UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _____________.
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Commission file number 1-13265
CENTERPOINT ENERGY RESOURCES CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 76-0511406
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1111 LOUISIANA
HOUSTON, TEXAS 77002 (713) 207-1111
(Address and zip code of (Registrant's telephone number,
principal executive offices) including area code)
----------
CENTERPOINT ENERGY RESOURCES CORP. MEETS THE CONDITIONS SET FORTH IN GENERAL
INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM 10-Q
WITH THE REDUCED DISCLOSURE FORMAT.
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
----- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
----- -----
As of August 1, 2005, all 1,000 shares of CenterPoint Energy Resources Corp.
common stock were held by Utility Holding, LLC, a wholly owned subsidiary of
CenterPoint Energy, Inc.
EXPLANATORY NOTE
CenterPoint Energy Resources Corp. (CERC Corp. or the Company) hereby
amends Items 1, 2, and 4 of Part I and Item 6 of Part II of its Quarterly Report
on Form 10-Q for the period ended June 30, 2005 as originally filed on August
11, 2005 (Form 10-Q) to reflect the restatement of the Company's unaudited
condensed consolidated financial statements as discussed in Note 12.
Contemporaneously with the filing of this Amendment No. 1 to the Form 10-Q on
this Form 10-Q/A, the Company is filing Amendment No. 2 to its Annual Report on
Form 10-K/A for the year ended December 31, 2004.
For purposes of this Form 10-Q/A, and in accordance with Rule 12b-15 under
the Securities Exchange Act of 1934, as amended, each item of the Form 10-Q that
was affected by the restatement has been amended to the extent affected and
restated in its entirety. NO ATTEMPT HAS BEEN MADE IN THIS FORM 10-Q/A TO UPDATE
OTHER DISCLOSURES AS PRESENTED IN THE FORM 10-Q EXCEPT AS REQUIRED TO REFLECT
THE EFFECTS OF THE RESTATEMENT. ACCORDINGLY, THIS FORM 10-Q/A SHOULD BE READ IN
CONJUNCTION WITH THE COMPANY'S SEC FILINGS MADE SUBSEQUENT TO THE FILING OF THE
FORM 10-Q, INCLUDING ANY AMENDMENTS OF THOSE FILINGS. IN ADDITION, THIS FORM
10-Q/A INCLUDES UPDATED CERTIFICATIONS FROM THE COMPANY'S CEO AND CFO AS
EXHIBITS 31.1, 31.2, 32.1 AND 32.2.
i
CENTERPOINT ENERGY RESOURCES CORP.
QUARTERLY REPORT ON FORM 10-Q/A
FOR THE QUARTER ENDED JUNE 30, 2005
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements...................................... 1
Condensed Statements of Consolidated Income
Three Months and Six Months Ended June 30, 2004 and
2005 (unaudited) (as restated)........................... 1
Condensed Consolidated Balance Sheets
December 31, 2004 and June 30, 2005 (unaudited)
(as restated)............................................ 2
Condensed Statements of Consolidated Cash Flows
Six Months Ended June 30, 2004 and 2005 (unaudited)
(as restated)............................................ 4
Notes to Unaudited Condensed Consolidated Financial
Statements........................... 5
Item 2. Management's Narrative Analysis of the Results of
Operations........................ ............................ 17
Item 4. Controls and Procedures................................... 25
PART II. OTHER INFORMATION
Item 6. Exhibits.................................................. 26
ii
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
From time to time we make statements concerning our expectations, beliefs,
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are not historical facts. These
statements are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
from those expressed or implied by these statements. You can generally identify
our forward-looking statements by the words "anticipate," "believe," "continue,"
"could," "estimate," "expect," "forecast," "goal," "intend," "may," "objective,"
"plan," "potential," "predict," "projection," "should," "will," or other similar
words.
We have based our forward-looking statements on our management's beliefs
and assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, we cannot assure you that actual results will
not differ materially from those expressed or implied by our forward-looking
statements.
The following are some of the factors that could cause actual results to
differ materially from those expressed or implied in forward-looking statements:
- state and federal legislative and regulatory actions or developments,
constraints placed on our activities or business by the Public Utility
Holding Company Act of 1935, as amended (1935 Act), the impact of the
repeal of the 1935 Act and 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;
- timely rate increases, including recovery of costs;
- industrial, commercial and residential growth in our service territory
and changes in market demand and demographic patterns;
- the timing and extent of changes in commodity prices, particularly
natural gas;
- changes in interest rates or rates of inflation;
- weather variations and other natural phenomena;
- the timing and extent of changes in the supply of natural gas;
- commercial bank and financial market conditions, our access to
capital, the costs of such capital, receipt of certain financing
approvals under the 1935 Act, and the results of our financing and
refinancing efforts, including availability of funds in the debt
capital markets;
- actions by rating agencies;
- effectiveness of our risk management activities;
- inability of various counterparties to meet their obligations to us;
- non-payment of our services due to financial distress of our
customers;
- our ability to control costs;
- the investment performance of CenterPoint Energy's employee benefit
plans;
iii
- 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 to have the anticipated benefits to us; and
- other factors we discuss in "Risk Factors" beginning on page 25 in
Item 5 of Part II of our Quarterly Report on Form 10-Q for the period
ending June 30, 2005 filed on August 11, 2005.
Additional risk factors are described in other documents we file with the
Securities and Exchange Commission.
You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement.
iv
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CENTERPOINT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(THOUSANDS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2004 2005 2004 2005
---------- ---------- ---------- ----------
(AS RESTATED, SEE NOTE 12)
REVENUES ................................ $1,216,622 $1,425,796 $3,286,677 $3,673,782
---------- ---------- ---------- ----------
EXPENSES:
Natural gas .......................... 903,669 1,102,062 2,539,379 2,883,293
Operation and maintenance ............ 170,147 171,254 351,980 344,529
Depreciation and amortization ........ 45,613 49,642 92,139 98,818
Taxes other than income taxes ........ 33,572 33,360 78,966 75,771
---------- ---------- ---------- ----------
Total ............................. 1,153,001 1,356,318 3,062,464 3,402,411
---------- ---------- ---------- ----------
OPERATING INCOME ........................ 63,621 69,478 224,213 271,371
---------- ---------- ---------- ----------
OTHER INCOME (EXPENSE):
Interest and other finance charges ... (46,531) (51,862) (88,813) (97,316)
Other, net ........................... 3,454 7,579 6,054 12,213
---------- ---------- ---------- ----------
Total ............................. (43,077) (44,283) (82,759) (85,103)
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES .............. 20,544 25,195 141,454 186,268
Income Tax (Expense) Benefit ......... (9,792) 1,590 (56,511) (63,526)
---------- ---------- ---------- ----------
NET INCOME .............................. $ 10,752 $ 26,785 $ 84,943 $ 122,742
========== ========== ========== ==========
See Notes to the Company's Interim Financial Statements
1
CENTERPOINT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONDENSED CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
ASSETS
JUNE 30,
2005
DECEMBER 31, (AS RESTATED,
2004 SEE NOTE 12)
------------ -------------
CURRENT ASSETS:
Cash and cash equivalents ................................... $ 140,466 $ 379,540
Accounts and notes receivable, net .......................... 545,348 324,913
Accrued unbilled revenue .................................... 502,163 147,434
Accounts and notes receivable - affiliated companies, net ... 11,987 115,236
Materials and supplies ...................................... 25,017 28,134
Natural gas inventory ....................................... 175,784 168,672
Non-trading derivative assets ............................... 50,219 67,638
Taxes receivable ............................................ 155,155 16,429
Deferred tax asset .......................................... 12,256 --
Prepaid expenses ............................................ 8,308 10,125
Other ....................................................... 92,160 87,136
---------- ----------
Total current assets ..................................... 1,718,863 1,345,257
---------- ----------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment ............................... 4,296,061 4,400,046
Less accumulated depreciation ............................... (461,978) (502,939)
---------- ----------
Property, plant and equipment, net ....................... 3,834,083 3,897,107
---------- ----------
OTHER ASSETS:
Goodwill .................................................... 1,740,510 1,744,252
Other intangibles, net ...................................... 19,719 19,033
Non-trading derivative assets ............................... 17,682 56,349
Accounts and notes receivable - affiliated companies, net ... 18,197 16,582
Other ....................................................... 118,089 138,123
---------- ----------
Total other assets ....................................... 1,914,197 1,974,339
---------- ----------
TOTAL ASSETS ................................................... $7,467,143 $7,216,703
========== ==========
See Notes to the Company's Interim Financial Statements
2
CENTERPOINT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONDENSED CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
(THOUSANDS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND STOCKHOLDER'S EQUITY
JUNE 30,
2005
DECEMBER 31, (AS RESTATED,
2004 SEE NOTE 12)
------------ -------------
CURRENT LIABILITIES:
Current portion of long-term debt ............. $ 366,873 $ 325,000
Accounts payable .............................. 732,853 439,365
Taxes accrued ................................. 77,802 60,292
Interest accrued .............................. 57,741 57,446
Customer deposits ............................. 60,164 58,994
Non-trading derivative liabilities ............ 26,323 13,124
Accumulated deferred income taxes, net ........ -- 4,311
Other ......................................... 272,996 292,280
---------- ----------
Total current liabilities .................. 1,594,752 1,250,812
---------- ----------
OTHER LIABILITIES:
Accumulated deferred income taxes, net ........ 640,780 616,726
Non-trading derivative liabilities ............ 6,412 5,873
Benefit obligations ........................... 128,537 127,874
Other ......................................... 556,819 591,831
---------- ----------
Total other liabilities .................... 1,332,548 1,342,304
---------- ----------
LONG-TERM DEBT ................................... 2,000,696 1,999,334
---------- ----------
COMMITMENTS AND CONTINGENCIES (NOTES 1 AND 9)
STOCKHOLDER'S EQUITY:
Common stock .................................. 1 1
Additional paid-in capital .................... 2,231,906 2,286,638
Retained earnings ............................. 305,291 328,033
Accumulated other comprehensive income ........ 1,949 9,581
---------- ----------
Total stockholder's equity ................. 2,539,147 2,624,253
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY .... $7,467,143 $7,216,703
========== ==========
See Notes to the Company's Interim Financial Statements
3
CENTERPOINT ENERGY RESOURCES CORP. AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(THOUSANDS OF DOLLARS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
--------------------------
2004 2005
--------- ---------
(AS RESTATED, SEE NOTE 12)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................ $ 84,943 $ 122,742
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization .......................... 92,139 98,818
Amortization of deferred financing costs ............... 4,956 4,514
Deferred income taxes .................................. 4,274 (23,499)
Changes in other assets and liabilities:
Accounts receivable and unbilled revenues, net ...... 386,956 575,244
Accounts receivable/payable, affiliates ............. (26,920) (3,405)
Inventory ........................................... 24,149 3,995
Taxes receivable .................................... 32,023 193,458
Accounts payable .................................... (148,221) (293,488)
Fuel cost recovery .................................. 53,376 (47,220)
Interest and taxes accrued .......................... (5,230) (17,805)
Net non-trading derivative assets and liabilities ... (8,347) 1,252
Other current assets ................................ 11,384 3,207
Other current liabilities ........................... 558 32,857
Other assets ........................................ (6,155) 4,571
Other liabilities ................................... (29,885) (20,192)
Other, net ............................................. (970) (1,362)
--------- ---------
Net cash provided by operating activities ........ 469,030 633,687
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ...................................... (104,285) (148,971)
Increase in notes receivable from affiliates .............. (214,176) (97,653)
Other, net ................................................ (5,539) (4,952)
--------- ---------
Net cash used in investing activities ............ (324,000) (251,576)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in short-term borrowings, net .................... (63,000) --
Payments of long-term debt ................................ -- (41,873)
Decrease in notes payable with affiliates ................. (31,985) (575)
Debt issuance costs ....................................... (1,676) (589)
Dividend to parent ........................................ (12,500) (100,000)
--------- ---------
Net cash used in financing activities ............ (109,161) (143,037)
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS .................... 35,869 239,074
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD ......... 34,447 140,466
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD ............... $ 70,316 $ 379,540
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest .................................................. $ 84,344 $ 90,916
Income taxes .............................................. 70,939 84,421
See Notes to the Company's Interim Financial Statements
4
CENTERPOINT ENERGY RESOURCES CORP. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BACKGROUND AND BASIS OF PRESENTATION
General. Included in this Quarterly Report on Form 10-Q/A (Form 10-Q/A) of
CenterPoint Energy Resources Corp. are the condensed consolidated interim
financial statements and notes (Interim Financial Statements) of CenterPoint
Energy Resources Corp. and its subsidiaries (collectively, CERC Corp. or the
Company). The Interim Financial Statements are unaudited, omit certain financial
statement disclosures and should be read with the Annual Report on Form 10-K of
CERC Corp. for the year ended December 31, 2004 filed on March 24, 2005 (CERC
Corp. Form 10-K), as amended by Amendment No. 1 thereto filed on August 29,
2005, and as amended by Amendment No. 2 thereto filed on January 10, 2006 (CERC
Corp. Form 10-K/A).
