EXHIBIT 99.1
ITEM 1. BUSINESS
REGULATION
We are subject to regulation by various federal, state and local
governmental agencies, including the regulations described below.
PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
As a subsidiary of a registered public utility holding company, we are
subject to a comprehensive regulatory scheme imposed by the SEC in order to
protect customers, investors and the public interest. Although the SEC does not
regulate rates and charges under the 1935 Act, it does regulate the structure,
financing, lines of business and internal transactions of public utility holding
companies and their system companies. In order to obtain financing, acquire
additional public utility assets or stock, or engage in other significant
transactions, we are generally required to obtain approval from the SEC under
the 1935 Act.
CenterPoint Energy received an order from the SEC under the 1935 Act on
June 30, 2003 and supplemental orders thereafter relating to its financing
activities and those of its regulated subsidiaries, including us, as well as
other matters. The orders are effective until June 30, 2005. As of December 31,
2004, the orders generally permitted CenterPoint Energy and its subsidiaries,
including us, to issue securities to refinance indebtedness outstanding at June
30, 2003, and authorized CenterPoint Energy and its subsidiaries, including us,
to issue certain incremental external debt securities and common and preferred
stock through June 30, 2005 in specified amounts, without prior authorization
from the SEC. The orders also contain certain requirements regarding ratings of
CenterPoint Energy's securities, interest rates, maturities, issuance expenses
and use of proceeds. The orders require that we maintain a ratio of common
equity to total capitalization of at least 30%. We intend to file an application
for approval of our post-June 30, 2005 financing activities.
The United States Congress from time to time considers legislation that
would repeal the 1935 Act. We cannot predict at this time whether this
legislation or any variation thereof will be adopted or, if adopted, the effect
of any such law on our business.
FEDERAL ENERGY REGULATORY COMMISSION
We are not a "public utility" under the Federal Power Act and therefore
are not generally regulated by the Federal Energy Regulatory Commission (FERC),
although certain of our transactions are subject to limited FERC jurisdiction.
STATE AND LOCAL REGULATION
We conduct operations pursuant to a certificate of convenience and
necessity issued by the Texas Utility Commission that covers our present service
area and facilities. In addition, we hold non-exclusive franchises, typically
having a term of 50 years, from the incorporated municipalities in our service
territory. These franchises give us the right to construct, operate and maintain
our transmission and distribution system within the streets and public ways of
these municipalities for the purpose of delivering electric service to the
municipality, its residents and businesses in exchange for payment of a fee. The
franchise for the City of Houston is scheduled to expire in 2007.
All retail electric providers in our service area pay the same rates and
other charges for transmission and distribution services.
Our distribution rates charged to retail electric providers for
residential customers are based on amounts of energy delivered, whereas
distribution rates for a majority of commercial and industrial customers are
based on peak demand. 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 us the same rates and other charges for transmission
services. Our transmission and distribution rates 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
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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.
ENVIRONMENTAL MATTERS
Our operations are subject to stringent and complex laws and regulations
pertaining to health, safety and the environment. As an owner or operator of
electric transmission and distribution systems we must comply with these laws
and regulations at the federal, state and local levels. These laws and
regulations can restrict or impact our business activities in many ways, such
as:
- restricting the way we can handle or dispose of our wastes;
- limiting or prohibiting construction activities in sensitive areas
such as wetlands, coastal regions, or areas inhabited by endangered
species;
- requiring remedial action to mitigate pollution conditions caused by
our operations, or attributable to former operations; and
- enjoining the operations of facilities deemed in non-compliance with
permits issued pursuant to such environmental laws and regulations.
In order to comply with these requirements, we may need to spend
substantial amounts and devote other resources from time to time to:
- construct or acquire new equipment; and
- modify or replace existing and proposed equipment.
Failure to comply with these laws and regulations may trigger a variety of
administrative, civil and criminal enforcement measures, including the
assessment of monetary penalties, the imposition of remedial requirements, and
the issuance of orders enjoining future operations. Certain environmental
statutes impose strict, joint and several liability for costs required to clean
up and restore sites where hazardous substances have been disposed or otherwise
released. Moreover, it is not uncommon for neighboring landowners and other
third parties to file claims for personal injury and property damage allegedly
caused by the release of hazardous substances or other waste products into the
environment.
