Text

Houston Industries Inc,1987 Annual Rept
	ML20155G155
Person / Time
Site:	South Texas
Issue date:	12/31/1987
From:	; HOUSTON LIGHTING & POWER CO.
To:	;
Shared Package
ML20155G140	List: ML20155G143; ML20155G150; ML20155G155; ML20155G162; ST-HL-AE-2639, Forwards Amend 10 to Application for CP & Ol,Reflecting Adjustment in Ownership Interests Resulting from Settlement of Litigation Between Util & City of Austin,Per 880317 Agreement.Financial Rept for 1987 Also Encl;
References
	NUDOCS 8806170183
	Download: ML20155G155 (68)
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\\ ly Pretuiling uiruls. shi(ting tides. Changes in direction on the raul to the ftaure. opportunities. Threats. UsuleniaNe. Unstoppable. Houston hulusnies, hke all businesses, is impicted by tresuls: Glohilfituincial tresuls. Local economic tresuls. Iruittsuy directions. We're co,1tinuing a long j tistoQ of sllCCess by u1EICrstaluling, adapting to arul, tl$leTC possible, siklping tlte Clulnges llult ate L affecting ourfiaure. 5. r Houston huhanies inanpaated is the sirent company o[seten subsidiaries: Houston Lighting 8 Pouer Compmy. HL&P is the ruition's eightit largest elecnie utdity in tern,s fourl 1 NirgCst Clly. ?Timaq fuels, Inc. PFI is an oil azul ou eg,loration a,ul nnlucti,ni conituny i L uith domestic inaluction and resert es located in the continental U.S. and in the Gulf of Mexico, .rj ) as u eil as intenuitiorud protluction in set eral counnies. Utility Fuch, Inc. L FI is a fidl-scrtice i i cad supply ann [Uny intult'ed in the adjuisition, transpirtation, hatulling, arultubnini'bation of l h [ cnd and lignite for Jecnic generating plants. KstcoM hunporated. KBLcoM is inn >lt ed in 1 l the < >towrship aiul opc7athin o[ cane teletisioit systents. It /1,ill3 a 50 b rcent inte7est m a } 4 multi-state QtNe teletis:on joint ter:ture called Paragori Communicatunis. u hich sertes ater ( 650AD customers. Innotatit>e Controls, Inc. ICI det elaps arul nurkets high-intensity dncluirue e lights drit en in electronic hdLuts. Housunt hulustries Finance, Inc. IIIF purch.ucs accounts i TCceitdNe ofIIL8P. l)et'elopment Ventures, Inc. INI n a t enture capaal organization u hich j intests in esuNished[taub azul protides start-it[> jiruincint for snudll'usinesscs. e t J t i i

FINANCI AL lilGlillGilTS 1987 1986 Operating Revenues (000) $3,628,213 $3,535.%8 Operating Expenses (010) $2,890,745 $2.8W,387 Net income t000) $434,958 $424,935 Eamings Per Share $3.74 $3.81 Dividends Per Share $2.S6 $2.76 Average Number of Shares Outstanding (000) 116,322 111,593 Return on Average Conunon Equity 13.6 % 14.5 4 Fixed Charge Coserage Ratio 2.86 2.76 Price / Earnings Ratio 8.0 9.1 Book Value Per Share (year-end) $28.33 $27.19 Market Price (year-end closing) $30.00 $34.75 Market To Book Value 106 % 1289 Total Return (Disidend3 & Price Appreciation) -5% M'4 Number of Common Stockholders 78,880 81,914 TABLE OF CONTENTS letter to Shareholders 3 Financial Resiew 6 Electne Utility Industry-Financial Trends 6 ilouston Industries Incorporated Financial Resiew 8 Houston Lighting & Power Company Operations 12 Houston Economy-Trends i2 Electricity Sales 14 Electrie Utility Industry Structure-Trends 16 Regulatory Pro::edings 18 Competit. e Strategies 19 Pow er Supply-Trends 22 South Texas Project 24 Fuel Strategies 25 Operations of Other Subsidiaries 25 Primary Fuch. Inc. 26 Utility Fueh. Inc. 28 KBLCOM incorporated 30 Inaosatisc Controk. Inc. 31 liouston Industries Finance, Inc. 32 Development Ventures, Inc. 32 Financial Section 33 L

1 r ( Pretuiling winds. Shifting tides. Changes in direction on the rotul to die future. Opparitmities. ? Threats. Undeniable. Unstoppable. Hotuton Indusnies, like all bicinesses, is impacted in treruis: GlohllJirumcicd tresuls. Local economic treiuis. Iruttutry directions. We're continuing a long i idslo1'y of sitCCe$s by tuulCrsta1ulillg, LLlayling to alul, M'lleTe [)ossible, slulping 0te Clumges 0klt GTC affccting ourfuture. L ? 4 1 ~ ouston $1Ll16tries InO1T[h rrated is d1C [\\lTelli Conlf\\lny of scttn std>shliarics.' t Houston Lighting & Power Company. HLGP is the ruition's eighth Lirgest electric utdity in ter,ns of kilouaa-hour sides, sening a 5,000 squarc-mile area u hich incluJes Houston, the ruiti<ni s fourth largest city. Prinuiry Fuels, Inc. PFI is an ud arul gas exploranint arul[m >ductin,1 ann [hirty V (' uith dumestic [m\\luction atul resert'es loatted in Ute anitittental U.S. a1ul in die Gulf of MexiO >, t. su U CII rU intenutio1LN production ili sctvTal Countries. Utility Fuels, Inc. Ufl is a fidl-sen ice s a kN suf'p$y Com[\\U'y int \\'It'Cd in N1e dQluisition, (Tans [X1Tlatioll, lhllklling, a1Lllk$ ministration of l o al and liglite for c!cenic generating pLmts. KBLCOM incorporated. KBL COM is into!t ed in 1 the ounership atti operation of cable telctisian ssstcms. It hulls a 50 [vrcent intere3t in a multi-state caNc tc!ct ision joint t enture ad!cd Paragon Comm:mications. u hich sert es ot er ( 650,000 automers. Innoturite Controls, Inc. !Cl dct clops an.1 nurkets high-intensay discharge 1 ( lights driten by c!cctronic MLuts. Houston liuhutries Firumce, Inc. HIF purcluiscs acarunts i recenuNe of HLSP. Detelopment Ventures, Inc. DVI is a ttnture capaal organi: anon uhich y [J intrsts in estaNishcJ fiotis atti mit tics sunt-up fiiuncine f<n sntJl binitiesses. I 1 I i. .a il ( u

FINANCI ALlilGilLIGilTS l l 1987 1986 Operating Resenues 600) $3,628,213 $3,535 %8 Operating Expenws (000) $2,890,745 $2,809,387 Net Income (000) $434,958 $424,935 Eamings Per Share $3.74 $3.81 Dividends Per Share $2.86 $2.76 Aserage Number of Shares l Outstanding (000) 116,322 Ii1.593 i Retum on Average Common Equity 13.6 % 14.5 9 l Fited Charge Coserage Ratio 2.86 2.76 Price / Earnings Ratio 8.0 9.1 ihk Value Per Share (year-end) $28.33 $27.19 Market Price (year-end closing) $30.00 $34.75 Market To Book Value 106 % 1289 Total Return (Disidends & Price Appreciation) -5% 34 9 Number of Common Stockhoiders 78,880 81,914 TABLE OF CONTENTS letter to Shareholders 3 Financial Review 5 Electrie Utihty Industry-Financial Trends 6 Ilouston Industries incorporated Financial Resiew S tlouston Lighting & Power Company Operations 12 llouston Econom>-Trends 12 Electricity Sales la Electrie Utility Industry Structure-Trends 16 Regulatory Proceedings 18 Competitae Strategies 19 Power Supply-Trends 22 South Teus Project 24 I uel Strategies 25 Operations of Other Subsidiaries 26 Primary I'uels. Inc. 26 l'tility Fuels. Inc. 28 KilLCOM incorporated 30 Innovatise Controls. Inc. 31 llouston Indu4 ries Finance, Inc. 32 Deselopnrnt Wntures, Inc. 32 Financial Section 33

I, l, j TO OUR SilAREHOLDERS ineteen eighty-seven

were $408.6 million, or $3.51

{ was a year of hard work, ! per share, compared to $434.9 i significant successes and ; million or $3.90 per share

building for the future for both in 19S6.

1 j

Houston Industries incorporated l Primary Fuels, while still i

s ! and our home city. l affected by unstable oil and gas . HoustonIndustries achieved ! prices, recorded significantlyim-i earnings of $435.0 million, up proved results during 1987,with l i i l . from $424.9 million in 19S6. a profit of $4.5 million, compared i l j Earnings per share were $3.74 ! to a $27.7 million lossin 1986. I in 1987, compared to $3.81 the l Earnings for Utility Fuels,Inc., l i previous year. our coal supply subsidiary,in-f i . creased to $24.2 million in 1987, j e Houston Lighting & Power l j 3 Company,our major subsidiary, l compared to $21.9 million the L i completed construction of Unit 1 j previous year. l - at the South Texas Project and HL&P will file a rate increase received a license for fuelloading request during the first half of 4 and low. power operation.

1988, primarily for recovery of e The Houston economy, costs associated with building which has been feeling the effects ! and operating two new generat-!

of depressed conditions in the en-j ing units. An equitable decision ergy sector, began showing early by the Public Utihty Commission ! i but convincing signs of economic of Texas could improve the finan-l i recovery. cial outlook for HL&P in 19S9. i Earnings Withstand Nuclear Plant Moves Toward i i { I Short TermImpacts Operation l Houston Industries achit ved The past year has been one of { solid financial results despite fac-major triumphs and a few disap-tors which continued to impact pointments for the South Texas I Houston Lighting & Power Project (STP). In August 19S7, l (HL&P) and Primary Fuels, Inc., the Nuclear Regulatory Commis-l our oil and gas subsidiary, sion issued a license for fuel l l HL&P felt the effects of a soft loading and low pow er operation i local economy and mcreased ex-of Unit 1. The first nuclear reac-penses due, primarily, to the cost tion took place March 8,19SS. l of operating a new generating l l unit, w hich ic not fully reflected in electnc rates. HL&P's carnings il i

~ We expect to put the unit in Austin's 16 percent share of STP forits principal subsidiary, commercial operation in the in exchange for an equal amount HL&P. We are, therefore, pur-summer of 1988. of capacity at HL&P's Limestone suing a diversification program After five v'a s cf successfullv I lignite plant,in addition, HL&P seeking business opportunities f nunaginganaggressivebudgat -l will make a cash payment for which offer the potential for l and schedule for STP, the com-purchase of nuclear fuel ow ned additional caniings growth in j mercial operation date for Unit 1 by Austin, reimbursement of the future. I l slipped somewhat from our tar-construction expenses incurred However,our diversification get date of December 1987. In by Austin during the later stages program is in its early stages,and j addition, the estimated com-of negotiations, legal fees,and we are proceeding cautiously. l pleted cost c,f the plant has settlement of an unrelated pur-HL&P will remain our core busi-increased by approximately 5.5 chased power contract. ness for the foreseeable future, i i percent, compared to the budget I am convinced that the settle-and continuing our record of suc- ! established in August 1982 when mentis in the best interests of cess within the electric utility industry is a top priority. l l about two thirds of the construc-both parties. We are committed l tion work stilllay ahead. i to working toward resolution of i j i i l HL&P Launches the remaining conditions. Unit 2 was 86.2 percent com-t g j plete at the end of 1987, on in January 1988, HL&P filed l Success within the electric utility ; schedule for fuelloadingin legal petitions designed to avert . dustry requireslooking ahead m i i December 1988 and commercial additionallitigation related to j and adapting to the fundamental operation the following June. STP.De petitions ask the courts ; I changes that are occurring.These ! to define certain rights and obli-j Austin Settlement Sought includeincreasing competition, Following months ofintense i gations of HL&P in relation to both from the natural gas indus-I I the other STP owners. In te-negotiations with the City of I try and from cogenerators. That I' sponse to HL&P's petitions, the i i means HL&P must become much ; Austin, HL&P reached an agree. other owners have sought arbi-l more competitive. i ment to acquire Austm's share l s tration of the disputes. of STP and to resolve a long-In addition to ongoing cost j i control efforts, w hich are helping l standing legal dispute between HISeeks Growth Through I f the two parties However, the Diversification keep electric rates down,we are agreement is subject to a number Houston Industries is looking { launching a greatly expanded I of events and conditions,includ-ahead to a period of declining l marketing effort in 1988. ) ing approval by state regulators capital requirements, improved HL&P devoted seven months 4 and the Nuclear Regulatory j cash flows, and modest grow th during 1937 to a detailed study Commission. l of the marketplace for electricity. l l If the agreement can be con-l Re result was a blueprint, by } cluded, HL&P will acquire l market segment, for a compre-l hensive program to increase the l 1 4

i I j use of electricity where ber.efi-l business to locate and prosper. A employees within our Company, cial to both customers and l case in point was voter approval, ar the driving forces behind shareholders. in early 19S8, to proceed with a that progress. Tne increased sales expected metro mobility construction pro-I also would hke to commend to result from these marketing l gram, which has set the course our Directors, w ho are called on I 4 I j programs will boost revenues { for transportation improvements I to participate more than the di-and support our goal of holding i in the Houston area through the rectors of any company with down electricity costs by allow-year 2000. which I am familiar.They were 1 ing fixed costs to be spread over The plan, which includes asked to attend an average of 33 a greater number of kilowatt-improvements to existing meetings each during 19S7, and hours sold. transportation systems and l their response was exemplary. I construction of a light rail sys-Attendance at meetings of the i City Builds for the Future l tem, will enhance the appeal of i full Board and of the various Just as HL&P is faced with com-our area and contribute to the committees averaged 92 percent. i petition for electricity sales, the success of our economic devel-l We owe a special debt of grat-Houston area is faced with com-t i opment efforts. itude for the contributions of l petition in attracting new l For Houston Industries and f three Directors who are retiring j businesses that will enhance the the Houston Gulf Coast,1987 this year. Searcy Bracewell has economy of the area. Success in was a year of progress.The l been a Director for 11 years, Joe that arena requires a with.ngness to invest m the future. forward looking people in our WessenJorff for 9 years and I. A. j t i communities, and the dedicated Naman for 5 years. Their dedi-In Houston, we are contmumg t to build the infrastructure which cated service is appreciated and 1 I their wise counsel will be missed. will make our region an increas-1 Our continued soness also ingly attractive place for new i depends on your support. We l smcerely appreciate your interest } l in Houston Industries and remain : 4 i l i committed to providing you with l 1 attractive, stable dividends while l t C t pursuing opportunities for long-i A i j term grow th. l l l k k. l l ~ f" ')~5 4 i Don D. Jordan President and i Chief becutive Othcer b-Houston. Te xas I l I)on ti lor.t.m March 15,1988 i s

Reliable utilities. + They're knoun for senice cusunners count on. Eamings investors kmk on. Consistent quarterly ditidatis azul attractite yiells. Suble suck prices. Malerate risk, malerate gains. Most of the time. + In the mLl-1980s, utility sucks registered rahat price gains: RLling the hdl on Wall Street. Gaining momentmn as interest rates nanbled aiu:i11testors bLl up die Inices of high yielling sharcs. + Then, the ups azul &>tt,ts of'87: For nailities, a peak in Jamuny And a retreat, as interest rates inched ignvard. Investors tunted d1eir attention to isulitstries tt here die bidl charged on. + Until Oauber: 13 lack Monday. A frightening plunge. Wall Street's tvill ride canied Dote trulustrials douvi 23 percerit for tlie motidi. Maintam..mg an S & I,500, off.,.,. percent. + h.ir utdities: even keelin Smoother sailing. Snudler price suings during die year. stormy waters Ad in die attemuuh of oadu, more im esa n s v sCeking shelteT in safC, suNNe, high-yiel$ int'estments. + Entaing '88: Tuo phaes for utility suds. Easing interest rates. Sound irulustn fmulamenuds: StdNe cantings. Gnnving fisunicLd strengdi as a l decade of capital expinsion auls. Capiud requirements &nen. l.img tenn debt shrinking. Cash pnes expnuling + Shne grou th, kne gn a th from utilay operati<nts. L,'pshle potentLd from ditersifica-tion. + Diversified tailities are investing available cash, pursuing nete s<mrces of grou th. Secking a healthy himce: Reg:Lued azulimregtLited bruinesses. Stabdity azulguntdt. I'n t kling economical CICChiC sCTViCC u flile nkl1imizi11g sluireholleT tulue. 1 } l l l i c:

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~l HOUSTON INDUSTRIES Eamings again create downward pressure FINANCI AL REVIEW - Houston Industries achieved on earningsin 1988, particularly earnings of $435.0 million during after Unit 1 at the South Texas 1987, up from the $424.9 million Project (STP)is in service. earned during 1986. However, HL&P plans to file a rate in-earnings per share decreased to . crease request during the first $3.74 in 1987, compared to $3.81 half of 1988, primanly for costs the previous year, on a 4.2 per-associated with Limestone Unit 2 cent increase in the weighted and STP Unit 1. Action by the average number of shares out-Public Utility Commission of standing. Return on average Texas (PUC) on the rate request NET INCOME m nA" common equity was 13.6 percent, could improve the financial out-compared to 14.5 percent in 19S6. look in 1989. ( f, j Houston Lighting & Power To relieve pressure on earnings Company, HI's principal subsid-in the interim, HL&P has asked iary, recorded eamings of $408.6 the PUC to authorize deferred million,or $3.51 per share,in accounting for Limestone Unit 2 6 1987, compared to $434.9 mil-and STP Unit 1.This would allow lion, or $3.90 per share, the HL&P to capitalize operating previous year. costs and carrying costs incurred Allawance for Funds Used from the in-senice date until During Construction (AFUDC), these units areincluded in electric or non-cash camings that repre-rates. j sent the carrying costs associated With only one generating unit with construction expenditures, still under construction,HL&P will k k accounted for 52 percent of be entering a period ofimproved I [ f, i a HL&P's camingsin both 1987 cash flow and substantially lower 9 M 85 M and 1986. capital requirements. Assuming that sufficient rate relief is Consolidated net unceme for 19%as Qut}ook $O10 millmn, up $10.1 million f rom granted, the quality of eamings r94,arnings. Operating costs for new genera-ting units, which will not be fully reflected in electric rates until HI &P's next rate order, will s

also should improve as non cash $2.i \\ This marked the 18th in-earnings would accouat for a de-creasein the past 18 years, and creasing portion of total camings. the 66th consecutive year that the Company has paid regular quar-Stock Performance, Dividends terly dividends on its common After reaching a 20-year high in stock. January 19S7,llouston Industries At prices prevalent during the common stock,like many other first quarter of 1988, current divi-issues, took a disappointing tum dends were providing a yield of later in the year. Over 9 percent. til clo ed at $30 per share on December 31,19S7, down 13.7 Bond Refinancings EARNINGS PER SilARE percent from the previous year-Houston Industries continues to end price of $34.75.This was utilize innovative financing tech-slightly better than the Dow Jones niques to meet the individual 7 n Utihty Index, which declined 15 needs of its various subsidiaries. percent during the year. For example, the Company While stock prices have lost has been aggressive in refirancing some ground, H1 continues to high coupon HL&P bonds m sup-provide shareholders with an port of company-wide effo ts to attractive, stable source of income. hold down erpenses. At the end De dividend yield averaged S.6 of 1987, HL& P's embedded cost l l l J percent during 1987, of long-term debt was S.32 per-g p j l j Effective with the June 19S7 cent, down from S.74 percent at { { l f payment, the quarterly dividend the end of the previous year. was increased from 70 to 72 cents Contributing to this reduction per share, for an annual rate of was the retirement of more than $390 million of high-coupon first a s 3s s mongage bonds through ex-change of fers. Holders of the COnwtisat<a carnenxy n aare l war s m in avs?, aown sn:a aare high-coupon bonds received new f,g,,,19sg g,,, q,,,<,,,,,,,yg,,, 9 percent bonds and a cash ' ' ' h ' " "M # d ""#' "" " Of aare% Ottinfartding. l premium. t i l i i n