Background. The Company's operating subsidiaries own and operate natural
gas distribution facilities, interstate pipelines and natural gas gathering,
processing and treating facilities. The Company's operations of its local
distribution companies are conducted by three unincorporated divisions: Houston
Gas, Minnesota Gas and Southern Gas Operations. Through wholly owned
subsidiaries, the Company owns two interstate natural gas pipelines and gas
gathering systems, provides various ancillary services, and offers variable and
fixed price physical natural gas supplies to commercial and industrial customers
and natural gas distributors.
The Company is an indirect wholly owned subsidiary of CenterPoint Energy,
Inc. (CenterPoint Energy), a public utility holding company created on August
31, 2002, as part of a corporate restructuring of Reliant Energy, Incorporated
(Reliant Energy) that implemented certain requirements of the Texas Electric
Choice Plan. CenterPoint Energy is a registered public utility holding company
under the Public Utility Holding Company Act of 1935, as amended (1935 Act). The
1935 Act and related rules and regulations impose a number of restrictions on
the activities of CenterPoint Energy and those of its subsidiaries. The 1935
Act, among other things, limits the ability of CenterPoint Energy and its
subsidiaries to issue debt and equity securities without prior authorization,
restricts the source of dividend payments to current and retained earnings
without prior authorization, regulates sales and acquisitions of certain assets
and businesses and governs affiliated service, sales and construction contracts.
On August 8, 2005, President Bush signed the Energy Policy Act of 2005 (Energy
Act), which, among other things, repeals the 1935 Act six months after the
enactment of the Energy Act. After the effective date of repeal, CenterPoint
Energy and its subsidiaries, including the Company, will no longer be subject to
restrictions imposed under the 1935 Act. Until the repeal is effective,
CenterPoint Energy and its subsidiaries remain subject to the provisions of the
1935 Act and the terms of orders issued by the Securities and Exchange
Commission (SEC) under the 1935 Act. The Energy Act transfers to the Federal
Energy Regulatory Commission (FERC) certain functions performed by the SEC under
the 1935 Act, including the requirement that holding companies and their
subsidiaries maintain certain books and records and make them available for
review by FERC and, through FERC, to state regulatory authorities. The Energy
Act requires FERC to issue regulations to implement its jurisdiction under the
Energy Act. It is presently unknown what, if any, specific obligations under
those rules may be imposed on the Company as result of that rulemaking.
Basis of Presentation. The preparation of financial statements in
conformity with generally accepted accounting principles in the United States of
America (GAAP) requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
The Company's Interim Financial Statements reflect all normal recurring
adjustments that are, in the opinion of management, necessary to present fairly
the financial position and results of operations for the respective periods.
Amounts reported in the Company's Condensed Statements of Consolidated Income
are not necessarily indicative of amounts expected for a full-year period due to
the effects of, among other things, (a) seasonal fluctuations in demand for
energy and energy services, (b) changes in energy commodity prices, (c) timing
of maintenance and other expenditures and (d) acquisitions and dispositions of
businesses, assets and other interests. In addition, certain amounts from the
prior year have been reclassified to conform to the Company's presentation of
financial statements in the current year. These reclassifications do not affect
net income.
5
Note 2(e) (Regulatory Assets and Liabilities), Note 3 (Regulatory Matters),
Note 5 (Derivative Instruments) and Note 9 (Commitments and Contingencies) to
the consolidated annual financial statements in the CERC Corp. Form 10-K/A (CERC
Corp. 10-K/A Notes) relate to certain contingencies. These notes, as updated
herein, should be read with this Form 10-Q/A.
For information regarding environmental matters and legal proceedings, see
Note 9 to the Interim Financial Statements.
(2) NEW ACCOUNTING PRONOUNCEMENTS
In May 2005, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 154, "Accounting Changes
and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement
No. 3" (SFAS No. 154). SFAS No. 154 provides guidance on the accounting for and
reporting of accounting changes and error corrections. It establishes, unless
impracticable, retrospective application as the required method for reporting a
change in accounting principle in the absence of explicit transition
requirements specific to the newly adopted accounting principle. The correction
of an error in previously issued financial statements is not an accounting
change and must be reported as a prior-period adjustment by restating previously
issued financial statements. SFAS No. 154 is effective for accounting changes
and corrections of errors made in fiscal years beginning after December 15,
2005.
In March 2005, the FASB issued FASB Interpretation No. (FIN) 47,
"Accounting for Conditional Asset Retirement Obligations" (FIN 47). FIN 47
clarifies that an entity must record a liability for a "conditional" asset
retirement obligation if the fair value of the obligation can be reasonably
estimated. FIN 47 is effective no later than the end of fiscal years ending
after December 15, 2005. The Company does not expect the adoption of this
standard to have a material effect on its financial position, results of
operations or cash flows.
(3) REGULATORY MATTERS
(a) Rate Cases.
In November 2004, Southern Gas Operations filed an application for a
general rate increase with the Arkansas Public Service Commission (APSC).
Southern Gas Operations' adjusted request, if approved, would increase base
rates by approximately $28 million annually. The APSC staff has made a
recommendation to the APSC for a rate decrease of $13 million. Hearings in the
rate case began in early August 2005 with billings under new rates expected to
begin in the fourth quarter.
In April 2005, the Railroad Commission of Texas (Railroad Commission)
approved a settlement that increased Southern Gas Operations' base rate and
service revenues by a combined $2 million in the unincorporated environs of its
Beaumont/East Texas and South Texas Divisions. In June 2005, Southern Gas
Operations filed a request to implement these rates within substantially all of
the incorporated cities located in its Beaumont/East Texas and South Texas
Divisions. If these rates are approved as requested, Southern Gas Operations'
base rate and service revenues are expected to increase by an additional $16
million annually.
In June 2005, the Minnesota Public Utilities Commission (MPUC) approved a
settlement which increases Minnesota Gas' base rates by approximately $9 million
annually. An interim rate increase of $17 million had been implemented in
October 2004. A liability has been recorded for the excess of amounts collected
in interim rates over those approved in the final settlement, which excess will
be refunded to customers in the third quarter.
(b) City of Tyler, Texas Dispute.
In July 2002, the City of Tyler, Texas, asserted that Southern Gas
Operations had overcharged residential and small commercial customers in that
city for gas costs under supply agreements in effect since 1992. That dispute
was referred to the Railroad Commission by agreement of the parties for a
determination of whether Southern Gas Operations has properly charged and
collected for gas service to its residential and commercial customers in its
Tyler distribution system in accordance with lawful filed tariffs during the
period beginning November 1, 1992, and ending October 31, 2002. In December
2004, the Railroad Commission conducted a hearing on the matter. On May 25,
2005, the Railroad Commission issued a final order finding that the Company had
complied with its tariffs, acted
6
prudently in entering into its gas supply contracts, and prudently managed those
contracts. An appeal from this order was taken by the City of Tyler to the
Travis County District Court on August 10, 2005.
(c) Settlement of FERC Audit.
On June 27, 2005, CenterPoint Energy Gas Transmission Company (CEGT), a
subsidiary of CERC Corp., received an Order from FERC accepting the terms of a
settlement agreed upon by CEGT with the Staff of the FERC's Office of Market
Oversight and Investigations (OMOI). The settlement brought to a conclusion an
investigation of CEGT initiated by OMOI in August 2003. Among other things, the
investigation involved a comprehensive review of CEGT's relationship with its
marketing affiliates and compliance with various FERC record-keeping and
reporting requirements covering the period from January 1, 2001 through
September 22, 2004.
OMOI Staff took the position that some of CEGT's actions resulted in a
limited number of violations of FERC's affiliate regulations or were in
violation of certain record-keeping and administrative requirements. OMOI did
not find any systematic violations of its rules governing communications or
other relationships among affiliates.
The settlement included two remedies: a payment of a $270,000 civil penalty
and the execution of a compliance plan, applicable to both CEGT and its sister
pipeline, CenterPoint Energy-Mississippi River Transmission Corporation (MRT).
The compliance plan consists of a detailed set of Implementation Procedures that
will facilitate compliance with FERC's Order No. 2004, the Standards of Conduct,
which regulate behavior between regulated entities and their affiliates. The
Company does not believe the compliance plan will have any material effect on
CEGT's or MRT's ability to conduct their business.