The trend in environmental regulation is to place more restrictions and
limitations on activities that may affect the environment, and thus there can be
no assurance as to the amount or timing of future expenditures for environmental
compliance or remediation, and actual future expenditures may be different from
the amounts we currently anticipate. We try to anticipate future regulatory
requirements that might be imposed and plan accordingly to remain in compliance
with changing environmental laws and regulations and to minimize the costs of
such compliance.
We do not believe that compliance with federal, state or local
environmental laws and regulations will have a material adverse effect on our
business, financial position or results of operations. In addition, we believe
that the various environmental remediation activities in which we are presently
engaged will not materially interrupt or diminish our operational ability. We
cannot assure you, however, that future events, such as changes in existing
laws, the promulgation of new laws, or the development or discovery of new facts
or conditions will not cause us to incur significant costs. The following is a
discussion of all material environmental and safety laws and regulations that
relate to our operations. We believe that we are in substantial compliance with
all of these environmental laws and regulations.
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AIR EMISSIONS
Our operations are subject to the federal Clean Air Act and comparable
state laws and regulations. These laws and regulations regulate emissions of air
pollutants from various industrial sources and also impose various monitoring
and reporting requirements. Such laws and regulations may require that we obtain
pre-approval for the construction or modification of certain projects or
facilities expected to produce air emissions or result in the increase of
existing air emissions, obtain and strictly comply with air permits containing
various emissions and operational limitations, or utilize specific emission
control technologies to limit emissions. Our failure to comply with these
requirements could subject us to monetary penalties, injunctions, conditions or
restrictions on operations, and potentially criminal enforcement actions. We may
be required to incur certain capital expenditures in the future for air
pollution control equipment in connection with obtaining and maintaining
operating permits and approvals for air emissions. We believe, however, that our
operations will not be materially adversely affected by such requirements, and
the requirements are not expected to be any more burdensome to us than to any
other similarly situated companies.
WATER DISCHARGES
Our operations are subject to the Federal Water Pollution Control Act of
1972, as amended, also known as the Clean Water Act, and analogous state laws
and regulations. These laws and regulations impose detailed requirements and
strict controls regarding the discharge of pollutants into waters of the United
States. The unpermitted discharge of pollutants, including discharges resulting
from a spill or leak incident, is prohibited. The Clean Water Act and
regulations implemented thereunder also prohibit discharges of dredged and fill
material in wetlands and other waters of the United States unless authorized by
an appropriately issued permit. Any unpermitted release of petroleum or other
pollutants from our pipelines or facilities could result in fines or penalties
as well as significant remedial obligations.
HAZARDOUS WASTE
Our operations generate wastes, including some hazardous wastes, that are
subject to the federal Resource Conservation and Recovery Act (RCRA), and
comparable state laws, which impose detailed requirements for the handling,
storage, treatment and disposal of hazardous and solid waste. RCRA currently
exempts many natural gas gathering and field processing wastes from
classification as hazardous waste. Specifically, RCRA excludes from the
definition of hazardous waste produced waters and other wastes associated with
the exploration, development, or production of crude oil and natural gas.
However, these oil and gas exploration and production wastes are still regulated
under state law and the less stringent non-hazardous waste requirements of RCRA.
Moreover, ordinary industrial wastes such as paint wastes, waste solvents,
laboratory wastes, and waste compressor oils may be regulated as hazardous
waste. The transportation of natural gas in pipelines may also generate some
hazardous wastes that are subject to RCRA or comparable state law requirements.
LIABILITY FOR REMEDIATION
The Comprehensive Environmental Response, Compensation and Liability Act
of 1980, as amended (CERCLA), also known as "Superfund," and comparable state
laws impose liability, without regard to fault or the legality of the original
conduct, on certain classes of persons responsible for the release of hazardous
substances into the environment. Such classes of persons include the current and
past owners or operators of sites where a hazardous substance was released, and
companies that disposed or arranged for disposal of hazardous substances at
offsite locations such as landfills. In the course of our ordinary operations we
generate wastes that may fall within the definition of a "hazardous substance."
CERCLA authorizes the United States Environmental Protection Agency (EPA) and,
in some cases, third parties to take actions in response to threats to the
public health or the environment and to seek to recover from the responsible
classes of persons the costs they incur. Under CERCLA, we could be subject to
joint and several liability for the costs of cleaning up and restoring sites
where hazardous substances have been released, for damages to natural resources,
and for the costs of certain health studies.
