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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
-- OR --
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission File Number 1-11668
TXU US Holdings Company
Texas 75-1837355
(State of Incorporation) (I.R.S. Employer Identification No.)
1601 Bryan Street, Dallas TX, 75201-3411 (214) 812-4600
(Address of Principal Executive Offices) (Registrant's Telephone Number)
(Zip Code)
-----------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ----
Common Stock outstanding at November 11, 2004: 2,062,768 Class A shares, without
par value and 39,192,594 Class B shares, without par value.
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TABLE OF CONTENTS
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PAGE
-----
Glossary .......................................................................................... ii
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Statements of Consolidated Income-
Three and Nine Months Ended September 30, 2004 and 2003....................... 1
Condensed Statements of Consolidated Comprehensive Income-
Three and Nine Months Ended September 30, 2004 and 2003....................... 2
Condensed Statements of Consolidated Cash Flows -
Nine Months Ended September 30, 2004 and 2003.................................. 3
Condensed Consolidated Balance Sheets -
September 30, 2004 and December 31, 2003....................................... 4
Notes to Condensed Financial Statements........................................ 5
Report of Independent Registered Public Accounting Firm........................ 25
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................................... 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................... 64
Item 4. Controls and Procedures........................................................ 66
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................. 67
Item 6. Exhibits....................................................................... 67
SIGNATURE............................................................................................ 68
Periodic reports on Form 10-K and Form 10-Q and current reports on Form 8-K that
contain financial information of TXU US Holdings Company and its subsidiaries
are made available to the public, free of charge, on the TXU Corp. website at
http://www.txucorp.com, shortly after they have been filed with the Securities
and Exchange Commission. TXU US Holdings Company will provide copies of current
reports not posted on the website upon request. The information on TXU Corp.'s
website shall not be deemed a part of, or incorporated by reference into, this
report on Form 10-Q.
i
GLOSSARY
When the following terms and abbreviations appear in the text of this report,
they have the meanings indicated below.
1999 Restructuring Legislation................. Legislation that restructured the electric utility industry
in Texas to provide for retail competition
2003 Form 10-K................................. US Holdings' Annual Report on Form 10-K for the year ended
December 31, 2003
Bcf............................................ billion cubic feet
Commission..................................... Public Utility Commission of Texas
EITF........................................... Emerging Issues Task Force
EITF 98-10 .................................... EITF Issue No. 98-10, "Accounting for Contracts Involved in
Energy Trading and Risk Management Activities"
EITF 02-3 ..................................... EITF Issue No. 02-3, "Issues Involved in Accounting for
Derivative Contracts Held for Trading Purposes and Contracts
Involved in Energy Trading and Risk Management Activities"
Electric Delivery.............................. refers to TXU Electric Delivery Company, formerly Oncor
Electric Delivery Company, a subsidiary of US Holdings,
or Electric Delivery and its consolidated bankruptcy
remote financing subsidiary, TXU Electric Delivery
Transition Bond Company LLC, depending on context
Energy......................................... refers to TXU Energy Company LLC, a subsidiary of US
Holdings, and/or its consolidated subsidiaries, depending on
context
ERCOT.......................................... Electric Reliability Council of Texas, the Independent
System Operator and the regional reliability
coordinator of various electricity systems within Texas
FASB........................................... Financial Accounting Standards Board, the designated organization
in the private sector for establishing standards for
financial accounting and reporting
FERC........................................... Federal Energy Regulatory Commission
FIN............................................ Financial Accounting Standards Board Interpretation
FIN 46......................................... FIN No. 46, "Consolidation of Variable Interest Entities -
An Interpretation of ARB No. 51"
FIN 46R........................................ FIN No. 46 (Revised 2003), "Consolidation of Variable
Interest Entities - An Interpretation of ARB 51"
Fitch.......................................... Fitch Ratings, Ltd.
GWh............................................ gigawatt-hours
Historical service territory................... US Holdings' historical service territory, largely in north
Texas, at the time of entering retail competition on January
1, 2002
ii
Moody's........................................ Moody's Investors Services, Inc.
MW............................................. megawatts
NRC............................................ United States Nuclear Regulatory Commission
price-to-beat rate............................. residential and small business customer electricity rates
established by the Commission in the restructuring of the Texas
market that are required to be charged in a REP's historical service
territories until January 1, 2005 or when 40% of the electricity
consumed by such customer classes is supplied by competing REPs,
adjusted periodically for changes in fuel costs, and required to
be available to those customers until January 1, 2007
REP............................................ retail electric provider
S&P............................................ Standard & Poor's, a division of The McGraw Hill Companies
Sarbanes-Oxley................................. Sarbanes - Oxley Act of 2002
SEC............................................ United States Securities and Exchange Commission
SFAS........................................... Statement of Financial Accounting Standards issued by the
FASB
SFAS 133....................................... SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities"
SFAS 140....................................... SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, a
replacement of FASB Statement 125"
SFAS 143....................................... SFAS No. 143, "Accounting for Asset Retirement Obligations"
SFAS 150....................................... SFAS No. 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity"
SG&A........................................... selling, general and administrative
TXU Business Services.......................... TXU Business Services Company, a subsidiary of TXU Corp.
TXU Corp....................................... refers to TXU Corp., a holding company, and/or its
consolidated subsidiaries, depending on context
TXU Gas........................................ TXU Gas Company, a subsidiary of TXU Corp.
TXU Mining..................................... TXU Mining Company LP, a subsidiary of Energy
TXU Portfolio Management....................... TXU Portfolio Management Company LP, a subsidiary of Energy
US............................................. United States of America
US GAAP........................................ accounting principles generally accepted in the US
US Holdings.................................... refers to TXU US Holdings Company, a subsidiary of TXU
Corp., and /or its consolidated subsidiaries, depending on
context
iii
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
TXU US HOLDINGS COMPANY
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2004 2003 2004 2003
------ ------ ------ ------
(millions of dollars)
Operating revenues................................................... $2,746 $2,606 $7,171 $6,672
------ ------ ------ ------
Costs and expenses:
Cost of energy sold and delivery fees............................. 1,137 1,096 3,048 2,864
Operating costs.................................................. 340 337 1,061 1,027
Depreciation and amortization..................................... 198 178 554 522
Selling, general and administrative expenses...................... 235 214 644 602
Franchise and revenue-based taxes................................. 94 88 264 268
Other income...................................................... (47) (21) (67) (47)
Other deductions.................................................. 22 6 322 9
Interest income................................................... (17) (2) (25) (11)
Interest expense and related charges.............................. 150 151 449 458
----- ----- ----- -----
Total costs and expenses...................................... 2,112 2,047 6,250 5,692
----- ----- ----- -----
Income from continuing operations before income taxes, extraordinary
gain and cumulative effect of changes in accounting principles.... 634 559 921 980
Income tax expense................................................... 212 187 289 317
----- ----- ----- -----
Income from continuing operations before extraordinary gain and
cumulative effect of changes in accounting principles............. 422 372 632 663
Loss from discontinued operations, net of tax benefit (Note 3)....... (3) (1) (33) (2)
Extraordinary gain, net of tax....................................... - - 16 -
Cumulative effect of changes in accounting principles, net of
tax benefit (Note 2) ................................................... - - - (58)
----- ----- ----- ------
Net income........................................................... $ 419 $ 371 $ 615 $ 603
Preferred stock dividends............................................ - 1 1 5
----- ----- ----- -----
Net income available for common stock................................ $ 419 $ 370 $ 614 $ 598
===== ===== ===== =====
See Notes to Financial Statements.
1
TXU US HOLDINGS COMPANY
CONDENSED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2004 2003 2004 2003
------ ------ ------ ------
(millions of dollars)
Components related to continuing operations:
Income from continuing operations before extraordinary gain and
cumulative effect of changes in accounting principles.................. $ 422 $ 372 $ 632 $ 663
----- ---- ----- -----
Other comprehensive income (loss), net of tax effects :
Cash flow hedge activity--
Net change in fair value of derivatives (net of tax benefit of
$2, $11, $46 and $63).............................................. (12) (20) (87) (118)
Amounts realized in earnings during the period (net of tax
expense of $3, $24, $11 and $63)................................... 8 45 21 117
----- ----- ----- -----
Total......................................................... (4) 25 (66) (1)
------ ----- ------ ------
Comprehensive income related to continuing operations....................... 418 397 566 662
Comprehensive loss related to discontinued operations....................... (3) (1) (33) (2)
Extraordinary gain, net of tax.............................................. - - 16 -
Cumulative effect of changes in accounting principles, net of tax benefits.. - - - (58)
----- ----- ----- ------
Comprehensive income ....................................................... $ 415 $ 396 $ 549 $ 602
===== ===== ===== =====
See Notes to Financial Statements.