(4) DERIVATIVE FINANCIAL INSTRUMENTS
The Company is exposed to various market risks. These risks arise from
transactions entered into in the normal course of business. The Company utilizes
derivative financial instruments such as physical forward contracts, swaps and
options to mitigate the impact of changes in cash flows of its natural gas
businesses on its operating results and cash flows.
Cash Flow Hedges. During the six months ended June 30, 2004 and 2005, hedge
ineffectiveness was less than $1 million from derivatives that qualify for and
are designated as cash flow hedges. No component of the derivative instruments'
gain or loss was excluded from the assessment of effectiveness. If it becomes
probable that an anticipated transaction will not occur, the Company realizes in
net income the deferred gains and losses recognized in accumulated other
comprehensive income. Once the anticipated transaction occurs, the accumulated
deferred gain or loss recognized in accumulated other comprehensive income is
reclassified and included in the Company's Statements of Consolidated Income
under the caption "Natural Gas." Cash flows resulting from these transactions in
non-trading energy derivatives are included in the Statements of Consolidated
Cash Flows in the same category as the item being hedged. As of June 30, 2005,
the Company expects $12 million in accumulated other comprehensive income to be
reclassified into net income during the next twelve months.
Other Derivative Financial Instruments. The Company also has natural gas
contracts that are derivatives which are not hedged. Load following services
that the Company offers its natural gas customers create an inherent tendency
for the Company to be either long or short natural gas supplies relative to
customer purchase commitments. The Company measures and values all of its
volumetric imbalances on a real-time basis to minimize its exposure to commodity
price and volume risk. The aggregate Value at Risk (VaR) associated with these
operations is calculated daily and averaged $0.3 million with a high of $1
million during the first six months of 2005. The Company does not engage in
proprietary or speculative commodity trading. Unhedged positions are accounted
for by adjusting the carrying amount of the contracts to market and recognizing
any gain or loss in operating income, net. During the six months ended June 30,
2004 and 2005, the Company recognized net gains (losses) related to unhedged
positions amounting to $(2) million and $6 million, respectively. As of December
31, 2004, the Company had recorded short-term risk management assets and
liabilities of $4 million and $5 million, respectively, included in other
current assets and other current liabilities, respectively. As of June 30, 2005,
the Company had recorded short-term risk management assets and liabilities of $3
million and $3 million, respectively, included in other current assets and other
current liabilities, respectively.
7
(5) GOODWILL AND INTANGIBLES
Goodwill by reportable business segment is as follows (in millions):
DECEMBER 31, JUNE 30,
2004 2005
------------ --------
Natural Gas Distribution .. $1,085 $1,085
Pipelines and Gathering ... 601 604
Other Operations .......... 55 55
------ ------
Total .................. $1,741 $1,744
====== ======
The Company reviews the carrying value of goodwill annually and at such
times when events or changes in circumstances indicate that it may not be
recoverable. The Company completed its annual evaluation of goodwill for
impairment as of January 1, 2005 and no impairment was indicated.
The components of the Company's other intangible assets consist of the
following:
DECEMBER 31, 2004 JUNE 30, 2005
----------------------- -----------------------
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------- ------------ -------- ------------
(IN MILLIONS)
Land use rights .. $ 7 $(3) $ 7 $(3)
Other ............ 21 (5) 21 (6)
--- --- --- ---
Total ............ $28 $(8) $28 $(9)
=== === === ===
The Company recognizes specifically identifiable intangibles, including
land use rights and permits, when specific rights and contracts are acquired.
The Company has no intangible assets with indefinite lives recorded as of June
30, 2005. The Company amortizes other acquired intangibles on a straight-line
basis over the lesser of their contractual or estimated useful lives that range
from 47 to 75 years for land use rights and 4 to 25 years for other intangibles.
Amortization expense for other intangibles for the three months ended June
30, 2004 and 2005 was $0.4 million and $0.5 million, respectively. Amortization
expense for other intangibles for the six months ended June 30, 2004 and 2005
was $0.8 million and $1.0 million, respectively. Estimated amortization expense
for the remainder of 2005 is approximately $1 million and is approximately $2
million per year for each of the five succeeding fiscal years.
(6) LONG-TERM DEBT AND RECEIVABLES FACILITY
(a) Long-Term Debt.
Credit Facilities. In June 2005, the Company replaced its $250 million
three-year revolving credit facility with a $400 million five-year revolving
credit facility. The new credit facility terminates on June 30, 2010. Borrowings
under this facility may be made at the London interbank offered rate (LIBOR)
plus 55 basis points, including the facility fee, based on current credit
ratings. An additional utilization fee of 10 basis points applies to borrowings
whenever more than 50% of the facility is utilized. Changes in credit ratings
could lower or raise the increment to LIBOR depending on whether ratings
improved or were lowered. As of June 30, 2005, such credit facility was not
utilized.
Junior Subordinated Debentures (Trust Preferred Securities). In June 1996,
a Delaware statutory business trust created by CERC Corp. (CERC Trust) issued
$173 million aggregate amount of convertible preferred securities to the public.
CERC Trust used the proceeds of the offering to purchase convertible junior
subordinated debentures issued by CERC Corp. having an interest rate and
maturity date that correspond to the distribution rate and mandatory redemption
date of the convertible preferred securities. The convertible junior
subordinated debentures represent CERC Trust's sole asset and its entire
operations. CERC Corp. considers its obligation under the Amended and Restated
Declaration of Trust, Indenture and Guaranty Agreement relating to the
convertible preferred securities, taken together, to constitute a full and
unconditional guarantee by CERC Corp. of CERC Trust's obligations with respect
to the convertible preferred securities. The amount of outstanding junior
subordinated debentures was included in long-term debt as of December 31, 2004
and June 30, 2005.
8
The convertible preferred securities were mandatorily redeemable upon the
repayment of the convertible junior subordinated debentures at their stated
maturity or earlier redemption. Effective January 7, 2003, the convertible
preferred securities were convertible at the option of the holder into $33.62 of
cash and 2.34 shares of CenterPoint Energy common stock for each $50 of
liquidation value. As of both December 31, 2004 and June 30, 2005, the
liquidation amount of convertible preferred securities outstanding was $0.3
million. The securities, and their underlying convertible junior subordinated
debentures, bore interest at 6.25% and had a June 2026 maturity date. Subject to
some limitations, CERC Corp. had the option of deferring payments of interest on
the convertible junior subordinated debentures. During any deferral or event of
default, CERC Corp. could not pay dividends on its common stock to CenterPoint
Energy. As of June 30, 2005, no interest payments on the convertible junior
subordinated debentures had been deferred.
On July 1, 2005, the remaining $0.3 million of convertible preferred
securities and the $6 million of related convertible junior subordinated
debentures were called for redemption on August 1, 2005. Most of the convertible
preferred securities were converted prior to the redemption date and the
remaining securities were redeemed.
(b) Receivables Facility.
In January 2005, the Company's $250 million receivables facility was
extended to January 2006 and temporarily increased, for the period from January
2005 to June 2005, to $375 million to provide additional liquidity to CERC
during the peak heating season of 2005. As of June 30, 2005, CERC had $181
million of advances under its receivables facility.
The average outstanding balance on the receivables facility was $181
million for the six months ended June 30, 2005. Sales of receivables were
approximately $0.6 billion and $0.4 billion for the three months ended June 30,
2004 and 2005, respectively, and $1.3 billion and $0.9 billion for the six
months ended June 30, 2004 and 2005, respectively.
(7) COMPREHENSIVE INCOME
The following table summarizes the components of total comprehensive income
(net of tax):
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- ------------------
2004 2005 2004 2005
---- ---- ---- ----
(IN MILLIONS)
Net income ................................................. $11 $27 $85 $123
--- --- --- ----
Other comprehensive income:
Net deferred gain from cash flow hedges ................. 8 1 16 10
Reclassification of deferred gain from cash flow
hedges realized in net income ........................ (5) (3) (7) (2)
--- --- --- ----
Other comprehensive income (loss) .......................... 3 (2) 9 8
--- --- --- ----
Comprehensive income ....................................... $14 $25 $94 $131
=== === === ====
The following table summarizes the components of accumulated other
comprehensive income:
DECEMBER 31, JUNE 30,
2004 2005
------------ --------
(IN MILLIONS)
Net deferred gain from cash flow hedges ..... $ 2 $10
=== ===
9
(8) RELATED PARTY TRANSACTIONS
The following table summarizes receivables from, or payables to,
CenterPoint Energy or its subsidiaries:
DECEMBER 31, JUNE 30,
2004 2005
------------ --------
(IN MILLIONS)
Accounts receivable from affiliates ....................................... $ 4 $ 4
Accounts payable to affiliates ............................................ (34) (28)
Notes receivable from affiliates(1) ....................................... 42 139
---- ----
Accounts and notes receivable -- affiliated companies, net ............. $ 12 $115
==== ====
Long-term accounts receivable from affiliates ............................. $ 64 $ 65
Long-term accounts payable to affiliates .................................. (45) (48)
Long-term notes payable to affiliates ..................................... (1) --
---- ----
Long-term accounts and notes receivable -- affiliated companies, net ... $ 18 $ 17
==== ====
- ----------
(1) Represents money pool investments.
For the three months ended June 30, 2004 and 2005, the Company had net
interest income related to affiliate borrowings of $2.5 million and $1.4
million, respectively. For the six months ended June 30, 2004 and 2005, the
Company had net interest income related to affiliate borrowings of $4.1 million
and $2.6 million, respectively.
The 1935 Act generally prohibits borrowings by CenterPoint Energy from its
subsidiaries, including the Company, either through the money pool or otherwise.
For the three and six months ended June 30, 2004, the sales and services
provided by the Company to Texas Genco Holdings, Inc. (Texas Genco), a former
subsidiary of CenterPoint Energy, totaled $11 million and $18 million,
respectively. For the three and six months ended June 30, 2005, the Company
provided no sales or services to CenterPoint Energy or its subsidiaries.
CenterPoint Energy provides some corporate services to the Company. The
costs of services have been directly charged to the Company using methods that
management believes are reasonable. These methods include negotiated usage
rates, dedicated asset assignment, and proportionate corporate formulas based on
assets, operating margins, operating expenses and employees. These charges are
not necessarily indicative of what would have been incurred had the Company not
been an affiliate. Amounts charged to the Company for these services were $28
million and $31 million for the three months ended June 30, 2004 and 2005,
respectively, and $55 million and $60 million for the six months ended June 30,
2004 and 2005, respectively, and are included primarily in operation and
maintenance expenses.
