OPERATIONS ARE SEASONAL.
A portion of our revenues is derived from rates that we collect from each
retail electric provider based on the amount of electricity we distribute on
behalf of each retail electric provider. Thus, our revenues and results of
operations are subject to seasonality, weather conditions and other changes in
electricity usage, with revenues being higher during the warmer months.
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WE DO NOT MAINTAIN INSURANCE COVERAGE ON OUR TRANSMISSION AND DISTRIBUTION
SYSTEM.
In common with other companies in our line of business that serve coastal
regions, we do not have insurance covering our transmission and distribution
system because we believe it to be cost prohibitive. If we were to sustain any
loss of or damage to our transmission and distribution properties, we would be
entitled to seek to recover such loss or damage through a change in our
regulated rates, although there is no assurance that we would ultimately obtain
any such rate recovery or that any such rate recovery would be timely granted.
Therefore, we cannot assure you that we will be able to restore any loss of or
damage to any of our transmission and distribution properties without negative
impact on our results of operations, financial condition and cash flows.
TECHNOLOGICAL CHANGE MAY MAKE ALTERNATIVE ENERGY SOURCES MORE ATTRACTIVE AND
MAY ADVERSELY AFFECT OUR REVENUES AND RESULTS OF OPERATIONS.
The continuous process of technological development may result in the
introduction to retail customers of economically attractive alternatives to
purchasing electricity through our distribution facilities. Manufacturers of
self-generation facilities continue to develop smaller-scale,
more-fuel-efficient generating units that can be cost-effective options for some
retail customers with smaller electric energy requirements. Any reduction in the
amount of electric energy we distribute as a result of these technologies may
have an adverse impact on our results of operations, financial condition and
cash flows in the future.
ITEM 3. LEGAL PROCEEDINGS
For a brief description of certain legal and regulatory proceedings
affecting us, see Note 10(b) to our consolidated financial statements, which
note is incorporated herein by reference.
ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
Our past earnings are not necessarily indicative of our future earnings and
results of operations. The magnitude of our future earnings and results of our
operations will depend on numerous factors including:
- state and federal legislative and regulatory actions or developments,
including deregulation, re-regulation and restructuring of the electric
utility industry, constraints placed on our activities or business by the
1935 Act, changes in or application of laws or regulations applicable to
other aspects of our business and actions with respect to:
- approval of stranded costs;
- allowed rates of return;
- rate structures;
- recovery of investments; and
- operation and construction of facilities;
- non-payment for our services due to financial distress of our customers,
including our largest customer, Reliant Resources;
- the successful and timely completion of our capital projects;
- industrial, commercial and residential growth in our service territory
and changes in market demand and demographic patterns;
- changes in business strategy or development plans;
- changes in interest rates or rates of inflation;
- unanticipated changes in operating expenses and capital expenditures;
- weather variations and other natural phenomena, which can affect the
demand for power over our transmission and distribution system;
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- commercial bank and financial market conditions, our access to capital,
the cost of such capital, receipt of certain approvals under the 1935
Act, and the results of our financing and refinancing efforts, including
availability of funds in the debt capital markets for transmission and
distribution companies;
- actions by rating agencies;
- legal and administrative proceedings and settlements;
- changes in tax laws;
- inability of various counterparties to meet their obligations with
respect to our financial instruments;
- any lack of effectiveness of our disclosure controls and procedures;
- changes in technology;
- significant changes in our relationship with our employees, including the
availability of qualified personnel and the potential adverse effects if
labor disputes or grievances were to occur;
- significant changes in critical accounting policies;
- acts of terrorism or war, including any direct or indirect effect on our
business resulting from terrorist attacks such as occurred on September
11, 2001 or any similar incidents or responses to those incidents;
- the availability and price of insurance;
- the outcome of the pending securities lawsuits against Reliant Energy and
Reliant Resources;
- the outcome of the Securities and Exchange Commission investigation
relating to the treatment in our consolidated financial statements of
certain activities of Reliant Resources;
- the ability of Reliant Resources to satisfy its indemnity obligations to
us;
- the reliability of the systems, procedures and other infrastructure
necessary to operate the retail electric business in our service
territory, including the systems owned and operated by the ERCOT ISO;
- political, legal, regulatory and economic conditions and developments in
the United States; and
- other factors discussed in Item 1 of this report under "Risk Factors."
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CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(e) REGULATORY ASSETS AND LIABILITIES
The Company applies the accounting policies established in SFAS No. 71,
"Accounting for the Effects of Certain Types of Regulation" (SFAS No. 71).
