ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA OF THE COMPANY.

                                                                YEAR ENDED DECEMBER 31,
                                                         --------------------------------------
                                                            1997          1996          1995
                                                         ----------    ----------    ----------
Revenues:
  Electric Operations..................................  $4,251,243    $4,025,027    $3,680,297
  Natural Gas Distribution.............................     892,569
  Interstate Pipeline..................................     108,333
  Energy Marketing.....................................   1,604,999
  International........................................      92,028        62,059        46,789
  Other................................................      47,851         8,191         2,185
  Eliminations.........................................    (123,638)
                                                         ----------    ----------    ----------
          Total........................................   6,873,385     4,095,277     3,729,271
                                                         ----------    ----------    ----------
Expenses:
  Electric and natural gas utilities:
     Fuel and cost of gas sold.........................   2,819,512     1,024,945       879,148
     Purchased power...................................     698,823       322,263       233,494
     Operation and maintenance.........................   1,205,993       888,699       866,170
     Taxes other than income taxes.....................     296,668       246,288       245,890
  Depreciation and amortization........................     651,875       550,038       478,034
  Other operating expenses.............................     136,014        72,578       121,085
                                                         ----------    ----------    ----------
          Total........................................   5,808,885     3,104,811     2,823,821
                                                         ----------    ----------    ----------
Operating Income.......................................   1,064,500       990,466       905,450
                                                         ----------    ----------    ----------
Other Income (Expense):
  Unrealized loss on ACES..............................    (121,402)
  Litigation settlements...............................                   (95,000)
  Time Warner dividend income..........................      41,340        41,610        20,132
  Interest income......................................       6,636         6,246         9,774
  Interest income -- IRS refund........................      56,269
  Other -- net.........................................       3,711        (8,268)      (12,061)
                                                         ----------    ----------    ----------
          Total........................................     (13,446)      (55,412)       17,845
                                                         ----------    ----------    ----------
Interest and Other Charges:
  Interest on long-term debt...........................     320,845       276,242       279,491
  Other interest.......................................      77,112        33,738        21,586
  Distribution on trust securities.....................      26,230
  Allowance for borrowed funds used during
     construction......................................      (2,872)       (2,598)       (4,692)
  Preferred dividends of subsidiary....................       2,255        22,563        29,955
                                                         ----------    ----------    ----------
          Total........................................     423,570       329,945       326,340
                                                         ----------    ----------    ----------
Income from Continuing Operations Before Income
  Taxes................................................     627,484       605,109       596,955
Income Taxes...........................................     206,374       200,165       199,555
                                                         ----------    ----------    ----------
Income from Continuing Operations......................     421,110       404,944       397,400
Discontinued Operations (Net of Income Taxes):
  Gain on sale of cable television subsidiary..........                                 708,124
Preferred Dividends....................................         162
                                                         ----------    ----------    ----------
Net Income.............................................  $  420,948    $  404,944    $1,105,524
                                                         ==========    ==========    ==========

(continued on next page)

                                                                YEAR ENDED DECEMBER 31,
                                                         --------------------------------------
                                                            1997          1996          1995
                                                         ----------    ----------    ----------
Basic Earnings Per Common Share:
  Continuing Operations................................  $     1.66    $     1.66    $     1.60
  Discontinued Operations:
     Gain on sale of cable television subsidiary.......                                    2.86
                                                         ----------    ----------    ----------
Basic Earnings Per Common Share........................  $     1.66    $     1.66    $     4.46
                                                         ==========    ==========    ==========
Diluted Earnings Per Common Share:
  Continuing Operations................................  $     1.66    $     1.66    $     1.60
  Discontinued Operations:
     Gain on sale of cable television subsidiary.......                                    2.86
                                                         ----------    ----------    ----------
Diluted Earnings Per Common Share......................  $     1.66    $     1.66    $     4.46
                                                         ==========    ==========    ==========

See Notes to the Company's Consolidated Financial Statements.

                                                                   YEAR ENDED DECEMBER 31,
                                                             ------------------------------------
                                                                1997         1996         1995
                                                             ----------   ----------   ----------
Balance at Beginning of Year...............................  $1,997,490   $1,953,672   $1,221,221
Add -- Net Income..........................................     420,948      404,944    1,105,524
                                                             ----------   ----------   ----------
          Total............................................   2,418,438    2,358,616    2,326,745
Common Stock Dividends:
     1997, $1.50; 1996, $1.50; 1995, $1.50 (per share).....    (405,383)    (361,126)    (371,760)
Stock Dividend Distribution................................                                (1,313)
                                                             ----------   ----------   ----------
Balance at End of Year.....................................  $2,013,055   $1,997,490   $1,953,672
                                                             ==========   ==========   ==========

See Notes to the Company's Consolidated Financial Statements.

                                                                     DECEMBER 31,
                                                              --------------------------
                                                                 1997           1996
                                                              -----------    -----------
Property, Plant and Equipment -- At Cost:
  Electric plant:
     Plant in service.......................................  $12,614,000    $12,387,375
     Construction work in progress..........................      224,959        251,497
     Nuclear fuel...........................................      255,567        241,001
     Plant held for future use..............................       48,631         48,631
  Gas plant and pipelines:
     Natural gas distribution...............................    1,326,442
     Interstate pipelines...................................    1,258,087
     Energy marketing.......................................      162,519
  Other property............................................      149,019         86,969
                                                              -----------    -----------
          Total.............................................   16,039,224     13,015,473
  Less accumulated depreciation and amortization............    4,770,179      4,259,050
                                                              -----------    -----------
          Property, plant and equipment -- net..............   11,269,045      8,756,423
                                                              -----------    -----------
Current Assets:
  Cash and cash equivalents.................................       51,712          8,001
  Accounts receivable -- net................................      962,974         36,277
  Accrued unbilled revenues.................................      205,860         77,853
  Time Warner dividends receivable..........................       10,313         10,313
  Fuel stock and petroleum products.........................       88,819         61,795
  Materials and supplies, at average cost...................      156,160        130,380
  Prepayments and other current assets......................       42,169         19,301
                                                              -----------    -----------
          Total current assets..............................    1,518,007        343,920
                                                              -----------    -----------
Other Assets:
  Goodwill -- net...........................................    2,026,395
  Investment in Time Warner securities......................      990,000      1,027,500
  Deferred plant costs -- net...............................      561,569        587,352
  Fuel-related debits.......................................      197,304         84,435
  Deferred debits...........................................      510,686        306,473
  Unamortized debt expense and premium on reacquired debt...      202,453        153,823
  Regulatory tax asset -- net...............................      356,509        362,310
  Recoverable project costs -- net..........................       78,485        163,630
  Equity investments in foreign and non-rate regulated
     affiliates -- net......................................      704,102        501,991
                                                              -----------    -----------
          Total other assets................................    5,627,503      3,187,514
                                                              -----------    -----------
            Total...........................................  $18,414,555    $12,287,857
                                                              ===========    ===========

See Notes to the Company's Consolidated Financial Statements.

                                                                     DECEMBER 31,
                                                              --------------------------
                                                                 1997           1996
                                                              -----------    -----------
Capitalization (statements on following pages):
  Common stock equity.......................................  $ 4,886,805    $ 3,827,961
  Preference stock, none outstanding........................
  Cumulative preferred stock, not subject to mandatory
     redemption.............................................        9,740        135,179
  Company/NorAm obligated mandatorily redeemable preferred
     securities of subsidiary trusts holding solely junior
     subordinated debentures of Company/NorAm...............      362,172
  Long-term debt............................................    5,218,015      3,025,650
                                                              -----------    -----------
          Total capitalization..............................   10,476,732      6,988,790
                                                              -----------    -----------
Current Liabilities:
  Notes payable.............................................    2,124,956      1,337,872
  Accounts payable..........................................      879,612        157,682
  Taxes accrued.............................................      240,739        191,011
  Interest accrued..........................................      109,901         67,707
  Dividends declared........................................      110,716         92,515
  Customer deposits.........................................       82,437         53,633
  Current portion of long-term debt and preferred stock.....      251,169        254,463
  Other.....................................................      193,384         89,238
                                                              -----------    -----------
          Total current liabilities.........................    3,992,914      2,244,121
                                                              -----------    -----------
Deferred Credits:
  Accumulated deferred income taxes.........................    2,792,781      2,265,031
  Benefit liabilities.......................................      397,586        249,875
  Unamortized investment tax credit.........................      349,072        373,749
  Fuel-related credits......................................       75,956         74,639
  Other.....................................................      329,514         91,652
                                                              -----------    -----------
          Total deferred credits............................    3,944,909      3,054,946
                                                              -----------    -----------
Commitments and Contingencies (Note 12)
              Total.........................................  $18,414,555    $12,287,857
                                                              ===========    ===========

See Notes to the Company's Consolidated Financial Statements

                                                                    DECEMBER 31,
                                                              -------------------------
                                                                 1997           1996
                                                              -----------    ----------
Common Stock Equity:
  Common stock, no par; authorized, 700,000,000 shares;
     issued, 295,357,276 and 262,748,447 shares at December
     31, 1997 and 1996, respectively........................  $ 3,112,098    $2,447,117
  Foreign currency translation loss.........................         (821)         (363)
  Treasury stock, at cost; 93,459 and 16,042,027 shares at
     December 31, 1997 and 1996, respectively...............       (2,066)     (361,196)
  Unearned ESOP shares, 12,388,551 and 13,370,939 shares at
     December 31, 1997 and 1996, respectively...............     (229,827)     (251,350)
  Retained earnings.........................................    2,013,055     1,997,490
  Unrealized loss on marketable equity securities...........       (5,634)       (3,737)
                                                              -----------    ----------
          Total common stock equity.........................    4,886,805     3,827,961
                                                              -----------    ----------
Preference Stock, no par; authorized, 10,000,000 shares;
  none outstanding..........................................
Cumulative Preferred Stock, no par; authorized, 10,000,000
  shares; outstanding, 97,397 and 1,604,397 shares at
  December 31, 1997 and 1996, respectively (entitled upon
  involuntary liquidation to $100 per share):
  Not subject to mandatory redemption:
     $4.00 series, 97,397 shares............................        9,740         9,740
     $6.72 series, 250,000 shares...........................                     25,115
     $7.52 series, 500,000 shares...........................                     50,226
     $8.12 series, 500,000 shares...........................                     50,098
                                                              -----------    ----------
          Total.............................................        9,740       135,179
                                                              -----------    ----------
  Subject to mandatory redemption:
     $9.375 series, 257,000 shares at December 31, 1996.....                     25,700
     Current redemptions....................................                    (25,700)
                                                              -----------    ----------
          Total.............................................
                                                              -----------    ----------
          Total cumulative preferred stock..................        9,740       135,179
                                                              -----------    ----------
Company/NorAm obligated mandatorily redeemable preferred
  securities of subsidiary trusts holding solely junior
  subordinated debentures of Company/NorAm:
     8.125% Trust Preferred Securities, Series A............      250,000
     8.257% Trust Capital Securities, Series B..............      100,000
     6 1/4% Convertible Trust Originated Preferred
      Securities............................................       21,730
     Unamortized Issuance Costs.............................       (9,558)
                                                              -----------    ----------
          Total Company/NorAm obligated mandatorily
            redeemable preferred securities of subsidiary
            trusts holding solely junior subordinated
            debentures of Company/NorAm-net.................      362,172
                                                              -----------    ----------
Long-Term Debt:
  7% Automatic common exchange securities, due 2000.........    1,173,786
                                                              -----------    ----------

(continued on next page)

                                                                  DECEMBER 31,
                                                            -------------------------
                                                               1997           1996
                                                            -----------    ----------
Debentures:
   9 3/8% series, due 2001................................  $   250,000    $  250,000
   7 7/8% series, due 2002................................      100,000       100,000
   8.9% series, due 2006..................................      165,055
   6% convertible subordinated, due 2012..................      107,180
   10% series, due 2019...................................       47,773
   Unamortized discount...................................         (717)         (902)
                                                            -----------    ----------
        Total debentures..................................      669,291       349,098
                                                            -----------    ----------
First Mortgage Bonds:
   5 1/4% series, due 1997................................                     40,000
   7 5/8% series, due 1997................................                    150,000
   6 3/4% series, due 1997................................                     35,000
   9.15% series, due 2021.................................      102,442       160,000
   8 3/4% series, due 2022................................       62,275        62,275
   7 3/4% series, due 2023................................      250,000       250,000
   7 1/2% series, due 2023................................      200,000       200,000
   4.90% pollution control series, due 2003...............       16,600        16,600
   7% pollution control series, due 2008..................       19,200        19,200
   6 3/8% pollution control series, due 2012..............       33,470        33,470
   6 3/8% pollution control series, due 2012..............       12,100        12,100
   8 1/4% pollution control series, due 2015..............       90,000        90,000
   5.80% pollution control series, due 2015...............       91,945        91,945
   7 3/4% pollution control series, due 2015..............       68,700        68,700
   5.80% pollution control series, due 2015...............       58,905        58,905
   7 7/8% pollution control series, due 2016..............                     68,000
   6.70% pollution control series, due 2017...............       43,820        43,820
   5.60% pollution control series, due 2017...............       83,565        83,565
   7 7/8% pollution control series, due 2018..............                     50,000
   7.20% pollution control series, due 2018...............       75,000        75,000
   7.20% pollution control series, due 2018...............      100,000       100,000
   7 7/8% pollution control series, due 2019..............       29,685        29,685
   7.70% pollution control series, due 2019...............       75,000        75,000
   8 1/4% pollution control series, due 2019..............      100,000       100,000
   8.10% pollution control series, due 2019...............      100,000       100,000
   7 5/8% pollution control series, due 2019..............      100,000       100,000
   7 1/8% pollution control series, due 2019..............      100,000       100,000
   7.60% pollution control series, due 2019...............       70,315        70,315
   6.70% pollution control series, due 2027...............       56,095        56,095
   Medium-term notes, series A, 9.80%-9.85%, due 1999.....      170,500       170,500
   Medium-term notes, series C, 6.10%, due 2000...........      150,000       150,000
   Medium-term notes, series B, 8.15%, due 2002...........      100,000       100,000
   Medium-term notes, series C, 6.50%, due 2003...........      150,000       150,000
   Unamortized discount...................................      (14,158)      (15,134)
                                                            -----------    ----------
        Total first mortgage bonds........................    2,495,459     2,895,041
                                                            -----------    ----------

(continued on next page)

                                                                    DECEMBER 31,
                                                              -------------------------
                                                                 1997           1996
                                                              -----------    ----------
Pollution Control Revenue Bonds:
  Gulf Coast 1980-T series, floating rate, due 1998.........  $     5,000    $    5,000
  1997 pollution control series, variable rate revenue due
     2028...................................................       68,000
  1997 pollution control series, variable rate revenue due
     2018...................................................       50,000
                                                              -----------    ----------
          Total pollution control revenue bonds.............      123,000         5,000
                                                              -----------    ----------
Medium-Term Notes:
  Series A, 9.30%-9.39%, due 1998-2000......................       24,838
  Series B, 8.43%-9.23%, due 1998-2001......................      236,367
                                                              -----------    ----------
          Total medium-term notes...........................      261,205
                                                              -----------    ----------
Capitalized lease obligations, discount rates of 5.2%-11.7%,
  due 1998-2018.............................................       16,166         4,418
Notes payable...............................................      730,277           856
                                                              -----------    ----------
     Subtotal...............................................      746,443         5,274
                                                              -----------    ----------
          Total.............................................    5,469,184     3,254,413
          Current maturities................................     (251,169)     (228,763)
                                                              -----------    ----------
          Total long-term debt..............................    5,218,015     3,025,650
                                                              -----------    ----------
               Total capitalization.........................  $10,476,732    $6,988,790
                                                              ===========    ==========

See Notes to the Company's Consolidated Financial Statements.

                                                                 YEAR ENDED DECEMBER 31,
                                                           -----------------------------------
                                                              1997         1996        1995
                                                           -----------   ---------   ---------
Cash Flows from Operating Activities:
  Income from continuing operations......................  $   421,110   $ 404,944   $ 397,400
  Adjustments to reconcile income from continuing
     operations to net cash provided by operating
     activities:
     Depreciation and amortization.......................      651,875     550,038     478,034
     Amortization of nuclear fuel........................       28,237      33,875      28,545
     Deferred income taxes...............................       35,523      54,098      78,382
     Investment tax credit...............................      (19,777)    (18,404)    (19,427)
     Unrealized loss on ACES.............................      121,402
     Contribution of marketable equity securities to
       charitable trust..................................       19,463
     Fuel (refund)/surcharge.............................      128,864                (189,571)
     Fuel cost over (under) recovery.....................     (212,683)   (137,362)     76,970
     Net cash provided by discontinued cable television
       operations........................................                               16,391
     Changes in other assets and liabilities, net of the
       effects of the acquisition:
       Accounts receivable -- net........................     (436,580)    (15,478)    (46,299)
       Inventory.........................................       55,111      21,624      13,901
       Other current assets..............................        6,966        (306)    (14,900)
       Accounts payable..................................      191,840      21,674     (23,217)
       Interest and taxes accrued........................       18,425       4,413      11,088
       Other current liabilities.........................        2,985      (4,135)     (9,215)
       Other -- net......................................       97,998        (661)     46,813
                                                           -----------   ---------   ---------
          Net cash provided by operating activities......    1,110,759     914,320     844,895
                                                           -----------   ---------   ---------
Cash Flows from Investing Activities:
  Capital expenditures (including allowance for borrowed
     funds used during construction).....................     (328,724)   (317,532)   (301,327)
  Purchase of NorAm net of cash acquired.................   (1,422,672)
  Non-rate regulated electric power project expenditures
     (including capitalized interest)....................     (234,852)   (495,379)    (49,835)
  Settlement of subsidiary debt in connection with sale
     of cable television subsidiary......................                              619,345
  Sale of investment in Time Warner common stock.........       25,043
  Corporate headquarters expenditures (including
     capitalized interest)...............................                   (6,543)    (96,469)
  Net cash used in discontinued cable television
     operations..........................................                              (47,601)
  Other -- net...........................................      (20,248)    (13,446)     (4,643)
                                                           -----------   ---------   ---------
          Net cash provided by (used in) investing
            activities...................................   (1,981,453)   (832,900)    119,470
                                                           -----------   ---------   ---------

(continued on next page)

                                                                 YEAR ENDED DECEMBER 31,
                                                           -----------------------------------
                                                              1997         1996        1995
                                                           -----------   ---------   ---------
Cash Flows from Financing Activities:
  Proceeds from sale of ACES -- net......................  $ 1,020,777
  Proceeds from sale of Company obligated mandatorily
     redeemable preferred securities of subsidiary trusts
     holding solely junior subordinated debentures of
     Company -- net......................................      340,785
  Purchase of treasury stock.............................                $(361,196)
  Proceeds from issuance of pollution control bonds......      115,739
  Proceeds from first mortgage bonds.....................                            $ 142,972
  Payment of matured debt................................     (277,000)   (150,000)
  Payment of common stock dividends......................     (405,288)   (361,126)   (371,731)
  Redemption of preferred stock..........................     (153,628)   (271,400)    (91,400)
  Increase (decrease) in notes payable-net...............      587,791   1,331,572    (416,991)
  Extinguishment of long-term debt.......................     (303,893)   (285,263)   (195,224)
  Redemption of convertible securities...................       (9,504)
  Net cash used in discontinued cable television
     operations..........................................                              (40,798)
  Other -- net...........................................       (1,374)     12,215      10,143
                                                           -----------   ---------   ---------
          Net cash provided by (used in) financing
            activities...................................      914,405     (85,198)   (963,029)
                                                           -----------   ---------   ---------
Net Increase (Decrease) in Cash and Cash Equivalents.....       43,711      (3,778)      1,336
Cash and Cash Equivalents at Beginning of Year...........        8,001      11,779      10,443
                                                           -----------   ---------   ---------
Cash and Cash Equivalents at End of Year.................  $    51,712   $   8,001   $  11,779
                                                           ===========   =========   =========
Supplemental Disclosure of Cash Flow Information:
Cash Payments:
  Interest (net of amounts capitalized)..................  $   437,952   $ 311,792   $ 342,551
  Income taxes...........................................      171,539     139,898     104,228

The aggregate consideration paid to Former NorAm stockholders in connection with the Merger consisted of $1.4 billion in cash and 47.8 million shares of the Company's common stock valued at approximately $1.0 billion. The overall transaction was valued at $4.0 billion consisting of $2.4 billion for Former NorAm's common stock and common stock equivalents and $1.6 billion of Former NorAm debt.

See Notes to the Company's Consolidated Financial Statements.

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

                                                       YEAR ENDED DECEMBER 31,
                                          --------------------------------------------------
                                                   1997                       1996
                                          -----------------------    -----------------------
                                             AS                         AS
                                          REPORTED     PRO FORMA     REPORTED     PRO FORMA
                                          --------    -----------    --------    -----------
                                                      (UNAUDITED)                (UNAUDITED)
Revenues................................   $6,873       $10,210       $4,095       $8,884
Net Income Available for Common Stock...   $  421       $   439       $  405       $  432
Basic Earnings Per Share................   $ 1.66       $  1.56       $ 1.66       $ 1.48
Diluted Earnings Per Share..............   $ 1.66       $  1.56       $ 1.66       $ 1.48

                                                           ELECTRIC               TOTAL
                                                          OPERATIONS    OTHER    COMPANY
                                                          ----------    -----    -------
                                                              (MILLIONS OF DOLLARS)
Deferred plant costs -- net.............................    $  562               $  562
Recoverable project costs -- net........................        78                   78
Regulatory tax asset -- net.............................       357                  357
Unamortized loss on reacquired debt.....................       127                  127
Deferred debits.........................................        71       $48        119
Accumulated deferred income taxes -- regulatory tax
  asset.................................................       (99)                 (99)
                                                            ------       ---     ------
          Total.........................................    $1,096       $48     $1,144
                                                            ======       ===     ======

                                                                       FOR THE YEAR ENDED
                                                            ----------------------------------------
                                                               1997          1996           1995
                                                            ----------    ----------    ------------
                                                            (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Basic EPS Calculation:
  Income from continuing operations......................    $421,110      $404,944      $  397,400
  Gain on sale of cable television subsidiary............                                   708,124
  Less: Preferred dividends..............................         162
                                                             --------      --------      ----------
  Net income available for common stock..................    $420,948      $404,944      $1,105,524
                                                             ========      ========      ==========
  Weighted average shares outstanding....................     253,599       244,443         247,706
Basic EPS:
  Income from continuing operations......................    $   1.66      $   1.66      $     1.60
  Gain on sale of cable television subsidiary............                                      2.86
  Less: Preferred dividends..............................         .00
                                                             --------      --------      ----------
  Net income available for common stock..................    $   1.66      $   1.66      $     4.46
                                                             ========      ========      ==========
Diluted EPS Calculation:
  Income from continuing operations......................    $421,110      $404,944      $  397,400
  Plus: Income impact of assumed conversions
     Interest on 6 1/4% convertible debentures...........         668
                                                             --------      --------      ----------
  Income from continuing operations assuming dilution....     421,778       404,944         397,400
  Gain on sale of cable television subsidiary............                                   708,124
  Less: Preferred dividends..............................         162
                                                             --------      --------      ----------
  Net income available for common stock assuming
     dilution............................................    $421,616      $404,944      $1,105,524
                                                             ========      ========      ==========
  Weighted average shares outstanding....................     253,599       244,443         247,706
  Plus: Incremental shares from assumed conversions:
     Stock options.......................................          89            33              21
     6 1/4% convertible debentures.......................         510
                                                             --------      --------      ----------
  Weighted average shares assuming dilution..............     254,198       244,476         247,727
                                                             ========      ========      ==========
Diluted EPS:
  Income from continuing operations......................    $   1.66      $   1.66      $     1.60
  Gain on sale of cable television subsidiary............                                      2.86
  Less: Preferred dividends..............................         .00
                                                             --------      --------      ----------
  Net income available for common stock..................    $   1.66      $   1.66      $     4.46
                                                             ========      ========      ==========

                                                                  VOLUME-FIXED
                                                   VOLUME-FIXED      PRICE         MAXIMUM
                                                   PRICE PAYOR      RECEIVER     TERM (YEARS)
                                                   ------------   ------------   ------------
Natural gas......................................     85,701         64,890           4
Electricity......................................     40,511         42,976           1

In addition to the fixed-price notional volumes above, NES also has variable-price swap agreements, as discussed above, totaling 101,465 Bbtue. Notional amounts reflect the volume of transactions but do not represent the amounts exchanged by the parties to the financial instruments. Accordingly, notional amounts do not accurately measure the Company's exposure to market or credit risks.