Pursuant to the tax sharing agreement with CenterPoint Energy, the Company
received an allocation of CenterPoint Energy's tax benefits totaling $24 million
and $55 million for the three and six months ended June 30, 2005, respectively,
which was recorded as an increase to additional paid-in capital.
In the second quarter of 2005, the Company paid a dividend of $100 million
to Utility Holding, LLC.
(9) COMMITMENTS AND CONTINGENCIES
(a) Legal Matters.
Natural Gas Measurement Lawsuits. CERC Corp. and certain of its
subsidiaries are defendants in a suit filed in 1997 under the Federal False
Claims Act alleging mismeasurement of natural gas produced from federal and
Indian lands. The suit seeks undisclosed damages, along with statutory
penalties, interest, costs, and fees. The complaint is part of a larger series
of complaints filed against 77 natural gas pipelines and their subsidiaries and
affiliates. An earlier single action making substantially similar allegations
against the pipelines was dismissed by the federal district court for the
District of Columbia on grounds of improper joinder and lack of jurisdiction. As
a result, the various individual complaints were filed in numerous courts
throughout the country. This case has been
10
consolidated, together with the other similar False Claims Act cases, in the
federal district court in Cheyenne, Wyoming.
In addition, CERC Corp. and certain of its subsidiaries are defendants in
two mismeasurement lawsuits brought against approximately 245 pipeline companies
and their affiliates pending in state court in Stevens County, Kansas. In one
case (originally filed in May 1999 and amended four times), the plaintiffs
purport to represent a class of royalty owners who allege that the defendants
have engaged in systematic mismeasurement of the volume of natural gas for more
than 25 years. The plaintiffs amended their petition in this suit in July 2003
in response to an order from the judge denying certification of the plaintiffs'
alleged class. In the amendment the plaintiffs dismissed their claims against
certain defendants (including two of the Company's subsidiaries), limited the
scope of the class of plaintiffs they purport to represent and eliminated
previously asserted claims based on mismeasurement of the Btu content of the
gas. The same plaintiffs then filed a second lawsuit, again as representatives
of a class of royalty owners, in which they assert their claims that the
defendants have engaged in systematic mismeasurement of the Btu content of
natural gas for more than 25 years. In both lawsuits, the plaintiffs seek
compensatory damages, along with statutory penalties, treble damages, interest,
costs and fees. The Company believes that there has been no systematic
mismeasurement of gas and that the suits are without merit. The Company does not
expect the ultimate outcome to have a material impact on its financial
condition, results of operations or cash flows.
Gas Cost Recovery Litigation. In October 2002, a suit was filed in state
district court in Wharton County, Texas against the Company, CenterPoint Energy,
Entex Gas Marketing Company, and certain non-affiliated companies alleging
fraud, violations of the Texas Deceptive Trade Practices Act, violations of the
Texas Utilities Code, civil conspiracy and violations of the Texas Free
Enterprise and Antitrust Act with respect to rates charged to certain consumers
of natural gas in the State of Texas. Subsequently the plaintiffs added as
defendants CenterPoint Energy Marketing Inc., CenterPoint Energy Gas
Transmission Company, United Gas, Inc., Louisiana Unit Gas Transmission Company,
CenterPoint Energy Pipeline Services, Inc., and CenterPoint Energy Trading and
Transportation Group, Inc., all of which are subsidiaries of the Company. The
plaintiffs alleged that defendants inflated the prices charged to certain
consumers of natural gas. In February 2003, a similar suit was filed in state
court in Caddo Parish, Louisiana against the Company with respect to rates
charged to a purported class of certain consumers of natural gas and gas service
in the State of Louisiana. In February 2004, another suit was filed in state
court in Calcasieu Parish, Louisiana against the Company seeking to recover
alleged overcharges for gas or gas services allegedly provided by Southern Gas
Operations to a purported class of certain consumers of natural gas and gas
service without advance approval by the Louisiana Public Service Commission
(LPSC). In October 2004, a similar case was filed in district court in Miller
County, Arkansas against the Company, CenterPoint Energy, Entex Gas Marketing
Company, CenterPoint Energy Gas Transmission Company, CenterPoint Energy Field
Services, CenterPoint Energy Pipeline Services, Inc., Mississippi River
Transmission Corp. and other non-affiliated companies alleging fraud, unjust
enrichment and civil conspiracy with respect to rates charged to certain
consumers of natural gas in at least the states of Arkansas, Louisiana,
Mississippi, Oklahoma and Texas. At the time of the filing of each of the Caddo
and Calcasieu Parish cases, the plaintiffs in those cases filed petitions with
the LPSC relating to the same alleged rate overcharges. The Caddo and Calcasieu
Parish cases have been stayed pending the resolution of the respective
proceedings by the LPSC. The plaintiffs in the Miller County case seek class
certification, but the proposed class has not been certified. In November 2004,
the Miller case was removed to federal district court in Texarkana, Arkansas. In
February 2005, the Wharton County case was removed to federal district court in
Houston, Texas, and in March 2005, the plaintiffs voluntarily moved to dismiss
the case and agreed not to refile the claims asserted unless the Miller County
case is not certified as a class action or is later decertified. In June 2005,
the Miller County case was remanded to state district court in Miller County.
The range of relief sought by the plaintiffs in these cases includes injunctive
and declaratory relief, restitution for the alleged overcharges, exemplary
damages or trebling of actual damages, civil penalties and attorney's fees. In
these cases, the Company, CenterPoint Energy and their affiliates deny that they
have overcharged any of their customers for natural gas and believe that the
amounts recovered for purchased gas have been in accordance with what is
permitted by state regulatory authorities. The Company and CenterPoint Energy do
not expect the outcome of these matters to have a material impact on the
financial condition, results of operations or cash flows of either the Company
or CenterPoint Energy. The allegations in these cases are similar to those
asserted in the City of Tyler proceeding described in Note 3(b).
Pipeline Safety Compliance. In 2005, the Company received an order from the
Minnesota Office of Pipeline Safety to remove certain components from a portion
of its distribution system by December 2, 2005. Those components were installed
by a predecessor company and are not in compliance with current state and
federal codes.
11
The Company estimates the range of expenditures to locate and replace such
components to be $35 to $45 million. The Company will request return on and of
the capitalized expenditures in future rate cases.
Minnesota Cold Weather Rule. In December 2004, the MPUC opened an
investigation to determine whether the Company's practices regarding restoring
natural gas service during the period between October 15 and April 15 (Cold
Weather Period) are in compliance with the MPUC's Cold Weather Rule (CWR), which
governs disconnection and reconnection of customers during the Cold Weather
Period. The Minnesota Office of the Attorney General issued its report alleging
the Company has violated the CWR and recommended a $5 million penalty. The
Company filed its reply comments in July 2005. In addition, in June 2005, the
Company was named in a suit filed on behalf of a purported class of customers
who allege that the Company's conduct under the CWR was in violation of the
Minnesota Consumer Fraud Act and the Minnesota Deceptive Trade Practices Act and
was negligent and fraudulent. The Company believes that it has not knowingly and
intentionally violated the CWR and intends to vigorously contest the lawsuit.
The Company does not expect this matter to have a material adverse effect on its
financial condition, results of operations or cash flows.
(b) Environmental Matters.
Hydrocarbon Contamination. CERC Corp. and certain of its subsidiaries are
among the defendants in lawsuits filed beginning in August 2001 in Caddo Parish
and Bossier Parish, Louisiana. The suits allege that, at some unspecified date
prior to 1985, the defendants allowed or caused hydrocarbon or chemical
contamination of the Wilcox Aquifer, which lies beneath property owned or leased
by certain of the defendants and which is the sole or primary drinking water
aquifer in the area. The primary source of the contamination is alleged by the
plaintiffs to be a gas processing facility in Haughton, Bossier Parish,
Louisiana known as the "Sligo Facility," which was formerly operated by a
predecessor in interest of CERC Corp. This facility was purportedly used for
gathering natural gas from surrounding wells, separating gasoline and
hydrocarbons from the natural gas for marketing, and transmission of natural gas
for distribution.
Beginning about 1985, the predecessors of certain CERC Corp. defendants
engaged in a voluntary remediation of any subsurface contamination of the
groundwater below the property they owned or leased. This work has been done in
conjunction with and under the direction of the Louisiana Department of
Environmental Quality. The plaintiffs seek monetary damages for alleged damage
to the aquifer underlying their property, unspecified alleged personal injuries,
alleged fear of cancer, alleged property damage or diminution of value of their
property, and, in addition, seek damages for trespass, punitive, and exemplary
damages. The Company does not expect the ultimate cost associated with resolving
this matter to have a material impact on the financial condition, results of
operations or cash flows of the Company.
Manufactured Gas Plant Sites. The Company and its predecessors operated
manufactured gas plants (MGP) in the past. In Minnesota, the Company has
completed remediation on two sites, other than ongoing monitoring and water
treatment. There are five remaining sites in the Company's Minnesota service
territory. The Company believes that it has no liability with respect to two of
these sites.
At June 30, 2005, the Company had accrued $18 million for remediation of
certain Minnesota sites. At June 30, 2005, the estimated range of possible
remediation costs for these sites was $7 million to $42 million based on
remediation continuing for 30 to 50 years. The cost estimates are based on
studies of a site or industry average costs for remediation of sites of similar
size. The actual remediation costs will be dependent upon the number of sites to
be remediated, the participation of other potentially responsible parties (PRP),
if any, and the remediation methods used. The Company has utilized an
environmental expense tracker mechanism in its rates in Minnesota to recover
estimated costs in excess of insurance recovery. As of June 30, 2005, the
Company has collected or accrued $13 million from insurance companies and
ratepayers to be used for future environmental remediation.
In addition to the Minnesota sites, the United States Environmental
Protection Agency and other regulators have investigated MGP sites that were
owned or operated by the Company or may have been owned by one of its former
affiliates. The Company has been named as a defendant in two lawsuits under
which contribution is sought by private parties for the cost to remediate former
MGP sites based on the previous ownership of such sites by former affiliates of
the Company or its divisions. The Company has also been identified as a PRP by
the State of Maine for a site that is the subject of one of the lawsuits. In
March 2005, the court considering the other suit for contribution granted the
Company's motion to dismiss on the grounds that the Company was not an
"operator" of the site as had
12
been alleged. The plaintiff in that case has filed an appeal of the court's
dismissal of the Company. The Company is investigating details regarding these
sites and the range of environmental expenditures for potential remediation.
However, the Company believes it is not liable as a former owner or operator of
those sites under the Comprehensive Environmental, Response, Compensation and
Liability Act of 1980, as amended, and applicable state statutes, and is
vigorously contesting those suits and its designation as a PRP.