2
TXU US HOLDINGS COMPANY
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
------------------
2004 2003
------ ------
(millions of dollars)
Cash flows - operating activities:
Income from continuing operations before extraordinary gain and cumulative
effect of changes in accounting principles.................................... $ 632 $ 663
Adjustments to reconcile income from continuing operations before
extraordinary gain and cumulative effect of changes in accounting principles
to cash provided by operating activities:
Depreciation and amortization ............................................... 601 577
Deferred income taxes and investment tax credits - net ...................... (109) 139
Asset writedown charges...................................................... 189 -
Net gain from sale of assets................................................. (65) (40)
Net effect of unrealized mark-to-market valuations of commodity contracts.... 46 (58)
Net equity loss from unconsolidated affiliates and joint ventures............ 10 -
Reduction in regulatory liability............................................ (1) (125)
Retail clawback accrual...................................................... - (19)
Changes in operating assets and liabilities..................................... (59) 184
------ ------
Cash provided by operating activities.................................... 1,244 1,321
------ ------
Cash flows - financing activities:
Issuances of long-term debt..................................................... 1,590 1,900
Retirements/repurchases of securities:
Long-term debt............................................................... (746) (899)
Preferred stock of subsidiary, subject to mandatory redemption............... - (91)
Common stock................................................................. - (463)
Change in advances - affiliates................................................. (2,652) (246)
Dividends paid to parent........................................................ (600) (250)
Change in notes payable - banks................................................. 565 (1,804)
Preferred stock dividends paid.................................................. (1) (5)
Redemption deposits applied to debt retirements................................. - 210
Debt premium, discount, financing and reacquisition expenses.................... (39) (57)
------ ------
Cash used in financing activities........................................ (1,883) (1,705)
------ ------
Cash flows - investing activities:
Capital expenditures............................................................ (541) (480)
Nuclear fuel.................................................................... (46) (45)
Proceeds from sale of businesses................................................ 513 19
Other........................................................................... (20) (12)
------ ------
Cash used in investing activities........................................ (94) (518)
------ ------
Cash contributions to discontinued operations..................................... (40) (3)
------ ------
Net change in cash and cash equivalents........................................... (773) (905)
Cash and cash equivalents - beginning balance..................................... 806 1,508
------ ------
Cash and cash equivalents - ending balance........................................ $ 33 $ 603
====== ======
See Notes to Financial Statements.
3
TXU US HOLDINGS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2004 2003
------------- -------------
(millions of dollars)
ASSETS
Current assets:
Cash and cash equivalents.................................................. $ 33 $ 806
Restricted cash............................................................ 29 12
Advances to affiliates..................................................... 2,173 -
Accounts receivable -- trade............................................... 1,059 1,001
Inventories................................................................ 327 415
Commodity contract assets.................................................. 707 548
Other current assets....................................................... 371 258
------- -------
Total current assets.................................................. 4,699 3,040
Investments:
Restricted cash............................................................ 15 13
Other investments.......................................................... 575 510
Property, plant and equipment -- net.......................................... 16,300 16,677
Goodwill...................................................................... 542 558
Regulatory assets -- net...................................................... 1,922 1,872
Commodity contract assets..................................................... 229 109
Cash flow hedge and other derivative assets................................... 24 88
Assets held for sale.......................................................... 27 60
Other noncurrent assets....................................................... 229 143
------- -------
Total assets....................................................... $24,562 $23,070
======= =======
LIABILITIES, PREFERRED INTERESTS AND SHAREHOLDERS' EQUITY
Current liabilities:
Advances from affiliates................................................... $ - $ 691
Notes payable -- banks..................................................... 565 -
Long-term debt due currently............................................... 318 249
Accounts payable -- trade.................................................. 910 775
Commodity contract liabilities............................................. 545 502
Accrued taxes.............................................................. 521 435
Other current liabilities.................................................. 764 784
------- -------
Total current liabilities............................................. 3,623 3,436
Accumulated deferred income taxes............................................. 3,211 3,382
Investment tax credits........................................................ 411 428
Commodity contract liabilities................................................ 309 47
Cash flow hedge and other derivative liabilities.............................. 218 140
Liabilities held for sale..................................................... 8 11
Other noncurrent liabilities and deferred credits............................. 1,785 1,592
Long-term debt, less amounts due currently.................................... 8,008 7,217
Preferred membership interests, held by TXU Corp. at September 30, 2004,
net of discount of $242 and $253 (Note 4).................................... 508 497
------- -------
Total liabilities..................................................... 18,081 16,750
Contingencies (Note 6)
Shareholders' equity and preferred interests (Note 5):
Preferred stock - not subject to mandatory redemption (Note 5).............. 38 38
Common stock without par value (Note 5):
Class A - Authorized shares--9,000,000, Outstanding shares--2,062,768.... 102 102
Class B - Authorized shares--171,000,000, Outstanding shares--39,192,594. 1,949 1,949
Retained earnings........................................................... 4,593 4,366
Accumulated other comprehensive loss........................................ (201) (135)
------- -------
Total common stock equity................................................ 6,443 6,282
------- -------
Total shareholders' equity and preferred interests..................... 6,481 6,320
------- -------
Total liabilities, preferred interests and shareholders' equity...... $24,562 $23,070
======= =======
See Notes to Financial Statements.
4
TXU US HOLDINGS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
Description of Business -- US Holdings is a subsidiary of TXU Corp. and is
a holding company conducting its operations principally through its Energy and
Electric Delivery subsidiaries. Energy is engaged in electricity generation and
retail and wholesale energy sales. Electric Delivery engages in regulated
electricity transmission and distribution operations. (See Note 7 for more
information on business segments).
Strategic Initiatives and Other Actions - Mr. C. John Wilder, who was
named president and chief executive of TXU Corp. in February 2004, and senior
management have been reviewing the operations of TXU Corp. and have formulated
certain strategic initiatives and continue to develop others. Areas being
reviewed include:
o Performance in competitive markets, including profitability in new
markets;
o Cost structure, including organizational alignments and headcount;
o Management of natural gas price risk and cost effectiveness of the
generation fleet; and
o Non-core business activities.
As discussed below, implementation of the strategic initiatives as well as
other actions taken to date have resulted in total charges of $9 million ($6
million after-tax) in the third quarter of 2004 and $305 million ($198 million
after-tax) year-to-date, substantially all reported in other deductions, related
to asset writedowns and employee severance. In the third quarter of 2004, US
Holdings recorded gains on the disposition of properties, principally
undeveloped land, totaling $18 million ($12 million after-tax), reported in
other income.
Charges recorded in the three-month and nine-month periods ended September
30, 2004 and 2003 reported in other deductions are detailed in Note 9.
Capgemini Energy Agreement
--------------------------
On May 17, 2004, Energy and Electric Delivery each entered into a service
agreement with a subsidiary of Cap Gemini North America Inc., Capgemini Energy
LP (Capgemini), a new company initially providing business process support
services to TXU Corp., but immediately implementing a plan to offer similar
services to other utility companies. Under the ten-year agreement, over 2,500
TXU Corp. employees (including approximately 1,300 from US Holdings) transferred
to Capgemini effective July 1, 2004. Outsourced base support services performed
by Capgemini for a fixed fee, subject to adjustment for volumes or other
factors, include information technology, customer call center, billing and
collections, human resources, supply chain and certain accounting activities.
As part of the agreement, Capgemini was provided a royalty-free right,
under an asset license arrangement, to use information technology assets,
consisting primarily of capitalized software. A portion of the software was in
development and had not yet been placed in service by US Holdings. As a result
of outsourcing its information technology activities, US Holdings no longer
intends to develop the majority of these projects and from US Holdings'
perspective the software is abandoned. The agreement with Capgemini does not
require that any software in development be completed and placed in service.
Consequently, the carrying value of these software projects was written off,
resulting in a charge of $109 million ($71 million after-tax) for the nine
months ended September 30, 2004, reported in other deductions, essentially all
of which was recorded in the second quarter of 2004. The remaining assets were
transferred to a subsidiary of TXU Corp. at book value in exchange for an
interest in that subsidiary. Such interest is accounted for by US Holdings on
the equity method, and US Holdings recorded equity losses (representing
depreciation expense) of $10 million, in the third quarter of 2004, reported in
other deductions.
5
The TXU Corp. subsidiary received a 2.9% limited partnership interest in
Capgemini in exchange for the asset license described above. Energy and Electric
Delivery have the right to sell (the "put option") their interest in the
subsidiary to Cap Gemini America Inc. for $200 million, plus the subsidiary's
share of Capgemini's undistributed earnings, upon expiration of the services
agreement, or earlier upon the occurrence of certain unexpected events. Cap
Gemini North America Inc. has the right to purchase Energy's and Electric
Delivery's interests under the same terms and conditions. The partnership
interest has been recorded at an initial value of $2.9 million and is being
accounted for on the cost method.