The exchange offers, announced 6th year, and has an average life in February 1937, were coupled of 8 years. with an announcement that up to in January 1988,liL&Pissued $145 mdlion of the outstanding $400 mdlion aggregate principal bonds would be subject to re-amount of 96 percent first demption, at par, under the mor' gage bonds in a private annual replacement fund pro-placement. Approximatelyequal visions of ilL&P's mortgage and principalamountsof thisissue deed of trust. will mature in 3. 4, and 5 years. The goals in structuring the ex-Proceeds were used to pay ex-change offers were to achieve a penditures related to IIL&P's TMGE yo high level of participation, min-construction program, including imae the cash premiums paid, repayment of construction- [. and avoid conventionalinvest-related, short term debt, and to f 5 ment banking fees. call the remaining $4S.5 million ,,a j The exchange offers, together principal amount of 13% percent 2 with the subsequent replacement series first mortgage bonds. fund call of $140 milhon pnncipal flouston Industries Finance. amount of first mortgage bonds, Inc. (ll!F) established a $300 mil-reduced liL&P's annual mterest hon bank credit facdity in July expen.se by approximately $14 1987 to finance the purchase of j [ mdlion. IIL&P also saved about liL&P accounts receivable. 1 4 $45 million in cash premiums, ten-Later in the year, the finance y i j I 4 s* J der fees, and underwriting costs. subsidiary implemented its own i R commercial paper program. The New Financings commercial paper received a i liL&P raised $99 million of new rating of Duff 1 + from Duff & capitalin June 1987 throuch the o n s Phelps and a rating of P-1 from l sale of 1 mdlion shares of pre-l Return on,rcr.w< common <quer.v l ferred stock carrying an 58.50 tras 11 b percent in NC, wmpared to } t 14,pers ent during 1%b. l l l other prefeired senes. the new l ! prefened is subject to a manda-l 1 l tory sinking fund beginning in the l l 1 i i l i j I ,t t + l l I w

r y Meady's.'Ihese are the highest Stock Sales ~ short term ratings given by the HIissued 3.5 million shares of agencies. common stock during 1987 tilFis now using the commercial - through its continuous offering paper for short tenn borrowing, program,its disidend rein-with the bank credit facility seiv-vestment plan,and certain ing principally as a backup, employee benefit plans. Paragon Communications, a Of this number,1,863,000 cable television operating com-shares were sold through the con-pany a which H1 has a 50 percent tinuous offering program. Net interest, finalized a $430 million proceeds were approximately bank credit facility during 19S7. $70.3 million,or an average of CASH DIVIDENDS DECLARED PER COMMON SilARE Proceeds from borrowings under $37.73 per share, 3 the facility, which is non-recourse a Capital Requirements to HI, were used to permanently 3 a ~- Capital requirements, while still

s finance the acquisition of cable a

substantial, are contine;ng to 2 telesision oroperties distributed decline as HL&P's power plant from the uioup W purchase. construction program winds Paragon's revohing credit facil-down. Projected capital require-ity provides financing flexibility ments for 1088,19S9, and 1990, through a letter of credit featurt, exclusive of AFUDC and maturi-which can be v>ed to support the I ties oflong term debt.are as issuance of Paragon debt securities. follows: Capital Requirements I o a l i 4j '} (Millionsof Dollars) 1988 1989 1990 y g E P Houston Lighting & a u M u n Power Company' $ 495 $ 444 $ 36S Utility."uels, Inc. 57 46 24 in,9 arterty sicisens was rais<a from 70 to 72 cents per share during Primary Fuels, Inc. 57 ry,7,,rfectic, wi,3,3, f,n, sici. d'" d "Y "" '- T TOTAL $ 609 $ 490 $ 392 %uston tyhurg & Power capital reqwremccts do not refled the p wbie acqumhon of an additenal'6 percent share of the South Texas Project "Pr: mary f ueln xpendaures for od and ps exploranon wbsequent to 19e are dqendent on reva!ts of as 198s exploraSon and des clopment pn pam, and tactors af fectmg the od and ps mJetry i i i k Ii

In its heyday, Hoicton !uulit aH. Or so it scented. + lt tvas a big tirne, booin toton, in die ruitior d spotlight. Help tvanted sipu, constnicti<nt pennits, and U-hand traders uith h1ichigan plates All tvere sigts of the tirnes: Gal tirnes. The days of $35 a ku,el vil. On the tvay to $50, sinne belieted. + Buill. Bonine. Buill some more. Wking to keep aherul of g, ant d1. thiten by die oil inice surge. + Stuldeniy: Oversupply, taulerdenunul. Oil nices phannteted, lehne $10 a hinciin i '86. Onlling actitity dn>ptei. Sales of eq1<ipnient arul nuiteritds folbnved. + NeXt the plint closings. Atul dte layof[s. Then, the ripple effect: Constniction. Banking mLultivatin entemimnex. resmurents. ena,emd Ssanm,1 rana n,, a botmtift Offi:e glut, f<nechist<res tuul U-lunds uta of totat + Firudly, a future tunting[xint. Houston futukl die b>ttant, arkl situteti turning up. + In 1987: The Lut stubbon1 symptonts of econinnic dls. The first tital sigts of recoteur Unenployinent 1 l [alling. Office 5[htce fdhng. l'el10chanicals reb >taulittg. Air tratel vising. The l' ort ofIlutat<nt btalling Steafn. Afkl tbe sCeds of Tenetved pou'!b frufn a beiddly mil ofif Lf!(StTies. 4 AeTos/Alcc. $2 bdliott in nete NASA contracts. kiedicine: $l.5 kilion in nete corutniction. Conventi<nts azul c #n:A l netc $100 million cont ention center. + hicanu hde, enerp is smrting a hunpy conk htck Od fnices l up and dinen Gu strengthening. Exploratiart arul prodtictivit bicigets up i2 to 10 tr, cent for I988 l i I + The future: Gra hul, stah!e puu th. Otepacing the stitiotud attrage oter die next deatle. l l \\ InLTetning economic tbt efsfly as Hallsto71 rebitNd5 on (>Ll stren(NB an(f el[\\likl5 lit btHl:Uns Cultn ating a b runtifulfiaure after the drought. l l l l \\ l l l i i i w I l l ] 5.

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HL&P Sales Improve i j l Just as the Houston economy at a cost lower than that of their However, when interruptible turned an important corner dur-other attematives. sales are included, the peak de-I irst 1987 and began showing signs increasing off system sales is mand actually served hit a new of renewed growth, Houston an HL&P strategy for utilizing nigh of 11,318 megawatts in 1987. 1.ighting & Power Company also available capacity. As a result of Growth in peak demand for reversed recent trends, with the stepped up marketing efforts, electricity is expected to re0cct first sales increase i-three years. revenue from off sysNm sales the pattern of economic recovery. Sales for 1987 were up by 3.5 jumped to $32.2 mill an in 19S7, The compound annual grow 1h percent compared to 1986, pri-up from $16.9 in 1986. rate in peak demand over the j marily as the result ofincreases in ; ladustrial sales ir reased by 4.8 decade from 19S8-1998 is pro-I off system sales and interruptible l percent during 1937, fueled in part jected at 1.1 percent. I sales to industrial customers. by a rebound in the petrochemical in addition to the Houston Interruptible sales are sales to industry. Residential sales, the economy, HL&P's future electric-l large customers who are able to _ ity sales willbe innuenced by l number of residential customers

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! fundamental changes within the i t c j during periods of peak demand showed little change in 1987. electnc utihty industry. HL&P's i for electncity in return forlower Commer:ial sales declined 2.2 strategies stress cost control, ex-ntes. Off system sales are made percent during the year. cellent customer sersice, and l to other u ilities, frequently as Peak demand for electricity in expanding the markets for its t economy energy transactions, l 1987 was 10.302 megawatts. ex-pmduct. when HL&P can provide energy ! ciudmg interruptible demand of t l

1,016 megewattt This is down from 10.556 megawatts in 1986.

mW \\ -y" 'l, \\ 1 w by. ~ \\. .,+ .\\ l l .r f Nearly $ L5 bulli m en con-fsf shurments througir struction svas undcrway. the "ort of Ilous ton } , approved. or completed Junng bor ro. bn dly.tu nng \\ 1%7at the ic1as Afr. local 1% 7, runnsng ge I Crn tcr in llouston. jf almost ten p<rs cnt A $2 bslluon N A S A contract l au ardcJto Afs!)onncil I ^ Douglas dunog i%7 u ull bentfit the llouston econom s l t 14

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1 r u a,4c m,m n m,. T he e,dy or e n n - + wnh pa r-Redanadnies fate saml the puNic ttcll. Bigger pLmts arulIvrter tecflitoloc krpt rates bnV a,ul suiNe. For abnost a i cennoy. + Then came the setenties, the deotle ofitiflition: The enac enmt h sent fuel prices ,mn4nu maestra,c,,ese C _ emne a, u a m,u,sds a m a,me.e,aam,m,a c du'bhffdf. bICanltflNe, sup[dy cA[\\Dkkd fn dk' Tklme of ConseTt'dtfon. fn hle funn of cogenCTdtfoll, f;- + Cogeneation is: Pwduaion of clearicity ond another fimn of enagy from the stune fuel An oI<$(CN1Molog%.NCttLNi:CN 11N la\\ Irreak Nurtured bs fetleral ptdicies rcluirisig radities to l'uy iE cogenerated kilattutts. Nete source of[nofit for Ei Shaning the bit UhllUtrhN CogCMCratoTs. NCtV souTCC of CompCotion i f0T a More for utilnics. + h,ete ndes. Different rules k com1Jetit1ve future = faf,ama pu>as: ndaics imenaaen,. s E W Regubacd t s unrepdued. Utilities in homess to sat e, ora the long tenn. Cogenaauns sell at tall, r as long (U profits aie fligfl. [Itditic5 m!(s! f'lty, Oagcherators not rd{Uiretl to sup[dy. bufpbd tafay, sflitriagJ fomO1Tou ? k [fk'n hle eigbtlC5, dle dcQLfc of daegidatloil: diTlines. Banking. CU fipebnes dik! tiledimnlitfl!Uitloits. [f uckmq and radrads. + Eleatic utdnies: Stdla rendued busincss. Ata k p S k. 8 I Cuinferitiiin is flere tHLl mrne ic(ubbM} f\\tniers nkly tionNc. + The fraure: Aiore[, layers Poteer ,g-O smj\\nlics, 0 ge7kTators. hkb'j'aklcllt [h M cr [)roducers AU secting Ades. Negottamg, initig igilators y i medun4nu. PeihJps, one dJ), babling to bilbf Mctt McMaating pbmt.s. + Puficy nu$ashdC g e 4. k 4 e l =- fi<cl mix It dn ewfal dnJ scace! Wdl cfficiency acuully maase: + Wdl the puNic re Uy Iv Ivita = i j sat'uff + Utday Lalas are s;vakmg out m Washmgton. Playing an aait e m!e in sfuping the l l cfLm(cs dLM J:e aj[cctmg thcir nLlintry Scpicsentmq dle m! crests o[06fomcrs afkl mtcshns ATLI a! dw %ime inne, dh')'re sLiv[1mq <tiatcylcs fui suitcss m a more aim l<tttttc tnnll ~ l I N If g--

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Rate Increase Request to be Filed Houston Lighting & Power Com-expected to go into commercial The Company believes that an i pany is monitoring electric utility operation later this year. equitable decision in the rate case indust:y trends, and is playing an The amount of the rate increase will eliminate downward pressure l active role in shaping the direction granted will be influenced by a on camings from costs which are l of proposed regulatory changes at PUC prudence review of manage-not yet reflected in electric rates. the Federallevel. Of more imme-ment, planning, and construction However, new rates may not be diate importance, however, are of STP. His type of review is effective early enough to favor-I severalissues specific to HL&P commonly used by regulators to ably impact 19SS results. which will be decided by state assess the planning and construc-In the meantime, HL&P has regulators. tion of complex projects in order asked the PUC for permission to Dunng the first half of 1988, to make appropriate rate decisions-u>e a special accounting treatment i l HL&P expects to file a request for HL&P has submitted a :ubstan-with respect to both Limestone i a rate increase, which is needed tial case to demonstrate that the Unit 2 and STP Unit 1, w hich l I primanly to recover construction owners were fully compensated would allow the Company to and operating costs associated ! for any possibleimprudent costs defer operating expenses and l . with two new generating units. by a $750 million settlement of a continue accruing a carrying Umt 2 at the Limestone hgnite lawsuit against the former charge. If granted, deferred ac-plant went into service in Decem. j architect-engineer and constructor. counting will help offset the ber 19S6. The first nuclear unit negative impact of costs auoci-l l at the South Texas Project is ! ated with operating these units l from theirin serwe dates until a l ! new rate order pu mto effect. l l l I I l l { i i l } I i l + \\ i j J \\ . 2_ --- 5 i j CR ' 1 i i .~,#" i t l ~~n ( } lIl t< Prmplov es hat e " " ~ - l l wmputed t clumes of sur- ! III t<l' rres tJen t inon i l rortm q Jata ta dm u ment %L ora testulurd en tles tns l tf.e necJ for a ba~r ra tt stuluty sndustry us~urs { m, rea se t rart Inhng us I,, fere a il s llou.c ot } antu spated Junn the fint la pve rentatu cs l A half ot 1% I s u t,, o m,m t te r \\ i I 4 i t

Cost Control Gives Competitive Edge HL&P is pursuing a number of costs is a staff reduction program, ing 1987, management approved strategies for successin a compet-which has enab!cd the Company almost 600 of approximately 850 itive business environment. to decrease payroll costs substan-suggestions. Savings from these De most obvious competitive tially without a major layoff. ideas are expected to exceed $5.3 strategy is to be the preferred, Target staffinglevels established ! million in 1989. Iow-cost pnxiucer. HL&P has in mid 1986 have been achieved, Employees also maintained ex. j achieved substantial success in with 914 positions eliminated cellent customer senice despite controlhng costs company wide through voluntary means, such as the need to do more with less.

through actions ranging from an early retirement program and Nearly four out of five customers i

i work force reductions to renego-employee reassignments. polled in the Annual Consumer I tiating fuel contracts. Reassignments are continuing Opinion Survey uid they had a This success is reflected in the to help the Company utilize favorable opinic.n of HL&P. l , Company's increasingly competi-employees for high priority activ-Customer perceptions that I l tive rates. In 1986, the average ities without increasing staffing. HL&P provides quality service i l i rates HL&P charged its large in-HL&P employees are playing contnbuted to the high ra'mgs, dustrial customers were the hfth an active role in control!ing costs with 87 percent of those polled lowest of 61 investor-owned util-by working efficiently and by giving the Company high marks 1 l j ities in 12 key states, and the contnbuting their good ideas. in this area. HL&P also received 1 t lowest of nine investor-owned t Employee Focus Groups have favorable ratings for good nan-i utthties in Texas. This.;as a sig-produced m'are than 1,500 ideas agement, willingness to listen and i i j j nificant improvement compared since their creation in 1933. Dar-respond, and being concemeJ 1 i 1 ' to 1985. I j about the cost of electric senice. 1 l In 19S7, HL&P underspent its l l operations and maintenance bud- ! g j get by 2.5 percent. Contnbuting l i P., ongoing success in holding dow n 1 l 1 i l ,1 1 1 l l i I I j j"~ w r~,. i The stars h lor ncw I Ilouston arca students are I{ cost-sai ung sJeas led l l s ta vang s om forta ble and fil i< P to tot ure ol bar i f s oding for accuracy and the schoolJustract ts satung t ltiscr cy an retalcrtals i moncy sinst su1tchtng to t I j \\ electru sty for hta ting in managemcnt. 1 some ss hools. Ill ul' rep-a ~ rncn tatu t cs hcip manu ( , 4 {, s u>tomer, nJcn tity bcncti-y.,.. s nal new u so oiciectria ry - ~ ~ W

Marketing Benefits all Customers Offering excel!:nt service at a benefit the economy by bringing generation for some large custom-competitive price is one put of new businesses to the area and ers who are able to accept the an effective marketing effcrt. encouraging local expansion by possibihty of curtailments. Understanding customers and those already here. During 1987, ilL&P consultants help cus-responding to their needs is liL&P's economic development tomers w ho are considering self ~ another. IIL&P has launched a efforts led to the creation of generation projects to avoid n ajor marketing initiative bascd 1.500 new jobs. those that do not measure up eco-on a detailed market and customer llL&P identifies prospects for nomically by explaining current analysis conducted during 1987. possible business relocation or rate options and providing fore-The new marketing programs expansion through advertising, casts of future energy costs. being implemented all have one working with area economic de-During 1988, HL&P will thing in common. Rey are de-velopment organizations, and pursue the residential market signed to benefit all customers, referrals. through a number of avenucs, not just those participating. The Comoany also has ex. including stimulating construction increased sales help hold down panded use of business research of energy efficient, all-electric the cost of electncity for every-as a tool to target companies and i homes. HL&P will promote one, because fixed costs are industnes which are expected ta the purchase of homes con-spread over a greater number grow. Prmpects are then con-structed ur. der the *GooJ of kilowatt-hours sold. tacted by HL&P representatives. (cnts"" program. Economic development activi-i Besides communicating the in the commercial sector of i ties improve electricity sales and benef.ts of the Houston area, HL&P's ser ice area, electncity is HL&P n w orking to improve the economically superior to natural j region's economic appeal The gas for heating and coohng, .e Company recently received ap-HL& P's marketing task is to edu. l /4 u,.x t4 '.g j - proval from the PUC for a special cate architects. engineers, and f.? ,7 p ;,. electric rate w hich offers up to a customers about relative costs. 20 percent discount for baic Re Company also is working p ".Q. ' }.[;3,t ( industries creating new jobs in l to strengthen relationships with ... +l. 1 ,c

-i' the area.

trade groups, such as builders q Offenng a vanety of rates to and heatmg and coohng con-meet different ctstomer needs tractors w ho are m a poution to til 61' u worbn.y to I mcrea +< nr ot rIcctriot& also is an importalt tool in main-influence appliante and equip- , for hea tm g an.l otirer res nicn tialstylu a tuso tJming and increas;ng sales to ment selection I r < cr citioor t r/n tric homa l rates, for examp!C. p? ovide a cost ef fective alternative to self f y

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s,g s b$ n'oflinaQBdl, l.ke c0nlinny exhlikfdl, afkl tlle t(se (if eleCtlicity fictc. b 166 to Y siinhc. + Easy to plot, casy to [4m for. + Fucl3 trere abmulant artiinexten3ite. Gixarine toteer [4 nits trae ncabl. Economics of scale meant Litrer clccnic rates. It tras clu Ivst of all tonLLs. + Thcri, the Oil Embargo of 197.1: Gas lincs, facl price shocks, shertaxes. Arti the irtetitable legislaion. Cad athl nlWlCar pla11is tWTe UtiI$liCs' netl' Upliolls: Extmisite to buill, eheater to ful + Costs spiralal aptrarJ: Fucl escaluions, ontstnction inacases, rising intacst rates. AnJ Jonb!c-Jigit inAmon. AfnCriGl pHficd tfle ffMR. k bsJge hittCnts tient allTy. Cofisert'ation bCGunc a TLitis nkd obsession. ProVCn mclIlobs of forCatSting ClcCtTicity NcnLUkl stklIcnl) yiCli$CN Balancm e enus.s,snsee,. Umcauns r ' a + iae mu. suppIy m 1 ~ ~ i 1980. Aluta face! An oversupply of oil anJ gas. s: ! new cen3 ands i s.a3nne knous ics rann,ran nia h<m,cmnmn37 I ! Arul how set ae ui!1fiume shortagcs Iv? + TaL4y. a fetc of the giant piteer pLmts begun Jming the sCt Cntics arc sall CU1ning on stTCam. Their Icgacy: ReliaNe electncity L ss depaulawe un ud arul gas. ^ f The pnce: Higha clccnicity o>sts. The resa!t: Consmna resistance, reedaton rehetance to i onts. + The immcJiate fararc: FlexiNc. Snu!!a nor unas, f.nta to hdl. Louer capitalint est-l ments. Pouer parchases. AnJ a myn tl of rett opti.nts stcctvJ in netc tmoutsc. l?aiunti stic opnons C<nuat ation anJ Ind m uugement to sr the trab in clccnicity use. Off peak nurketing to fdl ^ ta!L s anJ ice atai!aNe caowiry All un oc enJ. Use pLmts effiacntly mininu:e cmn lenga ! 3 l tenn: A ncu cycle o[unistniction bkcly 8mlbng[or neu gniu'th in the nmcrics a[ta dcnkullis I ctiJcnt. Lirxc-3 calc gencrannq anits tlut mect the tc3r as lcast-ant opro ots iiulajal as ont of an l otaallp,tcer supply P m + Utdaics ate pLintung Intty for the neu Jcnutuls of tomonote. The l L \\ ruks lan e ch.mecJ The gad has not. Stnic a lutmce: RcluNe <auce, reasutuHc ratcs, secure fac! supp!y uith a oongnntc rcnou f<n mtoton

