1
EXHIBIT 99(a)

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)

These and other pro forma results appearing in this Form 10-K are based on
assumptions deemed appropriate by the Company's management, have been prepared
for informational purposes only and are not necessarily indicative of the
combined results that would have resulted had the Merger occurred at the
beginning of the 1996 and 1997 reporting periods presented. Purchase related
adjustments to results of operations include amortization of goodwill and the
effects on depreciation, amortization, interest expense and deferred income
taxes of the revaluation, on a preliminary basis, of the fair value of certain
NorAm assets and liabilities.

As a result of the Merger, the Company has organized its financial
reporting into the following segments: Electric Operations, Natural Gas
Distribution, Interstate Pipeline, Energy Marketing, International and
Corporate. For segment information, see Note 15.

The Company and certain subsidiaries of NorAm apply the accounting policies
established in SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation," to the accounts of Electric Operations, Natural Gas Distribution
and the Interstate Pipeline operations of MRT. In general, SFAS No. 71 permits a
company with cost-based rates to defer certain costs that would otherwise be
expensed to the extent that the rate regulated company is recovering or expects
to recover such costs in rates charged to its customers.

The following is a list of regulatory assets and liabilities reflected on
the Company's Consolidated Balance Sheet as of December 31, 1997, detailed by
Electric Operations and other segments.

ELECTRIC TOTAL
OPERATIONS OTHER COMPANY
---------- ----- -------
(MILLIONS OF DOLLARS)

Deferred plant costs -- net............................. $ 562 $ 562
Recoverable project costs -- net........................ 78 78
Regulatory tax asset -- net............................. 357 357
Unamortized loss on reacquired debt..................... 127 127
Deferred debits......................................... 71 $48 119
Accumulated deferred income taxes -- regulatory tax
asset................................................. (99) (99)
------ --- ------
Total......................................... $1,096 $48 $1,144
====== === ======

If, as a result of changes in regulation or competition, the Company and
NorAm's ability to recover these assets and/or liabilities would not be assured,
then pursuant to SFAS No. 101, "Accounting for the Discontinuation of
Application of SFAS No. 71" and SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company and
NorAm would be required to write off or write down such net regulatory assets to
the extent that they ultimately were determined not to be recoverable.

Effective January 1, 1996, the Company and NorAm adopted SFAS No. 121. SFAS
No. 121 requires that long-lived assets and certain identifiable intangibles to
be held and used or disposed of by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Adoption of the standard did not result in a write-down
of the carrying amount of any asset on the books of the Company or NorAm.

In July 1997, the Emerging Issues Task Force (EITF) of the FASB reached a
consensus on Issue No. 97-4, "Deregulation of the Pricing of
Electricity -- Issues Related to the Application of FASB Statements No. 71,
Accounting for the Effects of Certain Types of Regulation, and No. 101,
Regulated Enterprises -- Accounting for the Discontinuation of Application of
FASB Statement No. 71" (EITF 97-4). EITF 97-4 concluded that the application of
SFAS No. 71 to a segment which is subject to a deregulation

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

reporting period, the options' exercise prices were greater than the average
market price of the common shares of $21.875 and would thus be anti-dilutive if
conversion were assumed.

(k) Statements of Consolidated Cash Flows.

For purposes of reporting cash flows, cash equivalents are considered to be
short-term, highly liquid investments readily convertible to cash.

(l) Derivative Financial Instruments (Risk Management).

For information regarding the Company's accounting for derivative financial
instruments associated with its subsidiaries' natural gas, electric power and
transportation risk management activities, see Note 2.

(m) Income Taxes.

The Company and its subsidiaries file a consolidated federal income tax
return. The Company follows a policy of comprehensive interperiod income tax
allocation. Investment tax credits were deferred and are being amortized over
the estimated lives of the related property. For additional information
regarding income taxes, see Note 11.

(n) Investments in Time Warner Securities.

The Company owns 11 million shares of non-publicly traded Time Warner
convertible preferred stock (TW Preferred). The TW Preferred is redeemable after
July 6, 2000, has an aggregate liquidation preference of $100 per share (plus
accrued and unpaid dividends), is entitled to annual dividends of $3.75 per
share until July 6, 1999, is currently convertible by the Company and after July
6, 1999 is exchangeable by Time Warner into approximately 22.9 million shares of
Time Warner common stock. Each share of preferred stock is entitled to two votes
(voting together with the holders of the Time Warner common stock as a single
class).

The Company has recorded its investment in these securities at a value of
$990 million on the Company's Consolidated Balance Sheets. Investment in the TW
Preferred is accounted for under the cost method. Dividends on these securities
are recognized as income at the time they are earned. The Company recorded
pre-tax dividend income with respect to the Time Warner securities of $41.3
million, $41.6 million and $20.1 million in 1997, 1996 and 1995, respectively.

