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[March 11, 2014]
CENTERPOINT ENERGY HOUSTON ELECTRIC LLC - 10-K - Management's Narrative Analysis of Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) The following narrative analysis should be read in combination with our consolidated financial statements and notes contained in Item 8 of this report.
OVERVIEW We provide electric transmission and distribution services to retail electric providers (REPs) serving over two million metered customers in a 5,000-square mile area of the Texas Gulf Coast that has a population of approximately six million people and includes the city of Houston.
On behalf of REPs, we deliver electricity from power plants to substations, from one substation to another and to retail electric customers in locations throughout our certificated service territory. The Electric Reliability Council of Texas, Inc. (ERCOT) serves as the regional reliability coordinating council for member electric power systems in Texas. ERCOT membership is open to consumer groups, investor and municipally-owned electric utilities, rural electric cooperatives, independent generators, power marketers, river authorities and REPs. The ERCOT market represents approximately 85% of the demand for power in Texas and is one of the nation's largest power markets. Transmission and distribution services are provided under tariffs approved by the Public Utility Commission of Texas (Texas Utility Commission).
EXECUTIVE SUMMARYFactors Influencing Our Business We are an electric transmission and distribution company. The majority of our revenues are generated from the transmission and delivery of electricity. We do not own or operate electric generating facilities or make retail sales to end-use electric customers. To assess our financial performance, our management primarily monitors our operating income and cash flows. Within these broader financial measures, we monitor margins, operation and maintenance expense, interest expense, capital spending and working capital requirements. In addition to these financial measures we also monitor a number of variables that management considers important to the operation of our business, including the number of customers, throughput, use per customer, and heating and cooling degree days. We also monitor system reliability, safety factors and customer satisfaction to gauge our performance.
To the extent adverse economic conditions affect our suppliers and customers, our business results may suffer. Reduced demand and lower energy prices could lead to financial pressure on some of our customers who operate within the energy industry. Also, adverse economic conditions, coupled with concerns for protecting the environment, may cause consumers to use less energy or avoid expansions of their facilities, resulting in less demand for our services.
Performance of our business is significantly influenced by the number of customers and energy usage per customer. Weather conditions can have a significant impact on energy usage, and we compare our results on a weather adjusted basis. The Houston area experienced extremely hot and dry weather during 2011. In 2012, we experienced a return to more normal weather in the summer months. In 2013, we experienced a colder than normal spring and very cold weather in November and December in Houston. In recent years, customers have typically reduced their energy consumption, and reduced consumption can adversely affect our results. However, due to more affordable energy prices and continued economic improvement in the area we serve, the trend toward lower usage has slowed. In our service area, we have benefited from growth in the number of customers that also tends to mitigate the effects of reduced consumption. We anticipate that this trend will continue as the region's economies resume typical growth. The profitability of our business is influenced significantly by the regulatory treatment we receive from the state and local regulators who set our electric distribution rates.
The nature of our business requires significant amounts of capital investment, and we rely on internally generated cash, borrowings under our credit facility and issuances of debt in the capital markets to satisfy these capital needs. We strive to maintain investment grade ratings for our securities in order to access the capital markets on terms we consider reasonable. A reduction in our ratings generally would increase our borrowing costs for new issuances of debt, as well as borrowing costs under our existing revolving credit facility.
Disruptions in the financial markets can also affect the availability of new capital on terms we consider attractive. In those circumstances, companies like us may not be able to obtain certain types of external financing or may be required to accept terms less favorable than they would otherwise accept. For that reason, we seek to maintain adequate liquidity for our business through the existing credit facility and prudent refinancing of existing debt.
15 -------------------------------------------------------------------------------- Consistent with the regulatory treatment of such costs, we can defer the amount of pension expense that differs from the level of pension expense included in our base rates.
Significant Events Intercompany Transactions In December 2013, we received a $750 million debt repayment from our sole member. Proceeds, together with cash on hand, were used in December 2013 to pay a distribution to our sole member of approximately $766 million. Excluding transition and system restoration bonds for which a dedicated revenue stream exists, our total debt at December 31, 2013 was approximately 56% of our total capitalization.
Debt Financing Transactions In March 2013, we retired $450 million aggregate principal amount of our 5.70% general mortgage bonds at their maturity.