The following is a list of regulatory assets/liabilities reflected on the
Company's Consolidated Balance Sheets as of December 31, 2001 and 2002:
<Table>
<Caption>
DECEMBER 31,
----------------
2001 2002
------- ------
(IN MILLIONS)
Excess cost over market (ECOM) true-up...................... $ -- $ 697
Recoverable electric generation related regulatory assets,
net....................................................... 160 100
Securitized regulatory asset................................ 740 706
Regulatory tax asset, net................................... 111 178
Unamortized loss on reacquired debt......................... 62 58
Recoverable electric generation plant mitigation............ 1,967 2,051
Excess mitigation liability................................. (1,126) (969)
Other long-term assets/liabilities.......................... 28 40
------- ------
Total..................................................... $ 1,942 $2,861
======= ======
</Table>
If events were to occur that would make the recovery of these assets and
liabilities no longer probable, the Company would be required to write off or
write down these regulatory assets and liabilities. In addition, the Company
would be required to determine any impairment of the carrying costs of plant and
inventory assets.
Through December 31, 2001, the Public Utility Commission of Texas (Texas
Utility Commission) provided for the recovery of most of the Company's fuel and
purchased power costs from customers through a fixed fuel factor included in
electric rates. Included in the above table in recoverable electric generation-
related regulatory assets, net are $126 million and $66 million of regulatory
assets related to the recovery of fuel costs as of December 31, 2001 and 2002,
respectively. For additional information regarding our fuel filings, see Note
4(c).
In 2001, the Company monetized $738 million of regulatory assets in a
securitization financing authorized by the Texas Utility Commission pursuant to
the Texas electric restructuring law. The securitized regulatory assets are
being amortized ratably as transition charges are collected over the life of the
outstanding transition bonds. For additional information regarding the
securitization financing, see Note 6.
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(4) REGULATORY MATTERS
(a) TEXAS ELECTRIC RESTRUCTURING LAW AND DISCONTINUANCE OF SFAS NO. 71 FOR
ELECTRIC GENERATION OPERATIONS
In June 1999, the Texas legislature adopted the Texas electric
restructuring law, which substantially amended the regulatory structure
governing electric utilities in Texas in order to allow retail electric
competition. Retail pilot projects allowing competition for up to 5% of each
utility's load in all customer classes began in the third quarter of 2001, and
retail electric competition for all other customers began in January 2002. In
preparation for competition, CenterPoint Energy made significant changes in the
electric utility operations it conducts through the Company. In addition, the
Texas Utility Commission issued a number of new rules and determinations in
implementing the Texas electric restructuring law.
The Texas electric restructuring law defined the process for competition
and created a transition period during which most utility rates were frozen at
rates not in excess of their then-current levels. The Texas electric
restructuring law provided for utilities to recover their generation related
stranded costs and regulatory assets (as defined in the Texas electric
restructuring law).
Unbundling. As of January 1, 2002, electric utilities in Texas such as the
Company unbundled their businesses in order to separate power generation,
transmission and distribution, and retail activities into different units.
Pursuant to the Texas electric restructuring law, CenterPoint Energy submitted a
plan in January 2000 that was later amended and updated to accomplish the
required separation (the business separation plan). The Company continues to be
subject to cost-of-service rate regulation and is responsible for the
transmission and distribution of electricity to retail customers. The Company
transferred its Texas generation facilities that were formerly part of Reliant
Energy HL&P (Texas generation business) to Texas Genco in connection with the
Restructuring.
Transmission and Distribution Rates. All retail electric providers in the
Company's service area pay the same rates and other charges for transmission and
distribution services.
The Company's distribution rates charged to retail electric providers are
generally based on amounts of energy delivered. The Company's transmission rates
charged to other distribution companies are based on amounts of energy
transmitted under "postage stamp" rates that do not vary with the distance the
energy is being transmitted. All distribution companies in ERCOT pay the Company
the same rates and other charges for transmission services. The transmission and
distribution rates for the Company have been in effect since January 1, 2002,
when electric competition began. This regulated delivery charge includes the
transmission and distribution rate (which includes costs for nuclear
decommissioning and municipal franchise fees), a system benefit fund fee imposed
by the Texas electric restructuring law, a transition charge associated with
securitization of regulatory assets and an excess mitigation credit imposed by
the Texas Utility Commission.
Stranded Costs. The Company will be entitled to recover its stranded costs
(the excess of net regulatory book value of historical generation assets (as
defined by the Texas electric restructuring law) over the market value of those
assets) and its regulatory assets related to generation. The Texas electric
restructuring law prescribes specific methods for determining the amount of
stranded costs and the details for their recovery. During the transition period
to deregulation (the Transition Period), which included 1998 and the first six
months of 1999, and extending through the base rate freeze period from July 1999
through 2001, the Texas electric restructuring law provided that earnings above
a stated overall annual rate of return on invested capital be used to recover
CenterPoint Energy's investment in generation assets (Accelerated Depreciation).