The estimated fair value of derivative financial instruments held for trading purposes at December 31, 1997 are presented below (dollars in millions):

                                                                              AVERAGE FAIR
                                                      FAIR VALUE                VALUE(A)
                                                 ---------------------    ---------------------
                                                 ASSETS    LIABILITIES    ASSETS    LIABILITIES
                                                 ------    -----------    ------    -----------
Natural gas..................................     $46          $39         $56          $48
Electricity..................................     $ 6          $ 6         $ 3          $ 2

(a) Computed using the ending balance of each month.

Substantially all of the fair value shown in the table above at December 31, 1997 has been recognized in income. The fair value as of and for the year ended December 31, 1997 was estimated using quoted prices where available and considering the liquidity of the market for the derivative financial instruments. The prices are subject to significant changes based on changing market conditions. The derivative financial instruments included in the NES trading portfolio as of and for the year ended December 31, 1996 were immaterial.

The weighted-average term of the trading portfolio, based on volumes, is less than one year. The maximum and average terms disclosed herein are not indicative of likely future cash flows as these positions may be changed by new transactions in the trading portfolio at any time in response to changing market conditions, market liquidity and the Company's risk management portfolio needs and strategies. Terms regarding cash settlements of these contracts vary with respect to the actual timing of cash receipts and payments.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(b) Non-Trading Activities.

To reduce the risk from market fluctuations in the price of electric power, natural gas and related transportation, NorAm and certain of its subsidiaries enter into futures transactions, swaps and options (Energy Derivatives) in order to hedge certain natural gas in storage, as well as certain expected purchases, sales and transportation of natural gas and electric power (a portion of which are firm commitments at the inception of the hedge). Energy Derivatives are also utilized to fix the price of compressor fuel or other future operational gas requirements, although usage to date for this purpose has not been material. Usage of electricity derivative financial instruments by the Company and its subsidiaries for purposes other than trading is immaterial.

Certain subsidiaries of the Company also utilize interest-rate derivatives (principally interest-rate swaps) in order to adjust the portion of its overall borrowings which are subject to interest-rate risk, and also utilize such derivatives to effectively fix the interest rate on debt expected to be issued for refunding purposes.

For transactions involving either Energy Derivatives or interest-rate derivatives, hedge accounting is applied only if the derivative (i) reduces the price risk of the underlying hedged item and (ii) is designated as a hedge at its inception. Additionally, the derivatives must be expected to result in financial impacts which are inversely correlated to those of the item(s) to be hedged. This correlation (a measure of hedge effectiveness) is measured both at the inception of the hedge and on an ongoing basis, with an acceptable level of a correlation of at least 80% for hedge designation. If and when correlation ceases to exist at an acceptable level, hedge accounting ceases and mark-to-market accounting is applied.

In the case of interest-rate swaps associated with existing obligations, cash flows and expenses associated with the interest-rate derivative transactions are matched with the cash flows and interest expense of the obligation being hedged, resulting in an adjustment to the effective interest rate. When interest rate swaps are utilized to effectively fix the interest rate for an anticipated debt issuance, changes in the market value of the interest-rate derivatives are deferred and recognized as an adjustment to the effective interest rate on the newly issued debt.

Unrealized changes in the market value of Energy Derivatives utilized as hedges are not generally recognized in the Company's Consolidated Statements of Income until the underlying hedged transaction occurs. Once it becomes probable that an anticipated transaction will not occur, deferred gains and losses are recognized. In general, the financial impact of transactions involving these Energy Derivatives is included in the Company's Statement of Consolidated Income under the captions (i) fuel expenses, in the case of natural gas transactions, and (ii) purchased power, in the case of electric power transactions. Cash flows resulting from these transactions in Energy Derivatives are included in the Company's Statements of Consolidated Cash Flows in the same category as the item being hedged.

At December 31, 1997, subsidiaries of NorAm were fixed-price payors and fixed-price receivers in Energy Derivatives covering 38,754 Bbtu and 7,647 Bbtu of natural gas, respectively. Also, at December 31, 1997 subsidiaries of NorAm were parties to variable-priced Energy Derivatives totaling 3,630 Bbtu of natural gas. The weighted average maturity of these instruments is less than one year.

The notional amount is intended to be indicative of the Company and its subsidiaries' level of activity in such derivatives, although the amounts at risk are significantly smaller because, in view of the price movement correlation required for hedge accounting, changes in the market value of these derivatives generally are offset by changes in the value associated with the underlying physical transactions or in other derivatives. When Energy Derivatives are closed out in advance of the underlying commitment or anticipated transaction, however, the market value changes may not offset due to the fact that price movement correlation ceases to exist when the positions are closed as further discussed below. Under such circumstances, gains (losses) are deferred and recognized as a component of income when the underlying hedged item is recognized in income.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The average maturity discussed above and the fair value discussed in Note 13 are not necessarily indicative of likely future cash flows as these positions may be changed by new transactions in the trading portfolio at any time in response to changing market conditions, market liquidity and the Company's risk management portfolio needs and strategies. Terms regarding cash settlements of these contracts vary with respect to the actual timing of cash receipts and payments.

(c) Trading and Non-trading -- General Policy.

In addition to the risk associated with price movements, credit risk is also inherent in the Company and its subsidiaries' risk management activities. Credit risk relates to the risk of loss resulting from non-performance of contractual obligations by a counterparty. While, as yet, the Company and its subsidiaries have experienced no significant losses due to the credit risk associated with these arrangements, the Company has off-balance sheet risk to the extent that the counterparties to these transactions may fail to perform as required by the terms of each such contract. In order to minimize this risk, the Company and/or its subsidiaries, as the case may be, enter into such contracts primarily with those counterparties with a minimum Standard & Poor's or Moody's rating of BBB- or Baa3, respectively. For long-term arrangements, the Company and its subsidiaries periodically review the financial condition of such firms in addition to monitoring the effectiveness of these financial contracts in achieving the Company's objectives. Should the counterparties to these arrangements fail to perform, the Company would seek to compel performance at law or otherwise, or obtain compensatory damages in lieu thereof. The Company might be forced to acquire alternative hedging arrangements or be required to honor the underlying commitment at then current market prices. In such event, the Company might incur additional loss to the extent of amounts, if any, already paid to the counterparties. In view of its criteria for selecting counterparties, its process for monitoring the financial strength of these counterparties and its experience to date in successfully completing these transactions, the Company believes that the risk of incurring a significant financial statement loss due to the non-performance of counterparties to these transactions is minimal.

The Company's policies prohibit the use of leveraged financial instruments.

The Company has established a Risk Oversight Committee to oversee all corporate price and credit risk, including NES' risk management and trading activities. The Risk Oversight Committee's responsibilities include reviewing the Company and its subsidiaries' overall risk management strategy and monitoring risk management activities to ensure compliance with the Company's risk management limitations, policies and procedures.

(3) RATE MATTERS

(a) Electric Proceedings.

The Texas Utility Commission has original (or in some cases appellate) jurisdiction over Electric Operations' electric rates and services. Texas Utility Commission orders may be appealed to a District Court in Travis County, and from that court's decision an appeal may be taken to the Court of Appeals for the 3rd District at Austin (Austin Court of Appeals). Discretionary review by the Supreme Court of Texas may be sought from decisions of the Austin Court of Appeals. In the event that the courts ultimately reverse actions of the Texas Utility Commission, such matters are remanded to the Texas Utility Commission for action in light of the courts' orders.

(b) Transition and Price Reduction Plan.

In 1997, the Texas legislature considered but did not pass legislation intended to address various issues concerning the restructuring of the electric utility industry, including proposals that would permit Texas retail electric customers to choose their own electric suppliers beginning on December 31, 2001. The legislative proposals included provisions relating to full stranded cost recovery; rate reductions; rate freezes; the

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unbundling of generation operations, transmission and distribution and customer service operations; securitization of regulatory assets; and consumer protections. Although the Company and certain other parties (including the Texas Utility Commission) supported the bill, it was not enacted prior to the expiration of the legislative session.

In October 1997, the Company announced a proposed transition to competition plan intended to address certain aspects of the proposals contained in the legislation formerly pending before the Texas legislature. By mid December 1997, negotiations resulted in a settlement agreement (Settlement Agreement) executed by the Company, the staffs of the Texas Utility Commission and the City of Houston, representatives of the state's principal consumer and industrial groups and others. The Settlement Agreement was subsequently filed with the Texas Utility Commission, where it is currently under consideration.

Under the terms of the Settlement Agreement, residential customers will receive a 4% credit to the base cost of electricity in 1998, increasing to 6% in 1999. Small and mid-sized businesses will receive a 2% credit to their base costs beginning in 1998. The combined effect of these reductions is expected to decrease base revenues by $166 million over a two year period. In addition, the Company (over the next two years) will be permitted, as a way to assist the Company in mitigating its potentially stranded costs, to (i) redirect to production property all of its current depreciation expenses that would otherwise be credited to accumulated depreciation for transmission and distribution property, and (ii) apply any and all earnings above a rate of return cap of 9.95% to increase the depreciation of production property. The Company estimates that redirected depreciation over the two-year period of 1998 and 1999 will be approximately $364 million. As part of the Settlement Agreement, the Company agreed to support proposed legislation in the 1999 Texas legislative session that includes provisions providing for retail customer choice effective December 31, 2001 and other provisions consistent with those in the 1997 proposed legislation.

The Settlement Agreement is currently under consideration by the Texas Utility Commission, the City of Houston and other cities served by HL&P. In December 1997, the Texas Utility Commission approved the petition filed by the Company to implement the requested base rate credits on a temporary basis beginning January 1, 1998, and pending final Texas Utility Commission consideration. The approval also included the accounting order necessary to permit the Company to begin redirecting depreciation from its transmission and distribution facilities to production property on a temporary basis pending final Texas Utility Commission consideration. A procedural schedule has been developed by the Texas Utility Commission whereby a final decision regarding the Settlement Agreement would be reached by the end of March 1998.

(c) 1995 Rate Case.

In August 1995, the Texas Utility Commission unanimously approved a settlement resolving the Company's most recent rate case (Docket No. 12065) as well as a separate proceeding (Docket No. 13126) regarding the prudence of operation of the South Texas Project.

See Note 1(f) regarding additional depreciation and amortization that is permitted under the 1995 Rate Case Settlement with respect to the South Texas Project and the Company's investment in certain lignite reserves associated with a canceled generating station.

(d) Docket No. 6668.

In September 1997, the Company received a judgment dismissing all outstanding appeals of the Texas Utility Commission's order in Docket No. 6668, an inquiry into the prudence of the planning and construction of the South Texas Project. In that order, the Texas Utility Commission had determined that $375.5 million of the Company's $2.8 billion investment in the South Texas Project had been imprudently incurred. That ruling was incorporated into Electric Operations' 1988 and 1991 rate cases. As a result of this judgment, all

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

outstanding appeals of prior rate cases involving the Company have now been dismissed and the orders granted in such cases are now final.

(4) JOINTLY OWNED ELECTRIC UTILITY PLANT

(a) Investment in South Texas Project.

The Company has a 30.8% interest in the South Texas Project, which consists of two 1,250 MW nuclear generating units, and bears a corresponding 30.8% share of capital and operating costs associated with the project. As of December 31, 1997, the Company's investment in the South Texas Project was $1.8 billion (net of $714 million accumulated depreciation). The Company's investment in nuclear fuel (including AFUDC) was $51 million (net of $205 million amortization) as of such date.

Effective November 1997, the Company and the other three owners of the South Texas Project completed the transfer of the Company's responsibilities for operation of the South Texas Project to a new Texas non-profit corporation formed by the four owners and known as the STP Nuclear Operating Company (STPNOC). STPNOC was formed exclusively for the purpose of operating the South Texas Project, and the Company's officers and employees who had been responsible for day-to-day operation and management of the South Texas Project were transferred to the operating company in October, 1997 and the related employee benefit obligations were transferred in December, 1997. The operating company is managed by a board of directors composed of one director from each of the four owners, along with the chief executive officer of STPNOC. Formation of STPNOC did not affect the underlying ownership of the South Texas Project, which continues as a tenancy in common among the four owners, with each owner retaining its undivided ownership interest in the two nuclear-fueled generating units and the electrical output from those units. The four owners continue to provide overall oversight of the operations of the South Texas Project through an owners' committee composed of representatives of each of the owners and through the board of directors of STPNOC.

(b) 1996 Settlement of South Texas Project Litigation.

In 1996, the Company recorded an aggregate $95 million ($62 million net of tax) charge in connection with various settlements of lawsuits filed by co-owners of the South Texas Project. The formation of STPNOC by the four co-owners (including the Company) of the South Texas Project was contemplated by these settlements. For information about the execution of an operations agreement with the City of San Antonio in connection with one of these settlements, see Note 12(c).

(c) Nuclear Insurance.

The Company and the other owners of the South Texas Project maintain nuclear property and nuclear liability insurance coverage as required by law and periodically review available limits and coverage for additional protection. The owners of the South Texas Project currently maintain $2.75 billion in property damage insurance coverage, which is above the legally required minimum, but is less than the total amount of insurance currently available for such losses. This coverage consists of $500 million in primary property damage insurance and excess property insurance in the amount of $2.25 billion. With respect to excess property insurance, the Company and the other owners of the South Texas Project are subject to assessments, the maximum aggregate assessment under current policies being $11.5 million during any one policy year. The application of the proceeds of such property insurance is subject to the priorities established by the Nuclear Regulatory Commission (NRC) regulations relating to the safety of licensed reactors and decontamination operations.

Pursuant to the Price Anderson Act (Act), the maximum liability to the public of owners of nuclear power plants, such as the South Texas Project, was $8.72 billion as of December 1997. Owners are required under the Act to insure their liability for nuclear incidents and protective evacuations by maintaining the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

maximum amount of financial protection available from private sources and by maintaining secondary financial protection through an industry retrospective rating plan. The assessment of deferred premiums provided by the plan for each nuclear incident is up to $79.3 million per reactor, subject to indexing for inflation, a possible 5% surcharge (but no more than $10 million per reactor per incident in any one year) and a 3% state premium tax. The Company and the other owners of the South Texas Project currently maintain the required nuclear liability insurance and participate in the industry retrospective rating plan.

There can be no assurance that all potential losses or liabilities will be insurable, or that the amount of insurance will be sufficient to cover them. Any substantial losses not covered by insurance would have a material effect on the Company's financial condition and results of operations.

(d) Nuclear Decommissioning.

The Company contributes $14.8 million per year to a trust established to fund its share of the decommissioning costs for the South Texas Project. For a discussion of securities held in the Company's nuclear decommissioning trust, see Note 1(o). In May 1994, an outside consultant estimated the Company's portion of decommissioning costs to be approximately $318 million (1994 dollars). The consultant's calculation of decommissioning costs for financial planning purposes used the DECON methodology (prompt removal/dismantling), one of the three alternatives acceptable to the NRC, and assumed deactivation of Units Nos. 1 and 2 upon the expiration of their 40-year operating licenses. While the current and projected funding levels currently exceed minimum NRC requirements, no assurance can be given that the amounts held in trust will be adequate to cover the actual decommissioning costs of the South Texas Project. Such costs may vary because of changes in the assumed date of decommissioning, changes in regulatory and accounting requirements, changes in technology and changes in costs of labor, materials and equipment.

(e) Assessment Fees for Spent Fuel Disposal and Enrichment and Decommission

By contract, the United States Department of Energy (DOE) has committed itself ultimately to take possession of all spent fuel generated by the South Texas Project. The DOE contract currently requires payment of a spent fuel disposal fee on nuclear plant-generated electricity of one mill (one-tenth of a cent) per net KWH sold. This fee is subject to adjustment to ensure full cost recovery by the DOE. The Energy Policy Act also includes a provision that assesses a fee upon domestic utilities that purchased nuclear fuel enrichment services from the DOE before October 24, 1992. The South Texas Project's assessment is approximately $2 million per year (subject to escalation for inflation). The Company has a remaining estimated liability of $5.5 million for such assessments.

(5) EQUITY INVESTMENTS IN FOREIGN AFFILIATES

HI Energy, a wholly owned subsidiary of the Company formed in 1993, participates primarily in the development and acquisition of foreign independent power projects and the privatization of foreign generating and distribution companies.

The Company accounts for affiliate investments of its subsidiaries under the equity method of accounting where: (i) the subsidiary's ownership interest in the affiliate ranges from 20% to 50%, (ii) the ownership interest is less than 20% but the subsidiary exercises significant influence over operating and financial policies of such affiliate or (iii) the subsidiary's ownership interest in the affiliate exceeds 50% but the subsidiary does not exercise control over the affiliate. The Company's proportionate share of the equity in net income in these affiliates for the years ended December 31, 1997, 1996 and 1995 was $48.6 million, $17 million and $.5 million, respectively, which amounts are included on the Company's Statements of Consolidated Income in Revenues -- International.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's and its subsidiaries' equity investments in foreign and non-regulated affiliates at December 31, 1997 and 1996 were $704 million and $502 million, respectively.

(a) Acquisitions.

In May 1996, a subsidiary of HI Energy acquired 11.35% of the common stock of Light, a publicly held Brazilian corporation, for $393 million which includes the direct costs of the acquisition. Light is the operator under a 30-year concession agreement of an integrated electric power and distribution system that serves a portion of the state of Rio de Janeiro, Brazil, including the city of Rio de Janeiro. The winning bidders in the government-sponsored auction of Light, including a subsidiary of HI Energy, formed a consortium whose aggregate ownership interest of 50.44% represents a controlling interest in Light.

In June 1997, a consortium of investors which included a subsidiary of HI Energy, acquired for $496 million a 56.7% controlling ownership interest in Empresa de Energia del Pacifico S.A.E.S.P. (EPSA), an electric utility system serving the Valle de Cauca region of Colombia, including the area surrounding the city of Cali. HI Energy contributed $152 million of the purchase price for a 28% ownership interest in EPSA. In addition to its distribution facilities, EPSA owns 850 MW of electric generation capacity.

In May 1997, HI Energy increased its indirect ownership interest in Empresa de la Plata S.A. (EDELAP), an Argentina electric utility, from 48% to 63%. The purchase price of the additional interest was $28 million. HI Energy has recorded its investment in EDELAP using the equity method because of the significance of the participatory rights held by a minority shareholder.

HI Energy has accounted for these transactions under purchase accounting and has recorded its investments and its interest in the affiliates' earnings after the acquisition dates using the equity method. The purchase prices were allocated on the basis of the estimated fair market values of the assets acquired and the liabilities assumed as of the dates of acquisition. The differences between the amounts paid and the underlying fair values of the net assets acquired are being amortized as a component of earnings attributable to unconsolidated affiliates over the estimated lives of the projects ranging from 30 to 40 years. Purchase price adjustments to fixed assets are being amortized over the underlying assets' estimated useful lives.

(b) Valuation Allowance.

HI Energy is an investor in two waste tire-to-energy projects in the State of Illinois. The projects had been developed by HI Energy in reliance upon a state subsidy intended to encourage development of energy project facilities for the disposal of solid waste. In March 1996, the State of Illinois repealed the subsidy. As a result of the loss of the subsidy, the Company recorded (i) a $28 million valuation allowance effective in the fourth quarter of 1995 (resulting in an $18 million after-tax charge in that year) and (ii) an additional $8 million valuation allowance in the first quarter of 1996 (resulting in a $5 million after-tax charge in that year). At the time of the Illinois legislature's actions, construction work on one of the waste-to-energy projects had been substantially completed.

The valuation allowance reflects the combined amounts lent to the projects on a subordinated basis by HI Energy. HI Energy also is a party to two separate note purchase agreements committing it, under certain circumstances, to lend up to an additional $16 million. The Company has entered into a support agreement to enable HI Energy to honor its obligation under these note purchase agreements. In the Company's opinion, it is unlikely that additional loans would be required to be made under the note purchase agreements relating to the facility for which construction had been substantially completed (Ford Heights Project). In March 1996, a subsidiary of HI Energy purchased from a senior lending bank all notes relating to the project for which construction had not yet commenced (Fulton Project) (approximately $4.1 million). As a consequence, HI Energy has discretion over when, if ever, the construction activities for the Fulton project will

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

resume and, in turn, control over future obligations of HI Energy to acquire additional subordinated notes for the Fulton project.

The Company and HI Energy are defendants in various lawsuits filed in connection with the Ford Heights Project. CGE Ford Heights, L.L.C., (CGE Ford Heights) the owner of the project, has filed for reorganization under Chapter 11 of the Federal Bankruptcy Code. In October 1997, CGE Ford Heights filed a lawsuit against First Trust National Association, HI Energy and Zurn Industries, Inc. (Zurn). CGE Ford Heights is seeking a determination of the funding obligations of HI Energy and Zurn. In addition, the trustee for the holders of the bonds issued to finance the project has filed suit against the Company, HI Energy and Zurn. The trustee alleges that the Company and HI Energy are obligated to contribute to CGE Ford Heights approximately $15 million in the form of subordinated debt obligations. The Company and HI Energy are vigorously contesting the matter. The Company does not believe that the litigation will have a material adverse impact on the Company's or HI Energy's financial statements.

(6) COMMON STOCK

At December 31, 1997, the Company had 282,875,266 shares of common stock issued and outstanding (out of a total of 700,000,000 authorized shares). At December 31, 1996, the number of shares of outstanding common stock of Former HI was 233,335,481.

Outstanding common shares excluded (i) shares pledged to secure a loan to the Company's Employee Stock Ownership Plan (12,388,551 and 13,370,939 at December 31, 1997 and 1996, respectively) and (ii) treasury shares (93,459 and 16,042,027 at December 31, 1997 and 1996, respectively). Treasury shares at December 31, 1996 represent shares purchased under a common stock repurchase program prior to the Merger. In connection with the Merger, these treasury shares were canceled and retired in August 1997. At December 31, 1997, the Company held 93,459 shares, which shares were received from holders of Company stock options, who surrendered shares of Company stock as partial payment for the exercise price of their stock options.

In 1997, the Company paid four regular quarterly dividends aggregating $1.50 per share on its common stock pursuant to dividend declarations made in December 1996, March 1997, June 1997 and September 1997. In December 1997, the Company declared its regular quarterly dividend of $0.375 per share to be paid in March 1998. For information regarding certain restrictions on payments of dividends, see Note 8(c).

(7) PREFERRED AND PREFERENCE STOCK

(a) Preferred Stock.

At December 31, 1997, the Company had 10,000,000 authorized shares of preferred stock, of which 97,397 shares were outstanding. As of such date, the Company's only outstanding series of preferred stock was its $4.00 Preferred Stock. The $4.00 Preferred Stock pays an annual dividend of $4.00 per share, is redeemable at $105 per share and has a liquidation price of $100 per share.

In April 1997, the Company redeemed all remaining 257,000 shares of its $9.375 cumulative preferred stock pursuant to mandatory sinking fund requirements at a cost of $25.7 million, plus accrued dividends. In February 1997, the Company redeemed the following three series of its cumulative preferred stock at the redemption prices, plus accrued dividends, indicated:

                                                            NUMBER OF    REDEMPTION PRICE
                         SERIES                              SHARES         PER SHARE
                         ------                             ---------    ----------------
$6.72....................................................    250,000         $102.51
$7.52....................................................    500,000         $102.35
$8.12....................................................    500,000         $102.25

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(b) Preference Stock.

At December 31, 1997, the Company had 10,000,000 authorized shares of preference stock, of which 700,000 shares are classified as Series A Preference Stock and 27,000 shares are classified as Series B Preference Stock. As of December 31, 1997, there were no shares of Series A Preference Stock issued and outstanding (such shares being issuable in accordance with the Company's Shareholder Rights Agreement upon the occurrence of certain events). The number of shares of Series B Preference Stock issued and outstanding as of December 31, 1997 was 17,000. The sole holder of the Series B Preference Stock is a wholly owned financing subsidiary of the Company. See Note 8(c).