On August 1, 2013, in connection with the redemption of approximately $92 million aggregate principal amount of pollution control bonds issued on behalf of CenterPoint Energy, we prepaid a note payable to our sole member, having an aggregate principal amount of approximately $92 million and bearing interest at an annual rate of 4%, at 101% of the principal amount of the note. The redeemed pollution control bonds were collateralized by approximately $92 million aggregate principal amount of our first mortgage bonds that were retired on August 1, 2013 in connection with the redemption.
On October 15, 2013, in connection with the redemption of approximately $59 million aggregate principal amount of pollution control bonds issued on behalf of CenterPoint Energy, we prepaid a note payable to our sole member, having an aggregate principal amount of approximately $59 million and bearing interest at an annual rate of 4%, at 101% of the principal amount of the note. The redeemed pollution control bonds were collateralized by approximately $59 million aggregate principal amount of our first mortgage bonds that were retired on October 15, 2013 in connection with the redemption.
Approximately $44 million aggregate principal amount of pollution control bonds issued on our behalf were redeemed on March 3, 2014 at 101% of their principal amount plus accrued interest. The bonds had an interest rate of 4.25%, were scheduled to mature in 2017 and were collateralized by our general mortgage bonds.
Approximately $56 million aggregate principal amount of pollution control bonds issued on our behalf were purchased by us on March 3, 2014 at 101% of their principal amount plus accrued interest pursuant to the mandatory tender provisions of the bonds. The bonds initially had an interest rate of 5.60% prior to our purchase but a variable rate thereafter. The bonds mature in 2027 and are collateralized by our general mortgage bonds. The purchased pollution control bonds may be remarketed.
CERTAIN FACTORS AFFECTING FUTURE EARNINGS Our past earnings and results of operations are not necessarily indicative of our future earnings and results of operations. The magnitude of our future earnings and results of our operations will depend on or be affected by numerous factors including: • state and federal legislative and regulatory actions or developments affecting various aspects of our business, including, among others, energy deregulation or re-regulation, health care reform, financial reform, tax legislation and actions regarding the rates we charge; • state and federal legislative and regulatory actions or developments relating to the environment, including those related to global climate change; • timely and appropriate rate actions that allow recovery of costs and a reasonable return on investment; • the timing and outcome of any audits, disputes and other proceedings related to taxes; • industrial, commercial and residential growth in our service territory and changes in market demand, including the effects of energy efficiency measures and demographic patterns; • weather variations and other natural phenomena, including the impact on operations and capital of severe weather events; 16--------------------------------------------------------------------------------• any direct or indirect effects on our facilities, operations and financial condition resulting from terrorism, cyber-attacks, data security breaches or other attempts to disrupt our business or the businesses of third parties, or other catastrophic events; • the impact of unplanned facility outages; • timely and appropriate regulatory actions allowing securitization or other recovery of costs associated with any future hurricanes or natural disasters; • changes in interest rates or rates of inflation; • commercial bank and financial market conditions, our access to capital, the cost of such capital, and the results of our financing and refinancing efforts, including availability of funds in the debt capital markets; • actions by credit rating agencies; • inability of various counterparties to meet their obligations to us; • non-payment for our services due to financial distress of our customers; • the ability of GenOn Energy, Inc. (GenOn) (formerly known as RRI Energy, Inc., Reliant Energy, Inc. and Reliant Resources, Inc. (RRI)) , a wholly owned subsidiary of NRG Energy, Inc. (NRG), and its subsidiaries to satisfy their obligations to us, including indemnity obligations; • the ability of REPs, including REP affiliates of NRG and Energy Future Holdings Corp. (Energy Future Holdings), which are our two largest customers, to satisfy their obligations to us and our subsidiaries; • the outcome of litigation brought by or against us; • our ability to control costs; • the investment performance of CenterPoint Energy's pension and postretirement benefit plans; • our potential business strategies, including restructurings, acquisitions or dispositions of assets or businesses, which we cannot assure you will be completed or will have the anticipated benefits to us; • acquisition and merger activities involving us or our competitors; • future economic conditions in regional and national markets and their effect on sales, prices and costs; and • other factors we discuss under "Risk Factors" in Item 1A of this report and in other reports we file from time to time with the Securities and Exchange Commission (SEC).
17-------------------------------------------------------------------------------- CONSOLIDATED RESULTS OF OPERATIONS Our results of operations are affected by seasonal fluctuations in the demand for electricity. Our results of operations are also affected by, among other things, the actions of various state and local governmental authorities having jurisdiction over rates we charge, debt service costs, income tax expense, our ability to collect receivables from REPs and our ability to recover our stranded costs and regulatory assets.
