EXHIBIT 99.1
ITEM 1A. RISK FACTORS
RISK FACTORS AFFECTING OUR BUSINESS
WE MAY NOT BE SUCCESSFUL IN ULTIMATELY RECOVERING THE FULL VALUE OF OUR TRUE-UP
COMPONENTS, WHICH COULD RESULT IN THE ELIMINATION OF CERTAIN TAX BENEFITS AND
COULD HAVE AN ADVERSE IMPACT ON OUR RESULTS OF OPERATIONS, FINANCIAL CONDITION
AND CASH FLOWS.
In March 2004, we filed our true-up application with the Texas Utility
Commission, requesting recovery of $3.7 billion, excluding interest. In December
2004, the Texas Utility Commission issued its final order (True-Up Order)
allowing us 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. We 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 our initial request. First, the
court reversed the Texas Utility Commission's decision to prohibit us from
recovering $180 million in credits through August 2004 that we were ordered to
provide to retail electric providers as a result of an inaccurate stranded cost
estimate made by the Texas Utility Commission in 2000. Additional credits of
approximately $30 million were paid after August 2004.
Second, the court reversed the Texas Utility Commission's disallowance
of $440 million in transition costs which are recoverable under the Texas
Utility Commission's regulations. We and other parties appealed the district
court decisions. Briefs have been filed with the 3rd Court of Appeals in Austin
but oral argument has not yet been scheduled. No prediction can be made as to
the ultimate outcome or timing of such appeals. Additionally, if the amount of
the true-up balance is reduced on appeal to below the amount recovered through
the issuance of transition bonds and under the CTC, while the amount of
transition bonds outstanding would not be reduced, we would be required to
refund the over recovery to our customers.
Among the issues raised in our appeal of the True-Up Order is the Texas
Utility Commission's reduction of our stranded cost recovery by approximately
$146 million for the present value of certain deferred tax benefits associated
with our former Texas Genco assets. Such reduction was considered in our
recording of an after-tax extraordinary loss of $977 million in the last half of
2004. We believe that the Texas Utility Commission based its order on proposed
regulations issued by the IRS in March 2003 related to those tax benefits. Those
proposed regulations would have allowed utilities which were deregulated before
March 4, 2003 to make a retroactive election to pass the benefits of ADITC and
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. If the December 2005 proposed regulations become
effective and 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 us to pay
an amount equal to our 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 us
the ability to elect accelerated depreciation benefits. If a normalization
violation should ultimately be found to exist, it could have an adverse impact
on our results of operations, financial condition and cash flows. The Texas
Utility Commission has not previously required a company subject to its
jurisdiction to take action that would result in a normalization violation.
OUR RECEIVABLES ARE CONCENTRATED IN A SMALL NUMBER OF RETAIL ELECTRIC PROVIDERS,
AND ANY DELAY OR DEFAULT IN PAYMENT COULD ADVERSELY AFFECT OUR CASH FLOWS,
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Our receivables from the distribution of electricity are collected from
retail electric providers that supply the electricity we distribute to their
customers. Currently, we do business with 66 retail electric providers. Adverse
economic conditions, structural problems in the market served by the Electric
Reliability Council of Texas, Inc. (ERCOT) or financial difficulties of one or
more retail electric providers could impair the ability of these retail
providers to pay for our services or could cause them to delay such payments. We
depend on these retail electric providers to remit payments on a timely basis.
Applicable regulatory provisions require that customers be shifted to a provider
of last resort if a retail electric provider cannot make timely payments.
Reliant Energy, Inc. (RRI), through its subsidiaries, is our largest customer.
Approximately 56% of our $127 million in billed receivables from retail electric
providers at December 31, 2005 was owed by subsidiaries of RRI. Any delay or
default in payment could adversely affect our cash flows, financial condition
and results of operations.
RATE REGULATION OF OUR BUSINESS MAY DELAY OR DENY OUR ABILITY TO EARN A
REASONABLE RETURN AND FULLY RECOVER OUR COSTS.