To monetize its investment in the TW Preferred, the Company sold in July
1997, 22.9 million of its unsecured 7% ACES. For additional information about
the offering of ACES, see Note 8(e). As a result of the issuance of the ACES, a
portion of the increase in the market value above $55.5844 per share of Time
Warner common stock (the security into which the TW Preferred is convertible)
results in unrealized accounting losses to the Company for the ACES, pending the
conversion of the Company's TW Preferred into Time Warner common stock. For
example, prior to the conversion of the TW Preferred into Time Warner common
stock, when the market price of Time Warner common stock increases above
$55.5844, the Company records in Other Income (Expense) an accounting loss for
the ACES equal to (i) the aggregate amount of such increase as applicable to all
ACES multiplied by (ii) 0.8264. In accordance with generally accepted accounting
principles, this accounting loss (which reflects the unrealized increase in the
Company's indebtedness with respect to the ACES) may not be offset by accounting
recognition of the increase in the market value of the Time Warner common stock
that underlies the TW Preferred. Upon conversion of the TW Preferred, the
Company will begin recording unrealized net changes in the market prices of the
Time Warner common stock and the ACES as a component of common stock equity.

As of December 31, 1997, the market price of Time Warner common stock was
$62.00 per share. Accordingly, the Company recognized an increase of $121
million in the unrealized liability relating to its ACES indebtedness (which
resulted in an after-tax earnings reduction of $79 million or $.31 per share).
The

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Company believes that this unrealized loss for the ACES is more than
economically hedged by the approximately $430 million unrecorded unrealized gain
at December 31, 1997 relating to the increase in the fair value of the Time
Warner common stock underlying the investment in TW Preferred since the date of
its acquisition. As of February 28, 1998, the price of Time Warner common stock
was $67.50 per share which would have resulted in the Company recognizing an
additional increase of $104 million in the unrealized liability represented by
its indebtedness under the ACES. The related unrecorded unrealized gain as of
February 28, 1998 would have been computed as an additional $126 million.

(o) Investment in Other Debt and Equity Securities.

The securities held in the Company's nuclear decommissioning trust are
classified as "available-for-sale" and, in accordance with SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," (SFAS No.
115) are reported at estimated fair value of $92.9 million as of December 31,
1997 and $67 million as of December 31, 1996 on the Company's Consolidated
Balance Sheets under deferred debits. The liability for nuclear decommissioning
is reported on the Company's Consolidated Balance Sheets under deferred credits.
Any unrealized gains or losses are accounted for in accordance with SFAS No. 71
as a regulatory asset/liability and reported on the Company's Consolidated
Balance Sheets as a deferred debit/ credit.

The Company, through its subsidiary, NorAm, holds certain equity securities
classified as "available-for-sale" and in accordance with SFAS No. 115 reports
such investments at estimated fair values on the Company's Consolidated Balance
Sheets as deferred debits and any unrealized gain or loss, net of tax, as a
separate component of stockholders' equity. At December 31, 1997, the unrealized
loss relating to these equity securities was approximately $5.6 million, net of
tax.

(p) Discontinued Operations.

In July 1995, the Company sold KBLCOM, its cable television subsidiary. The
Company's 1995 earnings include a one-time after-tax gain of $708 million
related to the sale, which includes the net loss for discontinued operations of
KBLCOM through the date of sale (July 6, 1995).

(q) Reclassifications and Use of Estimates.

Certain amounts from the previous years have been reclassified to conform
to the 1997 presentation of financial statements. Such reclassifications do not
affect earnings.

The preparation of financial statements in conformity with generally
accepted accounting principles 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.

(r) Other.

For information regarding executive incentive compensation, pensions and
other benefits, see Note 10.

(2) DERIVATIVE FINANCIAL INSTRUMENTS (RISK MANAGEMENT)

(a) Trading Activities.

The Company, through NES, a subsidiary of NorAm, offers price risk
management services primarily in the natural gas and electric industries. NES
provides these services through, and by utilizing, a variety of derivative
financial instruments, including fixed-price swap agreements, variable-price
swap agreements,

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

exchange-traded energy futures and option contracts, and swaps and options
traded in the over-the-counter financial markets. Fixed-price swap agreements
require payments to, or receipts of payments from, counterparties based on the
differential between a fixed and variable price for the commodity.
Variable-price swap agreements require payments to, or receipts of payments
from, counterparties based on the differential between either industry pricing
publications or exchange quotations.

Certain trading transactions qualify for hedge accounting and accordingly
unrealized gains and losses associated with these transactions are deferred. For
trading transactions that do not qualify for hedge accounting, NES uses
mark-to-market accounting. Accordingly, such financial instruments are recorded
at fair value with realized and unrealized gains (losses) recorded as a
component of operating revenues in the Company's Consolidated Statements of
Income. The recognized, unrealized balance is recorded as a deferred debit on
the Company's Consolidated Balance Sheets.

The notional quantities and maximum terms of derivative financial
instruments held for trading purposes at December 31, 1997 are presented below
(volumes in billions of British thermal units equivalent (Bbtue)):

VOLUME-FIXED
VOLUME-FIXED PRICE MAXIMUM
PRICE PAYOR RECEIVER TERM (YEARS)
------------ ------------ ------------

Natural gas...................................... 85,701 64,890 4
Electricity...................................... 40,511 42,976 1

In addition to the fixed-price notional volumes above, NES also has
variable-price swap agreements, as discussed above, totaling 101,465 Bbtue.
Notional amounts reflect the volume of transactions but do not represent the
amounts exchanged by the parties to the financial instruments. Accordingly,
notional amounts do not accurately measure the Company's exposure to market or
credit risks.