The following table sets forth selected financial data for the years ended December 31, 2013, 2012 and 2011, followed by a discussion of our consolidated results of operations based on operating income. We have provided a reconciliation of consolidated operating income to net income below.
Year Ended December 31, 2013 2012 2011 (in millions, except throughput and customer data) Revenues: Electric transmission and distribution utility $ 2,070 $ 1,949 $ 1,893 Transition and system restoration bond companies 507 591 444 Total Revenues 2,577 2,540 2,337 Expenses: Operation and maintenance, excluding transition and system restoration bond companies 1,045 942 908 Depreciation and amortization, excluding transition and system restoration bond companies 319 301 279 Taxes other than income taxes 225 214 210 Transition and system restoration bond companies 374 444 317 Total Expenses 1,963 1,901 1,714 Operating Income 614 639 623 Interest and other finance charges (99 ) (141 ) (150 ) Interest on transition and system restoration bonds (133 ) (147 ) (127 ) Return on True-Up Balance - - 352 Other income, net 33 41 38 Income Before Income Taxes and Extraordinary Item 415 392 736 Income Tax Expense 146 113 248 Income Before Extraordinary Item 269 279 488 Extraordinary Item, net of tax - - 598 Net Income $ 269 $ 279 $ 1,086 Throughput (in gigawatt-hours (GWh)): Residential 27,485 27,315 28,511 Total 79,985 78,593 80,013 Number of metered customers at end of period: Residential 1,982,699 1,943,423 1,904,818 Total 2,244,289 2,199,764 2,155,710 2013 Compared to 2012. We reported operating income of $614 million for 2013, consisting of $481 million from our regulated electric transmission and distribution utility operations (TDU) and $133 million related to transition and system restoration bond companies. For 2012, operating income totaled $639 million, consisting of $492 million from the TDU and $147 million related to transition and system restoration bond companies. TDU operating income decreased $11 million due to decreased usage ($6 million), primarily due to unfavorable weather, increased taxes other than income taxes ($11 million), increased depreciation ($10 million, excluding $8 million from increased investment in AMS offset by the related revenues), increased labor and benefits costs ($7 million), increased contracts and services ($4 million), increased support services ($4 million) and increased insurance costs ($3 million), partially offset by customer growth ($26 million) from the addition of over 44,000 new customers and higher transmission-related revenues net of the costs billed by transmission providers ($9 million).
Income Tax Expense. We reported an effective tax rate of 35.2% for 2013 compared to 28.8% for the same period in 2012. Our effective tax rate for 2013 increased by 6.4% as compared to the prior period primarily due to the tax benefits associated with the release of income tax reserves. We recognized a tax benefit of $5 million based on the settlement with the IRS of outstanding tax 18 --------------------------------------------------------------------------------claims for the 2002 and 2003 audit cycles in 2013 and a tax benefit of $26 million related to the release of certain tax reserves due to its settlements with the Internal Revenue Service (IRS) in 2012.
2012 Compared to 2011. We reported operating income of $639 million for 2012, consisting of $492 million from our TDU and $147 million related to transition and system restoration bond companies. For 2011, operating income totaled $623 million, consisting of $496 million from the TDU and $127 million related to transition and system restoration bond companies. TDU operating income decreased $4 million due to decreased usage ($54 million), primarily due to a return to more normal summer weather when compared to the previous year, and the impact of the 2010 rate case implemented in September 2011 ($34 million), partially offset by higher equity returns ($28 million) primarily related to true-up proceeds, increased miscellaneous revenues ($24 million), primarily from right-of-way easement grants, customer growth ($24 million) from the addition of over 44,000 new customers and decreased labor and benefits costs ($6 million).
Income Tax Expense. We reported an effective tax rate of 28.8% for 2012 compared to 33.7% for the same period in 2011. The decrease in our effective tax rate of 4.9% is due to favorable tax adjustments in 2012, including the re-measurement of certain unrecognized tax benefits of $26 million related to the IRS settlement of tax years 2006 through 2009.
