UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
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 1-3187
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC
(Exact name of registrant as specified in its charter)
TEXAS 22-3865106
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1111 LOUISIANA
HOUSTON, TEXAS 77002 (713) 207-1111
(Address and zip code of (Registrant's telephone number,
principal executive offices) including area code)
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CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC 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 a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [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, 2006, all 1,000 common shares of CenterPoint Energy Houston
Electric, LLC were held by Utility Holding, LLC, a wholly owned subsidiary of
CenterPoint Energy, Inc.
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2006
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, 2005 and
2006 (unaudited)........................................ 1
Condensed Consolidated Balance Sheets
December 31, 2005 and June 30, 2006 (unaudited)......... 2
Condensed Statements of Consolidated Cash Flows
Six Months Ended June 30, 2005 and 2006 (unaudited)..... 4
Notes to Unaudited Condensed Consolidated Financial
Statements.............................................. 5
Item 2. Management's Narrative Analysis of the Results of Operations.. 13
Item 4. Controls and Procedures....................................... 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 20
Item 1A. Risk Factors.................................................. 20
Item 5. Other Information............................................. 20
Item 6. Exhibits...................................................... 21
i
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
From time to time we make statements concerning our expectations, beliefs,
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are not historical facts. These
statements are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
from those expressed or implied by these statements. You can generally identify
our forward-looking statements by the words "anticipate," "believe," "continue,"
"could," "estimate," "expect," "forecast," "goal," "intend," "may," "objective,"
"plan," "potential," "predict," "projection," "should," "will," or other similar
words.
We have based our forward-looking statements on our management's beliefs
and assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, we cannot assure you that actual results will
not differ materially from those expressed or implied by our forward-looking
statements.
The following are some of the factors that could cause actual results to
differ materially from those expressed or implied in forward-looking statements:
- the timing and amount of our recovery of the true-up components,
including, in particular, the results of appeals to the courts of
determinations on rulings obtained to date;
- state and federal legislative and regulatory actions or developments,
including deregulation, re-regulation, 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 and appropriate rate actions and increases, allowing recovery
of costs and a reasonable return on investment;
- industrial, commercial and residential growth in our service territory
and changes in market demand and demographic patterns;
- changes in interest rates or rates of inflation;
- weather variations and other natural phenomena;
- commercial bank and financial market conditions, our access to
capital, the cost of such capital, and the results of our financing
and refinancing efforts, including availability of funds in the debt
capital markets;
- actions by rating agencies;
- non-payment for our services due to financial distress of our
customers, including Reliant Energy, Inc. (formerly named Reliant
Resources, Inc.) (RRI);
- the ability of RRI and its subsidiaries to satisfy their obligations
to us, including indemnity obligations;
- the outcome of litigation brought by or against us;
- our ability to control costs;
- the investment performance of CenterPoint Energy, Inc.'s employee
benefit plans;
ii
- 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" in Item 1A of Part I of our
Annual Report on Form 10-K for the year ended December 31, 2005, which
is incorporated herein by reference.
You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement.
iii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(MILLIONS OF DOLLARS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2005 2006 2005 2006
---- ---- ----- ----
REVENUES ........................................... $414 $456 $ 759 $841
---- ---- ----- ----
EXPENSES:
Operation and maintenance ....................... 153 147 292 282
Depreciation and amortization ................... 81 99 156 183
Taxes other than income taxes ................... 58 59 109 115
---- ---- ----- ----
Total ........................................ 292 305 557 580
---- ---- ----- ----
OPERATING INCOME ................................... 122 151 202 261
---- ---- ----- ----
OTHER INCOME (EXPENSE):
Interest and other finance charges .............. (76) (28) (152) (56)
Interest on transition bonds .................... (9) (33) (18) (66)
Return on true-up balance ....................... 35 -- 69 --
Other, net ...................................... 12 17 23 32
---- ---- ----- ----
Total ........................................ (38) (44) (78) (90)
---- ---- ----- ----
INCOME BEFORE INCOME TAXES AND EXTRAORDINARY ITEM .. 84 107 124 171
Income tax expense .............................. (29) (36) (41) (57)
---- ---- ----- ----
INCOME BEFORE EXTRAORDINARY ITEM ................... 55 71 83 114
Extraordinary item, net of tax .................. 30 -- 30 --
---- ---- ----- ----
NET INCOME ......................................... $ 85 $ 71 $ 113 $114
==== ==== ===== ====
See Notes to the Company's Interim Condensed Financial Statements
1
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONDENSED CONSOLIDATED BALANCE SHEETS
(MILLIONS OF DOLLARS)
(UNAUDITED)
ASSETS
DECEMBER 31, JUNE 30,
2005 2006
------------ --------
CURRENT ASSETS:
Cash and cash equivalents ............................. $ 40 $ 103
Accounts and notes receivable, net .................... 150 188
Accounts receivable -- affiliated companies ........... -- 50
Accrued unbilled revenues ............................. 108 126
Materials and supplies ................................ 60 56
Deferred tax asset .................................... 1 --
Other ................................................. 34 38
------- -------
Total current assets ............................... 393 561
------- -------
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment ......................... 6,463 6,616
Less accumulated depreciation and amortization ........ (2,386) (2,473)
------- -------
Property, plant and equipment, net ................. 4,077 4,143
------- -------
OTHER ASSETS:
Other intangibles, net ................................ 38 37
Regulatory assets ..................................... 2,902 2,840
Notes receivable -- affiliated companies .............. 750 750
Other ................................................. 67 50
------- -------
Total other assets ................................. 3,757 3,677
------- -------
TOTAL ASSETS .................................... $ 8,227 $ 8,381
======= =======
See Notes to the Company's Interim Condensed Financial Statements
2
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONDENSED CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
(MILLIONS OF DOLLARS)
(UNAUDITED)
LIABILITIES AND MEMBER'S EQUITY
DECEMBER 31, JUNE 30,
2005 2006
------------ --------
CURRENT LIABILITIES:
Current portion of transition bond long-term
debt ........................................... $ 73 $ 126
Accounts payable .................................. 57 43
Accounts and notes payable -- affiliated
companies ...................................... 79 153
Taxes accrued ..................................... 139 83
Interest accrued .................................. 50 103
Other ............................................. 43 54
------ ------
Total current liabilities ...................... 441 562
------ ------
OTHER LIABILITIES:
Accumulated deferred income taxes, net ............ 1,400 1,351
Unamortized investment tax credits ................ 42 38
Benefit obligations ............................... 139 138
Regulatory liabilities ............................ 294 334
Notes payable -- affiliated companies ............. 151 151
Other ............................................. 44 48
------ ------
Total other liabilities ........................ 2,070 2,060
------ ------
LONG-TERM DEBT:
Transition bonds .................................. 2,407 2,335
Other ............................................. 1,591 1,591
------ ------
Total long-term debt ........................... 3,998 3,926
------ ------
COMMITMENTS AND CONTINGENCIES (NOTE 6)
MEMBER'S EQUITY:
Common stock ...................................... -- --
Paid-in capital ................................... 1,719 1,720
Retained earnings (deficit) ....................... (1) 113
------ ------
Total member's equity .......................... 1,718 1,833
------ ------
TOTAL LIABILITIES AND MEMBER'S EQUITY ....... $8,227 $8,381
====== ======
See Notes to the Company's Interim Condensed Financial Statements
3
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(MILLIONS OF DOLLARS)
(UNAUDITED)
SIX MONTHS
ENDED JUNE 30,
-----------------------
2005 2006
------------ --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ........................................ $ 113 $ 114
Extraordinary item, net of tax .................... (30) --
----- -----
Income before extraordinary item .................. 83 114
Adjustments to reconcile income before
extraordinary item to net cash provided by
