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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 2002
-- OR --
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-3183
TXU Gas Company
A Texas Corporation I.R.S. Employer Identification
No. 75-0399066
ENERGY PLAZA, 1601 BRYAN STREET, DALLAS, TEXAS 75201-3411
(214) 812-4600
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______
Common Stock outstanding at November 8, 2002: 451,000 shares, par value
$0.01 per share.
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Condensed Statements of Consolidated Income --
Three and Nine Months Ended September 30, 2002 and 2001............................ 1
Condensed Statements of Consolidated Comprehensive Income --
Three and Nine Months Ended September 30, 2002 and 2001............................ 2
Condensed Statements of Consolidated Cash Flows --
Nine Months Ended September 30, 2002 and 2001...................................... 3
Condensed Consolidated Balance Sheets --
September 30, 2002 and December 31, 2001........................................... 4
Notes to Financial Statements...................................................... 5
Independent Accountants' Report.................................................... 15
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 23
Item 4. Controls and Procedures....................................................... 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................. 24
Item 6. Exhibits and Reports on Form 8-K.............................................. 24
SIGNATURE.......................................................................................... 25
CERTIFICATIONS..................................................................................... 26
(i)
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- --------------------
2002 2001 2002 2001
------- ------- ------- ------
Millions of Dollars
Operating revenues.................................... $ 137 $ 120 $ 641 $ 975
------- ------- ------- -------
Operating expenses
Gas purchased for resale........................... 47 54 302 640
Operation and maintenance.......................... 64 60 193 190
Depreciation and other amortization................ 17 17 49 48
Goodwill amortization.............................. -- 2 -- 6
Taxes other than income............................ 17 18 60 79
------- ------- ------- -------
Total operating expenses......................... 145 151 604 963
------- ------- ------- -------
Operating income (loss)............................... (8) (31) 37 12
Other income.......................................... 1 -- 5 5
Other deductions...................................... 1 -- 5 2
Interest income....................................... -- 7 -- 8
Interest expense and other charges.................... 16 17 50 49
------- ------- ------- -------
Loss from continuing operations before income taxes... (24) (41) (13) (26)
Income tax benefit.................................... (8) (13) (5) (6)
------- ------- ------- -------
Loss from continuing operations....................... (16) (28) (8) (20)
Loss from discontinued operations, net of tax......... -- (5) -- (2)
------- ------- ------- -------
Net loss.............................................. (16) (33) (8) (22)
Preferred stock dividends............................. 1 1 3 3
------- ------- ------- -------
Net loss applicable to common stock................... $ (17) $ (34) $ (11) $ (25)
======= ======= ======= =======
See Notes to Financial Statements.
1
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- ------------------
2002 2001 2002 2001
---- ---- ---- ----
Millions of Dollars
Loss from continuing operations.......................... $ (16) $ (28) $ (8) $ (20)
------- ------- ------- -------
Other comprehensive income (loss) from continuing operations
Net change during period, net of tax effect
Cash flow hedges:
Cumulative transition adjustment as of January 1, 2001
(net of tax expense of $1) ..................... -- -- -- 2
Net change in fair value of derivatives
(net of tax benefit of $-, $1, $-, and $3)...... (1) (2) (1) (5)
Amounts realized in earnings
(net of tax expense of $- and $-)............... 1 -- 1 --
------- ------- ------- -------
Total......................................... -- (2) -- (3)
------- ------- ------- -------
Comprehensive loss from continuing operations............ (16) (30) (8) (23)
------- ------- ------- -------
Loss from discontinued operations, net of tax............ -- (5) -- (2)
------- ------- ------- -------
Comprehensive loss....................................... $ (16) $ (35) $ (8) $ (25)
======= ======= ======= =======
See Notes to Financial Statements.
2
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
-----------------------
2002 2001
---- ----
Millions of Dollars
Cash flows - operating activities
Loss from continuing operations......................................... $ (8) $ (20)
Adjustments to reconcile loss from continuing operations
to cash provided by operating activities:
Depreciation and amortization.................................... 54 59
Deferred income taxes - net...................................... 20 32
Gain from sale of assets......................................... -- (4)
Other............................................................ (3) --
Changes in operating assets and liabilities............................. 58 (2)
------ ------
Cash provided by operating activities............................... 121 65
------ ------
Cash flows - financing activities
Net change in advances from parent and affiliates (Note 9).............. 15 74
Cash dividends paid..................................................... (3) (3)
------ ------
Cash provided by financing activities......................... 12 71
------ ------
Cash flows - investing activities
Capital expenditures.................................................... (75) (139)
Proceeds from sale of assets............................................ -- 5
Other investments....................................................... 10 6
------ ------
Cash used in investing activities............................. (65) (128)
------ ------
Cash used in discontinued operations........................................ (6) (11)
------ ------
Net change in cash and cash equivalents..................................... 62 (3)
Cash and cash equivalents - beginning balance............................... 3 6
------ ------
Cash and cash equivalents - ending balance.................................. $ 65 $ 3
====== ======
See Notes to Financial Statements.
3
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2002 2001
------------- -------------
Millions of Dollars
ASSETS
Current assets:
Cash and cash equivalents....................................................... $ 65 $ 3
Accounts receivable............................................................. 75 129
Inventories-at average cost..................................................... 112 116
Other current assets............................................................ 30 30
-------- -------
Total current assets....................................................... 282 278
Assets-discontinued operations (Note 3)............................................ -- 2,309
Investments-other.................................................................. 30 34
Property, plant and equipment-net.................................................. 1,506 1,485
Goodwill............................................................................... 305 305
Regulatory assets - net............................................................ 59 121
Deferred debits and other assets................................................... 13 11
-------- -------
Total assets............................................................... $ 2,195 $ 4,543
======== =======
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Advances from parent............................................................ $ 28 $ 248
Long-term debt due currently.................................................... 325 200
Accounts payable:
Parent and affiliates........................................................ 3 4
Trade........................................................................ 34 75
Taxes accrued................................................................... 16 21
Other current liabilities....................................................... 75 81
-------- -------
Total current liabilities.................................................. 481 629
Liabilities-discontinued operations (Note 3)....................................... -- 1,748
Accumulated deferred income taxes and investment tax credits....................... 199 183
Cash flow hedges and other derivative liabilities.................................. 5 6
Other deferred credits and noncurrent liabilities.................................. 214 216
Long-term debt, less amounts due currently......................................... 426 554
TXU Gas Company obligated, mandatorily redeemable, preferred securities of subsidiary
trust holding solely junior subordinated debentures of TXU Gas Company.......... 147 147
Contingencies (Note 8)
Shareholder's equity (Note 6)...................................................... 723 1,060
-------- -------
Total liabilities and shareholder's equity................................. $ 2,195 $ 4,543
======== =======
See Notes to Financial Statements.