In addition, during the Transition Period, the redirection of depreciation
expense to generation assets that the Company would otherwise apply to
transmission, distribution and general plant assets was permitted for regulatory
purposes (Redirected Depreciation). Please read the discussion of the accounting
treatment for depreciation for financial reporting purposes below under
"-- Accounting." The Company cannot predict the amount, if any, of these costs
that may not be recovered.
In accordance with the Texas electric restructuring law, beginning on
January 1, 2002, and ending December 31, 2003, any difference between market
power prices received in Texas Genco's generation capacity auctions mandated by
the Texas electric restructuring law and the Texas Utility Commission's earlier
estimates of those prices will be included in the 2004 stranded cost true-up
proceeding, as further discussed below. This component of the true-up is
intended to ensure that neither the customers nor CenterPoint Energy is
disadvantaged economically as a result of the two-year transition period by
providing this pricing structure.
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On October 24, 2001, CenterPoint Energy Transition Bond Company, LLC (Bond
Company), a Delaware limited liability company and wholly owned subsidiary of
the Company, issued $749 million aggregate principal amount of its Series 2001-1
Transition Bonds (Transition Bonds) pursuant to a financing order of the Texas
Utility Commission. Classes of the bonds have final maturity dates of September
15, 2007, September 15, 2009, September 15, 2011 and September 15, 2015, and
bear interest at rates of 3.84%, 4.76%, 5.16% and 5.63%, respectively. Scheduled
payments on the bonds are from 2002 through 2013. Net proceeds to the Bond
Company from the issuance were $738 million. The Bond Company paid the Company
$738 million for the transition property. Proceeds were used for general
corporate purposes, including the repayment of indebtedness.
The Transition Bonds are secured primarily by the "transition property,"
which includes the irrevocable right to recover, through non-bypassable
transition charges payable by certain retail electric customers, the qualified
costs of the Company authorized by the financing order. The holders of the Bond
Company's bonds have no recourse to any assets or revenues of the Company, and
the creditors of the Company have no recourse to any assets or revenues
(including, without limitation, the transition charges) of the Bond Company. The
Company has no payment obligations with respect to the Transition Bonds except
to remit collections of transition charges as set forth in a servicing agreement
between the Company and the Bond Company and in an intercreditor agreement among
the Company, the Bond Company and other parties.
The non-bypassable transition charges are required by the financing order
to be trued-up annually, effective November 1, for the term of the transition
charge. The Company filed an annual true-up with the Texas Utility Commission on
August 2, 2002 for transition charges that became effective November 1, 2002.
Costs associated with nuclear decommissioning will continue to be subject
to cost-of-service rate regulation and are included in a charge to transmission
and distribution customers. For further discussion of the effect of the business
separation plan on funding of the nuclear decommissioning trust fund, see Note
4(b).
True-Up Proceeding. The Texas electric restructuring law and current Texas
Utility Commission implementation guidance provide for a true-up proceeding to
be initiated in or after January 2004. The purpose of the true-up proceeding is
to quantify and reconcile the amount of stranded costs, the capacity auction
true-up, unreconciled fuel costs (see Note 3(e)), and other regulatory assets
associated with the Company's former electric generating operations that were
not previously securitized through the Transition Bonds. The 2004 true-up
proceeding will result in either additional charges being assessed on or credits
being issued to certain retail electric customers. CenterPoint Energy appealed
the Texas Utility Commission's true-up rule on the basis that there are no
negative stranded costs, that CenterPoint Energy should be allowed to collect
interest on stranded costs, and that the premium on the partial stock valuation
applies to only the equity of Texas Genco, not equity plus debt. The Texas court
of appeals issued a decision on February 6, 2003 upholding the rule in part and
reversing in part. The court ruled that there are no negative stranded costs and
that the premium on the partial stock valuation applies only to equity. The
court upheld the Texas Utility Commission's rule that interest on stranded costs
begins upon the date of the final true-up order. On February 21, 2003,
CenterPoint Energy filed a motion for rehearing on the issue that interest on
amounts determined in the true-up proceeding should accrue from an earlier date.
CenterPoint Energy has not accrued interest in its consolidated financial
statements, but estimates that interest could be material. If the court of
appeals denies CenterPoint Energy's motion, then CenterPoint Energy will have 45
days to appeal to the Texas Supreme Court. CenterPoint Energy has not decided
what action, if any, it will take if the motion for rehearing is denied.
Accounting. Historically, CenterPoint Energy has applied the accounting
policies established in SFAS No. 71. Effective June 30, 1999, CenterPoint Energy
applied SFAS No. 101 to Texas Genco.
10
In 1999, CenterPoint Energy evaluated the effects that the Texas electric
restructuring law would have on the recovery of its generation related
regulatory assets and liabilities. CenterPoint Energy determined that a pre-tax
accounting loss of $282 million existed because it believes only the economic
value of its generation related regulatory assets (as defined by the Texas
electric restructuring law) will be recoverable. Therefore, the Company recorded
a $183 million after-tax extraordinary loss in the fourth quarter of 1999.