operating activities:
Depreciation and amortization .................. 156 183
Amortization of deferred financing costs ....... 16 6
Deferred income taxes .......................... 31 (50)
Investment tax credits ......................... (3) (4)
Changes in other assets and liabilities:
Accounts and notes receivable, net .......... (58) (40)
Accounts receivable/payable, affiliates ..... (25) (40)
Inventory ................................... 3 4
Accounts payable ............................ (7) (6)
Taxes receivable ............................ 50 --
Interest and taxes accrued .................. (43) 58
Net regulatory assets and liabilities ....... (131) 41
Other current assets ........................ 2 3
Other current liabilities ................... (2) 4
Other assets ................................ (12) 7
Other liabilities ........................... 3 4
----- -----
Net cash provided by operating
activities ............................ 63 284
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures .............................. (138) (198)
Decrease in notes receivable from affiliates ...... 73 --
Increase in restricted cash of transition bond
companies ...................................... -- (6)
Other, net ........................................ -- (2)
----- -----
Net cash used in investing activities .... (65) (206)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt ........................ (17) (19)
Increase in notes payable to affiliates ........... 27 64
Debt issuance costs ............................... (2) --
Dividend to parent ................................ -- (61)
Other, net ........................................ -- 1
----- -----
Net cash provided by (used in) financing
activities ............................ 8 (15)
----- -----
NET INCREASE IN CASH AND CASH EQUIVALENTS ............ 6 63
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ..... 25 40
----- -----
CASH AND CASH EQUIVALENTS AT END OF PERIOD ........... $ 31 $ 103
===== =====
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Payments:
Interest, net of capitalized interest ............. $ 154 $ 70
Income taxes ...................................... 79 129
See Notes to the Company's Interim Condensed Financial Statements
4
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC 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 (Form 10-Q) of
CenterPoint Energy Houston Electric, LLC are the condensed consolidated interim
financial statements and notes (Interim Condensed Financial Statements) of
CenterPoint Energy Houston Electric, LLC and its subsidiaries (collectively,
CenterPoint Houston or the Company). The Interim Condensed Financial Statements
are unaudited, omit certain financial statement disclosures and should be read
with the Annual Report on Form 10-K of CenterPoint Houston for the year ended
December 31, 2005 (CenterPoint Houston Form 10-K).
Background. The Company engages in the electric transmission and
distribution business in a 5,000-square mile area of the Texas Gulf Coast that
includes Houston. 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 (Texas electric restructuring law).
CenterPoint Energy was a registered public utility holding company under
the Public Utility Holding Company Act of 1935, as amended (1935 Act). The
Energy Policy Act of 2005 (Energy Act) repealed the 1935 Act effective February
8, 2006, and since that date CenterPoint Energy and its subsidiaries have no
longer been subject to restrictions imposed under the 1935 Act. The Energy Act
includes a new Public Utility Holding Company Act of 2005 (PUHCA 2005) which
grants to the Federal Energy Regulatory Commission (FERC) authority to require
holding companies and their subsidiaries to maintain certain books and records
and make them available for review by the FERC and state regulatory authorities
in certain circumstances. On December 8, 2005, the FERC issued rules
implementing PUHCA 2005. Pursuant to those rules, on June 14, 2006, CenterPoint
Energy filed with the FERC the required notification of its status as a public
utility holding company. On April 24, 2006, the FERC proposed additional rules
regarding maintenance of books and records by utility holding companies and
additional reporting and accounting requirements for centralized service
companies that make allocations to public utilities regulated by the FERC under
the Federal Power Act. Although CenterPoint Energy provides services to its
subsidiaries through a service company, CenterPoint Energy Service Company, LLC,
its service company would not be subject to the service company rules.
Basis of Presentation. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America 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 Condensed Financial Statements reflect all normal
recurring adjustments that are, in the opinion of management, necessary to
present fairly the financial position, results of operations and cash flows 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, (b) timing of maintenance and other
expenditures and (c) acquisitions and dispositions of businesses, assets and
other interests.
(2) NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes - An
Interpretation of FASB Statement No. 109" (FIN 48). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with FASB Statement No. 109, "Accounting for
Income Taxes." FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. The new FASB
interpretation also provides guidance on derecognition, classification, interest
and penalties, accounting in interim periods, disclosure, and transition. The
provisions of FIN 48 are effective for fiscal years beginning after December 15,
2006. The Company expects to adopt FIN 48 in the first quarter of 2007 and is
currently evaluating the impact the adoption will have on the Company's
financial position.
5
(3) REGULATORY MATTERS
(a) Recovery of True-Up Balance.
In March 2004, the Company filed its true-up application with the Public
Utility Commission of Texas (Texas Utility Commission), requesting recovery of
$3.7 billion, excluding interest, as allowed under the Texas electric
restructuring law. In December 2004, the Texas Utility Commission issued its
final order (True-Up Order) allowing the Company to recover a true-up balance of
approximately $2.3 billion, which included interest through August 31, 2004, and
providing for adjustment of the amount to be recovered to include interest on
the balance until recovery, the principal portion of additional excess
mitigation credits returned to customers after August 31, 2004 and certain other
matters. The Company and other parties filed appeals of the True-Up Order to a
district court in Travis County, Texas. In August 2005, the court issued its
final judgment on the various appeals. In its judgment, the court affirmed most
aspects of the True-Up Order, but reversed two of the Texas Utility Commission's
rulings. The judgment would have the effect of restoring approximately $650
million, plus interest, of the $1.7 billion the Texas Utility Commission had
disallowed from the Company's initial request. The Company and other parties
appealed the district court decisions. Briefs have been filed with the 3rd Court
of Appeals in Austin, and oral argument has been scheduled for September 27,
2006. No amounts related to the district court's judgment have been recorded in
the consolidated financial statements.
Among the issues raised in the Company's appeal of the True-Up Order is the
Texas Utility Commission's reduction of the Company's stranded cost recovery by
approximately $146 million for the present value of certain deferred tax
benefits associated with its former electric generation assets. Such reduction
was considered in the Company's recording of an after-tax extraordinary loss of
$977 million in the last half of 2004. The Company believes that the Texas
Utility Commission based its order on proposed regulations issued by the
Internal Revenue Service (IRS) in March 2003 related to those tax benefits.
Those proposed regulations would have allowed utilities owning assets that were
deregulated before March 4, 2003 to make a retroactive election to pass the
benefits of Accumulated Deferred Investment Tax Credits (ADITC) and Excess
Deferred Federal Income Taxes (EDFIT) back to customers. However, in December
2005, the IRS withdrew those proposed normalization regulations and issued new
proposed regulations that do not include the provision allowing a retroactive
election to pass the tax benefits back to customers. In a recent Private Letter
Ruling issued to a Texas utility on facts similar to the Company's, the IRS,
without referencing its proposed regulations, ruled that a normalization
violation would occur if ADITC and EDFIT were required to be returned to
customers. Based on that ruling and the proposed regulations, if the Texas
Utility Commission's order on this issue is not reversed on appeal or the amount
of the tax benefits is not otherwise restored by the Texas Utility Commission,
the IRS is likely to consider that a normalization violation has occurred. If
so, the IRS could require the Company to pay an amount equal to the Company's
unamortized ADITC balance as of the date that the normalization violation was
deemed to have occurred. In addition, if a normalization violation is deemed to
have occurred, the IRS could also deny the Company the ability to elect
accelerated tax depreciation benefits. If a normalization violation should
ultimately be found to exist, it could have an adverse impact on the Company's
results of operations, financial condition and cash flows. However, the Company
is vigorously pursuing the appeal of this issue and will seek other relief from
the Texas Utility Commission to avoid a normalization violation. The Texas
Utility Commission has not previously required a company subject to its
jurisdiction to take action that would result in a normalization violation.