Our rates are regulated by certain municipalities and the Texas Utility
Commission based on an analysis of our invested capital and our expenses in a
test year. Thus, the rates that we are allowed to charge may not match our
expenses at any given time. The regulatory process by which rates are determined
may not always result in rates that will produce full recovery of our costs and
enable us to earn a reasonable return on our invested capital.
DISRUPTIONS AT POWER GENERATION FACILITIES OWNED BY THIRD PARTIES COULD
INTERRUPT OUR SALES OF TRANSMISSION AND DISTRIBUTION SERVICES.
We transmit and distribute to customers of retail electric providers
electric power that the retail electric providers obtain from power generation
facilities owned by third parties. We do not own or operate any power generation
facilities. If power generation is disrupted or if power generation capacity is
inadequate, our sales of transmission and distribution services may be
diminished or interrupted, and our results of operations, financial condition
and cash flows may be adversely affected.
OUR REVENUES AND RESULTS OF OPERATIONS ARE SEASONAL.
A significant portion of our revenues are derived from rates that we
collect from each retail electric provider based on the amount of electricity we
distribute on behalf of such retail electric provider. Thus, our revenues and
results of operations are subject to seasonality, weather conditions and other
changes in electricity usage, with revenues being higher during the warmer
months.
RISK FACTORS ASSOCIATED WITH OUR CONSOLIDATED FINANCIAL CONDITION
IF WE ARE UNABLE TO ARRANGE FUTURE FINANCINGS ON ACCEPTABLE TERMS, OUR ABILITY
TO REFINANCE EXISTING INDEBTEDNESS COULD BE LIMITED.
As of December 31, 2005, we had $4.1 billion of outstanding
indebtedness on a consolidated basis, which includes $2.5 billion of
non-recourse transition bonds. Our future financing activities may depend, at
least in part, on:
o the timing and amount of our recovery of the true-up components,
including, in particular, the results of appeals to the courts of
determination on rulings obtained to date;
o general economic and capital market conditions;
o credit availability from financial institutions and other lenders;
o investor confidence in us and the market in which we operate;
o maintenance of acceptable credit ratings by us and CenterPoint Energy;
o market expectations regarding our future earnings and probable cash
flows;
o market perceptions of our ability to access capital markets on
reasonable terms;
o our exposure to RRI as our customer and in connection with its
indemnification obligations arising in connection with its separation
from CenterPoint Energy; and
o provisions of relevant tax and securities laws.
As of December 31, 2005, we had outstanding $2.0 billion aggregate
principal amount of general mortgage bonds under the General Mortgage, including
approximately $527 million held in trust to secure pollution control bonds for
which CenterPoint Energy is obligated and approximately $229 million held in
trust to secure pollution control bonds for which we are obligated.
Additionally, we had outstanding approximately $253 million aggregate principal
amount of first mortgage bonds under the Mortgage, including approximately $151
million held in trust to secure certain pollution control bonds for which
CenterPoint Energy is obligated. We may issue additional general mortgage bonds
on the basis of retired bonds, 70% of property additions or cash deposited with
the trustee. Approximately $2.0 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 December 31, 2005. However, we are contractually
prohibited, subject to certain exceptions, from issuing additional first
mortgage bonds.
Our current credit ratings are discussed in "Management's Narrative
Analysis of Results of Operations -- Liquidity -- Impact on Liquidity of a
Downgrade in Credit Ratings" in Item 7 of this report. These credit ratings may
not remain in effect for any given period of time and one or more of these
ratings may be lowered or withdrawn entirely by a rating agency. We note that
these credit ratings are not recommendations to buy, sell or hold our
securities. Each rating should be evaluated independently of any other rating.
Any future reduction or withdrawal of one or more of our credit ratings could
have a material adverse impact on our ability to access capital on acceptable
terms.
THE FINANCIAL CONDITION AND LIQUIDITY OF OUR PARENT COMPANY COULD AFFECT OUR
ACCESS TO CAPITAL, OUR CREDIT STANDING AND OUR FINANCIAL CONDITION.