LIQUIDITY AND CAPITAL RESOURCES Our liquidity and capital requirements are affected primarily by our results of operations, capital expenditures, debt service requirements, tax payments, working capital needs and various regulatory actions. Our principal anticipated cash requirements during 2014 include capital expenditures of approximately $781 million, scheduled principal payments on transition and system restoration bonds of $354 million and March 2014 payments aggregating $101 million in connection with the purchase and redemption of pollution control bonds.
We expect that anticipated 2014 cash needs will be met with borrowings under our credit facility, proceeds from the issuance of general mortgage bonds, anticipated cash flows from operations and intercompany borrowings. Cash needs or discretionary financing or refinancing may result in the issuance of debt securities in the capital markets or the arrangement of additional credit facilities. Issuances of debt in the capital markets and additional credit facilities may not, however, be available to us on acceptable terms.
The following table sets forth our capital expenditures for 2013 and estimates of our capital expenditures for 2014 through 2018 (in millions): 2013 $ 759 2014 781 2015 833 2016 718 2017 655 2018 666 Our capital expenditures are expected to be used for investment in infrastructure for our electric transmission and distribution operations. These capital expenditures are anticipated to maintain reliability and safety.
The following table sets forth estimates of our contractual obligations, including payments due by period (in millions): 2019 and Contractual Obligations Total 2014 2015-2016 2017-2018 thereafter Transition and system restoration bond debt (1) $ 3,400 $ 354 $ 763 $ 845 $ 1,438 Other long-term debt 1,594 - - 127 1,467 Interest payments - transition and system restoration bond debt (1) (2) 594 119 203 146 126 Interest payments - other long-term debt (2) 1,244 75 150 145 874 Capital leases 1 - - - 1 Benefit obligations (3) - - - - - Total contractual cash obligations $ 6,833 $ 548 $ 1,116 $ 1,263 $ 3,906 ____________ 19--------------------------------------------------------------------------------(1) Transition and system restoration charges are adjusted at least annually to cover debt service on the transition and system restoration bonds.
(2) We calculated estimated interest payments for long-term fixed-rate debt and term debt based on the applicable rates and payment dates. We typically expect to satisfy such interest payment obligations with cash flows from operations and short-term borrowings.
(3) We expect to contribute approximately $7 million to our postretirement benefits plan in 2014 to fund a portion of our obligations in accordance with rate orders or to fund pay-as-you-go costs associated with the plan.
Off-Balance Sheet Arrangements Other than first mortgage bonds and general mortgage bonds issued as collateral for long-term debt of CenterPoint Energy as discussed below and operating leases, we have no off-balance sheet arrangements.
Regulatory Matters In October 2009, the Public Utility Commission of Texas (Texas Utility Commission) issued an order disallowing recovery of a performance bonus of $2 million on approximately $10 million in 2008 energy efficiency costs expended pursuant to the terms of a settlement agreement in a prior rate case. We appealed the denial of the full 2008 performance bonus. Similar orders by the Texas Utility Commission providing for the partial disallowance of performance bonuses totaling approximately $5.5 million relating to our 2009, 2010 and 2011 (only through August 2011) energy efficiency programs were also appealed. These subsequent cases were abated pending the final outcome of the 2008 bonus appeal.
In August 2013, the court of appeals reversed the Texas Utility Commission's decision disallowing such bonuses and the Texas Utility Commission appealed that decision to the Texas Supreme Court in October 2013. In January 2014, the Texas Supreme Court denied the Texas Utility Commission's appeal. Our energy efficiency programs are no longer funded pursuant to the terms of the prior settlement, and no additional performance bonus disallowances are expected.
In December 2013, we filed an application at the Texas Utility Commission seeking (i) to reconcile approximately $473 million in Advanced Metering System costs incurred during the time period April 1, 2010 through September 30, 2013 and currently in rates, and (ii) approval to amend the surcharge recovery period to account for the reconciled costs through September 30, 2013 as well as to recover costs expected to be incurred after September 30, 2013. A decision by the Texas Utility Commission is expected later this year.
Other Matters Credit Facility As of February 14, 2014, we had the following revolving credit facility and utilization of such facility (in millions): Amount Size of Utilized at Date Executed Facility February 14, 2014 Termination Date September 9, 2011 $ 300 $ 4 (1) September 9, 2018 _________(1) Represents outstanding letters of credit.
Our $300 million revolving credit facility can be drawn at the London Interbank Offered Rate (LIBOR) plus 112.5 basis points based on our current credit ratings. The revolving credit facility contains a financial covenant which limits our consolidated debt (excluding transition and system restoration bonds) to an amount not to exceed 65% of our consolidated capitalization.