Pursuant to EITF Issue No. 97-4 "Deregulation of the Pricing of
Electricity -- Issues Related to the Application of FASB Statements No. 71 and
No. 101" (EITF No. 97-4), the remaining recoverable regulatory assets are now
associated with the Company. For details regarding the Company's regulatory
assets, see Note 3(e).
At June 30, 1999, CenterPoint Energy performed an impairment test of its
previously regulated electric generation assets pursuant to SFAS No. 121 on a
plant specific basis. Under SFAS No. 121, an asset is considered impaired, and
should be written down to fair value, if the future undiscounted net cash flows
expected to be generated by the use of the asset are insufficient to recover the
carrying amount of the asset. For assets that are impaired pursuant to SFAS No.
121, CenterPoint Energy determined the fair value for each generating plant by
estimating the net present value of future cash flows over the estimated life of
each plant. CenterPoint Energy determined that $797 million of electric
generation assets was impaired in 1999. The Texas electric restructuring law
provides for recovery of this impairment through regulated cash flows during the
transition period and through charges to transmission and distribution
customers. As such, a regulatory asset for an amount equal to Texas Genco's
impairment loss and was included on the Company's Consolidated Balance Sheets as
a regulatory asset. The Company recorded amortization expense related to the
recoverable impaired plant costs and other assets created from discontinuing
SFAS No. 71 of $221 million during the six months ended December 31, 1999, $329
million in 2000 and $247 million in 2001.
The impairment analysis requires estimates of possible future market
prices, load growth, competition and many other factors over the lives of the
plants. The resulting impairment loss is highly dependent on these underlying
assumptions. In addition, after January 10, 2004, the Company must finalize and
reconcile stranded costs (as defined by the Texas electric restructuring law) in
a filing with the Texas Utility Commission. Any positive difference between the
regulatory net book value and the fair market value of the generation assets (as
defined by the Texas electric restructuring law) will be collected through
future charges. Any overmitigation of stranded costs may be refunded by a
reduction in future charges. This final reconciliation allows alternative
methods of third party valuation of the fair market value of these assets,
including outright sale, stock valuations and asset exchanges.
In order to reduce potential exposure to stranded costs related to
generation assets, the Company recognized Redirected Depreciation of $195
million and $99 million 1998 and for the six months ended June 30, 1999,
respectively, for regulatory and financial reporting purposes. This redirection
was in accordance with the Company's Transition Plan. Subsequent to June 30,
1999, Redirected Depreciation expense could no longer be recorded by CenterPoint
Energy's electric generation business for financial reporting purposes as these
operations are no longer accounted for under SFAS No. 71. During the six months
ended December 31, 1999 and during 2000 and 2001, $99 million, $218 million and
$230 million in depreciation expense, respectively, was redirected from
transmission and distribution for regulatory and financial reporting purposes
and was established as an embedded regulatory asset included in transmission and
distribution related plant and equipment balances. As of December 31, 2001, the
cumulative amount of Redirected Depreciation for regulatory purposes was $841
million, prior to the effects of the October 3, 2001 order discussed below.
Additionally, as allowed by the Texas Utility Commission, in an effort to
further reduce potential exposure to stranded costs related to generation
assets, the Company recorded Accelerated Depreciation of $194 million and $104
million in 1998 and for the six months ended June 30, 1999, respectively, for
regulatory and financial reporting purposes. Accelerated Depreciation expense
was recorded in accordance with the Company's Transition Plan during this
period. Subsequent to June 30, 1999, Accelerated Depreciation
11
expense could no longer be recorded by CenterPoint Energy's electric generation
business for financial reporting purposes, as these operations are no longer
accounted for under SFAS No. 71. During the six months ended December 31, 1999
and during 2000 and 2001, $179 million, $385 million and $264 million,
respectively, of Accelerated Depreciation was recorded for regulatory reporting
purposes, reducing the regulatory book value of the Company's stranded costs
recovery.
The Texas Utility Commission issued a final order on October 3, 2001
(October 3, 2001 Order) that established the transmission and distribution
utility rates that became effective in January 2002. In this Order, the Texas
Utility Commission found that the Company had overmitigated its stranded costs
by redirecting transmission and distribution depreciation and by accelerating
depreciation of generation assets as provided under the Transition Plan and
Texas electric restructuring law. As a result of the October 3, 2001 Order, the
Company was required to reverse the $841 million embedded regulatory asset
related to Redirected Depreciation, thereby reducing the net book value of
transmission and distribution assets. The Company was required to record a
regulatory liability of $1.1 billion related to Accelerated Depreciation. The
October 3, 2001 Order requires this amount to be refunded through excess
mitigation credits to certain retail electric customers during a seven-year
period which began in January 2002.