There are two ways for the Company to recover the true-up balance: by
issuing transition bonds to securitize the amounts due and/or by implementing a
competition transition charge (CTC). Pursuant to a financing order issued by the
Texas Utility Commission in March 2005 and affirmed in all respects in August
2005 by the same Travis County District Court considering the appeal of the
True-Up Order, in December 2005, a subsidiary of the Company issued $1.85
billion in transition bonds with interest rates ranging from 4.84 percent to
5.30 percent and final maturity dates ranging from February 2011 to August 2020.
Through issuance of the transition bonds, the Company recovered approximately
$1.7 billion of the true-up balance determined in the True-Up Order plus
interest through the date on which the bonds were issued.
In July 2005, the Company received an order from the Texas Utility
Commission allowing it to implement a CTC which will collect approximately $596
million over 14 years plus interest at an annual rate of 11.075 percent (CTC
Order). The CTC Order authorizes the Company to impose a charge on retail
electric providers (REPs) to recover the portion of the true-up balance not
covered by the financing order. The CTC Order also allows the Company to collect
approximately $24 million of rate case expenses over three years without a
return through a
6
separate tariff rider (Rider RCE). The Company implemented the CTC and Rider RCE
effective September 13, 2005 and began recovering approximately $620 million.
Effective September 13, 2005, the return on the CTC portion of the true-up
balance is included in the Company's tariff-based revenues. During the three and
six months ended June 30, 2006, the Company recognized approximately $18 million
and $35 million, respectively, in CTC operating income. As of June 30, 2006, the
Company had not recorded an allowed equity return of $241 million on its true-up
balance because such return is being recognized as it is recovered in the
future.
Certain parties appealed the CTC Order to the 98th District Court in Travis
County. In May 2006, the district court issued an order reversing the CTC Order
in three respects. First, the court ruled that the Texas Utility Commission had
improperly relied on provisions of its rule dealing with the interest rate
applicable to CTC amounts. The district court reached that conclusion on the
grounds that the Texas Supreme Court had previously invalidated that entire
section of the rule. Second, the district court reversed the Texas Utility
Commission's ruling that allows the Company to recover through the CTC the costs
(approximately $5 million) for a panel appointed by the Texas Utility Commission
in connection with the valuation of the Company's electric generation assets.
Finally, the district court accepted the contention of one party that the CTC
should not be allocated to retail customers who have switched to new on-site
generation. The Company and CenterPoint Energy disagree with the district
court's conclusions and in May 2006 appealed this decision to the court of
appeals and, if required, plans to seek further review from the Texas Supreme
Court. The Company's brief was filed in the court of appeals in August 2006.
Pending completion of judicial review and any action required by the Texas
Utility Commission following a remand from the courts, the CTC remains in
effect. The 11.075 percent interest rate in question was applicable from the
implementation of the CTC Order on September 13, 2005 until August 1, 2006, the
effective date of the implementation of a new CTC in compliance with the new
rule discussed below. The ultimate outcome of this matter cannot be predicted at
this time. However, the Company does not expect the disposition of this matter
to have a material adverse effect on the Company's or CenterPoint Energy's
financial condition, results of operations or cash flows.
In January 2006, the Texas Utility Commission staff (Staff) proposed that
the Texas Utility Commission adopt new rules governing the carrying charges on
unrecovered true-up balances. In June 2006, the Texas Utility Commission adopted
the revised rule as recommended by the Staff. The rule, which applies to the
Company, reduces carrying costs on the unrecovered CTC balance prospectively
from 11.075 percent to a weighted average cost of capital of 8.06 percent. The
annualized impact on operating income is expected to be approximately $18
million per year for the first year with lesser impacts in subsequent years. On
July 17, 2006, the Company made a compliance filing necessary to implement the
rule changes effective August 1, 2006 per the settlement agreement discussed in
Note 3(d) below.
(b) Final Fuel Reconciliation.
The results of the Texas Utility Commission's final decision related to the
Company's final fuel reconciliation are a component of the True-Up Order. The
Company has appealed certain portions of the True-Up Order involving a
disallowance of approximately $67 million relating to the final fuel
reconciliation in 2003 plus interest of $10 million. A judgment was entered by a
Travis County court in May 2005 affirming the Texas Utility Commission's
decision. The Company filed an appeal to the 3rd Court of Appeals in Austin in
June 2005, and in April 2006, the 3rd Court of Appeals issued an order affirming
the Texas Utility Commission's decision. The Company has until August 16, 2006
to file an appeal with the Texas Supreme Court.
(c) Remand of 2001 Unbundled Cost of Service (UCOS) Order.
The 3rd Court of Appeals in Austin remanded to the Texas Utility Commission
an issue that was decided by the Texas Utility Commission in the Company's 2001
UCOS proceeding. In its remand order, the court ruled that the Texas Utility
Commission had failed to adequately explain its basis for its determination of
certain projected transmission capital expenditures. The Court of Appeals
ordered the Texas Utility Commission to reconsider that determination on the
basis of the record that existed at the time of the Texas Utility Commission's
original order. In April 2006, the Texas Utility Commission opined orally that
the rate base should be reduced by $57 million and instructed its Staff to
quantify the effect on the Company's rates. In the settlement of the Company's
rate proceeding described in Note 3(d) below, the parties to the remand
proceeding have agreed to settle all issues that could be raised in the remand.
Under the terms of that settlement, the Company will add riders to its tariff
rates under which it will provide rate credits to retail and wholesale customers
for a total of approximately $8 million per year until a
7
total of $32 million has been credited to customers under those tariff riders.
The Company reduced revenues and established a corresponding regulatory
liability for $32 million in the second quarter of 2006 to reflect this
obligation.
(d) Rate Case.
The Texas Utility Commission requires each electric utility to file an
annual Earnings Report providing certain information to enable the Texas Utility
Commission to monitor the electric utilities' earnings and financial condition
within the state. In May 2005, the Company filed its Earnings Report for the
calendar year ended December 31, 2004. The Company's Earnings Report shows that
it earned less than its authorized rate of return on equity in 2004.
In October 2005, the Staff filed a memorandum summarizing its review of the
Earnings Reports filed by electric utilities. Based on its review, the Staff
concluded that continuation of the Company's rates could result in excess retail
transmission and distribution revenues of as much as $105 million and excess
wholesale transmission revenues of as much as $31 million annually and
recommended that the Texas Utility Commission initiate a review of the
reasonableness of existing rates.
In December 2005, the Texas Utility Commission considered the Staff report
and agreed to initiate a rate proceeding concerning the reasonableness of the
Company's existing rates for transmission and distribution service and to
require the Company to make a filing by April 15, 2006 to justify or change
those rates. In April 2006, the Company filed cost data and other information
that supported the current rates.
On July 31, 2006, the Company entered into a settlement agreement with the
parties to the proceeding that would resolve the issues raised in this matter.
Under the terms of the agreement, the Company's base rate revenues will be
reduced by a net of approximately $58 million per year. Also, the Company will
commit to increase its energy efficiency expenditures by an additional $10
million per year over the $13 million included in existing rates. The
expenditures will be made to benefit both residential and commercial customers.
The Company also will fund $10 million per year for programs providing financial
assistance to qualified low-income customers in its service territory.