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STP Starts Up, Construction Winds Down HL&P reached a major milestone the former architect engineer and Companyis able to conclude in its power plant construction l constructorof STP. an agreement with the City of program with completion of Unit 1 This amount reflects an Austin. HL&P's estimated share at the South Texas Project. increase of about 5.5 percent, of the completed cost would then The Nuclear Regulatory Com-compared to the budget estab-be approximately $3.0 billion, mission (NRC) issued a license for lished in August 1982 when based on the September 1987 fuelloading and low-power oper-about two thirds of the construc-cost estimate. ation of Unit 1in August 1987.The tion work stilllay ahead. The agreement is subject to a first nuclear reaction, or initial cnt-ne estimated cost to HL&P number of events and conditions, icality, took place March 8,198S. forits 30.8 percent ownershipis including regulatory approval. HL&P estimates that three to live $2.4 billion, or $3,181 per kilo-However,if finalized,it will months of additional testing are re-watt of capacity, including settle litigation filed by Austin quired after initial criticality,to put financing costs, or '.owance for again>t HL&P in 1983. Unit 1 in commercial operation. Funds l'.d During Construction. Under terms of the agreement, STP Unit 2 was 86.2 percent These estimates were based on Austin would exchange its 400 l complete at the end of 1987, a commercial operation date of megawatt interest in STP for on schedule for fuelloading March 1,1988 for Unit 1. ownership of an equal amount of l in December 1988, and for com-Commercial operation is now capacity at HL&P's ligriite fired l mercial operction in June 1989, anticipated during the sununer of Lii..estone plant and a cash l Completion of the plant will end 1988.He cost estimates are, payment. Re cash payment HL&P's major plant construction therefore, subject to review, and would cover purchase of l for the near term. HL&P anticipates that the cost of nuclear fuel owned by Austin, Based on its September 1987 the tota; plant mayincrease by reimbursement of construction n;pletion assessment, HL& P $100 to $150 million. expenses incurred by Austin dur-estimated that the total cost for HL&P's interest in the plant ing later stages of negotiations, the c;mpleted project would be willincrease to 46.8 percent if the legal fees, and settlement of an $5.28 billivn net of proceeds unrelated purchased power con-from settlement oflitigation with tract dispute. HL&P would assume the remaining construc-tion costs for Austin's share of STP, effective September 1,1987. De agreement will allow Operators at the South Tetas Projctf Austin to meet its objective of '*j,',h[""" ' "~ discontinuing participation in I I stc; s and tests I<ad-I STP. HL&P will benefit by aequir-ing up to the forst f*'"" ing additional nuclear capacity, to nua<ar r, action in Af arc h 194. ~ bk di ify ts fuel mix. I l L l

l i HL&P Maintains Favorable Fuel Costs By enabling HL&P to add low-in addition to completing plants state-of the-art gas storage facil-cost uranium toits fuel mix,STP that will use abundant fuels, ity, placed in service in October will contribute to the Company's HL&P is keepingits cost of natu-1987, which will help ensure a goal of securing a diversified fuel ralgas among the lowest of major stable natural gas supply and hold supply with prices that willbe utilities in the nation. Despite a down gas costs by allowing the stable over time. significant increase in the price of Company to control the timing of Uranium will account for ap-natural gaslatein the year, the purchases. proximately 3' percent of the Company's unit cost of natural HL&P also has added connec-l Company's energy mix in 1988 gas was about the same in 1987 tions which provide access to and 7* percent in 1989, after STP as it was the previous year, several additional competing sup-Unit 2 goes into sersice. Coal and To maintain its competitive pliers of natural gas. lignite will make up 39* percent edge in natural gas costs, even as The Company's coal costs were l of HL&P's 1988 energy mix, prices rise, HL&Pis pursuing reduced beginning in January l while natural gas will drop to 43* strategies to capitalize on the 19S8 as a result of renegotiation I percent. competitive forces which now of supply contracts by Utility This is a significant improve-exist in energy markets. This re-Fuels, Inc., H1's coal supply sub-ment in fuel diversification since quires maximum flexibility in the sidiary. The amendments to the 1977 when 100 percent of the timing of fuel purchases and the coal supply contracts are ex-Company's generating capacity l r pability to choose frorn among pected to result in substantial was gas fired. many competing suppliers. savings to HL&P's customers HL&P has completed the de-over a 22 year period.

Based on HlAP's original 30.8 per-velopment of a comprehensive cent o:cnership of STP.

fuel delivery system. A major component of this system is a llL&Phas taken advantage j of competitit eforces in I energy markets to achieve naturalgas costs that are among the lowest of major utilities in the nation, 1 -.e i i in August 1937, the iIl bP's dwcrse fuel STP Unis t reactor was mir, which now loaded with about 17 includes W pcrcent coal million fuelpcliets, and lignite, will help each containing the hold down fuelcats l energy equivalent of over the long tcrm. l l about one ton of cal. I' 1

Priman Fuels, Inc. (PFI) competes uith large, integrated energy companies, compmies otated by foreign gavenunents, aiul otlier irulepeiulents in a nuirket tiuit luts tuulergone considerable tia,noil in + A dranuttic oil arulgas O Prices urise ed' recent years. price collapse in mid-l986 tvas natur 8as showin8 follotved by some price improvement strength ~ during I987. However, at tite end of I987, oil prices renuiined totsettled. Natural gas pices, on the other lunul, were shouing signs of grouing strength ai year eruf. + Conflicting estimates of near-tenn oil and gas pices abomul. Hotvever, the general consensus is t}un prices uill continue to rise grcultutlly asul gain momenttan in the 1990s. Ph Resultsimprove include pre-tax gams of $2.3 mil-condensate, and natural gas liquids, Primary Fuels posted greatly im-iion associated with the purchase compared to 31.2 BCF of gas and proved results during 1987, with and subsequent sale of oiland gas 4,114,000 barrels of oil, condens-earnings of $4.5 million, compared propertieslocated in Oldahoma, ate, and natural gas liquids the to a $27.7 million loss in 1986. and $2.7 million related to the previous year. Higher oil prices and increased final settlement of various Revenuesincreased to $114.0 gas production contributed to the contracts. million in 1987, up from $105.4 improvement in earnings during Production during 1987 totaled million in 1986, as a result of im-1987, as did lower depreciation. 39.2 billion cubic feet (BCF) of proved oil prices and increased depletion. and amortization gas and 3,887,000 barrels of oil, natural gas sales. Domestic oil expense. Earnings for 1987 also prices averaged $16.0S per barrel lhe El GordofitId in Statagorda County, Trias is Mrs top $13.19 a year earlier. Domestic T"#"(i"# Pmpnfy. h auoun tra natural gas prices averaged $1.69 IM T' for 18pcicent of domestic natural j sas revenues in im per thousand cubic feet in De-l- cember 1987, compared to $1.74 per thousand cubic feet the 1 previous year. Ihh~ PFI's capital expenditures were l l $53.3 million in 1987 and are es-timated at $57 million for 1988. l { PFI acquired and began operat- ! l { mg an oil and gas license in l 'f Argentina during 1957, where i

6 l

l

The fo!!a:cune table sets forth the estunated net proved od and gas rn screes and the present value, JocounicJ at 10",, ol estunateJ futu w net ret enun, as of the dates mJicated. Estimats Jfuture nct rn enues were wmputed by ap;'i) mn earendpuces to y car-end resert e quant:t:es EstimatcJfuture producnon and Jn clopment cmts a cre hasch mt y ear.enJonts, unwmrtg contoruation of e rnting economsc condarons. Such tnfo >mation n bacedon reports preparedby Ncphnger anJ Anoaata, inc.. DeGolycr und MacNaughton, H K tan Poollen and Aswciates. I c., and J. R Huticr und Company, viderendent energ; cemsultants for 198 5 For 1%, the snformatwn n bascJ on reports by Ker!rnger and Auoctures, Inc., DeGolyer and SlacNaughton und iI N ravr Poolle n and Assoc ates. Inc.. andependent energy t onsuhants. For !987, the vrformahon n bared ou rcrurts by K & A Fnergy Covultants, Inc., successors to Kephnger and Assoaates, Inc., Haley E ngmcen'tg Inc, sua essors to H K. van roollen and Anoaarn. Inc, and DeGulyer and MacNaughton, mJependent energy consultants. The Company emphau:es !!iat the tolumes of rescrtcs shun below are estimates u huch are sub cctit e er nature ar.Jare su bject to later ret uton 1he ot: man s are made un tg allatadable i geologicaland resert otr Jata as trellas productwt rerformance data. These cstunates are rencu e,lannua!!y and ret ucJ, cither upward or downu ard, as warrantcJ by adJawnalperformance data. Proved Resen es Umted Statts Foreign Dncounted Dacounted

Oil, Present Od, Proent Condemate Yalue of Conj (nsate Value of Nataral And Nah !

l uture Net Natural And Nat ural f uture f et Gas Gas Lique Revenues" Gar Gas I iqmJs Revenues * (MMCF) (Barreh) (voo) (M MCI') (Barrek) m) January 1,198 5 102,050 5.121,416 $ 268,446 Revmons of Presiorn Estimates 530 (482,534) 110,650 fatermons, Discovenes, and Otber Add 2tivas 35,496 2,061.867 Purchasc ot Roerves in 11 ace 42.000 9,100 % 0 174, W 11.811/,08 Saie of Reserves in 11 ace (1.202) (173.313) Prodecuon (20,170) I1,415,509) (457; (730 2 % January 1,1986 159,004 14.211,927 $ 36 Lx03 173,552 11.192.000 $ 71,723 ' Revmons of Preuaus Estim ites (8304) (1,055.591) (50) 1323,197 Extenuons, Dncovenes and Other Additions 8.797 261,s61 Pruj uc t,on (24.511) (1.928,%6) (6,652) (2,186,044) January 1.19S7 134,386 11,459311 C 174.547 167,150 10.829.153 $ 70.990 ' Res nions of Prt nous Estunates

6. 29 608.473 2 S07 4355,430 Extensions, Dncover.es, and Othcr Additions 8.672 160,528 Purchase of Reserves in Place 13,260
15.473 Sale of Reserses in 11xe (12,277)

(182,1971 Produc tion (29,120) (1.626.145) 0 0.047) (2.261,045) January 1,1988 121.650 10.585.940 5161M61 160.010 12,926.5 % $ 71.52u ^ Prm ed Developed Resen es-As of january l.1986 153,816 13 397,935 5359.628 173.223 10.s11.700 5703;6 As of January 1,1987 130.691 11.487,811 $ 171,9S5 167.150 10.829.153 570.990 Ai of january l.198 9 121.210 10,584,214 5161.681 160.010 12i v,53S 5 67.h;0 ' Estimates of future net revt-nues do not contain any provmon for ledcralinwme tasn. AuorJmgly the prewnt ulut thcrtof J.,ts l not wnshtute the hnancul Auountirq; Standards BoarJ's stand.udacJ measure of dncounted Iuture n<t tash floe - I As of Janu.,rv 1,19XS.1987 and 1986, approumately 51%,70% and W. of the respectn e gar's dncounted prewnt u!ue of futare net reunues attnbutaNe to foreym resen t s a attnbuted to prm cJ reserves hated m Argennna. 30,.17^. and 39 ', respectivdy. is atinbuted to pros cd rneru s located in Grt ue,16",,11", and in. rupec tn dg e. aunhuNd to prm ed resc n t s located m Indono:a.and 31,2% and 5%, ropectively. as attnbuted to proved resern, louted m Carud i. approximately 45 wells will be its partners also obtained three Cornpany's strategic busin2ss drilled over the next 24 months. exploratory blocks in Argentina. plan calls for focusing its offorts Earnings and cash flow from this PH is addressng continued on existing auets and expertne in license are expected to have a volatility in energy markets uy Mst Texas, offshore in the Gulf positis e impact in 1988. PR and applying a conservative future l of Mexico, and internationally. f pncmg scenario when evaluatmg ( oil and gas prospects. The j i

Utility Fuels, Inc. (UFI) manages coal supply, transportation, and handling sertices. UFI's 1987 coal and lignite deliteries to six HL8P generating units represented about 2 percent of all coal supplied in the U.S., and about 6 percent of the teestern coal coa 1 de111and market, tchere UFI's supplies are l stable in near term concentrated. + The supply of coal niuion-uide cwiently exceeds dematul, azul grotetit in denullul is forecast at less than I percent annually ater the next decade, primarily because utility customers are planningfetv plimt culditions in the nearfuture. UR Salesincrease the Jewett Mine, which supplies aimed at achieving growth through Utility Fuels achieved record lignite for the Limestone plant. developing new customers, offer-highsin coal deliveries during The bucketwheel system,sched-ing new services, and acquiring 1987, and eamings of $24.2 mil-uled for startup by late 1989, will new businesses. lion, up from $21.9 milhon the be the second placed in operation in seeking new customers, UFl previous year. Revenues rose in Texas. This equipment is more is focusing on the western coal to $513A million, from $470.9 efficient than traditionalmining market and emphasizing its ability million in 1966. equipment in removing the in-to provide cost-effective service Capitalrequirements continued creased amounts of overburden in fuel supply, transportation, to decline, and UR met these encountered as thelignite seams handling, and management. requirements entirely from inter-being mined become deeper. The Company also has begun nally generated funds for the first ' Die capital cost for the bucket-marketmg technical services time in its history. wheel excavator will be related to coal supply and mater-With the second unit at Hous-approximately $25 million. Total ials handling.These include ton Lighting & Power Company's UR capital expenditures will customized operations training. Limestone plant completing its increase to $57 million in 1988 engineering,and procedure first full yearin service during and $46 million in 1989, com-development. 1987, UR's lignite salesincreased pared with $17 million in 1987. UFI continues to evaluate op-l to 7.5 million tons, up 85 percent Utility Fuels,like the coal portunities to acquire profitable over 1986. Total coal and lignite industry in general, faces flat coal supply operations or to in-sales were 15.8 million tons in sales. HL&P has no plans for ad-vest in coal transportation and j 1987. Sales of Westem coal were ditional fossil-fueled generating handling. With expertise in each 8.3 million tons. capacity until the late 1990s. UFl of these areas, UH can offer cus-In an effort to keep HL&P's has, therefore, adopted strategies tomers a coordinated fuel supply lignite costs as low as possibie. package with built-in efficiency UFl has contracted to purchase a and flexibility. bucketwheel excavator for use at i 28 ,__m

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KBLCOM Incorporated (KBLCOM) otens a 50 percent intoest in Paragon Comna cations, one of the top 20 cable teletision cmnpanies in the country. + Cable teletision is a $12 billion industry, grouing by over 10 percent per year. In 1987, cable became the nonn rather tlum the exception tihen the percentage of all American homes subsaibing to cable sertice bissed the 50 percent mark. Advances in programming, including exclusive oable television n coverage of nuijar s]x>rting et ents, plus the Collles of age proliferation of sertices such as home shopping, are giting people more reasons to king cable into their homes + The cable ituhatn is nuuming mul changing. Rate deregidation, uhich took effect in Jamuin 1987, has led to market-htsed pricing, uith a trend touurd higher jnices for basic cable sertice and lotver prices for premium set tices. 4 Meantchile, ongoing consolidation is creating a snudler field of bigger players taul increasing itulustry sophistication. Paragon Improves Saturation, television operations serving over (ATC), a subsidiary of Time Service,and Profit Margins 650,000 customers in eight states. Incorporated. Paragon Communications,a joint KBLCOM,an HI subsidiary,is Paragon systems are located in venture partnership, owns cable participating in the pannership Texas, Arizona,theTampa Bay with American Television and area of Florida, the nonheast. Communications Corporation including a ponion of Manhattan, and Cahfomia. The California M systems, located in the Los r j [< Angeles area, were acquired in , 7[Y June 19S7. 'k Paragon's mission as a ncv I L company is to ensure a comnut-l J. I ment to excellence through six t%wp measurable goals: a high level of customer satisfaction; a wide l choice of quality programming; Cable teferision sports g '[,'"""('l,'h j,',1 pcmtive relationships with its f, t Communities; skilled and tright) andihr Americas ~ Cup taborc> aregiving T.V. ~.; j i motivated employees; 'A t trarrs more reasons to bring cable in to their ~ ~-~,_ 9 homcs. g ~ 1 M

l and financial results that meet among the homes to which cable the acquisition of the Los Angeles realistic targets. Substantial is available, to 54.1 percent at County systems and other strate-l progress is being made in the end of 1987, up from 52.5 gic acquisitions in close proximity i j these areas. percent the previous year. to existing operations. For example, Paragon has Gross profit margins improved Paragon continues to seek op-markedly improved its service as as well, with an increase to 33.6 ponunities to acquire attractive perceived by customers, accord-percent of revenuein 1987, up cable properties.Thoselocated ing to the Company's semi annual from 32.2 percent the previous near current systems are of great-surveys. At the same time, the year. In addition, Paragon's cus-est interest because of the Company increased saturation, or tomer base grew by 55,000, with operating efficiencies that can the percentage of basic customers be realized. Innovative Controls, Inc. (ICI) Commitments already have engineenng group continues to completed major start up activi-been received from several major de /elop new applications for the ties during 19S7 and positioned retail chains to begin or expand ballasts. I itself to build market share in the diNbution ofICI products early in addition to technological su-l years ahead. in 1988, providing access to more periority, ICI offers retailers very l Re Company's new Houston than 1,000 new retail outlets. competitive pncing plus quality manufacturing facility began full ICI products feature the Com-control and warranties that are operation in July, with production pany's proprietary electronic unmatched in the industry. Every of 70 watt sodium security lights. ballasts, which weigh just a frac-fixture is tested before it leaves In December, the plant began tion as much and consume the Houston plant and most are producing ICl's new fluorescent substantially less energy than backed by a 10-year shop lights. conventional ballasts. ICI's com-warranty. in the first half of 1988. ICI will plete in-house research and j \\ begin producing a number of products ranging from functional l flood lights to decorative carriage i and walllights. The introductions j will enable the Company to offer a well rounded product line and A l'""""'

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4 X troduced late in 1987 tras should greatly enhance its abihty thr / irs t of several ncre lights u hich tall round to penetrate major retail chains. out icrs prod.ec t line. ,s. ~# * * #.. 11

Houston Industries Finance,Inc. a reasonable return on the equity Duff & Phelps and a rating of P 1 l (HIF),which began purchasing invested in HIF. from Moody's. Rese are the the accounts receivable of Hous-HIFis using commercial paper, highest short-term ratings given ton Lighting & Power Company with a bank credit facility as a by the agencies. in January 1987, recorded a $5.0 backup, to finance the receiv-The initial purpose of HIFis to million profit during its first year ables.The $300 million bank purchase the receivables of HL&P of operation. credit facility was established in and other HI subsidiaries. In the nrough use ofleverage and July 1987. Later in the year, the future, the finance subsidiary may short-tenn financing. HIF is able finance subsidiary implemented also seek opportunities to acquire to finance the receivables at a its own commercial paper pro-other high-quality receivables and lower cost than HL&P would gram.The commercial paper may pave the way for H1 diversi-incur. nis benefits HL&P cus-received a rating of Duff 1+ from fication into the financial senices tomers, while allowing HI to earn industry. l l Development Ventures,Inc. (DVl) Secondary consideration is given HI expects at least one new area is a venture capital subsidiary to new business startups. To com-of business to be identified for fonned in January 1987. plement its direct investments, diversification and significant DVIinvests in and assists with DVI will commit a limited portion future growth. the development of emerging ser-of its portfolio to other venture To date, four investments have vice and manufacturing businesses, capital funds. been completed. Two of these are sening markets demonstrating la add: tion to caming an attrac-in other venture capital funds. potential for above-average tive retum on committed funds, One fund is focused on technolo-growth, primarily in the sunbelt. the venture capitalinvestments of gies which are primarily for Priority is given to investments in DVI are expected to be an impor-application in the unhty industry. Texas, especia'ly in the area of tant component of the Houston ne other f0cuses on startup com-Houston and the Texas Gulf Coast. Industries corporate development panies, particularly those in the Investment emphasis is on ex-strategy. Through relatively small Houston area. DVI also has made pansion stage growth companies commitments. risk can be mini-direct investments in the commer-and new business concept com-mized w hile broadening H1's cialization of space and in the panies with proven products, experience to include new broad field of health care, two { senices. or technologies that industnes. Out of this process, industries that offer rapid expan-meet established market needs. sion opportumtics in Texas and around the world n