4
TXU GAS COMPANY AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. BUSINESS
TXU Gas Company (TXU Gas), a Texas corporation, is engaged in the
purchase, transmission, distribution and sale of natural gas in the
north-central, eastern and western parts of Texas, and provides energy asset
management services. Until January 1, 2002, TXU Gas was also engaged in
wholesale trading of natural gas and electricity throughout the United States
(US) and parts of Canada, as well as unregulated retail sales of natural gas to
large commercial and industrial customers (see discussion below). TXU Gas is a
wholly-owned subsidiary of TXU Corp., a Texas corporation. TXU Corp. is an
energy services company that engages in electricity generation, wholesale energy
sales, trading and risk management activities, retail energy sales, energy
delivery, other energy-related services and, through a joint venture,
telecommunications services.
Business Restructuring - Legislation was passed during the 1999 session
of the Texas Legislature that restructured the electric utility industry in
Texas (1999 Restructuring Legislation). As a result, TXU Corp. restructured
certain of its businesses effective January 1, 2002, whereby TXU Energy Company
LLC (TXU Energy), an indirect subsidiary of TXU Corp., acquired the wholesale
trading and risk management operations and the unregulated commercial and
industrial retail natural gas business of TXU Gas, among other operations of TXU
Corp.
The operations of TXU Gas acquired by TXU Energy have been accounted
for as discontinued operations, and prior year results have been restated herein
to reflect the results of those businesses on a discontinued basis (see Note 3).
A substantial majority of the remaining business is regulated.
The balance sheet of TXU Gas at December 31, 2001 included $773 million
of goodwill, net of amortization, arising from TXU Corp.'s 1997 acquisition of
ENSERCH Corporation (renamed TXU Gas Company). The wholesale trading and risk
management operations and the unregulated commercial and industrial retail gas
business were originally part of ENSERCH Corporation. In connection with the
restructuring and transfer of these two businesses to TXU Energy, $468 million
of that goodwill was allocated to these discontinued businesses and is reflected
in the September 30, 2002 balance sheet of TXU Energy. The remaining amount of
goodwill ($305 million) associated with the ENSERCH acquisition was allocated to
the continuing business of TXU Gas.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation -- The condensed consolidated financial
statements of TXU Gas and its subsidiaries have been prepared in accordance with
accounting principles generally accepted in the United States of America (US
GAAP) and, except for the adoption of Statement of Financial Accounting
Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets" discussed below,
on the same basis as the audited financial statements included in its Annual
Report on Form 10-K for the year ended December 31, 2001 (2001 Form 10-K). In
the opinion of management, all adjustments (consisting of normal recurring
accruals) necessary for a fair presentation of the results of operations and
financial position have been included therein. 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 Securities and Exchange Commission. The results of operations
for an interim period may not be indicative of results for a full year. Certain
previously reported amounts have been reclassified to conform to current
classifications. All dollar amounts in the financial statements and tables in
the notes to the financial statements are stated in millions of US dollars
unless otherwise indicated.
5
Changes in Accounting Standards -- SFAS No. 142 became effective on
January 1, 2002. SFAS No. 142 requires, among other things, the allocation of
goodwill to reporting units based upon the current fair value of the reporting
units and the discontinuance of goodwill amortization. Annual goodwill
amortization of TXU Gas' existing goodwill ($9 million annually related to
continuing operations) ceased effective January 1, 2002.
In addition, SFAS No. 142 required completion of a transitional
goodwill impairment test within six months from the date of adoption. It
establishes a new method of testing goodwill for impairment on an annual basis,
or on an interim basis if an event occurs or circumstances change that would
reduce the fair value of a reporting unit below its carrying value. TXU Gas
completed the transitional impairment test in the second quarter of 2002, the
results of which indicated no impairment of goodwill. The annual impairment test
date will be as of October 1 each year.
The table below reflects what reported income from continuing
operations, income from discontinued operations and net income would have been
in the 2001 periods, exclusive of goodwill amortization expense recognized in
that period compared to the 2002 periods.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
Reported loss from continuing operations................. $(16) $(28) $ (8) $(20)
Add back: goodwill amortization......................... -- 2 -- 6
---- ---- ---- ----
Adjusted loss from continuing operations................. $(16) $(26) $ (8) $(14)
==== ==== ===== ====
Reported loss from discontinued operations, net of tax... $ -- $ (5) $ -- $ (2)
Add back: goodwill amortization........................ -- 3 -- 10
---- ---- ---- ----
Adjusted income (loss) from discontinued operations, net
of tax $ -- $ (2) $ -- $ 8
==== ==== ==== ====
Reported net loss................................. $(16) $(33) $ (8) $(22)
Add back: goodwill amortization.................. -- 5 -- 16
---- ---- ---- ----
Adjusted net loss.................................. $(16) $(28) $ (8) $ (6)
==== ==== ==== ====
Exclusive of goodwill amortization expense, for the years ended
December 31, 2001, 2000 and 1999, net income would have been $51 million, $9
million and $3 million, respectively.
SFAS No. 143, "Accounting for Asset Retirement Obligations", will be
effective on January 1, 2003. SFAS No. 143 requires the recognition of a fair
value liability for any retirement obligation associated with long-lived assets.
SFAS 143 also requires additional disclosures. TXU Gas will conform its
accounting for asset retirement obligations to the new standard effective with
reporting for 2003.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", became effective on January 1, 2002. SFAS No. 144 establishes a single
accounting model, based on the framework established in SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of", for long-lived assets to be disposed of by sale, and resolves
significant implementation issues related to SFAS No. 121. The adoption of SFAS
No. 144 by TXU Gas has not affected its financial position or results of
operations.
SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement No. 13, and Technical Corrections", was issued in
April 2002 and will be effective on January 1, 2003. One of the provisions of
this statement is the rescission of SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt." Any gain or loss on the early extinguishment of debt
that was classified as an extraordinary item in prior periods in accordance with
SFAS No. 4 will be reclassified if it does not meet the criteria of an
extraordinary item as defined by Accounting Principles Board Opinion 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions".
6
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities", was issued in June 2002 and will be effective on January 1, 2003.
SFAS No. 146 requires that a liability for costs associated with an exit or
disposal activity be recognized only when the liability is incurred and measured
initially at fair value.
For accounting standards not yet adopted or fully implemented, TXU Gas
is evaluating the potential impact on its financial position and results of
operations.
Income Taxes -- TXU Gas is included in the consolidated federal income
tax return of TXU Corp. and subsidiary companies. TXU Gas uses the separate
return method to compute its income tax provision. Because of the alternative
minimum tax (AMT), differences may arise between the consolidated federal income
tax liability and the aggregated separate tax liability of the group members. In
instances where this occurs, the difference is allocated pro-rata, to those
companies that generated AMT on a separate company basis.
3. DISCONTINUED OPERATIONS
As a result of the deregulation of the electricity markets in Texas,
effective January 1, 2002, TXU Corp. restructured the operations of its US
subsidiaries, including those of TXU Gas. As a part of that restructuring,
ownership of the wholesale trading and risk management operations and
unregulated commercial and industrial retail gas business was transferred to TXU
Energy.
Accordingly, these businesses, which comprised the former energy
trading segment of TXU Gas, have been reflected as discontinued operations in
the statements of consolidated income and cash flows of TXU Gas and the related
consolidated financial statements for prior periods have been restated. The
results of operations of these discontinued businesses were as follows:
Three Months Nine Months
Ended Ended
September 30, September 30,
2001 2001
------------- ---------
Revenues................................................ $ 47 $ 127
Operating income (loss)................................. $ (5) $ 8
Loss after-tax from discontinued operations............. $ (5) $ (2)
Cash provided by operating activities................... $ 10
Cash provided by financing activities................... 17
Cash used in investing activities....................... (34)
-------
Cash used in discontinued operations............... $ (7)
=======
In addition, in the statement of cash flows for the nine months ended
September 30, 2001, an additional $4 million was used in previously discontinued
engineering and construction operations.
7
The assets and liabilities of the discontinued businesses segregated in
the TXU Gas balance sheet as of December 31, 2001 herein consisted of the
following:
December 31,
2001
-----------
Current assets
Accounts receivable......................... $ 542
Accounts receivable from affiliated companies 14
Commodity contract assets.................. 743
Other ...................................... 62
Long-term assets
Goodwill (net of accumulated amortization of $56) 468
Commodity contract assets................... 360
Other....................................... 120
-------
Total assets........................... 2,309
-------
Current liabilities
Accounts payable............................ (426)
Accounts payable to affiliated companies... (41)
Commodity contract liabilities.............. (602)
Other current liabilities................... (28)
Non-current liabilities
Commodity contract liabilities.............. (229)
Advances from TXU Corp...................... (383)
Other....................................... (39)
-------
Total liabilities...................... (1,748)
-------
Net investment................................. $ 561
=======
Certain reclassifications to balances related to the discontinued
businesses, primarily related to the allocation of goodwill (Note 1), have been
incorporated. See discussion in Note 3 of TXU Gas' 2001 Form 10-K.
In June 2002, the Emerging Issues Task Force (EITF) reached a consensus
on certain aspects of Issue 02-3, "Accounting for Contracts Involved in Energy
Trading and Risk Management Activities", regarding the presentation of trading
activities in the statement of income. The new rules were effective on July 1,
2002, and require that all trading contracts, whether or not physically settled,
be recorded net upon settlement, rather than gross as a sale and cost of sale.
The former energy trading segment of TXU Gas historically recorded financial
contracts net, but recorded those contracts that provide for physical delivery
gross upon settlement. TXU Gas' continuing operations are not impacted by this
change, but the revenues related to discontinued business presented above have
been reclassified to conform to this new reporting requirement. The table below
summarizes the impact of the new reporting requirement on the former energy
trading segment of TXU Gas' operating revenues and energy purchased for resale,
fuel consumed and delivery costs of the new reporting requirements. Transactions
affected by the new reporting requirement represent contracts that provided for
physical delivery but were settled financially without delivery, as well as
contracts physically settled but classified as trading activities. The new
reporting requirements have no impact on the former energy trading segment of
TXU Gas' gross margin, net income or cash provided by operating activities.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2001
----------------- -----------------
Operating revenues before reclassification.................. $1,028 $4,381
Less: energy purchased for resale, fuel consumed and delivery costs
netted with revenues............................... 981 4,254
------ ------
Operating revenues after reclassification................... $ 47 $ 127
====== ======
8
4. FINANCING ARRANGEMENTS
Short-term liquidity needs of TXU Gas are expected to be funded through
advances from affiliates. TXU Gas had short-term advances from affiliates of $28
million and $248 million as of September 30, 2002 and December 31, 2001,
respectively.
Debt Redemption -- On October 15, 2002, TXU Gas exercised its right to
redeem $200 million aggregate principal amount of Putable Asset Term Securities
(PATS) that would have matured on October 15, 2012 for a cash premium of $35
million ($23 million net of tax), which will be recognized as an extraordinary
debt extinguishment loss by TXU Gas in the fourth quarter of 2002. TXU Gas used
cash advances from TXU Corp. and cash on hand to fund the redemption of the
PATS.
5. CAPITALIZATION
TXU Gas Obligated, Mandatorily Redeemable, Preferred Securities of
Subsidiary Trust Holding Solely Junior Subordinated Debentures of TXU Gas (Trust
Securities) -- At September 30, 2002, a consolidated statutory business trust,
TXU Gas Capital I, had $147 million of floating rate mandatorily redeemable
preferred securities outstanding. Distributions on these Trust Securities are
payable quarterly based on an annual floating rate determined quarterly with
reference to a three-month LIBOR rate plus a margin. The only assets held by the
trust are $155 million principal amount of Floating Rate Junior Subordinated
Debentures Series A (Series A Debentures) of TXU Gas. The interest on the Series
A Debentures matches the distributions on the Trust Securities. The Series A
Debentures will mature on July 1, 2028. TXU Gas has the right to redeem the
Series A Debentures and cause the redemption of the Trust Securities in whole or
in part on or after July 1, 2003. TXU Gas owns the common securities issued by
its subsidiary trust and has effectively issued a full and unconditional
guarantee of the trust's securities. At September 30, 2002, TXU Gas had two
interest rate swap agreements with respect to the floating rate Trust
Securities, with notional principal amounts of $100 million and $50 million,
that effectively fixed the rate at 6.629% and 6.444%, respectively, per annum to
July 1, 2003.