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LIABILITY FOR PREEXISTING CONDITIONS
Asbestos. A number of facilities owned by CenterPoint Energy contain
significant amounts of asbestos insulation and other asbestos-containing
materials. CenterPoint Energy or its subsidiaries, including us, have been
named, along with numerous others, as a defendant in lawsuits filed by a large
number of individuals who claim injury due to exposure to asbestos. Most
claimants in such litigation have been workers who participated in construction
of various industrial facilities, including power plants. Some of the claimants
have worked at locations owned by CenterPoint Energy, but most existing claims
relate to facilities previously owned by CenterPoint Energy but currently owned
by Texas Genco LLC. We anticipate that additional claims like those received may
be asserted in the future. Under the terms of the separation agreement between
CenterPoint Energy and Texas Genco, ultimate financial responsibility for
uninsured losses relating to these claims has been assumed by Texas Genco, but
under the terms of its agreement to sell Texas Genco to Texas Genco LLC,
CenterPoint Energy has agreed to continue to defend such claims to the extent
they are covered by insurance maintained by CenterPoint Energy, subject to
reimbursement of the costs of such defense from Texas Genco LLC. Although their
ultimate outcome cannot be predicted at this time, we intend to continue
vigorously contesting claims that we do not consider to have merit and do not
believe, based on our experience to date, that these matters, either
individually or in the aggregate, will have a material adverse effect on our
financial condition, results of operations or cash flows.
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ITEM 3. LEGAL PROCEEDINGS
For a brief description of certain legal and regulatory proceedings
affecting us, please read "Regulation" and "Environmental Matters" in Item 1 of
this report and Notes 4 and 9(b) to our consolidated financial statements, which
information is incorporated herein by reference.
ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS -
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
Our past earnings and results of operations 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 or be affected by numerous
factors including:
- the timing and amount of our recovery of the true-up components;
- state and federal legislative and regulatory actions or
developments, including deregulation, re-regulation, 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:
- allowed rates of return;
- rate structures;
- recovery of investments; and
- operation and construction of facilities;
- industrial, commercial and residential growth in our service
territory and changes in market demand and demographic patterns;
- changes in interest rates or rates of inflation;
- weather variations and other natural phenomena;
- commercial bank and financial market conditions, our access to
capital, the cost 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;
- non-payment for our services due to financial distress of our
customers, including RRI;
- the outcome of the pending securities lawsuits against us, Reliant
Energy and RRI;
- the ability of RRI to satisfy its obligations to us, including
indemnity obligations;
- 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
- 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
(2) 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, 2003 and 2004:
DECEMBER 31,
-----------------
2003 2004
------- -------
(IN MILLIONS)
Recoverable electric generation-related regulatory assets........... $ 3,226 $ 1,946
Securitized regulatory asset........................................ 682 647
Unamortized loss on reacquired debt................................. 80 80
Estimated removal costs............................................. (232) (249)
Other long-term regulatory assets/liabilities....................... 32 32
------- -------
Total............................................................. $ 3,788 $ 2,456
======= =======
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. During 2004, the Company
wrote-off net regulatory assets of $1.5 billion in response to the Public
Utility Commission of Texas' (Texas Utility Commission) order on the Company's
final true-up application. For further discussion of regulatory assets, see Note
4.
The Company's rate-regulated businesses recognize removal costs as a
component of depreciation expense in accordance with regulatory treatment. As of
December 31, 2003 and 2004, these removal costs of $232 million and $249
million, respectively, are classified as regulatory liabilities in the
Consolidated Balance Sheets. The Company has also identified other asset
retirement obligations that cannot be estimated because the assets associated
with the retirement obligations have an indeterminate life.