The agreement provides for a rate freeze until June 30, 2010 under which
the Company will not seek to increase its base rates and the other parties will
not petition to decrease those rates. The rate freeze is subject to adjustments
for changes related to certain transmission costs, implementation of the Texas
Utility Commission's recently-adopted change to its CTC rule and certain other
changes. The rate freeze does not apply to changes required to reflect the
result of currently pending appeals of the True-Up Order, the pending appeal of
the Texas Utility Commission's order regarding the Company's final fuel
reconciliation, the appeal of the order implementing the Company's CTC or the
implementation of transition charges associated with current and future
securitizations. In addition, the Company will not be required to file annual
earnings reports for the calendar years 2006 through 2008, but will file an
earnings report for 2009 no later than March 1, 2010. The Company must make a
new base rate filing not later than June 30, 2010, based on a test year ended
December 31, 2009, unless the Texas Utility Commission staff and certain cities
with original jurisdiction notify the Company that such a filing is unnecessary.
The agreement does not provide for an increased storm reserve, but will
permit the Company to amortize its expenditures related to Hurricane Rita of
approximately $4 million per year over a seven-year period and to amortize
regulatory expenses of approximately $2 million per year over a four-year
period, both beginning in the month following the final order. The agreement
will result in a determination that franchise fees payable by the Company under
new franchise agreements with the City of Houston and certain other
municipalities in the Company's service area are deemed reasonable and
necessary, and other revised tariffs proposed in the Company's filing package
will go into effect along with the revised base rates.
The agreement also resolves all issues that could be raised in the Texas
Utility Commission's proceeding to review its decision in the Company's 2001
UCOS case. See Note 3(c) above.
The Company filed the Stipulation and Agreement with the Texas Utility
Commission. Assuming a favorable recommendation on the settlement is issued by
the administrative law judges, the settlement is expected to be considered by
the Texas Utility Commission later this year.
8
(4) LONG-TERM DEBT
In March 2006, the Company replaced its $200 million five-year revolving
credit facility with a $300 million five-year revolving credit facility. The
facility has a first drawn cost of London Interbank Offered Rate (LIBOR) plus 45
basis points based on the Company's current credit ratings, as compared to LIBOR
plus 75 basis points for borrowings under the facility it replaced. The facility
contains covenants, including a debt, excluding transition bonds, to total
capitalization covenant of 65%.
Under the credit facility, an additional utilization fee of 10 basis points
applies to borrowings any time more than 50% of the facility is utilized, and
the spread to LIBOR fluctuates based on the Company's credit rating. Borrowings
under the facility are subject to customary terms and conditions. However, there
is no requirement that the Company make representations prior to borrowings as
to the absence of material adverse changes or litigation that could be expected
to have a material adverse effect. Borrowings under the credit facility are
subject to acceleration upon the occurrence of events of default that the
Company considers customary.
As of June 30, 2006, the Company had no borrowings and approximately $4
million of outstanding letters of credit under its $300 million credit facility.
The Company was in compliance with all covenants as of June 30, 2006.
The Company has $151 million of first mortgage bonds and $527 million of
general mortgage bonds that it has issued as collateral for long-term debt of
CenterPoint Energy. These bonds are not reflected in the consolidated financial
statements because of the contingent nature of the obligations.
(5) RELATED PARTY TRANSACTIONS AND MAJOR CUSTOMERS
Related Party Transactions. The Company participates in a money pool
through which it 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 net funding requirements of the money pool are expected to be met
with borrowings under CenterPoint Energy's revolving credit facility or the sale
of commercial paper. As of December 31, 2005 and June 30, 2006, the Company had
borrowings from the money pool of $68 million and $132 million, respectively.
For the three months ended June 30, 2005 and 2006, the Company had net
interest income related to affiliate borrowings of $9 million and $12 million,
respectively, and $18 million and $23 million for the six months ended June 30,
2005 and 2006, respectively.
CenterPoint Energy provides some corporate services to the Company. The
costs of services have been charged directly 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 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
for each of the three month periods ended June 30, 2005 and 2006, and $54
million and $58 million for the six month periods ended June 30, 2005 and 2006,
respectively, and are included primarily in operation and maintenance expenses.
Major Customers. During the three months ended June 30, 2005 and 2006,
revenues derived from energy delivery charges provided by the Company to
subsidiaries of Reliant Energy, Inc. (formerly Reliant Resources, Inc.) (RRI)
totaled $183 million and $182 million, respectively, and $366 million and $344
million during the six months ended June 30, 2005 and 2006, respectively.
(6) COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
RRI Indemnified Litigation
The Company, CenterPoint Energy or their predecessor, Reliant Energy, and
certain of their former subsidiaries are named as defendants in several lawsuits
described below. Under a master separation agreement between
9
CenterPoint Energy and RRI, CenterPoint Energy and its subsidiaries, including
the Company, are entitled to be indemnified by RRI for any losses, including
attorneys' fees and other costs, arising out of the lawsuits described below
under Electricity and Gas Market Manipulation Cases and Other Class Action
Lawsuits. Pursuant to the indemnification obligation, RRI is defending
CenterPoint Energy and its subsidiaries to the extent named in these lawsuits.
The ultimate outcome of these matters cannot be predicted at this time.
Electricity and Gas Market Manipulation Cases. A large number of lawsuits
have been filed against numerous market participants and remain pending in
federal court in California, Colorado and Nevada and in state court in
California and Nevada in connection with the operation of the electricity and
natural gas markets in California and certain other western states in 2000-2001,
a time of power shortages and significant increases in prices. These lawsuits,
many of which have been filed as class actions, are based on a number of legal
theories, including violation of state and federal antitrust laws, laws against
unfair and unlawful business practices, the federal Racketeer Influenced Corrupt
Organization Act, false claims statutes and similar theories and breaches of
contracts to supply power to governmental entities. Plaintiffs in these
lawsuits, which include state officials and governmental entities as well as
private litigants, are seeking a variety of forms of relief, including recovery
of compensatory damages (in some cases in excess of $1 billion), a trebling of
compensatory damages and punitive damages, injunctive relief, restitution,
interest due, disgorgement, civil penalties and fines, costs of suit, attorneys'
fees and divestiture of assets. CenterPoint Energy's former subsidiary, RRI, was
a participant in the California markets, owning generating plants in the state
and participating in both electricity and natural gas trading in that state and
in western power markets generally.
CenterPoint Energy and/or Reliant Energy have been named in approximately
30 of these lawsuits, which were instituted between 2001 and 2006 and are
pending in California state court in San Diego County, in Nevada state court in
Clark County, in federal district court in Colorado, Nevada and the Northern
District of California and before the Ninth Circuit Court of Appeals. However,
the Company, CenterPoint Energy and Reliant Energy were not participants in the
electricity or natural gas markets in California. CenterPoint Energy and Reliant
Energy have been dismissed from certain of the lawsuits, either voluntarily by
the plaintiffs or by order of the court, and CenterPoint Energy believes it is
not a proper defendant in the remaining cases and will continue to seek
dismissal from such remaining cases.
To date, several of the electricity complaints have been dismissed, and
several of the dismissals have been affirmed by appellate courts. Others have
been resolved by the settlement described in the following paragraph. Four of
the gas complaints have also been dismissed based on defendants' claims of
federal preemption and the filed rate doctrine, and these dismissals have been
appealed. In June 2005, a San Diego state court refused to dismiss other gas
complaints on the same basis. The other gas cases remain in the early procedural
stages.
On August 12, 2005, RRI reached a settlement with the FERC enforcement
staff, the states of California, Washington and Oregon, California's three
largest investor-owned utilities, classes of consumers from California and other
western states, and a number of California city and county government entities
that resolves their claims against RRI related to the operation of the
electricity markets in California and certain other western states in 2000-2001.