9
6. SHAREHOLDER'S EQUITY
September 30, December 31,
2002 2001
------------- ---------
Preferred stock.................................................... $ 75 $ 75
-------- -------
Common stock (par value - $.01 per share):
Authorized shares - 100,000,000, Outstanding shares - 451,000... -- --
Paid in capital.................................................... 697 1,026
Deficit............................................................ (44) (36)
Accumulated other comprehensive loss............................... (5) (5)
-------- -------
Total common stock equity....................................... 648 985
-------- -------
Total shareholder's equity.................................... $ 723 $ 1,060
======== =======
TXU Energy acquired certain operations from TXU Gas (Note 3) in a
non-cash transaction. Accordingly, $561 million was charged to paid-in capital
to reflect this distribution of the net assets at book value at January 1, 2002.
In September of 2002, TXU Corp. made a non-cash capital contribution of
$235 million to TXU Gas by converting advances to paid-in capital.
7. REGULATION AND RATES
TXU Gas employs a continuing program of rate review for all classes of
customers in its regulatory jurisdictions. During the first nine months of 2002,
TXU Gas Distribution, a division of TXU Gas, filed rate cases with respect to
147 north Texas cities, including the city of Dallas, supporting $55.5 million
in annualized revenue increases. In the Northwest Region, a settlement has been
reached with 36 cities for an annual rate increase of $1.2 million. The Dallas
Distribution System gas rate case, representing 4 cities, was settled for an
annual rate increase of $6.8 million. In the North Texas Metroplex gas rate
case, settlement terms were accepted by 33 cities for an annual rate increase of
$760,000. The case was withdrawn from 23 Fort Worth area cities because the
settlement would have resulted in essentially no increase in rates. Fifty-one
cities declined the settlement offer and passed ordinances denying the
applicable rate cases. On July 15, 2002, TXU Gas Distribution filed an appeal of
these cities' actions with the Railroad Commission of Texas (RRC) for $24.5
million (GUD 9313). TXU Gas Distribution has reached an agreement in principle
to settle the appeal of these cities' actions for an annual increase of $7.5
million. The agreement will be final upon the passage of ordinances in each of
these cities. In addition to these rate case settlements, recovery mechanisms
that better match gas costs will be implemented for an estimated $5.4 million
annual improvement. Weather normalization adjustment clauses, which allow rates
to be adjusted to reflect warmer- or cooler-than-normal weather during the
winter months, are in effect for 358 cities served by TXU Gas Distribution. TXU
Gas Distribution has filed applications to terminate these clauses in the cities
involved above because the improved rate design minimizes the impact of weather.
10
On July 16, 2001, TXU Gas Distribution filed a 36 month gas cost prudence
review (GUD 9233) covering the period of November 1, 1997 through October 30,
2000 with the RRC. This filing was amended on March 15, 2002. TXU Gas believes
it has under-recovered its gas costs by $10.5 million during this period, which
amount is carried as a regulatory asset. The Administrative Law Judge (ALJ) has
ruled that the issue of the underrecovery should not be considered as part of
this proceeding. TXU Gas Distribution appealed the ALJ's ruling, which was
upheld by the RRC. TXU Gas Distribution is considering appealing the RRC's
ruling to District Court. Parties intervening in this case have recommended a
disallowance of $4.2 million. TXU Gas Distribution has requested a hearing in
January 2003 at the State Office of Administrative Hearing (SOAH) pertaining to
these issues. The outcome of these proceedings cannot be determined at this
time.
On August 31, 2001, TXU Gas Distribution filed a city gate rate cost
reconciliation (GUD 9246) with the RRC covering the period of July 1, 2000 to
June 30, 2001. This filing was amended on February 14, 2002. TXU Gas
under-recovered its gas costs by $18.6 million during the covered period. This
amount has been recovered through a surcharge under a settlement approved by the
RRC, which reserves prudence issues and rate case expenses for GUD 9233.
TXU Gas Distribution filed a city gate gas cost reconciliation with the RRC
on August 30, 2002 for the twelve month period ended June 30, 2002. During this
period TXU Gas over-recovered its gas costs by $23.9 million. This amount is
being refunded for the next nine months from October 2002 through June 2003. At
this time the filing has not been contested by any party and the refund has no
material impact on net income of TXU Gas.
8. CONTINGENCIES
Legal Proceedings -- In July 1999, the City of Gatesville, Texas filed suit
in the State District Court of Coryell County, Texas, 52nd Judicial District.
The suit has been amended to assert claims against TXU Gas and TXU Corp. The
plaintiff sought to represent a class of plaintiffs consisting of more than 300
Texas cities, towns and other municipalities to which TXU Gas Distribution had
paid municipal franchise fees since January 1, 1987. The plaintiff alleged that
TXU Gas Distribution failed to properly pay franchise fees by omitting
miscellaneous revenues from the franchise fee payment base used for determining
the municipal franchise fees owed to the plaintiff. This case has been settled
by TXU Gas for $45,000 as reimbursement for attorneys' fees, plus an agreement
to specifically include the disputed categories of revenue in the franchise fee
calculation, as may be elected by the City of Gatesville.
In September 1999, Quinque Operating Company (Quinque) filed suit in the
State District Court of Stevens County, Kansas against over 200 gas pipeline
companies, including TXU Gas (named in the litigation as ENSERCH Corporation).
The suit was removed to federal court; however, a motion to remand the case back
to Kansas State District Court was granted in January 2001, and the case is now
pending in Stevens County, Kansas. The plaintiffs amended their petition to join
TXU Fuel Company (TXU Fuel), a subsidiary of TXU Energy, as a defendant in this
litigation. Quinque has dismissed its claims and a new lead plaintiff has filed
an amended petition in which the plaintiffs seek to represent a class consisting
of all similarly situated gas producers, overriding royalty owners, working
interest owners and state taxing authorities either from whom defendants had
purchased natural gas or who received economic benefit from the sale of such gas
since January 1, 1974. No class has been certified. The petition alleges that
the defendants have mismeasured both the volume and heat content of natural gas
delivered into their pipelines resulting in underpayments to plaintiffs. No
amount of damages has been specified in the petition with respect to TXU Gas or
TXU Fuel. While TXU Gas and TXU Fuel are unable to estimate any possible loss or
predict the outcome of this case, TXU Gas and TXU Fuel believe these claims are
without merit and intend to vigorously defend this suit.