Each share of common stock of the Company includes one associated preference stock purchase right (Company Right). Under certain circumstances, each Company Right entitles the registered holder to purchase from the Company a unit consisting of one-thousandth of a share (Fractional Share) of Series A Preference Stock, without par value (Series A Preference Stock), at a purchase price of $42.50 per Fractional Share, subject to adjustments. The shareholder rights plan was adopted by the shareholders of Former HI in August 1990 and was assumed by the Company, with certain amendments, effective upon the Merger.

(8) LONG-TERM DEBT AND SHORT-TERM FINANCING

(a) Consolidated Debt.

The Company's consolidated long-term and short-term debt outstanding is summarized in the following table. Of the amount of long-term and short-term debt outstanding as of December 31, 1997, $1.8 billion represents debt of NorAm which was assumed and adjusted to fair market value as of the Acquisition Date.

                                              DECEMBER 31, 1997       DECEMBER 31, 1996
                                             --------------------    --------------------
                                             LONG-TERM    CURRENT    LONG-TERM    CURRENT
                                             ---------    -------    ---------    -------
Short-Term Borrowings:
  Commercial Paper........................                $1,435                  $1,338
  Lines of Credit.........................                   390
  NorAm Receivables Facility..............                   300
                                                          ------                  ------
Total Short-Term Borrowings...............                 2,125                   1,338
                                                          ------                  ------
Long-Term Debt -net:
  ACES....................................    $1,174
  Debentures(1)(2)........................       669                  $  349
  First Mortgage Bonds(1).................     2,495                   2,670         225
  Pollution Control Bonds.................       118           5           5
  NorAm Medium-Term Notes(2)..............       182          79
  Notes Payable(2)........................       565         166           1
  Capital Leases..........................        15           1           1           4
                                              ------      ------      ------      ------
Total Long-Term Debt......................     5,218         251       3,026         229
                                              ------      ------      ------      ------
  Total Long-Term and Short-Term Debt.....    $5,218      $2,376      $3,026      $1,567
                                              ======      ======      ======      ======

(1) Includes unamortized discount related to debentures of approximately $1 million at December 31, 1997 and 1996 and unamortized discount related to first mortgage bonds of approximately $14 million and $15 million at December 31, 1997 and 1996, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(2) Includes unamortized premium related to fair value adjustments of approximately $15.8 million for Debentures at December 31, 1997. The unamortized premium for NorAm long-term and current medium-term notes at December 31, 1997 was approximately $16.7 million and $2.8 million, respectively. The unamortized premium for long-term and current notes payable was approximately $13.7 million and $3.3 million, respectively, at December 31, 1997. See Note 1(b).

Consolidated maturities of long-term debt and sinking fund requirements for the Company (including NorAm) are approximately $251 million in 1998, $378 million in 1999, $1.430 billion in 2000, $401 million in 2001 and $207 million in 2002.

(b) First Mortgage Bonds.

As of December 31, 1997, the Company had an aggregate of $2.5 billion principal amount of its first mortgage bonds issued and outstanding.

In the first quarter of 1997, the Company repaid at maturity $40 million aggregate principal amount of its 5 1/4% first mortgage bonds and $150 million aggregate principal amount of its 7 5/8% first mortgage bonds. In June 1997, the Company purchased $57.6 million aggregate principal amount of its 9.15% first mortgage bonds due 2021 for a total purchase price of $69.6 million, plus accrued interest. In November 1997, the Company repaid at maturity $35 million aggregate principal amount of its 6 3/4% first mortgage bonds.

Sinking or improvement fund requirements of the Company's first mortgage bonds outstanding will be approximately $28.3 million for each of the years 1998 through 2002. Such requirements may be satisfied by certification of property additions at 100% of the requirements. Sinking or improvement fund requirements for 1997 and prior years have been satisfied by certification of property additions.

The Company has agreed to expend an amount each year for replacements and improvements in respect of its depreciable mortgaged utility property equal to $1,450,000 plus 2 1/2% of net additions to such mortgaged property made after March 31, 1948 and before July 1 of the preceding year. Such requirement may be met with cash, first mortgage bonds, gross property additions or expenditures for repairs or replacements, or by taking credit for property additions at 100% of the requirements. With respect to first mortgage bonds of a series subject to special redemption, the Company has the option to use deposited cash to redeem first mortgage bonds of such series at the applicable special redemption price. The replacement fund requirement to be satisfied in 1998 is approximately $310.3 million.

The amount of the first mortgage bonds that may be issued by the Company is unlimited as to issuance, but limited by property, earnings and other provisions of the Mortgage and Deed of Trust dated as of November 1, 1944, between the Company and South Texas Commercial National Bank of Houston (Chase Bank of Texas, National Association, as Successor Trustee) and the supplemental indentures thereto. Substantially all properties used in the conduct of the business and operations of Electric Operations are subject to liens securing the long-term debt under the mortgage.

(c) FinanceCo Credit Facility.

In August 1997, a limited partnership special purpose subsidiary of the Company (FinanceCo) established a five-year, $1.644 billion revolving credit facility with a consortium of commercial banks (FinanceCo Facility). The FinanceCo Facility supported $1.435 billion in commercial paper borrowings by FinanceCo at December 31, 1997 recorded as notes payable on the Consolidated Balance Sheet. The weighted average interest rate of these borrowings at December 31, 1997 was 6.15%. Proceeds from the initial issuances of commercial paper were used to purchase newly issued shares of Series B Preference Stock of the Company. The Company, in turn, used the proceeds from such stock issuance to fund the cash portion of the consideration paid to Former NorAm stockholders under the terms of the Merger.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Borrowings under the FinanceCo Facility bear interest at a rate based upon the London interbank offered rate (LIBOR) plus a margin, a base rate or at a rate determined through a bidding process. The FinanceCo Facility may be used
(i) to support the issuance of commercial paper or other short-term indebtedness of FinanceCo, (ii) subject to certain limitations, to finance repurchases of Company common stock and (iii) subject to certain limitations, to provide funds for general purposes of FinanceCo, including the making of intercompany loans to, or securing letters of credit for the benefit of, FinanceCo's affiliates.

The FinanceCo Facility requires the Company to maintain a ratio of consolidated indebtedness for borrowed money to consolidated capitalization (as defined) that does not exceed 0.62:1.00 from January 1, 1998 through December 31, 1998 and 0.60:1.00 from January 1, 1999 until termination of the FinanceCo Facility. The FinanceCo Facility also contains restrictions applicable to the Company and certain of its subsidiaries with respect to, among other things, (i) liens, (ii) consolidations, mergers and dispositions of assets, (iii) dividends and repurchases of common stock, (iv) certain types of investments and (v) certain changes in its business. The FinanceCo Facility contains customary covenants and default provisions applicable to FinanceCo and its subsidiaries, including limitations on, among other things, additional indebtedness (other than certain permitted indebtedness), liens and certain investments or loans.

Subject to certain conditions and limitations, the Company is required to make cash payments from time to time to FinanceCo from excess cash flow (as defined in the FinanceCo Facility) to the extent necessary to enable FinanceCo to meet its financial obligations. At December 31, 1997, commercial paper supported by the FinanceCo Facility was secured by pledges of (i) the shares of common stock of NorAm held by the Company, (ii) all of the limited and general partner interests of FinanceCo and all of the Company's interest in the general partner of FinanceCo, (iii) the capital stock of HI Energy, (iv) the Series B Preference Stock and (v) certain intercompany notes held by FinanceCo. The obligations under the FinanceCo Facility are not secured by the utility assets of the Company or NorAm or by the Company's investment in Time Warner securities.

The Company's outstanding commercial paper balance at December 31, 1996 was $1.3 billion. The weighted average interest rate at December 31, 1996 was 5.90%.

(d) Company Bank Facility.

The Company meets its short-term financing needs primarily through sales of commercial paper supported by a $200 million revolving credit facility. Borrowings under the facility are unsecured and a facility fee is paid. At December 31, 1997, there was no outstanding commercial paper and there were no outstanding borrowings under the bank facility.

(e) ACES.

The Company owns 11 million shares of non-publicly traded TW Preferred. See Note 1(n). To monetize its investment in these securities, the Company sold in July 1997, 22,909,040 of its unsecured 7% ACES having a face amount of $45.9375 per security.

At maturity, the principal amount of the ACES will be mandatorily exchangeable by the Company into either (i) a number of shares of common stock of Time Warner based on an exchange rate or (ii) cash having an equal value. Subject to adjustments that may result from certain dilution events, the exchange rate for each ACES is determined as follows: (i) 0.8264 shares of Time Warner common stock if the price of Time Warner common stock at maturity (Maturity Price) is at least $55.5844 per share, (ii) a fractional share of Time Warner common stock such that the fractional share will have a value equal to $45.9375 if the Maturity Price is less than $55.5844 but greater than $45.9375 and (iii) one share of Time Warner common stock if the Maturity Price is not more than $45.9375.

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Prior to maturity, the Company has the option of redeeming the ACES if (i) changes in federal tax regulations require recognition of a taxable gain on the Company's TW Preferred and (ii) the Company could defer such gain by redeeming the ACES. The redemption price is 105% of the closing sales price of the ACES as determined over a period prior to the redemption notice. The redemption price may be paid in cash or in shares of Time Warner common stock or a combination of the two.

The Company used the net proceeds of the sale of the ACES (approximately $1.021 billion) to retire in 1997 an equivalent amount of the Company's then outstanding commercial paper.

For information regarding the Company's accounting treatment of the ACES, including certain accounting losses that may result upon increases in the price of Time Warner common stock, see Note 1(n).

(f) Pollution Control Revenue Refunding Bonds.

In January 1997, the Brazos River Authority (BRA) and the Matagorda County Navigation District Number One (MCND) issued, on behalf of the Company, $118 million aggregate principal amount of pollution control revenue bonds. The BRA and MCND bonds will mature in 2018 and 2028, respectively. The proceeds from the sale of these securities were used to redeem all outstanding 7 7/8% BRA Series 1986A pollution control revenue bonds ($50 million) and 7 7/8% MCND Series 1986A pollution control revenue bonds ($68 million) at a redemption price of 102% of the aggregate principal amount of each series. In 1997, the bonds bore interest at a floating rate. The weighted average interest rate at December 31, 1997 was 5.01%. Subject to certain conditions, the Company may change the method of determining the interest rate on the bonds from a daily to a weekly, commercial paper or long-term interest rate. The bonds are subject to a mandatory tender for purchase upon certain events, including changes in the method of determining interest rates on the bonds. When a daily or weekly rate is in effect for the bonds, holders of the bonds of such issue have the option to have their bonds purchased at 100% of their principal amount plus accrued interest to the date of the purchase. Bonds tendered prior to maturity may be remarketed. Although it is anticipated that all bonds tendered will be purchased with proceeds from the subsequent offer and sale of the tendered bonds, the Company has entered into standby purchase agreements with commercial banks to provide approximately $120 million for the purchase of tendered bonds in the event such proceeds are not available. Facility fees are payable in connection with these facilities.

(g) NorAm Bank Facilities.

In 1997, NorAm met its short-term financing needs primarily through a bank facility, bank lines of credit and a receivables facility. NorAm's principal short-term credit facility (NorAm Credit Facility) of $400 million expires in December 1998. Unsecured borrowings under the NorAm Credit Facility at December 31, 1997 aggregated $340 million and had a weighted average interest rate of 6.30%. A facility fee of .14% per annum is payable on the $400 million commitment. In addition, NorAm had $50 million of outstanding loans under uncommitted lines of credit at December 31, 1997 having a weighted average interest rate of 6.82%.

Under a trade receivables facility (Receivables Facility) which expires in August 1999, NorAm sells, with limited recourse, an undivided interest (limited to a maximum of $300 million) in a designated pool of accounts receivable. The amount of receivables sold and uncollected was $300 million at December 31, 1997. The weighted average interest rate at December 31, 1997 was approximately 5.65%. Certain of NorAm's remaining receivables serve as collateral for receivables sold and represent the maximum exposure to NorAm should all receivables sold prove ultimately uncollectible. NorAm has retained servicing responsibility under the Receivables Facility for which it is paid a servicing fee. Beginning in 1997 and pursuant to SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", NorAm accounts for amounts transferred pursuant to the Receivables Facility as collateralized borrowings. As a result,

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

these receivables are recorded as assets on the Company's December 31, 1997 Consolidated Balance Sheet and amounts received by NorAm pursuant to this facility are recorded as notes payable.

In May 1997, NorAm obtained an unsecured, 18-month bank term loan in the amount of $150 million (included in Notes Payable). The term loan carries a LIBOR-based floating interest rate. Proceeds from the term loan were used to refund a portion of NorAm's 9.875% Notes which matured in April 1997. NorAm has entered into two interest rate swaps, each with a term of 19 months, having an aggregate notional amount of $150 million which, as of December 31, 1997, effectively fixed the interest rate on borrowings under the term loan agreement at approximately 6.775%.

(h) NorAm Long-Term Debt.

At December 31, 1997, NorAm has issued and outstanding $116 million aggregate principal amount ($107 million after Merger fair value adjustments) of its 6% Convertible Subordinated Debentures due 2012 (Subordinated Debentures). The holders of the Subordinated Debentures receive interest quarterly and have the right at any time on or before the maturity date thereof to convert each Subordinated Debenture into 0.65 shares of Company common stock and $14.24 in cash. NorAm is required to make annual sinking fund payments of $6.5 million on the Subordinated Debentures beginning on March 15, 1997 and on each succeeding March 15 up to and including March 15, 2011. NorAm (i) may credit against the sinking fund requirements any Subordinated Debentures redeemed by NorAm and Subordinated Debentures which have been converted at the option of the holder and (ii) may deliver purchased Subordinated Debentures in satisfaction of the sinking fund requirements. Since the Acquisition Date, Subordinated Debentures aggregating $27,250 were converted.

In the fourth quarter of 1997, NorAm purchased $101.4 million aggregate principal amount of its 10% Debentures due 2019 at an average price of 111.98% plus accrued interest. Because NorAm's debt was stated at fair market value as of the date of the acquisition, the loss on the reacquisition of these debentures was not material. In December 1997, NorAm repaid at maturity $52 million aggregate principal amount of its medium-term notes.

(i) Restrictions on NorAm's Stockholders' Equity and Debt.

Under the provisions of NorAm's revolving credit facility or certain other NorAm financial arrangements, NorAm's total debt is limited to 72% of its total capitalization and NorAm is required to maintain a minimum level of stockholders' equity. In addition, NorAm's total debt would be limited to $2.055 billion if its ratio of total debt to total capitalization increased to 60%. The minimum level of stockholders' equity was initially set at $700 million at December 31, 1995, increasing annually thereafter by (1) 50% of positive consolidated net income and (2) 50% of the proceeds from any incremental equity offering made after June 30, 1996. At December 31, 1997, these provisions did not significantly restrict NorAm's ability to issue debt or to pay dividends.

(j) HI Energy Notes Payable.

In 1996, a subsidiary of HI Energy entered into a $167.5 million loan agreement in order to refinance a portion of the acquisition costs of Light. The full proceeds of the loan, net of a $17.5 million debt reserve account established for the benefit of the lenders, was funded in April 1997. The loan (included in Notes Payable) is secured by, among other things, a pledge of the shares of Light and of a subsidiary of HI Energy that is the indirect holder of the shares of Light.

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(9) TRUST SECURITIES

(a) Company.

In February 1997, two Delaware statutory business trusts (HI Trusts) established by the Company issued (i) $250 million of preferred securities and
(ii) $100 million of capital securities, respectively. The preferred securities have a distribution rate of 8.125% payable quarterly in arrears, a stated liquidation amount of $25 per preferred security and must be redeemed by March 2046. The capital securities have a distribution rate of 8.257% payable quarterly in arrears, a stated liquidation amount of $1,000 per capital security and must be redeemed by February 2037.

The HI Trusts sold the preferred and capital securities to the public and used the proceeds to purchase $350 million aggregate principal amount of subordinated debentures (Debentures) from the Company having interest rates corresponding to the distribution rates of the securities and maturity dates corresponding to the mandatory redemption dates of the securities. The HI Trusts are accounted for as wholly owned consolidated subsidiaries of the Company. The Debentures are the HI Trusts' sole assets. Proceeds from the sale of the Debentures were used by the Company for general corporate purposes, including the repayment of short-term debt and the redemption of three series of the Company's outstanding cumulative preferred stock at the following redemption prices, plus accrued dividends:

                                                            NUMBER OF    REDEMPTION PRICE
                         SERIES                              SHARES         PER SHARE
                         ------                             ---------    ----------------
$6.72...................................................     250,000         $102.51
$7.52...................................................     500,000         $102.35
$8.12...................................................     500,000         $102.25

The Company has fully and unconditionally guaranteed, on a subordinated basis, each Trust's obligations, including the payment of distributions and all other payments due with respect to the respective preferred and capital securities.

The preferred and capital securities are mandatorily redeemable upon the repayment of the related Debentures at their stated maturity or earlier redemption.

Subject to certain limitations, the Company has the option of deferring payments of interest on the Debentures held by the HI Trusts. If and for as long as payments on the Debentures have been deferred, or an event of default under the indenture relating thereto has occurred and is continuing, the Company may not pay dividends on its capital stock. As of December 31, 1997, no interest payments on the Debentures had been deferred.

(b) NorAm.

In June 1996, a Delaware statutory business trust (NorAm Trust) established by NorAm issued $172.5 million of convertible preferred securities and sold approximately $5.3 million of NorAm Trust common securities (106,720 securities, representing 100% of the NorAm Trust's common equity) to NorAm . The convertible preferred securities have a distribution rate of 6.25% payable quarterly in arrears, a stated liquidation amount of $50 per convertible preferred security and must be redeemed by 2026. The NorAm Trust sold the convertible preferred securities to the public and used the proceeds, in addition to the common stock proceeds, to purchase $177.8 million of 6.25% Convertible Junior Subordinated Debentures from NorAm having an interest rate corresponding to the distribution rate of the convertible preferred securities and a maturity date corresponding to the mandatory redemption date of the convertible preferred securities. The NorAm Trust is accounted for as a wholly owned consolidated subsidiary of NorAm. The junior subordinated debentures are the sole assets of the NorAm Trust. NorAm has fully and unconditionally guaranteed, on a subordinated basis, the NorAm Trust's obligations, including the payment of distributions and all other

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

payments, with respect to the convertible preferred securities. The convertible preferred securities are mandatorily redeemable upon the repayment of the related junior subordinated debentures at their stated maturity or earlier redemption. Following the Merger, each convertible preferred security is convertible at the option of the holder into $33.62 of cash and 1.55 shares of Company common stock. Since the Acquisition Date, convertible preferred securities aggregating $14.1 million were converted, leaving $16.4 million principal amount (unamortized fair value of $21.3 million, net of issuance costs) of convertible preferred securities outstanding at December 31, 1997.

(10) STOCK-BASED INCENTIVE COMPENSATION PLANS AND RETIREMENT PLANS

(a) Incentive Compensation Plans.

The Company has Long-Term Incentive Compensation plans (LICP) and other incentive compensation plans that provide for the issuance of stock-based incentives (including performance-based stock compensation and restricted shares, stock options and stock appreciation rights) to key employees of the Company, including officers. As of December 31, 1997, 96 current and former employees participated in the plans. A maximum of approximately 9 million shares of common stock may be issued under these plans. Under the LICP, beginning one year after the grant date, the options become exercisable in one-third increments each year. Performance-based stock compensation issued and restricted shares granted were 704,865 in 1997, 69,905 in 1996, and 49,792 in 1995.

Stock option activity for the years 1995 through 1997 is summarized below:

                                                                            WEIGHTED
                                                                             AVERAGE
                                                            NUMBER      PRICE AT DATE OF
                                                           OF SHARES    GRANT OR EXERCISE
                                                           ---------    -----------------
Outstanding at December 31, 1994.......................      302,578      $    22.7025
  Options Granted......................................      133,324      $    17.8277
  Options Canceled.....................................      (24,560)

Outstanding at December 31, 1995.......................      411,342      $    21.1414
  Options Granted......................................      101,798      $     24.375
  Options Exercised....................................         (574)     $      17.75
  Options Withheld for Taxes...........................          (90)
  Options Canceled.....................................      (13,824)

Outstanding at December 31, 1996.......................      498,652      $    21.7796
  Options Granted......................................      382,954      $    21.0673
  Options Converted at Acquisition(1)..................      622,504      $    12.9002
  Options Exercised(1).................................     (281,053)     $     9.2063
  Options Withheld for Taxes...........................          (72)
  Options Canceled.....................................     (148,418)

Outstanding at December 31, 1997.......................    1,074,567      $    19.0728

Exercisable at:
  December 31, 1997....................................      645,304      $ 7.00-35.18
  December 31, 1996....................................      280,270      $17.75-23.25
  December 31, 1995....................................      181,924      $21.75-23.25

(1) Effective upon the Merger, each holder of an unexpired NorAm stock option, whether or not then exercisable, was entitled to elect to either (i) have all or any portion of their NorAm stock options canceled and "cashed out" or
(ii) have all or any portion of their NorAm stock options converted to the Company's stock options. There were 622,504 NorAm stock options converted into the Company's stock

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

options at the Acquisition Date. Options exercised during 1997 included approximately 277,000 shares related to NorAm stock options which were converted at the Merger.

Effective January 1, 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation." (SFAS No. 123) In accordance with SFAS No. 123, the Company will continue to apply the existing rules contained in Accounting Principles Opinion No. 25, "Accounting for Stock Issued to Employees," and disclose the required pro forma effect on net income and earnings per share of the fair value based method of accounting for stock compensation as required by SFAS No. 123.

The following pro forma summary of the Company's consolidated results of operations have been prepared as if the fair value based method of accounting for employee stock compensation as required by SFAS No. 123 had been applied:

                                                      1997        1996         1995
                                                    --------    --------    ----------
                                                          (THOUSANDS OF DOLLARS,
                                                          EXCEPT PER SHARE DATA)
Net Income as reported............................  $420,948    $404,944    $1,105,524
SFAS No. 123 effect...............................    (2,374)     (1,098)         (244)
                                                    --------    --------    ----------
Pro forma Net Income..............................  $418,574    $403,846    $1,105,280
                                                    ========    ========    ==========
Basic and Diluted Earnings per Common Share As
  reported........................................  $   1.66    $   1.66    $     4.46
                                                    $   1.65    $   1.66    $     4.46

The fair value of options granted during 1995, 1996 and 1997 were calculated using the Black-Scholes model. The significant assumptions incorporated in the Black-Scholes model in estimating the fair value of the options include (i) an interest rate of 7.78% for 1995 and 5.65% for 1996 and an interest rate of 6.58% for 1997 that represents the interest rate on a U.S. Treasury security with a maturity date corresponding with the option term, (ii) an option term of ten years, (iii) volatility of 19.647% for 1995, 15.713% for 1996 and a volatility of 22.06% for 1997 calculated using daily stock prices for the period prior to the grant date, and (iv) expected common dividends of $1.50 per share representing annualized dividends at the date of grant.

(b) Pension.

The Company has a noncontributory retirement plan which covers the employees of the Company and its subsidiaries other than NorAm. NorAm has two noncontributory retirement plans: (i) the plan which covers the employees of NorAm other than Minnegasco employees and (ii) the plan which covers Minnegasco employees. The plans provide retirement benefits based on years of service and compensation. The Company and NorAm's funding policy is to contribute amounts annually in accordance with applicable regulations in order to achieve adequate funding of projected benefit obligations. The assets of the plans consist principally of common stocks and high-quality, interest-bearing obligations.