The settlement also resolves the claims of the three states and the
investor-owned utilities related to the 2000-2001 natural gas markets. The
settlement has been approved by the FERC, by the California Public Utilities
Commission, and by the courts in which the class action cases are pending. Two
parties have appealed the courts' approval of the settlement to the Ninth
Circuit Court of Appeals. A party in the FERC proceedings filed a motion for
rehearing of the FERC's order approving the settlement, which the FERC denied in
May 2006. That party has filed for review of the FERC's orders in the Ninth
Circuit Court of Appeals. CenterPoint Energy is not a party to the settlement,
but may rely on the settlement as a defense to any claims brought against it
related to the time when CenterPoint Energy was an affiliate of RRI. The terms
of the settlement do not require payment by CenterPoint Energy.
Other Class Action Lawsuits. In May 2002, three class action lawsuits were
filed in federal district court in Houston on behalf of participants in various
employee benefits plans sponsored by CenterPoint Energy. Two of the lawsuits
were dismissed without prejudice. In the remaining lawsuit, CenterPoint Energy
and certain current and former members of its benefits committee are defendants.
That lawsuit alleged that the defendants breached their fiduciary duties to
various employee benefits plans, directly or indirectly sponsored by CenterPoint
Energy, in violation of the Employee Retirement Income Security Act of 1974 by
permitting the plans to purchase or hold securities issued by CenterPoint Energy
when it was imprudent to do so, including after the prices for such securities
10
became artificially inflated because of alleged securities fraud engaged in by
the defendants. The complaint sought monetary damages for losses suffered on
behalf of the plans and a putative class of plan participants whose accounts
held CenterPoint Energy or RRI securities, as well as restitution. In January
2006, the federal district judge granted a motion for summary judgment filed by
CenterPoint Energy and the individual defendants. The plaintiffs have filed an
appeal of the ruling to the Fifth Circuit Court of Appeals. CenterPoint Energy
believes that this lawsuit is without merit and will continue to vigorously
defend the case. However, the ultimate outcome of this matter cannot be
predicted at this time.
ENVIRONMENTAL MATTERS
Asbestos. Some facilities owned by CenterPoint Energy contain or have
contained asbestos insulation and other asbestos-containing materials.
CenterPoint Energy or its subsidiaries, including the Company, have been named,
along with numerous others, as a defendant in lawsuits filed by a number of
individuals who claim injury due to exposure to asbestos. Some of the claimants
have worked at locations owned by CenterPoint Energy, but most existing claims
relate to facilities previously owned by CenterPoint Energy or its subsidiaries.
CenterPoint Energy anticipates that additional claims like those received may be
asserted in the future. In 2004, CenterPoint Energy sold its generating
business, to which most of these claims relate, to Texas Genco LLC, which is now
known as NRG Texas LP (NRG). Under the terms of the arrangements regarding
separation of the generating business from CenterPoint Energy and its sale to
Texas Genco LLC, ultimate financial responsibility for uninsured losses from
claims relating to the generating business has been assumed by Texas Genco LLC
and its successor, but CenterPoint Energy has agreed to continue to defend such
claims to the extent they are covered by insurance maintained by CenterPoint
Energy, subject to reimbursement of the costs of such defense from the
purchaser. Although their ultimate outcome cannot be predicted at this time,
CenterPoint Energy intends to continue vigorously contesting claims that it does
not consider to have merit and does not expect, based on its experience to date,
these matters, either individually or in the aggregate, to have a material
adverse effect on CenterPoint Energy'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 potentially
responsible party 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.
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 regularly analyzes
current information and, as necessary, provides accruals for probable
liabilities on the eventual disposition of these matters. The Company 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.
NUCLEAR DECOMMISSIONING FUND COLLECTIONS
Pursuant to regulatory requirements and its tariff, the Company, as
collection agent, collects from its transmission and distribution customers the
nuclear decommissioning charge assessed with respect to the 30.8% ownership
interest in the South Texas Project which it owned when it was part of an
integrated electric utility. Amounts collected are transferred to nuclear
decommissioning trusts maintained by the current owner of that interest in the
South Texas Project. During 2003 and 2004, $2.9 million was transferred each
year and $3.2 million was transferred in 2005. There are various investment
restrictions imposed on owners of nuclear generating stations by the Texas
Utility Commission and the Nuclear Regulatory Commission relating to nuclear
decommissioning trusts. Pursuant to the provisions of both a separation
agreement and a final order of the Texas Utility Commission relating to the 2005
transfer of ownership to Texas Genco LLC, now NRG, the Company and a subsidiary
of NRG were, until July 1, 2006, jointly administering the decommissioning funds
through the Nuclear Decommissioning Trust Investment Committee. On June 9, 2006,
the Texas Utility Commission approved an application by the Company and an NRG
subsidiary to
11
name the NRG subsidiary as the sole fund administrator. As a result, the Company
is no longer responsible for administration of decommissioning funds it collects
as collection agent.
TAX CONTINGENCIES
The Company has established reserves for certain tax items, primarily
certain items related to employee benefits. The total amount reserved for these
tax items was approximately $12 million as of December 31, 2005 and June 30,
2006.
(7) EMPLOYEE BENEFIT PLANS
The Company's employees participate in CenterPoint Energy's postretirement
benefits plan. The Company's net periodic cost includes the following components
relating to postretirement benefits:
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
2005 2006 2005 2006
---- ---- ---- ----
(IN MILLIONS)
Service cost ........................... $-- $ 1 $-- $ 1
Interest cost .......................... 5 4 9 8
Expected return on plan assets ......... (2) (3) (5) (6)
Amortization of transition obligation .. 1 1 3 3
--- --- --- ---
Net periodic cost ................... $ 4 $ 3 $ 7 $ 6
=== === === ===
The Company expects to contribute approximately $10 million to CenterPoint
Energy's postretirement benefits plan in 2006, of which $5 million had been
contributed as of June 30, 2006.
12
ITEM 2. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS
The following narrative analysis should be read in combination with our
Interim Condensed Financial Statements contained in this Form 10-Q.
We meet the conditions specified in General Instruction H(1)(a) and (b) to
Form 10-Q and are therefore permitted to use the reduced disclosure format for
wholly owned subsidiaries of reporting companies. Accordingly, we have omitted
from this report the information called for by Item 2 (Management's Discussion
and Analysis of Financial Condition and Results of Operations) and Item 3
(Quantitative and Qualitative Disclosures About Market Risk) of Part I and the
following Part II items of Form 10-Q: Item 2 (Unregistered Sales of Equity
Securities and Use of Proceeds), Item 3 (Defaults Upon Senior Securities) and
Item 4 (Submission of Matters to a Vote of Security Holders). The following
discussion explains material changes in our results of operations between the
three and six months ended June 30, 2005 and the three and six months ended June
30, 2006. Reference is made to "Management's Narrative Analysis of Results of
Operations" in Item 7 of our Annual Report on Form 10-K for the year ended
December 31, 2005 (CenterPoint Houston Form 10-K).
RECENT EVENTS
AGREEMENT REGARDING SETTLEMENT OF THE 2006 RATE CASE AND THE 2001 UNBUNDLED COST
OF SERVICE (UCOS) REMAND
On July 31, 2006, we entered into a settlement agreement with the parties
to the proceeding that would resolve the issues raised in our pending rate case.
Under the terms of the agreement, our base rate revenues will be reduced by
approximately $58 million per year. Also, we will commit to increase our energy
efficiency expenditures by an additional $10 million per year over the $13
million included in existing rates. The expenditures will be made to benefit
both residential and commercial customers. We also will fund $10 million per
year for programs providing financial assistance to qualified low-income
customers in our service territory. The agreement provides for a rate freeze
until June 30, 2010 under which we will not seek to increase our base rates and
the other parties will not petition to decrease those rates.