Mercury Contamination. The Company's pipeline and distribution operations
have in the past employed elemental mercury in measuring and regulating
equipment. It is possible that small amounts of mercury may have been spilled in
the course of normal maintenance and replacement operations and that these
spills may have contaminated the immediate area with elemental mercury. This
type of contamination has been found by the Company at some sites in the past,
and the Company has conducted remediation at these sites. It is possible that
other contaminated sites may exist and that remediation costs may be incurred
for these sites. Although the total amount of these costs cannot be known at
this time, based on experience by the Company and that of others in the natural
gas industry to date and on the current regulations regarding remediation of
these sites, the Company does not expect the costs of any remediation of these
sites to be material to the Company's financial condition, results of operations
or cash flows.
Other Environmental. From time to time the Company has received notices
from regulatory authorities or others regarding its status as a PRP in
connection with sites found to require remediation due to the presence of
environmental contaminants. In addition, the Company has been named from time to
time as a defendant in litigation related to such sites. Although the ultimate
outcome of such matters cannot be predicted at this time, the Company does not
expect, based on its experience to date, these matters, either individually or
in the aggregate, to have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
(c) Other Proceedings.
The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management does not expect the disposition of these matters to have a material
adverse effect on the Company's financial condition, results of operations or
cash flows.
(10) REPORTABLE BUSINESS SEGMENTS
Because CERC Corp. is an indirect wholly owned subsidiary of CenterPoint
Energy, the Company's determination of reportable segments considers the
strategic operating units under which CenterPoint Energy manages sales,
allocates resources and assesses performance of various products and services to
wholesale or retail customers in differing regulatory environments.
The Company has identified the following reportable business segments:
Natural Gas Distribution, Pipelines and Gathering, and Other Operations. For
descriptions of the reportable business segments, see Note 12 to the CERC Corp.
10-K/A Notes.
The following table summarizes financial data for the Company's reportable
business segments:
FOR THE THREE MONTHS ENDED JUNE 30, 2004
-----------------------------------------------
REVENUES FROM NET
EXTERNAL INTERSEGMENT OPERATING
CUSTOMERS REVENUES INCOME (LOSS)
------------- ------------ ----------------
(IN MILLIONS)
Natural Gas Distribution ... $1,138(1) $-- $23
Pipelines and Gathering .... 79(2) 34 42
Other Operations ........... -- 2 (1)
Eliminations ............... -- (36) --
------ --- ---
Consolidated ............... $1,217 $-- $64
====== === ===
13
FOR THE THREE MONTHS ENDED JUNE 30, 2005
-----------------------------------------------
REVENUES FROM NET
EXTERNAL INTERSEGMENT OPERATING
CUSTOMERS REVENUES INCOME (LOSS)
------------- ------------ ----------------
(IN MILLIONS)
Natural Gas Distribution ... $1,339 $ 1 $19
Pipelines and Gathering .... 87 38 52
Other Operations ........... -- 1 (2)
Eliminations ............... -- (40) --
------ ---- ---
Consolidated ............... $1,426 $ -- $69
====== ==== ===
FOR THE SIX MONTHS ENDED JUNE 30, 2004
-----------------------------------------------
REVENUES FROM NET TOTAL ASSETS
EXTERNAL INTERSEGMENT OPERATING AS OF DECEMBER
CUSTOMERS REVENUES INCOME (LOSS) 31, 2004
------------- ------------ ---------------- --------------
(IN MILLIONS)
Natural Gas Distribution ... $3,142 (1) $ 1 $140 $4,732
Pipelines and Gathering .... 145 (2) 71 87 2,637
Other Operations ........... -- 5 (3) 792
Eliminations ............... -- (77) -- (694)
------ ---- ---- ------
Consolidated ............... $3,287 $ -- $224 $7,467
====== ==== ==== ======
FOR THE SIX MONTHS ENDED JUNE 30, 2005
--------------------------------------------
REVENUES FROM NET TOTAL ASSETS
EXTERNAL INTERSEGMENT OPERATING AS OF JUNE 30,
CUSTOMERS REVENUES INCOME (LOSS) 2005
------------- ------------ ------------- --------------
(IN MILLIONS)
Natural Gas Distribution ... $3,500 $ 3 $158 $ 4,729
Pipelines and Gathering .... 171 75 116 2,798
Other Operations ........... 3 3 (3) 1,069
Eliminations ............... -- (81) -- (1,379)
------ ---- ---- -------
Consolidated ............... $3,674 $ -- $271 $ 7,217
====== ==== ==== =======
- ----------
(1) Sales to Texas Genco for the three and six months ended June 30, 2004 of
$10 million and $16 million, respectively, have been reclassified from
sales to affiliates to revenues from external customers due to the sale of
Texas Genco by CenterPoint Energy.
(2) Sales to Texas Genco for the three and six months ended June 30, 2004 of $1
million and $2 million, respectively, have been reclassified from sales to
affiliates to revenues from external customers due to the sale of Texas
Genco by CenterPoint Energy.
14
(11) EMPLOYEE BENEFIT PLANS
The Company's employees participate in CenterPoint Energy's postretirement
benefit plan. The Company's net periodic cost includes the following components
relating to postretirement benefits:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2004 2005 2004 2005
---- ---- ---- ----
(IN MILLIONS)
Service cost..................... $ 1 $ 1 $ 1 $ 1
Interest cost.................... 3 2 5 4
Expected return on plan assets... (1) (1) (1) (1)
Net amortization................. -- -- 1 1
Other ........................... -- -- 1 --
--- ---- --- ---
Net periodic cost............. $ 3 $ 2 $ 7 $ 5
=== ==== === ===
The Company previously disclosed in its financial statements for the year
ended December 31, 2004, that it expected to contribute $16 million to its
postretirement benefits plan in 2005. As of June 30, 2005, $5 million has been
contributed.
(12) RESTATEMENT
Subsequent to the issuance of its condensed consolidated financial
statements for the three- and six- month periods ended June 30, 2004 and 2005,
the Company determined that, during 2004 and 2005, certain transactions
involving purchases and sales of natural gas among divisions within the
Company's Natural Gas Distribution segment were not properly eliminated in the
Company's consolidated financial statements. Consequently, revenues and natural
gas expenses for the three and six months ended June 30, 2004 were each
overstated by approximately $107 million and $233 million, respectively. For the
three and six months ended June 30, 2005, revenues and natural gas expenses were
each overstated by approximately $90 million and $257 million, respectively, for
the same reason. As a result, the accompanying condensed consolidated financial
statements have been restated from the amounts previously reported to reflect
the elimination of interdivision purchases and sales of natural gas. There was
no effect on the Company's previously reported operating income, net income or
net cash flows for the three and six months ended June 30, 2004 and 2005.
A summary of the significant effects of the restatement is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2004
--------------------------- ---------------------------
AS PREVIOUSLY AS PREVIOUSLY
AS RESTATED REPORTED AS RESTATED REPORTED
----------- ------------- ----------- -------------
(IN MILLIONS)
STATEMENTS OF CONSOLIDATED INCOME:
Revenues.............................. $1,217 $1,324 $3,287 $3,520
Expenses: Natural gas................. 904 1,011 2,540 2,773
Total Expenses........................ 1,153 1,260 3,063 3,296
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2005 JUNE 30, 2005
--------------------------- ---------------------------
AS PREVIOUSLY AS PREVIOUSLY
AS RESTATED REPORTED AS RESTATED REPORTED
----------- ------------- ----------- -------------
(IN MILLIONS)
STATEMENTS OF CONSOLIDATED INCOME:
Revenues.............................. $1,426 $1,516 $3,674 $3,931
Expenses: Natural gas................. 1,103 1,193 2,884 3,141
Total Expenses........................ 1,357 1,447 3,403 3,660
15
AS OF JUNE 30, 2005
---------------------------
AS PREVIOUSLY
AS RESTATED REPORTED
----------- -------------
(IN MILLIONS)
CONSOLIDATED BALANCE SHEETS:
Accounts receivable, net...................... $ 325 $ 376
Total current assets.......................... 1,345 1,395
Total assets.................................. 7,217 7,267
Accounts payable.............................. 439 489
Total current liabilities..................... 1,251 1,301
Total liabilities and stockholder's equity.... 7,217 7,267
16
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS
The following narrative analysis should be read in combination with our
Interim Financial Statements contained in this Form 10-Q/A.
RESTATEMENT
The following management narrative analysis gives effect to the restatement
discussed in Note 12 to our unaudited condensed consolidated financial
statements.
We are an indirect wholly owned subsidiary of CenterPoint Energy, Inc.
(CenterPoint Energy), a public utility holding company created on August 31,
2002, as part of a corporate restructuring of Reliant Energy, Incorporated
(Reliant Energy). CenterPoint Energy is a registered public utility holding
company under the Public Utility Holding Company Act of 1935, as amended (1935
Act). For information about the 1935 Act, please read " -- Liquidity -- Certain
Contractual and Regulatory Limits on Our Ability to Issue Securities, Borrow
Money and Pay Dividends."
The following discussion explains material changes in our revenue and
expense items between the three and six months ended June 30, 2004 and the three
and six months ended June 30, 2005. Reference is made to "Management's Narrative
Analysis of the Results of Operations" in Item 7 of the Annual Report on Form
10-K of CERC Corp. for the year ended December 31, 2004 filed on March 24, 2005
(CERC Corp. Form 10-K), as amended by Amendment No. 1 thereto filed on August
29, 2005 and by Amendment No. 2 thereto filed on January 10, 2006 (CERC Corp.
Form 10-K/A).
REPEAL OF THE PUBLIC UTILITY HOLDING COMPANY ACT OF 1935
On August 8, 2005, President Bush signed the Energy Policy Act of 2005
(Energy Act), which, among other things, repeals the 1935 Act six months after
the enactment of the Energy Act. After the effective date of repeal, CenterPoint
Energy and its subsidiaries, including us, will no longer be subject to
restrictions imposed under the 1935 Act. Until the repeal is effective,
CenterPoint Energy and its subsidiaries remain subject to the provisions of the
1935 Act and the terms of orders issued by the Securities and Exchange
Commission (SEC) under the 1935 Act. The Energy Act transfers to the Federal
Energy Regulatory Commission (FERC) certain functions performed by the SEC under
the 1935 Act, including the requirement that holding companies and their
subsidiaries maintain certain books and records and make them available for
review by FERC and, through FERC, to state regulatory authorities. The Energy
Act requires FERC to issue regulations to implement its jurisdiction under the
Energy Act. It is presently unknown what, if any, specific obligations under
those rules may be imposed on us as result of that rulemaking.