                                                          YEAR ENDED DECEMBER 31,
                                                     ---------------------------------
                                                       1997         1996        1995
                                                     ---------    --------    --------
                                                           (THOUSAND OF DOLLARS)
Service cost -- benefits earned during the
  period...........................................  $  26,848    $ 24,392    $ 22,852
Interest cost on projected benefit obligation......     67,640      51,560      49,317
Actual (return) loss on plan assets................   (100,390)    (75,326)    (96,004)
Net amortization and deferrals.....................     14,025      17,514      50,889
                                                     ---------    --------    --------
          Net pension cost.........................      8,123      18,140      27,054
Transfer of obligation to STPNOC...................     (6,077)
SFAS No. 88 -- curtailment expense.................     12,947      12,698       7,096
                                                     ---------    --------    --------
          Total pension cost.......................  $  14,993    $ 30,838    $ 34,150
                                                     =========    ========    ========

The funded status of the Company's retirement plans was as follows:

                                                                   DECEMBER 31,
                                                              ----------------------
                                                                 1997         1996
                                                              ----------    --------
                                                              (THOUSANDS OF DOLLARS)
Actuarial present value of:
  Vested benefit obligation.................................  $  948,017    $542,714
                                                              ==========    ========
  Accumulated benefit obligation............................  $1,017,190    $578,786
                                                              ==========    ========
Plan assets at fair value(1)................................  $1,304,023    $675,401
Projected benefit obligation(1).............................   1,246,582     756,597
                                                              ----------    --------
Assets in excess of (less than) projected benefit
  obligation................................................      57,441     (81,196)
Unrecognized transitional asset.............................      (9,008)    (11,502)
Unrecognized prior service cost.............................      14,735      31,154
Unrecognized net loss.......................................       8,750      19,405
                                                              ----------    --------
     (Accrued) prepaid pension cost.........................  $   71,918    $(42,139)
                                                              ==========    ========

(1) Includes transfer of approximately $40 million of assets and related liabilities of plans related to STPNOC. See Note 4(a).

The projected benefit obligation was determined using an assumed discount rate of 7.25% in 1997 and in 1996. A long-term annual rate of compensation increase ranging from 4% to 6% was assumed for both the Company and NorAm plans in 1997 and 1996. The assumed long-term rate of return on plan assets was 9.5% in 1997 and 1996 (10% for the NorAm plans in 1997). The transitional asset at January 1, 1986, is being recognized over approximately 17 years, and the prior service cost is being recognized over approximately 15 years for the Company's plan. The unrecognized transitional asset, prior service cost and net (gain) or loss related to the NorAm plans were recognized at the Acquisition Date.

In 1995, the Company offered eligible employees (excluding officers) of the Company and HI Energy, who were 55 years of age or older and had at least 10 years of service as of July 31, 1995, an incentive program to retire early. For employees electing early retirement, the program added five years of service credit and five years in age up to 35 years of service and age 65, respectively, in determining an employee's pension. Each participating employee (under age 62) would also receive a supplemental benefit to age 62. During July 1995, the early retirement incentive was accepted by approximately 300 employees.

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Pension benefits and supplemental benefits (if applicable) are being paid out from the Houston Industries Incorporated Retirement Trust. Based on the projected costs associated with the program, the Company increased its retirement plan and supplemental benefits in 1995 by approximately $28 million and $5 million, respectively. Pursuant to SFAS No. 71, the Company deferred the costs associated with the increases in its benefit obligations and amortized the costs through the period ending December 31, 1997. In 1997, 1996 and 1995, the Company amortized $12.9 million, $12.7 million and $7.1 million, respectively, of those costs as a curtailment under SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," with regards to the Company's early retirement program.

(c) Savings Plan.

The Company has an employee savings plan that qualifies as cash or deferred arrangements under Section 401(k) of the Internal Revenue Code of 1986, as amended (IRC). Under the plan, participating employees may contribute a portion of their compensation, pretax or after-tax, up to a maximum of 16% of compensation limited by an annual deferral limit ($9,500 for calendar year 1997) prescribed by IRC Section 402(g) and the IRC Section 415 annual additions limits. The Company matches 70% of the first 6% of each employee's compensation contributed, subject to a vesting schedule which entitles the employee to a percentage of the matching contributions depending on years of service. Substantially all of the Company's match is invested in the Company's common stock.

In October 1990, the Company amended its savings plan to add a leveraged Employee Stock Ownership Plan (ESOP) component. The Company may use ESOP shares to satisfy its obligation to make matching contributions under the savings plan. Debt service on the ESOP loan is paid using all dividends on shares in the ESOP, interest earnings on funds held in the ESOP and cash contributions by the Company. Shares of the Company's common stock are released from the encumbrance of the ESOP loan based on the proportion of debt service paid during the period.

The Company adopted Statement of Position (SOP) 93-6, effective January 1, 1994, which requires that the Company recognize benefit expense for the ESOP equal to the fair value of the ESOP shares committed to be released. In accordance with SOP 93-6, the Company credits to unearned ESOP shares the original purchase price of ESOP shares committed to be released to plan participants with the difference between the fair value of the shares and the original purchase price recorded to common stock. Dividends on allocated ESOP shares are recorded as a reduction to retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt or accrued interest on the ESOP loan.

The Company's savings plan benefit expense attributable to continuing operations was $18.4 million, $16.0 million, and $18.9 million in 1997, 1996 and 1995, respectively. Savings plan benefit expense attributable to discontinued operations was not material.

The ESOP shares were as follows:

                                                                  DECEMBER 31,
                                                          ----------------------------
                                                              1997            1996
                                                          ------------    ------------
Allocated shares transferred/distributed from the
  Savings Plan(1).......................................     1,920,406         580,132
Allocated shares........................................     4,453,227       4,811,113
Unearned shares.........................................    12,388,551      13,370,939
                                                          ------------    ------------
     Total Original ESOP shares.........................    18,762,184      18,762,184
                                                          ============    ============
Fair value of unearned ESOP shares......................  $331,393,739    $302,517,495

(1) 1,102,203 allocated shares transferred are related to shares transferred to STPNOC in December, 1997.

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NorAm has an employee savings plan (NorAm Savings Plan) which covers substantially all employees other than Minnegasco employees. Under the terms of the NorAm Savings Plan, employees may contribute up to 12% of total compensation, which contributions up to 6% are matched by the Company. The Minnegasco employees are covered by a savings plan, the terms of which are somewhat similar to the NorAm Savings Plan. Employer contributions related to the NorAm and Minnegasco Savings Plan of $3.7 million have been expensed since the Acquisition Date.

(d) Postretirement Benefits.

The Company and NorAm record the liability for post-retirement benefit plans other than pensions (primarily health care) under SFAS No. 106, "Employer's Accounting for Postretirement Benefits Other Than Pensions" (SFAS No. 106). The Company is amortizing over a 22 year period approximately $213 million to cover the "transition cost" of adopting SFAS No. 106 (i.e., the Company's liability for postretirement benefits payable with respect to employee service years accrued prior to the adoption of SFAS No. 106). The unrecognized transitional asset and net (gain) loss related to the NorAm plans were recognized at the Acquisition Date.

As provided in the Rate Case Settlement, the Company is required to fund during each year in an irrevocable external trust approximately $22 million of postretirement benefit costs which are included in Electric Operations' rates. In December 1995, the Company commenced funding by contributing a total of $15.1 million to three Voluntary Employees' Beneficiary Association trusts and one
Section 401(h) account of the retirement plan. This contribution represented the amount of postretirement benefits included in Electric Operations' rates (which included the Company's interest in the South Texas Project costs) less the estimated pay-as-you-go amounts for 1995 plus interest as if the contributions had been made on a monthly basis during the year. Beginning in 1996, the Company funded postretirement benefits costs on a monthly basis for the amount included in Electric Operations' rates. Minnegasco is required to fund postretirement benefit costs for the amount included in its rates. The Company and NorAm, excluding Electric Operations and Minnegasco, will continue funding their postretirement benefits on a pay-as-you-go basis. The net postretirement benefit cost for the Company and its subsidiaries includes the following components:

                                                            YEAR ENDED DECEMBER 31,
                                                          ---------------------------
                                                           1997      1996      1995
                                                          -------   -------   -------
                                                            (THOUSANDS OF DOLLARS)
Service cost -- benefits earned during the period.......  $ 8,927   $ 8,242   $ 9,093
Interest cost on accumulated benefit obligation.........   14,176    12,265    11,143
Actual return on plan assets............................   (5,063)   (2,342)
Net amortization and deferrals..........................    4,732     5,983     6,061
                                                          -------   -------   -------
Net postretirement benefit cost.........................  $22,772   $24,148   $26,297
                                                          =======   =======   =======

                                                                   DECEMBER 31,
                                                              ----------------------
                                                                1997         1996
                                                              ---------    ---------
                                                              (THOUSANDS OF DOLLARS)
Accumulated benefit obligation:
  Retirees..................................................  $ 220,436    $ 107,642
  Fully eligible active plan participants...................     22,150       16,340
  Other active plan participants............................     26,945       26,090
                                                              ---------    ---------
          Total.............................................    269,531      150,072
Plan assets at fair market value............................     56,340       38,493
                                                              ---------    ---------
Assets (less than) accumulated benefit obligation...........   (213,191)    (111,579)
Unrecognized transitional obligation........................    155,107      173,954
Unrecognized net gain.......................................    (96,463)     (99,417)
                                                              ---------    ---------
(Accrued) postretirement benefit cost.......................  $(154,547)   $ (37,042)
                                                              =========    =========

The assumed health care cost trend rates used in measuring the accumulated postretirement benefit obligation in 1997 are as follows:

Medical -- under 65.........................................  6.6%
Medical -- 65 and over......................................  7.3%
Dental......................................................  6.0%

The assumed health care rates gradually decline to 5.4% for both medical categories and 3.7% for dental by 2001. The accumulated postretirement benefit obligation was determined using an assumed discount rate of 7.25% for 1997 and 1996.

If the healthcare cost trend rate assumptions were increased by 1%, the accumulated postretirement benefit obligation as of December 31, 1997 would be increased by approximately 8%. The annual effect of the 1% increase on the total of the service and interest costs would be an increase of approximately 11%.

The discount rate used in determining the accumulated postretirement benefit obligation for the NorAm plan was 7.25% in 1997. The cost of covered health care benefits (for those participants entitled to a defined benefit as a result of having retired prior to July 1, 1992) is assumed to increase by 8.5% per year initially and then increase at a decreasing rate to an annual and continuing increase of 4.5% by 2006. Based on these assumptions, a one percentage point increase in the assumed health care cost trend rate would increase the total of the service plus interest costs (before any deferral for regulatory reasons) and the accumulated postretirement benefit obligation related to the NorAm plan at December 31, 1997 by 9.2% and 10.8%, respectively.

(e) Postemployment Benefits.

Effective January 1, 1994, the Company adopted SFAS No. 112, "Employer's Accounting for Postemployment Benefits," which requires the recognition of a liability for benefits, not previously accounted for on the accrual basis, provided to former or inactive employees, their beneficiaries and covered dependents, after employment but before retirement (primarily health care and life insurance benefits for participants in the long-term disability plan). Net postemployment benefit costs were not material in 1997, 1996 and 1995.

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(11) INCOME TAXES

The Company records income taxes under SFAS No. 109, "Accounting for Income Taxes," (SFAS No. 109) which, among other things, (i) requires the liability method be used in computing deferred taxes on all temporary differences between book and tax bases of assets other than nondeductible goodwill; (ii) requires that deferred tax liabilities and assets be adjusted for an enacted change in tax laws or rates; and (iii) prohibits net-of-tax accounting and reporting. SFAS No. 109 requires that regulated enterprises recognize such adjustments as regulatory assets or liabilities if it is probable that such amounts will be recovered from or returned to customers in future rates.

The Company's current and deferred components of income tax expense from continuing operations are as follows:

                                                         YEAR ENDED DECEMBER 31,
                                                     --------------------------------
                                                       1997        1996        1995
                                                     --------    --------    --------
                                                          (THOUSANDS OF DOLLARS)
Current............................................  $199,011    $150,658    $141,076
Deferred...........................................     7,363      49,507      58,479
                                                     --------    --------    --------
Income taxes for continuing operations.............  $206,374    $200,165    $199,555
                                                     ========    ========    ========

The Company's effective income tax rates are lower than statutory corporate rates for each year as follows:

                                                         YEAR ENDED DECEMBER 31,
                                                     --------------------------------
                                                       1997        1996        1995
                                                     --------    --------    --------
                                                          (THOUSANDS OF DOLLARS)
Income from continuing operations before income
  taxes............................................  $627,484    $605,109    $596,955
Preferred dividends of subsidiary..................     2,255      22,563      29,955
                                                     --------    --------    --------
          Total....................................   629,739     627,672     626,910
Statutory rate.....................................        35%         35%         35%
                                                     --------    --------    --------
Income taxes at statutory rate.....................   220,409     219,685     219,419
                                                     --------    --------    --------
Net reduction (addition) in taxes resulting from:
  Amortization of investment tax credit............    19,777      18,404      19,427
  Excess deferred taxes............................     5,570       4,331       4,384
  Difference between book and tax depreciation for
     which deferred taxes have not been
       normalized..................................   (27,466)    (22,638)    (15,211)
  Equity dividend exclusion........................     5,075      10,194       4,932
  Equity income -- foreign affiliates..............    17,011       5,936
  Goodwill.........................................    (7,242)
  Other -- net.....................................     1,310       3,293       6,332
                                                     --------    --------    --------
          Total....................................    14,035      19,520      19,864
                                                     --------    --------    --------
Income taxes.......................................  $206,374    $200,165    $199,555
                                                     ========    ========    ========
Effective rate.....................................      32.8%       31.9%       31.8%

                                                                    DECEMBER 31,
                                                              ------------------------
                                                                 1997          1996
                                                              ----------    ----------
                                                               (THOUSANDS OF DOLLARS)
Deferred Tax Assets:
  Alternative minimum tax credit carryforwards..............  $   60,669    $   19,014
  Employee benefits.........................................     145,794        68,078
  Internal Revenue Service (IRS) audit assessment...........                    74,966
  Disallowed plant cost -- net..............................      22,378        23,237
  ACES......................................................      42,491
  State operating loss carryforwards........................      29,515
  Deferred state income taxes...............................      14,460
  Other.....................................................      69,235        26,061
  Valuation allowance.......................................      (6,353)
                                                              ----------    ----------
     Total deferred tax assets -- net.......................     378,189       211,356
                                                              ----------    ----------
Deferred Tax Liabilities:
  Depreciation..............................................   2,115,717     1,450,894
  Deferred plant costs -- net...............................     186,472       194,243
  Regulatory assets -- net..................................     356,509       362,310
  Capitalized taxes, employee benefits and removal costs....      46,584       108,530
  Gain on sale of cable television subsidiary...............     222,942       228,449
  Deferred state income taxes...............................      70,000
  Deferred gas costs........................................      34,113
  Other.....................................................     138,633       131,961
                                                              ----------    ----------
     Total deferred tax liabilities.........................   3,170,970     2,476,387
                                                              ----------    ----------
          Accumulated deferred income taxes -- net..........  $2,792,781    $2,265,031
                                                              ==========    ==========

Tax Refund Case. In July 1990, Former HI paid approximately $104.5 million to the Internal Revenue Service (IRS) following an IRS audit of Former HI's 1983 and 1984 federal income tax returns. In November 1991, Former HI filed a refund suit in the U.S. Court of Federal Claims seeking the return of $52.1 million of tax and $36.3 million of accrued interest, plus interest on both of those amounts accruing after July 1990. The major contested issue in the refund case involved the IRS allegation that certain amounts related to the over-recovery of fuel costs should have been included as taxable income in 1983 and 1984 even though the Company had an obligation to refund the over-recoveries to its ratepayers.

In September 1997, the United States Court of Appeals for the Federal Circuit upheld a lower court ruling that the Company (as successor corporation to Former HI) was due a refund of federal income taxes assessed on fuel over-recoveries during 1983 and 1984 that subsequently were refunded to HL&P's customers.

In February 1998, the Company received a refund of approximately $142 million in taxes and interest paid by Former HI in July 1990, including interest accrued since 1990 in the amount of approximately $57 million. After giving effect to the Company's deferred recognition of the 1990 tax payment and payment of federal income taxes due on the accrued interest on the refund, the refund had the effect of increasing the Company's earnings in the fourth quarter of 1997 by $37 million (after-tax).

Tax Attribute Carryforwards. At December 31, 1997, NorAm has approximately $439 million of state net operating losses available to offset future state taxable income through the year 2012. Based on the Company's assessment of its ability to use such loss carryforwards in future tax years, a valuation allowance of

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$6.4 million was recorded at the Acquisition Date. In addition, NorAm has approximately $58 million of federal alternative minimum tax credits which are available to reduce future federal income taxes payable, if any, over an indefinite period (although not below the tentative minimum tax otherwise due in any year), and approximately $2.6 million of state alternative minimum tax credits which are available to reduce future state income taxes payable, if any, through the year 2001.

(12) COMMITMENTS AND CONTINGENCIES

(a) Commitments.

The Company has various commitments for capital expenditures, fuel, purchased power, cooling water and operating leases. Commitments in connection with Electric Operations' capital program are generally revocable by the Company, subject to reimbursement to manufacturers for expenditures incurred or other cancellation penalties. The Company's and its subsidiaries' other commitments have various quantity requirements and durations. However, if these requirements could not be met, various alternatives are available to mitigate the cost associated with the contracts' commitments.

(b) Fuel and Purchased Power.

The Company is a party to several long-term coal, lignite and natural gas contracts which have various quantity requirements and durations. Minimum payment obligations for coal and transportation agreements are approximately $200 million in 1998, $203 million in 1999 and $177 million in 2000. Additionally, minimum payment obligations for lignite mining and lease agreements are approximately $9 million for 1998, $9 million for 1999 and $10 million for 2000. Minimum payment obligations for both natural gas purchase and storage contracts associated with Electric Operations are approximately $9 million annually in 1998, 1999 and 2000.

The Company also has commitments to purchase firm capacity from cogenerators of approximately $22 million in both 1998 and 1999. Texas Utility Commission rules currently allow recovery of these costs through Electric Operations' base rates for electric service and additionally authorize the Company to charge or credit customers through a purchased power cost recovery factor for any variation in actual purchased power costs from the cost utilized to determine its base rates. In the event that the Texas Utility Commission, at some future date, does not allow recovery through rates of any amount of purchased power payments, the two principal firm capacity contracts contain provisions allowing the Company to suspend or reduce payments and seek repayment for amounts disallowed.

(c) Operations Agreement with City of San Antonio.

As part of the settlement with the City of San Antonio, the Company entered into a 10-year joint operations agreement under which the Company and the City of San Antonio, acting through the City Public Service Board of San Antonio (CPS), share savings resulting from the joint dispatching of their respective generating assets in order to take advantage of each system's lower cost resources. Under the terms of the joint operations agreement entered into between CPS and Electric Operations, the Company has guaranteed CPS minimum annual savings of $10 million and a minimum cumulative savings of $150 million over the 10-year term of the agreement. Based on current forecasts and other assumptions regarding the combined operation of the two generating systems, the Company anticipates that the savings resulting from joint operations will equal or exceed the minimum savings guaranteed under the joint operating agreement. In 1996, savings generated for CPS' account for a partial year of joint operations were approximately $14 million. In 1997, savings generated for CPS' account for a full year of operation were approximately $22 million.

(d) Transportation Agreement.

NorAm had an agreement (the ANR Agreement) with ANR Pipeline Company (ANR) which contemplated a transfer to ANR of an interest in certain of NorAm's pipeline and related assets, representing

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

capacity of 250 Mmcf/day, and pursuant to which ANR had advanced $125 million to the Company. The ANR Agreement has been restructured and, after refunds of $84 million through December 31, 1997, NorAm currently retains $41 million (recorded as a liability) in exchange for ANR's or its affiliates' use of 130 Mmcf/ day of capacity in certain of NorAm's transportation facilities. The level of transportation will decline to 100 Mmcf/day in the year 2003 with a refund of $5 million to ANR and the ANR Agreement will terminate in 2005 with a refund of the remaining balance.

(e) Lease Commitments.

The following table sets forth certain information concerning NorAm's obligations under operating leases:

                                                             (MILLIONS OF DOLLARS)
                                                             ---------------------
1998.......................................................          $ 24
1999.......................................................            19
2000.......................................................            16
2001.......................................................            15
2002.......................................................             9
2003 and beyond............................................            22
                                                                     ----
          Total............................................          $105
                                                                     ====

(1) Principally consisting of rental agreements for building space and data processing equipment and vehicles (including major work equipment).

NorAm has a master leasing agreement which provides for the lease of vehicles, construction equipment, office furniture, data processing equipment and other property. For accounting purposes, the lease is treated as an operating lease. At December 31, 1997, NorAm had leased assets with a value of approximately $58.1 million under this lease with a basic term of one year. NorAm does not expect to lease additional property under this lease agreement.

Lease payments related to NorAm's master leasing agreement are included in the preceding table for only their basic term. Total rental expense for all leases since the Acquisition Date was approximately $15 million in 1997.

(f) Letters of Credit.

At December 31, 1997, NorAm had letters of credit incidental with its ordinary business operations totaling approximately $42 million under which NorAm is obligated to reimburse drawings, if any.

(g) Indemnity Provisions.

At December 31, 1997, NorAm has $11.4 million accounting reserve on the Company's Consolidated Balance Sheet in Other Deferred Credits for possible indemnity claims asserted in connection with its disposition of NorAm's former subsidiaries or divisions, including the sale of (i) Louisiana Intrastate Gas Corporation, a former NorAm subsidiary engaged in the intrastate pipeline and liquids extraction business; (ii) Arkla Exploration Company, a former NorAm subsidiary engaged in oil and gas exploration and production activities; and
(iii) Dyco Petroleum Company, a former NorAm subsidiary engaged in oil and gas exploration and production.

HOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(h) Other.

Electric Operations' service area is heavily dependent on oil, gas, refined products, petrochemicals and related businesses. Significant adverse events affecting these industries would negatively affect the revenues of the Company. The Company and NorAm are involved in legal, tax and regulatory proceedings before various courts, regulatory commissions and governmental agencies regarding matters arising in the ordinary course of business, some of which involve substantial amounts. The Company's management regularly analyzes current information and, as necessary, provides accruals for probable liabilities on the eventual disposition of these matters. The Company's management believes that the effect on the Company's and NorAm's respective financial statements, if any, from the disposition of these matters will not be material.

In February 1996, the cities of Wharton, Galveston and Pasadena filed suit, for themselves and a proposed class, against the Company and Houston Industries Finance Inc. (formerly a wholly owned subsidiary of the Company) citing underpayment of municipal franchise fees. The plaintiffs claim, among other things, that from 1957 to the present, franchise fees should have been paid on sales taxes collected by HL&P on non-electric receipts as well as electric sales. Plaintiffs advance their claims notwithstanding their failure to notice such claims over the previous four decades. Because all of the franchise ordinances affecting HL&P expressly impose fees only on electric sales, the Company regards plaintiffs' allegations as spurious and is vigorously contesting the matter. The plaintiffs' pleadings assert that their damages exceed $250 million. No trial date is currently set. Although the Company believes the claims to be without merit, the Company cannot at this time estimate a range of possible loss, if any, from the lawsuit, nor can any assurance be given as to its ultimate outcome

The Company is a party to litigation (other than that specifically noted) which arises in the normal course of business. Management regularly analyzes current information and, as necessary, provides accruals for probable liabilities on the eventual disposition of these matters. Management believes that the effect on the Company's financial statements, if any, from the disposition of these matters will not be material.

                                                                    DECEMBER 31,
                                                  -------------------------------------------------
                                                           1997                      1996
                                                  -----------------------   -----------------------
                                                   CARRYING       FAIR       CARRYING       FAIR
                                                    AMOUNT       VALUE        AMOUNT       VALUE
                                                  ----------   ----------   ----------   ----------
                                                               (THOUSANDS OF DOLLARS)
Financial Assets:
  Company:
     Investment in Time Warner securities.......  $  990,000   $1,420,360   $1,027,500   $1,027,500
  NorAm:
     Energy derivatives.........................       9,399       13,060
Financial Liabilities:
  Company:
     First mortgage bonds.......................   2,495,459    2,651,260    2,895,041    3,045,833
     Debentures.................................     349,283      379,490      349,098      380,455
     ACES.......................................   1,173,786    1,307,247           --           --
     Cumulative preferred stock (subject to
       mandatory redemption)....................          --           --       25,700       25,957
     Trust preferred and capital securities.....     340,882      366,220           --           --
  NorAm:
     Long-term debt.............................   1,148,848    1,147,344
     Trust preferred securities.................      21,290       24,569
     Interest rate swaps........................          --          755
  HI Energy:
     Interest rate swaps........................          --        1,679           --           --

The fair values of cash and short-term investments, investment in the Company's nuclear decommissioning trust, short-term and other notes payable, floating rate debt of HI Energy, and floating rate pollution control revenue bonds are estimated to be equivalent to carrying amounts. The remaining fair values have been determined using quoted market prices of the same or similar securities when available or other estimation techniques.