US Holdings has recorded its share of the fair value of the put option as
a noncurrent asset largely offset by a reduction to the carrying value of the
software transferred to the subsidiary, in accordance with the accounting
principles related to sales and licensing of internally developed software
described in AICPA Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use."
Also as part of the agreement, TXU Corp. agreed to indemnify Capgemini for
severance costs incurred by Capgemini for former TXU Corp. employees terminated
within 18 months of their transfer to Capgemini. Accordingly, US Holdings
recorded a $38 million ($25 million after-tax) charge for severance expense in
the second quarter of 2004, which represents a reasonable estimate of the
indemnity and is reported in other deductions. The charge includes an allocation
of severance related to TXU Business Services Company employees. The transition
costs applicable to US Holdings are expected to be largely recorded during the
fourth quarter of 2004.
Transfer and Sale of TXU Fuel Company
-------------------------------------
On April 30, 2004, Energy distributed the assets of TXU Fuel Company, its
gas transportation subsidiary, to US Holdings. On June 2, 2004, US Holdings
completed the sale of the assets of TXU Fuel Company to Energy Transfer
Partners, L.P. for $500 million in cash. The assets of TXU Fuel Company
consisted of approximately 1,900 miles of intrastate pipeline and a total system
capacity of 1.3 Bcf/day. As part of the transaction, Energy entered into a
market-price based transportation agreement with the new owner to transport gas
to Energy's generation plants. Because of the continuing involvement in the
business through the transportation agreement, the pre-tax gain related to the
sale of $377 million will be recognized over the eight-year life of the
transportation agreement and the business has not been accounted for as a
discontinued operation. The pre-tax gain is net of $16 million of Energy
goodwill allocated to TXU Fuel Company.
Facility Closures and Other Actions Related to Generation Operations
--------------------------------------------------------------------
In the third quarter of 2004, Energy recorded gains totaling $18 million
($12 million after-tax) related to the sale of undeveloped land. The gains are
reported in other income.
In the second quarter of 2004, Energy initiated a plan to sell the
Pedricktown, New Jersey 122 MW power production facility and exit the related
power supply and gas transportation agreements. Accordingly, Energy recorded an
impairment charge of $26 million ($17 million after-tax) to write down the
facility to estimated fair market value. The results of the business and the
impairment charge are reported in discontinued operations as discussed in Note
3.
As part of Energy's review of its generation asset portfolio, Energy
completed a review of its spare parts and equipment inventory to determine the
appropriate level of such inventory. The review included nuclear, coal and
gas-fired generation-related facilities. As a result of this review, Energy
recorded a charge of $79 million ($51 million after-tax), reported in other
deductions, in the second quarter of 2004 to reflect excess inventory on hand
and to write down carrying values to scrap values.
In March 2004, Energy announced the planned permanent retirement,
completed in the second quarter of 2004, of eight gas-fired operating units due
to electric industry market conditions in Texas. Energy also temporarily closed
four other gas-fired units and placed them under evaluation for retirement. The
12 units represented a total of 1,471 MW, or more than 13%, of Energy's
gas-fired generation capacity in Texas. A majority of the 12 units were
designated as "peaking units" and operated only during the summer for many years
and have operated only sparingly during the last two years. Most of the units
were built in the 1950's. Energy also determined that it would close its
Winfield North Monticello lignite mine in Texas, and such closure has been
completed, as it is no longer economical to operate when compared to the cost of
purchasing coal to fuel the adjacent generation facility. A total charge of $8
million ($5 million after-tax) was recorded in the first quarter of 2004,
reported in other deductions, for production employee severance costs ($7
million pre-tax) and impairments related to the various facility closures ($1
million pre-tax).
6
Organizational Realignment and Headcount Reductions
---------------------------------------------------
During the second quarter of 2004, management completed a comprehensive
organizational review, including an analysis of staffing requirements. As a
result, TXU Corp. completed a self-nomination severance program and finalized a
plan for additional headcount reductions under an involuntary severance program,
which has been largely completed. Accordingly, in the second quarter of 2004, US
Holdings recorded severance charges totaling $50 million ($33 million
after-tax), reported in other deductions.
Preferred Membership Interest
-----------------------------
In April 2004, TXU Corp. purchased from the holders Energy's preferred
membership interests with a liquidation value of $750 million. Energy's carrying
amount of the security, which remains outstanding, is the $750 million
liquidation amount less $242 million remaining unamortized discount and $30
million in unamortized debt issuance costs.
Discontinued Businesses -- Note 3 presents detailed information regarding
the discontinued New Jersey generation operations and the strategic retail
services business. The condensed consolidated financial statements for all
periods presented reflect the reclassification of the results of these
businesses as discontinued operations.
Basis of Presentation -- The condensed consolidated financial statements
of US Holdings have been prepared in accordance with US GAAP and on the same
basis as the audited financial statements included in its 2003 Form 10-K, except
for the changes in estimates of depreciable lives of assets discussed below and
the presentation of certain operations as discontinued. In the opinion of
management, all other adjustments (consisting of normal recurring accruals)
necessary for a fair presentation of the results of operations and financial
position have been included therein. All intercompany items and transactions
have been eliminated in consolidation. Certain information and footnote
disclosures normally included in annual consolidated financial statements
prepared in accordance with US GAAP have been omitted pursuant to the rules and
regulations of the SEC. Because the condensed consolidated interim financial
statements do not include all of the information and footnotes required by US
GAAP, they should be read in conjunction with the audited financial statements
and related notes included in the 2003 Form 10-K. The results of operations for
an interim period may not give a true indication of results for a full year.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
(the Medicare Act) was enacted in December 2003. TXU Corp. is accounting for the
effects of the Medicare Act in accordance with FASB Staff Position 106-2. For
the three and nine months ended September 30, 2004, the effect of adoption of
the Medicare Act was a reduction of approximately $6 million and $17 million,
respectively, in US Holding's postretirement benefit costs.
Certain reclassifications have been made to conform prior period data to
the current period presentation. All dollar amounts in the financial statements
and tables in the notes are stated in millions of dollars unless otherwise
indicated.
Depreciation of Energy Production Facilities -- Effective January 1, 2004,
the estimates of the depreciable lives of lignite-fired generation facilities
were extended an average of nine years to better reflect the useful lives of the
assets, and depreciation rates for the Comanche Peak nuclear generating plant
were decreased as a result of an increase in the estimated lives of boiler and
turbine generator components of the plant by an average of five years. The net
impact of these changes was a reduction in depreciation expense of $11 million
and $33 million ($7 million and $21 million after-tax) in the three and nine
months, respectively, ended September 30, 2004.
Effective April 1, 2003, the estimates of the depreciable lives of the
Comanche Peak nuclear generating plant and several gas generation plants were
extended to better reflect the useful lives of the assets. At the same time,
depreciation rates were increased on lignite and gas generation facilities to
reflect additional investments in equipment. The net impact of these changes was
an additional reduction in depreciation expense of $12 million ($8 million
after-tax) in the nine months ended September 30, 2004.
7
Changes in Accounting Standards -- FIN 46R was issued in December 2003 and
replaced FIN 46, which was issued in January 2003. FIN 46R expands and clarifies
the guidance originally contained in FIN 46, regarding consolidation of variable
interest entities. FIN 46R did not impact results of operations or financial
position for the first nine months of 2004.
Extraordinary gain -- An extraordinary gain of $16 million (net of tax of
$9 million) in 2004 represents an increase in the carrying value of Electric
Delivery's regulatory asset subject to securitization. The second and final
tranche of the securitization bonds was issued in June 2004. The increase in the
related regulatory asset, with a carrying value of $1.6 billion, is due to the
effect of higher interest rates on the bonds and therefore increased amounts to
be recovered from REPs through delivery fee surcharges to service the bonds.
2. CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES
The following summarizes the effect on results for 2003, reported in the
first quarter, of changes in accounting principles effective January 1, 2003:
Charge from rescission of EITF 98-10, net of tax effect of $34 million... $(63)
Credit from adoption of SFAS 143, net of tax effect of $3 million........ 5
----
Total net charge.................................................... $(58)
====
On October 25, 2002, the EITF, through EITF 02-3, rescinded EITF 98-10,
which required mark-to-market accounting for all trading activities. Pursuant to
this rescission, only financial instruments that are derivatives under SFAS 133
are subject to mark-to-market accounting. Financial instruments that may not be
derivatives under SFAS 133, but were marked-to-market under EITF 98-10, consist
primarily of gas transportation and storage agreements, power tolling, full
requirements and capacity contracts. This new accounting rule was effective for
new contracts entered into after October 25, 2002. Non-derivative contracts
entered into prior to October 26, 2002, continued to be accounted for at fair
value through December 31, 2002; however, effective January 1, 2003, such
contracts were required to be accounted for on a settlement basis. Accordingly,
a charge of $97 million ($63 million after-tax) was reported as a cumulative
effect of a change in accounting principles in the first quarter of 2003. Of the
total, $75 million reduced net commodity contract assets and liabilities and $22
million reduced inventory that had previously been marked-to-market as a trading
position. The cumulative effect adjustment represents the net gains previously
recognized for these contracts under mark-to-market accounting.
SFAS 143 became effective on January 1, 2003. SFAS 143 requires entities
to record the fair value of a legal liability for an asset retirement obligation
in the period of its inception. For US Holdings, such liabilities primarily
relate to nuclear generation plant decommissioning, land reclamation related to
lignite mining and removal of lignite plant ash treatment facilities. The
liability is recorded at its net present value with a corresponding increase in
the carrying value of the related long-lived asset. The liability is accreted
each period, representing the time value of money, and the capitalized cost is
depreciated over the remaining useful life of the related asset.
As the new accounting rule required retrospective application to the
inception of the liability, the effects of the adoption reflect the accretion
and depreciation from the liability inception date through December 31, 2002.
Further, the effects of adoption take into consideration liabilities of $215
million (previously reflected in accumulated depreciation) US Holdings had
previously recorded as depreciation expense and $26 million (reflected in other
noncurrent liabilities) of unrealized net gains associated with the
decommissioning trusts.
8
The following table summarizes the impact as of January 1, 2003 of
adopting SFAS 143:
Increase in property, plant and equipment - net................ $488
Increase in other noncurrent liabilities and deferred credits.. (528)
Increase in accumulated deferred income taxes.................. (3)
Increase in regulatory assets - net............................ 48
----
Cumulative effect of change in accounting principles........... $ 5
====
The asset retirement liability at September 30, 2004 was $610 million,
comprised of a $599 million liability as of December 31, 2003 and $30 million of
accretion during the nine months ended September 30, 2004, reduced by $19
million in reclamation payments.
With respect to nuclear decommissioning costs, for US Holdings the
adoption of SFAS 143 results in timing differences in the recognition of asset
retirement costs that are being recovered through the regulatory process.
3. DISCONTINUED OPERATIONS
The following summarizes the historical consolidated financial information
of the businesses reported as discontinued operations:
Three Months Ended September 30, 2004 Nine Months Ended September 30, 2004
------------------------------------- ------------------------------------
Strategic Strategic
Retail Retail
Services Pedricktown Total Services Pedricktown Total
-------- ----------- ----- -------- ----------- -----
Operating revenues........................ $ 3 $ 8 $ 11 $ 13 $ 27 $ 40
Operating costs and expenses.............. 4 8 12 16 30 46
Other deductions (income) - net........... - - - 10 - 10
----- ----- ----- ----- ----- -----
Operating loss before income taxes........ (1) - (1) (13) (3) (16)
Income tax expense (benefit).............. 1 - 1 (4) (1) (5)
----- ----- ----- ----- ----- -----
Operating loss............................ (2) - (2) (9) (2) (11)
Charge related to exit (after-tax)........ (1) - (1) (5) (17) (22)
----- ----- ----- ----- ----- -----
Loss from discontinued operations.... $ (3) $ - $ (3) $ (14) $ (19) $ (33)
----- ----- ----- ------ ----- -----
Three Months Ended September 30, 2003 Nine Months Ended September 30,2003
------------------------------------- -----------------------------------
Strategic Strategic
Retail Retail
Services Pedricktown Total Services Pedricktown Total
--------- ----------- ----- -------- ----------- -----
Operating revenues........................ $ 11 $ 10 $ 21 $ 54 $ 18 $ 72
Operating costs and expenses.............. 8 10 18 49 21 70
Other deductions (income) - net........... 4 - 4 4 - 4
----- ----- ----- ----- ----- -----
Operating income (loss) before income taxes (1) - (1) 1 (3) (2)
Income tax expense (benefit).............. - - - 1 (1) -
----- ----- ----- ----- ------ -----
Operating loss............................ (1) - (1) - (2) (2)
------ ----- ------ ----- ------ ------
Loss from discontinued operations.... $ (1) $ - $ (1) $ - $ (2) $ (2)
----- ---- ----- ---- ----- -----
Pedricktown - In the second quarter of 2004, Energy initiated a plan to
sell the Pedricktown, New Jersey 122 MW power production facility and exit the
related power supply and gas transportation agreements. Accordingly, results for
the second quarter of 2004 include a $17 million after-tax charge to write down
the facility to estimated fair market value.
Strategic Retail Services - In December 2003, Energy finalized a formal
plan to sell its strategic retail services business, which is engaged
principally in providing energy management services. Energy expects to
substantially complete the sales of these operations to various parties by
year-end 2004. Results for 2004 reflect a $9 million ($6 million after-tax)
charge recorded in the second quarter to settle a contract dispute.
9
Balance sheet - The following details the assets and liabilities held for
sale:
September 30, 2004
----------------------------------
Strategic
Retail
Services Pedricktown Total
---------- ----------- -----
Current assets........................................... $ 4 $ 2 $ 6
Investments.............................................. 2 - 2
Property, plant and equipment............................ 3 16 19
----- ----- -----
Assets held for sale................................ $ 9 $ 18 $ 27
===== ===== =====
Current liabilities...................................... $ - $ 4 $ 4
Noncurrent liabilities................................... - 4 4
----- ----- -----
Liabilities held for sale........................... $ - $ 8 $ 8
===== ===== =====
4. FINANCING ARRANGEMENTS
Short-term Borrowings -- At September 30, 2004, US Holdings had
outstanding short-term borrowings consisting of bank borrowings under the
three-year revolving credit facility of $565 million at a weighted average
interest rate of 4.27%. At December 31, 2003, US Holdings had outstanding
short-term advances from affiliates of $691 million at a weighted average
interest rate of 2.92%.
Credit Facilities -- At September 30, 2004, TXU Corp. had credit
facilities (some of which provide for long-term borrowings) as follows:
- ----------------------------------- ------------ ---------------- ----------------------------------------------
At September 30, 2004
- ----------------------------------- ------------ ---------------- ----------------------------------------------
Maturity Authorized Facility Letters of Cash
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Facility Date Borrowers Limit Credit Borrowings Availability
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Energy, Electric
364-day Credit Facility June 2005 Delivery $ 600 $ 80 $ - $ 520
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Three-Year Revolving Credit Energy, Electric
Facility June 2007 Delivery 1,400 - 565 835
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Five-Year Revolving Credit
Facility August 2008 TXU Corp. 500 429 - 71
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Five-Year Revolving Credit Energy, Electric
Facility June 2009 Delivery 500 - - 500
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Total $3,000 $ 509 $ 565 $ 1,926
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
In June 2004, US Holdings, Energy and Electric Delivery replaced $2.25
billion of credit facilities scheduled to mature in 2005 with $2.5 billion of
credit facilities for Energy and Electric Delivery maturing in June 2005, 2007
and 2009. These facilities are used for working capital and general corporate
purposes and provide back-up for any future issuances of commercial paper by
Energy or Electric Delivery. At September 30, 2004, there was no such commercial
paper outstanding.
In April 2004, Energy entered into a $1.0 billion, 364-day credit
facility. In July 2004, borrowings under this facility were repaid with proceeds
from Energy's issuance of $800 million floating rate senior notes and repayment
of advances to affiliates and the facility was subsequently terminated.
TXU Corp.'s $500 million five-year revolving credit facility provides for
up to $500 million in letters of credit and/or up to $250 million of loans ($500
million in the aggregate). To the extent capacity is available under this
facility, it may be made available to US Holdings, Energy or Electric Delivery
for borrowings, letters of credit or other purposes.
Sale of Receivables -- TXU Corp. has established an accounts receivable
securitization program. The activity under this program is accounted for as a
sale of accounts receivable in accordance with SFAS 140. Under the program,
subsidiaries of TXU Corp. (originators) sell trade accounts receivable to TXU
Receivables Company, a consolidated wholly-owned bankruptcy remote direct
subsidiary of TXU Corp., which sells undivided interests in the purchased
10
accounts receivable for cash to special purpose entities established by
financial institutions (the funding entities). As of September 30, 2004, $700
million of undivided interests in US Holdings' accounts receivable had been sold
by TXU Receivables Company. Effective June 30, 2004, the program was extended
through June 28, 2005. As part of the extension, the maximum amount available
under the program was increased from $600 million to $700 million in recognition
of seasonal power sales. Additionally, the extension allows for increased
availability of funding through a credit ratings-based reduction (based on each
originator's credit rating) of customer deposits previously used to reduce the
amount of undivided interests that could be sold. Undivided interests will now
be reduced by 100% of the customer deposit for a Baa3/BBB- rating; 50% for a
Baa2/BBB rating; and zero % for a Baa1/BBB+ and above rating.