The estimated fair value of derivative financial instruments held for
trading purposes at December 31, 1997 are presented below (dollars in millions):

AVERAGE FAIR
FAIR VALUE VALUE(A)
--------------------- ---------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------

Natural gas.................................. $46 $39 $56 $48
Electricity.................................. $ 6 $ 6 $ 3 $ 2

- ---------------

(a) Computed using the ending balance of each month.

Substantially all of the fair value shown in the table above at December
31, 1997 has been recognized in income. The fair value as of and for the year
ended December 31, 1997 was estimated using quoted prices where available and
considering the liquidity of the market for the derivative financial
instruments. The prices are subject to significant changes based on changing
market conditions. The derivative financial instruments included in the NES
trading portfolio as of and for the year ended December 31, 1996 were
immaterial.

The weighted-average term of the trading portfolio, based on volumes, is
less than one year. The maximum and average terms disclosed herein are not
indicative of likely future cash flows as these positions may be changed by new
transactions in the trading portfolio at any time in response to changing market
conditions, market liquidity and the Company's risk management portfolio needs
and strategies. Terms regarding cash settlements of these contracts vary with
respect to the actual timing of cash receipts and payments.

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(b) Non-Trading Activities.

To reduce the risk from market fluctuations in the price of electric power,
natural gas and related transportation, NorAm and certain of its subsidiaries
enter into futures transactions, swaps and options (Energy Derivatives) in order
to hedge certain natural gas in storage, as well as certain expected purchases,
sales and transportation of natural gas and electric power (a portion of which
are firm commitments at the inception of the hedge). Energy Derivatives are also
utilized to fix the price of compressor fuel or other future operational gas
requirements, although usage to date for this purpose has not been material.
Usage of electricity derivative financial instruments by the Company and its
subsidiaries for purposes other than trading is immaterial.

Certain subsidiaries of the Company also utilize interest-rate derivatives
(principally interest-rate swaps) in order to adjust the portion of its overall
borrowings which are subject to interest-rate risk, and also utilize such
derivatives to effectively fix the interest rate on debt expected to be issued
for refunding purposes.

For transactions involving either Energy Derivatives or interest-rate
derivatives, hedge accounting is applied only if the derivative (i) reduces the
price risk of the underlying hedged item and (ii) is designated as a hedge at
its inception. Additionally, the derivatives must be expected to result in
financial impacts which are inversely correlated to those of the item(s) to be
hedged. This correlation (a measure of hedge effectiveness) is measured both at
the inception of the hedge and on an ongoing basis, with an acceptable level of
a correlation of at least 80% for hedge designation. If and when correlation
ceases to exist at an acceptable level, hedge accounting ceases and
mark-to-market accounting is applied.

In the case of interest-rate swaps associated with existing obligations,
cash flows and expenses associated with the interest-rate derivative
transactions are matched with the cash flows and interest expense of the
obligation being hedged, resulting in an adjustment to the effective interest
rate. When interest rate swaps are utilized to effectively fix the interest rate
for an anticipated debt issuance, changes in the market value of the
interest-rate derivatives are deferred and recognized as an adjustment to the
effective interest rate on the newly issued debt.

Unrealized changes in the market value of Energy Derivatives utilized as
hedges are not generally recognized in the Company's Consolidated Statements of
Income until the underlying hedged transaction occurs. Once it becomes probable
that an anticipated transaction will not occur, deferred gains and losses are
recognized. In general, the financial impact of transactions involving these
Energy Derivatives is included in the Company's Statement of Consolidated Income
under the captions (i) fuel expenses, in the case of natural gas transactions,
and (ii) purchased power, in the case of electric power transactions. Cash flows
resulting from these transactions in Energy Derivatives are included in the
Company's Statements of Consolidated Cash Flows in the same category as the item
being hedged.

At December 31, 1997, subsidiaries of NorAm were fixed-price payors and
fixed-price receivers in Energy Derivatives covering 38,754 Bbtu and 7,647 Bbtu
of natural gas, respectively. Also, at December 31, 1997 subsidiaries of NorAm
were parties to variable-priced Energy Derivatives totaling 3,630 Bbtu of
natural gas. The weighted average maturity of these instruments is less than one
year.

The notional amount is intended to be indicative of the Company and its
subsidiaries' level of activity in such derivatives, although the amounts at
risk are significantly smaller because, in view of the price movement
correlation required for hedge accounting, changes in the market value of these
derivatives generally are offset by changes in the value associated with the
underlying physical transactions or in other derivatives. When Energy
Derivatives are closed out in advance of the underlying commitment or
anticipated transaction, however, the market value changes may not offset due to
the fact that price movement correlation ceases to exist when the positions are
closed as further discussed below. Under such circumstances, gains (losses) are
deferred and recognized as a component of income when the underlying hedged item
is recognized in income.

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The average maturity discussed above and the fair value discussed in Note
13 are not necessarily indicative of likely future cash flows as these positions
may be changed by new transactions in the trading portfolio at any time in
response to changing market conditions, market liquidity and the Company's risk
management portfolio needs and strategies. Terms regarding cash settlements of
these contracts vary with respect to the actual timing of cash receipts and
payments.