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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
(4) REGULATORY MATTERS
(a) 2004 TRUE-UP PROCEEDING
In March 2004, the Company filed the final true-up application required by
the Texas electric restructuring law with the Texas Utility Commission (2004
True-Up Proceeding). The Company's requested true-up balance was $3.7 billion,
excluding interest and net of the retail clawback from RRI described below. In
June, July and September 2004, the Texas Utility Commission conducted hearings
on, and held public meetings addressing, the Company's true-up application. In
December 2004, the Texas Utility Commission approved a final order in the
Company's true-up proceeding (2004 Final Order) authorizing the Company to
recover $2.3 billion including interest through August 31, 2004, subject to
adjustments to reflect the benefit of certain deferred taxes and the accrual of
interest and payment of excess mitigation credits after August 31, 2004. As a
result of the 2004 Final Order, the Company wrote-off net regulatory assets of
$1.5 billion and recorded a related income tax benefit of $526 million,
resulting in an after-tax charge of $977 million, which is reflected as an
extraordinary loss in the Company's Statements of Consolidated Operations. The
Company recorded an expected loss of $894 million in the third quarter of 2004
and increased this amount by $83 million in the fourth quarter of 2004 based on
the Company's assessment of the amounts ultimately recoverable. In January 2005,
the Company appealed certain aspects of the final order seeking to increase the
true-up balance ultimately recovered by the Company. Other parties have also
appealed the order, seeking to reduce the amount authorized for the Company's
recovery. Although the Company believes it has meritorious arguments and that
the other parties' appeals are without merit, no prediction can be made as to
the ultimate outcome or timing of such appeals.
The Company has recorded as a regulatory asset a return of $374 million on
the true-up balance for the period from January 1, 2002 through December 31,
2004 as allowed by the Texas Utility Commission's 2004 Final Order. The Company,
under the 2004 Final Order, will continue to accrue a return until the true-up
balance is recovered by the Company, either from rate payers or through a
securitization offering as discussed below. The rate of return is based on the
Company's cost of capital, established in the Texas Utility Commission's final
order issued in October 2001 (2001 Final Order), which is derived from the
Company's cost to finance assets and an allowance for earnings on shareholders'
investment. Accordingly, in accordance with SFAS No. 92, "Regulated Enterprises
- - Accounting for Phase-in Plans," the rate of return has been bifurcated into
components representing a return of costs to finance assets and an allowance for
earnings on shareholders' investment. The component representing a return of
costs to finance assets of $226 million has been recognized in the fourth
quarter of 2004 and is included in other income in the Company's Statements of
Consolidated Operations. The component representing a return of costs to finance
assets will continue to be recognized as earned going forward. The component
representing an allowance for earnings on shareholders' investment of $148
million has been deferred and will be recognized as it is collected through
rates in the future.
In November 2004, RRI paid $177 million to the Company, representing the
"retail clawback" determined by the Texas Utility Commission in the 2004 True-Up
Proceeding. The Texas electric restructuring law requires the Texas Utility
Commission to determine the retail clawback if the formerly integrated utility's
affiliated retail electric provider retained more than 40 percent of its
residential price-to-beat customers within the utility's service area as of
January 1, 2004 (offset by new customers added outside the service territory).
That retail clawback is a credit against the stranded costs the utility is
entitled to recover and was reflected in the $2.3 billion recovery authorized.
Under the terms of a master separation agreement between RRI and the Company,
RRI agreed to pay the Company the amount of the retail clawback determined by
the Texas Utility Commission. The payment was used by the Company to reduce
outstanding indebtedness.
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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
The Texas electric restructuring law provides for the use of special
purpose entities to issue transition bonds for the economic value of
generation-related regulatory assets and stranded costs. These transition bonds
will be amortized over a period not to exceed 15 years through non-bypassable
transition charges. In October 2001, a special purpose subsidiary of the Company
issued $749 million of transition bonds to securitize certain generation-related
regulatory assets. These transition bonds have a final maturity date of
September 15, 2015 and are non-recourse to the Company and its subsidiaries
other than to the special purpose issuer. Payments on the transition bonds are
made solely out of funds from non-bypassable transition charges.
In December 2004, the Company filed for approval of a financing order to
issue transition bonds to securitize its true-up balance. On March 9, 2005, the
Texas Utility Commission issued a financing order allowing the Company to
securitize approximately $1.8 billion and requiring that the benefit of certain
deferred taxes be reflected as a reduction in the competition transition charge.
The Company anticipates that a new special purpose subsidiary of the Company
will issue bonds in one or more series through an underwritten offering.
Depending on market conditions and the impact of possible appeals of the
financing order, among other factors, the Company anticipates completing such an
offering in 2005.