                                                              YEAR ENDED DECEMBER 31, 1997
                                                   ---------------------------------------------------
                                                     FIRST       SECOND         THIRD        FOURTH
                                                    QUARTER      QUARTER       QUARTER       QUARTER
                                                   ---------   -----------   -----------   -----------
                                                    (THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
Revenues.........................................  $878,101    $1,064,448    $2,158,551    $2,772,285
Operating Income.................................   156,216       247,172       462,716       198,396
Net Income.......................................    59,620       121,463       243,898        (4,033)
Basic Earnings (loss) per common share(a)........       .26           .52           .93          (.01)
Diluted earnings (loss) per common share(a)......       .26           .52           .93          (.01)

                                                              YEAR ENDED DECEMBER 31, 1996
                                                   ---------------------------------------------------
                                                     FIRST       SECOND         THIRD        FOURTH
                                                    QUARTER      QUARTER       QUARTER       QUARTER
                                                   ---------   -----------   -----------   -----------
                                                    (THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
Revenues.........................................  $823,507    $1,113,763    $1,251,025    $  906,982
Operating Income.................................   137,139       286,280       441,069       125,978
Net income (loss)................................   (16,740)      145,334       240,024        36,326
Basic Earnings (loss) per common share(a)........      (.07)          .58           .98           .15
Diluted earnings (loss) per common share(a)......      (.07)          .58           .98           .15

(a) Quarterly earnings per common share are based on the weighted average number of shares outstanding during the quarter, and the sum of the quarters may not equal annual earnings per common share.

(15) REPORTABLE SEGMENTS

Upon the acquisition of NorAm, the Company organized its business into the following segments: Electric Operations, Natural Gas Distribution, Interstate Pipeline, Energy Marketing, International and Corporate segments. Consistent with the purchase accounting treatment of the Merger, financial information for the Natural Gas Distribution, Interstate Pipeline and Energy Marketing segments are presented only for periods beginning on the Acquisition Date. In 1996 and 1995, the Company's Electric Operations accounted for in excess of 90% of the Company's total revenues, income and identifiable assets and as such, the required segment information for those periods is provided on the face of the Company's consolidated financial statements and in the related notes thereto. The Company has presented the following summary of financial information by business segment for 1997 and has included supplemental comparative information for 1996.

                                                                YEAR ENDED DECEMBER 31,
                                                              ---------------------------
                                                                1997(1)          1996
                                                              ------------    -----------
Revenues:
  Electric Operations.......................................  $  4,251,243    $ 4,025,027
  Natural Gas Distribution..................................       892,569
  Interstate Pipeline.......................................       108,333
  Energy Marketing..........................................     1,604,999
  International.............................................        92,028         62,059
  Corporate and Other.......................................        47,851          8,191
  Eliminations..............................................      (123,638)
                                                              ------------    -----------
         Total Revenues.....................................  $  6,873,385    $ 4,095,277
                                                              ============    ===========
Operating Income (Loss):
  Electric Operations.......................................  $    994,938    $   997,147
  Natural Gas Distribution..................................        54,502
  Interstate Pipeline.......................................        31,978
  Energy Marketing..........................................        16,407
  International.............................................        19,510          2,339
  Corporate and Other.......................................       (52,835)        (9,020)
                                                              ------------    -----------
         Total Operating Income.............................     1,064,500        990,466
                                                              ------------    -----------
Other income (expenses).....................................       (13,446)       (55,412)
Interest and Other Charges..................................       423,570        329,945
                                                              ------------    -----------
Income from Continuing Operations Before Tax................  $    627,484    $   605,109
                                                              ============    ===========
Depreciation and Amortization:
  Electric Operations.......................................  $    568,541    $   545,685
  Natural Gas Distribution..................................        51,883
  Interstate Pipeline.......................................        19,088
  Energy Marketing..........................................         4,448
  International.............................................         3,470          1,648
  Corporate and Other.......................................         4,445          2,705
                                                              ------------    -----------
         Total Depreciation and Amortization................  $    651,875    $   550,038
                                                              ============    ===========
Identifiable Assets:
  Electric Operations.......................................  $ 10,540,849    $10,596,232
  Natural Gas Distribution..................................     3,047,195
  Interstate Pipeline.......................................     3,055,610
  Energy Marketing..........................................     1,267,867
  International.............................................       869,485        607,103
  Corporate and Other.......................................    12,837,302      5,771,648
  Eliminations..............................................   (13,203,753)    (4,687,126)
                                                              ------------    -----------
         Total Identifiable Assets..........................  $ 18,414,555    $12,287,857
                                                              ============    ===========
Capital Expenditures:
  Electric Operations.......................................  $    236,977    $   317,532
  Natural Gas Distribution..................................        61,078
  Interstate Pipeline.......................................        16,304
  Energy Marketing..........................................        14,365
  International.............................................       231,528        495,379
  Corporate and Other.......................................        23,572         19,989
                                                              ------------    -----------
         Total Capital Expenditures.........................  $    583,824    $   832,900
                                                              ============    ===========

(1) New categories for segments in 1997 result from the NorAm Merger. See Note 1(b).

(16) SUBSEQUENT EVENTS

In January 1998, the MCND issued on behalf of the Company $104.7 million aggregate principal amount of pollution control revenue refunding bonds with $29.7 million at 5.25% and $75 million at 5.15%. The MCND bonds will mature in 2029. The Company used the proceeds from the sale of these securities to redeem all outstanding 7 7/8% MCND Series 1989A pollution control revenue bonds ($29.7 million) and 7.70% MCND Series 1989B pollution control revenue bonds ($75 million) at a redemption price of 102% of the aggregate principal amount of each series.

In February 1998, the BRA issued on behalf of the Company $290 million aggregate principal amount of pollution control revenue refunding bonds. The BRA bonds will mature in May 2019 ($200 million at 5 1/8%) and November 2020 ($90 million at 5 1/8%). The Company will use the proceeds from the sale of these securities to redeem all the outstanding 8.25% BRA 1988A Series pollution control revenue bonds ($100 million), the 8.25% BRA 1988B Series pollution control revenue bonds ($90 million), and the 8.10% BRA 1988C Series pollution control revenue bonds ($100 million) at a redemption price of 102% of the aggregate principal amount of each series.

In February 1998, NorAm issued $300 million principal amount of 6.5% debentures due February 1, 2008. The debentures are not redeemable prior to maturity and are not subject to any sinking fund requirements. The proceeds from the sale of the debentures were used to repay short-term indebtedness of NorAm, including the indebtedness incurred in connection with the 1997 purchase of $101 million aggregate principal amount of its 10% Debentures and the repayment of $53 million aggregate principal amount of NorAm debt that matured in December 1997 and January 1998. In connection with the issuance of the 6.5% debentures NorAm received approximately $1 million upon unwinding a $300 million treasury rate lock agreement, which was tied to the interest rate on 10-year treasury bonds. The rate lock agreement was executed in January 1998, and proceeds from the unwind will be amortized over the 10 year life of NorAm's 6.5% debentures.

                                                 ACTUAL(1)                  PRO FORMA(2)
                                          YEAR ENDED DECEMBER 31,     YEAR ENDED DECEMBER 31,
                                          ------------------------    ------------------------
                                             1997          1996          1997          1996       % CHANGE
                                          ----------    ----------    ----------    ----------    --------
                                                                             UNAUDITED
                                                         (THOUSANDS OF DOLLARS)
Operating Revenues:
  Natural Gas Distribution..............  $2,202,301    $2,113,589    $2,202,301    $2,113,589        4%
  Interstate Pipeline...................     295,044       346,762       295,044       346,762      (15%)
  Energy Marketing......................   3,589,118     2,645,106     3,589,118     2,645,106       36%
  Corporate and Other...................      81,694        55,403        81,694        55,403       47%
  Elimination of Inter-unit
    Revenues(5).........................    (309,767)     (372,398)     (309,767)     (372,398)     (17%)
                                          ----------    ----------    ----------    ----------
                                           5,858,390     4,788,462     5,858,390     4,788,462      (22%)
                                          ----------    ----------    ----------    ----------
Operating Income (loss):
  Natural Gas Distribution..............     166,435       183,972       152,463       160,020       (5%)
  Interstate Pipeline...................     108,708       124,417        99,927       109,362       (9%)
  Energy Marketing......................      19,288        55,693        15,295        48,848      (69%)
  Corporate and Other...................     (30,235)      (27,272)      (22,613)      (14,204)      59%
                                          ----------    ----------    ----------    ----------
                                             264,196       336,810       245,072       304,026      (19%)
Merger Transaction Costs(3).............      18,400
Early Retirement and Severance(4).......                    22,344                      22,344     (100%)
                                          ----------    ----------    ----------    ----------
Consolidated............................     245,796       314,466       245,072       281,682      (13%)
Interest Expense, Net...................     126,150       132,557       112,482       109,128        3%
Distributions on Subsidiary Trust
  Securities............................       6,596         5,842         1,479         1,110       33%
Other (Income) and Deductions...........      (9,453)       14,577        (9,453)       14,577     (165%)
Income Tax Expense......................      55,781        66,352        72,261        79,973      (10%)
Extraordinary (Gain) Loss, Less Taxes...        (237)        4,280            --            --        --
                                          ----------    ----------    ----------    ----------
  Net Income............................  $   66,959    $   90,858    $   68,303    $   76,894      (11%)
                                          ==========    ==========    ==========    ==========

                                                               UNAUDITED
                                                               PRO FORMA
                                                               YEAR ENDED
                                                              DECEMBER 31,
                                                            ----------------    PERCENT
                                                             1997      1996     CHANGE
                                                            ------    ------    -------
                                                            ($ IN MILLIONS)
Operating Revenues........................................  $2,202    $2,113       4%
Operating Expenses:
  Natural Gas.............................................   1,441     1,348       7%
  Operation and Maintenance...............................     247       250      (1%)
  Depreciation and Amortization...........................     123       120       3%
  Other Operating Expenses(1).............................     238       235       1%
                                                            ------    ------
Total Operating Expenses..................................   2,049     1,953       5%
                                                            ------    ------
  Operating Income........................................  $  153    $  160      (4%)
                                                            ======    ======
Throughput Data (in Bcf):
  Residential and Commercial Sales........................     326       333      (2%)
  Industrial Sales........................................      59        58       2%
  Transportation..........................................      42        42       --
                                                            ------    ------
     Total Throughput.....................................     427       433      (1%)
                                                            ======    ======

                                                                 UNAUDITED
                                                                 PRO FORMA
                                                                 YEAR ENDED
                                                                DECEMBER 31,
                                                              ----------------    PERCENT
                                                               1997      1996     CHANGE
                                                              ------    ------    -------
                                                              ($ IN MILLIONS)
Operating Revenues..........................................   $295      $347      (15%)
Operating Expenses:
  Natural Gas...............................................     42        76      (45%)
  Operation and Maintenance.................................     45        49       (8%)
  Depreciation and Amortization.............................     46        45        2%
  Other Operating Expenses(1)...............................     62        68       (9%)
                                                               ----      ----
          Total Operating Expenses..........................    195       238      (18%)
                                                               ----      ----
Operating Income............................................   $100      $109       (9%)
                                                               ====      ====
Throughput Data (in million MMBtu):
Natural Gas Sales...........................................     18        33      (45%)
Transportation..............................................    911       952       (4%)
     Elimination(2).........................................    (17)      (31)      45%
                                                               ----      ----
Total Throughput............................................    912       954       (4%)
                                                               ====      ====

                                                           UNAUDITED PRO FORMA
                                                                YEAR ENDED
                                                               DECEMBER 31
                                                           --------------------     PERCENT
                                                             1997        1996       CHANGE
                                                           --------    --------     -------
                                                              (IN MILLIONS)
Operating Revenues.......................................   $3,589      $2,645        36%
Operating Expenses:
  Natural Gas and Purchased Power, net...................    3,477       2,489        40%
  Operation and Maintenance..............................       46          68       (32%)
  Depreciation and Amortization..........................       11          10        10%
  Other Operating Expenses...............................       40          29        38%
                                                            ------      ------
          Total Operating Expenses.......................    3,574       2,596        38%
                                                            ------      ------
Operating Income.........................................   $   15      $   49       (69%)
                                                            ======      ======
Operations Data:
  Natural Gas (in Bcf):
     Sales...............................................    1,185       1,076        10%
     Transportation......................................       24          26        (8%)
     Gathering...........................................      242         231         5%
                                                            ------      ------
          Total..........................................    1,451       1,333         9%
                                                            ======      ======
  Electricity:
     Wholesale Power Sales (in thousand MWH).............   24,997       2,776       800%
                                                            ======      ======

                                       CURRENT NORAM                     FORMER NORAM
                                       -------------    ----------------------------------------------
                                        FIVE MONTHS     SEVEN MONTHS    TWELVE MONTHS    TWELVE MONTHS
                                           ENDED           ENDED            ENDED            ENDED
                                       DECEMBER 31,       JULY 31,      DECEMBER 31,     DECEMBER 31,
                                           1997             1997            1996             1995
                                       -------------    ------------    -------------    -------------
Operating Revenues...................   $2,521,342       $3,337,048      $4,788,462       $2,964,679
                                        ----------       ----------      ----------       ----------
Operating Expenses
  Natural gas and purchased power,
     net.............................    2,041,504        2,636,340       3,571,411        1,857,166
  Operation and maintenance..........      259,315          370,369         621,279          564,790
  Depreciation and amortization......       78,207           84,901         142,362          147,109
  Taxes other than income taxes......       50,416           73,142         116,600          108,309
  Merger transaction costs...........        1,144           17,256              --               --
  Early retirement and severance.....           --               --          22,344               --
                                        ----------       ----------      ----------       ----------
                                         2,430,586        3,182,008       4,473,996        2,677,374
                                        ----------       ----------      ----------       ----------
Operating Income.....................       90,756          155,040         314,466          287,305
                                        ----------       ----------      ----------       ----------
Other (Income) and Deductions
  Interest expense, net..............       47,490           78,660         132,557          157,959
  Dividend requirement on preferred
     securities of subsidiary
     trust...........................          279            6,317           5,842               --
  Other, net.........................       (2,243)          (7,210)          3,078           (1,333)
  Loss on sale of accounts
     receivable......................           --               --          11,499            9,771
                                        ----------       ----------      ----------       ----------
                                            45,526           77,767         152,976          166,397
                                        ----------       ----------      ----------       ----------
Income Before Income Taxes...........       45,230           77,273         161,490          120,908
Income Tax Expense...................       24,383           31,398          66,352           55,379
                                        ----------       ----------      ----------       ----------
Income Before Extraordinary Item.....       20,847           45,875          95,138           65,529
Extraordinary gain(loss) on early
  retirement of debt, less taxes.....           --              237          (4,280)             (52)
                                        ----------       ----------      ----------       ----------
Net Income...........................       20,847           46,112          90,858           65,477
Preferred dividend requirement.......           --               --           3,597            7,800
                                        ----------       ----------      ----------       ----------
Earnings Available to Common Stock...   $   20,847       $   46,112      $   87,261       $   57,677
                                        ==========       ==========      ==========       ==========

See Notes to NorAm's Consolidated Financial Statements.

                                                                                                         UNREALIZED
                                COMMON STOCK(1)         PREFERRED STOCK(2)                   RETAINED    INVESTMENT
                            -----------------------   ----------------------     PAID-IN     EARNINGS    GAIN (LOSS)
                               SHARES       AMOUNT      SHARES      AMOUNT       CAPITAL     (DEFICIT)   NET OF TAX      TOTAL
                            ------------   --------   ----------   ---------   -----------   ---------   -----------   ----------
FORMER NORAM:
Balance at January 1,
  1995....................   122,530,248   $ 76,581    2,600,000   $ 130,000   $   868,289   $(360,079)    $ 2,586     $  717,377
Net Income................                                                                      65,477                     65,477
Cash Dividends:
  Preferred stock -- $3.00
    per share.............                                                                      (7,800)                    (7,800)
  Common stock -- $0.28
    per share.............                                                                     (34,538)                   (34,538)
Change in Market Value of
  Marketable Equity
  Securities, net of
  tax.....................                                                                                  12,730         12,730
Issuance of Common stock
  under Direct Stock
  Purchase Plan...........     1,610,148      1,006                                  8,795                                  9,801
Other Issuances...........       663,297        415                                  3,801                                  4,216
                            ------------   --------   ----------   ---------   -----------   ---------     -------     ----------
Balance at December 31,
  1995....................   124,803,693     78,002    2,600,000     130,000       880,885    (336,940)     15,316        767,263
                            ------------   --------   ----------   ---------   -----------   ---------     -------     ----------
Net Income................                                                                      90,858                     90,858
Cash Dividends:
  Preferred stock -- $1.50
    per share.............                                                                      (3,900)                    (3,900)
  Common stock -- $0.28
    per share.............                                                                     (36,721)                   (36,721)
Change in Market Value of
  Marketable Equity
  Securities, net of
  tax.....................                                                                                 (15,311)       (15,311)
Conversion to Subordinated
  Debentures..............                            (2,600,000)   (130,000)                                            (130,000)
Issuance of Common Stock
  under Direct Stock
  Purchase Plan...........       937,193        586                                  9,668                                 10,254
Public Issuance of Common
  Stock...................    11,500,000      7,188                                101,775                                108,963
Other Issuances...........       667,287        417                                  8,725                                  9,142
                            ------------   --------   ----------   ---------   -----------   ---------     -------     ----------
Balance at December 31,
  1996....................   137,908,173     86,193           --          --     1,001,053    (286,703)          5        800,548
                            ------------   --------   ----------   ---------   -----------   ---------     -------     ----------
Net Income................                                                                      46,112                     46,112
Cash Dividends:
  Common stock -- $0.14
    per share.............                                                                     (19,281)                   (19,281)
Change in Market Value of
  Marketable Equity
  Securities, net of
  tax.....................                                                                                   5,874          5,874
Conversion of
  NorAm-Obligated
  Mandatorily Redeemable
  Convertible Preferred
  Securities of Subsidiary
  Trust Holding Solely
  Subordinated Debentures
  of NorAm to Common
  Stock...................    11,428,262      7,143                                131,425                                138,568
Other Issuances...........       347,527        216                                  5,796                                  6,012
                            ------------   --------   ----------   ---------   -----------   ---------     -------     ----------
  Balance at July 31,
    1997..................   149,683,962     93,552           --          --     1,138,274    (259,872)      5,879        977,833
                            ------------   --------   ----------   ---------   -----------   ---------     -------     ----------
CURRENT NORAM (POST
  MERGER):
Adjustments due to Merger:
  Eliminate Former NorAm
    Balances..............  (149,683,962)   (93,552)                            (1,138,274)    259,872      (5,879)      (977,833)
Capital contribution from
  Parent..................         1,000          1                              2,463,831                              2,463,832
Net Income................                                                                      20,847                     20,847
Change in Market Value of
  Marketable Equity
  Securities, net of
  tax.....................                                                                                  (5,634)        (5,634)
                            ------------   --------   ----------   ---------   -----------   ---------     -------     ----------
Balance at December 31,
  1997....................         1,000   $      1           --   $      --   $ 2,463,831   $  20,847     $(5,634)    $2,479,045
                            ============   ========   ==========   =========   ===========   =========     =======     ==========

(1) $.625 par, authorized 250,000,000 shares. On the Acquisition Date, NorAm's pre-merger common stock was canceled and replaced with 1,000 shares of common stock (all of which are owned by Houston Industries); see Note 1(b).

(2) $3.00 Convertible exchangeable preferred stock, Series A ($50 liquidation preference), cumulative, non-voting; authorized 10,000,000 shares. On the Acquisition Date, NorAm's pre-merger preferred stock was canceled.

See Notes to NorAm's Consolidated Financial Statements.

                                                              CURRENT NORAM    FORMER NORAM
                                                              -------------    ------------
                                                              DECEMBER 31,     DECEMBER 31,
                                                                  1997             1996
                                                              -------------    ------------
Property, Plant and Equipment
  Natural gas distribution..................................   $1,326,442       $2,158,013
  Interstate pipeline.......................................    1,258,087        1,685,959
  Energy marketing..........................................      162,519          252,509
  Other.....................................................       14,972           20,150
                                                               ----------       ----------
          Total.............................................    2,762,020        4,116,631
  Less accumulated depreciation and amortization............       59,531        1,675,576
                                                               ----------       ----------
  Property, plant and equipment -- net......................    2,702,489        2,441,055
                                                               ----------       ----------
Current Assets
  Cash and cash equivalents.................................       35,682           27,981
  Accounts and notes receivable, principally customer.......      969,248          696,982
  Accounts receivable from parent...........................       10,161
  Deferred income taxes.....................................        8,309           10,495
  Gas in underground storage................................       63,702           70,651
  Materials and supplies....................................       29,611           30,595
  Gas purchased in advance of delivery......................        6,200            6,200
  Other current assets......................................       24,386           15,423
                                                               ----------       ----------
          Total current assets..............................    1,147,299          858,327
                                                               ----------       ----------
Other Assets
  Goodwill, net.............................................    2,026,395          466,938
  Prepaid pension asset.....................................       92,064           45,390
  Investment in marketable equity securities................       27,046           26,670
  Regulatory asset for environmental costs..................       21,745           39,152
  Gas purchased in advance of delivery......................       29,048           34,895
  Deferred debits, net......................................       23,954           32,200
                                                               ----------       ----------
          Total other assets................................    2,220,252          645,245
                                                               ----------       ----------
Deferred Charges, net.......................................       69,056           72,850
                                                               ----------       ----------
Total Assets................................................   $6,139,096       $4,017,477
                                                               ==========       ==========

See Notes to NorAm's Consolidated Financial Statements

                                                              CURRENT NORAM    FORMER NORAM
                                                              -------------    ------------
                                                              DECEMBER 31,     DECEMBER 31,
                                                                  1997             1996
                                                              -------------    ------------
Stockholders' Equity:
  Common stock..............................................   $        1       $   86,193
  Paid-in capital...........................................    2,463,831        1,001,053
  Retained earnings (deficit)...............................       20,847         (286,703)
  Unrealized gain (loss) on marketable equity securities,
     net of tax.............................................       (5,634)               5
                                                               ----------       ----------
          Total.............................................    2,479,045          800,548
                                                               ----------       ----------
NorAm-Obligated Mandatorily Redeemable Convertible Preferred
  Securities of Subsidiary Trust Holding Solely Junior
  Subordinated Debentures of NorAm, net.....................       21,290          167,768
Long-Term Debt, less Current Maturities.....................      916,703        1,054,221
Current Liabilities:
  Current maturities of long-term debt......................      232,145          277,000
  Notes payable to banks....................................      390,000          115,000
  Notes payable to parent...................................       22,100
  Receivables facility......................................      300,000
  Accounts payable, principally trade.......................      668,269          762,164
  Income taxes payable......................................                        11,684
  Interest payable..........................................       27,273           31,928
  General taxes.............................................       41,315           51,082
  Customer deposits.........................................       36,626           35,711
  Other current liabilities.................................      133,278          113,628
                                                               ----------       ----------
          Total current liabilities.........................    1,851,006        1,398,197
                                                               ----------       ----------
Deferred Credits and Other Liabilities:
  Accumulated deferred income taxes.........................      483,039          320,506
  Estimated environmental remediation costs.................       21,745           39,152
  Payable under capacity lease agreement....................       41,000           41,000
  Benefit liabilities.......................................      182,687           90,544
  Estimated obligations under indemnification provisions of
     sale agreements........................................       11,391           29,098
  Refundable excess deferred income taxes...................       13,569           17,946
  Other.....................................................      117,621           58,497
                                                               ----------       ----------
          Total.............................................      871,052          596,743
                                                               ----------       ----------
Commitments and Contingencies (Note 8)
Total Liabilities and Stockholders' Equity..................   $6,139,096       $4,017,477
                                                               ==========       ==========