In addition to the risk associated with price movements, credit risk is
also inherent in the Company and its subsidiaries' risk management activities.
Credit risk relates to the risk of loss resulting from non-performance of
contractual obligations by a counterparty. While, as yet, the Company and its
subsidiaries have experienced no significant losses due to the credit risk
associated with these arrangements, the Company has off-balance sheet risk to
the extent that the counterparties to these transactions may fail to perform as
required by the terms of each such contract. In order to minimize this risk, the
Company and/or its subsidiaries, as the case may be, enter into such contracts
primarily with those counterparties with a minimum Standard & Poor's or Moody's
rating of BBB- or Baa3, respectively. For long-term arrangements, the Company
and its subsidiaries periodically review the financial condition of such firms
in addition to monitoring the effectiveness of these financial contracts in
achieving the Company's objectives. Should the counterparties to these
arrangements fail to perform, the Company would seek to compel performance at
law or otherwise, or obtain compensatory damages in lieu thereof. The Company
might be forced to acquire alternative hedging arrangements or be required to
honor the underlying commitment at then current market prices. In such event,
the Company might incur additional loss to the extent of amounts, if any,
already paid to the counterparties. In view of its criteria for selecting
counterparties, its process for monitoring the financial strength of these
counterparties and its experience to date in successfully completing these
transactions, the Company believes that the risk of incurring a significant
financial statement loss due to the non-performance of counterparties to these
transactions is minimal.

The Company's policies prohibit the use of leveraged financial instruments.

The Company has established a Risk Oversight Committee to oversee all
corporate price and credit risk, including NES' risk management and trading
activities. The Risk Oversight Committee's responsibilities include reviewing
the Company and its subsidiaries' overall risk management strategy and
monitoring risk management activities to ensure compliance with the Company's
risk management limitations, policies and procedures.

(3) RATE MATTERS

(a) Electric Proceedings.

The Texas Utility Commission has original (or in some cases appellate)
jurisdiction over Electric Operations' electric rates and services. Texas
Utility Commission orders may be appealed to a District Court in Travis County,
and from that court's decision an appeal may be taken to the Court of Appeals
for the 3rd District at Austin (Austin Court of Appeals). Discretionary review
by the Supreme Court of Texas may be sought from decisions of the Austin Court
of Appeals. In the event that the courts ultimately reverse actions of the Texas
Utility Commission, such matters are remanded to the Texas Utility Commission
for action in light of the courts' orders.

(b) Transition and Price Reduction Plan.

In 1997, the Texas legislature considered but did not pass legislation
intended to address various issues concerning the restructuring of the electric
utility industry, including proposals that would permit Texas retail electric
customers to choose their own electric suppliers beginning on December 31, 2001.
The legislative proposals included provisions relating to full stranded cost
recovery; rate reductions; rate freezes; the

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

unbundling of generation operations, transmission and distribution and customer
service operations; securitization of regulatory assets; and consumer
protections. Although the Company and certain other parties (including the Texas
Utility Commission) supported the bill, it was not enacted prior to the
expiration of the legislative session.

In October 1997, the Company announced a proposed transition to competition
plan intended to address certain aspects of the proposals contained in the
legislation formerly pending before the Texas legislature. By mid December 1997,
negotiations resulted in a settlement agreement (Settlement Agreement) executed
by the Company, the staffs of the Texas Utility Commission and the City of
Houston, representatives of the state's principal consumer and industrial groups
and others. The Settlement Agreement was subsequently filed with the Texas
Utility Commission, where it is currently under consideration.

Under the terms of the Settlement Agreement, residential customers will
receive a 4% credit to the base cost of electricity in 1998, increasing to 6% in
1999. Small and mid-sized businesses will receive a 2% credit to their base
costs beginning in 1998. The combined effect of these reductions is expected to
decrease base revenues by $166 million over a two year period. In addition, the
Company (over the next two years) will be permitted, as a way to assist the
Company in mitigating its potentially stranded costs, to (i) redirect to
production property all of its current depreciation expenses that would
otherwise be credited to accumulated depreciation for transmission and
distribution property, and (ii) apply any and all earnings above a rate of
return cap of 9.95% to increase the depreciation of production property. The
Company estimates that redirected depreciation over the two-year period of 1998
and 1999 will be approximately $364 million. As part of the Settlement
Agreement, the Company agreed to support proposed legislation in the 1999 Texas
legislative session that includes provisions providing for retail customer
choice effective December 31, 2001 and other provisions consistent with those in
the 1997 proposed legislation.

The Settlement Agreement is currently under consideration by the Texas
Utility Commission, the City of Houston and other cities served by HL&P. In
December 1997, the Texas Utility Commission approved the petition filed by the
Company to implement the requested base rate credits on a temporary basis
beginning January 1, 1998, and pending final Texas Utility Commission
consideration. The approval also included the accounting order necessary to
permit the Company to begin redirecting depreciation from its transmission and
distribution facilities to production property on a temporary basis pending
final Texas Utility Commission consideration. A procedural schedule has been
developed by the Texas Utility Commission whereby a final decision regarding the
Settlement Agreement would be reached by the end of March 1998.

In August 1995, the Texas Utility Commission unanimously approved a
settlement resolving the Company's most recent rate case (Docket No. 12065) as
well as a separate proceeding (Docket No. 13126) regarding the prudence of
operation of the South Texas Project.

See Note 1(f) regarding additional depreciation and amortization that is
permitted under the 1995 Rate Case Settlement with respect to the South Texas
Project and the Company's investment in certain lignite reserves associated with
a canceled generating station.

(d) Docket No. 6668.