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i-ms s p r i 'V s - yg-4 y kc e, . 'Ih. r-e d ' TABLEOF CONTENTS Five Year Comparison of Selected Financial Data 33 . IIL&P Operating Statistics _36 M.>nagement's Discussion and Analysis ' 37 . Statements of Consolidated Income 42 Statements of Consolidated Retained Eamings 43 Consolidated Balance Sheets. 44 Statements of Subsidiaries' Preferred Stock and Long-Term Debt 46 Statements of Changes in Consolidated Financial Position 48' Notes to Consolidated Financial Statements 50- . Auditors' Opinion 64 Officers and Directors 65 ShareholderInfonnation 66 j QUARTERLY lilGli AND LOW STOCK PRICES on the New LL Sul Exchange ard Guymte Tape IW7 % P to Wh 1a (uner 2.w, - 14% kN' .. me- - - 16 % 2tiCuner m u.,re- - mm Sl% llt' + ax >.w 15 3r3 Quc u.-= 3l% 7:<* w me. aa,. 14 4 4:b Quaner = ac -.m-72t'

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26 % 1%e % rrwes 33% Iq Qurter 4 -e ur LEU N( - w n r t s mr*- ilk ZnJ Quarter .:--+-n-- 70 ( .m m. - ;_ 29 4 .37 3rJQuarter. ma-w-704' .. ewe v.4.mw--- )N 36 % 4th Quarter. u.w n----,+-- lQt* .- >, o -.s y a <1 we e.ssc 51st - - - - 31 0 %dena atl2:eJ gr Jure FIVE YEAR COMPARISON OF SELECTED FIN ANCIAL DATA }kuston Industnes inwrrented ar.d SManes 'Ihe foUowing table sets forth selected financial data with respect to the Company's consolidated financial condition and consolidated results of operations and should be read in conjunction with the Consolidated Financial Statements and the related notes included elsewhere herein. . _. - - - -Year Ended December 31, (Thousands of Dollars, except per share amounts) 1987 1986 19S5 1984 1983 Revenues $3,628,213 $3,535,96S $4,061,812 $4,181,575 $3,992,75S Net income $ 434,958 $ 424,935 $ 434,126 $ 331,146 $ 299,857 Earnings per share 3.74 3.81 4.13 3.69 3.50 Cash dividends declared per common dare 2.86 2.76 2.60 2.44 2 28 Ret.rn on average common equity 13.6 % 14.5 % 16.7 % 15.7 % 15.6 % Ratio of earnings to fixed charges: Including AFUDC 2.86 2.76 2.96 2.87 3.01 Excluding AFUDC - 2.14 2.00 2.23 2.43 2.79 At Year End: Book value per common share 28.33 27.19 25.88 24.31 23.27 Market price per common share 30.00 34.75 28.00 5 22.50 19.38 ._ _ ___..._ Market pnce as a percent of book value 106 % 128 % 10S % 93 % 83 % At Year End: Total assets $9,727,688 $9,027.817 $8,625,667 $ 7,525,977 $6,483,035 Long-term debt (including current matunties) $3,136,852 $3.208,160 $2,952,926 $2,683,319 $2.274,616 Capitalization: Common stock equity 4S% 47 % 46% 45 % 46 % Cumulative preferred stcck 6% 5% 6% 5% 5% Long tenn debt (including current matunties) 46% 48% 4S% 50 % 49"r ~ Capital Expenditures: Construction and nuclear fuel expenditures (excluding AFUDC) $ 662,054 $ 755,273 $ S93.053 $ 997,982 5 913,825 Oil and gas additions S 41.488 16,187 $ 224.150 $ 65,928 $ 65,858 Cable television investment $ 58,336 $ 26.046 HL&P Selected Data: Percent of construction expenditures financed intemally from operatens 29 % 35 % 39% 3 7",, 42 % Ratio of earnings to fixed chary Including AFUDC 3.35 3.36 3.76 3 55 3.30 Excluding AFUDC 2.41 2.42 2 54 2.99 3.22 AFUDC as a percent of net income 52 % 52% 45 % 31% 17 % n OPERATING STATISTICS OF HL&P Houster. Industnes Incmpxated ar.d Subi& aries Year Ended December 31, 1987 1986 1985 Operating Revenue (Thousands of Dollars): Rcsidential $ 1,078,934 $ 1,071,356 $ 1,244,002 Commercial 690,078 707,386 831,277 Industrial 993,610 1,02A,459 1.353,16' - Street lighting-govermnent and municipal 17,786 -16,6S3 16,888 Other electric utilities 79,503 68,990 106,273 Total 2,859,911 2,888,874 3,551,602 Miscellaneous electric revenues 140,921 70,866 (18,238) _ _ _ _ _ _ _ _ _ _ $ 3,000,832 $ 2,959,740 $ 3,533,364 Total Electric Plant Investment (Ihousands of Dollars): Gross additions S 857,045 $ 938,075 $ 950,241 Total plant investment $ 9,799,877 $ 8,993,854 $ 8,137,530 Accumulated depreciation $ 1,530,543 $ 1,351,412 $ 1,203,039 Percent of total plant investment 15.6 % 15.0 % 14.8 % Generating Statistics: Steam electric stations ccenomy-Btu per net KWH generated 10,457 10,434 10,331 Net generating capability (MW)- at time of maximum system load' 13,755 13.258 13,913 Maximum system load (MW)" 10,302 10.556 10,618 Electric plant in service par KW of maximum' system load ($) 664 618 557 General Statistics: Kilowatt hour saks (000J 55,9.1.1,327 54,007,557 55,968.716 Number of customers 1,306,328 1,303,205 1,316,316 Average residential use (KWH) 12,812 12,675 12,961 Average residential revenue per KWH 7.34c 7.32v SJ0e Average reside ntial fuel revenue per KWH 1.83c 2.17e 3.40e "Induding purchased power and cogeneration capabihty of 1.295 MW,1,395 MW and 1,55-5 MWin 1987,19S6 and 1985, respectively. "Excluding interrupt:ble demand. x ~ MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCI AL CONDITION AND RESULTS OF OPERATIONS Results of Operations Consolidated net income for 1987 was $435 million, up $10 million from 1986 and up $1 million from 1985. Consolidated camings per share decreased to $3.74 for the current year as compared to $3.81 per share in 1986, while 1985 earnings were - $_4.13 per share. Houston Lighting & Power Company (HlhP), the Company's principal operating subsidiary, contributed $3.51 to the 1987 L consolidated earnings per share on income after preferred dividends of $409 million. Utility Fuels, Inc. (Utility Fuels). contnbuted $.21 per share on eamings of $24.2 million while Primary Fuels, Inc. (Primary Fueh) reported income of $4.5 . million or $ 04 per share. The Company's other subsidiaries posted a combined low of $.10 per share HIAP's 1987 income after preferred dividends fell $26 million from 1986 and $47 million from the record camings of 1985. Allowance for funds used during construction (AFUDC) accounted for 52% of camings in both 1987 and 1986 compared to 45% in 1985. AFUDC is a non-cash item of net income which represents the cost of funds used to finance constmetion projects and is capitalized as part of the cost of the assets being constructed. Decreases in AFUDC in 1987 were primanly related to a reduction in the net-of tax AFUDC rate and the commencement of commercial operation of. Unit No. 2 of the Limestone Electric Generating Station (Limestone). Increases in AFUDC in 1986 resulted from inueased levels of investment in constmction without corresponding increases in the amount of construction included in rate base and eaming a current cash retum. The decline in HL&P's 1987 income is attributable to increased expenses principally associated with Limestone, which - expenses are not yet fully reflected in electric rates, partially offset by the reduction of the federal corporate income tax rate due to the Tax Reform Act of 1986. Eamings were positively affected by base rate increases allowed by the City of Houston and the Public Utility Commission of Texas (Utility Commission) in July and December 1986, respectively. ME @ 'a. Ud 4 M'M k #. e ON N '{ %Y N NNY 1 F ' KILOWATT HOUR SALES AVERAGE RESIDENTIAL REVENUE AVERAGE COST OF FUEL m i rbu en s ibh .cc m m h 8TU i U N w a g + q h 5 Y . k ~ n b .Z L y I u o a L i 3 V) i i { j g s I 2 N 9 g i j p i g-l g ( / 1 g 5 s 6 3 s e i i l 3 + 3 P ) ) !s e s a 3 M { l h Y e s< es a a n a e u n n e< n a n ~. Electric operatmg revenues increased 1% and declined 16% for the y ears 1987 and 1986, respectively. The increase in revenues in 1987 is pnmarily due to higher base revenues from rate increases implemerded in 1936. Kilowatt hour (KWH) sales were up 3.5% during 19S7 and down 3.5% in 1986. The majority of the increases was due to off system sales and sales to industrial customers on an interruptible basis, both of which provide minimal contnbution to base electric revenues. Residential KWH sales increased by.5% in 1987 and declined 2.4% in 1986. Commercial KWH sales declined by 2.2% in 1987 and.5% in 1986. Industrial KWH sales, which account for approximately half of HL&P's overall sales, were up 4.8% l and down 4.5% for 19S7 and 1986, respectis ely. However, most of the increase was due to sales made on an interruptible basis as docnbed above. Fuel expense increased $47 million in 1987 and declined $485 milbon in 1956. He increase in 1987 was primanly due to increased generation, partially offset by decreases in the price paid for fuel. De average cost of fuel used by H11P during 1937 was $1.92 per million Btu as compared with $1.97 for 1936 and $2.77 for 1985.The combined cost of fuel used by HL&P and the fuel portion of purchased paw te dunng 19S7 was 1.86 cents per KWH as compared with 2.10 cents in 1986 l and 3.02 cents in 1935. Purchased power expenw decreased 10% in 1957 and 5% in 1986 due to decreases in purchases of I energy from cogenerators. Electric operating and maintenance expenses in 1987 increased 9% or $52 million when compared to 1986. In 1986, operating and maintenance expenses der. cased $33 mdlion or 6% when compared to 1985. The increase in 1987 was due pnmarily to increases in operation and maintenance expenses related to Limestone and in administrative and general expenses. He decrease in 1936 w as primanly due to a reduction in transmission expenses, customer expenses and administrative and general expenses. In Jar uary 1987, fodowing the December 19S6 commencement of commercial operation of Limestone Unit No. 2, HL&P filed a petition with the Utility Commission requesting interim accounting treatment to capitalize costs and to continue the accrual of AFUDC asmated with Unit No. 2 from the time it was placed in commercial operation untd rates reflecting the costs of such unit are placed in effect. Electric rates do not currently reflect approximately $174 mdlion of the project's cost or any provision for operatmg expenses, non reconedable lignite mining and handling costs, taxes or depreciation related to Unit No. 2, estimated to be $57 million on an annual basis. In July 1987, a simdar request was made for the first unit of the South l l ENERGY MIX' u e a r s. s.. p-r y ~- h 9% 4% h)% r 5f_. z .. 3 ~ f' 'l%: ^ h ih O + v L T-4 9, Et+ 5; M RN i ' t.ar. Ei 'u

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s e gi m-T, S% Texas project once it goes into commercial 6peration.The annualized effect of operatir., apenses, taxes, depreciation and AFUDC related to Unit No.1 is estimated to be $230 million based on HL&P's 30.8% interest ($290 million based on a 46.8% interest), none of which is reflected in electric rates.The Utihty Commission has not ruled on either request. Until rate relief is obtained which reflects Limestone Unit No. 2 as plant in service or the requested accounting treatment or other regulatory action is granted with respect to Limestone Unit No. 2, operating results of HL&P and the Company will be adversely affected. Upon the commencement of commercial operation of Unit No. l of the South Texas project, the operating - results of HL& P and the Company will be more severely impacteci until similar regulatory relief is granted with respect to such unit. Utility Fuels' 1987 operating results showed improvement over 1986, pnmarily as a result of increased salemf lignite fuel for use at HL&P's Limestone Unit No. 2. Net income in 1987 was 424.2 million compared to $21.9 million in 1986 and $12.2 million in 1955. Utility Fuels' fvel supply contract with HL&P generally allows Utility Fuels to recover its costs plus a fixed return on its net investment in facilities. As a result of the regulation of affiliated ccnts by the Utility Commission, a portion of Utility Fuels' billings are not recoverable through HL&P's electric rates. Primary Fuels posted income of $4.5 million, reboundmg from losses of $27.7 million in 1986 and $35 million in 1985. The oil and gas subsidiary's operating results have improved primanly due to increased natural gas production, higher oil pnces and reduced depreciation, depletion and amortization expense. Primary Fuels' natural gas production incnased to 39,167 MMCF this year from 31.163 MMCF in 1986 and 20,627 MMCF in 1985. The average pnce per barrel of cd seld by Primary Fuels was $15.74 in 1987 as compared to $13.61 and $25.44 in 1986 and 1985, respectively. Primary Fuels' depreciation, depletion and amortization expense for 1986 and 1985 reflected writedowns of $12.4 rnillion and $23.6 million, respectively, related to the impairment of cenain oil and gas propenies asulting from 3 teep dechnes in oil and gas prices. Earnings for 1987 also include gains of $23 million awociated with the purchase and subsequent sale of od and gas properties and $2.7 million related to the final settlement of various contracts. KBLCOM Incorporated (KBLCOM) expenenced a net loss of $10.6 million in 19S7, the first full year of operations for the Company's cable television subsidiary, compared to a $6.5 million loss in 1986. Established in June 1986, KBLCOM holds a 50 percent interest in Paragon Communications (Paragon), a partnership which operates cable television systems in several states. KBLCOMS eamings outlook for the near future is dependent to a large degree on Paragon's success in achieving in-creased basic cable saturation in existing markets and the acquis: tion of additional cable propenies near those presently held. In pnor years, the Company's operating results were adversely affected by the lag in recovery of increaed costs through electric rates due primarily to relatively high rates of inflation. The rate of inflation, however, has moderated over the last several years, and the Company and its subsidianes have not been signif cantly impacted by the effects of inflation. Liquidity and Capital Resources Liquidity and capital resources are affected pnmanly through capital programs The carital requirements for 1987, and as estimated for 1988 through 1990, are as fc!!aws: 9"N#L _ _ _ _ _ - ~ _ - _ I9N __N I957 I955 I Coratraton arJ nudcar fx!(exdadmg AfrDC)' $645 5495 $448 5363 Coal hrang fact', tics arJ hgute nupnd handhrg !2ethtn 17 57 4 24 OJ and ps cybranon and develepment* 55 53 5' F44 mvestmem m cable tcievson jcur.t s er;ture

53 55 SS 3

E'I*#5 II""MC"'dcbt_ TatJ $$26 $W $543 5.195 __ ~ _ _. ~ -. ~ "nese ameats do nut edude npend::ure< ou peqeas for w tzh HLAP eyecs to be renbmed by custmm or ecsenerawn Thee amets aba k ret reikct the posble acqumba by HLLP d en a titonal 16% mternt a the Sowh Teus pmed prnently owt4d by ex Cay M Asm (Amn), w hh odd name the est mated etwrxten and nudear fad eyed:ces by $205 rran for de lh ic% rend $42 neon of wthh a teWJ to the reurbacment of cms tr.cereJ by Aaen pner to IW rJ the parthne of Austn's n2 dear Let

Pnmary Fuch' evenitures for od and p ex;4eraun sukpent to 19b3 are deprdent upm the teds of its 19% en o min and des dgment pcyam arJ fxtm affetiq the oJ and ps adey

^1he emnt shown represenu mve>tnwis by KBLCOM m Pawn and wral weer permhy. Condruction and nudear fuel expenditures for the 195S-1990 period pnncipauy represent estimated costs of HL&P's construction program and reflect the cost estimate for the South Texas project adopted in December 1937 (awuming a commercial operation date for Umt No.1 of March 1,1989 The estimated expenditures for coa! hand!mg facihties and lignite mining and handling faahties are expected to tm incurred by Utdity Fuels m connection with HL&P's hgnite pro;ects. 'lhese o amounts reflect the modification of the scheduled in service dates for the two lignite units at the Malakoff Electric Generating Station as discussed in Note 11 to the Consolidated Financial Statements. HL&P expects to finance a portion of its construction program through funds generated intemally from operations. The extent to which HL&P is able to fund its capital requirements from intemal funds is dependent, to a large degree, on regulatory practices which determine the amtunt and timing of recovery of investments in new plant facihties, depreciation rates, recovery of operating expenses and the opportunity to em a reasonable rate of return on its invested capital It is presently estimated that during 1988,10% to 20% of HL&Pb stmetion program can be financed through intemally

generated funds from operations. Internally generated funds for subsequent yean will be primarily dependent on the regulatory treatment of HL&P's investment in the South Texas project. The balance of HL&P's constniction program is expected to be financed through extemal sources, primarily sales of long-term debt, preferred stock and additional shares of common stock to the Company, and, on an interim basis, the issuance of short term debt securities. See Note 5 to the Consolidated Financia! 5tatements for a discussion of short-term financing.