CONSOLIDATED RESULTS OF OPERATIONS
Our results of operations are affected by, among other things, seasonal
fluctuations in the demand for natural gas and price movements of energy
commodities, the actions of various federal, state and municipal governmental
authorities having jurisdiction over rates we charge, competition in our various
business operations, debt service costs and income tax expense. For more
information regarding factors that may affect the future results of operations
of our business, please read "Risk Factors" beginning on page 25 in Item 5 of
Part II of our Quarterly Report on Form 10-Q for the period ended June 30, 2005
filed on August 11, 2005 and "Management's Narrative Analysis of the Results of
Operations -- Certain Factors Affecting Future Earnings" in Item 7 of the CERC
Corp. Form 10-K, which is incorporated herein by reference.
The following table sets forth our consolidated results of operations for
the three and six months ended June 30, 2004 and 2005, followed by a discussion
of our consolidated results of operations based on operating income. We have
provided a reconciliation of consolidated operating income to net income below.
17
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2004 2005 2004 2005
------ ------ ------ ------
(IN MILLIONS)
Revenues ............................ $1,217 $1,426 $3,287 $3,674
------ ------ ------ ------
Expenses:
Natural gas ...................... 904 1,103 2,540 2,884
Operation and maintenance ........ 170 171 352 344
Depreciation and amortization .... 45 50 92 99
Taxes other than income taxes .... 34 33 79 76
------ ------ ------ ------
Total Expenses ................ 1,153 1,357 3,063 3,403
------ ------ ------ ------
Operating Income .................... 64 69 224 271
Interest and Other Finance Charges .. (47) (52) (89) (97)
Other Income, net ................... 3 8 6 12
------ ------ ------ ------
Income Before Income Taxes .......... 20 25 141 186
Income Tax (Expense) Benefit ........ (9) 2 (56) (63)
------ ------ ------ ------
Net Income .......................... $ 11 $ 27 $ 85 $ 123
====== ====== ====== ======
THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 30, 2004
We reported net income of $27 million for the three months ended June 30,
2005 as compared to $11 million for the same period in 2004. The increase in net
income of $16 million was primarily due to increased operating income of $10
million in our Pipelines and Gathering business segment and a $11 million
decrease in income tax expense due to a favorable tax audit adjustment and lower
state income taxes offset by a decrease in operating income in our Natural Gas
Distribution business segment of $4 million.
SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
We reported net income of $123 million for the six months ended June 30,
2005 as compared to $85 million for the same period in 2004. The increase in net
income of $38 million was primarily due to increased operating income of $29
million in our Pipelines and Gathering business segment and increased operating
income of $18 million in our Natural Gas Distribution business segment. This
increase was partially offset by increased income tax expense of $7 million due
to higher pre-tax income which was reduced by a favorable tax audit adjustment
recorded in the second quarter of 2005.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The following table presents operating income for our Natural Gas
Distribution and Pipelines and Gathering business segments for the three and six
months ended June 30, 2004 and 2005. Some amounts from the previous year have
been reclassified to conform to the 2005 presentation of the financial
statements. These reclassifications do not affect consolidated net income. For
information regarding factors that may affect the future results of operations
of our business segments, please read "Risk Factors -- Principal Risk Factors
Associated with Our Businesses," "-- Risk Factors Associated with Our
Consolidated Financial Condition" and "-- Other Risks" beginning on page 25 in
Item 5 of Part II of our Quarterly Report on Form 10-Q for the period ended June
30, 2005 filed on August 11, 2005.
18
NATURAL GAS DISTRIBUTION
The following table provides summary data of our Natural Gas Distribution
business segment for the three and six months ended June 30, 2004 and 2005:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2004 2005 2004 2005
---------- ------------ ---------- ----------
(IN MILLIONS, EXCEPT CUSTOMER DATA)
Revenues ................................... $ 1,138 $ 1,340 $ 3,143 $ 3,503
---------- ---------- ---------- ----------
Expenses:
Natural gas ............................. 920 1,123 2,583 2,931
Operation and maintenance ............... 133 133 283 273
Depreciation and amortization ........... 35 39 70 77
Taxes other than income taxes ........... 27 26 67 64
---------- ---------- ---------- ----------
Total expenses ....................... 1,115 1,321 3,003 3,345
---------- ---------- ---------- ----------
Operating Income ........................... $ 23 $ 19 $ 140 $ 158
========== ========== ========== ==========
Throughput (in billion cubic feet (Bcf)):
Residential ............................. 21 21 106 98
Commercial and industrial ............... 49 43 132 120
Non-rate regulated ...................... 167 148 306 331
Elimination (1) ......................... (63) (29) (73) (78)
---------- ---------- ---------- ----------
Total Throughput ..................... 174 183 471 471
========== ========== ========== ==========
Average number of customers:
Residential ............................. 2,793,297 2,833,773 2,802,379 2,842,645
Commercial and industrial ............... 242,111 246,032 244,388 247,429
Non-rate regulated ...................... 6,265 6,533 6,228 6,522
---------- ---------- ---------- ----------
Total ................................ 3,041,673 3,086,338 3,052,995 3,096,596
========== ========== ========== ==========
- ----------
(1) Elimination of intrasegment sales.
THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 30, 2004
Our Natural Gas Distribution business segment reported operating income of
$19 million for the three months ended June 30, 2005 as compared to $23 million
for the same period in 2004. Increases in operating income from rate increases
($5 million) and increased contributions from our competitive natural gas sales
business ($1 million) were more than offset by the impact of decreased
throughput net of continued customer growth with the addition of approximately
47,000 customers since June 2004 ($5 million) and increased depreciation expense
primarily due to higher plant balances ($4 million). Decreases in operation and
maintenance expenses primarily from lower employee benefit expenses ($7 million)
and the capitalization of previously incurred restructuring expenses as allowed
by a recent regulatory order from the Railroad Commission of Texas ($4 million)
offset other expense increases ($11 million).
SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
Our Natural Gas Distribution business segment reported operating income of
$158 million for the six months ended June 30, 2005 as compared to $140 million
for the same period in 2004. Increases in operating income from rate increases
($16 million) and increased contributions from our competitive natural gas sales
business ($4 million) were partially offset by the impact of milder weather and
decreased throughput net of continued customer growth with the addition of
approximately 47,000 customers since June 2004 ($10 million). Operation and
maintenance expense decreased $10 million. Excluding an $8 million charge
recorded in the first quarter of 2004 for severance costs associated with staff
reductions, which has reduced costs in later periods, operation and maintenance
expenses decreased by $2 million primarily due to lower employee benefit
expenses ($11 million) and the capitalization of previously incurred
restructuring expenses as discussed above ($4 million), which more than offset
other expense
19
increases ($13 million). These net increases to operating income were partially
offset by increased depreciation expense primarily due to higher plant balances
($7 million).
PIPELINES AND GATHERING
The following table provides summary data of our Pipelines and Gathering
business segment for the three and six months ended June 30, 2004 and 2005:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- -------------------------
2004 2005 2004 2005
---- ---- ---- ----
(IN MILLIONS)
Revenues .......................... $113 $125 $216 $246
---- ---- ---- ----
Expenses:
Natural gas .................... 18 18 28 25
Operation and maintenance ...... 37 40 70 74
Depreciation and amortization .. 11 11 22 22
Taxes other than income taxes .. 5 4 9 9
---- ---- ---- ----
Total expenses .............. 71 73 129 130
---- ---- ---- ----
Operating Income .................. $ 42 $ 52 $ 87 $116
==== ==== ==== ====
Throughput (in Bcf):
Natural Gas Sales .............. 4 3 7 4
Transportation ................. 207 230 477 501
Gathering ...................... 79 87 154 170
Elimination (1) ................ (3) (2) (5) (3)
---- ---- ---- ----
Total Throughput ............ 287 318 633 672
==== ==== ==== ====
- ----------
(1) Elimination of volumes both transported and sold.
THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 30, 2004
Our Pipelines and Gathering business segment reported operating income of
$52 million for the three months ended June 30, 2005 compared to $42 million for
the same period in 2004. Operating margins (revenues less natural gas costs)
increased by $12 million primarily due to increased demand for certain
transportation and ancillary services ($7 million) and increased throughput and
demand for services related to our core gas gathering operations ($9 million).
SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
Our Pipelines and Gathering business segment reported operating income of
$116 million for the six months ended June 30, 2005 compared to $87 million for
the same period in 2004. Operating margins (revenues less natural gas costs)
increased by $33 million primarily due to increased demand for certain
transportation and ancillary services ($18 million) and increased throughput and
demand for services related to our core gas gathering operations ($14 million).
Additionally, operation and maintenance expenses increased by $4 million
primarily due to increased pipeline integrity compliance expenses.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Management's Narrative Analysis of
Results of Operations -- Certain Factors Affecting Future Earnings" in Item 7 of
Part II of the CERC Corp. Form 10-K, which is incorporated herein by
reference, and "Risk Factors" beginning on page 25 in Item 5 of Part II of our
Quarterly Report on Form 10-Q for the period ended June 30, 2005 filed on August
11, 2005.
20
LIQUIDITY
Our liquidity and capital requirements are affected primarily by our
results of operations, capital expenditures, debt service requirements, and
working capital needs. Our principal cash requirements for the last six months
of 2005 are approximately $276 million of capital expenditures and $325 million
principal amount of senior notes which were repaid in July 2005. We expect that
borrowings under our credit facility, anticipated cash flows from operations and
borrowings from affiliates under the money pool described below will be
sufficient to meet our cash needs for 2005. Cash needs may also be met by
issuing securities in the capital markets.
The 1935 Act currently regulates our financing ability, as more fully
described in "--Certain Contractual and Regulatory Limits on Our Ability to
Issue Securities, Borrow Money and Pay Dividends" below.
Off-Balance Sheet Arrangements. Other than operating leases, we have no
off-balance sheet arrangements. However, we do participate in a receivables
factoring arrangement. We have a bankruptcy remote subsidiary, which we
consolidate, which was formed for the sole purpose of buying receivables created
by us and selling those receivables to an unrelated third-party. This
transaction is accounted for as a sale of receivables under the provisions of
SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," and, as a result, the related receivables are
excluded from the Consolidated Balance Sheet. In January 2005, the $250 million
facility was extended to January 2006 and temporarily increased, for the period
from January 2005 to June 2005, to $375 million. As of June 30, 2005, we had
$181 million of advances under our receivables facility.
Credit Facilities. In June 2005, we replaced our $250 million three-year
revolving credit facility with a $400 million five-year revolving credit
facility. The new credit facility terminates on June 30, 2010. Borrowings under
this facility may be made at the London interbank offered rate (LIBOR) plus 55
basis points, including the facility fee, based on current credit ratings. An
additional utilization fee of 10 basis points applies to borrowings whenever
more than 50% of the facility is utilized. Changes in credit ratings could lower
or raise the increment to LIBOR depending on whether ratings improved or were
lowered.