11
On November 21, 2000, the City of Denton, Texas and other Texas cities
filed suit in the 134th Judicial District Court of Dallas County, Texas against
TXU Gas, TXU US Holdings Company (US Holdings) and TXU Corp. The petition
alleges claims for breach of contract, negligent representation, fraudulent
inducement of contract, breach of duty of good faith and fair dealing and unjust
enrichment related to the defendants' alleged exclusion of certain revenues from
the cities' franchise fee base. No specified damages have been alleged. On
January 31, 2002, TXU Gas, US Holdings, and TXU Corp. entered into a Memorandum
of Understanding with the plaintiffs to settle this lawsuit, subject to the
execution of a definitive settlement agreement. Final versions of the settlement
document have been provided to the plaintiff cities for execution. Most of the
cities named as plaintiffs in the litigation have accepted the settlement and
executed the settlement agreement. If any plaintiff cities decline to execute
the settlement, the suit will continue as to those cities. TXU Gas believes the
allegations in this suit are without merit and intends to vigorously defend this
suit against any plaintiff cities that do not execute the settlement. TXU Gas
does not believe the ultimate resolution of this suit will have a material
effect on TXU Gas' financial position, results of operations or cash flows.
General -- In addition to the above, TXU Gas and its subsidiaries are
involved in various other legal and administrative proceedings the ultimate
resolution of which, in the opinion of management, are not expected to have a
material effect on their financial position, results of operations or cash
flows.
9. SUPPLEMENTARY FINANCIAL INFORMATION
Other Income and Deductions --
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ --------------------
2002 2001 2002 2001
------- ------- ------ -----
Other income
Gain on sale of properties.................... $ -- $ -- $ 1 $ 4
Other (consists of several immaterial items).. 1 -- 4 1
---- ---- ---- ----
Total other income........................ $ 1 $ -- $ 5 $ 5
==== ==== ==== ====
Other deductions
Loss on sale of properties.................... $ -- $ -- $ -- $ 2
Other (consists of several immaterial items).. 1 -- 5 --
---- ---- ---- ----
Total other deductions.................... $ 1 $ -- $ 5 $ 2
==== ==== ==== ====
Accounts receivable -- At September 30, 2002 and December 31, 2001,
accounts receivable are stated net of uncollectible accounts of $4 million and
$5 million, respectively. Accounts receivable included $13 million and $39
million of unbilled revenues at September 30, 2002 and December 31, 2001,
respectively.
Regulatory Assets and Liabilities -- Included in regulatory assets -
net are regulatory assets of $98 million and regulatory liabilities of $39
million at September 30, 2002, and regulatory assets of $134 million and
regulatory liabilities of $13 million at December 31, 2001. Regulatory assets of
$69 million at September 30, 2002 and $74 million at December 31, 2001 were not
earning a return. The remaining regulatory assets have an average remaining
recovery period of approximately 15 years.
12
Sale of Receivables -- Certain US subsidiaries of TXU Corp. sell customer
accounts receivable to TXU Receivables Company, a wholly-owned bankruptcy remote
indirect subsidiary of TXU Corp., which sells undivided interests in accounts
receivable it purchases to financial institutions. As of September 30, 2002, TXU
Energy Retail Company LP, TXU SESCO Energy Services Company, Oncor and TXU Gas
are qualified originators of accounts receivable under the program. TXU
Receivables Company may sell up to an aggregate of $600 million in undivided
interests in the receivables purchased from the originators under the program.
As of September 30, 2002, TXU Gas had sold $44 million face amount of
receivables to TXU Receivables Company under the program in exchange for cash of
$21 million and $22 million in subordinated notes, with $1 million of losses on
sales for the nine months ended September 30, 2002 principally representing the
interest on the underlying financing. These losses approximated 4% of the cash
proceeds from the sale of undivided interests in accounts receivable on an
annualized basis. Upon termination, cash flows to TXU Gas would be delayed as
collections of sold receivables were used by TXU Receivables Company to
repurchase the undivided interests of the financial institutions instead of
purchasing new receivables. The level of cash flows would normalize in
approximately 16 to 31 days. TXU Business Services Company, an affiliate of TXU
Gas, services the purchased receivables and is paid a market-based servicing fee
by TXU Receivables Company. The subordinated notes receivable from TXU
Receivables Company represent TXU Gas' retained interest in the transferred
receivables and are recorded at book value, net of allowances for bad debts,
which approximates fair value due to the short-term nature of the subordinated
notes, and are included in accounts receivable in the consolidated balance
sheet.
Inventories by major category--
September 30, December 31,
2002 2001
----------- --------
Materials and supplies....................................................... $ 8 $ 6
Gas stored underground....................................................... 104 110
------- -------
Total inventories....................................................... $ 112 $ 116
======= =======
Property, plant and equipment--
September 30, December 31,
2002 2001
----------- --------
Gas distribution and pipeline................................................ $ 1,757 $ 1,678
Other........................................................................ 27 26
------- -------
Total................................................................ 1,784 1,704
Less accumulated depreciation................................................ 315 265
------- -------
Net of accumulated depreciation...................................... 1,469 1,439
Construction work in progress................................................ 37 46
------- -------
Net property, plant and equipment.................................... $ 1,506 $ 1,485
======= =======
13
Goodwill -- At September 30, 2002 and December 31, 2001, goodwill is
stated net of accumulated amortization of $37 million.
Derivative Instruments and Hedging Activities - The terms of TXU Gas'
derivatives that have been designated as accounting hedges match the terms of
the underlying hedged items. As a result, TXU Gas experienced no hedge
ineffectiveness during the third quarter of 2002.
