What drove the increase in 2006 net income despite lower revenues?

Net income rose to $432 million from $252 million in 2005 (net of a $30 million extraordinary gain in 2005 and discontinued operations). The main drivers were a $200 million decrease in interest expense from lower borrowing levels and costs, and a $133 million decrease in income tax expense from the ZENS and ACES tax settlement. Operating income also improved by $106 million, led by Electric T&D, Interstate Pipelines and Field Services, while Natural Gas Distribution declined.

How much could CenterPoint Houston recover from the True-Up litigation, and when?

The August 2005 district court judgment would restore approximately $650 million plus interest of the $1.7 billion disallowed from the initial request. The judgment is under appeal, with oral arguments held in January 2007 and a decision not expected for several months. No amounts have been recorded, so any recovery would be a future upside, and the outcome is uncertain.

What is the IRS normalization risk and how large could it be?

The Texas Utility Commission reduced stranded cost recovery by about $146 million for the present value of deferred tax benefits. If the IRS determines this violates normalization rules and the order is not reversed, the company could have to pay CenterPoint Houston's unamortized ADITC balance and could lose accelerated tax depreciation benefits. The filing says a violation could have a material adverse impact, but it does not quantify the unamortized balance. A private letter ruling request is pending.

How concentrated is CenterPoint Houston's customer base?

CenterPoint Houston serves 68 retail electric providers, but two are subsidiaries of Reliant Energy (RRI). Sales to RRI subsidiaries were approximately 56% of 2006 transmission and distribution revenues, down from 71% in 2004. About 53% of the $140 million in billed receivables at year-end 2006 was owed by RRI subsidiaries. CenterPoint Houston has no long-term customer contracts, so this concentration is a material credit risk.

What is the outlook for capital spending and financing?

Capital expenditures were $1.121 billion in 2006 and are estimated at about $1.055 billion in 2007, falling to roughly $770 to $820 million per year in 2009 through 2011. Major projects include the CEGT Carthage to Perryville pipeline (about $500 million, in service mid-2007) and the Southeast Supply Header (total $800 to $900 million, with CERC's net share $700 to $800 million, targeted for summer 2008). Early 2007 debt issuance and conversion settlements are funded through $250 million and $150 million senior notes plus the existing credit facilities.

CNP 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 28, 2007. Cited figures are marked; the original filing is the authoritative source.

CenterPoint Energy (CNP) is a public utility holding company whose core regulated operations are CenterPoint Energy Houston Electric (CenterPoint Houston), a Texas Gulf Coast electric transmission and distribution utility, and CenterPoint Energy Resources Corp. (CERC), which runs natural gas distribution in six states, interstate pipelines, field services and competitive gas sales.

For 2006, revenues were $9.319 billion^a (down from $9.722 billion in 2005), operating income rose to $1.045 billion from $939 million, and income from continuing operations was $432 million ($1.33 diluted EPS), versus $225 million ($0.67) in 2005. Much of the improvement reflected a $200 million drop in interest expense and a $133 million reduction in income tax expense tied to the settlement of ZENS and ACES tax issues, rather than purely operating growth. Gas Operations and Electric T&D earnings were mixed, with the Natural Gas Distribution segment's operating income falling to $124 million from $175 million.

The filing's most significant investor issue is the unresolved true-up litigation at CenterPoint Houston. A Travis County district court judgment could restore roughly $650 million^b plus interest of disallowed stranded costs, but it is under appeal and no amounts have been recorded. A separate risk is an IRS normalization violation: a $146 million reduction in stranded cost recovery could force payment of unamortized ADITC or loss of accelerated depreciation benefits if the IRS rules against the company.

Management describes both as potentially material but does not quantify a probable outcome. Liquidity relies on bank facilities, a receivables facility, and new debt issued in early 2007, while total debt stood at about $9.0 billion^c including $2.4 billion of non-recourse transition bonds.