Our ratings and credit may be impacted by CenterPoint Energy's credit
standing. As of December 31, 2005, CenterPoint Energy and its subsidiaries other
than us have approximately $665 million principal amount of debt required to be
paid through 2008. This amount excludes amounts related to capital leases,
securitization debt and indexed debt securities obligations. In addition,
CenterPoint Energy has $830 million of outstanding convertible notes on which
holders could exercise their "put" rights during this period. CenterPoint Energy
and its other subsidiaries may not be able to pay or refinance these amounts. If
CenterPoint Energy were to experience a deterioration in its credit standing or
liquidity difficulties, our access to credit and our ratings could be adversely
affected and the repayment of notes receivable from CenterPoint Energy in the
amount of $750 million as of December 31, 2005 could be adversely affected.
RISKS COMMON TO OUR BUSINESS AND OTHER RISKS
WE ARE SUBJECT TO OPERATIONAL AND FINANCIAL RISKS AND LIABILITIES ARISING FROM
ENVIRONMENTAL LAWS AND REGULATIONS.
Our operations are subject to stringent and complex laws and
regulations pertaining to health, safety and the environment. As an owner or
operator of electric transmission and distribution systems, we must comply with
these laws and regulations at the federal, state and local levels. These laws
and regulations can restrict or impact our business activities in many ways,
such as:
o restricting the way we can handle or dispose of our wastes;
o limiting or prohibiting construction activities in sensitive areas such
as wetlands, coastal regions, or areas inhabited by endangered species;
o requiring remedial action to mitigate pollution conditions caused by
our operations, or attributable to former operations; and
o enjoining the operations of facilities deemed in non-compliance with
permits issued pursuant to such environmental laws and regulations.
In order to comply with these requirements, we may need to spend
substantial amounts and devote other resources from time to time to:
o construct or acquire new equipment;
o acquire permits for facility operations; and
o modify or replace existing and proposed equipment.
Failure to comply with these laws and regulations may trigger a variety
of administrative, civil and criminal enforcement measures, including the
assessment of monetary penalties, the imposition of remedial actions, and the
issuance of orders enjoining future operations. Certain environmental statutes
impose strict, joint and several liability for costs required to clean up and
restore sites where hazardous substances have been disposed or otherwise
released. Moreover, it is not uncommon for neighboring landowners and other
third parties to file claims for personal injury and property damage allegedly
caused by the release of hazardous substances or other waste products into the
environment.
OUR INSURANCE COVERAGE MAY NOT BE SUFFICIENT. INSUFFICIENT INSURANCE COVERAGE
AND INCREASED INSURANCE COSTS COULD ADVERSELY IMPACT OUR RESULTS OF OPERATIONS,
FINANCIAL CONDITION AND CASH FLOWS.
In common with other companies in our line of business that serve
coastal regions, we do not have insurance covering our transmission and
distribution system because we believe it to be cost prohibitive. Additionally,
we do not have business interruption coverage. If we were to sustain any loss
of, or damage to, our transmission and distribution properties, we may not be
able to recover such loss or damage through a change in our regulated rates, and
any such recovery may not be timely granted. Therefore, we may not be able to
restore any loss of, or damage to, any of our transmission and distribution
properties without negative impact on our results of operations, financial
condition and cash flows.
WE AND CENTERPOINT ENERGY COULD INCUR LIABILITIES ASSOCIATED WITH BUSINESSES AND
ASSETS THAT WE HAVE TRANSFERRED TO OTHERS.
Under some circumstances, we and CenterPoint Energy could incur
liabilities associated with assets and businesses we and CenterPoint Energy no
longer own. These assets and businesses were previously owned by Reliant Energy,
Incorporated (Reliant Energy), our predecessor, directly or through subsidiaries
and include:
o those transferred to RRI or its subsidiaries in connection with the
organization and capitalization of RRI prior to its initial public
offering in 2001; and
o those transferred to Texas Genco in connection with its organization
and capitalization.