As of December 31, 2002, in contemplation of the 2004 true-up proceeding,
the Company has recorded a regulatory asset of $2.0 billion representing the
estimated future recovery of previously incurred stranded costs, which includes
$1.1 billion of previously recorded Accelerated Depreciation plus Redirected
Depreciation, both reversed in 2001. Offsetting this regulatory asset is a $969
million regulatory liability to refund the excess mitigation to ratepayers. This
estimated recovery is based upon current projections of the market value of
CenterPoint Energy's Texas generation assets to be covered by the 2004 true-up
proceeding calculations. The regulatory liability reflects a current refund
obligation arising from prior mitigation of stranded costs deemed excessive by
the Texas Utility Commission. The Company began refunding excess mitigation
credits with January 2002 bills. These credits are to be refunded over a
seven-year period. Because accounting principles generally accepted in the
United States of America require the Company to estimate fair market values in
advance of the final reconciliation, the financial impacts of the Texas electric
restructuring law with respect to the final determination of stranded costs in
the 2004 true-up proceeding are subject to material changes. Factors affecting
such changes may include estimation risk, uncertainty of future energy and
commodity prices and the economic lives of the plants. If events were to occur
that made the recovery of some of the remaining generation related regulatory
assets no longer probable, the Company would write off the unrecoverable balance
of such assets as a charge against earnings.
(b) AGREEMENTS RELATED TO TEXAS GENERATING ASSETS
Texas Genco is the beneficiary of the decommissioning trust that has been
established to provide funding for decontamination and decommissioning of the
South Texas Project in which Texas Genco owns a 30.8% interest. The Company
collects through rates or other authorized charges to its electric utility
customers amounts designated for funding the decommissioning trust, and pays the
amounts to Texas Genco. Texas Genco in turn deposits these amounts into the
decommissioning trust. Upon decommissioning of the facility, in the event funds
from the trust are inadequate, the Company or its successor will be required to
collect through rates or other authorized charges to customers as contemplated
by the Texas Utilities Code all additional amounts required to fund Texas
Genco's obligations relating to the decommissioning of the facility. Following
the completion of the decommissioning, if surplus funds remain in the
decommissioning trust, the excess will be refunded to the ratepayers of the
Company or its successor.
(c) CENTERPOINT HOUSTON REGULATORY FILINGS
Texas Genco and the Company filed their joint application to reconcile fuel
revenues and expenses with the Texas Utility Commission on July 1, 2002. This
final fuel reconciliation filing covers reconcilable fuel revenue, fuel expense
and interest of approximately $8.5 billion incurred from August 1, 1997 through
January 30, 2002. Also included in this amount is an under-recovery of $94
million, which was the balance at July 31, 1997 as approved in the Company's
last fuel reconciliation. On January 28, 2003, a settlement agreement was
reached under which it was agreed that certain items totaling $24 million were
written off during the fourth quarter of 2002 and items totaling $203 million
will be carried forward for resolution by the Texas Utility Commission in late
2003 or early 2004.
12
(8) EMPLOYEE BENEFIT PLANS
(a) PENSION PLANS
Substantially all of the Company's employees participate in CenterPoint
Energy's qualified non-contributory pension plan. Under the cash balance
formula, participants accumulate a retirement benefit based upon 4% of eligible
earnings and accrued interest. Prior to 1999, the pension plan accrued benefits
based on years of service, final average pay and covered compensation. As a
result, certain employees participating in the plan as of December 31, 1998 are
eligible to receive the greater of the accrued benefit calculated under the
prior plan through 2008 or the cash balance formula.
CenterPoint Energy's funding policy is to review amounts annually in
accordance with applicable regulations in order to achieve adequate funding of
projected benefit obligations. Pension expense is allocated to the Company based
on covered employees. This calculation is intended to allocate pension costs in
the same manner as a separate employer plan. Assets of the plan are not
segregated or restricted by CenterPoint Energy's participating subsidiaries.
Pension benefit was $10 million and $6 million for the years ended December 31,
2000 and 2001, respectively. The Company recognized pension expense of $7
million for the year ended December 31, 2002.
In addition to the Plan, the Company participates in CenterPoint Energy's
non-qualified pension plan, which allows participants to retain the benefits to
which they would have been entitled under the qualified pension plan except for
federally mandated limits on these benefits or on the level of salary on which
these benefits may be calculated. The expense associated with the non-qualified
pension plan was $3 million in 2000 and less than $1 million in 2001 and 2002.
As of December 31, 2001, CenterPoint Energy allocated $83 million of
pension assets, $7 million of non-qualified pension liabilities and $2 million
of minimum pension liabilities to the Company. As of December 31, 2002,
CenterPoint Energy has not allocated such pension assets or liabilities to the
Company. This change in method of allocation had no impact on pension expense
recorded for the year ended December 31, 2002.