Our $400 million credit facility contains covenants, including a total debt
to capitalization covenant of 65% and an earnings before interest, taxes,
depreciation and amortization (EBITDA) to interest covenant. Borrowings under
our $400 million credit facility are available notwithstanding that a material
adverse change has occurred or litigation that could be expected to have a
material adverse effect has occurred, so long as other customary terms and
conditions are satisfied.
As of August 1, 2005, our $400 million credit facility was not utilized.
Securities Registered with the SEC. At June 30, 2005, we had a shelf
registration statement covering $50 million of debt securities.
Temporary Investments. On June 30, 2005, we had temporary investments with
unrelated parties of $366 million. Our temporary external investments were
reduced by $325 million in July 2005 when the proceeds from the liquidation of
such investments were used to pay our maturing debt. As of August 1, 2005, we
had temporary investments in a money market fund of $9 million. Such investments
may be utilized to meet our cash flow needs.
Money Pool. We participate in a "money pool" through which we and certain
of our affiliates can borrow or invest on a short-term basis. Funding needs are
aggregated and external borrowing or investing is based on the net cash
position. The money pool's net funding requirements are generally met by
borrowings of CenterPoint Energy. The terms of the money pool are in accordance
with requirements currently applicable to registered public utility holding
companies under the 1935 Act and under an order from the SEC relating to our
financing activities dated June 29, 2005 (June 2005 Financing Order). Our money
pool borrowing limit under the existing order is $600 million. At August 1,
2005, we had $122 million invested in the money pool. The money pool may not
provide sufficient funds to meet our cash needs.
Impact on Liquidity of a Downgrade in Credit Ratings. On July 22, 2005,
Moody's upgraded our ratings, including our senior unsecured debt to Baa3 from
Bal. These rating actions concluded the review for possible upgrade that was
initiated on March 24, 2005.
21
As of August 1, 2005, Moody's Investors Service, Inc. (Moody's), Standard &
Poor's Ratings Services, a division of The McGraw Hill Companies (S&P) and
Fitch, Inc. (Fitch) had assigned the following credit ratings to our senior
unsecured debt:
MOODY'S S&P FITCH
- ------------------- ------------------- -------------------
RATING OUTLOOK(1) RATING OUTLOOK(2) RATING OUTLOOK(3)
- ------ ---------- ------ ---------- ------ ----------
Baa3 Stable BBB Negative BBB Stable
- ----------
(1) A "stable" outlook from Moody's indicates that Moody's does not expect to
put the rating on review for an upgrade or downgrade within 18 months from
when the outlook was assigned or last affirmed.
(2) An S&P rating outlook assesses the potential direction of a long-term
credit rating over the intermediate to longer term.
(3) A "stable" outlook from Fitch encompasses a one-to-two year horizon as to
the likely ratings direction.
We cannot assure you that these ratings will remain in effect for any given
period of time or that one or more of these ratings will not be lowered or
withdrawn entirely by a rating agency. We note that these credit ratings are not
recommendations to buy, sell or hold our securities and may be revised or
withdrawn at any time by the rating agency. Each rating should be evaluated
independently of any other rating. Any future reduction or withdrawal of one or
more of our credit ratings could have a material adverse impact on our ability
to obtain short- and long-term financing, the cost of such financings, the
willingness of suppliers to extend credit lines to us on an unsecured basis and
the execution of our commercial strategies.
A decline in credit ratings could increase borrowing costs under our $400
million revolving credit facility. A decline in credit ratings would also
increase the interest rate on long-term debt to be issued in the capital markets
and would negatively impact our ability to complete capital market transactions
as more fully described in " -- Certain Contractual and Regulatory Limits on Our
Ability to Issue Securities, Borrow Money and Pay Dividends" below.
Additionally, a decline in credit ratings could increase cash collateral
requirements and reduce margins of our Natural Gas Distribution business
segment.
As described above under "-- Credit Facilities," our $400 million credit
facility does not contain a material adverse change clause with respect to
borrowings.
CenterPoint Energy Services, Inc. (formerly CenterPoint Energy Gas
Services, Inc.) (CES), one of our wholly owned subsidiaries, provides
comprehensive natural gas sales and services to industrial and commercial
customers, electric generators and natural gas utilities throughout the central
United States. In order to hedge its exposure to natural gas prices, CES has
agreements with provisions standard for the industry that establish credit
thresholds and require a party to provide additional collateral on two business
days' notice when that party's rating or the rating of a credit support provider
for that party (CERC Corp. in this case) falls below those levels. We estimate
that as of June 30, 2005, unsecured credit limits extended to CES by
counterparties could aggregate $105 million; however, utilized credit capacity
is significantly lower. In addition, we purchase natural gas under supply
agreements that contain an aggregate credit threshold of $100 million based on
our S&P Senior Unsecured Long-Term Debt rating of BBB. Upgrades and downgrades
from this BBB rating will increase and decrease the aggregate credit threshold
accordingly.
Cross Defaults. Under CenterPoint Energy's revolving credit facility, a
payment default on, or a non-payment default that permits acceleration of, any
indebtedness exceeding $50 million by us will cause a default. Pursuant to the
indenture governing CenterPoint Energy's senior notes, a payment default by us,
in respect of, or an acceleration of, borrowed money and certain other specified
types of obligations, in the aggregate principal amount of $50 million will
cause a default. As of August 1, 2005, CenterPoint Energy had issued five series
of senior notes aggregating $1.4 billion in principal amount under this
indenture. A default by CenterPoint Energy would not trigger a default under our
debt instruments or bank credit facilities.
Other Factors that Could Affect Cash Requirements. In addition to the above
factors, our liquidity and capital resources could be affected by:
22
- cash collateral requirements that could exist in connection with
certain contracts, including gas purchases, gas price hedging and gas
storage activities of our Natural Gas Distribution business segment,
particularly given gas price levels and volatility;
- acceleration of payment dates on certain gas supply contracts under
certain circumstances, as a result of increased gas prices and
concentration of suppliers;
- increased costs related to the acquisition of gas for storage;
- increases in interest expense in connection with debt refinancings and
borrowings under our credit facility;
- various regulatory actions; and
- various of the risks identified in "Risk Factors" beginning on page 25
in Item 5 of Part II of our Quarterly Report on Form 10-Q for the
period ended June 30, 2005 filed on August 11, 2005.
Certain Contractual and Regulatory Limits on Our Ability to Issue
Securities, Borrow Money and Pay Dividends. Our bank facility and our
receivables facility limit our debt as a percentage of our total capitalization
to 65% and 60%, respectively, and contain an EBITDA to interest covenant.
Our parent, CenterPoint Energy, is a registered public utility holding
company under the 1935 Act. The 1935 Act and related rules and regulations
impose a number of restrictions on our parent's activities and those of its
subsidiaries, including us. The 1935 Act, among other things, limits our
parent's ability and the ability of its regulated subsidiaries, including us, to
issue debt and equity securities without prior authorization, restricts the
source of dividend payments to current and retained earnings without prior
authorization, regulates sales and acquisitions of certain assets and businesses
and governs affiliated service, sales and construction contracts. On August 8,
2005, President Bush signed the Energy Act, which, among other things, repeals
the 1935 Act six months after the enactment of the Energy Act. After the
effective date of repeal, CenterPoint Energy and its subsidiaries, including us,
will no longer be subject to restrictions imposed under the 1935 Act. Until the
repeal is effective, CenterPoint Energy and its subsidiaries remain subject to
the provisions of the 1935 Act and the terms of orders issued by the SEC under
the 1935 Act. The Energy Act transfers to the FERC certain functions performed
by the SEC under the 1935 Act, including the requirement that holding companies
and their subsidiaries maintain certain books and records and make them
available for review by FERC and, through FERC, to state regulatory authorities.
The Energy Act requires FERC to issue regulations to implement its jurisdiction
under the Energy Act. It is presently unknown what, if any, specific obligations
under those rules may be imposed on us as result of that rulemaking.
The June 2005 Financing Order establishes limits on the amount of external
debt and equity securities that can be issued by CenterPoint Energy and its
regulated subsidiaries, including us, without additional authorization but
generally permits CenterPoint Energy to refinance its existing obligations and
those of its regulated subsidiaries, including us. We are in compliance with the
authorized limits. The order also generally permits utilization of our undrawn
credit facilities. Unless we obtain a further order from the SEC, as of July 31,
2005, we are authorized to issue an additional $367 million of debt or preferred
securities.
In the June 2005 Financing Order, the SEC "reserved jurisdiction" over a
number of matters, meaning that an order will be required from the SEC before we
may conduct those activities. However, an order regarding the activities over
which the SEC has reserved jurisdiction generally can be issued by the SEC more
quickly than orders on other matters, although there is no assurance that a
release of jurisdiction will be granted on a given matter or the terms under
which such an order may be issued. In the June 2005 Financing Order, the SEC
reserved jurisdiction over all authority otherwise granted if the common equity
level of CenterPoint Energy falls below its level as of March 31, 2005 (11.4%
net of securitization debt) or if the common equity ratio of either us or
CenterPoint Energy Houston Electric, LLC, another wholly owned subsidiary of
CenterPoint Energy, falls below 30%. Among the other transactions over which the
SEC reserved jurisdiction are: (i) issuance of securities by CenterPoint Energy
or any of its subsidiaries, including us, unless our and the issuer's other
securities which are rated have an investment grade rating from at least one
nationally recognized statistical rating organization, (ii) further investment
in inactive subsidiaries and (iii) payment of dividends by us from capital or
unearned surplus. The June 2005 Financing Order also contains certain
requirements for interest rates, maturities, issuance expenses and use of
proceeds in connection
23
with securities issued by us or any of our subsidiaries. So long as the common
equity of CenterPoint Energy is less than 30% of its capitalization, the SEC
also reserved jurisdiction over the use of proceeds from authorized financings
for the acquisition of additional energy-related or gas-related companies.
Finally, the SEC reserved jurisdiction over the issuance of $500 million in
incremental debt and preferred securities by us. The total authorized amount of
debt and preferred securities that could be outstanding during the authorization
period, including the amounts over which the SEC has reserved jurisdiction and
undrawn amounts under our revolving credit facility is $3.256 billion. The
foregoing and the following restrictions contained in the June 2005 Financing
Order, along with other restrictions contained in that order, will cease to
apply to us on the effective date of repeal of the 1935 Act.
The 1935 Act limits the payment of dividends to payment from current and
retained earnings unless specific authorization is obtained to pay dividends
from other sources. The June 2005 Financing Order also requires that we maintain
a ratio of common equity to total capitalization of 30%. At June 30, 2005, our
ratio was 53%.