In September 1997, the Company received a judgment dismissing all
outstanding appeals of the Texas Utility Commission's order in Docket No. 6668,
an inquiry into the prudence of the planning and construction of the South Texas
Project. In that order, the Texas Utility Commission had determined that $375.5
million of the Company's $2.8 billion investment in the South Texas Project had
been imprudently incurred. That ruling was incorporated into Electric
Operations' 1988 and 1991 rate cases. As a result of this judgment, all

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

outstanding appeals of prior rate cases involving the Company have now been
dismissed and the orders granted in such cases are now final.

(4) JOINTLY OWNED ELECTRIC UTILITY PLANT

(a) Investment in South Texas Project.

The Company has a 30.8% interest in the South Texas Project, which consists
of two 1,250 MW nuclear generating units, and bears a corresponding 30.8% share
of capital and operating costs associated with the project. As of December 31,
1997, the Company's investment in the South Texas Project was $1.8 billion (net
of $714 million accumulated depreciation). The Company's investment in nuclear
fuel (including AFUDC) was $51 million (net of $205 million amortization) as of
such date.

Effective November 1997, the Company and the other three owners of the
South Texas Project completed the transfer of the Company's responsibilities for
operation of the South Texas Project to a new Texas non-profit corporation
formed by the four owners and known as the STP Nuclear Operating Company
(STPNOC). STPNOC was formed exclusively for the purpose of operating the South
Texas Project, and the Company's officers and employees who had been responsible
for day-to-day operation and management of the South Texas Project were
transferred to the operating company in October, 1997 and the related employee
benefit obligations were transferred in December, 1997. The operating company is
managed by a board of directors composed of one director from each of the four
owners, along with the chief executive officer of STPNOC. Formation of STPNOC
did not affect the underlying ownership of the South Texas Project, which
continues as a tenancy in common among the four owners, with each owner
retaining its undivided ownership interest in the two nuclear-fueled generating
units and the electrical output from those units. The four owners continue to
provide overall oversight of the operations of the South Texas Project through
an owners' committee composed of representatives of each of the owners and
through the board of directors of STPNOC.

(b) 1996 Settlement of South Texas Project Litigation.

In 1996, the Company recorded an aggregate $95 million ($62 million net of
tax) charge in connection with various settlements of lawsuits filed by
co-owners of the South Texas Project. The formation of STPNOC by the four
co-owners (including the Company) of the South Texas Project was contemplated by
these settlements. For information about the execution of an operations
agreement with the City of San Antonio in connection with one of these
settlements, see Note 12(c).

The Company and the other owners of the South Texas Project maintain
nuclear property and nuclear liability insurance coverage as required by law and
periodically review available limits and coverage for additional protection. The
owners of the South Texas Project currently maintain $2.75 billion in property
damage insurance coverage, which is above the legally required minimum, but is
less than the total amount of insurance currently available for such losses.
This coverage consists of $500 million in primary property damage insurance and
excess property insurance in the amount of $2.25 billion. With respect to excess
property insurance, the Company and the other owners of the South Texas Project
are subject to assessments, the maximum aggregate assessment under current
policies being $11.5 million during any one policy year. The application of the
proceeds of such property insurance is subject to the priorities established by
the Nuclear Regulatory Commission (NRC) regulations relating to the safety of
licensed reactors and decontamination operations.

Pursuant to the Price Anderson Act (Act), the maximum liability to the
public of owners of nuclear power plants, such as the South Texas Project, was
$8.72 billion as of December 1997. Owners are required under the Act to insure
their liability for nuclear incidents and protective evacuations by maintaining
the

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

maximum amount of financial protection available from private sources and by
maintaining secondary financial protection through an industry retrospective
rating plan. The assessment of deferred premiums provided by the plan for each
nuclear incident is up to $79.3 million per reactor, subject to indexing for
inflation, a possible 5% surcharge (but no more than $10 million per reactor per
incident in any one year) and a 3% state premium tax. The Company and the other
owners of the South Texas Project currently maintain the required nuclear
liability insurance and participate in the industry retrospective rating plan.

There can be no assurance that all potential losses or liabilities will be
insurable, or that the amount of insurance will be sufficient to cover them. Any
substantial losses not covered by insurance would have a material effect on the
Company's financial condition and results of operations.

(d) Nuclear Decommissioning.

The Company contributes $14.8 million per year to a trust established to
fund its share of the decommissioning costs for the South Texas Project. For a
discussion of securities held in the Company's nuclear decommissioning trust,
see Note 1(o). In May 1994, an outside consultant estimated the Company's
portion of decommissioning costs to be approximately $318 million (1994
dollars). The consultant's calculation of decommissioning costs for financial
planning purposes used the DECON methodology (prompt removal/dismantling), one
of the three alternatives acceptable to the NRC, and assumed deactivation of
Units Nos. 1 and 2 upon the expiration of their 40-year operating licenses.
While the current and projected funding levels currently exceed minimum NRC
requirements, no assurance can be given that the amounts held in trust will be
adequate to cover the actual decommissioning costs of the South Texas Project.
Such costs may vary because of changes in the assumed date of decommissioning,
changes in regulatory and accounting requirements, changes in technology and
changes in costs of labor, materials and equipment.