All new trade receivables under the program generated by the originators
are continuously purchased by TXU Receivables Company with the proceeds from
collections of receivables previously purchased. Changes in the amount of
funding under the program, through changes in the amount of undivided interests
sold by TXU Receivables Company, are generally due to seasonal variations in the
level of accounts receivable and changes in collection trends. TXU Receivables
Company has issued subordinated notes payable to the originators for the
difference between the face amount of the uncollected accounts receivable
purchased, less a discount, and cash paid to the originators that was funded by
the sale of the undivided interests.
The discount from face amount on the purchase of receivables principally
funds program fees paid by TXU Receivables Company to the funding entities, as
well as a servicing fee paid by TXU Receivables Company to TXU Business
Services, a direct subsidiary of TXU Corp. The program fees (losses on sale),
which consist primarily of interest costs on the underlying financing, were
approximately $7 million and $8 million for the nine-month periods ending
September 30, 2004 and 2003, respectively, and approximated 1.9% and 2.5% for
the first nine months of 2004 and 2003, respectively, of the average funding
under the program on an annualized basis; these fees represent the net
incremental costs of the program to US Holdings and are reported in SG&A
expenses. The servicing fee, which totaled approximately $3 million and $4
million for the first nine months of 2004 and 2003, respectively, compensates
TXU Business Services for its services as collection agent, including
maintaining the detailed accounts receivable collection records.
The September 30, 2004 balance sheet reflects $1.1 billion face amount of
trade accounts receivable of Energy and Electric Delivery, reduced by $700
million of undivided interests sold by TXU Receivables Company. Funding under
the program increased $153 million for the nine months ended September 30, 2004.
Funding under the program for the nine months ended September 30, 2003 increased
$220 million. Funding increases or decreases under the program are reflected as
operating cash flow activity in the statement of cash flows. The carrying amount
of the retained interests in the accounts receivable approximated fair value due
to the short-term nature of the collection period.
Activities of TXU Receivables Company related to US Holdings for the nine
months ended September 30, 2004 and 2003 were as follows:
Nine Months
Ended September 30,
---------------------
2004 2003
------ ------
Cash collections on accounts receivable...................................... $ 5,390 $5,210
Face amount of new receivables purchased..................................... (5,472) (5,167)
Discount from face amount of purchased receivables........................... 10 12
Program fees paid............................................................ (7) (8)
Servicing fees paid.......................................................... (3) (4)
Increase (decrease) in subordinated notes payable............................ (71) (263)
-------- -------
Operating cash flows provided to US Holdings under the program.......... $ (153) $ (220)
======== =======
Upon termination of the program, cash flows to US Holdings would be
delayed as collections of sold receivables would be used by TXU Receivables
Company to repurchase the undivided interests sold instead of purchasing new
receivables. The level of cash flows would normalize in approximately 16 to 31
days.
11
Contingencies Related to Sale of Receivables Program -- Although TXU
Receivables Company expects to be able to pay its subordinated notes from the
collections of purchased receivables, these notes are subordinated to the
undivided interests of the financial institutions in those receivables, and
collections might not be sufficient to pay the subordinated notes. The program
may be terminated if either of the following events occurs:
1) all of the originators cease to maintain their required fixed charge
coverage ratio and debt to capital (leverage) ratio;
2) the delinquency ratio (delinquent for 31 days) for the sold
receivables, the default ratio (delinquent for 91 days or
deemed uncollectible), the dilution ratio (reductions for discounts,
disputes and other allowances) or the days collection outstanding
ratio exceed stated thresholds and the financial institutions do not
waive such event of termination. The thresholds apply to the entire
portfolio of sold receivables, not separately to the receivables of
each originator.
The delinquency and dilution ratios exceeded the relevant thresholds
during the first four months of 2003, but waivers were granted. These ratios
were affected by issues related to the transition to competition. Certain
billing and collection delays arose due to implementation of new systems and
processes within Energy and ERCOT for clearing customers' switching and billing
data. Strengthened credit and collection policies and practices have brought the
ratios into consistent compliance with the program requirement.
Under terms of the receivables sale program, all the originators are
required to maintain specified fixed charge coverage and leverage ratios (or
supply a parent guarantor that meets the ratio requirements). The failure, by an
originator or its parent guarantor, if any, to maintain the specified financial
ratios would prevent that originator from selling its accounts receivable under
the program. If all the originators and the parent guarantor, if any, fail to
maintain the specified financial ratios so that there are no eligible
originators, the facility would terminate.
12
Long-term Debt -- At September 30, 2004 and December 31, 2003, the
long-term debt of US Holdings and its consolidated subsidiaries consisted of the
following:
September 30, December 31,
2004 2003
------------- -------------
Energy
------
Pollution Control Revenue Bonds:
Brazos River Authority:
3.000% Fixed Series 1994A due May 1, 2029, remarketing date May 1, 2005(a).......... $ 39 $ 39
5.400% Fixed Series 1994B due May 1, 2029, remarketing date May 1, 2006(a).......... 39 39
5.400% Fixed Series 1995A due April 1, 2030, remarketing date May 1, 2006(a)........ 50 50
5.050% Fixed Series 1995B due June 1, 2030, remarketing date June 19, 2006(a)....... 114 118
7.700% Fixed Series 1999A due April 1, 2033......................................... 111 111
6.750% Fixed Series 1999B due September 1, 2034, remarketing date April 1, 2013(a).. 16 16
7.700% Fixed Series 1999C due March 1, 2032......................................... 50 50
4.950% Fixed Series 2001A due October 1, 2030, remarketing date April 1, 2004(a).... -- 121
4.750% Fixed Series 2001B due May 1, 2029, remarketing date November 1, 2006(a)..... 19 19
5.750% Fixed Series 2001C due May 1, 2036, remarketing date November 1, 2011(a)..... 217 274
1.464% Floating Series 2001D due May 1, 2033........................................ 268 271
1.730% Floating Taxable Series 2001I due December 1, 2036(b)........................ 63 63
1.436% Floating Series 2002A due May 1, 2037(b)..................................... 45 61
6.750% Fixed Series 2003A due April 1, 2038, remarketing date April 1, 2013(a)...... 44 44
6.300% Fixed Series 2003B due July 1, 2032.......................................... 39 39
6.750% Fixed Series 2003C due October 1, 2038....................................... 52 72
5.400% Fixed Series 2003D due October 1, 2029, remarketing date October 1, 2014(a).. 31 31
Sabine River Authority of Texas:
6.450% Fixed Series 2000A due June 1, 2021....................................... 51 51
5.500% Fixed Series 2001A due May 1, 2022, remarketing date November 1, 2011(a).. 91 91
5.750% Fixed Series 2001B due May 1, 2030, remarketing date November 1, 2011(a).. 107 107
5.800% Fixed Series 2003A due July 1, 2022....................................... 12 12
6.150% Fixed Series 2003B due August 1, 2022..................................... 45 45
Trinity River Authority of Texas:
6.250% Fixed Series 2000A due May 1, 2028........................................ 14 14
5.000% Fixed Series 2001A due May 1, 2027, remarketing date November 1, 2006(a).. 37 37
Other:
6.875% TXU Mining Fixed Senior Notes due August 1, 2005.......................... 30 30
6.125% Fixed Senior Notes due March 15, 2008(c).................................. 250 250
7.000% Fixed Senior Notes due March 15, 2013..................................... 1,000 1,000
2.380% Floating Rate Senior Notes due January 17, 2006 .......................... 800 --
Capital lease obligations........................................................ 9 13
Other............................................................................ 1 8
Fair value adjustments related to interest rate swaps............................ 17 11
Unamortized--discount............................................................ -- (2)
------- -------
Total Energy ................................................................ 3,661 3,085
Electric Delivery
- -----------------
8.250% Fixed First Mortgage Bonds due April 1, 2004.............................. -- 100
6.250% Fixed First Mortgage Bonds due October 1, 2004............................ 121 121
6.750% Fixed First Mortgage Bonds due July 1, 2005............................... 92 92
7.625% Fixed First Mortgage Bonds due July 1, 2025............................... -- 215
7.375% Fixed First Mortgage Bonds due October 1, 2025............................ -- 178
6.375% Fixed Senior Secured Notes due May 1, 2012................................ 700 700
7.000% Fixed Senior Secured Notes due May 1, 2032................................ 500 500
6.375% Fixed Senior Secured Notes due January 15, 2015........................... 500 500
7.250% Fixed Senior Secured Notes due January 15, 2033........................... 350 350
5.000% Fixed Debentures due September 1, 2007.................................... 200 200
7.000% Fixed Debentures due September 1, 2022.................................... 800 800