In March 1987, HL&P issued $391 million aggregate principal amount of a new 9% series of first mortgage bonds due 2017 in exchange for a like pnncipal amount of outstanding high coupon first mongage bonds. An additional $140 million principal amount of high coupon first mortgage bonds was redeemed under the Replacement Fund provisions of HL&P's Mortgage and Deed of Trust and was retired by the bond tmstee in May 1987. In February 1988, $48 million principal amount of HL&P's 13%% series first mortgage bonds due 1991 was redeemed at 100% of the principal amount plus accrued interest.These actions are part of a continuing program to reduce HL&P's long-term debt costs. In June 1987, HL&P sold 1,000,000 shares of $8.50 cumulative preferred stock which are subject to mandatory redemption.The mandatory redemption provision requires HL&P to redeem 200,000 shares annually beginning on June 1, 1993. HL&P received net proceeds of $99 million from the sale. During 1987, ML&P received approximately $12S million from the proceeds of previously issued pollution control revenue bonds ar.d first mortgage bonds, which proceeds had been held in trust. Approximately $87 million (mcluding interest camed on funds held in trust) was held in trust at December 31,1987. Substantially all the funds held in trust are expected to be drawn down by HL&P in 1988 and 1989 to fund quahfying construction expenditures. On November 1,19S7,540 million principal amount of HL&P's 4%% series first mortgage bonds matured. In January 1988, HL&P issued in a private placement $400 million principal amount of 96% first mortgage bonds which wdl mature in approximately equal principal amounts in each of the years 1991,1992, and 1993. HL&P's capitalization ratios at December 31,1987 consisted of 45% long-term debt,7% preferred stock and 48% common equity, with similar ratios expected to be maintained in the future, assuming HL&P is able to obtain rate relief at levels comparable to those obtained in the past. Utility Fuels and Primary Fuels expect to fund a substantial part of their capital requirements through internally generated funds. Extemal funding will be met by advances from the Company. KBLCOM's future capital requirements will be primarily dependent upon the acquisiton of additional cable television systems by KBLCOM or Paragon. Any such requirements will be met through advances or capital contnbutions by the l Company. In June 1987, KBLCOM contnbuted approximately $42 million to Paragon in connection with the permanent finanang for Paragon and the acquisitica of additiona! cable television systems M 1937. KBLCOM also invested $11 million in other partnerships which hold certain cable television systems and other assets formerly owned by Group W Cable, Inc. pendmg disposition of such systems and assets. Houston Industnes Finance,Inc. (Houston Industnes Finance) began purchasing HL&P's customer accounts receivable in January 1987.The use of leve age and short tenn borrowings by Houston Industnes Finance allows the receivables to be financed at a lower cost than would traditionally be incurred by HL&P. The financing requirements of the new subsidiary are met through short term bank loans and the issuance of commercial paper. Hauston Industries Finance has entered into a bank revolving credit faality which provides for borrowings of up to $300 million aggregate pnncipal amount. This facility is availabic to make direct borrowings or to support the issuance of commercial paper. The Tax Reform Act of 1936 (the Tax Act) includes a number of provisions that have adversely affected the Company's operating subsidianes, particularly HL&P. Although the Tax Act reduced corporate income tax rates, it elimmated investment tax credits elfective January 1,1986 (except with respect to certain transition properties, including the South Texas pmject), eliminated current deductions for interest and property taxes dunng construction and made substantial changes to the -~ calcubtion of the ahernative minimum in. His latter provision effectively provides for the inclusion of up to one ha!f of the amount of AFUDC, a non-cash item of fmancial reportin income, as tnab!e income in duemumng the alternrive minimum tiFhese and other provisicms of the Tn Act are expected to reduce the amount of cash fk,w gencrated fn>m operations and therefore increase the Company's rehance on external s3urce3 of fundt Changes in Accounting Standards In December 1%, the Financul Accc;unting Standard; Board (FASB) issued Statement of Fuuncul Accountmg StanJards (SFAS) No 90,"Regubted Enterprises Actcunting for Abandonmtms and Daallowances of Fiant Costs? whuh becon'es effective for facal years beginning after DecembCr 15,1957. SFAS No. 90 requires the future retenue that is expected ta result from the regulvor's alasion of the co t of an abandoned pbnt in ahowable costs for ratemaking purposes to be reportcd at its pre >ent value when the abandem: ent becomes probab!e. If the carrfmg amount of the abandoned pbnt excteds th at prey,t va'ae, a loss would be recognized in adition, SFAS No. 90 regmres any to>ts of a rrcently wmpleted p' ant w hich are dnal!o4 ed to be recogni?cd as a loss w ben such a disa!!owance becomes probable anJ the amount of the disallow ance is redonaMy esumabit. If part of 'he cost is dsailowed indirectly buch as a didawance of return on invesurent on a pernon of the pbnth an equ;va!cnt amot.nt of cost sha ! be deducted from the reported cest of the pbnt and recognaed as a lon Fma!1y. SFAS No 90 speabes that AFUDC shou!d be camtahzcd ordv if its subsegnent e..usma in u!'ow ab!c costs for ratemak:ng purmes is prcb2He. See Note 10 to the Consohdated Fnuncu. Memcats for a discu3 sic a of the pruince review of the soum Texa project by the Unhty Commuon HL&P recorded a partial!oss cri abandomner,t d the A!!cns Creek Nudcar Prn:ca (A!!cns Crt eki m 1982, and n currendy amortiz.ng; the rcwvtrable amount over a ten year renod. HLiP beheves that the apphcat.nn of SEAS No. 90 to Ailens Cred would not matenally affect the results of operations. See Notes S and 12 to the Consehdated Emanm! Statements for Jscumon; of Allens Creek. In Auf st 1987, the FASB issued SFAS No. 92. "Regubad Enterpns s-Acwuntmg for Pna;e in Plans.' SFAS No. 92 e requires a!!owab!e wsts defttred for future recovery under a pha+in p'an rebted to pbnis cump!tted before January 1. 19E and p!a:.ts on ubch sub<tanual censtructbn has been perfonned before January 1,195s. to be cap;tahzed as a deferred l < han;c if each of femr cntena is met. Tnse entena are (M the pbn has been agreed to t,y the :cgulator. ib) *he p:m specifucs w btn recos tri will e, cur,(c) ad allow abic cmts deferred urder the pbn are schedultd for ruo',eq within ten 3 ears of the 1 l date when defenals begm, and fdj the percentage increase m rates schedu!cd ict each future > car under the pbn is not ptater than the perctutJge lacrease in rMt> iCheduIed Ier caCh Immediatt!y pr0Ced.ng ytar. SE AS No. 92 does 301 permit the equity penion of AFCDC to be capita!ued c&er than dunng construchen or as part of a quahned phaein p!an Re povera of SFAS No. 92 r at N adopted for fnca!) ears btgnnm.:af ter Decernber 15,1%7. See Note 10 to th Cwohda;d FirunJal Statements for a da:m on of the afect of SFA5 No. 92 en H! & Pi defened accountmg requot for Umt No.1 of the South Texas p n s et in Dmnber 1957 the FASB mucd SEAS No. % " Anuunnr.g for iname Tne ' wbuh bem:nes t!fectne fm f. cal ens S begc.nmg af ter December 15,19% 5FAS Nu 40 aquirts, amang other tbnp it habity method of re.ogmtion for A temporary dciuenmos. requires that defened in labine, and arets be adjusted for an (natted thw;c m tax ! m er rate < anJ pn bbits not.cf an accountmg and reporting Certam pro ismns of SFAS No 96 prouJe that recu!ated entcrpnm are penmt:cd to recegnue su,h duamtas u regulatory awets c: hab.h* c3 d a is prob #e th 3t sch amw 's w:ll be recovered from or retw.J to cutomers in tuture tres. The Cempany s currently cHurin; no cffect' of SF.\\S No. 90 but Jces not expt.: tL new pronut utn _nt ta has e a ma'erial c:ect en the Empny i hnansu; pout: a er redts of operate. s iht iad 'UneY$5NO %in1D9 l Ct u pa'l) pie't nt. - 'n " t '. t l l 4 STATEMENTS OF CONSOLIDATEDINCOME Houston incastnes incorporated and Subsid:ard Year Ended December 31, (ThogndsgDolJg) __ _ _ _ _ __ _ _____ _ _ _ _ 1987 1986 1985 Revenues: E!ectric $3,000,832 $2,959,740 $3,533,364 Fuel f, ales 513,394 470,852 418,063 Oiland gr 113,987 105,376 110385 Total 3,628,213 3,535,968 4,061,812 Expenses: Electric: Fuel 981.922 935,169 1,420,262 Purchased power 179,497 421,893 442,802 Operation and rnaintenance 613,355 561,406 594,576 Taxes other than federal mcome taxes 151,667 146,791 140,185 Cost of fuel sold 430,754 392,777 372,274 Oil and gas operating expenses 47,703 53,440 79,833 Depreciation, depletion and amortization 285,547 297,911 267,004 Total 2,890,745 2,809,387 3,316,936 726,581 744,876 Operating !ncome. _ _ _ _ _ _ _ _ _ _ _ _ 737,468__ _ OtherIncome (Expense): Allowance for other funds used dunng construction 143,584 170,348 154,246 Othgr-agt ___ _ _ _ _____ __ _ ______ _ j04_99, _ _ _ - (9,002 [ __ _. 54_93 Total 153,783 161,346 159,439 Fixed Charges: laterest on long term debt 270,958 287,506 259,363 Other interest 44,747 42,137 48,608 Allowance for borrowed funds used during construction (109,160) (109,369) (104,573) _ Preferred dividends of subsidiary _ _ _ _ _ _ _ _ 26,60) 31,406 26,817 Total 237,951 247,091 '30,000 l l Income Before FederalIncome Taxes 653,300 640.S36 674,315 240,159 FederalIncomeTaxes 218,342 215,901-... ---_-_ Net Income $ 434,958 $ 424.935 $ 434,126 Earnings Per Common Share 3.74 3 S1 5 4.13 116,322 111,593 105,014 Weighted Average Common Shares Outstanding (000) See Notes to Consolidated Financial Statements. l 4: STATEMENTS OF CONSOLIDATED RETAINED EARNINGS Hom:on hiaennInmawaend suhdann Year Ended December 31. (Ihousands of Dollars) 19S7 1986 1985 Balance at Beginning of Ynr $1,223,409 $1,106,221 $ 945,227 pdd NetIncome_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ , _ _ _ _424,935 434,126 7_ 434,95S Total 1,658,367 1,531,156 1,379,353 Deduct-Common Stock Dividends: 1987, $2.86; 1986, $2.76; 1985, $2.60 (per share) 332,458 307,747 273,132 Balaycy at End of Year _ _ ______ _ _ _ _ _ _,. S1,325,909 $1.223,409 $ 1,106,221 See Notes to Consolidated Financial Statements. CONSOLIDATED BALANCE SHEETS }bustan E6atdn kuged arJ Su%dres - December 31, - -. 1987 1986 (Thousands of Dollars) __ Assets Property, Plant and Equipment-At Cost: Electric plant: Freduction S 3,894,100 $3,747,442 Transmission 640,423 601,0S4 Distribution 1,845,618 1,747,216 General 456.232 431,048 Construction work in progress 2,648,682 2,170,700 Nuclear fuel 131,323 126,190 Held for future use 150.333 167,00S Electrie plant acquisition adjustments 3,166 3,166 Coal handling equipment and mining property 542,549 527,505 Oil and gas property 458,947 430,668 13,217 7,931 Other property-Total 10,814,590 9,959,961 Less accumubted depreciation, depletion and amortization 1,868,791 1,627,621 Propcity, plant and equipment-net 8,945,799 S,332,340 Current Assets: Cash and temporary investmeats 1,05S 13.512 Working funds and special deposits 569 34,85S Accounts receivable: Customers 124,333 110,741 Others 65,S91 64,611 Fuel stock. at hfo cost: Oil and gas 15.698 16,5S3 Coal and lignite 49,478 41.286 Matenals and supplies, at as crage cost 108,046 87,9S9 Other 14.06S 17.SSS Total current aucts 382,141 387.16s bther Assets: Cable television investment 70,423 16,036 hecoverable cance'ded projat costs 36,129 43.382 Unamattued debt expense and premium on texqu: red debt 69,345 49.342 Deferred debits 223,H4S 199,549 Total other assets 399,74S 308.309 Total 5 9,727,655 $ 9,027.S17 See Notes to Consohdated Fir.an:ial Stateraents i4 CONSOI.lDATED BALANCE SHEETS Hetm tad stes !=orpomed x3 SaWJbras Dec ember 31. (Ihousands of Dollars) 1987 19S6 Capitalization and Liabirties Capitalization: l Common Stock Equity: Common stock, no par; authorized,200,000,000 shares; outstanding 117,660,632 si' ares at D cember 31,1987 and n4,ns,vo snares at Decunber 31,1986 S2,007,466 $1,879,218 Retaincd eam:ngs 1,325,909 1.223,409 -- Total common stock equity- -.- _ . __ - _ 3,102,627 3,333375 Preference Stock, no par; authorized 10,000,000 shares; none outstanding Cumulat.ve Prefened Stock of Subsid:ary: (state nents on following page) Not subject to mandatory redemption 341,319 341,319 -. Subject to rnandatory redemption-99,055 Total cumu!ative preferred stock 440,374 341,319 Long-Term Debt: Debentures,9h% series due 1996 199,234 199,139 Long term debt of subsidiaries (statements on following pagel 2,S79,915 2,956,254 Totallong term debt 3,079,149 3,155 393 Total capitalization 6,S52,898 6,599339 Current Liabilities: Notes payable 725,820 220,292 Accounts payable 264,256 276,166 Taxes accmed 87,138 108,89S Interest accrued 74,S70 75,493 Accrued liabilities to municipalities 70,685 72,263 Current portion of long tern debt 57,703 52,767 Fuel cost over recovery 94,309 Other 49.696 57.349 Total current liabihties 1J30,168 957,537 Deferred Credits: Accumulated defctred feden1 income t.ixes 902,153 811.096 Unamortized investment tax (redit 537,674 561,376 Other 84,793 98,469 Total deferred cred:t> 1,544,622 1,470,941 Commitments and Contingencies Total $9,727,6S8 $9,027.817 See Notes to Conschdad hnancul 5tatenn nts. 4> L i s STATEMENTS OF SUBSIDIARIES' PREFERRED STOCK AND LONG. TERM DEBT Ikuton Industnes inwrpned and suWd: anes l l l l l December 31, 19S7 1986 Ghousands of Dollars) Cumulative Preferred Stock, no par; authonzed 10,000,000 shares; outstanding 4,447.397 shares at December 31,1987 and 3,447,397 shares at December 31,19S6 (entitled upon involuntary liquidation to $100 per share) Houston Lighting & Power Company: l Not subject to mandatory redemption: $4.00 series, 97.397 shares 5 9,740 9,740 $6.72 series,250,000 shares 25,115 25,115 $7.52 series,500,000 shares 50,225 50,225 $9.52 series,400.000 shares 39,372 39,372 $9.03 series,400,000 shares 39,395 39,395 $8.12 senes,500,000 shares 50,098 50,098 $9.04 series,300,000 shares 29,573 29.573 - A" series. 500,000 shares 48,809 48,809

B series,500.000 shares 4S,992 4S,992 Total 341,319 341,319 Subject to mandatory redemption:

$S.50 series,1,000.000 shares 99,055 l $ 440,374 5 341,319 - Total cumulative preferred stock-Iong Term L'ebt: Houston Lighting & Power Cotr.pany: l First mortgage bonds: 4%% senes, due 1987 $ 40,000 3% series, due 1989 30,000 30,000 4%% senes, due 19S9 25,000 25,000 133% senes, due 1991 4S,473 65,301 15%% series, due 1992 52,662 68,712 4Pb series, duc 1992 25,000 25,000 5%% series, due 1996 40,000 40,000 5%% series, due 1997 40,000 40,000 6%% series, due 1997 35,000 35,000 6%% series, due 1993 35,0?0 35,000 7W% series, due 1999 30,000 30,000 7%% senes, due 2001 50,000 50,000 7W% series, due 2001 30,000 50,000 8%% series,due 2004 100,000 100,000 10Po senes, due 2004 35.407 100,000 S%% senes, due 2005 125,000 125 000 S%% series, duc 2006 125,000 125.000 84% series, due 2007 125,000 125,000 l SS% series, duc 2008 125,000 125,000 9%% senes, due 2008 100,000 100.000 4*, STATEMENTS OF SUBSIDIARIES' PREFERRED STOCK AND LONG. TERM DEBT lbuston Industnes inwrprated and subsidunes (Cortinued) Dccember 31, (Thousands of Dollars) 1987 1986 11%% series, due 2009 $ 125,000 12% series,due 2010 100,000 12H% series,due 2013 7,944 11%% serics, due 2015 200,000 9% series, due 2017 $ 390,519 7%% po!!ution control series, due 2016 68,000 68,000 7%% pollution control series, due 201S 50,000 50,000 -.-Funds on deposit with Tmstee --(39,112) (12,612) Total first mongage bonds 1,692,449 1,845,845 Pollution control rev;nue bonds: Gulf Coast 1978 senes. 9 A%, due 1998 19,200 19,200 Gulf Coast 1980-T series, Roating Rate due 1998 5,000 5,000 Brazos River 19S3 series,10M%, due 2003 25,000 25,000 Gulf Coast 1974 suies,7K%, due 2004 18,000 18,000 l Brazos River 1985 A2 series,96%, duc 2005 10,000 10,000 l Gulf Coast 1982 series 9%%, due 2012 12,100 12,100 l Brazos River 1982 series,9%%, Joe 2012 42,800 42,800 Brazos River 1983 series,10n%, due 2013 75,000 75,000 Brazos River 1985 Al series,9%%, duc 2015 100,000 100,000 Brazos River 1985 B series, Roating Rate, due 2015 90,000 90,000 Matagcrda County 1985 series,10"b, due 2015 115,000 115,000 Brazos Rivtr 19S4 F series, Roating Rate, due 2016 68,700 68,700 Brazos River 19S4 A E series, Roating Rate, due 2019 400,000 400,000 Matagorda County 1984 A-C series, Roating Rate, due 2019 250,000 250,000 funds on depo >it with Trustee (74,126) (167,110) Total pollution control revenue bonds 1,156,674 1,063,690 __ Unamortized premium or (discount) net (4,427) (5,611) Capitalized lease obligations, average discount rate 13.S". 1,1S1 4,353 Total 2,545,877 2.908,277 Utihty Fuels, Inc 9% secured notes. due 1988 3,800 11,000 Variable rate notes, due 1958 50,000 50,000 Other 7,472 6,968 Cap:talized leate obhgations, average duount rate ' 3 4 % 30,469 32,776 Total 91,741 100,744 Total 2,937,618 3.009,021 Leu current maturitim 57,703 52,767 Totallong term debt of subsiJiaries $ 2,879,915 $ 2.956,254 See Notes te Condd3teJ Fmandal Statunents. 1 G STATEMENTS OF CllANGES IN CONSOLIDATED FINANCIAL POSITION Hann Nasmes inairparated ed saNia.m - ~ - - - - - - _. - -.. -Year Ended December 31, -. - (lhouunds of Dollars) 1987 19S6 19S5 Sources of Funds: Operations: Net income S 434,938 $424,935 5 434,126 Items not requiring current outlay of working capital: Depreciation, depletion and amortization 296,068 309,42S 264,487 Lowes from equityinvestments 11,039 10,213 Defened federalincome taxes-net 123,505 161,561 133,868 investment tax credit deferred-net (3,472) 24,470 53,255 (279,717) (25S,819) - --..._. Allowance for funds used during construction- -. - - _ -. - -.. _ _(252,744)~ _. - _ -.. _. Total 609,354 650,S90 626,947 Common stock dividends (332.458) (307.747) (273,132) 276,396 343,143 353,815 _ - -. Reinvested funds from operations. _ - - -. -. _ - Financing: Sale of common stock 128,248 116,847 229,215 Sale of preferred stock 99,127, 49,021 Sale of first mortgage bonds 200,000 Proceeds from pollution control revenue bonds and first mortgage bonds held in trust 127,874 238,503 275,2.58 First mortgage bonds issued in exchange offer 390.519 Sa!e of &bentures and other debt 200,000 S,027 Change in notes payable and temporary cash investments _ (71,004) 518,42S 95,220 1,264,194 710.570 690,517 Total fmancing Other: Decrease (increase) in working capital (excluuve of notes payable and temporary cash investment 3) (140,770) IS9.573) 118,184 Reclawification to currtnt maturity of long term debt (57,703) (52,767) (44,193) Proceeds from settlement of htigation 177,439 4,957 (64,340) Other-net (50,324) Total other (248,797) (137,3S3) 187,090 Total $ 1,292,293 $916.330 51,231,422 Application of Funds: Construction and nuclear fuel expenditures (net of a!!owance for funds used during construction) S 662,054 5755.273 $ 593,053 Od anJ gas additions 41,4ss 16.1S7 224,150 Cane television investment 5S,336 26.046 Reacqmred long-tenn debt 530,415 118.S24 114.219 Total $ 1.292,293 $916.330 $ 1,231,422 1 4. STATEMENTS OF CHANGES IN CONSOLIDATED FINANCIAL POSITION ikwen bdustno bamwa:ed ar.d suhdaries (Co:uinuedi l Year Ended December 31, i (Ihousands of Dollars). 1987 1956 1985 ~. l Changes in Components of Working Capital (exclusive of notes pr.yable and temporary cash investments) . Increase (decrease) in current assets: Cash 446 5(11,460) 702 Accounts receivaMe 14,872 (16,279) (14,933) Inventory 30,364 20.281 (41,992) Other (37,809) 32,205 6.375 Total 7,S73 24,747 . - (49,848) Increase (decrease) in current liabilities: Accounts payab!e (11,910) 5.595 (34,057) Taxes and interest accrued (22,3S3) (8.555) 26,S49 l Current portion of long-tenn debt 4,936 8,574 (34.500) l Fuel uxt over recovery (94,309) (62,290) 95,831 Other (9,231) (8.150) 14,213 Total (132,897) (64,826) 6S.336 Increase (Decrease) in Working Capital (exclusive of notes payaHe and temporary cash ins estments) $ 140,770 $ 89.573 5 (11S,184) See Notes to Conschdated Financial Statements. f s> NOTES TG CONSOLIDATED FINANCIAL STATEMENTS Hounon bdustries beerpnied and Subsidam fa the lece Yem Ended Deumber 31,1957

1. Summary of Systemof Accounts Significant ne accounting records of Houston Lighting & Pow er Company (HL&P), the Company's principal

' Accounting subsidiary, are maintained in accordance with the Federal Energy Regulatory Commission's Uniform Policies System of Accounts which has been adopted by the Public Utility Commission of Texas (Utility Commission). Principles of Consolidation ne consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, HL& P, Primary Fuels, InedPrimary Fueh), Utility Fuels, Inc. (Utihty Fuels), hmovative Controls, Inc., KBLCOM Incorporated (KBLCOM), Houston Industries Finance, Inc. (Houston Industries Fmance) and Development Ventures, Inc. Fuel sales and related cost of fuel sold generally represent Utihty Fuels' coal and lignite sales to HL&P and are not eliminated because of the distinction for regulatory purposes between utility and non utility operations. Fer this same reason, the purchases of account; receivable from HL&P by Houston Industries Finance also are not eliminated. All other significant intercompany transactions and balances are eliminated in consolidation. Investments in affiliates in which the Company has a 20% to 50% interest are recorded using the equity method of accounting. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 94, "Consolidation of All Majority Owned Subsidiaries," in the fourth quarter of 1987. As a result, the accounts of Houston Industries Finance, a wholiy-owned finance subsiaary, are included in the Company's consohdated financial statements for the first time. During the first three quarters of 19S7, Houston Industries Fmance was presented as an unconschdated subsidiary accounted for under the equity method. Plant Additions to electrie plant, betterments to existmg property and replacements of units of property are capitalized at cost. Cost includes the origmal cost cf contracted services, direct labor and material, indirect charges for engineering supervision and similar overhead items and an allcwance for funds used dunng construction (AFUDC). Customer advances for construction reduce additions to electric plant. Maintenance of property and replacements and renew als of items dctermined to be less than units of property are charged ta expense. The actual or average book cost of units of property replaced or renewed is removed from plant and such ;ost, plus removal cost less salvage, is charged to accumulated depreaation ne Company computes depreciation for its non oil and gas preperties using the straight line method. He depreciation provision as a percentage of the depreciable cost of plant was 3.6"w for 19S7,3.7% for 1956, and 3.8 L for 1985. Oil and Gas Property Be Company fonou the successful efforts method of accountmg for costs incurred m the exploration and development cf od and gas reserves. Lease acquintion costs are mitially capitalized and are periothcally assessed for impainnent of value, and a loss is recognized wben appropnate. Intangible developmcat costs apphcable to productive welk and to devdopment dry holes and tangible equ:pment costs related to the dev&pment of od and gas reserves are carttahzed. Exploratory costs, including geolopeal costs, co<ts of dry hole exploratory weib and lease rentalc, are expensed as incurred. Prodacing oi! and gas ! cases are depleted on the umt of producnon method over the estimated proved resen ei of the field. Related tangb!c and intanpble costs are depreciated or amortized on the unit.of-pmduction methnd over the eshmated proved devdoped reserves The Company recognizes unpwment of ::s producme propertes wl.en the net capitalized costs exceed tbc esumated reahable value dettnnined on a hc!d-by-fald bad l I e Allowance for Funds Used During Construction HL&P accrues AFUDC on construction projects and nuclear fuel payments except for amounts included in the rate base by regulatory authonties. AFUDC was computed using a gross rate of 10,75% beginning in 1987 due to changes caused by the Tax Reform Act of 1986, which generally eliminates a current tax deduction for interest during construction. %is gross rate is applicable to all property except certain transition property, prir cipally the South Texas Project Electric Generating Station (South Texas project), on which interest will be permitted as a current deduction. The net-of-tax accrual rate was 9% during 1987, and such rate w n 10% dunng 1986 and 1985. Revenues-Electric Revenues are recognized from the sale of electricity as bills are rendered to customers.He Utihty Commission provides for the recovery of fuel and the energy portion of purchased power costs through an energy component of base electric rates. He energy component is established during a utili'/s general rate proceeding and is effective for a minimum of twelve months. He rules provide for a reconciliation of fuct revenues, with any over or under recovery of fuel costs to be considered in establishing future fuel cost recovenes. In February 1986, the Utility Commission adopted a rule that requires a monthly reduction of the fuel factor if the Utihty Commission de' ermines that a utility has materially over recovered, or projects t:iat it will over recover allowable fuel costs under its existing fuel factor. ne rule ako provides for any fuel cost savings to be rafunded as a one-time credit to customers' bills. FederalIncome Taxes De Company follows a pohcy of comprehensive interperiod income tax allocation. The Tax Reform Act of 1986 eliminated investment tax cred?.s effective January 1,1986, except with respect to certain transition pmperties, pnncipally the South Texas project. Investment tax credits are deferred and amortzed over the estimated lives of the related property. Earnings Per Common Share Eamings per common share are computed by dividing net income by the weighted average number of shares outstandmg during the respective periods.