(e) Assessment Fees for Spent Fuel Disposal and Enrichment and Decommission

By contract, the United States Department of Energy (DOE) has committed
itself ultimately to take possession of all spent fuel generated by the South
Texas Project. The DOE contract currently requires payment of a spent fuel
disposal fee on nuclear plant-generated electricity of one mill (one-tenth of a
cent) per net KWH sold. This fee is subject to adjustment to ensure full cost
recovery by the DOE. The Energy Policy Act also includes a provision that
assesses a fee upon domestic utilities that purchased nuclear fuel enrichment
services from the DOE before October 24, 1992. The South Texas Project's
assessment is approximately $2 million per year (subject to escalation for
inflation). The Company has a remaining estimated liability of $5.5 million for
such assessments.

(5) EQUITY INVESTMENTS IN FOREIGN AFFILIATES

HI Energy, a wholly owned subsidiary of the Company formed in 1993,
participates primarily in the development and acquisition of foreign independent
power projects and the privatization of foreign generating and distribution
companies.

The Company accounts for affiliate investments of its subsidiaries under
the equity method of accounting where: (i) the subsidiary's ownership interest
in the affiliate ranges from 20% to 50%, (ii) the ownership interest is less
than 20% but the subsidiary exercises significant influence over operating and
financial policies of such affiliate or (iii) the subsidiary's ownership
interest in the affiliate exceeds 50% but the subsidiary does not exercise
control over the affiliate. The Company's proportionate share of the equity in
net income in these affiliates for the years ended December 31, 1997, 1996 and
1995 was $48.6 million, $17 million and $.5 million, respectively, which amounts
are included on the Company's Statements of Consolidated Income in
Revenues -- International.

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

The Company's and its subsidiaries' equity investments in foreign and
non-regulated affiliates at December 31, 1997 and 1996 were $704 million and
$502 million, respectively.

(a) Acquisitions.

In May 1996, a subsidiary of HI Energy acquired 11.35% of the common stock
of Light, a publicly held Brazilian corporation, for $393 million which includes
the direct costs of the acquisition. Light is the operator under a 30-year
concession agreement of an integrated electric power and distribution system
that serves a portion of the state of Rio de Janeiro, Brazil, including the city
of Rio de Janeiro. The winning bidders in the government-sponsored auction of
Light, including a subsidiary of HI Energy, formed a consortium whose aggregate
ownership interest of 50.44% represents a controlling interest in Light.

In June 1997, a consortium of investors which included a subsidiary of HI
Energy, acquired for $496 million a 56.7% controlling ownership interest in
Empresa de Energia del Pacifico S.A.E.S.P. (EPSA), an electric utility system
serving the Valle de Cauca region of Colombia, including the area surrounding
the city of Cali. HI Energy contributed $152 million of the purchase price for a
28% ownership interest in EPSA. In addition to its distribution facilities, EPSA
owns 850 MW of electric generation capacity.

In May 1997, HI Energy increased its indirect ownership interest in Empresa
de la Plata S.A. (EDELAP), an Argentina electric utility, from 48% to 63%. The
purchase price of the additional interest was $28 million. HI Energy has
recorded its investment in EDELAP using the equity method because of the
significance of the participatory rights held by a minority shareholder.

HI Energy has accounted for these transactions under purchase accounting
and has recorded its investments and its interest in the affiliates' earnings
after the acquisition dates using the equity method. The purchase prices were
allocated on the basis of the estimated fair market values of the assets
acquired and the liabilities assumed as of the dates of acquisition. The
differences between the amounts paid and the underlying fair values of the net
assets acquired are being amortized as a component of earnings attributable to
unconsolidated affiliates over the estimated lives of the projects ranging from
30 to 40 years. Purchase price adjustments to fixed assets are being amortized
over the underlying assets' estimated useful lives.

(b) Valuation Allowance.

HI Energy is an investor in two waste tire-to-energy projects in the State
of Illinois. The projects had been developed by HI Energy in reliance upon a
state subsidy intended to encourage development of energy project facilities for
the disposal of solid waste. In March 1996, the State of Illinois repealed the
subsidy. As a result of the loss of the subsidy, the Company recorded (i) a $28
million valuation allowance effective in the fourth quarter of 1995 (resulting
in an $18 million after-tax charge in that year) and (ii) an additional $8
million valuation allowance in the first quarter of 1996 (resulting in a $5
million after-tax charge in that year). At the time of the Illinois
legislature's actions, construction work on one of the waste-to-energy projects
had been substantially completed.

The valuation allowance reflects the combined amounts lent to the projects
on a subordinated basis by HI Energy. HI Energy also is a party to two separate
note purchase agreements committing it, under certain circumstances, to lend up
to an additional $16 million. The Company has entered into a support agreement
to enable HI Energy to honor its obligation under these note purchase
agreements. In the Company's opinion, it is unlikely that additional loans would
be required to be made under the note purchase agreements relating to the
facility for which construction had been substantially completed (Ford Heights
Project). In March 1996, a subsidiary of HI Energy purchased from a senior
lending bank all notes relating to the project for which construction had not
yet commenced (Fulton Project) (approximately $4.1 million). As a consequence,
HI Energy has discretion over when, if ever, the construction activities for the
Fulton project will

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

resume and, in turn, control over future obligations of HI Energy to acquire
additional subordinated notes for the Fulton project.