Borrowings under our revolving credit facility are subject to customary terms and conditions. However, there is no requirement that we make representations prior to borrowings as to the absence of material adverse changes or litigation that could be expected to have a material adverse effect. Borrowings under our revolving credit facility are subject to acceleration upon the occurrence of events of default that we consider customary. The revolving credit facility also provides for customary fees, including commitment fees, administrative agent fees, fees in respect of letters of credit and other fees. In our revolving credit facility, the borrowing spread to LIBOR and the commitment fees fluctuate based on our credit rating. We are currently in compliance with the various business and financial covenants contained in our revolving credit facility.
20 --------------------------------------------------------------------------------On September 9, 2013, our revolving credit facility was amended to extend the scheduled termination date from September 9, 2016 to September 9, 2018.
Securities Registered with the SEC We have filed a shelf registration statement with the SEC registering an indeterminate principal amount of our general mortgage bonds.
Temporary Investments As of February 14, 2014, we had no external temporary investments.
Money Pool We participate in a money pool through which we and certain of our affiliates can borrow or invest on a short-term basis. Funding needs are aggregated and external borrowing or investing is based on the net cash position. The net funding requirements of the money pool are expected to be met with borrowings under CenterPoint Energy's revolving credit facility or the sale of CenterPoint Energy's commercial paper. As of February 14, 2013, we had $135 million borrowed from the money pool. The money pool may not provide sufficient funds to meet our cash needs.
Long-term Debt Our long-term debt consists of our obligations and the obligations of our four special purpose subsidiaries that have issued transition and system restoration bonds.
As of December 31, 2013, our outstanding first mortgage bonds and general mortgage bonds aggregated approximately $2.0 billion, of which $408 million collateralized debt of CenterPoint Energy and is not reflected in our consolidated financial statements because of the contingent nature of the obligations. As of December 31, 2013, CenterPoint Energy held $290 million of the collateralized bonds for future remarketing.
The lien of the general mortgage indenture is junior to that of the mortgage pursuant to which the first mortgage bonds are issued. We may issue additional general mortgage bonds on the basis of retired bonds, 70% of property additions or cash deposited with the trustee. Approximately $3.9 billion of additional general mortgage bonds could be issued on the basis of retired bonds and 70% of property additions as of December 31, 2013. We have contractually agreed that we will not issue additional first mortgage bonds, subject to certain exceptions.
At December 31, 2013, our subsidiaries had the following aggregate principal amount of transition and system restoration bonds outstanding. Amounts are expressed in millions.
Company Aggregate Principal Amount Outstanding Bond Company II $ 1,057 Bond Company III 318 Restoration Bond Company 510 Bond Company IV 1,515 Total $ 3,400 The transition bonds and system restoration bonds are paid through the imposition of "transition" or "system restoration" charges, as defined in the Texas Public Utility Regulatory Act, which are irrevocable, non-bypassable charges payable by most of our retail electric customers to the bond company subsidiaries in order to provide recovery of authorized qualified costs. The transition and system restoration bonds are reported as our long-term debt, although the holders of these bonds have no recourse to any of our assets or revenues, and our creditors have no recourse to any assets or revenues (including, without limitation, the transition or system restoration charges) of the bond companies. We have no payment obligations with respect to the transition and system restoration 21 -------------------------------------------------------------------------------- bonds except to remit collections of transition and system restoration charges as set forth in servicing agreements between us and the bond companies and in an intercreditor agreement among us, the bond companies and other parties.
Impact on Liquidity of a Downgrade in Credit Ratings The interest on borrowings under our credit facility is based on our credit rating. As of February 14, 2013, Moody's Investors Service, Inc. (Moody's), Standard & Poor's Ratings Services (S&P), a division of The McGraw Hill Companies, and Fitch, Inc. (Fitch) had assigned the following credit ratings to our senior debt.
Moody's S&P Fitch Instrument Rating Outlook(1) Rating Outlook (2) Rating Outlook (3) Senior Secured Debt A1 Stable A Stable A Stable ____________(1) A Moody's rating outlook is an opinion regarding the likely direction of an issuer's rating over the medium term.
(2) An S&P rating outlook assesses the potential direction of a long-term credit rating over the intermediate to longer term.