Unamortized discount............................................................. (19) (30)
------- -------
Sub-total 3,244 3,726
13
September 30, December 31,
2004 2003
------------- -------------
TXU Electric Delivery Transition Bond Company LLC (e)
- -----------------------------------------------------
2.260% Fixed Series 2003 Bonds due in bi-annual installments through
February 15, 2007............................................................... 80 103
4.030% Fixed Series 2003 Bonds due in bi-annual installments through
February 15, 2010............................................................... 122 122
4.950% Fixed Series 2003 Bonds due in bi-annual installments through
February 15, 2013............................................................... 130 130
5.420% Fixed Series 2003 Bonds due in bi-annual installments through
August 15, 2015................................................................. 145 145
3.520% Fixed Series 2004 Bonds due in bi-annual installments through
November 15, 2009............................................................... 279 --
4.810% Fixed Series 2004 Bonds due in bi-annual installments through
November 15, 2012............................................................... 221 --
5.290% Fixed Series 2004 Bonds due in bi-annual installments through
May 15, 2016.................................................................... 290 --
------- -------
Total TXU Electric Delivery Transition Bond Company LLC....................... 1,267 500
------- -------
Total Electric Delivery....................................................... 4,511 4,226
US Holdings
- -----------
7.170% Fixed Senior Debentures due August 1, 2007................................ 10 10
9.580% Fixed Notes due in bi-annual installments through December 4, 2019........ 70 70
8.254% Fixed Notes due in quarterly installments through December 31, 2021....... 65 66
2.494% Floating Rate Junior Subordinated Debentures, Series D due January 30,
2037(d).......................................................................... 1 1
8.175% Fixed Junior Subordinated Debentures, Series E due January 30, 2037....... 8 8
------- -------
Total US Holdings............................................................ 154 155
Total US Holdings consolidated...................................................... 8,326 7,466
Less amount due currently........................................................... 318 249
------- -------
Total long-term debt................................................................ $ 8,008 $ 7,217
======= =======
(a) These series are in the multiannual mode and are subject to mandatory
tender prior to maturity on the mandatory remarketing date. On such
date, the interest rate and interest rate period will be reset for the
bonds.
(b) Interest rates in effect at September 30, 2004. These series are in a
flexible or weekly rate mode and are classified as long-term as they are
supported by long-term irrevocable letters of credit. Series in the
flexible mode will be remarketed for periods of less than 270 days.
(c) Interest rates swapped to floating on an aggregate $250 million principal
amount.
(d) Interest rates in effect at September 30, 2004.
(e) These bonds are nonrecourse to Electric Delivery.
On September 28, 2004, portions of the Brazos River Authority Pollution
Control Revenue Refunding Bonds related to the Twin Oak facility were redeemed
at par value as follows: $57 million of Series 2001C; $21 million of Series
2003C; $16 million of Series 2002A; $4 million of Series 1995B; and $3 million
of Series 2001D.
In July 2004, Energy issued $800 million of floating rate senior notes in
a private placement offering with registration rights. The net proceeds of $798
million were used to repay, in part, borrowings outstanding under its fully
drawn $1.0 billion 364 day credit facility, which was subsequently terminated.
The notes bear interest at an annual rate equal to 3-month LIBOR, reset
quarterly, plus 0.78% and will mature on January 17, 2006.
In June 2004, Electric Delivery's wholly-owned, special purpose
bankruptcy-remote subsidiary, TXU Electric Delivery Transition Bond Company LLC,
issued $790 million aggregate principal amount of transition (securitization)
bonds in accordance with a settlement agreement with the Commission and a
financing order related to the transition to competition. The bonds were issued
in three classes that require bi-annual interest and principal installment
payments beginning in November 2004 through specified dates in 2009 through
2016. The transition bonds bear interest at fixed annual rates ranging from
3.52% to 5.29%. Electric Delivery used the proceeds to retire two series of
mortgage bonds with an aggregate principal amount of $393 million due in 2025
and repurchase shares of common stock from US Holdings for $375 million. US
Holdings used the proceeds it received to repay short-term borrowings. As a
result of the retirement of these two series of mortgage bonds, Electric
Delivery will be able to release the liens on its outstanding senior secured
notes, making them rank equally with Electric Delivery's other senior unsecured
debt. No decision has been made as to the timing of such release.
In April 2004, the Brazos River Authority Series 2001A pollution control
revenue bonds with an aggregate principal amount of $121 million were purchased
upon mandatory tender. Energy intends to remarket these bonds at a later date.
Other retirements of long-term debt in 2004 totaling $131 million
represent payments at scheduled maturity dates.
14
Fair Value Hedges -- US Holdings uses fair value hedging strategies to
manage its exposure to fixed interest rates on long-term debt. At September 30,
2004, $250 million of fixed rate debt had been effectively converted to variable
rates through interest rate swap transactions, expiring through 2008. These
swaps qualified for and have been designated as fair value hedges using the
short-cut method of hedge accounting provided by SFAS 133, as such, the company
assumes that changes in the value of the derivative are perfectly offset by
changes in the value of the debt; therefore, there is no hedge ineffectiveness
recognized.
In August 2004, fixed-to-variable swaps related to $500 million debt were
settled for a gain of $394 thousand, which will be amortized to offset interest
expense over the remaining life of the related debt. In April 2004,
fixed-to-variable interest rate swaps related to $100 million of debt were
settled for a gain of $3.5 million, which will be amortized to offset interest
expense over the remaining life of the debt. In March 2004, fixed-to-variable
interest rate swaps related to $400 million of debt were settled for a gain of
$18 million, which will also be amortized to offset interest expense over the
remaining life of the related debt.
Preferred Membership Interests -- In July 2003, Energy exercised its right
to exchange its $750 million 9% Exchangeable Subordinated Notes issued in
November 2002 and due November 2012 for exchangeable preferred membership
interests with identical economic and other terms. The preferred membership
interests bear distributions at the annual rate of 9% and permit the deferral of
such distributions. The holders of the preferred membership interests had the
option to exchange these interests at any time, subject to certain restrictions,
for up to approximately 57 million shares of TXU Corp. common stock at an
exchange price of $13.1242 per share. At issuance of the notes that were
subsequently exchanged for the preferred membership interests, Energy recognized
a capital contribution from TXU Corp. and a corresponding discount on the
securities of $266 million, which represented the value of the exchange right as
TXU Corp. granted an irrevocable right to exchange the securities for TXU Corp.
common stock. This discount is being amortized to interest expense and related
charges over the term of the securities. As a result, the effective distribution
rate on the preferred membership interests is 16.2%. In April 2004, TXU Corp.
purchased these mandatorily redeemable securities from the holders, as discussed
in Note 1, and as a result the securities effectively represent Energy debt held
by TXU Corp.
5. SHAREHOLDERS' EQUITY
At September 30, 2004, US Holdings had 379,231 shares of cumulative,
preferred stock without par value outstanding with dividend rates ranging from
$4.00 to $5.08 per share. The preferred stock can be redeemed at prices ranging
from $101.79 per share to $112.00 per share. The preferred stock is not
mandatorily redeemable.
The holders of preferred stock of US Holdings have no voting rights except
for changes to the articles of incorporation that would change the rights or
preferences of such stock, authorize additional shares of stock or create an
equal or superior class of stock. They have the right to vote for the election
of directors only if certain dividend arrearages exist.
The legal form of cash distributions to TXU Corp. has been both common
stock repurchases and the payment of dividends. For accounting purposes, the
cash distributions in the form of share repurchases are recorded as a return of
capital.
Certain debt instruments and preferred securities of US Holdings and its
subsidiaries contain provisions that restrict payment of dividends during any
interest or distribution payment deferral period or while any payment default
exists. An Electric Delivery mortgage restricts the payment of dividends to the
amount of Electric Delivery's retained earnings. At September 30, 2004, US
Holdings and its subsidiaries were in compliance with these provisions.
US Holdings declared a cash dividend of $212 million to TXU Corp. in
November 2003 which was paid in January 2004. In February 2004, US Holdings
declared a dividend of $212.5 million which was paid to TXU Corp. in April 2004.
In June 2004, US Holdings declared a dividend of $175 million which was paid to
TXU Corp. in July 2004. In August 2004, US Holdings declared a dividend of $175
million which was paid to TXU Corp. in October 2004.