In January 2005, the Company filed an application for a competition
transition charge to recover its true-up balance. The Company will adjust the
amount sought through that charge to the extent that it is able to securitize
any of such amount. Under the Texas Utility Commission's rules, the unrecovered
true-up balance to be recovered through the competition transition charge earns
a return until fully recovered.
In the 2001 Final Order, the Texas Utility Commission established the
transmission and distribution rates that became effective in January 2002. Based
on its 2001 revision of the 1998 stranded cost estimates, the Texas Utility
Commission determined that the Company had over-mitigated its stranded costs by
redirecting transmission and distribution depreciation and by accelerating
depreciation of generation assets as provided under its 1998 transition plan and
the Texas electric restructuring law. In the 2001 Final Order, the Company was
required to reverse the amount of redirected depreciation and accelerated
depreciation taken for regulatory purposes as allowed under the 1998 transition
plan and the Texas electric restructuring law. In accordance with the 2001 Final
Order, the Company recorded a regulatory liability to reflect the prospective
refund of the accelerated depreciation, and in January 2002 the Company began
paying excess mitigation credits, which were to be paid over a seven-year period
with interest at 7 1/2% per annum. The annual payment of excess mitigation
credits is approximately $264 million. In its December 2004 final order in the
2004 True-Up Proceeding, the Texas Utility Commission found that the Company
did, in fact, have stranded costs (as originally estimated in 1998). Despite
this ruling, the Texas Utility Commission denied the Company recovery of
approximately $180 million of the interest portion of the excess mitigation
credits already paid by the Company and refused to terminate future excess
mitigation credits. In January 2005, the Company filed a writ of mandamus
petition with the Texas Supreme Court asking that court to order the Texas
Utility Commission to terminate immediately the payment of all excess mitigation
credits and to ensure full recovery of all excess mitigation credits. Although
the Company believes it has meritorious arguments, a writ of mandamus is an
extraordinary remedy and no prediction can be made as to the ultimate outcome or
timing of the mandamus petition. If the Supreme Court denies the Company's
mandamus petition, it will continue to pursue this issue through regular
appellate mechanisms. On March 1, 2005, a non-unanimous settlement was filed in
Docket No. 30774, which involves the adjustment of RRI's Price-to-Beat. Under
the terms of that settlement, the excess mitigation credits being paid by the
Company would be terminated as of April 29, 2005. The Texas Utility Commission
approved the settlement on March 9, 2005.
8
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(b) FINAL FUEL RECONCILIATION
On March 4, 2004, an Administrative Law Judge (ALJ) issued a Proposal for
Decision (PFD) relating to the Company's final fuel reconciliation. The Company
reserved $117 million, including $30 million of interest, in the fourth quarter
of 2003 reflecting the ALJ's recommendation. On April 15, 2004, the Texas
Utility Commission affirmed the PFD's finding in part, reversed in part, and
remanded one issue back to the ALJ. On May 28, 2004, the Texas Utility
Commission approved a settlement of the remanded issue and issued a final order
which reduced the disallowance. As a result of the final order, the Company
reversed $23 million, including $8 million of interest, of the $117 million
reserve recorded in the fourth quarter of 2003. The results of the Texas Utility
Commission's final decision are a component of the 2004 True-Up Proceeding. The
Company has appealed certain portions of the Texas Utility Commission's final
order involving a disallowance of approximately $67 million relating to the
final fuel reconciliation plus interest of $10 million. Briefs on this issue
were filed on January 5, 2005, and a hearing on this issue is scheduled for
April 22, 2005.
9
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(9) 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,
2004, which primarily consist of rental agreements for building space, data
processing equipment and vehicles, including major work equipment (in millions).
2005.................. $ 5
2006.................. 6
2007.................. 5
2008.................. 3
2009.................. -
----
Total................ $ 19
====
Total lease expense for all operating leases was approximately $5 million,
$5 million and $4 million for the years ended December 31, 2002, 2003 and 2004,
respectively.