2. Common Stock Common stock tssued during 1987,1986 and 1985 amounted to 3,536,617 shares,5,598,652 shares and 9,063,738 shares, respectmly.

3. Preferred Stock H iP's preferred stock may be red $emed at the following per share prices, plus any unpaid accrued dividends to the date of redemption:

~ Not subject to mandatory redemptmn: $4.00 Series: $105.00. $6.72 Scries: $102.51. $7.52 Senes: $102.35. $9.52 Sener through September 30,1990-$10i00, thereafter-$103.00 to $101.00. $9.0S Series: through March 3L 1991-$103bO; thcreaf ter-5101.00. $8.12 Series: through Ncnember.R 1992-3104.25; thereafter-5102.25. 59.04 Senes: through January 31,1959-5105.00, thercafter-$103 00 to $101.00. Adjustable Rate Senes "A": through March 31,1989-not redecmaNe; thereafter-$103,00 to $100 00. The di idend rate on :his senes, as of January 1,1939,is 7.75% The rate is adjusted quarterly, based on the yield on U.S. Treasury secunties. Adjustable Rate Senes "B": through September ',0,19hnot redeemaHe; thereafter-$103 00 to $100.00. He dividend rate on this sencs. as of Januay 1,1988,is 7.50%. The rate is adjusted quarterly, based on the yield en U S. Treasury secunties. Subject to mandatory rcdemption: $K50 S<.nes. through May 31,1992-$103 50; theretiter $104.25 to $100.00; pmdded that the $S 30 Senes may not be redeemed, directly or mdirettiy, prior to Jene 1, lu92 f rom the proceeds of any refuthng 'hrough the mcurrence of debt or thmugh the issuar.cc oh referred stock rankmg equally with ) y 1 ' \\ l or prior to the $8.50 Series as to dividends or Equidation, whete such dbt M an effective interest cos' or such p eferred stock ias an effec *;c d vidend cost, of less than UM d annum. He mandatory i i redemption provision rgires HL&P to redeem 200,000 shares nyai!y ec nning June} 1993. f

4. Long-Term At December 31,1987, sinking or improvement fund requiremeq ul.M 9's first mortgage bonds Debt outstanding will be appnximately $36 million for each of the ydrs 1988 throy;h 1991 Cf such requirements, approxima'ily $17 mi!Pon for aach of the years UKthro$ 19M may be satisfied by certification of preperty aaditions at 100% of the requirements, an. N p.: AndcQregh cert: fica, tion

{ \\j( > of such property additions at 16M of the reqmrements. Sinking or ir pu Ament fund requiremeh6 for 1987 and paor years have oecn satafkd by certiheation of property'addicas. HL&P has agreed to expend an amoonwach year for replacements and improvements it respect at iu, ' l depreciable mortgaged utihty propesy equal to $1,450,000 plus 2% of net additions to such mortgaged ' ([ property made after March 31,19E and before July 1 of the preceding ym Such req @m Vmay be [ met with cash, fmt mortgage bonJn gross property additions or expendituo for repairs or replace > ments, or by taking credit for propeay addaien< at 100 of the requirem4 At thWm 3f HL&P, but on!y with respect to first mortp;e bcndaf a wrics subject to speaal redeing:;or Atb isited cash may be used to redeem hrst rvongage bonds c f such senes at the app!icaQsnecial ree.tcap<ien pnce. Consohdated annual matunties of long-term debt and minimum capitaiiease payments are approxi-mately $58 million.n NSS, $5S mi! hon in 1959, $3 mil!!on in 1990, $5 { mdhon in 1991 and $81 nJhon p in 1992. See al o Note M L The issuable amount d R&P's first mortgage bonds is unhmited as to authenzation, but I nitid by } property, carmor, and ctndproviswis of the Mortgage and Deed et TW and the supp!cmenta1 mdentures thereto ; Subs. mtially all propentes of HL&P are subject to herncurmg its long-tenn dtim ' ~ g S u

5. Short Term The interim fmancing requiremet y of the Company's operatmg subsidianes ne s e through shan-tenn

' u i i Financing bank loans, the issuance of commu 3 paper and short term advar.ces from the Company Ttm Campar r I and its subsidiaries had bank lin u 9 cred:t agerec4 $1350 bilhon and $1.050 bilhon at Decemb tr 31. 1987 and 1986, respectively, wh:ch hmit its total shontm borrowmgs and provide for intc resi at i les generally less than the pnme rate. ilank loans and commercicJ pamt eutstaaang were $6,000.000 a j < $718,609,000, respectively, at December 31,1987 and 550,000,000 and $169,011,000, respectis ely, it December 31,1956. Commitment fees are required on the undrawn portan of the hnes i l

6. Retirement In 1956, the Company adopted SEAS No. S7, "Eml'oyeN Accounaq fv Pensions," for its rc urement g

Plan plan, retroactive to January 1, !9h Pension costs for Mi7 and 1% a. GeJa vd duciosures as of - 1 the plan m 1955 are detennmed under the p badon i! w, d kcoua 4 pnnaples. -j Deccmber 31, loS7 and 19?6. are deterre. M unde be pu 9m of W $ Nm 87 tmi?n con for The Company has a nc ncontnbutory retircment pL: v, m

obsta lahy ad emp!oyees % hn 1

proviJes retirement benehts bred on years of seruce aid the e Woyu s huhest 36 cemecuta e

j months' base compencatnn danng the last 120 months 0: emdeyrr.cnn The pahey of the Com;uny it to

- j fund all ret pensmn costs, bm past semce costs only to ti.e u.' that the exms of plan asse fever accrued benthts does not nect the Company's fundme obhuaans for pr.t wice cc,ts in 'G :nd 19% however, as a rcsuP of the change m federal mcoat tax i m r.r.d HLWs early ret.cmr program, dncuwed bdow, the Company funded the mnanum aamunt dedx!5!e !m iedera ";come tax purposes. Plan astets consist prinapa!!) of common &M and c vement, m shon-t"rv high quah's interest beat'n; cbhgations in January 197. HI &P oHered employees (e. tluirm a OceW W u crc 55 ye.rs of ace and had li years of semce as of Februarv 28.19C an mcem

nrop g to ret,re cany Tor a,p!oyees c!cctag early ret:rement. tr e precram won'd al' &ee uas of en, ' h.4 acJ thi
I ns m age up to li year 5 of terMCC and, fe 65, rtspCetn dy 5 driernHnmg F (0) aye6 p Nom fAh pani @ahrd employee V ou!d dlso receive a supple!PC *:d h'? )Cbt to i.cc I E, Or a 1.un:W Pn n! tw 69 )eaN lhecarIy rel:rtment Inter'tive Was MCUpted by 4h ern,T I"

Pension bent h!s are beina po d a o' tl.e Paip6s redn ra nt plan at ts at d the supp!tinentJ benthts are bem? p ud bv HI &P Wot the a < % o N N e4 retw wm plan. th-pmjettcJ N ntut obh;ations penamm t' the Cowany's a tuen ca' r ;an ud suppi W h mts uc:e mm w J K 3 I n mm y 3E m]h _ S[, proceeding before regulato.y authorities. At December 31,1987, HL&P's obligation related to the $17.5 million and $7.2 million, respectively. HL&P has deferred the costs associated with the increases in q/ ... / /'}' these projected benefit obligations and wiu req"est recovery through electric rates in its next rate dl/ 3 y ,-].1 supplemental benefits was,35.8 million. bT J N iY ti Net pension cost includes the following components: ai Y \\( -.. - .--..L.,, Year Ended December 31, if (Thousands of Do!!ars) 1987 1986 }g$ <A [ Service cost-benefits camed during thmriod $ 13,536 $ 11,254 interest cost on projected beilefit obhgatial 23,096 18,202 .( Return on plan assets-actual (10,359) (26,666) -deferred gain doss) (10,257) 9,128 Amortization of transitional asset and prior 3ervice cost (1,474) (1,924) Net pension cost ,O $ 14,542 $ 9,994 He funded sta us oht v re(itement plan was as follows: )i s 4 December 31, (Rousands of Do!!ars) 1987 1986 Actuarial present value of: 7 _.. _. Vested benefit obligation _...._...___ _._. _. _. _ _ _ _ _ _ _ _. $182,097 $140,468 Accumulated benefit obligation _ _ _ $210,849 $169,494 P!aa assats at market value $254,211 $237,702 ,N..e:ted benefit ediga@.3. 279,860 237,643 I Asshs in excess of (less than) projected benefit obbgathn (25,649) 59 4 I) [ h Unteedgnircd wai:sitional asset at January 1,1986 (28,779) (30,703) ./j ' , Unrefogmzed prier senice est 6,220 I{ 7 l'rueergnized net loss 16,174 y . -.. -. - - -. -. -. - ~. -. - -. 11,598 Accrued pension cost at December 31 $ (32,034) $ (19,046) i 1 5 He projected beneft obli ation was detennined using an assumed discount rate of 96% in 1987 and 3 M 8% in 1986 and an..ssumed long-term rate of compensation increase of 6%% in both years. nc assumed long term r1 h of return on plan aws is 9% De transitional asset at January 1,19S6 is being recognized over apptc Lhtc! 17 years, a9 the pnor ser. ice co3t is being recognized over apprc.d-mately 15 yea s. He total penhen cost he Company s r@ ment plan for 1985 was $14,649,000. Significant commitments h$ve been incurred in cunnection with HL&P's constmetion program a

7. Commitments and Contingencies talear fuel ephases De construction prc' gram (exclusive of AFUDC)is rvesently estimated to cost

$477 miUtan ni 19SS, $4 M miHion in 1939 and $349 railhon in 1990. Rese amounts do not include expenditures on projects r which HL&P expects to be reimbursed by customers or cogenerators and S ako do not reflect the possiNe acquisamt. by HL&P of an additional 16% interest in the South Texas project. See Note 10 for discussions of such nossible acquisition and the revised budget and schedule f> the South Fexas projcct. An additional $34 million is expected to be spent dunng such period for uranium concentrate and nuclear fuel processing seMces for HL&P's portion of the South Texas project. Commitmer,ts ti connection with Hl &Pi onctruction program, pnncipauy for generatmg plants and related facihties, are generally revoable t y HL&P subject to reimbursement to manufacturers for expenditure fncurred or ather cancePatton penaltaes. In add: tion, durin; the 19581990 period, Utihty fuels expea b spend $127 milhon for cual and hgnite supply related equipment, of w hich $57 million is expected to be spent in 1988,546 milhon in 1959, and $24 e alhon in 1990. Pnmary Fuels expects to mcnd appmxinutely $57 miUwn on oil and gas e> p! oration and development dunng 1988. u ( ' ; \\k, A. J

8. Pending Appeal of 1982 Rate Order.

- Litigation On December 16,1987, the Texas Supreme Court rendered its decision on an Application for Writ of Error filed by the Utility Commission in connection with a December 1932 rate order by the Utdity Commission (Docket No. 4540). In the rate order, the Utility Commission disallowed the recovery by HL&P of approximately $166 million of costs incurred in connection with its cancelled Al! ens Creek nuclear project, and ordered that any tax savings associated with the disallowed portion be passed through to customers. While the Utdity Commission purported to permit $195 million of expenditures for the project to be recovered over a ten year period, the flow-through of tax sasings on the disallowed portion reduced the recovery to approximately $S4 million. That decision was appealed by HL&P to the 201st Judicial District Court in Travis County, Texas which ruled,in December 1984, that the Utility Commission was without legal authonty ia imposing such punitive measures. The District Court nded that, since the Utility Commission had found that the shareholders, and not the ratepayers, should bear the disal! owed Allens Creek expenditures, the shareholders should oceive any and all tax benefits associated with those expend:tures.The rate order had ako reduced a recommended return on common equity from 16.85% to 1635% as "a penahy for poor management," based principally on findings that HL&P had been imprudent in the handling of its nuclear constn:ction projects. He District Court ruled that the aihty Commission had no statutory authonty for such a penalty, and that the Utihty Com-mission's findmgs regarding HL&P's management of the South Texas project were "premature and presumptuous" in view of the then pending litigation on such issues against the former architect-engineer. The District Court also ruled that the 1982 rate orde had erroneously and prematurely attempted to exclude from HL&P's cost of ser ice any of its expenses in connection with the htigation, as well as any amounts w hich may ultimately be assessed against HL&P in such litigation. Based on such rulings, the District Coud remanded the case to the Utihty Commission for funhcr proceedings consistent with the finai judgment. The Utility Commission appealed the District Court's decision to the Court of Appeals for the Third Supreme Judicial Distnct of Texas, which essentially upheld the District Court in an opinion issued April 9,1986 (which was modified and reissued on July 2,1986) The Texas Supreme Court granted the Utdity Commission appbcation for Writ of Error to consider certain points of error raised by the Utility Commission, as well as certain other points raised by HL&P. Ahhough the Texas Supreme Court affirmed certain aspects of the lower courts' decisions, including a ruhng to the effect that the Utihty Commission had no statutory authority to impose a penalty on HL&P's rate of return, that court reversed the lower courts' decisions regarding allocation of certain income tax benefits associated with the disallow ed costs to the benefit of shareholders and held that such income tax benefits should inure to the benefit of HL& P's ratepayers. HL&P has ided a motmn for rehearing on the issue reversed by the Texas Supreme Court. De Utihty Commission has also sought reheanng on the issues affirmed by that court. Action on those motions is currently pending before the Texas Supreme Coun. As a result of the Texas Supreme Court's affirmation of certain of the lower courts' decisions, the case is to be remanded to the Utdity Commission for determination and implementation subject to pending motions for reheanng and possfale further appeals by HL&P. Previously repcrted financial resuhs will not require restatement. Jury Award in Condemnation Proceeding. In July 1981. HL&P filed a condemnation action agamst the Klem Independent School DistrimKlein) to take approumately 8.6 acres of Klein's property as an casement for the purpose of erecting, operatmg and mamtaming a 345 kdovolt electnc transmi3smn bne. Klein subsequently alleged in the County Cail Court at Law No 1 of Harris County. Texas that HL&P had abused its discrenon in the taking of the property. On November 27,1955, the jury returned a verdict fmdmg that Klein sustained actual damages of approximately $104.000. The jury also found that HL&P's conduct in the construction operation and mamtenance of the transmission line on Kicin's property was in reckless disregard of the school purposes for w hich the property was being u3ed, and awarded exemplary damages in the amount of $25 milhon. Le jury found, further, that the ulue of Klem's property had been reduced to zem and that the cost of land and facihties necessary to replace or restore K!cm's property and f acihues was approximately $42.1 mdlion On December 13,1985, the trialjudge entered judgment m favor of Klem, awarding the full amounts of actual and pumtive damages, or a total of approumately $251 mi! bon, plus interest. Klem havmg elected that funn of judgment rather than a judgment awardmg condemnation damagex In add: tion, the court granted an m) unction, pendmg appeah that effectively prohib:ted HL&P from uung 54 -8. Pending the line for the transmission of energy, except during certain specified emergencies when there are no [ Litigation. regularly conducted school or other publicly sponsored activities occurring on Kiein's property. (continued) On January 2,1986, HL&P appealed the case to the Court of Appeals for the 14th Supreme Judicial District of Texas,and also sought, from that coun, relief from the mjunction against use of the hne pending appeal or,in the attemative, an order increasing the bond which Klein must file in order to protect the interests of HL&P pending appeal On February 27,1986, the appeUate court granted Hl1P's requested relief from the injunction and directed the trial court to allow HLAP to post a bond that would allow continued use of the easement pending a fmal decision on the ments of HlaP's appeat i Klein responded on March 3,1986, by asking the Texas Supreme Court for leave to file a mandamus petition against the 14th District Court of Appeals. On November 26,1986, the Supreme Court conditionally granted the mandamus petition sought by Klein. Ruling that the trial court had not abused its discretmn in denying HL&P's request to supersede the injunction, the Supreme Court indicated that it would grant the writ of mandamus if the Court of Appeals did not vacate its judgment, with the result of that dccision bemg the reinstatement of the trial court's original order,which had enjoined HL&P from using the line pendmg the outcome of the appeal on the ments. In light of the injunction that effectively prohibited use of the line, HL&P placed a rerouted line in service in August 1987. On November 5,1987, the 14th District Court of Appeals issued its decision on the ments of the t l appeal by HL&P. The court ruled that HLAP's action pursuant to the statutory condemnation procedure l could not amount to trespass and set aside the award of exemplary damages to Klein, thus relieving HL& P from liability for the $25 nullion in exemplary damages awarded by the trial court. The appeals court affirmed the trial court judgment on the balance of the points raised in the appeal, leaving intact the jury's award of approximately $104,000 in actual damages. The appeals court noted, however, that H1AP had rerouted the transmission line away from Klein's property. Klein has hled an Application for Wnt of Error with the Texas Supreme Court seeking further review of the appeals court's decision. HL&P has hied a contingent Application for Writ of Error to be considered in the event that the Texas Supreme Court grants Klein's Application. It is possibk that the exemplary damages awarded by the trial court might be reinstated if the Supreme Coun agrees to hear a further appeal of the decision. While HL&P and the Company can give no defmitive assurance regardmg the ultimate resolution of this matter, they presently do not believe such resolution will have a material adverse impact on HIA P's or the Company's financial position. No prediction can be made, however, of the final outcome or the timing of final judicial action in this suit. t 1 t Prudence Review of Coal Supply Agreements and Litigation with Coal Suppliers. Dunng the course of hearing HlAP's 19S6 general rate proceedma (Docket No. 6765), the Utihty Commission severed into a separate docket (Docket No. 6963) certain issues related to the prudence of the two long-term contracts under w hich substantia!!y all of the coal for HL&P's W. A. Parish generating i units is obtained, including the degree to which the chemical charactenstics of coal from one of those suppliers led to HL&P's decision to upgrade existmg pollution control equipment by installing baghouses on three of those generatmg umts. The Utility Commission staff requested that, pendmg the outcome of the separate docket, HL& P be at nsk for all costs associated with the mstallatmn of the baghouses (eamated to total $178 mdlion excludmg AFUDC) and for payments made for coalin excess of the equ. valent of a delivered price of $151 per mdlion Bru's. As a resu t of the Utihty Commisswn's action, the Company, HL&P and Utdity Fuels filed suit against the two coal suppliers in questwn in the Uruted States District Court for the Northem District of Texas in l Dallas. In that lawsuit, the p!amtiffs requested the court to determine that performance under the contracts should be suspended or the contracts modified in the event the Utibty Conunimon should i proceed to a final detennination that the maximum cost that can be included in e!ectric rates charged to HL&P's customers is less than the amounts called for under the contracts. In addmen, Unhty Fuels began withholdmg from payments to the coal supphers the difference betw een the amounts cal!ed for in the contracts and the equivalent of a Jelivered pace of $1.51 per mdhan Btu's and sought to deposit that ddference into the registry of the Court. In response, both coal supphers ided counterdaims and motions i for partial summary judgment on those counterclaims. On November IS,1986, the trial court granted those motiom for summary judgment in pan, ruling that HL1P and Utthty fuels must pay the full contract price for coal pending the outcome of the Uuhty Commmion pmceeJing and directing that the amounts previously withheld be paid to the coal compames with internt. ,c------