(10) COMMITMENTS AND CONTINGENCIES
(a) LEASE COMMITMENTS
The following table sets forth information concerning the Company's
obligations under non-cancelable long-term operating leases at December 31,
2002, which primarily consist of rental agreements for building space, data
processing equipment and vehicles, including major work equipment (in millions).
<Table>
2003........................................................ $ 5
2004........................................................ 5
2005........................................................ 5
2006........................................................ 6
2007........................................................ 6
---
Total $27
===
</Table>
Total lease expense for all operating leases was $3 million during 2000 and
$5 million during 2001 and 2002, respectively.
(b) LEGAL MATTERS
The Company's predecessor, Reliant Energy, and certain of its former
subsidiaries are named as defendants in several lawsuits described below. Under
a master separation agreement between Reliant Energy and Reliant Resources,
CenterPoint Energy and its subsidiaries, including the Company, are entitled to
be indemnified by Reliant Resources for any losses arising out of the lawsuits
described under "California Class Actions and Attorney General Cases,"
"Long-Term Contract Class Action," "Washington and Oregon Class Actions,"
"Bustamante Price Reporting Class Action" and "Trading and Marketing
Activities," including attorneys' fees and other costs. Pursuant to the
indemnification obligation, Reliant Resources is defending CenterPoint Energy
and its subsidiaries, including the Company, to the extent named in these
lawsuits. The ultimate outcome of these matters cannot be predicted at this
time.
California Class Actions and Attorney General Cases. Reliant Energy,
Reliant Resources, Reliant Energy Services, Inc. (Reliant Energy Services),
Reliant Energy Power Generation, Inc. (REPG) and several other subsidiaries of
Reliant Resources, as well as two former officers and one present officer of
some of these companies, have been named as defendants in class action lawsuits
and other lawsuits filed against a number of companies that own generation
plants in California and other sellers of electricity in California markets.
While the plaintiffs allege various violations by the defendants of antitrust
laws and state laws against unfair and unlawful business practices, each of the
lawsuits is grounded on the central allegation that the defendants conspired to
drive up the wholesale price of electricity. In addition to injunctive relief,
the plaintiffs in these lawsuits seek treble the amount of damages alleged,
restitution of alleged overpayments, disgorgement of alleged unlawful profits
for sales of electricity, costs of suit and attorneys' fees. All of these suits
originally were filed in state courts in San Diego, San Francisco and Los
Angeles Counties. The suits in San Diego and Los Angeles Counties were
consolidated and removed to the federal district court in San Diego, but on
December 13, 2002, that court remanded the suits to the state courts. Prior to
the remand, Reliant Energy was voluntarily dismissed from two of the suits.
Several parties, including the Reliant defendants, have appealed the judge's
remand decision. The United States court of appeals has entered a briefing
schedule that could result in oral arguments by summer of 2003. Proceedings
before the state court are expected to resume during the first quarter of 2003.
In March and April 2002, the California Attorney General filed three
complaints, two in state court in San Francisco and one in the federal district
court in San Francisco, against Reliant Energy, Reliant
13
Resources, Reliant Energy Services and other subsidiaries of Reliant Resources
alleging, among other matters, violations by the defendants of state laws
against unfair and unlawful business practices arising out of transactions in
the markets for ancillary services run by the California independent systems
operator, charging unjust and unreasonable prices for electricity, in violation
of antitrust laws in connection with the acquisition in 1998 of electric
generating facilities located in California. The complaints variously seek
restitution and disgorgement of alleged unlawful profits for sales of
electricity, civil penalties and fines, injunctive relief against unfair
competition, and undefined equitable relief. Reliant Resources has removed the
two state court cases to the federal district court in San Francisco where all
three cases are now pending.
Following the filing of the Attorney General cases, seven additional class
action cases were filed in state courts in Northern California. Each of these
purports to represent the same class of California ratepayers, assert the same
claims as asserted in the other California class action cases, and in some
instances repeat as well the allegations in the Attorney General cases. All of
these cases have been removed to federal district court in San Diego. Reliant
Resources has not filed an answer in any of these cases. The plaintiffs have
agreed to a stipulated order that would require the filing of a consolidated
complaint by early March 2003 and the filing of the defendants' initial response
to the complaint within 60 days after the consolidated complaint is filed. In
all of these cases before the federal and state courts in California, the
Reliant defendants have filed or intend to file motions to dismiss on grounds
that the claims are barred by federal preemption and the filed rate doctrine.
Long-Term Contract Class Action. In October 2002, a class action was filed
in state court in Los Angeles against Reliant Energy and several subsidiaries of
Reliant Resources. The complaint in this case repeats the allegations asserted
in the California class actions as well as the Attorney General cases and also
alleges misconduct related to long-term contracts purportedly entered into by
the California Department of Water Resources. None of the Reliant entities,
however, has a long-term contract with the Department of Water Resources. This
case has been removed to federal district court in San Diego.