15
6. CONTINGENCIES
Request from Commodities Futures Trading Commission (CFTC) On April 13,
2004, the CFTC issued a subpoena requiring TXU Corp. to produce information
about storage of natural gas, including weekly and monthly storage reports to
the Energy Information Administration submitted by TXU Fuel Company and TXU Gas.
The request sought information for the period of October 31, 2003 through
January 2, 2004. TXU Corp. cooperated with the CFTC by producing the requested
information and believes that TXU Gas and TXU Fuel Company have not engaged in
any activity that would justify action against them by the CFTC. On August 30,
2004, the CFTC issued a press release confirming that its investigation, which
included the investigation regarding gas storage reports, had been closed, and
TXU Corp. has received nothing from the CFTC to indicate that the CFTC will take
any action against TXU Gas or TXU Fuel Company.
Guarantees -- US Holdings has entered into contracts that contain
guarantees to outside parties that could require performance or payment under
certain conditions. These guarantees have been grouped based on similar
characteristics and are described in detail below.
Project development guarantees -- In 1990, US Holdings repurchased an
electric co-op's minority ownership interest in the Comanche Peak nuclear
generation plant and assumed the co-op's indebtedness to the US government for
the facilities. US Holdings is making principal and interest payments to the
co-op in an amount sufficient for the co-op to make payments on its
indebtedness. US Holdings guaranteed the co-op's payments, and in the event that
the co-op fails to make its payments on the indebtedness, the US government
would assume the co-op's rights under the agreement, and such payments would
then be owed directly by US Holdings. At September 30, 2004, the balance of the
indebtedness was $134 million with maturities of principal and interest
extending to December 2021. The indebtedness is secured by a lien on the
facilities.
Residual value guarantees in operating leases -- US Holdings is the lessee
under various operating leases, entered into prior to January 1, 2003 that
obligate it to guarantee the residual values of the leased facilities. At
September 30, 2004, the aggregate maximum amount of residual values guaranteed
was approximately $243 million with an estimated residual recovery of
approximately $148 million. The average life of the lease portfolio is
approximately six years.
Debt obligations of the parent-- Energy has provided a guarantee of the
obligations under TXU Corp.'s finance lease (approximately $120 million at
September 30, 2004) for its headquarters building.
Shared saving guarantees -- As part of the operations of the strategic
retail services business, which Energy intends to sell (see Note 3), Energy has
guaranteed that certain customers will realize specified annual savings
resulting from energy management services it has provided. In aggregate, the
average annual savings have exceeded the annual savings guaranteed. The maximum
potential annual payout is approximately $1 million and the maximum total
potential payout is approximately $6 million. No shared savings guarantees were
issued during the nine months ended September 30, 2004 that required recording a
liability. The average remaining life of the portfolio is approximately seven
years. These guarantees will be transferred or eliminated as part of expected
transactions for the sale of the strategic retail services business.
Letters of credit -- Energy has entered into various agreements that
require letters of credit for financial assurance purposes. Approximately $384
million of letters of credit were outstanding at September 30, 2004 to support
existing floating rate pollution control revenue bond debt of approximately $376
million. The letters of credit are available to fund the payment of such debt
obligations. These letters of credit expire in 2008.
US Holdings has outstanding letters of credit in the amount of $12 million
for miscellaneous credit support requirements. Although the average life of the
letters of credit is for approximately one year, the obligation to provide
guarantees is ongoing.
Energy has outstanding letters of credit in the amount of $113 million to
support hedging and risk management margin requirements in the normal course of
business. As of September 30, 2004, approximately 84% of the obligations
supported by these letters of credit mature within one year, and substantially
all of the remainder mature in the next six years.
16
Surety bonds -- US Holdings has outstanding surety bonds of approximately
$30 million to support performance under various subsidiary contracts and legal
obligations in the normal course of business. The term of the surety bond
obligations is approximately one year.
Other -- US Holdings has entered into contracts with public agencies to
purchase cooling water for use in the generation of electric energy and has
agreed, in effect, to guarantee the principal, $7 million at September 30, 2004,
and interest on bonds issued by the agencies to finance the reservoirs from
which the water is supplied. The bonds mature at various dates through 2011 and
have interest rates ranging from 5.5% to 7.0%. US Holdings is required to make
periodic payments equal to such principal and interest, including amounts
assumed by a third party and reimbursed to US Holdings. In addition, US Holdings
is obligated to pay certain variable costs of operating and maintaining the
reservoirs. US Holdings has assigned to a municipality all its contract rights
and obligations in connection with $8 million remaining principal amount of
bonds at September 30, 2004, issued for similar purposes, which had previously
been guaranteed by US Holdings. US Holdings is, however, contingently liable in
the event of default by the municipality.
Legal Proceedings -- On July 7, 2003, a lawsuit was filed by Texas
Commercial Energy (TCE) in the United States District Court for the Southern
District of Texas, Corpus Christi Division, against Energy and certain of its
subsidiaries, as well as various other wholesale market participants doing
business in ERCOT, claiming generally that defendants engaged in market
manipulation, in violation of antitrust and other laws, primarily during the
period of extreme weather conditions in late February 2003. An amended complaint
was filed in February 2004 that joined additional, unaffiliated defendants.
Three retail electric providers filed motions for leave to intervene in the
action alleging claims substantially identical to TCE's. In addition,
approximately 25 purported former customers of TCE filed a motion to intervene
in the action alleging claims substantially identical to TCE's, both on their
own behalf and on behalf of a putative class of all former customers of TCE. An
order granting Energy's Motion to Dismiss based on the filed rate doctrine was
entered on June 24, 2004. TCE has appealed the dismissal, however, Energy
believes the dismissal of the antitrust claims was proper and that it has not
committed any violation of the antitrust laws. Further, the Commission's
investigation of the market conditions in late February 2003 has not resulted in
any findings adverse to US Holdings. Accordingly, US Holdings believes that
TCE's and the interveners' claims against Energy and its subsidiary companies
are without merit and Energy and its subsidiaries intend to vigorously defend
the lawsuit on appeal. US Holdings is, however, unable to estimate any possible
loss or predict the outcome of this action.
On April 28, 2003, a lawsuit was filed by a former employee of TXU
Portfolio Management in the United States District Court for the Northern
District of Texas, Dallas Division, against TXU Corp., Energy and TXU Portfolio
Management. The Court has reset this case for trial on June 6, 2005 and
discovery in the case is proceeding. Plaintiff asserts claims under Section 806
of Sarbanes-Oxley arising from plaintiff's employment termination and claims for
breach of contract relating to payment of certain bonuses. Plaintiff seeks back
pay, payment of bonuses and alternatively, reinstatement or future compensation,
including bonuses. US Holdings believes the plaintiff's claims are without
merit. The plaintiff was terminated as the result of a reduction in force, not
as a reaction to any concerns the plaintiff had expressed, and plaintiff was not
in a position with TXU Portfolio Management such that he had knowledge or
information that would qualify the plaintiff to evaluate TXU Corp.'s financial
statements or assess the adequacy of TXU Corp.'s financial disclosures. Thus, US
Holdings does not believe that there is any merit to the plaintiff's claims
under Sarbanes-Oxley. TXU Corp., Energy and TXU Portfolio Management dispute the
plaintiff's claims and intend to vigorously defend the litigation.
17
On March 10, 2003, a lawsuit was filed by Kimberly P. Killebrew in the
United States District Court for the Eastern District of Texas, Lufkin Division,
against TXU Corp. and TXU Portfolio Management, asserting generally that
defendants engaged in manipulation of the wholesale electric market, in
violation of antitrust and other laws. This case was transferred to the Beaumont
Division of the Eastern District of Texas and on March 24, 2004 subsequently
transferred to the Northern District of Texas, Dallas Division. This action is
brought by an individual, alleged to be a retail consumer of electricity, on
behalf of herself and as a proposed representative of a putative class of retail
purchasers of electricity that are similarly situated. Defendants have filed a
motion to dismiss the lawsuit which is pending before the court; however, as a
result of the dismissal of the antitrust claims in the litigation described
above brought by TCE, the parties have agreed to stay this litigation until the
appeal in the TCE case has been decided. US Holdings believes that the plaintiff
lacks standing to assert any antitrust claims against TXU Corp. or TXU Portfolio
Management, and that defendants have not violated antitrust laws or other laws
as claimed by plaintiff. Therefore, US Holdings believes that plaintiff's claims
are without merit and plans to vigorously defend the lawsuit. US Holdings is,
however, unable to estimate any possible loss or predict the outcome of this
action.