Operationally, capital expenditures rose to $1.121 billion^d in 2006 and are planned at about $1.0 to $1.1 billion per year through 2007, with major interstate pipeline projects (Carthage to Perryville, and the Southeast Supply Header joint venture) in construction. Credit ratings are investment grade at CenterPoint Houston and CERC but sub-investment grade at the parent (Ba1 Moody's), and the company has significant concentration risk because Reliant Energy (RRI) is a major customer and indemnitor.

02—Key points

Key Highlights

2006 operating income rose 11% to $1.045 billion, driven by Electric T&D and Interstate Pipelines/Field Services gains, partly offset by a weaker Natural Gas Distribution segment ($124 million vs. $175 million).
Net income of $432 million ($1.33 diluted EPS) was boosted by a $133 million lower tax expense from the ZENS/ACES IRS settlement and a $200 million reduction in interest expense.
Potential upside of about $650 million plus interest from the pending Texas 3rd Court of Appeals decision on the True-Up Order; no amounts recorded.
IRS normalization risk tied to a $146 million stranded-cost reduction could require repayment of unamortized ADITC or loss of accelerated tax depreciation if unresolved.
Customer concentration: subsidiaries of RRI represented 56% of CenterPoint Houston's 2006 transmission and distribution revenues and about 53% of its $140 million in billed receivables.
Capital spending increased to $1.121 billion in 2006, with approximately $1.05 billion planned for 2007, mainly for interstate pipeline expansion including the Carthage to Perryville line and SESH.
Total debt about $9.0 billion (including $2.4 billion of transition bonds); parent senior unsecured debt rated Ba1/BBB-/BBB- (Moody's/S&P/Fitch), with CenterPoint Houston and CERC rated investment grade.

03—Questions

Frequently Asked Questions

What drove the increase in 2006 net income despite lower revenues?
Net income rose to $432 million from $252 million in 2005 (net of a $30 million extraordinary gain in 2005 and discontinued operations). The main drivers were a $200 million decrease in interest expense from lower borrowing levels and costs, and a $133 million decrease in income tax expense from the ZENS and ACES tax settlement. Operating income also improved by $106 million, led by Electric T&D, Interstate Pipelines and Field Services, while Natural Gas Distribution declined.
How much could CenterPoint Houston recover from the True-Up litigation, and when?
The August 2005 district court judgment would restore approximately $650 million plus interest of the $1.7 billion disallowed from the initial request. The judgment is under appeal, with oral arguments held in January 2007 and a decision not expected for several months. No amounts have been recorded, so any recovery would be a future upside, and the outcome is uncertain.
What is the IRS normalization risk and how large could it be?
The Texas Utility Commission reduced stranded cost recovery by about $146 million for the present value of deferred tax benefits. If the IRS determines this violates normalization rules and the order is not reversed, the company could have to pay CenterPoint Houston's unamortized ADITC balance and could lose accelerated tax depreciation benefits. The filing says a violation could have a material adverse impact, but it does not quantify the unamortized balance. A private letter ruling request is pending.
How concentrated is CenterPoint Houston's customer base?
CenterPoint Houston serves 68 retail electric providers, but two are subsidiaries of Reliant Energy (RRI). Sales to RRI subsidiaries were approximately 56% of 2006 transmission and distribution revenues, down from 71% in 2004. About 53% of the $140 million in billed receivables at year-end 2006 was owed by RRI subsidiaries. CenterPoint Houston has no long-term customer contracts, so this concentration is a material credit risk.
What is the outlook for capital spending and financing?
Capital expenditures were $1.121 billion in 2006 and are estimated at about $1.055 billion in 2007, falling to roughly $770 to $820 million per year in 2009 through 2011. Major projects include the CEGT Carthage to Perryville pipeline (about $500 million, in service mid-2007) and the Southeast Supply Header (total $800 to $900 million, with CERC's net share $700 to $800 million, targeted for summer 2008). Early 2007 debt issuance and conversion settlements are funded through $250 million and $150 million senior notes plus the existing credit facilities.

04—Continue

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