Washington and Oregon Class Actions. In December 2002, a lawsuit was filed
in Circuit Court of the State of Oregon for the County of Multnomah on behalf of
a class of all Oregon purchasers of electricity and natural gas. Reliant Energy,
Reliant Resources and several Reliant Resources subsidiaries are named as
defendants, along with many other electricity generators and marketers. Like the
other lawsuits filed in California, the plaintiffs claim the defendants
manipulated wholesale power prices in violation of state and federal law. The
plaintiffs seek injunctive relief and payment of damages based on alleged
overcharges for electricity. Also in December 2002, a nearly identical lawsuit
on behalf of consumers in the State of Washington was filed in federal district
court in Seattle. Reliant Resources has removed the Oregon suit to federal
district court in Portland. It is anticipated that before answering the
lawsuits, the defendants will file motions to dismiss on the grounds that the
claims are barred by federal preemption and by the filed rate doctrine.
Bustamante Price Reporting Class Action. In November 2002, California
Lieutenant Governor Cruz Bustamante filed a lawsuit in state court in Los
Angeles on behalf of a class of purchasers of gas and power alleging violations
of state antitrust laws and state laws against unfair and unlawful business
practices based on an alleged conspiracy to report and publish false and
fraudulent natural gas prices with an intent to affect the market prices of
natural gas and electricity in California. Reliant Energy, Reliant Resources and
several Reliant Resources subsidiaries are named as defendants, along with other
market participants and publishers of some of the price indices. The complaint
seeks injunctive relief, compensatory and punitive damages, restitution of
alleged overpayment, disgorgement of all profits and funds acquired by the
alleged unlawful conduct, costs of suit and attorneys' fees. The parties have
stipulated to a schedule that would require the defendants to respond to the
complaint by March 31, 2003. The Reliant defendants intend to deny both their
alleged violation of any laws and their alleged participation in any conspiracy.
14
Trading and Marketing Activities. Reliant Energy has been named as a party
in several lawsuits and regulatory proceedings relating to the trading and
marketing activities of its former subsidiary, Reliant Resources.
In June 2002, the SEC advised Reliant Resources and Reliant Energy that it
had issued a formal order in connection with its investigation of Reliant
Resources' financial reporting, internal controls and related matters. The
Company understands that the investigation is focused on Reliant Resources'
same-day commodity trading transactions involving purchases and sales with the
same counterparty for the same volume at substantially the same price and
certain structured transactions. These matters were previously the subject of an
informal inquiry by the SEC. Reliant Resources and CenterPoint Energy are
cooperating with the SEC staff.
In connection with the Texas Utility Commission's industry-wide
investigation into potential manipulation of the ERCOT market on and after July
31, 2001, Reliant Energy and Reliant Resources have provided information to the
Texas Utility Commission concerning their scheduling and trading activities.
Fifteen class action lawsuits filed in May, June and July 2002 on behalf of
purchasers of securities of Reliant Resources and/or Reliant Energy have been
consolidated in federal district court in Houston. Reliant Resources and certain
of its executive officers are named as defendants. Reliant Energy is also named
as a defendant in seven of the lawsuits. Two of the lawsuits also name as
defendants the underwriters of the May 2001 initial public offering of
approximately 20% of the common stock of Reliant Resources (Reliant Resources
Offering). One lawsuit names Reliant Resources' and Reliant Energy's independent
auditors as a defendant. The consolidated amended complaint seeks monetary
relief purportedly on behalf of three classes: (1) purchasers of Reliant Energy
common stock from February 3, 2000 to May 13, 2002; (2) purchasers of Reliant
Resources common stock on the open market from May 1, 2001 to May 13, 2002; and
(3) purchasers of Reliant Resources common stock in the Reliant Resources
Offering or purchasers of shares that are traceable to the Reliant Resources
Offering. The plaintiffs allege, among other things, that the defendants
misrepresented their revenues and trading volumes by engaging in round-trip
trades and improperly accounted for certain structured transactions as cash-flow
hedges, which resulted in earnings from these transactions being accounted for
as future earnings rather than being accounted for as earnings in fiscal year
2001.
In February 2003, a lawsuit was filed by three individuals in federal
district court in Chicago against CenterPoint Energy and certain former and
current officers of Reliant Resources for alleged violations of federal
securities laws. The plaintiffs in this lawsuit allege that the defendants
violated federal securities laws by issuing false and misleading statements to
the public, and that the defendants made false and misleading statements as part
of an alleged scheme to inflate artificially trading volumes and revenues. In
addition, the plaintiffs assert claims of fraudulent and negligent
misrepresentation and violations of Illinois consumer law. The defendants expect
to file a motion to transfer this lawsuit to the federal district court in
Houston and to consolidate this lawsuit with the consolidated lawsuits described
above.