General -- In addition to the above, US Holdings is involved in various
other legal and administrative proceedings in the normal course of business the
ultimate resolution of which, in the opinion of management, should not have a
material effect upon its financial position, results of operations or cash
flows.
7. SEGMENT INFORMATION
US Holdings' operations are aligned into two reportable segments: Energy
and Electric Delivery.
Energy - consists of operations, principally in the competitive Texas
market, involving power production (electricity generation), retail and
wholesale energy sales, and hedging and risk management activities.
Electric Delivery - consists of regulated operations involving the
transmission and distribution of electricity in Texas.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. US Holdings evaluates
performance based on income from continuing operations before extraordinary
items and cumulative effect of changes in accounting principles. US Holdings
accounts for intersegment sales and transfers as if the sales or transfers were
to third parties, that is, at current market prices.
18
No customer provided more than 10% of consolidated revenues.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2004 2003 2004 2003
------ ----- ------ ------
(millions of dollars)
Operating revenues:
Energy............................................................ $2,517 $2,437 $6,589 $6,243
Electric Delivery................................................. 648 613 1,688 1,605
Other............................................................. - - 5 -
Eliminations...................................................... (419) (444) (1,111) (1,176)
------ ------ ------ ------
Consolidated.................................................... $2,746 $2,606 $7,171 $6,672
===== ====== ====== ======
Regulated revenues included in operating revenues:
Energy............................................................ $ - $ - $ - $ -
Electric Delivery................................................. 648 613 1,688 1,605
Eliminations...................................................... (417) (441) (1,101) (1,167)
----- ----- ----- ------
Consolidated.................................................... $ 231 $ 172 $ 587 $ 438
===== ===== ===== ======
Affiliated revenues included in operating revenues:
Energy............................................................ $ 2 $ 3 $ 7 $ 9
Electric Delivery................................................. 417 441 1,101 1,167
Other............................................................. - 3 -
Eliminations...................................................... (419) (444) (1,111) (1,176)
----- ----- ----- ------
Consolidated.................................................... $ - $ - $ - $ -
===== ===== ===== ======
Income (loss) from continuing operations before extraordinary gain and
cumulative effect of changes in accounting principles:
Energy............................................................ $ 309 $ 250 $ 408 $ 440
Electric Delivery................................................. 107 125 220 239
Other............................................................. 6 (3) 4 (16)
----- ----- ----- -----
Consolidated.................................................... $ 422 $ 372 $ 632 $ 663
===== ===== ===== =====
8. DERIVATIVES AND HEDGES
Derivatives and Hedges -- As of September 30, 2004, it is expected that
$69 million of after-tax net losses accumulated in other comprehensive income
will be reclassified into earnings during the next twelve months. Of this
amount, $62 million relates to commodities hedges and $7 million relates to
financing-related hedges.
US Holdings experienced net hedge ineffectiveness of $4 million and $21
million, reported as a loss in revenues, for the three and nine months ended
September 30, 2004. For the three and nine months ended September 30, 2003,
there was no hedge ineffectiveness.
The net effect of unrealized mark-to-market ineffectiveness accounting,
which includes the above amounts as well as the effect of reversing unrealized
gains and losses recorded in previous periods to offset realized gains and
losses in the current period, totaled $3 million and $20 million, respectively,
in net losses for the three and nine months ended September 30, 2004 and $10
million and $24 million, respectively, in net gains for the three and nine
months ended September 30, 2003.
19
9. SUPPLEMENTARY FINANCIAL INFORMATION
Regulated Versus Unregulated Operations --
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- --------------------
2004 2003 2004 2003
------ ------ ------ ------
(millions of dollars)
Operating revenues:
Regulated......................................................... $ 648 $ 613 $1,688 $1,605
Unregulated....................................................... 2,517 2,437 6,594 6,243
Intercompany sales eliminations - regulated....................... (417) (441) (1,101) (1,167)
Intercompany sales eliminations - unregulated..................... (2) (3) (10) (9)
----- ----- ------ ------
Total operating revenues...................................... 2,746 2,606 7,171 6,672
----- ----- ------ ------
Costs and operating expenses:
Cost of energy sold and delivery fees - unregulated*.............. 1,137 1,096 3,048 2,864
Operating costs - regulated....................................... 193 175 547 525
Operating costs - unregulated..................................... 147 162 514 502
Depreciation and amortization - regulated......................... 116 78 286 215
Depreciation and amortization - unregulated....................... 82 100 268 307
Selling, general and administrative expenses - regulated.......... 53 49 154 145
Selling, general and administrative expenses - unregulated........ 182 165 490 457
Franchise and revenue-based taxes - regulated..................... 66 63 183 183
Franchise and revenue-based taxes - unregulated................... 28 25 81 85
Other income...................................................... (47) (21) (67) (47)
Other deductions.................................................. 22 6 322 9
Interest income................................................... (17) (2) (25) (11)
Interest expense and related charges.............................. 150 151 449 458
----- ----- ----- -----
Total costs and expenses........................................ 2,112 2,047 6,250 5,692
----- ----- ----- -----
Income from continuing operations before income taxes, extraordinary
gain and cumulative effect of changes in accounting principles...... $ 634 $ 559 $ 921 $ 980
===== ===== ===== =====
*Includes cost of fuel consumed of $308 million and $402 million for the three
months ended September 30, 2004 and 2003, respectively, and $770 million and
$1.2 billion for the nine months ended September 30, 2004 and 2003,
respectively. The balance in each period represents energy purchased for resale
and delivery fees.
The operations of the Energy segment are included above as unregulated, as
the Texas market is open to competition. However, retail pricing to residential
customers in its historical service territory continues to be subject to
transitional regulatory provisions.
Other Income and Deductions --
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2004 2003 2004 2003
-------- -------- -------- ------
Other income:
Net gain on sale of properties and businesses. $ 47 $ 19 $ 65 $ 40
Equity portion of allowance for funds used during
construction.............................. - 1 1 3
Other......................................... - 1 1 4
------ ------ ------ ------
Total other income......................... $ 47 $ 21 $ 67 $ 47
====== ====== ====== ======
Other deductions:
Software write-off............................ $ (2) $ - $ 109 $ -
Employee severance charges.................... 3 - 107 -
Spare parts inventory writedown............... - - 79 -
Equity in losses of unconsolidated entities... 10 - 10 -
Expenses related to impaired construction
projects..................................... 1 2 5 4
Casualty loss (gas storage explosion)......... 5 - 5 -
Settlement of purchase power agreement........ 3 - 3 -
Transaction-related fees...................... - - 1 -
Premium on redemption of preferred stock...... - 3 - 3
Debt extinguishment losses ................... 1 1 1 1
Other ........................................ 1 - 2 1
------ ------ ------ ------
Total other deductions..................... $ 22 $ 6 $ 322 $ 9
====== ====== ====== ======
20
Severance Liability Related to Restructuring Activities --
Electric
Energy Delivery Total
------- --------- ------
Liability for severance costs accrued as of June 30, 2004........... $ 84 $ 18 $ 102
Additions to liability........................................... 3 - 3
Payments charged against liability............................... (53) (7) (60)
----- ----- -----
Liability for severance costs accrued as of September 30, 2004...... $ 34 $ 11 $ 45
===== ===== =====
Interest Expense and Related Charges --
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
-------- -------- -------- ------
Interest (a)........................................... $ 126 $ 130 $ 381 $ 428
Distributions on preferred membership interests (b).... 17 17 51 17
Amortization of debt discounts, premiums
and issuance cost................................... 11 7 26 22
Allowance for borrowed funds used during construction
and capitalized interest............................ (4) (3) (9) (9)
------- ------- ------- -------
Total interest expense and related charges....... $ 150 $ 151 $ 449 $ 458
====== ====== ====== ======
(a) Included in interest for the nine months ended September 30, 2003 is $34
million related to the exchangeable subordinated notes that were exchanged
for preferred membership interests in July 2003.
(b) In April 2004, TXU Corp. purchased from the holders Energy's preferred
membership interests, and subsequent to this purchase, Energy has paid
distributions on the preferred membership interests to TXU Corp.
Regulatory Assets and Liabilities --
September 30, December 31,
2004 2003
------------- -------------
Regulatory assets:
Generation-related regulatory assets securitized by transition bonds........ $1,640 $1,654
Securities reacquisition costs.............................................. 127 121
Recoverable deferred income taxes -- net.................................... 98 96
Other regulatory assets..................................................... 162 95
------ ------
Total regulatory assets................................................. 2,027 1,966
Regulatory liabilities:
Investment tax credit and protected excess deferred taxes.................. 81 88
Over-collection of transition bond (securitization) revenues................ 24 6
------ ------
Total regulatory liabilities............................................ 105 94