CNP

Business Context and Reporting Period

Company: CenterPoint Energy, Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2005
Business Overview: CenterPoint Energy is a public utility holding company operating primarily through two subsidiaries: CenterPoint Energy Houston Electric, LLC (electric transmission and distribution in the Houston area) and CenterPoint Energy Resources Corp. (natural gas distribution, pipelines, and gathering). The company is currently subject to the Public Utility Holding Company Act of 1935 (1935 Act), which is scheduled to be repealed effective February 8, 2006.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 33% for the three months and 17% for the nine months ended September 30, 2005, compared to the same periods in 2004. This was driven by higher natural gas costs passed through to customers, increased customer growth, and higher transmission cost recovery.
• Profitability Improvement: Net income for the nine months ended September 30, 2005, was $171 million, a significant turnaround from a net loss of $1,005 million in the same period in 2004. The 2004 loss was heavily impacted by a $894 million extraordinary item (after-tax) related to the write-down of generation-related regulatory assets and a $154 million loss from discontinued operations (Texas Genco).
• Discontinued Operations: The company completed the sale of its Texas Genco subsidiary in April 2005. Consequently, discontinued operations losses were minimal ($3 million) for the nine months of 2005 compared to $154 million in 2004.
• Operating Income by Segment:
  • Pipelines and Gathering: Operating income increased $45 million (nine months) due to higher demand for transportation and gathering services.
  • Natural Gas Distribution: Operating income increased $9 million (nine months) despite milder weather, driven by rate increases and reduced pension costs.
  • Electric Transmission & Distribution: Operating income decreased slightly ($5 million) due to higher transmission costs and the absence of a land sale gain recorded in 2004.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• True-Up Recovery: A district court judgment in August 2005 restored approximately $620 million of costs previously disallowed by the Texas Utility Commission for recovery via transition bonds or a Competition Transition Charge (CTC). The company expects to issue transition bonds in the fourth quarter of 2005. The CTC was implemented in September 2005 to recover the remaining balance.
• Regulatory Changes: The repeal of the 1935 Act in February 2006 will remove restrictions on issuing debt and equity and paying dividends from capital or unearned surplus.
• Capital Expenditures: The company expects to incur approximately $223 million in capital expenditures for the remainder of 2005. A new $375 million pipeline project with XTO Energy Inc. is expected to increase capital requirements significantly in 2006 and 2007.

Risks and Contingencies

• Regulatory Uncertainty: The Texas Utility Commission Staff has recommended a review of CenterPoint Houston's rates, alleging potential excess revenues of up to $105 million annually. A rate proceeding may be initiated if no settlement is reached.
• Legal Proceedings: The company faces various lawsuits, including those related to California electricity and gas market manipulation (indemnified by Reliant Energy, Inc.), municipal franchise fees, and natural gas measurement disputes. Management does not expect these to have a material adverse effect.
• Environmental Liabilities: The company has accrued $18 million for remediation of Manufactured Gas Plant sites in Minnesota, with a potential range of $7 million to $42 million.
• Tax Contingencies: The IRS has disallowed deductions for Original Issue Discount (OID) on certain notes. The company increased its tax reserve by $32 million in the first nine months of 2005, bringing the total reserve to $111 million.
• Weather and Natural Disasters: Hurricanes Katrina and Rita impacted service areas in late 2005. Restoration costs for Hurricane Rita are estimated at $20-$30 million, to be deferred for future rate recovery.

Investor Verification Checklist

• True-Up Recovery Status: Verify the final outcome of the appeals regarding the $620 million restoration of costs and the timing of transition bond issuance.
• Rate Case Proceedings: Monitor the Texas Utility Commission's potential rate review of CenterPoint Houston following the Staff's recommendation of excess earnings.
• Debt Maturity: Confirm the refinancing of the $1.31 billion CenterPoint Houston term loan maturing in November 2005.
• Tax Reserve Impact: Assess the potential for further increases in the tax reserve related to the IRS dispute over OID deductions on ZENS notes.
• Discontinued Operations: Ensure no residual liabilities remain from the Texas Genco sale, particularly regarding indemnification obligations from Reliant Energy, Inc.