The agreement also resolves all issues that could be raised in the Public
Utility Commission of Texas' (Texas Utility Commission) proceeding to review its
decision in our 2001 UCOS case. Under the terms of the agreement, we will add
riders to our tariff rates under which we will provide rate credits to retail
and wholesale customers for a total of approximately $8 million per year until a
total of $32 million has been credited to customers under those tariff riders.
We reduced revenues and established a corresponding regulatory liability for $32
million in the second quarter of 2006 to reflect this obligation.
COMPETITION TRANSITION CHARGE (CTC) INTEREST RATE REDUCTION
In January 2006, the Texas Utility Commission staff (Staff) proposed that
the Texas Utility Commission adopt new rules governing the carrying charges on
unrecovered true-up balances. In June 2006, the Texas Utility Commission adopted
the revised rule as recommended by the Staff. The rule, which applies to us,
reduces carrying costs on the unrecovered CTC balance prospectively from 11.075
percent to a weighted average cost of capital of 8.06 percent. The annualized
impact on operating income is expected to be approximately $18 million per year
for the first year with lesser impacts in subsequent years. In accordance with
the agreement discussed above, we implemented the rule change effective August
1, 2006.
CONSOLIDATED RESULTS OF OPERATIONS
Our results of operations are affected by seasonal fluctuations in the
demand for electricity. Our results of operations are also affected by, among
other things, the actions of various governmental authorities having
jurisdiction over rates we charge, debt service costs, income tax expense, our
ability to collect receivables from retail electric providers and our ability to
recover our stranded costs and regulatory assets. For more information regarding
factors that may affect the future results of operations of our business, please
read "Risk Factors" in Item 1A of Part I of the CenterPoint Houston Form 10-K.
13
The following table sets forth our consolidated results of operations for
the three and six months ended June 30, 2005 and 2006, followed by a discussion
of our consolidated results of operations based on operating income. We have
provided a reconciliation of consolidated operating income to net income below.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
2005 2006 2005 2006
---------- ---------- ---------- ----------
(IN MILLIONS, EXCEPT CUSTOMER DATA)
Revenues:
Electric transmission and distribution utility .. $ 388 $ 386 $ 711 $ 717
Transition bond companies ....................... 26 70 48 124
---------- ---------- ---------- ----------
Total revenues ............................... 414 456 759 841
---------- ---------- ---------- ----------
Expenses:
Operation and maintenance ....................... 153 147 291 281
Depreciation and amortization ................... 64 61 128 124
Taxes other than income taxes ................... 58 59 108 115
Transition bond companies ....................... 17 38 30 60
---------- ---------- ---------- ----------
Total expenses ............................... 292 305 557 580
---------- ---------- ---------- ----------
Operating income ................................... 122 151 202 261
---------- ---------- ---------- ----------
Interest and other finance charges ................. (85) (61) (170) (122)
Return on true-up balance .......................... 35 -- 69 --
Other income, net .................................. 12 17 23 32
---------- ---------- ---------- ----------
Income before income taxes and extraordinary item .. 84 107 124 171
Income tax expense ................................. (29) (36) (41) (57)
---------- ---------- ---------- ----------
Income before extraordinary item ................... 55 71 83 114
Extraordinary item, net of tax ..................... 30 -- 30 --
---------- ---------- ---------- ----------
Net income ......................................... $ 85 $ 71 $ 113 $ 114
========== ========== ========== ==========
Actual gigawatt-hours (GWh) delivered:
Residential ..................................... 6,594 6,808 10,736 10,794
Total ........................................... 18,956 20,422 34,783 36,409
Average number of metered customers:
Residential ..................................... 1,675,573 1,730,130 1,668,447 1,723,983
Total ........................................... 1,904,090 1,965,180 1,895,556 1,958,005
THREE MONTHS ENDED JUNE 30, 2006 COMPARED TO THREE MONTHS ENDED JUNE 30, 2005
We reported operating income of $151 million for the three months ended
June 30, 2006, consisting of $119 million for the regulated electric
transmission and distribution utility and $32 million related to the transition
bonds. For the three months ended June 30, 2005, operating income totaled $122
million, consisting of $113 million for the regulated electric transmission and
distribution utility and $9 million related to the transition bonds. Revenues
for the regulated electric transmission and distribution utility continue to
benefit from solid customer growth, with nearly 60,000 metered customers added
since June 2005 ($10 million), recovery of our 2004 true-up balance through the
CTC, which was implemented in September 2005 ($12 million) as well as favorable
weather and increased usage ($6 million). This increase in revenues was more
than offset by the impact related to the resolution of the 2001 UCOS order,
which reduced revenues by $32 million. Operation and maintenance expense
decreased primarily due to lower employee benefit expenses ($4 million).
SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO SIX MONTHS ENDED JUNE 30, 2005
We reported operating income of $261 million for the six months ended June
30, 2006, consisting of $197 million for the regulated electric transmission and
distribution utility and $64 million related to the transition bonds. For the
six months ended June 30, 2005, operating income totaled $202 million,
consisting of $184 million for the regulated electric transmission and
distribution utility and $18 million related to the transition bonds. Revenues
for the regulated electric transmission and distribution utility increased due
to continued customer growth, with nearly 60,000 metered customers added since
June 2005 ($18 million), recovery of our 2004 true-up balance through the
14
CTC ($26 million) and favorable weather ($2 million), partially offset by
decreased usage ($8 million) and the impact related to the resolution of the
2001 UCOS order ($32 million). Operation and maintenance expense decreased
primarily due to a gain on the sale of land in 2006 ($14 million) and lower
employee benefit expenses ($5 million), which was partially offset by higher
transmission costs ($5 million) and severance costs associated with staff
reductions ($4 million). Additionally, taxes other than income taxes increased
primarily due to higher franchise fees ($7 million).
EXTRAORDINARY ITEM
Net income for both the three months and six months ended June 30, 2005
included an after-tax extraordinary gain of $30 million reflecting an adjustment
to the extraordinary loss recorded in the last half of 2004 to write-down
generation-related regulatory assets as a result of the final orders issued by
the Texas Utility Commission.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS
For information on other developments, factors and trends that may have an
impact on our future earnings, please read "Risk Factors" in Item 1A of Part I
and "Management's Narrative Analysis of Results of Operations -- Certain Factors
Affecting Future Earnings" in Item 7 of Part II of the CenterPoint Houston Form
10-K.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity and capital requirements are affected primarily by our
results of operations, capital expenditures, debt service requirements, working
capital needs, various regulatory actions and appeals relating to such
regulatory actions. Our principal cash requirements for the remaining six months
of 2006 include approximately $160 million of capital expenditures and $54
million of scheduled payments on transition bonds.
We expect that borrowings under our credit facility, anticipated cash flows
from operations and intercompany borrowings will be sufficient to meet our cash
needs for the next twelve months.
Off-Balance Sheet Arrangements. Other than operating leases and first
mortgage bonds and general mortgage bonds issued as collateral for long-term
debt of CenterPoint Energy, Inc. (CenterPoint Energy) as discussed below, we
have no off-balance sheet arrangements.
Credit Facilities. In March 2006, we replaced our $200 million five-year
revolving credit facility with a $300 million five-year revolving credit
facility. The facility has a first drawn cost of London Interbank Offered Rate
(LIBOR) plus 45 basis points based on our current credit ratings, as compared to
LIBOR plus 75 basis points for borrowings under the facility it replaced. The
facility contains covenants, including a debt, excluding transition bonds, to
total capitalization covenant of 65%.