See Notes to NorAm's Consolidated Financial Statements

                                                  CURRENT NORAM                   FORMER NORAM
                                                  -------------   --------------------------------------------
                                                   FIVE MONTHS    SEVEN MONTHS   TWELVE MONTHS   TWELVE MONTHS
                                                      ENDED          ENDED           ENDED           ENDED
                                                  DECEMBER 31,      JULY 31,     DECEMBER 31,    DECEMBER 31,
                                                      1997            1997           1996            1995
                                                  -------------   ------------   -------------   -------------
Cash Flows from Operating Activities:
  Net income....................................   $   20,847      $  46,112       $  90,858       $  65,477
  Adjustments to reconcile net income to net
     cash provided by (used in) operating
     activities:
     Depreciation and amortization..............       78,207         84,901         142,362         147,109
     Deferred income taxes......................       36,770         14,589          28,809          34,883
     Early retirement and severance, less cash
       costs....................................                                      12,941
     Extraordinary (gain)loss, less taxes.......                        (237)          4,280              52
     Utilization of tax loss carryforwards......                                      (2,405)        (19,797)
     Changes in other assets and liabilities,
       net of the effects of the acquisition:
       Accounts and notes receivable-net........     (361,285)       313,586        (353,703)       (119,933)
       Inventories..............................       (2,250)         9,980         (14,895)         25,112
       Deferred gas costs.......................        8,655         (7,715)         12,788         (19,831)
       Other current assets.....................       (1,298)        (1,128)         10,935          10,661
       Accounts payable.........................      148,071       (224,590)        266,446         162,595
       Interest and taxes accrued...............      (13,402)       (19,996)          4,712          19,597
       Other current liabilities................       42,284        (22,633)         10,483           5,151
       Recoveries under gas contract disputes...        2,600          5,500          10,900          24,200
       Other-net................................       10,557            903           3,642           3,633
                                                   ----------      ---------       ---------       ---------
          Net cash provided by (used in)
            operating activities................      (30,244)       199,272         228,153         338,909
                                                   ----------      ---------       ---------       ---------
Cash Flows from Investing Activities:
  Purchase of Former NorAm, net of cash
     acquired...................................   (1,422,672)
  Capital expenditures..........................      (93,414)       (88,638)       (172,200)       (173,600)
  Cash surrender value of life insurance........                                                      12,276
  Other, net....................................       (1,079)        (6,424)         (4,957)         (4,403)
                                                   ----------      ---------       ---------       ---------
          Net cash used in investing
            activities..........................   (1,517,165)       (95,062)       (177,157)       (165,727)
                                                   ==========      =========       =========       =========

(continued on next page)

                                                  CURRENT NORAM                   FORMER NORAM
                                                  -------------   --------------------------------------------
                                                   FIVE MONTHS    SEVEN MONTHS   TWELVE MONTHS   TWELVE MONTHS
                                                      ENDED          ENDED           ENDED           ENDED
                                                  DECEMBER 31,      JULY 31,     DECEMBER 31,    DECEMBER 31,
                                                      1997            1997           1996            1995
                                                  -------------   ------------   -------------   -------------
Cash Flows from Financing Activities:
  Cash portion of capital contribution from
     Houston Industries.........................   $1,426,067
  Proceeds from issuance of 7 1/2% notes........                                                   $ 200,000
  Retirements and reacquisitions of long-term
     debt.......................................     (165,808)     $(230,667)      $(396,733)       (335,352)
  Proceeds from bank term loan..................                     150,000                         150,000
  Public issuance of common stock...............                                     108,963
  Public issuance of convertible preferred
     securities by
     subsidiary trust...........................                                     167,756
  Other debt borrowings (repayments)............      317,500        (42,500)        105,000        (100,000)
  Return of advance received under contingent
     sales agreement............................                                                     (50,000)
  Increase in receivables facility..............       24,000         41,000
  Issuance of common stock under direct stock
     purchase plan, net.........................                                      10,254           9,801
  Common and preferred stock dividends..........                     (19,281)        (40,621)        (42,338)
  Redemption of convertible securities..........       (9,504)
  Increase (decrease) in overdrafts.............       (9,164)       (27,348)          9,055          (9,614)
                                                   ----------      ---------       ---------       ---------
          Net cash provided by (used in)
            financing activities................    1,583,091       (128,796)        (36,326)       (177,503)
                                                   ----------      ---------       ---------       ---------
Net Increase (Decrease) in Cash and Cash
  Equivalents...................................       35,682        (24,586)         14,670          (4,321)
Cash and Cash Equivalents at Beginning of the
  Period........................................                      27,981          13,311          17,632
                                                   ----------      ---------       ---------       ---------
Cash and Cash Equivalents at End of the
  Period........................................   $   35,682      $   3,395       $  27,981       $  13,311
                                                   ==========      =========       =========       =========
Supplemental Disclosure of Cash Flow
  Information:
Cash Payments:
  Interest (net of amounts capitalized).........   $   55,951      $  67,100       $ 140,751       $ 154,866
  Income taxes, net.............................          714         20,900          29,657          19,970

The aggregate consideration paid to Former NorAm stockholders in connection with the Merger consisted of $1.4 billion in cash and 47.8 million shares of Houston Industries common stock valued at approximately $1.0 billion. The overall transaction was valued at $4.0 billion consisting of $2.4 billion for Former NorAm's common stock and common stock equivalents and $1.6 billion of Former NorAm debt. A significant portion ($139 million) of NorAm obligated mandatorily redeemable convertible preferred securities of subsidiary trust holding solely subordinated debentures of NorAm was converted to NorAm Common Stock in non-cash transactions prior to the Merger; see Note 5.

See Notes to NorAm's Consolidated Financial Statements.

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1997

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Nature of Operations.

NorAm Energy Corp. (NorAm), a Delaware corporation, is a wholly owned subsidiary of Houston Industries defined below. NorAm is principally engaged in the natural gas industry, including gathering, transmission, marketing, storage and distribution. Collectively, these operations accounted for in excess of 90% of NorAm's total revenues, income or loss and identifiable assets during 1997.

NorAm's natural gas distribution operations (Natural Gas Distribution) are conducted by three of its unincorporated divisions: Entex, Minnegasco and Arkla. NorAm's interstate pipeline operations (Interstate Pipeline) are conducted by its wholly owned subsidiaries, NorAm Gas Transmission Company (NGT) and Mississippi River Transmission Corporation (MRT). NorAm's energy marketing activities are conducted primarily by NorAm Energy Services, Inc. (NES) and NorAm Energy Management, Inc. (NEM) and its gathering activities are conducted by NorAm Field Services Corp. (NFS) (collectively Energy Marketing). NorAm's principal operations are located in Arkansas, Louisiana, Minnesota, Mississippi, Missouri and Texas.

As of December 31, 1997, all shares of NorAm's common stock were pledged as collateral under a $1.64 billion loan arrangement entered into by a subsidiary of Houston Industries in connection with the Merger (defined below). Under the provisions of this facility, Houston Industries may become obligated to pledge additional stock of subsidiaries of NorAm if such subsidiaries should become "significant subsidiaries" (as defined under the facility) of Houston Industries.

(b) Merger With Houston Industries Incorporated.

On August 6, 1997 (Acquisition Date), Houston Industries Incorporated (Former HI) merged with and into Houston Lighting & Power Company, which was renamed "Houston Industries Incorporated" (Houston Industries), and NorAm Energy Corp., (Former NorAm) merged with and into a subsidiary of Houston Industries, HI Merger, Inc., which was renamed "NorAm Energy Corp." (NorAm). Effective upon the mergers (collectively, the Merger), each outstanding share of common stock of Former HI was converted into one share of common stock (including associated preference stock purchase rights) of Houston Industries, and each outstanding share of common stock of Former NorAm was converted into the right to receive $16.3051 cash or 0.74963 shares of common stock of Houston Industries. The aggregate consideration paid to Former NorAm stockholders in connection with the Merger consisted of $1.4 billion in cash and 47.8 million shares of Houston Industries' common stock valued at approximately $1.0 billion. The overall transaction was valued at $4.0 billion consisting of $2.4 billion for Former NorAm's common stock and common stock equivalents and $1.6 billion of Former NorAm debt ($1.3 billion of which was long-term debt).

The Merger was recorded under the purchase method of accounting with assets and liabilities of NorAm reflected at their estimated fair values as of the Acquisition Date, resulting in a "new basis" of accounting. In NorAm's consolidated financial statements (NorAm's Consolidated Financial Statements), periods which reflect the new basis of accounting are labeled as "Current NorAm" and periods which do not reflect the new basis of accounting are labeled "Former NorAm". Former NorAm's Statement of Consolidated Income for the seven months ended July 31, 1997 include certain adjustments from August 1, 1997 to the Acquisition Date for pre-merger transactions.

NorAm's Consolidated Balance Sheets for periods after the Acquisition Date reflect adjustments associated with Houston Industries' assignment of the purchase price, principally consisting of (1) the revaluation of certain property, plant and equipment and long-term debt to their estimated fair market value, (2) the recognition of certain pension and postretirement benefit obligations previously being recognized through amortization, (3) the recognition of goodwill as described above, (4) the elimination of NorAm's historical goodwill, (5) the elimination of NorAm's historical stockholders' equity balances and accumulated

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

depreciation and amortization as of the Acquisition Date and (6) the recognition of the associated deferred income tax effects. In addition, NorAm's pre-merger common stock was canceled and replaced with 1,000 shares of common stock (all of which are owned by Houston Industries), rendering presentation of per share data no longer meaningful. Houston Industries' debt to fund the cash portion of the purchase consideration has not been allocated or "pushed down" to NorAm and is not reflected on NorAm's Financial Statements.

NorAm's Statements of Consolidated Income for periods after the Acquisition Date are principally affected by (1) the amortization (over 40 years) of the newly-recognized goodwill, partially offset by the elimination of the amortization of NorAm's historical goodwill, (2) the amortization (to interest expense) of the revaluation of long-term debt, (3) the removal of the amortization (to operating expense) previously associated with the pension and postretirement obligations as described preceding and (4) the deferred income tax expense associated with these adjustments. Interest expense on Houston Industries' debt which was used to fund the cash portion of the acquisition has not been allocated or "pushed down" to NorAm and is not reflected on NorAm's Financial Statements. For these reasons, among others, certain financial information for periods before and after the Acquisition Date is not comparable.

If the Merger had occurred on January 1, 1997 and 1996, NorAm's unaudited pro forma net income for 1997 and 1996 would have been $68.3 million and $76.9 million, respectively. Pro forma results are based on assumptions deemed appropriate by NorAm's management, have been prepared for informational purposes only and are not necessarily indicative of the results which would have resulted had the Merger actually taken place on the date indicated.

(c) Regulatory Assets and Regulation.

In general, NorAm's interstate pipelines are subject to regulation by the Federal Energy Regulatory Commission, while its natural gas distribution operations are subject to regulation at the state or municipal level. Historically, all of NorAm's rate-regulated businesses have followed the accounting guidance contained in Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation" . NorAm discontinued application of SFAS No. 71 to NGT in 1992. As a result of the continued application of SFAS No. 71 to MRT and the natural gas distribution operations, NorAm's financial statements contain assets and liabilities which would not be recognized by unregulated entities.

At December 31, 1997 approximately $48 million in regulatory assets are reflected on NorAm's Consolidated Balance Sheet as deferred debits. These assets represent probable future revenue to NorAm associated with certain incurred costs as these costs are recovered through the rate making process. These costs are being recovered through rates over varying periods up to 40 years.

(d) Principles of Consolidation.

NorAm's Consolidated Financial Statements include the accounts of NorAm and its wholly owned subsidiaries (NorAm). All significant intercompany transactions and balances are eliminated in consolidation.

(e) Property, Plant and Equipment.

Property, plant and equipment have been revalued to estimated fair market value as of the Acquisition Date in accordance with the purchase method of accounting, and depreciated or amortized on a straight-line basis over their estimated useful lives; see Note 1(b) above. Prior to the Acquisition Date, such assets were carried at cost. Additions to and betterments of utility property are charged to property accounts at cost, while the costs of maintenance, repairs and minor replacements are charged to expense as incurred. Upon normal retirement of units of utility property, plant and equipment, the cost of such property, together with cost of removal less salvage, is charged to accumulated depreciation.

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(f) Depreciation and Amortization Expense.

Goodwill, none of which is being recovered in regulated service rates, is amortized on a straight-line basis over 40 years. Approximately $29.9 million of goodwill was amortized during 1997. Of this amount, $21.6 million represents amortization related to the Merger and incurred during the period from the Acquisition Date through December 31, 1997. Goodwill amortization for 1996 was approximately $14.2 million. NorAm periodically compares the carrying value of its goodwill to the anticipated undiscounted future operating income from the businesses whose acquisition gave rise to the goodwill and, as yet, no impairment is indicated or expected. For additional information regarding the amortization of goodwill in connection with the Merger, see Note 1(b) above.

(g) Fuel Stock and Other Inventories.

Inventories principally follow the average cost method. Gas inventory (at average cost) was $63.7 million and $70.7 million at December 31, 1997 and 1996, respectively. All non-utility inventories held for resale are valued at the lower of cost or market.

(h) Revenues.

NorAm's rate-regulated divisions/subsidiaries bill customers on a monthly cycle billing basis. Revenues are recorded on an accrual basis, including an estimate for gas delivered but unbilled at the end of each accounting period.

(i) Statements of Consolidated Cash Flows.

For purposes of reporting cash flows, cash equivalents are considered to be short-term, highly liquid investments readily convertible into cash.

(j) Derivative Financial Instruments (Risk Management).

For information regarding NorAm's accounting for derivative financial instruments associated with natural gas, electric power and transportation risk management activities, see Note 2.

(k) Income Taxes.

Houston Industries files a consolidated federal income tax return, in which NorAm and its subsidiaries are included (as of the Acquisition Date). Houston Industries follows a policy of comprehensive interperiod income tax allocation. For additional information regarding income taxes, see Note 7.

(l) Investments in Marketable Equity Securities.

A subsidiary of NorAm holds certain equity securities classified as "available-for-sale" and, in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," reports such investments at estimated fair value with any unrealized gain or loss, net of tax, as a separate component of stockholders' equity. At December 31, 1997, NorAm's unrealized loss relating to these marketable equity securities was approximately $5.6 million, net of tax of $3.0 million.

(m) Reclassifications and Use of Estimates.

Certain amounts from the previous years have been reclassified to conform to the 1997 presentation of financial statements. Such reclassifications do not affect earnings.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

(n) Early Retirement and Severance.

During the first quarter of 1996, NorAm instituted several early retirement and reorganization plans, pursuant to which a total of approximately 400 positions were eliminated resulting in expense for severance payments and enhanced retirement benefits reported as a non-recurring pre-tax charge of approximately $22.3 million (approximately $13.4 million after tax).

(o) Merger Transaction Costs.

"Merger transaction costs" include expenses associated with completion of the business combination with Houston Industries (see Note 1(b)), principally consisting of investment banking and legal fees.

(p) Allowance for Doubtful Accounts.

Accounts and notes receivable, principally customer as presented on NorAm's Consolidated Balance Sheets are net of an allowance for doubtful accounts of $15.3 million and $13.0 million at December 31, 1997 and 1996, respectively.

(q) Accounts Payable.

Certain of NorAm's cash balances reflect credit balances to the extent that checks written have not yet been presented for payment. Such balances included in accounts payable, principally trade on the NorAm Consolidated Balance Sheets were approximately $17.0 million and $53.5 million at December 31, 1997 and 1996, respectively.

(2) DERIVATIVE FINANCIAL INSTRUMENTS (RISK MANAGEMENT)

(a) Trading Activities.

NorAm, through NES, offers price risk management services primarily in the natural gas and electric industries. NES provides these services through, and by utilizing, a variety of derivative financial instruments, including fixed-price swap agreements, variable-price swap agreements, exchange-traded energy futures and option contracts, and swaps and options traded in the over-the-counter financial markets. Fixed-price swap agreements require payments to, or receipts of payments from, counterparties based on the differential between a fixed and variable price for the commodity. Variable-price swap agreements require payments to, or receipts of payments from, counterparties based on the differential between either industry pricing publications or exchange quotations.

Certain trading transactions qualify for hedge accounting and accordingly unrealized gains and losses associated with these transactions are deferred. For trading transactions that do not qualify for hedge accounting, NES uses mark-to-market accounting. Accordingly, such financial instruments are recorded at fair value with realized and unrealized gains (losses) recorded as a component of revenues in NorAm's Statements of Consolidated Income. The recognized, unrealized balance is recorded as a deferred debit on NorAm's Consolidated Balance Sheets.

                                               VOLUME-FIXED     VOLUME-FIXED       MAXIMUM
                                               PRICE PAYOR     PRICE RECEIVER    TERM (YEARS)
                                               ------------    --------------    ------------
Natural gas..................................     85,701           64,890             4
Electricity..................................     40,511           42,976             1

In addition to the fixed-price notional volumes above, NES also has variable-price swap agreements, as discussed above, totaling 101,465 Bbtue. Notional amounts reflect the volume of transactions but do not represent the amounts exchanged by the parties to the financial instruments. Accordingly, notional amounts do not accurately measure NorAm's exposure to market or credit risks.

The estimated fair value of derivative financial instruments held for trading purposes at December 31, 1997 are presented below (dollars in millions):

                                                    FAIR VALUE           AVERAGE FAIR VALUE(A)
                                               ---------------------    -----------------------
                                               ASSETS    LIABILITIES    ASSETS      LIABILITIES
                                               ------    -----------    ------      -----------
Natural gas..................................   $46          $39         $56            $48
Electricity..................................   $ 6          $ 6         $ 3            $ 2

(a) Computed using the ending balance of each month.

Substantially all of the fair value shown in the table above at December 31, 1997 has been recognized in income. The fair value as of and for the year ended December 31, 1997 was estimated using quoted prices where available and considering the liquidity of the market for the derivative financial instruments. The prices are subject to significant changes based on changing market conditions. The derivative financial instruments included in the NES trading portfolio as of and for the year ended December 31, 1996 were immaterial.

The weighted-average term of the trading portfolio, based on volumes, is less than one year. The maximum and average terms disclosed herein are not indicative of likely future cash flows as these positions may be changed by new transactions in the trading portfolio at any time in response to changing market conditions, market liquidity and NorAm's risk management portfolio needs and strategies. Terms regarding cash settlements of these contracts vary with respect to the actual timing of cash receipts and payments.

(b) Non-Trading Activities.

To reduce the risk from market fluctuations in the price of electric power, natural gas and related transportation, NorAm and certain of its subsidiaries enter into futures transactions, swaps and options (Energy Derivatives) in order to hedge certain natural gas in storage, as well as certain expected purchases, sales and transportation of natural gas and electric power (a portion of which are firm commitments at the inception of the hedge). Energy Derivatives are also utilized to fix the price of compressor fuel or other future operational gas requirements, although usage to date for this purpose has not been material. Usage of electricity derivative financial instruments by NorAm and its subsidiaries for purposes other than trading is immaterial.

NorAm also utilizes interest-rate derivatives (principally interest-rate swaps) in order to adjust the portion of its overall borrowings which are subject to interest-rate risk, and also utilizes such derivatives to effectively fix the interest rate on debt expected to be issued for refunding purposes.

For transactions involving either Energy Derivatives or interest-rate derivatives, hedge accounting is applied only if the derivative (i) reduces the price risk of the underlying hedged item and (ii) is designated as a hedge at its inception. Additionally, the derivatives must be expected to result in financial impacts which are

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

inversely correlated to those of the item(s) to be hedged. This correlation (a measure of hedge effectiveness) is measured both at the inception of the hedge and on an ongoing basis, with an acceptable level of correlation of 80% for hedge designation. If and when correlation ceases to exist at an acceptable level, hedge accounting ceases and mark-to-market accounting is applied.

In the case of interest-rate swaps associated with existing obligations, cash flows and expenses associated with the interest-rate derivative transactions are matched with the cash flows and interest expense of the obligation being hedged, resulting in an adjustment to the effective interest rate. When interest rate swaps are utilized to effectively fix the interest rate for an anticipated debt issuance, changes in the market value of the interest-rate derivatives are deferred and recognized as an adjustment to the effective interest rate on the newly issued debt.

Unrealized changes in the market value of Energy Derivatives utilized as hedges are not generally recognized in NorAm's Statements of Consolidated Income until the underlying hedged transaction occurs. Once it becomes probable that an anticipated transaction will not occur, deferred gains and losses are recognized. In general, the financial impact of transactions involving these Energy Derivatives is included in NorAm's Statements of Consolidated Income under the caption natural gas and purchased power, net. Cash flows resulting from these transactions in Energy Derivatives are included in NorAm's Statements of Consolidated Cash Flows in the same category as the item being hedged.

At December 31, 1997, subsidiaries of NorAm were fixed-price payors and fixed-price receivers in Energy Derivatives covering 38,754 Bbtu and 7,647 Bbtu of natural gas, respectively. At December 31, 1996, subsidiaries of NorAm were fixed-price payors and fixed-price receivers in Energy Derivatives covering approximately 150,300 Bbtu and 66,500 Bbtu of natural gas, respectively. Also, at December 31, 1997, subsidiaries of NorAm were parties to variable-priced Energy Derivatives totaling 3,630 Bbtu of natural gas. The weighted average maturity of these instruments at December 31, 1997 and 1996, respectively, is less than one year.

NorAm has entered into options with various third parties which principally serve to limit the year-to-year escalation from January 1998 to April 1999 in the purchase price of gas which NorAm is committed to deliver to a distribution affiliate. These options, which covered 9,800 Bbtu and 2,400 Bbtu at December 31, 1997 and 1996, respectively, expired in January 1998 unexercised. NorAm previously established a reserve equal to its projected maximum exposure to losses during the term of this commitment and, accordingly, no impact on earnings is expected.

The notional amount is intended to be indicative of NorAm and its subsidiaries' level of activity in such derivatives, although the amounts at risk are significantly smaller because, in view of the price movement correlation required for hedge accounting, changes in the market value of these derivatives generally are offset by changes in the value associated with the underlying physical transactions or in other derivatives. When Energy Derivatives are closed out in advance of the underlying commitment or anticipated transaction, however, the market value changes may not offset due to the fact that price movement correlation ceases to exist when the positions are closed as further discussed below. Under such circumstances gains (losses) are deferred and recognized as a component of income when the underlying hedged item is recognized in income.

The average maturity discussed above and the fair value discussed in Note 10 are not necessarily indicative of likely future cash flows as these positions may be changed by new transactions in the trading portfolio at any time in response to changing market conditions, market liquidity and NorAm's risk management portfolio needs and strategies. Terms regarding cash settlements of these contracts vary with respect to the actual timing of cash receipts and payments.

(c) Trading and Non-trading -- General Policy.

In addition to the risk associated with price movements, credit risk is also inherent in NorAm and its subsidiaries' risk management activities. Credit risk relates to the risk of loss resulting from non performance

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

of contractual obligations by a counterparty. While, as yet, NorAm and its subsidiaries have experienced no significant losses due to the credit risk associated with these arrangements, NorAm has off-balance sheet risk to the extent that the counterparties to these transactions may fail to perform as required by the terms of each such contract. In order to minimize this risk, NorAm and/or its subsidiaries, as the case may be, enter into such contracts primarily with those counterparties with a minimum Standard & Poor's or Moody's rating of BBB- or Baa3, respectively. For long-term arrangements, NorAm and its subsidiaries periodically review the financial condition of such firms in addition to monitoring the effectiveness of these financial contracts in achieving NorAm's objectives. Should the counterparties to these arrangements fail to perform, NorAm would seek to compel performance at law or otherwise, or obtain compensatory damages in lieu thereof. NorAm might be forced to acquire alternative hedging arrangements or be required to honor the underlying commitment at then-current market prices. In such event, NorAm might incur additional loss to the extent of amounts, if any, already paid to the counterparties. In view of its criteria for selecting counterparties, its process for monitoring the financial strength of these counterparties and its experience to date in successfully completing these transactions, NorAm believes that the risk of incurring a significant financial statement loss due to the non-performance of counterparties to these transactions is minimal.

NorAm's policies prohibit the use of leveraged financial instruments.

