CNP

Business Context and Reporting Period

Company: CenterPoint Energy, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2007
Business Overview: CenterPoint Energy is a public utility holding company formed in 2002 from the restructuring of Reliant Energy. Its operations include electric transmission and distribution (CenterPoint Houston), natural gas distribution (CERC Corp.), interstate pipelines, and competitive natural gas sales and services.

Key Financial Metrics

Note: Operating margins (Operating Income/Revenues) were approximately 11.9% for the quarter and 11.6% for the six-month period.

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased significantly compared to the prior year periods. For the three months ended June 30, 2007, net income was $70 million compared to $194 million in 2006. For the six months, it was $200 million compared to $282 million in 2006.
• Tax Impact: The primary driver for the net income decline was a $144 million increase in income tax expense. In the prior year periods, the company benefited from a net tax benefit due to a $119 million reduction in tax reserves related to ZENS and ACES issues. In 2007, the effective tax rate was 29% (Q2) and 33% (YTD).
• Operating Income Growth: Despite the net income drop, consolidated operating income increased by $22 million (10%) for the quarter and $69 million (13%) for the six months compared to 2006.
• Segment Performance:
  • Interstate Pipelines: Operating income increased due to the new Carthage to Perryville pipeline entering service in May 2007.
  • Natural Gas Distribution: Operating income improved due to customer growth and reduced O&M expenses.
  • Competitive Natural Gas Sales: Operating income decreased in the quarter due to reduced price differentials and mark-to-market losses on derivatives, though it increased for the six-month period.
• Cash Flow: Net cash provided by operating activities decreased by $90 million year-over-year (six months) primarily due to fuel under-recovery and increased tax and interest payments. Investing cash outflows increased by $313 million due to higher capital expenditures ($664 million vs. $381 million) for pipeline projects.

Guidance, Outlook, Risks, and Unusual Items

• Regulatory Matters (True-Up): CenterPoint Houston is pursuing the recovery of a "true-up" balance related to the Texas electric restructuring. A district court judgment potentially restored $650 million of disallowed costs, but this is under appeal. No amounts have been recorded pending the outcome. The company expects to issue transition bonds to securitize the remaining Competition Transition Charge (CTC) balance of over $500 million later in 2007.
• Convertible Debt: The company's 3.75% convertible senior notes are classified as current liabilities because the stock price met conversion criteria. Holders can convert these notes during the third quarter of 2007.
• Legal Proceedings:
  • RRI Indemnification: The company relies on indemnification from Reliant Energy, Inc. (RRI) for liabilities related to California energy market manipulation cases. RRI's credit rating is below investment grade, creating a risk that indemnification may not be honored.
  • Environmental: A settlement regarding hydrocarbon contamination in Louisiana was reached in July 2007. The company continues to monitor MGP site remediation costs in Minnesota.
• Liquidity: The company amended its credit facilities in June 2007, increasing capacity and improving terms. It maintains $1.2 billion in commercial paper capacity, with $353 million outstanding as of June 30, 2007.
• Unusual Items: The company recorded a $17 million regulatory asset in Q2 2007 related to a fuel reconciliation settlement. Additionally, a $32 million settlement from AOL Time Warner litigation was received in July 2007 and will be recorded in Q3.

Investor Verification Checklist

• True-Up Recovery Status: Verify the status of the Texas 3rd Court of Appeals decision regarding the $650 million restoration of disallowed costs and the timeline for the issuance of new transition bonds.
• Convertible Note Conversion: Monitor the volume of 3.75% convertible notes converted to equity or cash in Q3 2007 and the resulting impact on share count and cash flow.
• RRI Solvency: Assess the financial health of Reliant Energy, Inc. (RRI) to evaluate the risk of the company having to absorb liabilities for which it is indemnified.
• Capital Expenditures: Confirm the completion and revenue generation of the Carthage to Perryville pipeline expansion phases.
• Regulatory Rate Cases: Track the outcome of the Arkansas Public Service Commission (APSC) rate case and the Minnesota Public Utilities Commission (MPUC) appeal regarding unrecovered gas costs.