Under the credit facility, an additional utilization fee of 10 basis points
applies to borrowings any time more than 50% of the facility is utilized, and
the spread to LIBOR fluctuates based on our credit rating. Borrowings under the
facility are subject to customary terms and conditions. However, there is no
requirement that we make representations prior to borrowings as to the absence
of material adverse changes or litigation that could be expected to have a
material adverse effect. Borrowings under the credit facility are subject to
acceleration upon the occurrence of events of default that we consider
customary. We are currently in compliance with the various business and
financial covenants contained in our credit facility. As of August 1, 2006, we
had no borrowings and approximately $4 million of outstanding letters of credit
under the credit facility.
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 net funding requirements of the money pool are expected to be met
with borrowings under CenterPoint Energy's revolving credit facility or the sale
of commercial paper. At August 1, 2006, we had borrowings of $94 million from
the money pool. The money pool may not provide sufficient funds to meet our cash
needs.
Long-term Debt. Our long-term debt consists of our obligations and the
obligations of our subsidiaries, including transition bonds issued by wholly
owned subsidiaries. The following table shows future maturity dates of
15
long-term debt issued by us to third parties and affiliates and scheduled future
payment dates of transition bonds issued by our subsidiaries, CenterPoint Energy
Transition Bond Company, LLC (Bond Company) and CenterPoint Energy Transition
Bond Company II, LLC (Bond Company II), as of August 1, 2006. Amounts are
expressed in millions.
TRANSITION
YEAR THIRD-PARTY AFFILIATE SUB-TOTAL BONDS TOTAL
- --------- ----------- --------- --------- ---------- ------
2006 .... $ -- $ -- $ -- $ 36 $ 36
2007 .... -- -- -- 147 147
2008 .... -- -- -- 159 159
2009 .... -- -- -- 175 175
2010 .... -- -- -- 190 190
2011 .... -- -- -- 207 207
2012 .... 46 -- 46 227 273
2013 .... 450 -- 450 245 695
2014 .... 300 -- 300 147 447
2015 .... -- 151 151 158 309
2016 .... -- -- -- 169 169
2017 .... 127 -- 127 181 308
2018 .... -- -- -- 194 194
2019 .... -- -- -- 208 208
2021 .... 102 -- 102 -- 102
2023 .... 200 -- 200 -- 200
2027 .... 56 -- 56 -- 56
2033 .... 312 -- 312 -- 312
------ ---- ------ ------ ------
Total ... $1,593 $151 $1,744 $2,443 $4,187
====== ==== ====== ====== ======
As of August 1, 2006, outstanding first mortgage bonds and general mortgage
bonds aggregated approximately $2.3 billion as shown in the following table.
Amounts are expressed in millions.
ISSUED AS ISSUED AS COLLATERAL
ISSUED DIRECTLY COLLATERAL FOR THE FOR CENTERPOINT
TO THIRD PARTIES COMPANY'S DEBT ENERGY'S DEBT TOTAL
---------------- ------------------ -------------------- ------
First Mortgage Bonds .... $ 102 $ -- $151 $ 253
General Mortgage Bonds .. 1,262 229 527 2,018
------ ---- ---- ------
Total ................ $1,364 $229 $678 $2,271
====== ==== ==== ======
The lien of the general mortgage indenture is junior to that of the
mortgage, pursuant to which the first mortgage bonds are issued. We may issue
additional general mortgage bonds on the basis of retired bonds, 70% of property
additions or cash deposited with the trustee. Approximately $2.1 billion of
additional first mortgage bonds and general mortgage bonds could be issued on
the basis of retired bonds and 70% of property additions as of June 30, 2006.
However, we are contractually prohibited, subject to certain exceptions, from
issuing additional first mortgage bonds.
The following table shows the maturity dates of the $678 million of first
mortgage bonds and general mortgage bonds that we have issued as collateral for
long-term debt of CenterPoint Energy. These bonds are not reflected in our
consolidated financial statements because of the contingent nature of the
obligations. Amounts are expressed in millions.
FIRST MORTGAGE GENERAL
YEAR BONDS MORTGAGE BONDS TOTAL
- ----------- -------------- -------------- -----
2011 ...... $ -- $ 19 $ 19
2015 ...... 151 -- 151
2018 ...... -- 50 50
2019 ...... -- 200 200
2020 ...... -- 90 90
2026 ...... -- 100 100
2028 ...... -- 68 68
---- ---- ----
Total .. $151 $527 $678
==== ==== ====
16
At August 1, 2006, Bond Company had $611 million aggregate principal amount
of outstanding transition bonds that were issued in 2001 in accordance with the
1999 Texas Electric Choice Plan (Texas electric restructuring law). At August 1,
2006, Bond Company II had $1.83 billion aggregate principal amount of
outstanding transition bonds that were issued in 2005 in accordance with the
Texas electric restructuring law. The transition bonds are secured by
"transition property," as defined in the Texas electric restructuring law, which
includes the irrevocable right to recover, through non-bypassable transition
charges payable by retail electric customers, qualified costs provided in the
Texas electric restructuring law. The transition bonds are reported as our
long-term debt, although the holders of the transition bonds have no recourse to
any of our assets or revenues, and our creditors have no recourse to any assets
or revenues (including, without limitation, the transition charges) of the bond
companies. We have no payment obligations with respect to the transition bonds
except to remit collections of transition charges as set forth in a servicing
agreement between us and the bond companies and in an intercreditor agreement
among us, the bond companies and other parties.
Impact on Liquidity of a Downgrade in Credit Ratings. As of August 1, 2006,
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 debt.
MOODY'S S&P FITCH
-------------------- -------------------- --------------------
INSTRUMENT RATING OUTLOOK (1) RATING OUTLOOK (2) RATING OUTLOOK (3)
---------- ------ ----------- ------ ----------- ------ -----------
Senior Secured Debt (First Mortgage Bonds)... Baa2 Stable BBB Stable A- 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 and the
execution of our commercial strategies.
A decline in credit ratings could increase borrowing costs under our $300
million 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 could
negatively impact our ability to complete capital market transactions.
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, 2006, CenterPoint Energy had issued six 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:
- increases in interest expense in connection with debt refinancings and
borrowings under our credit facility;
- various regulatory actions;
17
- the ability of RRI and its subsidiaries to satisfy their obligations
as our principal customers and in respect of RRI's indemnity
obligations to us;
- the outcome of litigation brought by and against us;
- restoration costs and revenue losses resulting from natural disasters
such as hurricanes; and
- various other risks identified in "Risk Factors" in Item 1A of Part I
of the CenterPoint Houston Form 10-K.
Certain Contractual Limits on Ability to Issue Securities and Pay
Dividends. Our credit facility limits our debt, excluding transition bonds, as a
percentage of our total capitalization to 65 percent. Additionally, in
connection with the issuance of a certain series of general mortgage bonds, we
agreed not to issue, subject to certain exceptions, additional first mortgage
bonds.
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 CenterPoint Houston 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.
ACCOUNTING FOR RATE REGULATION
Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for
the Effects of Certain Types of Regulation" (SFAS No. 71), provides that
rate-regulated entities account for and report assets and liabilities consistent
with the recovery of those incurred costs in rates if the rates established are
designed to recover the costs of providing the regulated service and if the
competitive environment makes it probable that such rates can be charged and
collected. Application of SFAS No. 71 to the electric generation portion of our
business was discontinued as of June 30, 1999. We continue to apply SFAS No. 71
which results in our accounting for the regulatory effects of recovery of
stranded costs and other regulatory assets resulting from the unbundling of the
transmission and distribution business from our electric generation operations
in our consolidated financial statements. Certain expenses and revenues subject
to utility regulation or rate determination normally reflected in income are
deferred on the balance sheet and are recognized in income as the related
amounts are included in service rates and recovered from or refunded to
customers. Significant accounting estimates embedded within the application of
SFAS No. 71 relate to $321 million of recoverable electric generation-related
regulatory assets as of June 30, 2006. These costs are recoverable under the
provisions of the Texas electric restructuring law. Based on our analysis of the
final order issued by the Texas Utility Commission, we recorded an after-tax
charge to earnings in 2004 of approximately $977 million to write-down our
electric generation-related regulatory assets to their realizable value, which
is reflected as an extraordinary loss in the Condensed Statements of
Consolidated Income.