Houston Industries has established a Risk Oversight Committee that oversees all price and credit risk, including NES's risk management and trading activities. The Risk Oversight Committee's responsibilities include reviewing NorAm's overall risk management strategy and monitoring risk management activities to ensure compliance with Houston Industries' risk management limitations, policies and procedures.

(3) CAPITAL STOCK

(a) Earnings Per Share.

As a result of the Merger, NorAm is no longer required to present earnings per share (EPS) data as its common shares (all of which are owned by Houston Industries) are not publicly held. EPS data for 1996 and 1995 has not been included because NorAm believes it is no longer meaningful.

(b) Equity Transactions Prior to the Merger.

In June 1996, NorAm issued 11,500,000 shares of NorAm common stock to the public at a price of $9.875 per share, yielding net cash proceeds of approximately $109 million. The net proceeds from the offering principally were used to retire debt as described in Note 4(b).

(c) Direct Stock Purchase Plan and Dividend Reinvestment Plan.

The Direct Stock Purchase Plan and Dividend Reinvestment Plan were suspended and canceled in connection with the Merger.

(4) LONG-TERM AND SHORT-TERM FINANCING

(a) Short-Term Financing.

In 1997 and 1996, NorAm met its short-term financing needs primarily through a bank facility, bank lines of credit and a receivables facility. NorAm's principal short-term credit facility (NorAm Credit Facility) of $400 million expires in December 1998. Borrowings under the NorAm Credit Facility are unsecured. The weighted average interest rate at December 31, 1997 and 1996 was 6.3%. NorAm pays a facility fee on the $400 million facility of .14% per annum which is subject to increase based on NorAm's debt rating. Borrowings under the credit facility at December 31, 1997 and 1996 were $340 million and $115 million, respectively. In addition, NorAm had $50 million of outstanding loans under uncommitted lines of credit at December 31, 1997 having a weighted average interest rate of 6.82%.

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Under a trade receivables facility (Receivables Facility) which expires in August 1999, NorAm sells, with limited recourse, an undivided interest (limited to a maximum of $300 million) in a designated pool of accounts receivable. The amount of receivables sold and uncollected was $300 million and $235 million at December 31, 1997 and 1996, respectively. The weighted average interest rate at December 31, 1997 and 1996 was 5.65% and 5.41%, respectively. Certain of NorAm's remaining receivables serve as collateral for receivables sold and represent the maximum exposure to NorAm should all receivables sold prove ultimately uncollectible. NorAm has retained servicing responsibility under the Receivables Facility for which it is paid a servicing fee. Beginning in 1997 and pursuant to SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", NorAm accounts for amounts transferred pursuant to the Receivables Facility as collateralized borrowings. As a result, these receivables are recorded as assets on NorAm's December 31, 1997 Consolidated Balance Sheet and amounts received by NorAm pursuant to this facility are recorded as a current liability under the caption Receivables facility. In 1996, pursuant to SFAS No. 77, "Reporting by Transferors for Transfers of Receivables with Recourse", the receivables sold were deducted from "Accounts and notes receivable, principally customers" in the accompanying Consolidated Balance Sheet. Additionally, amounts reported in 1996 and 1995 in NorAm's Statements of Consolidated Income as "Loss on sale of accounts receivables" are recorded as interest expense in NorAm's 1997 Statement of Consolidated Income.

(b) Long-Term Debt.

NorAm's consolidated long-term debt outstanding, which is summarized in the following table, is noncallable and without sinking fund requirements except as noted. Carrying amounts and amounts due in one year reflect $46.3 million and $6.1 million, respectively, for fair value adjustments recorded in connection with the Merger.

                                                              CURRENT NORAM
                                                            DECEMBER 31, 1997
                                             ------------------------------------------------
                                                                          CARRYING AMOUNTS
                                                                       ----------------------
                                             EFFECTIVE    PRINCIPAL    NON-CURRENT    CURRENT
                                               RATE        AMOUNT        PORTION      PORTION
                                             ---------    ---------    -----------    -------
                                                          (MILLIONS OF DOLLARS)
Medium-term notes, Series A and B due
  through 2001, weighted average rate of
  8.90% at December 31, 1997..............     8.23%      $  241.6       $182.4       $ 78.8
Bank Term Loan due 1998...................     6.54%         150.0                     153.3
8.875% Series due 1999....................     8.54%         200.0        207.8
7.5% Series due 2000......................     7.32%         200.0        205.0
8.9% Series due 2006......................     7.82%         145.1        165.1
6% Convertible Subordinated Debentures due
  2012....................................     6.51%         116.3        107.2
10% Series due 2019(1)....................     8.95%          42.8         47.8
Other.....................................     4.10%           0.6          1.4
                                                          --------       ------       ------
                                                          $1,096.4       $916.7       $232.1
                                                          ========       ======       ======

                                                                    FORMER NORAM
                                                                 DECEMBER 31, 1996
                                                               ----------------------
                                                                  CARRYING AMOUNTS
                                                               ----------------------
                                                               NON-CURRENT    CURRENT
                                                                 PORTION      PORTION
                                                               -----------    -------
                                                               (MILLIONS OF DOLLARS)
Medium-term notes, Series A and B due through 2001, weighted
  average rate of 8.96% at December 31, 1996................    $  241.6      $ 52.0
9.875% Series due 1997......................................                   225.0
8.875% Series due 1999......................................       200.0
7.5% Series due 2000........................................       200.0
8.9% Series due 2006........................................       145.1
6% Convertible Subordinated Debentures due 2012.............       122.7
10% Series due 2019(1)......................................       144.2
Other.......................................................         0.6
                                                                --------      ------
                                                                $1,054.2      $277.0
                                                                ========      ======

(1) In the fourth quarter of 1997 NorAm purchased $101.4 million aggregate principal amount of its 10% Debentures due 2019 at an average price of 111.98% plus accrued interest. Because NorAm's debt was stated at fair market value as of the Acquisition Date, the loss on the reacquisition of these debentures was not material.

Consolidated maturities of long-term debt and sinking fund requirements for NorAm are approximately $232 million for 1998, $201 million in 1999, $222 million in 2000, $144 million in 2001 and $0 in 2002.

NorAm's retirements and reacquisitions of long-term debt are summarized in the following table. In cases where premiums were paid or discounts were realized in association with these reacquisitions and retirements, such amounts are reported in NorAm's Statements of Consolidated Income as "Extraordinary gain
(loss) on early retirement of debt, less taxes" and are net of taxes of $0.1 million, ($2.5) million and ($0.03) million in 1997, 1996 and 1995, respectively. For retirements and reacquisitions after the Acquisition Date, gains or losses on early retirement are immaterial since the carrying amounts reflect the fair value adjustments described above.

                                                             YEAR ENDED DECEMBER 31,
                                                           ---------------------------
                                                           1997(1)     1996      1995
                                                           -------    ------    ------
                                                              (MILLIONS OF DOLLARS)
Reacquisition of 8% Series due 1997......................                       $150.0
Reacquisition of 9.875% Debentures due 2018..............             $  7.4       5.7
Reacquisition of 10% Debentures due 2019.................  $101.4                 15.0
Reacquisition of 6% Convertible Subordinated Debentures
  due 2012(2)............................................     5.8        7.2
Retirement, at maturity, of Medium Term Notes(3).........    52.0      118.8       1.0
Retirement of Bank Term Loan due 2000....................              150.0
Retirement of 9.45% Series due 1995......................                        150.0
Retirement of 9.875% Notes due 1997......................   225.0
Retirement of 9.875% Debentures due 2018.................              109.0
Retirement of Note Payable to Gas Supplier...............                         13.6
Net (gain) loss on reacquisition of debt, less taxes.....    (0.2)       4.3       0.1
                                                           ------     ------    ------
                                                           $384.0     $396.7    $335.4
                                                           ======     ======    ======

(1) Excludes the conversion of 6% Convertible Subordinated Debentures due 2012 in the amount of approximately $1.0 million.

(2) These reacquired debentures may be credited against sinking fund requirements.

(3) Weighted average interest rate of 9.25%, 9.06% and 9.0% in 1997, 1996 and 1995, respectively.

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In June 1996, NorAm exercised its right to exchange the $130 million principal amount of its $3.00 Convertible Exchangeable Preferred Stock, Series A for its 6% Convertible Subordinated Debentures due 2012 (Subordinated Debentures). The holders of the Subordinated Debentures receive interest quarterly and have the right at any time on or before the maturity date thereof to convert each Subordinated Debenture into 0.65 shares of common stock of Houston Industries and $14.24 in cash. The Subordinated Debentures are callable beginning in 1999 at redemption prices beginning at 105.0% and declining to par in November 2009. NorAm is required to make annual sinking fund payments of $6.5 million on the Subordinated Debentures which began on March 15, 1997 and will continue on each succeeding March 15 up to and including March 15, 2011. NorAm
(i) may credit against the sinking fund requirements any Subordinated Debentures redeemed by NorAm and Subordinated Debentures which have been converted at the option of the holder and (ii) may deliver purchased Subordinated Debentures in satisfaction of the sinking fund requirements. NorAm satisfied its 1997 sinking fund requirement of $6.5 million by delivering a portion of the $7.2 million principal amount of Subordinated Debentures purchased in 1996.

In May 1997, NorAm obtained an unsecured, 18-month bank term loan in the amount of $150 million. The term loan carries a LIBOR-based floating interest rate. Proceeds from the term loan were used to refund a portion of NorAm's 9.875% Notes which matured in April 1997. NorAm has entered into two interest rate swaps, each with a term of 19 months, having an aggregate notional amount of $150 million which effectively fixed the interest rate on borrowings under the term loan agreement at approximately 6.775%.

At December 31, 1996 NorAm had a portfolio of six interest rate swaps with a total notional amount of $300 million. Five of these swaps were terminated during 1997 representing a total notional amount of $250 million. The remaining $50 million was terminated in January 1998.

(c) Restrictions on Stockholders' Equity and Debt.

Under the provisions of NorAm's revolving credit facility or certain other NorAm financial arrangements, NorAm's total debt is limited to 72% of its total capitalization and NorAm is required to maintain a minimum level of stockholders' equity. In addition, NorAm's total debt would be limited to $2.055 billion if its ratio of total debt to total capitalization increased to 60%. The minimum level of stockholders' equity was initially set at $700 million at December 31, 1995, increasing annually thereafter by (1) 50% of positive consolidated net income and (2) 50% of the proceeds from any incremental equity offering made after June 30, 1996. At December 31, 1997, these provisions did not significantly restrict NorAm's ability to issue debt or to pay dividends.

(5) TRUST SECURITIES

In June 1996, a Delaware statutory business trust (NorAm Trust) established by NorAm issued in a public offering $172.5 million of convertible preferred securities and sold approximately $5.3 million of NorAm Trust common stock (106,720 shares, representing 100% of the NorAm Trusts common equity) to NorAm. The convertible preferred securities have a distribution rate of 6.25% payable quarterly in arrears, a stated liquidation amount of $50 per convertible preferred security and must be redeemed by 2026. The proceeds from the sale of the preferred and common securities were used by NorAm Trust to purchase $177.8 million of 6.25% Convertible Junior Subordinated Debentures from NorAm having an interest rate corresponding to the distribution rate of the convertible preferred securities and a maturity date corresponding to the mandatory redemption date of the convertible preferred securities. Under existing law, interest payments made by NorAm for the junior subordinated debentures are deductible for federal income tax purposes. NorAm has the right at any time and from time to time to defer interest payments on the junior subordinated debentures for successive periods not to exceed 20 consecutive quarters for each such extension period. In such case, (1) quarterly distributions on the junior subordinated debentures would also be deferred

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

and (2) NorAm has agreed to not declare or pay any dividend on any common or preferred stock, except in certain instances.

The NorAm Trust is accounted for as a wholly owned consolidated subsidiary of NorAm. The junior subordinated debentures are the sole assets of the NorAm Trust. NorAm has fully and unconditionally guaranteed, on a subordinated basis, NorAm Trust's obligations, including the payment of distributions and all other payments, with respect to the convertible preferred securities. The convertible preferred securities are mandatorily redeemable upon the repayment of the related junior subordinated debentures at their stated maturity or earlier redemption. Following the Merger, each convertible preferred security is convertible at the option of the holder into $33.62 of cash and 1.55 shares of Houston Industries common stock. In 1997, convertible preferred securities aggregating $156.1 million were converted, leaving $16.4 million principal amount (unamortized fair value of $21.3 million, net of issuance costs) of convertible preferred securities outstanding at December 31, 1997.

Utilizing, in large part, the proceeds from the offerings previously discussed, in June 1996, NorAm (1) retired the $109.0 million principal amount then outstanding of its 9.875% Debentures due 2018 at a price equal to 105.93% of face value, recognizing an extraordinary pre-tax loss of approximately $6.5 million (approximately $3.9 million after tax) and (2) retired its $150 million bank term loan due 2000 at face value.

(6) STOCK-BASED INCENTIVE COMPENSATION PLANS AND EMPLOYEE BENEFIT PLANS

(a) Incentive Compensation Plans.

Prior to the Merger, NorAm had several incentive compensation plans which provide for the issuance of stock-based incentives (including restricted shares, stock options and stock appreciation rights) to directors and key employees of NorAm, including officers. The charge to earnings in 1997, 1996 and 1995 related to the incentive compensation plans was $1.4 million, $4.4 million and $0.5 million, respectively. All stock options granted under such plans were either converted into similar Houston Industries options or "cashed out" prior to the Merger. All restricted stock and substantially all stock appreciation rights were "cashed out" with the Merger. NorAm granted 463,856 shares of restricted stock in 1996 with a weighted average fair value at the grant date of $11.86. At December 31, 1996, there were 77,371 stock appreciation rights outstanding. As of the Acquisition Date, less than 1,000 stock appreciation rights were outstanding. The following is certain information relating to options issued pursuant to NorAm's incentive compensation plans.

                                                                        WEIGHTED-AVERAGE
                                                           NUMBER        EXERCISE PRICE
                                                          OF SHARES        PER SHARE
                                                          ---------     ----------------
Outstanding at December 31, 1994........................    650,938          $12.89
Options Granted(2)......................................    546,550          $ 5.54
Options Forfeited/Expired...............................   (164,469)         $14.05
Outstanding at December 31, 1995........................  1,033,019          $ 8.82
Options Granted(2)......................................    579,749          $ 8.69
Options Exercised.......................................    (28,019)         $ 6.44
Options Forfeited/Expired...............................    (76,821)         $11.99

                                                                        WEIGHTED-AVERAGE
                                                           NUMBER        EXERCISE PRICE
                                                          OF SHARES        PER SHARE
                                                          ---------     ----------------
Outstanding at December 31, 1996........................  1,507,928          $ 8.65
Options Exercised.......................................   (147,092)         $ 6.47
Options Forfeited/Expired...............................    (10,682)         $12.42
Options Cashed Out Upon Merger..........................   (521,857)
Options Converted at Acquisition(1).....................   (828,297)
Outstanding at December 31, 1997........................          0
Exercisable at:
  December 31, 1997.....................................          0
  December 31, 1996.....................................    911,660          $ 9.48
  December 31, 1995.....................................    431,615          $16.14

(1) Effective upon the Merger, each holder of an unexpired NorAm stock option, whether or not then exercisable, was entitled to elect to either (i) have all or any portion of their NorAm stock options canceled and "cashed out" or
(ii) have all or any portion of their NorAm stock options converted to the Houston Industries stock options. There were 828,297 NorAm stock options converted into 622,504 Houston Industries stock options at the Acquisition Date.

(2) The weighted average grant date fair value of the options granted in 1995 and 1996 was $1.64 and $2.39, respectively.

In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123). SFAS No. 123 provides for the disclosure of certain information concerning the "fair value" of securities issued pursuant to stock-based employee compensation plans, and gives NorAm the option of calculating and recording compensation expense utilizing either (1) SFAS No. 123's "fair value" methodology which measures compensation expense as the "fair value" of all securities at the date on which they are granted to the employee or (2) the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25) which, in general, do not require the recording of compensation expense for options and stock appreciation rights issued pursuant to plans structured similarly to those of NorAm. NorAm elected to continue to apply the provisions of APB No. 25 for the purpose of computing compensation expense associated with the relevant plan, although certain additional required disclosure has been made in accordance with the provisions of SFAS No. 123.

The "fair value" as applied to restricted stock represents the quoted NYSE closing market price of the shares on the grant date. The term "fair value" as applied to stock options granted in 1996 and 1995 is a statistical calculation made utilizing a methodology generally referred to as the Black-Scholes option pricing model (BS model). The BS model yields a value for each option which is dependent on a number of variables which are inputs to the relevant calculations. For the purposes of determining the "fair value" of stock options in the preceding table, NorAm assumed (i) a risk free interest rate (based on U.S. Treasury strips with a remaining term of five years) of 5.24% to 7.84%,
(ii) an expected option life (duration) of five years, (iii) an expected volatility of 31.6% to 36.4% and (iv) an expected dividend yield of 3.4%. To the extent that actual conditions during the post-grant, pre-exercise period differ from these assumptions, the actual value of the options to the employee will differ from the calculated "fair value" at grant date (see above regarding the effect of the Merger). Had compensation cost been determined in accordance with the provisions of SFAS No. 123, the impact on NorAm's earnings for 1995 and 1996 would have been immaterial.

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(b) Employee Benefit Plans.

NorAm has two qualified pension plans (the Qualified Plans) which cover substantially all employees: (1) the plan which covers NorAm's employees other than Minnegasco employees and (2) the plan which covers Minnegasco employees. The Qualified Plans provide benefits based on the participants' years of service and highest average compensation. The funding policy for the Qualified Plans is to contribute at least the minimum amount required to be funded as determined by NorAm's consulting actuaries. Plan assets are made up of marketable equity and high-grade fixed income securities.

In addition to the Qualified Plans, NorAm maintains certain non-qualified plans which principally consist of (1) a retirement restoration plan which allows participants to retain the benefit to which they would have been entitled under the Qualified Plans except for the federally mandated limits on such benefits or on the level of salary on which such benefits may be calculated and
(2) certain supplemental benefit plans which, in the past, were entered into with individual employees or with small groups of employees. Participants in these non-qualified plans are general creditors of NorAm with respect to these benefits, as these plans are not funded by NorAm in advance of the cash payment of benefits. Expense of approximately $3.1 million, $2.0 million and $2.1 million associated with these non-qualified plans was recorded during 1997, 1996, and 1995, respectively.

Net Pension cost (qualified plans only) for NorAm includes the following components:

                                                                         FORMER NORAM
                                        CURRENT NORAM    --------------------------------------------
                                        -------------                       TWELVE          TWELVE
                                         FIVE MONTHS     SEVEN MONTHS       MONTHS          MONTHS
                                            ENDED           ENDED           ENDED           ENDED
                                        DECEMBER 31,       JULY 31,      DECEMBER 31,    DECEMBER 31,
                                            1997             1997            1996            1995
                                        -------------    ------------    ------------    ------------
                                                           (THOUSANDS OF DOLLARS)
Service cost -- benefits earned during
  the period..........................    $  5,095         $  7,220        $ 11,817        $  9,900
Interest cost on projected benefit
  obligation..........................      15,014           20,313          29,946          27,097
Actual return on plan assets..........      (1,851)         (90,148)        (41,800)        (36,909)
Amortization and deferrals (a)........     (22,004)          63,498            (641)         (1,388)
                                          --------         --------        --------        --------
Net pension cost (credit).............    $ (3,746)        $    883        $   (678)       $ (1,300)
                                          ========         ========        ========        ========

                                                      CURRENT NORAM               FORMER NORAM
                                                -------------------------   -------------------------
                                                                    DECEMBER 31,
                                                -----------------------------------------------------
                                                          1997                        1996
                                                -------------------------   -------------------------
                                                QUALIFIED   NON-QUALIFIED   QUALIFIED   NON-QUALIFIED
                                                  PLANS         PLANS         PLANS         PLANS
                                                ---------   -------------   ---------   -------------
                                                             (THOUSANDS OF DOLLARS)
Net assets available for benefits.............  $569,718            --      $500,452            --
                                                --------      --------      --------      --------
Actuarial present value of accumulated plan
  benefits:
  Vested (assuming immediate separation)......   401,468      $ 34,578       325,461      $ 30,554
  Non-vested..................................    36,359           973        30,096         1,663
                                                --------      --------      --------      --------
  Accumulated benefit obligation..............   437,827        35,551       355,557        32,217
  Additional amount related to projected pay
     increases................................    75,420           746        79,933           712
                                                --------      --------      --------      --------
          Total projected benefit
            obligation........................   513,247        36,297       435,490        32,929
                                                --------      --------      --------      --------
Funded status.................................    56,471       (36,297)       64,962       (32,929)
Unrecognized transition obligation at January
  1(a)........................................        --            --        (8,290)           --
Unrecognized prior service costs(a)...........        --            --        (2,222)        5,004
Unrecognized net loss (gain) from past
  experience different from that assumed and
  effects of changes in actuarial
  assumptions(a)..............................    35,593           646        (9,060)       (1,506)
                                                --------      --------      --------      --------
  (Accrued) prepaid pension cost..............  $ 92,064      $(35,651)     $ 45,390      $(29,431)
                                                ========      ========      ========      ========

(a) The unrecognized transition obligation, unrecognized prior service costs and net actuarial gain were recognized on the Acquisition Date pursuant to the purchase method of accounting for the Merger. Amortization and deferrals after the Acquisition Date represents deferral of net loss from past experience identified after the Acquisition Date. For further discussion of the accounting for the Merger; see Note 1(b).

The assumed rate of increase in future compensation levels utilized in the above calculations was 4.5% in 1997 and 4% in 1996. The expected long-term rate of return on fund assets utilized in the above calculations was 10% for 1997 and 1996. The weighted average discount rate was 7.5% for 1997 and 1995 and 7.25% for 1996.

NorAm has an employee savings plan (the ESP) which covers substantially all employees other than Minnegasco employees. Under the terms of the ESP, employees may contribute up to 12% of total compensation, of which contributions up to 6% are matched by NorAm. Employer contributions to the ESP of $9.3 million, $8.9 million and $8.9 million were expensed during 1997, 1996 and 1995, respectively. The Minnegasco employees are covered by various thrift and profit sharing plans, the terms of which vary from plan to plan. Expense of approximately $1.5 million, $1.4 million and $1.4 million related to these plans was recorded during 1997, 1996, and 1995, respectively.

NorAm records the liability for post-retirement benefit plans other than pensions (primarily health care) under SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions". NorAm provides these benefits under a defined benefit plan for all eligible former employees who retired prior to July 1, 1992, and under a defined contribution plan for all others. A substantial number of NorAm's employees may become eligible for postretirement benefits if they are participating in such plans when they reach normal retirement age. As of December 31, 1997, NorAm had contributed a total of $4.5 million to an

                                      CURRENT NORAM                     FORMER NORAM
                                      -------------    ----------------------------------------------
                                       FIVE MONTHS     SEVEN MONTHS    TWELVE MONTHS    TWELVE MONTHS
                                          ENDED           ENDED            ENDED            ENDED
                                      DECEMBER 31,       JULY 31,      DECEMBER 31,     DECEMBER 31,
                                          1997             1997            1996             1995
                                      -------------    ------------    -------------    -------------
                                                          (THOUSANDS OF DOLLARS)
Service cost.......................      $  115           $  164          $   306          $   291
Interest cost on accumulated
  benefit obligation...............       3,561            4,948            9,234           10,183
Actual (return) loss on plan
  assets...........................        (143)             142             (108)
Amortization of transition
  obligation on a straight line
  basis over 20 years(a)...........                        3,886            6,662            6,663
Amortization of actuarial
  loss(a)..........................          70             (249)           1,321
Deferral of asset loss.............                          (11)                             (195)
                                         ------           ------          -------          -------
Net periodic cost..................      $3,603           $8,880          $17,415          $16,942
                                         ======           ======          =======          =======

Following is the funded status of NorAm's postretirement benefit plans:

                                                          CURRENT NORAM    FORMER NORAM
                                                          -------------    ------------
                                                                  DECEMBER 31,
                                                          -----------------------------
                                                              1997             1996
                                                          -------------    ------------
                                                             (THOUSANDS OF DOLLARS)
Accumulated postretirement benefit obligation
  Retirees.............................................     $110,579        $ 121,183
  Fully-eligible active plan participants..............        3,349            3,711
  Other active plan participants.......................        4,544            4,487
                                                            --------        ---------
          Total........................................      118,472          129,381
  Fair value of plan assets............................        4,502            3,051
                                                            --------        ---------
          Total........................................      113,970          126,330
  Unrecognized transition obligation(a)................                      (106,599)
  Unrecognized net actuarial (gain) loss...............       (1,563)          14,292
                                                            --------        ---------
  Accrued postretirement benefit cost..................     $112,407        $  34,023
                                                            ========        =========

(a) The unrecognized transition obligation and unrecognized prior service costs were recognized on the Acquisition Date pursuant to the purchase method of accounting for the Merger. Amortization after the Acquisition Date represents amortization of unrecognized actuarial loss incurred after the Acquisition Date. For further discussion of the accounting for the Merger, see Note 1(b).