As of September 30, 2002, it is expected that $3 million of after-tax
net gains accumulated in other comprehensive income will be reclassified into
earnings during the next twelve months. This amount represents the projected
value of the hedges over the next twelve months relative to what would be
recorded if the hedge transactions had not been established. The amount expected
to be reclassified is not a forecasted gain incremental to normal operations,
but rather it demonstrates the extent to which the volatility in earnings (which
would otherwise exist) is mitigated through the use of cash flow hedges.
Non-cash Transactions - During the third quarter of 2002, $235 million
of advances from TXU Corp. was converted to paid-in capital.
14
INDEPENDENT ACCOUNTANTS' REPORT
TXU Gas Company:
We have reviewed the accompanying condensed consolidated balance sheet of TXU
Gas Company and subsidiaries (TXU Gas) as of September 30, 2002, and the related
condensed statements of consolidated income and comprehensive income for the
three-month and nine-month periods ended September 30, 2002 and 2001 and the
consolidated cash flows for the nine months ended September 30, 2002 and 2001.
These financial statements are the responsibility of TXU Gas' management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit in accordance with
auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of TXU
Gas as of December 31, 2001, and the related statements of consolidated
operations, comprehensive income, cash flows and shareholders' equity for the
year then ended (not presented herein); and in our report dated January 31,
2002, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of December 31, 2001, is fairly stated
in all material respects in relation to the consolidated balance sheet from
which it has been derived.
As discussed in Note 2 to the Notes to the Financial Statements, TXU Gas changed
its method of accounting for goodwill amortization in 2002 in connection with
the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets."
DELOITTE & TOUCHE LLP
Dallas, Texas
November 13, 2002
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
As a result of the business restructuring effective January 1, 2002,
the wholesale trading and risk management operations and the unregulated
commercial and industrial retail gas business of TXU Gas were transferred to an
affiliate company, TXU Energy. The operations of the transferred business have
been reflected as discontinued operations in the statements of consolidated
income and cash flows, and the related consolidated financial statements for
prior periods have been restated accordingly. TXU Gas' continuing natural gas
pipeline, gas distribution and asset management services operations are managed
as one integrated business; accordingly, there are no separate reportable
segments.
Although the price of natural gas has varied significantly since the
first quarter of 2001, the city gate rate for the cost of gas TXU Gas ultimately
delivers to residential and commercial customers is established by the Railroad
Commission of Texas (RRC) and generally provides for full recovery of the actual
cost of gas delivered.
Results of operations of TXU Gas are subject to seasonal variation,
reflecting higher gas usage in the first and fourth quarters due to colder
weather. These variations generally result in higher net income and cash flow
from operations during these periods.
Selected Statistical and Financial Data
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- --------------------
2002 2001 2002 2001
------- ------- ------- -----
Gas distribution volumes (billion cubic feet - Bcf):
Residential................................. 6 6 57 60
Commercial.................................. 7 6 38 39
Industrial and electric generation.......... 1 1 5 6
------- ------- ------- -------
Total gas sales........................ 14 13 100 105
======= ======= ======= =======
Pipeline transportation volumes (Bcf).......... 129 112 347 292
======= ======= ======= =======
Revenues (millions):
Gas distribution:
Residential............................... $ 64 $ 57 $ 363 $ 560
Commercial................................ 39 38 181 311
Industrial and electric generation........ 5 6 18 44
------- ------- ------- -------
Sub-total gas.......................... 108 101 562 915
Pipeline transportation..................... 16 13 44 37
Other revenues, net of eliminations......... 13 6 35 23
------- ------- ------- -------
Total operating revenues............... $ 137 $ 120 $ 641 $ 975
======= ======= ======= =======
Heating degree days (% of normal).............. -- -- 99% 104%
Three Months Ended September 30, 2002 Compared to Three Months Ended
September 30, 2001
- ---------------------------------------------------------------------------
Operating revenues for TXU Gas increased by $17 million, or 14%, to
$137 million in 2002. The increase is due primarily to a nonrecurring
unfavorable adjustment for unrecoverable gas costs recorded in the prior year.
The effects of rate increases in 2002 for transportation and other services and
sales volume increases were offset by decreases in gas costs passed through to
customers. Gas distribution sales volumes increased 3%.
Gross margin (operating revenues less gas purchased for resale)
increased by $24 million, or 36%, to $90 million in 2002. The increase was
driven by the adjustment for unrecoverable gas costs in the prior year, rate
increases for transportation and other services, and the sales volume increase.
Operation and maintenance expense increased by $4 million, or 7%, to
$64 million in 2002. The increase primarily reflects $3 million in claim
settlements. Total net pension and post-retirement benefit costs increased $1
million, to $3 million, in 2002.
16
Other operating expenses (depreciation and other amortization, goodwill
amortization, and taxes other than income) decreased $3 million, or 8%, to $34
million in 2002. Of the decrease, $2 million represented goodwill amortization
in the prior year compared to none in 2002. Amortization of goodwill ceased in
the current year pursuant to the adoption of Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
There was no interest income in 2002 compared to $7 million in 2001
resulting from the recognition in 2001 of interest income for under collected
gas costs. The amount in 2001 reflected unusually high under collections related
to high gas costs during the winter of 2000/2001.
Loss from continuing operations declined by $12 million, or 43%, to $16
million in 2002, as a result of increased gross margin partially offset by
increased expenses and reduced interest income. Net pension and postretirement
benefit costs reduced net income by $2 million in both 2002 and 2001. The
effective tax rate benefit was 33.3% in 2002 and 31.7% in 2001, with the
difference due to the cessation of nondeductible goodwill amortization.
Nine Months Ended September 30, 2002 Compared to Nine Months Ended
September 30, 2001
- ----------------------------------------------------------------------------
Operating revenues for TXU Gas decreased by $334 million, or 34%, to
$641 million in 2002. The decrease reflects the reduced cost of gas and lower
distribution sales volumes, generally driven by milder winter weather and
reduced heating demand relative to 2001. Gas distribution sales volumes declined
5%.
Gross margin increased by $4 million, or 1%, to $339 million in 2002.
The increase is primarily due to the unfavorable adjustments for unrecoverable
gas costs in 2001, partially offset by reduced gross receipts tax collections
(see discussion below regarding taxes other than income). Rate increases were
largely offset by the effect of lower volumes.