The Company and HI Energy are defendants in various lawsuits filed in
connection with the Ford Heights Project. CGE Ford Heights, L.L.C., (CGE Ford
Heights) the owner of the project, has filed for reorganization under Chapter 11
of the Federal Bankruptcy Code. In October 1997, CGE Ford Heights filed a
lawsuit against First Trust National Association, HI Energy and Zurn Industries,
Inc. (Zurn). CGE Ford Heights is seeking a determination of the funding
obligations of HI Energy and Zurn. In addition, the trustee for the holders of
the bonds issued to finance the project has filed suit against the Company, HI
Energy and Zurn. The trustee alleges that the Company and HI Energy are
obligated to contribute to CGE Ford Heights approximately $15 million in the
form of subordinated debt obligations. The Company and HI Energy are vigorously
contesting the matter. The Company does not believe that the litigation will
have a material adverse impact on the Company's or HI Energy's financial
statements.

(6) COMMON STOCK

At December 31, 1997, the Company had 282,875,266 shares of common stock
issued and outstanding (out of a total of 700,000,000 authorized shares). At
December 31, 1996, the number of shares of outstanding common stock of Former HI
was 233,335,481.

Outstanding common shares excluded (i) shares pledged to secure a loan to
the Company's Employee Stock Ownership Plan (12,388,551 and 13,370,939 at
December 31, 1997 and 1996, respectively) and (ii) treasury shares (93,459 and
16,042,027 at December 31, 1997 and 1996, respectively). Treasury shares at
December 31, 1996 represent shares purchased under a common stock repurchase
program prior to the Merger. In connection with the Merger, these treasury
shares were canceled and retired in August 1997. At December 31, 1997, the
Company held 93,459 shares, which shares were received from holders of Company
stock options, who surrendered shares of Company stock as partial payment for
the exercise price of their stock options.

In 1997, the Company paid four regular quarterly dividends aggregating
$1.50 per share on its common stock pursuant to dividend declarations made in
December 1996, March 1997, June 1997 and September 1997. In December 1997, the
Company declared its regular quarterly dividend of $0.375 per share to be paid
in March 1998. For information regarding certain restrictions on payments of
dividends, see Note 8(c).

(7) PREFERRED AND PREFERENCE STOCK

(a) Preferred Stock.

At December 31, 1997, the Company had 10,000,000 authorized shares of
preferred stock, of which 97,397 shares were outstanding. As of such date, the
Company's only outstanding series of preferred stock was its $4.00 Preferred
Stock. The $4.00 Preferred Stock pays an annual dividend of $4.00 per share, is
redeemable at $105 per share and has a liquidation price of $100 per share.

In April 1997, the Company redeemed all remaining 257,000 shares of its
$9.375 cumulative preferred stock pursuant to mandatory sinking fund
requirements at a cost of $25.7 million, plus accrued dividends. In February
1997, the Company redeemed the following three series of its cumulative
preferred stock at the redemption prices, plus accrued dividends, indicated:

NUMBER OF REDEMPTION PRICE
SERIES SHARES PER SHARE
------ --------- ----------------

$6.72.................................................... 250,000 $102.51
$7.52.................................................... 500,000 $102.35
$8.12.................................................... 500,000 $102.25

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

$6.4 million was recorded at the Acquisition Date. In addition, NorAm has
approximately $58 million of federal alternative minimum tax credits which are
available to reduce future federal income taxes payable, if any, over an
indefinite period (although not below the tentative minimum tax otherwise due in
any year), and approximately $2.6 million of state alternative minimum tax
credits which are available to reduce future state income taxes payable, if any,
through the year 2001.

(12) COMMITMENTS AND CONTINGENCIES

(a) Commitments.

The Company has various commitments for capital expenditures, fuel,
purchased power, cooling water and operating leases. Commitments in connection
with Electric Operations' capital program are generally revocable by the
Company, subject to reimbursement to manufacturers for expenditures incurred or
other cancellation penalties. The Company's and its subsidiaries' other
commitments have various quantity requirements and durations. However, if these
requirements could not be met, various alternatives are available to mitigate
the cost associated with the contracts' commitments.

(b) Fuel and Purchased Power.

The Company is a party to several long-term coal, lignite and natural gas
contracts which have various quantity requirements and durations. Minimum
payment obligations for coal and transportation agreements are approximately
$200 million in 1998, $203 million in 1999 and $177 million in 2000.
Additionally, minimum payment obligations for lignite mining and lease
agreements are approximately $9 million for 1998, $9 million for 1999 and $10
million for 2000. Minimum payment obligations for both natural gas purchase and
storage contracts associated with Electric Operations are approximately $9
million annually in 1998, 1999 and 2000.

The Company also has commitments to purchase firm capacity from
cogenerators of approximately $22 million in both 1998 and 1999. Texas Utility
Commission rules currently allow recovery of these costs through Electric
Operations' base rates for electric service and additionally authorize the
Company to charge or credit customers through a purchased power cost recovery
factor for any variation in actual purchased power costs from the cost utilized
to determine its base rates. In the event that the Texas Utility Commission, at
some future date, does not allow recovery through rates of any amount of
purchased power payments, the two principal firm capacity contracts contain
provisions allowing the Company to suspend or reduce payments and seek repayment
for amounts disallowed.