(b) LEGAL AND ENVIRONMENTAL MATTERS
Legal Matters
RRI Indemnified Litigation
The Company, CenterPoint Energy or their predecessor, Reliant Energy, and
certain of their former subsidiaries are named as defendants in several lawsuits
described below. Under a master separation agreement between CenterPoint Energy
and RRI, CenterPoint Energy and its subsidiaries, including the Company, are
entitled to be indemnified by RRI for any losses, including attorneys' fees and
other costs, arising out of the lawsuits described below under Electricity and
Gas Market Manipulation Cases and Other Class Action Lawsuits. Pursuant to the
indemnification obligation, RRI is defending 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.
Electricity and Gas Market Manipulation Cases. A large number of lawsuits
have been filed against numerous market participants and remain pending in both
federal and state courts in California and Nevada in connection with the
operation of the electricity and natural gas markets in California and certain
other western states in 2000-2001, a time of power shortages and significant
increases in prices. These lawsuits, many of which have been filed as class
actions, are based on a number of legal theories, including violation of state
and federal antitrust laws, laws against unfair and unlawful business practices,
the federal Racketeer Influenced Corrupt Organization Act, false claims statutes
and similar theories and breaches of contracts to supply power to governmental
entities. Plaintiffs in these lawsuits, which include state officials and
governmental entities as well as private litigants, are seeking a variety of
forms of relief, including recovery of compensatory damages (in some cases in
excess of $1 billion), a trebling of compensatory damages and punitive damages,
injunctive relief, restitution, interest due, disgorgement, civil penalties and
fines, costs of suit, attorneys' fees and divestiture of assets. To date, some
of these complaints have been dismissed by the trial court and are on appeal,
several of which dismissals have been affirmed by the appellate courts, but most
of the lawsuits remain in early procedural stages. The Company's former
subsidiary, RRI, was a participant in the California markets, owning generating
plants in the state and participating in both electricity and natural gas
trading in that state and in western power markets generally. RRI, some of its
subsidiaries and, in some cases, corporate officers of some of those companies
have been named as defendants in these suits.
CenterPoint Energy or its and the Company's predecessor, Reliant Energy,
have been named in approximately 30 of these lawsuits, which were instituted
between 2001 and 2004 and are pending in California state courts in Alameda
County, Los Angeles County, San Francisco County, San Mateo County and San Diego
County, in Nevada state court in Clark County, in federal district courts in San
Francisco, San Diego, Los Angeles, Fresno, Sacramento and Nevada and before the
Ninth Circuit Court of Appeals. However, the Company, CenterPoint Energy and
Reliant Energy were not participants in the electricity or natural gas markets
in California. CenterPoint Energy and Reliant Energy have been dismissed from
certain of the lawsuits, either voluntarily by the plaintiffs or by order of the
court and CenterPoint Energy believes it is not a proper defendant in the
remaining cases and will continue to seek dismissal from such remaining cases.
On July 6, 2004 and on October 12, 2004, the Ninth Circuit affirmed CenterPoint
Energy's removal to federal district court of two electric cases brought by the
California Attorney General and affirmed the federal court's dismissal of these
cases based upon the filed rate doctrine and federal preemption.
10
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other Class Action Lawsuits. Fifteen class action lawsuits filed in May,
June and July 2002 on behalf of purchasers of securities of RRI and/or Reliant
Energy have been consolidated in federal district court in Houston. RRI and
certain of its former and current executive officers are named as defendants.
The consolidated complaint also names RRI , Reliant Energy, the underwriters of
the initial public offering of RRI's common stock in May 2001 (RRI Offering),
and RRI's and Reliant Energy's independent auditors as defendants. The
consolidated amended complaint seeks monetary relief purportedly on behalf of
purchasers of common stock of Reliant Energy or RRI during certain time periods
ranging from February 2000 to May 2002, and purchasers of common stock that can
be traced to the RRI Offering. The plaintiffs allege, among other things, that
the defendants misrepresented their revenues and trading volumes by engaging in
round-trip trades and improperly accounted for certain structured transactions
as cash-flow hedges, which resulted in earnings from these transactions being
accounted for as future earnings rather than being accounted for as earnings in
fiscal year 2001. In January 2004 the trial judge dismissed the plaintiffs'
allegations that the defendants had engaged in fraud, but claims based on
alleged misrepresentations in the registration statement issued in the RRI
Offering remain. In June 2004, the plaintiffs filed a motion for class
certification, which the court granted in February 2005. The defendants have
appealed the court's order certifying the class.