Operation and maintenance expense increased by $3 million, or 2%, to
$193 million in 2002. The increase reflects $5 million in increased employee
benefit costs, $4 million in developmental expenses in the unregulated asset
management services business, $3 million in claim settlements, and several other
cost increases totaling $6 million, partially offset by reduced bad debt expense
of $8 million, reflecting the lower cost of gas passed on to customers, and
decreases in pipeline maintenance of $7 million. Total net pension and
post-retirement benefit costs increased $3 million, to $11 million, in 2002.
Other operating expenses decreased $24 million, or 18%, to $109 million
in 2002. The decrease reflects $19 million in lower taxes other than income, and
the cessation of goodwill amortization ($6 million in 2001) pursuant to the
adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets." The decline in taxes other than income was driven by
lower gross receipts taxes, reflecting comparatively lower revenues on which
such taxes are based.
There was no interest income in 2002 compared to $8 million in 2001
resulting from the recognition in 2001 of interest income for under collected
gas costs. The amount in 2001 reflected unusually high under collections related
to high gas costs during the winter of 2000/2001.
Loss from continuing operations improved by $12 million, or 60%, to $8
million in 2002 as a result of decreased operating costs and improved gross
margin, partially offset by decreased interest income. Net pension and
post-retirement benefit costs reduced net income by $7 million in 2002 and $5
million in 2001. The effective tax rate was 38.5% in 2002 and 23.1% in 2001,
with the difference primarily due to the cessation of nondeductible goodwill
amortization.
17
FINANCIAL CONDITION
Liquidity and Capital Resources
Cash provided by operating activities for the nine months ended
September 30, 2002 was $121 million compared with $65 million for the same
period last year. The increase of $56 million reflected a $72 million favorable
movement in regulatory assets due to collection from customers of previously
unrecovered gas costs, partially offset by other working capital needs.
Cash of $12 million was provided by financing activities in 2002
compared with $71 million provided in 2001. Cash provided by advances from TXU
Corp. decreased $59 million.
Cash of $65 million was used in investing activities in 2002 compared
with $128 million used in the prior year period. The decline was driven by lower
capital expenditures, reflecting higher than normal spending for system
reliability improvements in 2001.
US Credit Agreements described in Note 4 of TXU Gas' Annual Report on
2001 Form 10-K were amended in February 2002 to remove TXU Gas as a borrower.
TXU Gas will meet its short-term liquidity needs through advances from
affiliates.
On October 15, 2002, TXU Gas exercised its right to redeem $200 million
aggregate principal amount of Putable Asset Term Securities (PATS) that would
have matured on October 15, 2012 for a cash premium of $35 million
($23 million net of tax), which will be recognized as an extraordinary debt
extinguishment loss by TXU Gas in the fourth quarter of 2002. TXU Gas used cash
advances from TXU Corp. and cash on hand to fund the redemption of the PATS.
Financing Arrangements
Short-term liquidity needs of TXU Gas are expected to be funded through
advances from TXU Corp. and affiliated companies. TXU Gas had short-term
advances from affiliates of $28 million and $248 million as of September 30,
2002 and December 31, 2001, respectively.
Credit Facilities of Affiliates - TXU Corp., TXU US Holdings Company (US
Holdings), a subsidiary of TXU Corp., TXU Energy LLC (TXU Energy) and Oncor
Electric Delivery Company (Oncor), subsidiaries of US Holdings, had credit
facilities (some of which provide for long-term borrowings) available as
follows:
Credit Facilities
-------------------------------------------------
At September 30, 2002 At November 5, 2002(a)
---------------------- ---------------------
Expiration Authorized Facility Letters of Cash Letters of Cash
Facility Date Borrowers Limit Credit Borrowings Credit Borrowings
-------- ------------ -------------- -------- ----------- ----------- ----------- -----------
(Millin of Dollars)
364-Day Revolving Credit Facility. April 2003 US Holdings,
TXU
Energy, Oncor $1,000 $ 81 $ -- $ 88 $ 912
Five -Year Revolving Credit February 2005 US Holdings 1,400 462 -- 461 939
Facility(b).......................
Three-Year Revolving Credit Facility May 2005 TXU Corp 500 -- 350 -- 500
Standby Liquidity Facility........ November 2002 US Holdings 400 -- -- -- 400
Standby Liquidity Facility........ November 2002 US Holdings,
TXU Energy,
Oncor 400 -- -- -- 400
------ ------ ------ ------ ------
Total (c)................... $3,700 $ 543 $ 350 $ 549 $3,151
====== ====== ====== ====== ======
(a) On October 15, 2002, US Holdings and TXU Energy drew approximately $2.6
billion in cash against their available credit facilities. These funds and
other available cash will be used, in part, to repay outstanding commercial
paper.
(b) In February 2002, TXU Gas was removed as a borrower under this facility.
TXU Corp. was removed as a borrower under this facility effective July 31,
2002.
(c) Supported commercial paper borrowings.
18
Sale of Receivables -- Certain US subsidiaries of TXU Corp. sell customer
accounts receivable to TXU Receivables Company, a wholly-owned bankruptcy remote
indirect subsidiary of TXU Corp., which sells undivided interests in accounts
receivable it purchases to financial institutions. As of September 30, 2002, TXU
Energy Retail Company LP, TXU SESCO Energy Services Company, Oncor and TXU Gas
are qualified originators of accounts receivable under the program. TXU
Receivables Company may sell up to an aggregate of $600 million in undivided
interests in the receivables purchased from the originators under the program.
As of September 30, 2002, TXU Gas had sold $44 million face amount of
receivables to TXU Receivables Company under the program in exchange for cash of
$21 million and $22 million in subordinated notes, with $1 million of losses on
sales for the nine months ended September 30, 2002 principally representing the
interest on the underlying financing. These losses approximated 4% of the cash
proceeds from the sale of undivided interests in accounts receivable on an
annualized basis. Upon termination, cash flows to TXU Gas would be delayed as
collections of sold receivables were used by TXU Receivables Company to
repurchase the undivided interests of the financial institutions instead of
purchasing new receivables. The level of cash flows would normalize in
approximately 16 to 31 days. TXU Business Services Company, an affiliate of TXU
Gas, services the purchased receivables and is paid a market-based servicing fee
by TXU Receivables Company. The subordinated notes receivable from TXU
Receivables Company represent TXU Gas' retained interest in the transferred
receivables and are recorded at book value, net of allowances for bad debts,
which approximates fair value due to the short-term nature of the subordinated
notes, and are included in accounts receivable in the consolidated balance
sheet.