(3) A Fitch rating outlook encompasses a one- to two-year horizon as to the likely ratings direction.
We cannot assure you that the ratings set forth above will remain in effect for any given period of time or that one or more of these ratings will not be lowered or withdrawn entirely by a rating agency. We note that these credit ratings are included for informational purposes and are not recommendations to buy, sell or hold our securities and may be revised or withdrawn at any time by the rating agency. 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 obtain short- and long-term financing, the cost of such financings and the execution of our commercial strategies.
A decline in credit ratings could increase borrowing costs under our $300 million credit facility. If our credit ratings had been downgraded one notch by each of the three principal credit rating agencies from the ratings that existed at December 31, 2013, the impact on the borrowing costs under our credit facility would have been immaterial. A decline in credit ratings would also increase the interest rate on long-term debt to be issued in the capital markets and could negatively impact our ability to complete capital market transactions.
Cross Defaults Under CenterPoint Energy's $1.2 billion revolving credit facility, a payment default on, or a non-payment default that permits acceleration of, any indebtedness exceeding $75 million by us will cause a default. In addition, three outstanding series of CenterPoint Energy's senior notes, aggregating $750 million in principal amount as of December 31, 2013, provide that a payment default by us in respect of, or an acceleration of, borrowed money and certain other specified types of obligations, in the aggregate principal amount of $50 million, will cause a default. A default by CenterPoint Energy would not trigger a default under our debt instruments or revolving credit facility.
Collection of Receivables from REPs Our receivables from the distribution of electricity are collected from REPs that supply the electricity we distribute to their customers. Adverse economic conditions, structural problems in the market served by ERCOT or financial difficulties of one or more REPs could impair the ability of these REPs to pay for our services or could cause them to delay such payments. We depend on these REPs to remit payments on a timely basis, and any delay or default in payment by REPs could adversely affect our cash flows. In the event of a REP's default, our tariff provides a number of remedies, including our option to request that the Texas Utility Commission suspend or revoke the certification of the REP.
Applicable regulatory provisions require that customers be shifted to another REP or a provider of last resort if a REP cannot make timely payments. However, we remain at risk for payments not made prior to the shift to the replacement REP or provider of last resort. If a REP were unable to meet its obligations, it could consider, among various options, restructuring under the bankruptcy laws, in which event such REP might seek to avoid honoring its obligations, and claims might be made against us involving payments we had received from such REP. If a REP were to file for bankruptcy, we may not be successful in recovering accrued receivables owed by such REP that are unpaid as of the date the REP filed for bankruptcy. However, Texas Utility Commission regulations authorize utilities, such as us, to defer bad debts resulting from defaults by REPs for recovery in future rate cases, subject to a review of reasonableness and necessity.
22 --------------------------------------------------------------------------------Other Factors that Could Affect Cash Requirements In addition to the above factors, our liquidity and capital resources could be affected by: • increases in interest expense in connection with debt refinancings and borrowings under our credit facility; • various legislative or regulatory actions; • the ability of GenOn Energy, Inc. (GenOn) and its subsidiaries to satisfy their obligations in respect of GenOn's indemnity obligations to us; • the outcome of litigation brought by and against us; • restoration costs and revenue losses resulting from future natural disasters such as hurricanes and the timing of recovery of such restoration costs; and • various other risks identified in "Risk Factors" in Item 1A of this report.
Certain Contractual Limits on Our Ability to Issue Securities and Borrow Money Our revolving credit facility contains a financial covenant which limits our consolidated debt (excluding transition and system restoration bonds) to an amount not to exceed 65% of our consolidated capitalization. Additionally, we have contractually agreed that we will not issue additional first mortgage bonds, subject to certain exceptions.
Relationship with CenterPoint Energy We are an indirect wholly owned subsidiary of CenterPoint Energy. As a result of this relationship, the financial condition and liquidity of our parent company could affect our access to capital, our credit standing and our financial condition.
CRITICAL ACCOUNTING POLICIES A critical accounting policy is one that is both important to the presentation of our financial condition and results of operations and requires management to make difficult, subjective or complex accounting estimates. An accounting estimate is an approximation made by management of a financial statement element, item or account in the financial statements. Accounting estimates in our historical consolidated financial statements measure the effects of past business transactions or events, or the present status of an asset or liability.
The accounting estimates described below require us to make assumptions about matters that are highly uncertain at the time the estimate is made.