In February 2003, a lawsuit was filed by three individuals in federal
district court in Chicago against CenterPoint Energy and certain former officers
of RRI for alleged violations of federal securities laws. The plaintiffs in this
lawsuit allege that the defendants violated federal securities laws by issuing
false and misleading statements to the public, and that the defendants made
false and misleading statements as part of an alleged scheme to artificially
inflate trading volumes and revenues. In addition, the plaintiffs assert claims
of fraudulent and negligent misrepresentation and violations of Illinois
consumer law. In January 2004 the trial judge ordered dismissal of plaintiffs'
claims on the ground that they did not set forth a claim. The plaintiffs filed
an amended complaint in March 2004, which the defendants asked the court to
dismiss. On August 18, 2004, the court granted the defendants' motion to dismiss
with prejudice.
In May 2002, three class action lawsuits were filed in federal district
court in Houston on behalf of participants in various employee benefits plans
sponsored by Reliant Energy. Two of the lawsuits have been dismissed without
prejudice. Reliant Energy and certain current and former members of its benefits
committee are the remaining defendants in the third lawsuit. That lawsuit
alleges that the defendants breached their fiduciary duties to various employee
benefits plans, directly or indirectly sponsored by Reliant Energy, in violation
of the Employee Retirement Income Security Act of 1974. The plaintiffs allege
that the defendants permitted the plans to purchase or hold securities issued by
Reliant Energy when it was imprudent to do so, including after the prices for
such securities became artificially inflated because of alleged securities fraud
engaged in by the defendants. The complaint seeks monetary damages for losses
suffered on behalf of the plans and a putative class of plan participants whose
accounts held Reliant Energy or RRI securities, as well as restitution. In July
2004, another class action suit was filed in federal court on behalf of the
Reliant Energy Savings Plan and a class consisting of participants in that plan
against Reliant Energy and the Reliant Energy Benefits Committee. The
allegations and the relief sought in the new suit are substantially similar to
those in the previously pending suit; however, the new suit also alleges that
Reliant Energy and its Benefits Committee breached their fiduciary duties to the
Savings Plan and its participants by investing plan funds in Reliant Energy
stock when Reliant Energy or its subsidiaries were allegedly manipulating the
California energy market. On October 14, 2004, the plaintiff voluntarily
dismissed the newly filed lawsuit.
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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
In October 2002, a derivative action was filed in the federal district
court in Houston against the directors and officers of the Company. The
complaint set forth claims for breach of fiduciary duty, waste of corporate
assets, abuse of control and gross mismanagement. Specifically, the shareholder
plaintiff alleged that the defendants caused the Company to overstate its
revenues through so-called "round trip" transactions. The plaintiff also alleged
breach of fiduciary duty in connection with the spin-off of RRI and the RRI
Offering. The complaint sought monetary damages on behalf of the Company as well
as equitable relief in the form of a constructive trust on the compensation paid
to the defendants. The Company's board of directors investigated that demand and
similar allegations made in a June 28, 2002 demand letter sent on behalf of a
Company shareholder. The second letter demanded that the Company take several
actions in response to alleged round-trip trades occurring in 1999, 2000, and
2001. In June 2003, the board determined that these proposed actions would not
be in the best interests of the Company. In March 2003, the court dismissed this
case on the grounds that the plaintiff did not make an adequate demand on the
Company before filing suit. Thereafter, the plaintiff sent another demand
asserting the same claims.
The Company believes that none of the lawsuits described under Other Class
Action Lawsuits has merit because, among other reasons, the alleged
misstatements and omissions were not material and did not result in any damages
to the plaintiffs.
Other Legal Matters
Texas Antitrust Actions. In July 2003, Texas Commercial Energy filed in
federal court in Corpus Christi, Texas a lawsuit against Reliant Energy, the
Company and CenterPoint Energy, as successors to Reliant Energy, Genco LP, RRI,
Reliant Energy Solutions, LLC, several other RRI subsidiaries and a number of
other participants in the Electric Reliability Council of Texas (ERCOT) power
market. The plaintiff, a retail electricity provider with the ERCOT market,
alleged that the defendants conspired to illegally fix and artificially increase
the price of electricity in violation of state and federal antitrust laws and
committed fraud and negligent misrepresentation. The lawsuit sought damages in
excess of $500 million, exemplary damages, treble damages, interest, costs of
suit and attorneys' fees. The plaintiff's principal allegations had previously
been investigated by the Texas Utility Commission and found to be without merit.