Relationship with CenterPoint Energy. We are an indirect wholly owned
subsidiary of CenterPoint Energy. As a result of this relationship, the
financial condition and liquidity of our parent company could affect our access
to capital, our credit standing and our financial condition.
CRITICAL ACCOUNTING POLICIES
A critical accounting policy is one that is both important to the
presentation of our financial condition and results of operations and requires
management to make difficult, subjective or complex accounting estimates. An
accounting estimate is an approximation made by management of a financial
statement element, item or account in the financial statements. Accounting
estimates in our historical consolidated financial statements measure the
effects of past business transactions or events, or the present status of an
asset or liability. The accounting estimates described below require us to make
assumptions about matters that are highly uncertain at the time the estimate is
made. Additionally, different estimates that we could have used or changes in an
accounting estimate that are reasonably likely to occur could have a material
impact on the presentation of our financial condition or results of operations.
The circumstances that make these judgments difficult, subjective and/or complex
have to do with the need to make estimates about the effect of matters that are
inherently uncertain. Estimates and assumptions about future events and their
effects cannot be predicted with certainty. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments. These estimates may change as new events occur, as more experience is
acquired, as additional information is obtained and as our operating environment
changes. Our significant accounting policies are discussed in Note 2 to the
consolidated financial statements in the CERC Corp. Form 10-K. We believe the
following accounting policies involve the application of critical accounting
estimates. Accordingly, these accounting estimates have been reviewed and
discussed with the audit committee of the board of directors of CenterPoint
Energy.
IMPAIRMENT OF LONG-LIVED ASSETS AND INTANGIBLES
We review the carrying value of our long-lived assets, including goodwill
and identifiable intangibles, whenever events or changes in circumstances
indicate that such carrying values may not be recoverable, and at least annually
for goodwill as required by SFAS No. 142, "Goodwill and Other Intangible
Assets." No impairment of goodwill was indicated based on our analysis as of
January 1, 2005. Unforeseen events and changes in circumstances and market
conditions and material differences in the value of long-lived assets and
intangibles due to changes in estimates of future cash flows, regulatory matters
and operating costs could negatively affect the fair value of our assets and
result in an impairment charge.
Fair value is the amount at which the asset could be bought or sold in a
current transaction between willing parties and may be estimated using a number
of techniques, including quoted market prices or valuations by third parties,
present value techniques based on estimates of cash flows, or multiples of
earnings or revenue performance measures. The fair value of the asset could be
different using different estimates and assumptions in these valuation
techniques.
24
UNBILLED REVENUES
Revenues related to the sale and/or delivery of natural gas are generally
recorded when natural gas is delivered to customers. However, the determination
of sales to individual customers is based on the reading of their meters, which
is performed on a systematic basis throughout the month. At the end of each
month, amounts of natural gas delivered to customers since the date of the last
meter reading are estimated and the corresponding unbilled revenue is estimated.
Unbilled natural gas sales are estimated based on estimated purchased gas
volumes, estimated lost and unaccounted for gas and tariffed rates in effect. As
additional information becomes available, or actual amounts are determinable,
the recorded estimates are revised. Consequently, operating results can be
affected by revisions to prior accounting estimates.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 2 to the Interim Financial Statements for a discussion of new
accounting pronouncements that affect us.
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, we have
re-evaluated, under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, the
effectiveness of our disclosure controls and procedures (as such term is defined
in Rule 13(a)-15(e) under the Securities Exchange Act of 1934, as amended) as of
the end of the period covered by this report. Based on that evaluation, our
principal executive officer and principal financial officer concluded that,
solely because of the material weakness in internal control over financial
reporting described below, our disclosure controls and procedures were not
effective as of June 30, 2005. This conclusion is different than the conclusion
disclosed in the original filing of our Quarterly Report on Form 10-Q for the
period ended June 30, 2005 in which management concluded that our disclosure
controls and procedures were effective. As a result of the material weakness
described below, which was identified subsequent to the original filing of our
Quarterly Report on Form 10-Q for the period ended June 30, 2005, management has
re-evaluated the effectiveness of our disclosure controls and procedures.
We determined that, during 2004 and 2005, certain transactions involving
purchases and sales of natural gas among divisions within our Natural Gas
Distribution segment were not properly eliminated in the consolidated financial
statements. Consequently, revenues and natural gas expenses during the three and
six months ended June 30, 2004 were each overstated by approximately $107
million and $233 million, respectively. For the three and six months ended June
30, 2005, revenues and natural gas expenses were each overstated by
approximately $90 million and $257 million, respectively, for the same reason
and management concluded that a restatement of the consolidated financial
statements for the three and six months ended June 30, 2004 and 2005 was
necessary to correct this error. Subsequent to the period covered by this
report, in connection with the discovery of the error described above and the
conclusion that we had a material weakness in our internal control over
financial reporting related to ineffective controls over the process of
eliminating certain interdivision purchases and sales of natural gas within our
Natural Gas Distribution segment in the consolidation process, we improved
procedures related to the recording and reporting of purchases and sales of
natural gas, including increased review and approval controls by senior
financial personnel over the personnel that will prepare the accruals and
enhanced analysis of the recorded activity, including ensuring that intercompany
activity is properly eliminated in consolidation.
There has been no change in our internal control over financial reporting
that occurred during the three months ended June 30, 2005 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. However, subsequent to the date of filing our original
Quarterly Report on Form 10-Q for the period ended June 30, 2005, we took the
remedial action described above.
25
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
The following exhibits are filed herewith:
Exhibits included with this report are designated by a cross (+); exhibits
previously filed with our Quarterly Report on Form 10-Q for the period ended
June 30, 2005 as filed on August 11, 2005 are designated by two crosses (++);
all exhibits not so designated are incorporated by reference to a prior filing
of CenterPoint Energy Resources Corp.
REPORT OR SEC FILE OR
EXHIBIT REGISTRATION REGISTRATION EXHIBIT
NUMBER DESCRIPTION STATEMENT NUMBER REFERENCE
- ------- ----------- ------------ ------------ ---------
3.1.1 - Certificate of Incorporation of RERC Form 10-K for the year ended 1-13265 3(a)(1)
Corp. December 31, 1997
3.1.2 - Certificate of Merger merging former Form 10-K for the year ended 1-13265 3(a)(2)
NorAm Energy Corp. with and into HI December 31, 1997
Merger, Inc. dated August 6, 1997
3.1.3 - Certificate of Amendment changing the Form 10-K for the year ended 1-13265 3(a)(3)
name to Reliant Energy Resources Corp. December 31, 1998
3.1.4 - Certificate of Amendment changing the Form 10-Q for the quarter ended 1-13265 3(a)(4)
name to CenterPoint Energy Resources June 30, 2003
Corp.
3.2 - Bylaws of RERC Corp. Form 10-K for the year ended 1-13265 3(b)
December 31, 1997
4.1 - $400,000,000 Credit Agreement, dated as Form 8-K dated June 29, 2005 1-13265 4.1
of June 30, 2005, among CERC Corp., as
Borrower, and the Initial Lenders named
therein, as Initial Lenders
+31.1 - Rule 13a-14(a)/15d-14(a) Certification of
David M. McClanahan
+31.2 - Rule 13a-14(a)/15d-14(a) Certification of
Gary L. Whitlock
+32.1 - Section 1350 Certification of David M.
McClanahan
+32.2 - Section 1350 Certification of Gary L.
Whitlock
++99.1 - Items incorporated by reference from the
CERC Corp. Form 10-K. Item 1 "Business --
Regulation" and "-- Environmental
Matters," Item 3 "Legal Proceedings" and
Item 7 "Management's Narrative Analysis
of the Results of Operations -- Certain
Factors Affecting Future Earnings" and
Notes 2(e) (Regulatory Assets and
Liabilities), 3 (Regulatory Matters), 5
(Derivative Instruments), 9 (Commitments
and Contingencies) and 12 (Reportable
Business Segments).
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CENTERPOINT ENERGY RESOURCES CORP.
By: /s/ James S. Brian
------------------------------------
James S. Brian
Senior Vice President and Chief
Accounting Officer
Date: January 10, 2006
27
EXHIBIT INDEX
Exhibits included with this report are designated by a cross (+); exhibits
previously filed with our Quarterly Report on Form 10-Q for the period ended
June 30, 2005 as filed on August 11, 2005 are designated by two crosses (++);
all exhibits not so designated are incorporated by reference to a prior filing
of CenterPoint Energy Resources Corp.
REPORT OR SEC FILE OR
EXHIBIT REGISTRATION REGISTRATION EXHIBIT
NUMBER DESCRIPTION STATEMENT NUMBER REFERENCE
- ------- ----------- ------------ ------------ ---------
3.1.1 - Certificate of Incorporation of RERC Form 10-K for the year ended 1-13265 3(a)(1)
Corp. December 31, 1997
3.1.2 - Certificate of Merger merging former Form 10-K for the year ended 1-13265 3(a)(2)
NorAm Energy Corp. with and into HI December 31, 1997
Merger, Inc. dated August 6, 1997
3.1.3 - Certificate of Amendment changing the Form 10-K for the year ended 1-13265 3(a)(3)
name to Reliant Energy Resources Corp. December 31, 1998
3.1.4 - Certificate of Amendment changing the Form 10-Q for the quarter ended 1-13265 3(a)(4)
name to CenterPoint Energy Resources June 30, 2003
Corp.
3.2 - Bylaws of RERC Corp. Form 10-K for the year ended 1-13265 3(b)
December 31, 1997
4.1 - $400,000,000 Credit Agreement, dated as Form 8-K dated June 29, 2005 1-13265 4.1
of June 30, 2005, among CERC Corp., as
Borrower, and the Initial Lenders named
therein, as Initial Lenders
+31.1 - Rule 13a-14(a)/15d-14(a) Certification of
David M. McClanahan
+31.2 - Rule 13a-14(a)/15d-14(a) Certification of
Gary L. Whitlock
+32.1 - Section 1350 Certification of David M.
McClanahan
+32.2 - Section 1350 Certification of Gary L.
Whitlock
++99.1 - Items incorporated by reference from the
CERC Corp. Form 10-K. Item 1 "Business --
Regulation" and "-- Environmental
Matters," Item 3 "Legal Proceedings" and
Item 7 "Management's Narrative Analysis
of the Results of Operations -- Certain
Factors Affecting Future Earnings" and
Notes 2(e) (Regulatory Assets and
Liabilities), 3 (Regulatory Matters), 5
(Derivative Instruments), 9 (Commitments
and Contingencies) and 12 (Reportable
Business Segments).