8. Pending The Company, HL&P and Utihty Fuels appealed the trial court's decision to the Fifth Circuit Coun of Litigation Appeals and continued to withhold the amounts in dispute pending the outcome of the appeal On (continued)

October 7,1987, the Fifth Circuit Court of Appeals ruled that the trial court's decision was not a final, appealable order and therefore d:smissed the appeal without considenng the issues raised therein. On April 30,1987, a Utility Commission Hearings Examiner granted a moten by HL&P to suspend the procedural dates then in effect in Docket No. 6963 in order to aHow Utihty Fuels, HL&P and the coal companies to continue negotiations of cenain modifications to the coal supply arrangements in an attempt to provide the basis for resolution of the issues in Docket No. 6963. Those negotiations were conduded on December 21,19S7, when amendments to both coal supply contracts in question were executed. Under the amended contracts, the pnce paid by Utihty Fuels was reduced as of January 1, 1988, and changes were made in the escalation and certain other provisions of the contracts. At the time the amended contracts were executed, Utility Fuels, pursuant to an agreed court order, paid the coal suppliers the amounts which previously had been withheld, mduding interest threon. In January 1988, HL&P and the Utility Commission staff filed testimony proposing that the amended coal supply arrangements be accepted by the Utdity Cormnission in resolution of the issues raised in Docket No. 6963. HL& P also filed an agreed stipulation executed by HL&P, the staff and one other party to the docket. Under the stipulation, the new coal supply arrangements would be accepted by the Utibty Commission and issues raised in the docket with respect to (i) prudence of amounts incurred pnor to January 1,1988 and (ii) the relationship of coal quality to the decision to install baghouses would be resolved without disallowance of amounts paid by HL&P for prior coal dehveries. However,in March 1988, the Utility Conunission Hearings Examiner considering the docket issued a recommended decision in which he urged the Utdity Commission to remand the matter for further evidentiary proceedings on certain points in the proposed stipulation which were questioned by the Heanngs Examiner. Rather than reopening the record on his own motion, the Heanngs Examiner chose to present his contems to the Utibty Commission for ruhng prior to remand. A decision by the Utility Commission on the Hearings Examiner's recommendations is expected at the end of March 1988. In the event that the outstanding coal prudence issues are not resolved by the Utihty Commission on a mutually acceptable basis, the panies to the new coal supply arrangements have reserved the right is terminate those arrangements and resume the litigation relating to the previous long term agreements. While HL&P and the Company can give no definitive assurance regarding the ultimate resolution of this matter, they presently do not believe that such resolution will have a material adverse impact on HL&P's or the Company's fmancial position. Should HL&P be unable to recover its costs, such costs may have to be charged against earnings. FuelTransportation Litigation. On July 31,1986, HL&P and Utility Fuels fded suit in Federal District Coun in Houston, Texas against three railroad holding companies and their railroad operating subsidiaries and two other radroads. The suit alleges that the railroads violated certain federal statutes,induding the Shennan Act,in activities aimed at precluding development of coal sbrry pipehnes that could have delivered coal to the plaintiffs in competition with the railroads. On February 13,1987, with the agreement of all panics, the Federal District Court in Beaumont, Texas entered its order permitting HL&P and Utility Fuels to fue the same claims for alleged antitrust violations against the same railroads by inter entmn in an actwn there pending between a third party and the same railroads. HL&P and Utihty Fuels have joined with the radroads in requesting the Federal District Coun in Houston to stay proceedmgs in the Houston litigation pendind the outcome of the Beaumont litigation. Among the defendants are the Burhngton Northem Railroad Ccmpany (Burhngton Northem) and the Atchison, Topeka and Santa Fe Raihvay Company (ATSF). w hich supply rail transportation services to Utihty Fue' for coal purchased from mines in the Powder River Ba,in m Montana and Wyoming. In the litigation Burbngton Nonhem and ATSF have fded counterdaims based on the assertion that cenain of the matters alleged to be in dispute in the htigation fi!cd by Utdity Fuck and HL&P were settled as a result of the executien of the Rad Transponaten A'greement, dated March S 1931 among Utiht) Fueh and Burlington Nonhem and ATSF. Accordmgly, the counterdamn acen that Utihty lueh is m breach ofits obligation under the RailTranTortation Agreement by vinue o! the idng of smt namst Burhngwn Northem and ATSF. In their counterclaims Burlington Northern and ATSF wek ungecihed damget mdudmg pumtive damages. Utdity Fueh and HI &P regard the counterdanns to be mthout ment, but no aue"ment of t!.e uhlmate outcome of the litigation can be made at thi3 time See aho Note 10-Jomtiy-Oued Nudear Plant g

9. Umestone in December 1986, the second of two 720 megawatt, lignite-fired generating units at HL&P's Limestone Generating Units Electric Generating Station (Limestone) was placed into commercial operation. In January 1987, HL&P requested that the Utility Commission order an accounting treatment which would pennit HL&P to capitalize operating and maintenance expenses, non-reconcilable mining and handling charges, taxes and depreciation associated with Limestone Unit No. 2 and to continue recording AFUDC from the date Unit No. 2 was placed in commercial operation until the date when new rates are implemented that reflect Limestone Unit No. 2 as plant in service in rate base (Docket No. 7375). HL&P further requested, as an alternative, that if the mining and handling charges referred to above are not allowed to be capitalized, then those costs would be allowed recovery through the reconcilable fuel portion of base rates. Hearings in this docket concluded on June 10,1987, and a decision by the Utdity Commission is pending. A similar l

accounting treatment had been requested by HL& P for Limestone Unit No.1 but was denied by the Utility Commission. Until rate relief or other regulatory action is taken with respect to Limestone Unit No. 2, operating results of HL&P and the Company will be adversely affected.

10. Jointly-Owned HL&P is project manager and one of four participants in the South Texas project, which consists of two i

Nuclear Plant 1,250 megawatt nuclear generating units. Each participant finances its own share of construction expenditures with HL&P's participating interest in the project currently being 30.8%. As of December 31,1987, HL&P's investments in the South Texas project and in nuclear fuel, including AFUDC, were $2.2 billion and $131 milhon, respectively. Pending Litigation and Agreement in Principle with the City of Austin. In January 19S3, the City of Austin (Austin), one of the four owners of the South Texas project, filed suit against HL& P and the Company in the 98th Judicial Distnct Court in Travis County, Texas (Cause No. 343,240), a!!cging that HL&P had misrepresented the capabilities of the original architect. engineer and construction manager of the project and failed to properly perform its duties as project manager. Because of such alleged misrepresentations and failures, Austm asserted it was entitled to, among other things, (a) a reformation of the participation agreement such that Austin would convey to HL&P its 16% interest in the project,(b) a refund from llL&P of the approximately $437 mdlion expended by Austin to that date, and of all sums expended by Austin on the project thereafter, and (c) damages in an additional unspecified amount. In December 1985, Austin filed an amended petition which again alleged that HL&P had misrepresented the capabilities of the former architect-engineer and failed to properly perform its duties as project manager for the South Texas project. In addition, the amended petition asserted claims against HL&P under the Texas Deceptive Trade Practices-Consumer Protection Act (DTPA) and sought, from HL&P and the Company, either (a) an unspecified amount of damages, including treble & mages to the extent proper under the DTPA, as well as pre-judgment interest costs and attomeys' fees, or (o) e reformation or rescission of the participation agreement for the South Texas project requinng HL&P to i retum to Austm all of the moneys expended by Austin with respect to its 16% interest in the project to the date of the judgment, with interest, relieving Austin of all future obligations with respect to such interest in the project, and providing for a concurrent transfer by Austin of such interest to HL&P. Austin and HL&P have ftled motions for partial summny judgment. On October 10,1986, the trial judge ruled that Austin is not entitled to reformation oc rescission of the participation agreement for the South Te xas project. Tne tnaljudge overruled HL&P's motion for partial summary judgment directed at Austin's allegations asserting a cause of action under the DTPA and HL&P's motion for partial summary judgment directed at Austin's allegations that there was fraud in the inducement relating to Austm's entry into the participation agreement. On June 29,1937, a newly appointed trial judge denied Austin's motion seeking to hold HL&P responsible for the actions of the former architect engmeer. He judge denied, however, HL&P's request for summary judgment on all claims relating to the participatmn agreement. The judge ruled th?t Austin must prove that HL& P breached the participation agreement by l faihng to report materialinformation and must prove damages specihcally related to such failure to provide information. The judge permitted Austin to maintain its claim for $330 million under this theory of recovery if it could show that the owners wou!d have cancelled the South Texas project in 1976 and that Austin would have but!t a coal plant m beu of the South Texas project. However, on August 10, 1937, Austm provided an updated calculation of its alleged damages under that claim, dropping its claim under this theory of recovery to 1740 milhen. On August 11,19S7, the juJge reversed the earher onler a . - -.. - - ~

10. Jointly Owned denying HL&P's motion for summary judgment as to Austm's DTPA claims.nus, Austin's DTPA claims Nudear Plant are been mooted and its damage claims are no longer subject to trebling under the DTPA.

(continued) As a result, the maximum damage claim remaining in the case is an ahernahve claim for $S11 milhon rebtmg to Austm's claim that it was fraudulently induced to enter into the South Texas project in 1973. Le judge has not yet acted on HL& P's motion for summary judgment on this issue. On September 3,1987, HL&P announced that it had reached an agreement in pnnciple (Agreement in Principle) with Austin to acquire Austin's 16% share of the South Texas project. Under the tcrms of the Agreement in Pnnciple, HL&P and Austm would dntmss all htigatmn and other claims currently pending. The Agreement in Principle provides that Austin would convey to HL&P its 400 megaw att (MW) intere3t in the South Texas project. together with nuclear fuel and related property,in exchange for a 400 MW interest in HL&P's Limeston at:en, a lignite pbnt havmg a capabihty of 1,440 MW which has been completed and placed in senice. His conveyance would result in Austin having an undivided proportionate interest in the land, capital equipment. and fixed renonal property of HL&P at Limestone. A 200 MW interest in Limestone Unit No. I would be conveyed on the later of June 1,1983 or the dos.ng of the settlement, and a 200 MW interest in Lime 3tene Unit No. 2 would be conveyed on January 1,1990. HL&P would operate Lunestone in accordance with an operatmg agreement to be mutuaHy agreed upon as part of the defimtive dacumentation. UnJer the tenns of the Agreement in Principle, HL&P wou!d (a) assume Au3tm's South Texas project obhgations for the remaining construction and fuel costs effective September 1,1987, as w ell as Austin's obhgations for continuing capital anprovements, decommissioning, and all other matters ansmg out of Ausan's mterest in the South Texas project; fb) pay Austm $19.7 milhon for a porton of construction costs mcurred dunng negotiatmns; (c) purchase Austin's nudeac fuel for $30 million; and (d) pay certain of Austin's legal expenses. In additmn cedain daims asserted by Austin under an outstandmg purchased power contract would be reselved Austin would assume responubihty for its pmtmn of the capital improvements and fuel, operatm.; anJ maintenance expenses at Umestone. 1he Agreement in Pnnaple prendes that no contract obbgation will come into existence until execution of the defmitive contract documents and other conluuns have been satisfied, mduding approval by the Ut:hty Commis90n and the Nudear Regulatory CommiWon (NRC). In addition, the Agreement m Pnnaple pron &s that it would be necessary that the order of the Utihty Commission, among other things, contain no findmgs, condusions, reservations, or obervations by a majonty of the Utdity Comnussion that raise reasonable doubt that the transfers contemplated by the Agreement in Pnnaple w ould resuh m rate treatment to Hl1P less favorable than the rate treatment of Hi &P pnor to such transfers. Ir. September 19S7, HL&P fded an apphcatmn with the Utihty Commnuon (Docket No. 7725) to reflect the exchange of ownenhip of Limestone and the South Texas project pursuant to the Agreement in Pnneiple. The settlement is also contmgent upon the City of San Antomo (San Antomo) anJ Central Pow er and L:ght Company tCPL), the other pani-ipants in the South 'lexas project, waivmg their nghts of first refusal relatmg to acquinng part of Austm's interest. On January 7,19SS, HL&P f: led a Fourth Amended Answer. Onginal Thrd Party Petition and Ongmal Pention for Dedaratory Rthef rllird Party Petiton) m the penir htiganon with Aetm. In the R:rd Party Petition. Hl4P requested lene of the court m u hich the Ausan htigation is pendmg to make senice on San Antomo and CPL and its parent corporation, Central and Southwen Corporation (CSW) ne Th:rd Party Pention makes da:m agamst San Antonio, CPL and CSW for coninbution and indemmty shou J HI &P be found to be hable to Austm with reyct to certam daims of Austin in the pendmg hugatwn. The Bird Party Pention asks for a dedaratory juJement that HL&P is not hable to Austm. San Antomo, CPL or CSW with respect to its actmns or mactmns as projett manager unJer the Partiapanon Agreement among the co-owners of the South L us project and further requests the coun in the Austm htigation to impbment altemative methods of dmte resolutwn provihd by the Teus Ciul Pracace and Remeles Act such a; non-bmdmg arb:traton hnaHy the HmJ Party Pehtmn a<ks the court to defer or abate proceedings untd amp!ctmn of the second umt at tne South Teus project but no !ahr than December 31.19W l'mt No 2 of the South Ttus projest n presently s heduled for commercul operatmo m June 1%9 At a heanng on Januan 27, IM the court m the Austm htigatmn wt the pendmg su.t between Au'tm and HL&P for tnal the hnt week m June 1%S lb court m the Ausna knaatu n, whuh has dnactmn whtther to ac pt junsdutmn our the dauns assened a the 1hrJ Party huner. al!owcJ Hl AP to u i

10. Jointly-Owned serve the %ird Party Petition on San Antonio, CPL and CSW willmut prejudice to the nght of those Nuclear Plant parties to later assert that the %ird Party Petition should be dismissed or severed for a separate trial in (continued) the Austin litigation or severed into a separate docket independent of the Austm litigationM.e murt also advised the parties that in no event would San Antonio, CPL and CSW be required to participate in the trial of the pending suit between Austm and HL&P. HL&P has also filed an original complaint in the 130th District Court of Matagorda County against San Antonio, CPL and CSW requesting substantially the same relief. If the court in the Austin litigation does not ultimately dismiss the Dird Party Petition, prosecution of the action in Matagorda County will be deferred.

On March 3,1988, San Antonio and CPL filed responses to the nird Party Petition, and each delivered letters requesting arbitration. In their responses and letters, both San Antonio and CPI asserted that HL&P has breached its duties and obligations as project manager for the South Texas project and is liable to San Antonio and CPL for resulting unspecified damages. San Antonio and CPL asked the trial judge in the Austin litigation to compel their requested arbitration and to stay further proceedings with respect to CPL and San Antonio pending the outcome of that arbitraten. ney fmther asked the trial court to enjoin HL&P from pursuing either its Lird Party Petition or the separate litigation filed by HL&P in Matagorda County. No heanng has been scheduled by the court in the Austin litigation to consider these matters. CSW also tesponded to the %ird Party Petition on March 3,1988, asking that further proceedings be deferred pending the arbitration, and den *g any habihty with respect to the South Texas project. The parties have contmued settlement negotiations withir wotk contemplated by the Agreement in Principle; however, no prediction can be made. nether a settlement with Austin can be achieved if a defmitive agreement cannot be reached, any juvent entered after tnal, as well as the intermediate mling discussed above, will be subject to appeal af ter trial With respect to the pending L litigation, HL&P and the Company regard Austin's claims and those asserted by CPL and San Antonio to be without merit. Whde HL& P and the Company cannot give definitive assurance regarding the ultimate resoluten of these matters, they presently do not believe such reso!ution will hm a matenal adverse impact on HL&P's or the Company's financial position. Assuming the Agreement in Principle is consummated, HL& P's construction and nuclear fuel expendi-tures would increase by $205 mdlion for the 1988-1990 period, $92 mi!1 ion of w hich is re ated to l reimbursement of costs incurred by Austin prior to 1988 and the purchase of Austin's nuclear fuel Order of the Texas Supreme Court. On November 4,1987, the Texas Supreme Court entered an order w hich hkely will delay the schedu!e for Docket No. 7725 and certain other dockets pending before the Utihty Commission The Court's order directed the Commissioners of the Utility Commission to stay hearings and actions in Docket No. 7725 and certain other dockets pendmg disposition by the Court of a Motion fded by the Attomey General of Texas for Leave to File Petition for Writ of Mandaraus against the Commiwioners. In addition to Docket No,7725, the Court's order applies to Docket No. 6184, an mquiry concerning the economic viabihty of Unit No. 2 of the South Texas project, and Docket No. 7582,in which HLhP petnioned for deferred accounting treatment for costs related to Umt No.1 of the South Texas project. He mandamus petition arose from action by the Utihty Commissmn in these and certam other dockets denying the Attomey Generars petitmns to intervene on behalf of the Texas state agencies. HL&P and the Company cannot be certam at this time as to the duration of the Texas Supreme Court's stay or as to the effect of the Court's action on these dockets. A heant>g by the Court en the Attomey Generars petition was held on December 16,19S7, and the Wnt of Mandamus wdl remain m effect unta the Texas Supreme Court resolves this issue. Prudence Review of South Texas Project by Utility Commission. He Utihty Commission has instituted a prudence review of the South Texas project for the purpose of reaching a fmal and bmdmg determination for future rate base treatraent of the amounts im ested in the South Texas project.This proceeding (Docket No. 666S) wdl enwmpass an mvattpnon of the prudt nce and efficiency of the plannmg, management and construction of the South Texas project, as well as the proper accounting treatment of the pnxeeds received from the furtner architect-engmcer m the scitle. ment (Settlement) of certam htiption relating to the South Texas projett. fhere a no detmitn e whedule for commenccment of heanngs, but it is unhkely that heanngs wdl bt gm before the fall of IWS. E. )

10. Jointly Owned The Ut;lity Commission retained a consulting firm to evaluate the prudence and efficiency of the Nuclear Plant planning and management of the South Texas project and to make recommendations to the Utility (continued)

Commission rej;arding regulatory actions based on such evaluation. In June 1986, the consulting hrm presented its report (Report) to the Utility Commission, which Report covered the period through 1983. The consulting firm concluded in the Report that de6ciencies in management of the project had cautred and that such deficiencies led to imprudent expenditures estimated to be m a range of 51.1 to $13 billion. Accordmg to the Repon, such amounts do not include AFUDC or rate effects w hich the consult ng ftrm concluded would substantially offset each other. The Repod also indicated that the i estimates relating to the prudence issue were preliminary, were based upon certain assumptions that should be refined and were subject to further refmement and modifkation. A new consultant is expected to be retaincd by the Utility Conunission in March 1988 to complete all work necessary for a final evaluation conceming the prudence of management and the reasonableness of costs associated with the South Texas project. Ahhough the scope of that invertgation has not ban finalized, HL&P anticipates that tb Report will not be sponsored by the Utihty Comminion staff. The manner in which the new consultant or any other party will utdize the Report in that docket,however, remains unclear. HL&P believes that the Settlement with the forme architect-engineer prmided full compensatka for any imprudent or mefficient plaaning or management during the period in question. HL& P wdl strongly contest any ricammendation or fmding that amounts invested in the South Texas project, after taking into consideration the Settlement, nave been a result of mcfficiency or imprudence. While no definitive assurance can De given that all amounts invested in the South Texas project wdl be recoveraHe by HI &P through electric rates or otherwise, HL&P end the Company presently believe the ultimate resolution of the Utility Commission s prudence review will not have a material adverse effect on HlA P's or the Company's fin.ncial position. Any amcunts that are not recoverable would have to be charged against earnings. A substantial write off could adverscly affect the Company's abdity to finance its capital propram and meet other fmancial obligations. Request for Deferred Accounting Treatment. h July 19S' HL&P requested that the Utitty Commiuion order an accounting treatment which would allow HL&P to defer its portian of all operating and maintenance expenses, taxes and depreciation that would otherwise be expensed effective with the commercial operation of Unit No.1 of the South Texas pmject and to continue recording AFUDC associated with this investment untd rates are placed into (ffeci which w ould reflect this investment as electrc plant in senice in rate base (Docket No. 75S2). 3ecause the hearings in Docket No. 6668 relatmg to the prudence review of the South Texas project l are not currently scheduled and are unlikely to bepn btfore the fall of 19SS, a si;nificant lag time could occur between the commercial operation date of Unit No.1 of the South Texas project and imple-mentation of new rates reflecting such facihty at plant in senice. As a result of such bg time and w uhout the requested accounting treatment referenced above, HL&P's operatmg rnults w ill be adversely affected unless some other mitigative action by the Utihty Commission is taken. In October 1987, HL&P fded supplemental testimony m response to the issuance of SFAS No. 92. SFAS No. 92 predudes the capitahzation of the equity portion of AFUDC for financial reportmg purposes as was previously requested in Docket No. 7582. It n anticipated that the effect of such limitation would reduce camings of the Company by approximately $100 m:! hon on an annuahzed baus. In its supplemental testimony,in lieu of the AFUDC a rual, HL&P requested the accrual of interest on the deferred cests and on the plant investment m Unit No 1 of e mus Taas projut. Under this request, HL& P^s 198S fmancial rnu'ts would be similar to those under the ongmal dewml request. Revised Budget and Schedule. On September 17,19S7, HL&P presented a completion estimate for the South Texas project to the management cornrmttee for the project, which estimate was adopted by the committee on December 17, 19S7. Based upon its September 1987 complction assewment bvhich avumcJ a commeraal operation cate for Unit No. I of March 1,195S), HI &P estimated that the total cost for the completed project would be $5.28 bdhon, excluding AFUDC and ntt of the Settlement 'lhe revwed et estenate represents an increase of $300 million oser the prevloes cost estunate w hich was $4 98 bh,n. excludmg AFUDC and net of the Settlement, for the entir South Texas project. Hl1P's letton of such mcreased costs would be approtmately $92 ralEen be,ed on its current 30% mternt m the south Texas prejc(t. w r

10. Jointly Owned in August 1987, the NRC granted a low power opu ating hcense for Unit No.1 of the South Texas Nuclear Plant project. In 1987, the Govemment Accountabihty Project (GAP), a cituens interest group, demanded that (continued) the NRC establish a special task force to investigate alleged safety defects at the South Texas project The group claimed to have esidence al defects but refused to turn over the evidence untillate in 1987. The NRC concluded an on site investigation to review and evaluate the G AP allegations. De NRC review of all the GAP allegations has identified no substantive safety issues that would warrant delay in the NRC's consideration of a full power Ucense for Umt No.1 of the South Texas project. In February 19SS, the NRC imposed a civd penalty in the amount of $75,000 for two instances in late 1987 when opaations during testing at the South Texas project violated certain technical specifications. In March 19S8, the NRC imposed a second civil penalty in the amount of $50,000 for secunty deficiencies indentified in the fall of 1987.