In June 2004, the federal court dismissed the plaintiff's claims and in July
2004, the plaintiff filed a notice of appeal. The Company is vigorously
contesting the appeal. The ultimate outcome of this matter cannot be predicted
at this time.
In February 2005, Utility Choice Electric filed in federal court in
Houston, Texas a lawsuit against the Company, CenterPoint Energy, CenterPoint
Energy Gas Services, Inc., CenterPoint Energy Alternative Fuels, Inc., Genco LP
and a number of other participants in the ERCOT power market. The plaintiff, a
retail electricity provider with the ERCOT market, alleged that the defendants
conspired to illegally fix and artificially increase the price of electricity in
violation of state and federal antitrust laws, intentionally interfered with
prospective business relationships and contracts, and committed fraud and
negligent misrepresentation. The plaintiff's principal allegations had
previously been investigated by the Texas Utility Commission and found to be
without merit. The Company intends to vigorously defend the case. The ultimate
outcome of this matter cannot be predicted at this time.
Municipal Franchise Fee Lawsuits. In February 1996, the cities of Wharton,
Galveston and Pasadena (Three Cities) filed suit in state district court in
Harris County, Texas for themselves and a proposed class of all similarly
situated cities in Reliant Energy's electric service area, against Reliant
Energy and Houston Industries Finance, Inc. (formerly a wholly owned subsidiary
of the Company's predecessor, Reliant Energy) alleging underpayment of municipal
franchise fees. The plaintiffs claimed that they were entitled to 4% of all
receipts of any kind for business conducted within these cities over the
previous four decades. After a jury trial involving the Three Cities' claims
(but not the class of cities), the trial court entered a judgment on the Three
Cities' breach of contract claims for $1.7 million, including interest, plus an
award of $13.7 million in legal fees. It also decertified the class. Following
this ruling, 45 cities filed individual suits against Reliant Energy in the
District Court of Harris County.
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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
On February 27, 2003, a state court of appeals in Houston rendered an
opinion reversing the judgment against the Company and rendering judgment that
the Three Cities take nothing by their claims. The court of appeals held that
all of the Three Cities' claims were barred by the jury's finding of laches, a
defense similar to the statute of limitations, due to the Three Cities' having
unreasonably delayed bringing their claims during the more than 30 years since
the alleged wrongs began. The court also held that the Three Cities were not
entitled to recover any attorneys' fees. The Three Cities filed a petition for
review to the Texas Supreme Court, which declined to hear the case. Thus, the
Three Cities' claims have been finally resolved in the Company's favor, but the
individual claims of the 45 cities remain pending in the same court.
ENVIRONMENTAL MATTERS
Asbestos. A number of facilities owned by CenterPoint Energy contain
significant amounts of asbestos insulation and other asbestos-containing
materials. CenterPoint Energy or its subsidiaries, including the Company, have
been named, along with numerous others, as a defendant in lawsuits filed by a
large number of individuals who claim injury due to exposure to asbestos. Most
claimants in such litigation have been workers who participated in construction
of various industrial facilities, including power plants. Some of the claimants
have worked at locations owned by CenterPoint Energy, but most existing claims
relate to facilities previously owned by CenterPoint Energy but currently owned
by Texas Genco LLC. The Company anticipates that additional claims like those
received may be asserted in the future. Under the terms of the separation
agreement between CenterPoint Energy and Texas Genco, ultimate financial
responsibility for uninsured losses relating to these claims has been assumed by
Texas Genco, but under the terms of its agreement to sell Texas Genco to Texas
Genco LLC, CenterPoint Energy has agreed to continue to defend such claims to
the extent they are covered by insurance maintained by CenterPoint Energy,
subject to reimbursement of the costs of such defense from Texas Genco LLC.
Although their ultimate outcome cannot be predicted at this time, the Company
intends to continue vigorously contesting claims that it does not consider to
have merit and does not believe, based on its experience to date, that these
matters, either individually or in the aggregate, will have a material adverse
effect on the Company's financial condition, results of operations or cash
flows.
Other Proceedings
The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management believes that the disposition of these matters will not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.
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