In connection with the organization and capitalization of RRI, RRI and
its subsidiaries assumed liabilities associated with various assets and
businesses Reliant Energy transferred to them. RRI also agreed to indemnify, and
cause the applicable transferee subsidiaries to indemnify, CenterPoint Energy
and its subsidiaries, including us, with respect to liabilities associated with
the transferred assets and businesses. The indemnity provisions were intended to
place sole financial responsibility on RRI and its subsidiaries for all
liabilities associated with the current and historical businesses and operations
of RRI, regardless of the time those liabilities arose. If RRI is unable to
satisfy a liability that has been so assumed in circumstances in which
Reliant Energy has not been released from the liability in connection with the
transfer, we and CenterPoint Energy could be responsible for satisfying the
liability.
RRI's unsecured debt ratings are currently below investment grade. If
RRI were unable to meet its obligations, it would need to consider, among
various options, restructuring under the bankruptcy laws, in which event RRI
might not honor its indemnification obligations and claims by RRI's creditors
might be made against us as its former owner.
Reliant Energy and RRI are named as defendants in a number of lawsuits
arising out of power sales in California and other West Coast markets and
financial reporting matters. Although these matters relate to the business and
operations of RRI, claims against Reliant Energy have been made on grounds that
include the effect of RRI's financial results on Reliant Energy's historical
financial statements and liability of Reliant Energy as a controlling
shareholder of RRI. We could incur liability if claims in one or more of these
lawsuits were successfully asserted against us and indemnification from RRI were
determined to be unavailable or if RRI were unable to satisfy indemnification
obligations owed with respect to those claims.
In connection with the organization and capitalization of Texas Genco,
Texas Genco assumed liabilities associated with the electric generation assets
Reliant Energy transferred to it. Texas Genco also agreed to indemnify, and
cause the applicable transferee subsidiaries to indemnify, CenterPoint Energy
and it subsidiaries, including us, with respect to liabilities associated with
the transferred assets and businesses. In many cases the liabilities assumed
were our obligations and we were not released by third parties from these
liabilities. The indemnity provisions were intended generally to place sole
financial responsibility on Texas Genco and its subsidiaries for all liabilities
associated with the current and historical businesses and operations of Texas
Genco, regardless of the time those liabilities arose. In connection with the
sale of Texas Genco's fossil generation assets (coal, lignite and gas-fired
plants) to Texas Genco LLC, the separation agreement CenterPoint Energy entered
into with Texas Genco in connection with the organization and capitalization of
Texas Genco was amended to provide that all of Texas Genco's rights and
obligations under the separation agreement relating to its fossil generation
assets, including Texas Genco's obligation to indemnify CenterPoint Energy and
its subsidiaries, including us, with respect to liabilities associated with the
fossil generation assets and related business, were assigned to and assumed by
Texas Genco LLC. In addition, under the amended separation agreement, Texas
Genco is no longer liable for, and CenterPoint Energy has assumed and agreed to
indemnify Texas Genco LLC against, liabilities that Texas Genco originally
assumed in connection with its organization to the extent, and only to the
extent, that such liabilities are covered by certain insurance policies or other
similar agreements held by CenterPoint Energy. If Texas Genco or Texas Genco LLC
were unable to satisfy a liability that had been so assumed or indemnified
against, and provided Reliant Energy had not been released from the liability in
connection with the transfer, we could be responsible for satisfying the
liability.
CenterPoint Energy or it subsidiaries have been named, along with
numerous others, as a defendant in lawsuits filed by a large number of
individuals who claim injury due to exposure to asbestos. Most claimants in such
litigation have been workers who participated in construction of various
industrial facilities, including power plants. Some of the claimants have worked
at
locations CenterPoint Energy owns, but most existing claims relate to
facilities previously owned by CenterPoint Energy but currently owned by Texas
Genco LLC. We anticipate that additional claims like those received may be
asserted in the future. Under the terms of the separation agreement between
CenterPoint Energy and Texas Genco, ultimate financial responsibility for
uninsured losses from claims relating to facilities transferred to Texas Genco
has been assumed by Texas Genco, but under the terms of CenterPoint Energy's
agreement to sell Texas Genco to Texas Genco LLC, CenterPoint Energy has agreed
to continue to defend such claims to the extent they are covered by insurance
CenterPoint Energy maintains, subject to reimbursement of the costs of such
defense from Texas Genco LLC.