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Based on subsequent orders received from the Texas Utility Commission, we
recorded an extraordinary gain of $30 million after-tax in the second quarter of
2005 related to the regulatory asset. Additionally, a district court in Travis
County, Texas issued a judgment that would have the effect of restoring
approximately $650 million, plus interest, of disallowed costs. Appeals of the
district court's judgment are still pending. Oral arguments have been scheduled
for September 27, 2006. No amounts related to the district court's judgment have
been recorded in our consolidated financial statements. For additional
information relating to regulatory proceedings, see Note 3 to our Interim
Condensed Financial Statements.
IMPAIRMENT OF LONG-LIVED ASSETS AND INTANGIBLES
We review the carrying value of our long-lived assets, including
identifiable intangibles, whenever events or changes in circumstances indicate
that such carrying values may not be recoverable. 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.
ASSET RETIREMENT OBLIGATIONS
We account for our long-lived assets under SFAS No. 143, "Accounting for
Asset Retirement Obligations" (SFAS No. 143), and Financial Accounting Standards
Board Interpretation No. 47, "Accounting for Conditional Asset Retirement
Obligations - An Interpretation of SFAS No. 143" (FIN 47). SFAS No. 143 and FIN
47 require that an asset retirement obligation be recorded at fair value in the
period in which it is incurred if a reasonable estimate of fair value can be
made. In the same period, the associated asset retirement costs are capitalized
as part of the carrying amount of the related long-lived asset. Rate-regulated
entities may recognize regulatory assets or liabilities as a result of timing
differences between the recognition of costs as recorded in accordance with SFAS
No. 143 and FIN 47, and costs recovered through the ratemaking process.
We estimate the fair value of asset retirement obligations by calculating
the discounted cash flows that are dependent upon the following components:
- Inflation adjustment - The estimated cash flows are adjusted for
inflation estimates for labor, equipment, materials, and other
disposal costs;
- Discount rate - The estimated cash flows include contingency factors
that were used as a proxy for the market risk premium; and
- Third party markup adjustments - Internal labor costs included in the
cash flow calculation were adjusted for costs that a third party would
incur in performing the tasks necessary to retire the asset.
Changes in these factors could materially affect the obligation recorded to
reflect the ultimate cost associated with retiring the assets under SFAS No. 143
and FIN 47. For example, if the inflation adjustment increased 25 basis points,
this would increase the balance for asset retirement obligations by
approximately 2%. Similarly, an increase in the discount rate by 25 basis points
would decrease asset retirement obligations by approximately the same
percentage. At June 30, 2006, our estimated cost of retiring these assets was
approximately $12 million.
UNBILLED ENERGY REVENUES
Revenues related to the delivery of electricity are generally recorded when
electricity is delivered to customers. However, the determination of electricity
deliveries 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 electricity delivered to customers since the date of the
last meter reading are estimated and the corresponding unbilled revenue is
estimated. Unbilled electricity delivery revenue is estimated each month based
on daily supply volumes,
19
applicable rates and analyses reflecting significant historical trends and
experience. 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 Condensed Financial Statements for a discussion
of new accounting pronouncements that affect us.
ITEM 4. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an
evaluation, under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, of
the effectiveness of our disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, our principal executive
officer and principal financial officer concluded that our disclosure controls
and procedures were effective as of June 30, 2006 to provide assurance that
information required to be disclosed in our reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms
and such information is accumulated and communicated to our management,
including our principal executive officer and principal financial officer, as
appropriate to allow timely decisions regarding disclosure.
There has been no change in our internal controls over financial reporting
that occurred during the three months ended June 30, 2006 that has materially
affected, or is reasonably likely to materially affect, our internal controls
over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For a discussion of material legal and regulatory proceedings affecting us,
please read Notes 3 and 6 to our Interim Condensed Financial Statements, each of
which is incorporated herein by reference. See also "Business -- Regulation" and
"-- Environmental Matters" in Item 1 and "Legal Proceedings" in Item 3 of the
CenterPoint Houston Form 10-K.
ITEM 1A. RISK FACTORS
There have been no material changes from the risk factors disclosed in the
CenterPoint Houston Form 10-K.
ITEM 5. OTHER INFORMATION
Our ratio of earnings to fixed charges for the six months ended June 30,
2005 and 2006 was 1.89 and 2.36, respectively. We do not believe that the ratios
for these six month periods are necessarily indicators of the ratios for the
twelve month period due to the seasonal nature of our business. The ratios were
calculated pursuant to applicable rules of the Securities and Exchange
Commission.
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ITEM 6. EXHIBITS
The following exhibits are filed herewith:
Exhibits not incorporated by reference to a prior filing are designated by
a cross (+); all exhibits not so designated are incorporated by reference to a
prior filing of CenterPoint Houston or CenterPoint Energy as indicated.
Report or Registration SEC File or Exhibit
Exhibit Number Description Statement Registration Number References
- -------------- ------------------------ ---------------------- ------------------- ----------
3.1 Articles of CenterPoint Houston's 1-3187 3(b)
Organization of Form 8-K dated August
CenterPoint Energy 31, 2002 filed with
Houston Electric the SEC on September
3, 2002
3.2 Limited Liability CenterPoint Houston's 1-3187 3(c)
Company Regulations of Form 8-K dated August
CenterPoint Energy 31, 2002 filed with
Houston Electric the SEC on September
3, 2002
4.1 $300,000,000 Credit CenterPoint Houston's 1-3187 4.2
Agreement dated as of Form 8-K dated March
March 31, 2006 among 31, 2006
CenterPoint Houston,
as Borrower, and the
Initial Lenders named
therein, as Initial
Lenders
+12 Computation of Ratios
of Earnings to Fixed
Charges
+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
CenterPoint Houston
Form 10-K. Item 1A
"--Risk Factors."
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC
By: /s/ James S. Brian
------------------------------------
James S. Brian
Senior Vice President and Chief
Accounting Officer
Date: August 7, 2006
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INDEX TO EXHIBITS
Exhibits not incorporated by reference to a prior filing are designated by
a cross (+); all exhibits not so designated are incorporated by reference to a
prior filing of CenterPoint Houston or CenterPoint Energy as indicated.
Report or Registration SEC File or Exhibit
Exhibit Number Description Statement Registration Number References
- -------------- ------------------------ ---------------------- ------------------- ----------
3.1 Articles of CenterPoint Houston's 1-3187 3(b)
Organization of Form 8-K dated August
CenterPoint Energy 31, 2002 filed with
Houston Electric the SEC on September
3, 2002
3.2 Limited Liability CenterPoint Houston's 1-3187 3(c)
Company Regulations of Form 8-K dated August
CenterPoint Energy 31, 2002 filed with
Houston Electric the SEC on September
3, 2002
4.1 $300,000,000 Credit CenterPoint Houston's 1-3187 4.2
Agreement dated as of Form 8-K dated March
March 31, 2006 among 31, 2006
CenterPoint Houston,
as Borrower, and the
Initial Lenders named
therein, as Initial
Lenders
+12 Computation of Ratios
of Earnings to Fixed
Charges
+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
CenterPoint Houston
Form 10-K. Item 1A
"--Risk Factors."
23