Initial criticahty at Unit No.1 of the South Texas project was achieved in March 1988. The delay in achieving initial enticahty has been principally attnbutable to certain equipment protlems identified dunng the testing process, which have been analyced and corrected, and the need for additional operator training undertaken to address concerns r ised by the NRC.'Ihe steps remaining before Unit No,1 can be placed mto commercial operation are satisfactory completion of low power operation at.d the receipt of a full power hcense from the NRC. The in-service date and cost estimate for Unit No.1 of the South Texas project are subject to continuing review in light of these matters and the ongoing testing process. HL&P estimates that three to fis e months of additional testing will be required after initial criticahty before Unit No. I can be placed in commercial operation. Although no definitwe estimate of additional costs has been approved, HL&P anticipates that cost increases in the range of $100 to $150 mil! ion (of which HL&P's portion wou!d be $31 to $4 mi!! ion based on its 30.8% interest) may result from the delays in achievmg imtial cnticahty nd the resulting delay in the anticipated date of commercial operation of Unit Na.1. HL&P estimates that t e canymg cost of its 30n interest in the South Texas project is approximately $15 milhon per month Comueraal operation of Umt No. 2 of the South Texas project is scheduled to commence in June 1989. Nuclev Insurance, HL&P and the other owners of the South Texas project have obtained all nuclear property and nudear habdity insurance required to date, and additionalinsurance coverage will be purchased when the full power hcense for Unit No.1 is obtained in aJdition HL&P is evaluating msurance coverage for in:remental replacement powcr costs resulting from certain possible outages at the South Texas project. However, there can be no assurance that all potentiallosses or liabihties wdl be msurab!e or that the amount of insurance camed will be sufficient to cover all potentiallosses and habihties. Any substantial losses not covered by insurance could have a matenal adverse effect on the financial condition of HL&P and the Company. The owners of the South Texas project curnntly maintain property damace insurance in the amount of $1.23 bilhon through Amen:an Nuclear Insurers (AND anJ Nuclear Electr: Insurance Limited (NFJL) and are planmng to purchase an additional $165 milhon in hmits from NEll a ben the full pow er hcense for Unit No.1 n obtained. The ow ners are ako considenng the purchase of an additional $130 mi:Eun in hmas w'uc!. has recently become avadable from ANI. He NEIL excess proptny damage msurance must be used to cover decontammation and dean up expenses before being used to cover arect losses to property Although there can be no esurance as to the maumum amount of property insurance as adab!e from time to time,it is anticipated that property insurance coverage will be maintamed for the South Texas project m such amounts as are customary in the industry f or similar nudear generatma plants As a member msured of NJJL, HL&P wdi become sub;cct to annual assessments, which could amount to approximatdy $9 mdhon for the project, m the event that lones as a resu!t of an accident at a nudcar p! ant of any NEIL insund company exceed the ucumulated funds avadable to the msurer. HL&P anJ the other owners of the South Texas pro;ect have entered mta an arranaement such that the total aim of insurance for the South Texas project tindudmg p:emiums and awerments) are to be shared pro rata based upon the owners' respectn e ownership mterests m the project UnJer this arragement, HI & P would ultimately bear that porton of total prope1y damage msarance costs, mdud.ng any averms nt b3 NEIL, attnbutabic to its ownership mterest (currendy 30m s Effective in October 1987, the NRC amended its regulations to require nuclear power plant licensees to obtain property insurance coverage in the minimum amount of $1.06 billion. These regulations further provide that the proceeds of this insurance shall be used to first ensure that the licensed reactor is in a safe and stab!e cond: tion. nd can be maintained in that condition so as to prevent any significant risk to the public health or safety. Any property insurance proceeds not already expended to place the reactorin a safe and stable condition must be used first to complete decontamination operations that may be ordered by the NRC. He owners of the South Texas project are insured against liability claims that may result from a nuclear incident to the full amount to which such claims are limited under the Pnce-Andenon Act (which is $720 million as of January 18,1 M). In January 1987, H11P and the other owners of the South Texas project executed with the NRC an mdemnification agreement under the provisions of the Price-Anderson Act. His hmitation on habihty will increase by 55 mdlion for each additional operating license issued by the NRC. Bis insurance is provided through a combination of private insurance and a mandatory industry wide program of selbirsurance under which beensees may be assessed in the event of a nuclear incident involving any beensed f a dity in the Umted States up to $5 million per incident for each of its licemed reactors and up to a manmum per reactor owned of $10 mi!! ion in any calendar year. HL&P and each of the other owners are subject to such assessments, which HL&P and such owners have agreed will be bome on the basis of their respecove ownership interests in the project For purposes of such assessment, the South Texas project currently has one licensed reactor. When fuelloacing begins at Umt No. 2, which is expected in December 1958, the South Texas project wij have two licensed reactors. Various proposals have been made to amend the Pnce-Andenen Act including amendments which would increase the bmit on liabi!!ty. If enacted, such amendments could result in an increase in assessments or other charges to fund the resuhing increased coverage. HL&P is unable to predict what action Congress might take regardmg the Price-Andenon Act or what effect such actions might have on HL&P.

11. Modified in January 1987, HL&P announced that the whedule for the construction of two 645 megawatt hgnite Schedule for umts at the proposed Malakoff Electnc Generating Statmn in Hendenon County, Texaqthe Malakoff Malakoff Project project) had been modifmd. The scheJu!cd in-service dates, w hich are the dates the units are expected to be avadable to meet peak demani are now 1997 for Unit No.1 and 1999 for Uni: No. 2. He modified schedule resuhed from lowered projections of future demand for electricity in the Houston area. As a result of the modified schedule, all developmental work on the two lignite units has stopped, but HL&P wdl resume actnity w hen necessary to meet load growth regmremems. HL&P's total investment in the Malakoff project, through December 31,19S7,is $154 milhon including AFUDC and land. This amount is induded in Plant He:d for Future Use and the accrual of AFUDC has been suspended untd such time as comtmetion resumes. HL&P has agreed to indemnify Unhty Fuels for all necessary and actual costs incurred due to the modificahon of the schedule. Utdity Fuels has invested $121 million in lignite reserves and handhng systems relating to the Malakoff project through December 31,1957 and suspended capitalization of interest ef fecta e December 31,19S6. For the 198S-1990 period. Utility Fuels anticipates $22 million of expend:tures relating to the Malakoff project which are primanly associated with kaping hgmte leases and other related agreements in effect.

12. Unrecovered ne Unhty Commivdon has allowed recovery of certain costs over a p(nod of time by amortizing those Costs cuts for rate making purposet Howes er, unrecovered amounts have not been mduded in rate base and, as a resuh, no rt turn on im estm(nt is bemg camed dunng the recovery period. He amounts of such assets and the remaining recovery perioJ appheable to each are htted below; t memered Aount Remainmg Recovery Period (thouunJs of Dollars) a thenkt 31.190 at Dnember 31,1987 Allens Crtek Pn ject W. I N 60 months Othe r U3 11 106 months e

13, Federal ]he current and deferred components of tax expenses are as followsg IncomeTaxes - ---Year Ended December 31, (Ihousands of Dollars) 1987 1986 1935 Current: U. S. $ 93,607 $ 23,337 $ 52,259 Foreign 4,703 2,781 2,572 Deferred: Liberalizeddepreciation 79,894 88,441 85,472 Applicsble to AFUDC 40,263 50,310 47,842 Investment tax credit-net (3,472) 28,174 51,495 Oil and gas 695 (6,460) (17,440) Other-net 2,652 29,268 17,989 Federalincome taxes $218,342 $215,901 $240,189 Effective federal income tax rates are lower than statutory corporate rates for each year as follows: -. _ Year Ended December 31, (Thousandsof Dollars) 1987 1986 1935 Income before federalincome taxe, $653,300 $640,836 $674,315 Preferred dnidends of subsidiary... 26,817 26,602 31,406 Total 684,706 667,653 700,917 Statutory rate 40 % 46% 46 % Federalincome taxes at statutory corporate rate 322,422 273,882 307,120 Reduction in taxes resultm; from: AFUDC-otherincluded in income 57,434 78,360 70,953 Other-net 12.859 11.280 (1,S94). Total 55,540 91,219 82,233 Federalincome taxes $218,342 $215,901 $240,189 - ~. Effective rate 31,9 % 32.3 % 34.3 %

14. Supplemen-Tares, o'her than federal income taxes, were charged to expense as follow s:

tary Expense ~ ~ ~ ~ ear Ended Dcccmber 31, Information (Thousands of Dollars) 19S7 1986 1985 l l Eccinc: Ad valorem $ 76,6S6 $ 73,366 $ 62,806 State gross receipts 35,177 31,630 38,349 Payrull 15,222 18,788 17,712 PUC assessment 4,758 4,709 5,717 Miscellaneous 19,S24 18,298 15.601 Total 151,667 146,791 140,185 Taxes included in cost of f cel sold 5,936 4,743 3,193 Taxes induded in od and gas expense 5,475 7,067 S924 Total $163,078 $158,601 5152,302 Fesearch and development costs charged to expense $ 16.141 $ 14,462 $ 14.03S 15 Cable KBLCOM ow ns a SON, intcrest in Paragon Commumcations (Pargont a partnership that owm cable Television Joint television sy stems whxh. as of December 31,19S7 served approximately 651.000 basic cable customer' Venture and approximately 469h00 premium programmmg cucomert The remainng mterest in the partner < hip is owned by Amencan Television and Communications Corporatmn ( ATCh a subs:du y of Time, Inc. es In June 1937, Paragon entered into a $ 130 million revohing credit and letter of credit faality agreement with a group of banks. Borrowings under the agreement are non recourse to the Company and to ATC. ne initial borrowings under the faality were used to provide pennanent financing for the acquisition of cable television properties fonnerly owned by Group W Cable, Inc. The Company records its investment in Paragon utilizing the equity method of accounting. KBLCOM experienced after. tax losses of $10.6 million and $6.5 million during 1937 and 1986, espectively.

16. Subsequent In January 1988,if L&P so!d $400 million aggregate principal amount of 9K% first mortgage bonds Events which will mature in approximately equal principal amounts in each of the years 1991,1992 and 1993.

In January 1988, HL&P deposited $52 million with the bond trustee to redeem all of the outstandmg bonds of the 13%% series at 100% of the pnncipal amount and to pay accmed interest.The bonds were redeemed pursuant to the general redemption provisions of HIlP's Mortgage and Deed of Trust. 17.Unaudited The following unaudited quarterly financial information includes,in the opinion of management, all Quarterly adjustments (w hich comprise only nonnal recuning accruals) necessary for a fair presentation. Quarterly Information results are not necessanly indicative of expectations for a full year's operations because of seasonal and other factors, induding rate increases and variations in operating expense patterns. Operating Net Eamings rer @mands of DoppsL _ _ _ Revenues Income Income Common Share Marcli 31,1986 $ 795,752 $129,627 $ 72,717 5.67 June 30,1986 860,429 135,437 78,151 .70 September 30,1956 1,101,220 326,245 184,845 1 65 Dece nber 31,1986 778,567 135,272 89,222 .79 March 31,1987 777,250 106,533 57,775 .50 June 30,1987 899,016 171,136 99,690 .86 SeptemLcr 30,1987 1,135,650 327,527 203,676 1.75 816,267 132.272 73,817 .63 December 31,1987_ _... _ _ _ ____ _

18. Reclassification Certain amounts from the previous years have been redassified to confonn to the 1987 presentation of financial statements. Such reclassifications do not affect eamings.

AUDITORS' OPINION Houston Industries Incorporated: We have examined the consolidated balance sheets and the statements of cubsidunes' preferred stock and long-term debt of Houston Industries incor-grated and subsidiaries as of December 31,1987 and 1986 and the related statements of consolidated income, conso!idated retained camings and changes in consolidated finanaal position for each of the three years in the period ended December 31,19S7. Our examinations w ere made in accerdance with generally accepted auditing standards and accordingly, included such tests of the accounting records and such other auditing procedures as we constdered necessary in the circumstances. In our opinion, the accompanying consolidated finanaal statements present fairly the fmannal position of the Company and its subsidiaries at December 31,1987 and 1986 and the results of their operations and the changes m their financial position for each of the three years in the period ended December 31,1987,in confoamty with generally accepted accounting pnnciples applied on a consistent basis. DELOITTE HASKINS & SELLS Houston, Texas Man.h 3,198S

4

o

HOUSTON INDUSTRIES INCORPORATED Officers Marc Kilbride Hollis R. Dean.

Thomas B. McDade 35, Assutant Secretary and 62, Executive Vke President 64, Consultant to Tens . Don D.' Jordan Asmtant Trmurer and Chief neanaalomcer Commerce Bancshares, 55, Presidera and Chief ef theCompany,llaston, liouston, Texas,6 rector Executive Offtcer Kevin P. Loughnane Texa arector since 19n. sixe 19so..

c 31, Assictant Treasurer liollis R. Dean Joseph M. Hendrie, Ph.D

1. A.Naman 62.Executae %ce

- Rufus S. Scott

63. Consulting Engineer, 70 Ch.urman of the Board Presi&nt and Chief 44, Assistant Corporate Bdiport, New York,,

of LA.Naman + Assocates, Fmaxul0ffket Secretary & rector sace 1985. lac. lbton,Teut, 6 rector smce 1933. Wilham A. Cropper Robert E. Smith Howard W. Horne 48, %ce President and 43, Assistant Corpora:e 61, Chairman of the Board Kenneth L Schnitzer, Sr. Treasurer Scaetary of ne llorne Company, SS, Chairman of the Board flouston, Teus,6 rector of Century Developrnect Robert B. Dyer Directors suee 1978. Corp., stomtm,Tezw 51,%ce Presdent director since 1983. CorporateDe ek,pment Charles E. Bishop, Ph.D Don D. Jordan - 66 President Emeritus of 55, Presdent and Chief Don D.Sykora Hugh Rice Kelly University of flouston System, Executiveof6cerof the 57,%ce Presdent of the 45, %ce President, llouston, Tens,6tector Cornpuy, flouston,Tetw Company, FWton,Teus, Ger.eral Coed and smce 19S3. 6tector since 1974. & rector s:xe 1932. l-Corporate Secretary Searcy Bracewell James R. Lesch Jack T, Trotter David M.McClanahan 70, Adytsory Director of 66 RetiredChamasof 61, Cha.rman of Ent intentate Bek 38,Yke Pres &nt Sheanon Izhrnan i!atton, the Board of Hughes Tool of Teus,liou< ton, Texas, I and Cornptrdler Inc., lloustc.n. Tens, Company,llouston, Teus, dzector snee 1985. 6 rector smce 1977, director since 1982. g g ,g 57, Vke Presani John T. Cater 70, engaged ir axbeg and - Gretchen H. Denurn 52, Presdent and Chki penonal mvestmects, Rxhmond, operatmg offwer, MCorp. Teus,1 rector smce 1979. 33, Awtant Corporate liouston, Tem, erector Secretary ,;ce,3933, i HOUSTON LIGHTING & POWER COMPANY j j Officers Ray J. Snokhous Ross E. Doan Dr;id G. Tees 58, Group Yke Presider.t 58, %ce P,esideet 43, Wre Presdent Don D. Jordan External Affa;n IMan and 1-formabon Ezergy Product:oo 55.Chainnan and Chkf Resu>mes Fututne offavr Edward A.Thrner Gerald E. Vaughn 60, Group %ce President Jack D. Greenwade 45.%ce President Don D. Sykora Administn*aon ed Sapport 43, Uce President Nadear Operatxes 57, Presdent and Chel system Operat; ens o ratmgotticer Allen R. Beavers Ken W.Nabors n 64, %ce Presdent Lawrente B. Horrigan, Jr. 44, Treasurer Jerome H. Goldberg Pnmect Corau! tant 53, Yve Prnoeni 57, Group Vre Preudent Purchaung ant Matensis Rufus S. Sectt Nadear L G. Brackeen gegement 44, Awcate Genent 54, %ce President Counseland Avtant Hugh Rice Kelly Fad fed Rw urces R. Steve LetMter Corponte secteury a 45, Serwr %;e President. 39, %ce Presdent Genaal Counel ar.d James S. Enan Regu'2 tory eiatms Gretchen H. Denum Corporate Secretary 40,%ce Presdent g

33. Asmtar.1 Corporate Emance and Comptrotkr Ancel D. Maddox s&retay D. E. S,mnons 47, vec Presdent i

63. Group Vre President Cestomer Rchtens I. rank C. Gemar Power Operaws 50 Assicant Secretary and Ass %nt Treasurer M

o PRIMARY FUELS,INC. 3 Officers ? Don D. Jordan Duane C. Radtke Frank L. Cascio, Jr. Kenneth W. Harbin [ ss,ch.ero 3% Gruup N rreuJ<r.t 49, Vxe PrecJent Lx.d

49. Vxt PreuJent i

Rrth Amenia r.d Corporre Secretary hbd:ad D stnct ? IM E. St. John t, ss, n es.a ct James N. Ahup Kenneth R. Stout Ruth W. Simms i

41. 6 Prntaent F.naxe, 63, vice Prevat et

31. Comr'ra;ict Itwu er and Anwart hae runenal i

Secreary [ t LJTILITY FUELS,INC. j= Officers Don D. JorJan Ho!!is R. Dean Lawrence J. Rogers Ronald D. Baalman 55, ch rm n e, h e hoacr.' 41, Vxe Pro:Jent 33, Comptreer F. Ken Smith Charles L Merka s i,1 :. sa d so.v.cePnsJcm John J. Bartell opranun

50. wrtwy ard Trume r INNOVATIVE KBLCOM llOUSTON INDUSTRIES DEVELOPMENT I

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