Additionally, different estimates that we could have used or changes in an accounting estimate that are reasonably likely to occur could have a material impact on the presentation of our financial condition, results of operations or cash flows. The circumstances that make these judgments difficult, subjective and/or complex have to do with the need to make estimates about the effect of matters that are inherently uncertain. Estimates and assumptions about future events and their effects cannot be predicted with certainty. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments. These estimates may change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. Our significant accounting policies are discussed in Note 2 to our consolidated financial statements. We believe the following accounting policies involve the application of critical accounting estimates.
Accordingly, these accounting estimates have been reviewed and discussed with the audit committee of the board of directors of CenterPoint Energy.
Accounting for Rate Regulation Accounting guidance for regulated operations provides that rate-regulated entities account for and report assets and liabilities consistent with the recovery of those incurred costs in rates if the rates established are designed to recover the costs of providing the regulated service and if the competitive environment makes it probable that such rates can be charged and collected. We apply this accounting guidance. Certain expenses and revenues subject to utility regulation or rate determination normally reflected in income are deferred on the balance sheet as regulatory assets or liabilities and are recognized in income as the related amounts are included in service rates and recovered from or refunded to customers. Regulatory assets and liabilities are recorded when it is probable that these items will be recovered or reflected in future rates. Determining probability requires significant judgment on the part of management and includes, but is not limited to, consideration of testimony presented in regulatory hearings, proposed regulatory decisions, final regulatory orders and the strength or status of applications for rehearing or state court appeals. If events were to 23 -------------------------------------------------------------------------------- occur that would make the recovery of these assets and liabilities no longer probable, we would be required to write off or write down these regulatory assets and liabilities. At December 31, 2013, we had recorded regulatory assets of $3.0 billion and regulatory liabilities of $509 million.
Impairment of Long-Lived Assets and Intangibles We review the carrying value of our long-lived assets, including identifiable intangibles, whenever events or changes in circumstances indicate that such carrying values may not be recoverable. Unforeseen events and changes in circumstances and market conditions and material differences in the value of long-lived assets and intangibles due to changes in estimates of future cash flows, interest rates, regulatory matters and operating costs could negatively affect the fair value of our assets and result in an impairment charge.
Fair value is the amount at which the asset could be bought or sold in a current transaction between willing parties and may be estimated using a number of techniques, including quoted market prices or valuations by third parties, present value techniques based on estimates of cash flows, or multiples of earnings or revenue performance measures. The fair value of the asset could be different using different estimates and assumptions in these valuation techniques.
Unbilled Energy Revenues Revenues related to electricity delivery are generally recognized upon delivery to customers. However, the determination of deliveries to individual customers is based on the reading of their meters, which is performed on a systematic basis throughout the month either electronically through AMS meter communications or manual readings. At the end of each month, deliveries to non-AMS customers since the date of the last meter reading are estimated and the corresponding unbilled revenue is estimated. Information regarding deliveries to AMS customers after the last billing is obtained from actual AMS meter usage data. Unbilled electricity delivery revenue is estimated each month based on actual AMS meter data, daily supply volumes and applicable rates. As additional information becomes available, or actual amounts are determinable, the recorded estimates are revised. Consequently, operating results can be affected by revisions to prior accounting estimates.
NEW ACCOUNTING PRONOUNCEMENTSSee Note 2(l) to the consolidated financial statements, incorporated herein by reference, for a discussion of new accounting pronouncements that affect us.
OTHER SIGNIFICANT MATTERS Pension Plans. As discussed in Note 5(a) to the consolidated financial statements, we participate in CenterPoint Energy's qualified and non-qualified pension plans covering substantially all employees. We recorded pension cost of $26 million, $31 million and $28 million for the years ended December 31, 2013, 2012 and 2011, respectively, of which $21 million, $21 million and $10 million impacted pre-tax earnings. Our actuarially determined pension and other postemployment expense for 2013 and 2012 in excess of the amounts being recovered through rates is being deferred for rate making purposes. Pension cost for 2014 is expected to be $27 million, of which we expect $21 million to impact pre-tax earnings after effecting such deferrals, based on an expected return on plan assets of 7.00% and a discount rate of 4.80% as of December 31, 2013.
Future changes in plan asset returns, assumed discount rates and various other factors related to the pension plan will impact our future pension expense and liabilities. We cannot predict with certainty what these factors will be in the future.
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