The Company believes that none of these lawsuits has merit because, among
other reasons, the alleged misstatements and omissions were not material and did
not result in any damages to any of the plaintiffs.
In May 2002, three class action lawsuits were filed in federal district
court in Houston on behalf of participants in various employee benefits plans
sponsored by Reliant Energy. Reliant Energy and its directors are named as
defendants in all of the lawsuits. Two of the lawsuits have been dismissed
without prejudice. The remaining lawsuit alleges that the defendants breached
their fiduciary duties to various employee benefits plans, directly or
indirectly sponsored by Reliant Energy, in violation of the Employee Retirement
Income Security Act. The plaintiffs allege that the defendants permitted the
plans to purchase or hold securities issued by Reliant Energy when it was
imprudent to do so, including after the prices for such securities became
artificially inflated because of alleged securities fraud engaged in by the
defendants. The complaints seek
15
monetary damages for losses suffered by a putative class of plan participants
whose accounts held Reliant Energy or Reliant Resources securities, as well as
equitable relief in the form of restitution.
In October 2002, a derivative action was filed in the federal district
court in Houston, against the directors and officers of CenterPoint Energy. The
complaint sets forth claims for breach of fiduciary duty, waste of corporate
assets, abuse of control and gross mismanagement. Specifically, the shareholder
plaintiff alleges that the defendants caused CenterPoint Energy to overstate its
revenues through so-called "round trip" transactions. The plaintiff also alleges
breach of fiduciary duty in connection with the spin-off and the Reliant
Resources Offering. The complaint seeks monetary damages on behalf of
CenterPoint Energy as well as equitable relief in the form of a constructive
trust on the compensation paid to the defendants. The defendants have filed a
motion to dismiss this case on the ground that the plaintiff did not make an
adequate demand on CenterPoint Energy before filing suit.
A Special Litigation Committee appointed by CenterPoint Energy's Board of
Directors is investigating similar allegations made in a June 28, 2002 demand
letter sent on behalf of a CenterPoint Energy shareholder. The letter states
that the shareholder and other shareholders are considering filing a derivative
suit on behalf of CenterPoint Energy and demands that CenterPoint Energy take
several actions in response to alleged round-trip trades occurring in 1999,
2000, and 2001. The Special Litigation Committee is reviewing the demands made
by the shareholder to determine if these proposed actions are in the best
interests of CenterPoint Energy.
Reliant Energy Municipal Franchise Fee Lawsuits. In February 1996, the
cities of Wharton, Galveston and Pasadena filed suit, for themselves and a
proposed class of all similarly situated cities in Reliant Energy's electric
service area, against Reliant Energy and Houston Industries Finance, Inc.
(formerly a wholly owned subsidiary of Reliant Energy) alleging underpayment of
municipal franchise fees. The plaintiffs claim that they are entitled to 4% of
all receipts of any kind for business conducted within these cities over the
previous four decades. A jury trial of the original claimant cities (but not the
class of cities) in the 269th Judicial District Court for Harris County, Texas,
ended in April 2000 (the Three Cities case). Although the jury found for Reliant
Energy on many issues, it found in favor of the original claimant cities on
three issues, and assessed a total of $4 million in actual and $30 million in
punitive damages. However, the jury also found in favor of Reliant Energy on the
affirmative defense of laches, a defense similar to a statute of limitations
defense, due to the original claimant cities having unreasonably delayed
bringing their claims during the 43 years since the alleged wrongs began. The
trial court in the Three Cities case granted most of Reliant Energy's motions to
disregard the jury's findings. The trial court's rulings reduced the judgment to
$1.7 million, including interest, plus an award of $13.7 million in legal fees.
In addition, the trial court granted Reliant Energy's motion to decertify the
class. Following this ruling, 45 cities filed individual suits against Reliant
Energy in the District Court of Harris County.
On February 27, 2003, the state court of appeals in Houston rendered an
opinion reversing the judgment against CenterPoint Energy and rendering judgment
that the Three Cities take nothing by their claims. The court of appeals found
that the jury's finding of laches barred all of the Three Cities' claims and
that the Three Cities were not entitled to recovery of any attorneys' fees. The
judgment of the court of appeals is subject to motions for rehearing and an
appeal to the Texas Supreme Court.
The extent to which issues in the Three Cities case may affect the claims
of the other cities served by Reliant Energy cannot be assessed until judgments
are final and no longer subject to appeal. However, the court of appeals' ruling
appears to be consistent with Texas Supreme Court opinions. The Company
estimates the range of possible outcomes for recovery by the plaintiffs in the
Three Cities case to be between $0 and $18 million inclusive of interest and
attorneys' fees.
Other Matters
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.
16