As part of the settlement with the City of San Antonio, the Company entered
into a 10-year joint operations agreement under which the Company and the City
of San Antonio, acting through the City Public Service Board of San Antonio
(CPS), share savings resulting from the joint dispatching of their respective
generating assets in order to take advantage of each system's lower cost
resources. Under the terms of the joint operations agreement entered into
between CPS and Electric Operations, the Company has guaranteed CPS minimum
annual savings of $10 million and a minimum cumulative savings of $150 million
over the 10-year term of the agreement. Based on current forecasts and other
assumptions regarding the combined operation of the two generating systems, the
Company anticipates that the savings resulting from joint operations will equal
or exceed the minimum savings guaranteed under the joint operating agreement. In
1996, savings generated for CPS' account for a partial year of joint operations
were approximately $14 million. In 1997, savings generated for CPS' account for
a full year of operation were approximately $22 million.

(d) Transportation Agreement.

NorAm had an agreement (the ANR Agreement) with ANR Pipeline Company (ANR)
which contemplated a transfer to ANR of an interest in certain of NorAm's
pipeline and related assets, representing

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

capacity of 250 Mmcf/day, and pursuant to which ANR had advanced $125 million to
the Company. The ANR Agreement has been restructured and, after refunds of $84
million through December 31, 1997, NorAm currently retains $41 million (recorded
as a liability) in exchange for ANR's or its affiliates' use of 130 Mmcf/ day of
capacity in certain of NorAm's transportation facilities. The level of
transportation will decline to 100 Mmcf/day in the year 2003 with a refund of $5
million to ANR and the ANR Agreement will terminate in 2005 with a refund of the
remaining balance.

(e) Lease Commitments.

The following table sets forth certain information concerning NorAm's
obligations under operating leases:

Minimum Lease Commitments at December 31, 1997(1)

(MILLIONS OF DOLLARS)
---------------------

1998....................................................... $ 24
1999....................................................... 19
2000....................................................... 16
2001....................................................... 15
2002....................................................... 9
2003 and beyond............................................ 22
----
Total............................................ $105
====

- ---------------

(1) Principally consisting of rental agreements for building space and data
processing equipment and vehicles (including major work equipment).

NorAm has a master leasing agreement which provides for the lease of
vehicles, construction equipment, office furniture, data processing equipment
and other property. For accounting purposes, the lease is treated as an
operating lease. At December 31, 1997, NorAm had leased assets with a value of
approximately $58.1 million under this lease with a basic term of one year.
NorAm does not expect to lease additional property under this lease agreement.

Lease payments related to NorAm's master leasing agreement are included in
the preceding table for only their basic term. Total rental expense for all
leases since the Acquisition Date was approximately $15 million in 1997.

(f) Letters of Credit.

At December 31, 1997, NorAm had letters of credit incidental with its
ordinary business operations totaling approximately $42 million under which
NorAm is obligated to reimburse drawings, if any.

(g) Indemnity Provisions.

At December 31, 1997, NorAm has $11.4 million accounting reserve on the
Company's Consolidated Balance Sheet in Other Deferred Credits for possible
indemnity claims asserted in connection with its disposition of NorAm's former
subsidiaries or divisions, including the sale of (i) Louisiana Intrastate Gas
Corporation, a former NorAm subsidiary engaged in the intrastate pipeline and
liquids extraction business; (ii) Arkla Exploration Company, a former NorAm
subsidiary engaged in oil and gas exploration and production activities; and
(iii) Dyco Petroleum Company, a former NorAm subsidiary engaged in oil and gas
exploration and production.

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HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

(h) Other.

Electric Operations' service area is heavily dependent on oil, gas, refined
products, petrochemicals and related businesses. Significant adverse events
affecting these industries would negatively affect the revenues of the Company.
The Company and NorAm are involved in legal, tax and regulatory proceedings
before various courts, regulatory commissions and governmental agencies
regarding matters arising in the ordinary course of business, some of which
involve substantial amounts. The Company's management regularly analyzes current
information and, as necessary, provides accruals for probable liabilities on the
eventual disposition of these matters. The Company's management believes that
the effect on the Company's and NorAm's respective financial statements, if any,
from the disposition of these matters will not be material.

In February 1996, the cities of Wharton, Galveston and Pasadena filed suit,
for themselves and a proposed class, against the Company and Houston Industries
Finance Inc. (formerly a wholly owned subsidiary of the Company) citing
underpayment of municipal franchise fees. The plaintiffs claim, among other
things, that from 1957 to the present, franchise fees should have been paid on
sales taxes collected by HL&P on non-electric receipts as well as electric
sales. Plaintiffs advance their claims notwithstanding their failure to notice
such claims over the previous four decades. Because all of the franchise
ordinances affecting HL&P expressly impose fees only on electric sales, the
Company regards plaintiffs' allegations as spurious and is vigorously contesting
the matter. The plaintiffs' pleadings assert that their damages exceed $250
million. No trial date is currently set. Although the Company believes the
claims to be without merit, the Company cannot at this time estimate a range of
possible loss, if any, from the lawsuit, nor can any assurance be given as to
its ultimate outcome

The Company is a party to litigation (other than that specifically noted)
which arises in the normal course of business. Management regularly analyzes
current information and, as necessary, provides accruals for probable
liabilities on the eventual disposition of these matters. Management believes
that the effect on the Company's financial statements, if any, from the
disposition of these matters will not be material.