The weighted average discount rate used in determining the accumulated benefit obligation for postretirement benefits was 7.25% for 1997, 7.5% for 1996 and 7.25% for 1995. The cost of covered health care benefits (for those participants entitled to a defined benefit as a result of having retired prior to July 1, 1992) is assumed to increase by 8.5% per year initially and then increase at a decreasing rate to an annual and continuing increase of 4.5% by 2006. Based on these assumptions, a one percentage point increase in the assumed health care cost trend rate would increase the annual net periodic postretirement benefit cost (before

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

any deferral for regulatory reasons) and the accumulated benefit obligation at December 31, 1997 by approximately 9.2% and 10.8%, respectively.

(7) INCOME TAXES

Prior to the Acquisition Date, NorAm and its subsidiaries filed a consolidated federal income tax return. Such returns have been audited and settled through the year 1986. Subsequent to the Acquisition Date, Houston Industries files a consolidated federal income tax return, in which NorAm and its subsidiaries are included. Investment tax credits are generally deferred and amortized over the lives of the related assets. The unamortized investment tax credit in deferred credits on the accompanying Consolidated Balance Sheets was $5.2 million and $4.5 million for 1997 and 1996, respectively.

Following are the components of NorAm's income tax provision:

                                      CURRENT NORAM                     FORMER NORAM
                                      -------------    ----------------------------------------------
                                       FIVE MONTHS     SEVEN MONTHS    TWELVE MONTHS    TWELVE MONTHS
                                          ENDED           ENDED            ENDED            ENDED
                                      DECEMBER 31,       JULY 31,      DECEMBER 31,     DECEMBER 31,
                                          1997             1997            1996             1995
                                      -------------    ------------    -------------    -------------
                                                          (THOUSANDS OF DOLLARS)
Federal
  Current...........................    $(12,005)        $16,339          $33,654          $18,760
  Deferred..........................      36,673          12,795           25,760           24,377
  Investment tax credit.............        (262)           (363)            (636)            (639)
State
  Current...........................         536             833            4,525            2,375
  Deferred..........................        (559)          1,794            3,049           10,506
                                        --------         -------          -------          -------
Income tax expense..................    $ 24,383         $31,398          $66,352          $55,379
                                        ========         =======          =======          =======

The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate of 35% to income from continuing operations. The reasons for this difference are as follows:

                                           CURRENT NORAM                    FORMER NORAM
                                           -------------   ----------------------------------------------
                                            FIVE MONTHS    SEVEN MONTHS   TWELVE MONTHS    TWELVE MONTHS
                                               ENDED          ENDED           ENDED            ENDED
                                           DECEMBER 31,      JULY 31,      DECEMBER 31,     DECEMBER 31,
                                               1997            1997            1996             1995
                                           -------------   ------------   --------------   --------------
                                                               (THOUSANDS OF DOLLARS)
Income before income taxes...............     $45,230        $77,273         $161,490         $120,908
Statutory rate...........................          35%            35%              35%              35%
                                              -------        -------         --------         --------
Income taxes at statutory rate...........      15,831         27,046           56,522           42,318
                                              -------        -------         --------         --------
Increase (decrease) in tax resulting
  from:
  State income taxes, net of federal
     income tax benefit(1)...............          (9)         1,708            4,923            8,373
  Investment tax credit..................        (262)          (363)            (636)            (639)
  Research and experimentation credit....                                        (188)            (375)
  Adjustment to prior year accruals......         106            (34)             301              510
  Goodwill amortization..................       7,242          2,430            4,163            4,163
  Other, net.............................       1,475            611            1,267            1,029
                                              -------        -------         --------         --------
Provision for income taxes...............     $24,383        $31,398         $ 66,352         $ 55,379
                                              =======        =======         ========         ========

(1) Calculation of the accrual for state income taxes at the end of each year requires that NorAm estimate the manner in which its income for that year will be allocated and/or apportioned among the various

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

states in which it conducts business, which states have widely differing tax rules and rates. These allocation/apportionment factors change from year to year and the amount of taxes ultimately payable may differ from that estimated as a part of the accrual process. For these reasons, the amount of state income tax expense may vary significantly from year-to-year, even in the absence of significant changes to state income tax valuation allowances or changes in individual state income tax rates.

The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and liabilities as of December 31, 1997 and 1996, were as follows:

                                                              CURRENT      FORMER
                                                               NORAM       NORAM
                                                              --------    --------
                                                                  DECEMBER 31,
                                                              --------------------
                                                                1997        1996
                                                              --------    --------
                                                                 (THOUSANDS OF
                                                                    DOLLARS)
Deferred Tax Assets:
  Employee benefit accruals.................................  $ 53,277    $ 27,282
  Inventory revaluation and capitalization..................       466         552
  Gas purchase contract accruals............................     8,267      15,495
  Regulatory obligations....................................                 7,469
  Indemnifications and other reserves.......................     3,497       9,332
  Deferred state income taxes...............................    14,460      13,799
  Other.....................................................    53,546      29,295
  State operating loss carryforwards........................    29,515      28,517
  Alternative minimum tax credit carryforwards..............    60,669      76,089
  Valuation allowance.......................................    (6,353)     (6,761)
                                                              --------    --------
          Total deferred tax assets -- net..................   217,344     201,069
                                                              --------    --------
Deferred Tax Liabilities:
  Property, plant and equipment, principally due to
     depreciation methods and lives.........................   558,758     458,506
  Deferred gas costs........................................    34,113      25,043
  Employee benefit accruals.................................                 5,807
  Deferred state income taxes...............................    70,000
  Regulatory obligations....................................     6,690
  Other.....................................................    22,513      21,724
                                                              --------    --------
          Total deferred tax liabilities....................   692,074     511,080
                                                              --------    --------
          Net deferred tax liabilities......................  $474,730    $310,011
                                                              ========    ========

At December 31, 1997, NorAm has approximately $439 million of state net operating losses available to offset future state taxable income through the year 2012. In addition, NorAm has approximately $58 million of federal alternative minimum tax credits which are available to reduce future federal income taxes payable, if any, over an indefinite period (although not below the tentative minimum tax otherwise due in any year), and approximately $2.6 million of state alternative minimum tax credits which are available to reduce future state income taxes payable, if any, through the year 2001. The change in the valuation allowance during 1997 was a net reduction of $0.4 million, resulting from a reassessment of NorAm's ability to use state net operating loss carryforwards and state alternative minimum tax credit carryforwards in future tax years, offset by expiring state net operating losses for which valuation allowances had been provided in prior years.

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(8) COMMITMENTS AND CONTINGENCIES

(a) Lease Commitments.

The following table sets forth certain information concerning NorAm's obligations under operating leases:

                                                             (MILLIONS OF DOLLARS)
                                                             ---------------------
1998.......................................................          $ 24
1999.......................................................            19
2000.......................................................            16
2001.......................................................            15
2002.......................................................             9
2003 and beyond............................................            22
                                                                     ----
          Total............................................          $105
                                                                     ====

(1) Principally consisting of rental agreements for building space and data processing equipment and vehicles (including major work equipment).

NorAm has a master leasing agreement which provides for the lease of vehicles, construction equipment, office furniture, data processing equipment and other property. For accounting purposes, the lease is treated as an operating lease. At December 31, 1997, NorAm had leased assets with a value of approximately $58.1 million under this lease with a basic term of one year. NorAm does not expect to lease additional property under this lease agreement.

Lease payments related to NorAm's leasing agreements are included in the preceding table for only their basic term. Total rental expense for all leases was $24.0 million, $33.4 million and $48.9 million in 1997, 1996 and 1995, respectively.

(b) Letters of Credit.

At December 31, 1997, NorAm had letters of credit incidental to its ordinary business operations totaling approximately $42 million under which NorAm is obligated to reimburse drawings, if any.

(c) Indemnity Provisions.

At December 31, 1997, NorAm has an $11.4 million accounting reserve on its Consolidated Balance Sheets in "Estimated obligations under indemnification provisions of sale agreements" for possible indemnity claims asserted in connection with its disposition of former subsidiaries or divisions, including the sale of (i) Louisiana Intrastate Gas Corporation, a former subsidiary engaged in the intrastate pipeline and liquids extraction business (1992); (ii) Arkla Exploration Company, a former subsidiary engaged in oil and gas exploration and production activities (June 1991); and (iii) Dyco Petroleum Company, a former subsidiary engaged in oil and gas exploration and production (1991).

(d) Sale of Receivables.

Certain of NorAm's receivables are collateral for receivables which have been sold pursuant to the terms of NorAm's receivables facility, see "Receivables Facility" included in Note 4(a).

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(e) Gas Purchase Claims.

In conjunction with settlements of "take-or-pay" claims, NorAm has prepaid for certain volumes of gas, which prepayments have been recorded at their net realizable value and, to the extent that NorAm is unable to realize at least the carrying amount as the gas is delivered and sold, NorAm's earnings will be reduced, although such reduction is not expected to be material. In addition to these prepayments, NorAm is a party to a number of agreements which require it to either purchase or sell gas in the future at prices which may differ from then prevailing market prices or which require it to deliver gas at a point other than the expected receipt point for volumes to be purchased. To the extent that NorAm expects that these commitments will result in losses over the contract term, NorAm has established reserves equal to such expected losses.

(f) Transportation Agreement.

NorAm had an agreement (ANR Agreement) with ANR Pipeline Company (ANR) which contemplated a transfer to ANR of an interest in certain of NorAm's pipeline and related assets, representing capacity of 250 Mmcf/day, and pursuant to which ANR had advanced $125 million to NorAm. The ANR Agreement has been restructured and, after refunds of $50 million and $34 million in 1995 and 1993, respectively, NorAm currently retains $41 million (recorded as a liability) in exchange for ANR's or its affiliates' use of 130 Mmcf/ day of capacity in certain of NorAm's transportation facilities. The level of transportation will decline to 100 Mmcf/day in the year 2003 with a refund of $5 million to ANR and the ANR Agreement will terminate in 2005 with a refund of the remaining balance.

(g) Environmental Matters.

To the extent that potential environmental remediation costs are quantified within a range, NorAm establishes reserves equal to the most likely level of costs within the range and adjusts such accruals as better information becomes available. In determining the amount of the liability, future costs are not discounted to their present value and the liability is not offset by expected insurance recoveries. If justified by circumstances within NorAm's business subject to SFAS No. 71, corresponding regulatory assets are recorded in anticipation of recovery through the rate making process.

Manufactured Gas Plant Sites. NorAm and its predecessors operated a manufactured gas plant (MGP) adjacent to the Mississippi River in Minnesota formerly known as Minneapolis Gas Works (FMGW) until 1960. NorAm has completed remediation of the main site other than ongoing water monitoring and treatment. There are six other former MGP sites in the Minnesota service territory. Remediation has been completed on one site. Of the remaining five sites, NorAm believes that two were neither owned nor operated by NorAm; two were owned by NorAm at one time but were operated by others and are currently owned by others; and one site was previously operated by NorAm but was owned by others. NorAm believes it has no liability with respect to the sites it neither owned nor operated.

At December 31, 1997, NorAm had estimated a range of $15 million to $77 million for possible remediation of the Minnesota sites. The low end of the range was determined based on only those sites presently owned or known to have been operated by NorAm, assuming use of NorAm's proposed remediation methods. The upper end of the range was determined based on the sites once owned by NorAm, whether or not operated by NorAm. The cost estimates for the FMGW site are based on studies of that site. The remediation costs for other sites are based on industry average costs for remediation of sites of similar size. The actual remediation costs will be dependent upon the number of sites remediated, the participation of other potentially responsible parties, if any, and the remediation methods used.

In its 1995 rate case, NorAm's Minnegasco division was allowed to recover approximately $7 million annually for remediation costs. Such costs are subject to a true-up mechanism whereby any over or under recovered amounts, net of certain insurance recoveries, plus carrying charges, would be deferred for recovery

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

or refund in the next rate case. At December 31, 1997 and 1996, Minnegasco had recorded a liability of $20.6 million and $35.9 million, respectively, to cover the cost of future remediation. In addition, at December 31, 1997, Minnegasco had receivables from insurance settlements of $2.9 million. These insurance settlements will be collected through 1999. Minnegasco expects that approximately half of its accrual as of December 31, 1997 will be expended within the next five years. The remainder will be expended on an ongoing basis for an estimated 40 years. In accordance with the provisions of SFAS No. 71, a regulatory asset has been recorded equal to the liability accrued. Minnegasco is continuing to pursue recovery of at least a portion of these costs from insurers. Minnegasco believes the difference between any cash expenditures for these costs and the amount recovered in rates during any year will not be material to NorAm's overall cash requirements, results of operations or cash flows.

At December 31, 1997 and 1996, NorAm had recorded an accrual of $3.3 million (with a maximum estimated exposure of approximately $18 million) and an offsetting regulatory asset for environmental matters in connection with a former fire training facility and a landfill for which future remediation may be required. This accrual is in addition to the accrual for MGP sites as previously discussed.

Issues relating to the identification and remediation of MGPs are common in the natural gas distribution industry. NorAm has received notices from the EPA and others regarding its status as a potentially responsible party for other sites. Based on current information, NorAm has not been able to quantify a range of environmental expenditures for potential remediation expenditures with respect to other MGP sites.

Mercury Contamination. Like other natural gas pipelines, NorAm's pipeline operations have in the past employed elemental mercury in meters used on its pipelines. Although the mercury has now been removed from the meters, it is possible that small amounts of mercury have been spilled at some of those sites in the course of normal maintenance and replacement operations and that such spills have contaminated the immediate area around the meters with elemental mercury. Such contamination has been found by NorAm at some sites in the past, and NorAm has conducted remediation at sites found to be contaminated. Although NorAm is not aware of additional specific sites, it is possible that other contaminated sites exist and that remediation costs will be incurred for such sites. Although the total amount of such costs cannot be known at this time, based on experience by NorAm and others in the natural gas industry to date and on the current regulations regarding remediation of such sites, NorAm believes that the cost of any remediation of such sites will not be material to NorAm's financial position, results of operation or cash flows.

Potentially Responsible Party Notifications. From time to time NorAm and its subsidiaries have been notified that they are potentially responsible parties with respect to properties which environmental authorities have determined warrant remediation under state or federal environmental laws and regulations. In October 1994 the United States Environmental Protection Agency issued such a notice with respect to a landfill site in West Memphis, Arkansas, and in December 1995, the Louisiana Department of Environmental Quality advised that one of NorAm subsidiaries had been identified as a potentially responsible party with respect to a hazardous waste site in Shreveport, Louisiana. Considering the information currently known about such sites and the involvement of NorAm or its subsidiaries in activities at these sites, NorAm does not believe that these matters will have a material adverse effect on NorAm's financial position, results of operation or cash flows.

(h) Other

NorAm Merger Lawsuit. In August 1996, a purported NorAm stockholder filed a lawsuit, Shaw v. NorAm Energy Corp., et al., in the District Court of Harris County, Texas, against NorAm, certain of its officers and directors and the Company to enjoin the Merger or to rescind the Merger and/or to recover damages in the event that the Merger was consummated. In February 1998, the plaintiffs withdrew their lawsuit and the court issued an order of non-suit dismissing the litigation.

NORAM ENERGY CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NorAm is a party to litigation (other than that specifically noted) which arises in the normal course of business. Management regularly analyzes current information and, as necessary, provides accruals for probable liabilities on the eventual disposition of these matters. Management believes that the effect on NorAm's financial statements, if any, from the disposition of these matters will not be material.

                                                  CURRENT NORAM                FORMER NORAM
                                                  -------------   --------------------------------------
                                                   FIVE MONTHS         SEVEN MONTHS        TWELVE MONTHS
                                                      ENDED               ENDED                ENDED
                                                  DECEMBER 31,           JULY 31,          DECEMBER 31,
                                                      1997                 1997                1996
                                                  -------------   ----------------------   -------------
                                                                  (THOUSANDS OF DOLLARS)    (UNAUDITED)
Revenues:
  Natural Gas Distribution......................   $   892,569          $1,309,732          $ 2,113,589
  Interstate Pipeline...........................       108,333             186,711              346,762
  Energy Marketing..............................     1,604,999           1,984,119            2,645,106
  Corporate.....................................        39,079              42,615               55,403
  Eliminations(1)...............................      (123,638)           (186,129)            (372,398)
                                                   -----------          ----------          -----------
          Total Revenues........................   $ 2,521,342          $3,337,048          $ 4,788,462
                                                   ===========          ==========          ===========
Operating Income:
  Natural Gas Distribution......................   $    54,502          $  111,933          $   178,141
  Interstate Pipeline...........................        31,978              76,730              107,904
  Energy Marketing..............................        16,407               2,881               55,693
  Corporate.....................................       (12,131)            (36,504)             (27,272)
                                                   -----------          ----------          -----------
          Total Operating Income................        90,756             155,040              314,466
Other Income (Expense)..........................         2,243               7,210              (14,577)
  Interest and Other Charges....................        47,769              84,977              138,399
                                                   -----------          ----------          -----------
  Income Before Income Taxes....................   $    45,230          $   77,273          $   161,490
                                                   ===========          ==========          ===========
Depreciation and Amortization:
  Natural Gas Distribution......................   $    51,883          $   56,626          $    94,853
  Interstate Pipeline...........................        19,088              17,229               29,172
  Energy Marketing..............................         4,448               2,115                2,931
  Corporate.....................................         2,788               8,931               15,406
                                                   -----------          ----------          -----------
          Total Depreciation and Amortization...   $    78,207          $   84,901          $   142,362
                                                   ===========          ==========          ===========
Identifiable Assets:
  Natural Gas Distribution......................   $ 3,047,195                              $ 1,920,601
  Interstate Pipeline...........................     3,055,610                                2,151,092
  Energy Marketing..............................     1,267,867                                  778,348
  Corporate.....................................     4,517,953                                4,580,845
  Eliminations..................................    (5,749,529)                              (5,413,409)
                                                   -----------                              -----------
          Total Identifiable Assets(2)..........   $ 6,139,096                              $ 4,017,477
                                                   ===========                              ===========
Capital Expenditures:
  Natural Gas Distribution......................   $    61,078          $   69,422          $   116,400
  Interstate Pipeline...........................        16,304               9,619               39,900
  Energy Marketing..............................        14,365               9,637               12,300
  Corporate.....................................         1,667                 (40)               3,600
                                                   -----------          ----------          -----------
          Total Capital Expenditures............   $    93,414          $   88,638          $   172,200
                                                   ===========          ==========          ===========

(1) Elimination of operating revenues derived from sales to affiliated business units.

(2) As of the Acquisition Date, NorAm's assets and liabilities are reflected at their estimated fair market value; see Note 1(b).

                                                    CURRENT NORAM              FORMER NORAM
                                               -----------------------    -----------------------
                                                                  DECEMBER 31,
                                               --------------------------------------------------
                                                        1997                       1996
                                               -----------------------    -----------------------
                                                CARRYING       FAIR        CARRYING       FAIR
                                                 AMOUNT       VALUE         AMOUNT       VALUE
                                               ----------   ----------    ----------   ----------
                                                             (THOUSANDS OF DOLLARS)
Financial Assets of NorAm:
  Interest rate swaps........................                                          $    6,700
  Energy Derivatives(1)......................  $    9,399   $   13,060    $      800        9,800
Financial Liabilities of NorAm:
  Long-term debt.............................   1,148,848    1,147,344     1,331,200    1,389,500
  Trust preferred securities.................      21,290       24,569       167,800      219,100
  Interest rate swaps........................                      755

(1) At December 31, 1996, NorAm had deferred losses of approximately $11.9 million associated with expected sales under "peaking" contracts with certain customers which, in effect, give the customer a "call" on certain volumes of gas. All such losses were recognized in January 1997 when the anticipated transactions were scheduled to occur.

The fair values of cash and short-term investments, marketable equity securities, short-term and other notes payable are estimated to be equivalent to carrying amounts. The remaining fair values have been determined using quoted market prices of the same or similar securities when available or other estimation techniques.

(11) UNAUDITED QUARTERLY INFORMATION

The following unaudited quarterly financial information includes, in the opinion of management, all adjustments (which comprise only normal recurring accruals) necessary for a fair presentation. Quarterly results are not necessarily indicative of a full year's operations because of seasonality and other factors, including rate increases and variations in operating expense patterns.

The merger in 1997 was recorded under the purchase method of accounting, resulting in new carrying values for certain of NorAm's assets, liabilities and equity based on preliminary analysis. The new basis is reflected in NorAm's Consolidated Financial Statements beginning with the Acquisition Date. For additional information; see Note 1(b).

                                                       YEAR ENDED DECEMBER 31, 1997
                                   --------------------------------------------------------------------
                                               FORMER NORAM                        CURRENT NORAM
                                   -------------------------------------    ---------------------------
                                                               ONE MONTH     TWO MONTHS
                                                                 ENDED          ENDED
                                     FIRST         SECOND      JULY 31,     SEPTEMBER 30,      FOURTH
                                    QUARTER       QUARTER        1997           1997          QUARTER
                                   ----------    ----------    ---------    -------------    ----------
                                          (THOUSANDS OF DOLLARS)              (THOUSANDS OF DOLLARS)
Operating Revenues...............  $1,924,182    $1,015,998    $396,868       $749,412       $1,771,930
Operating Income (loss)..........     145,221        36,616     (26,797)        10,781           79,975
Income (loss) before
  extraordinary item.............      68,410           702     (23,237)        (6,646)          27,493
Extraordinary item, less
  taxes(1).......................         237            --          --             --               --
Net income (loss)(3).............  $   68,647    $      702    $(23,237)      $ (6,646)      $   27,493

                                                                     FORMER NORAM
                                                             YEAR ENDED DECEMBER 31, 1996
                                                   ------------------------------------------------
                                                     FIRST        SECOND      THIRD        FOURTH
                                                   QUARTER(2)    QUARTER     QUARTER      QUARTER
                                                   ----------    --------    --------    ----------
                                                                (THOUSANDS OF DOLLARS)
Operating revenues...............................  $1,417,663    $891,325    $899,283    $1,580,191
Operating income.................................     146,582      39,673      18,634       109,577
Income (loss) before extraordinary item..........      61,197       2,335      (8,183)       39,789
Extraordinary Item, less taxes(1)................        (278)     (4,455)        477           (24)
Net income (loss)(3).............................  $   60,919    ($ 2,120)   ($ 7,706)   $   39,765

(1) Net gain (loss) on early retirement of debt, less taxes.

(2) Includes a pre-tax charge of $22.3 million associated with early retirement and severance costs.

(3) Before preferred dividend requirement.

(12) SUBSEQUENT EVENTS

In February 1998, NorAm issued $300 million principal amount of 6.5% debentures due February 1, 2008. The debentures are not redeemable prior to maturity and are not subject to any sinking fund requirements. The proceeds from the sale of the debentures were used to repay short-term indebtedness of NorAm, including the indebtedness incurred in connection with the 1997 purchase of $101 million aggregate principal amount of its 10% Debentures and the repayment of $53 million aggregate principal amount of NorAm debt that matured in December 1997 and January 1998. In connection with the issuance of the 6.5% debentures NorAm received approximately $1 million upon unwinding a $300 million treasury rate lock agreement, which was tied to the interest rate on 10-year treasury bonds. The rate lock agreement was executed in January 1998, and proceeds from the unwind will be amortized over the 10 year life of NorAm's 6.5% debentures.