Issuance of Debt and Equity -- TXU Gas may issue and sell additional
debt and equity securities which are currently registered with the Securities
and Exchange Commission for offering pursuant to Rule 415 under the Securities
Act of 1933. This includes the possible future offering of up to an aggregate of
$400 million of debt securities and/or preferred securities of subsidiary
trusts.
Recent Actions by TXU Corp.
In October 2002, TXU Corp. made a determination to exit its TXU Europe
Limited (TXU Europe) operations. Further, in consideration of concerns in US
financial markets about its liquidity, such concerns having already been
prevalent in the markets with respect to the performance of the US energy
sector, TXU Corp. took the following actions to strengthen its credit position:
o Reduced its common stock dividend by 80 percent to an annual indicated
rate of $.50 per share effective with the dividend payable in January 2003
o Significantly reduced planned capital expenditures in all its businesses.
These reductions are primarily directed to developmental as opposed to
maintenance spending.
o Reversed previous plans to support TXU Europe with up to $700 million in
capital contributions
o Eliminated by amendment the cross-default provision in a US financing
arrangement that would have been triggered by a TXU Europe default (TXU
Australia's financing arrangements have no cross-default provisions
that would have been triggered by a TXU Europe default.)
o Drew $2.6 billion in cash on its US revolving credit facilities
o On October 30, 2002, entered into a commitment for a secured credit
facility of up to $1 billion at Oncor. The facility is intended to fund
interim refinancings of approximately $700 million of maturities should
market conditions not support a timely, cost effective refinancing. The
balance will be available for general corporate purposes at Oncor.
Credit Ratings of TXU Corp., US Holdings, Oncor, TXU Energy, and TXU Gas
The current credit ratings, which are all investment grade, for TXU
Corp., US Holdings, Oncor, TXU Energy and TXU Gas are presented below:
TXU Corp. US Holdings Oncor TXU Energy TXU Gas
--------------- ------------- ---------- -------------- -------------
(Senior (Senior (Secured) (Senior (Senior
Unsecured) Unsecured) Unsecured) Unsecured)
S&P........... BBB- BBB- BBB BBB BBB
Moody's....... Baa3 Baa3 A3 Baa2 Baa2
Fitch......... BBB BBB+ A- BBB+ BBB
- -------------------------------------------------------------------------------------------------------------
19
Moody's is currently reviewing its ratings of TXU Corp., US Holdings,
Oncor, TXU Energy and TXU Gas. S&P currently maintains a negative outlook for
TXU Corp. and its US Subsidiaries. Fitch currently maintains a negative outlook
for TXU Corp., but maintains a stable outlook for the US Subsidiaries.
A rating reflects only the view of a rating agency and it is not a
recommendation to buy, sell or hold securities. Any rating can be revised upward
or downward at any time by a rating agency if such rating agency decides that
circumstances warrant such a change.
Credit Rating and Cross Default Provisions-- Certain of TXU Gas' financing
arrangements contain provisions that are specifically affected by changes in
credit ratings and also include cross-default provisions. The material
provisions are described below.
Credit Rating Provisions --Under the $600 million Accounts Receivables
Sale Program, all originators (currently TXU Gas, TXU Energy Retail Company LP,
SESCO Energy Services Company and Oncor), are required to maintain a 'BBB-'
(S&P) and a 'Baa3' (Moody's) rating (or supply a parent guarantee with a similar
rating). A downgrade below the required ratings for an originator would prevent
that originator from selling its accounts receivables under the program. If all
originators are downgraded so that there are no eligible originators, the
facility would terminate. Upon termination, cash flows to the originators would
be delayed as collections of sold receivables were used to repurchase the
undivided interests of the financial institutions instead of purchasing new
receivables. The level of cash flows would normalize in approximately 16 to 31
days.
Cross Default Provisions -- Certain financing arrangements of TXU Gas
and its subsidiaries contain provisions that would result in an event of default
under these arrangements if there is a failure under other financing
arrangements to meet payment terms or to observe other covenants that would
result in an acceleration of payments due. Such provisions are referred to as
"cross default" provisions. Most agreements have a cure period of up to 30 days
from the occurrence of the specified event during which the company is allowed
to rectify or correct the situation before it becomes an event of default.
A default by TXU Gas or any of its material subsidiaries on
indebtedness of $25 million or more would result in a cross-default under the
TXU Gas senior notes due 2004 and 2005 ($300 million) and two interest rate swap
agreements entered into in connection with TXU Gas' floating rate mandatorily
redeemable preferred securities (see Note 5). In the event of default on the
swap agreements, cash settlement of $4 million (as of October 31, 2002) for the
out-of-the money position would be required.
20
The accounts receivable program, described above, contains a cross
default provision with a threshold of $50 million applicable to each of the
originators under the program. TXU Receivables Company, a wholly-owned
bankruptcy remote subsidiary of TXU Corp. which sells undivided interests in
accounts receivable it purchases to financial institutions, and TXU Business
Services Company, a subsidiary of TXU Corp. which services the purchased
receivables, each have a cross default threshold of $50 thousand. If either an
originator, TXU Business Services Company or TXU Receivables Company defaults on
indebtedness of the applicable threshold, the facility could terminate.
Minimum Pension Liability --TXU Gas believes that if actual investment
returns continue at current levels and interest rates remain unchanged through
the rest of the year, it will be required to record an increase in minimum
pension liability as of December 31, 2002. The minimum pension liability
represents the difference between the excess of the accumulated benefit
obligation over the plans' assets and the liability recorded. A majority of the
liability would be recorded as a reduction to shareholder's equity, as a
component of accumulated comprehensive income. A preliminary estimate based on
information available at this time indicates that the minimum pension liability
for the TXU Corp. plan would be approximately $140 million. The amount
applicable to TXU Gas is not yet determinable.
Further, based on the current assumptions and available information, in
2003 funding requirements for TXU Corp. related to the pension plans are
expected to increase by $10 million and pension expense is expected to increase
approximately $30 million over the current year amounts. The amounts applicable
to TXU Gas are not yet determinable.
CONTINGENCIES
See Note 8 to Financial Statements for discussion of contingencies.
REGULATION AND RATES
Although TXU Gas cannot predict future regulatory or legislative
actions or any changes in economic and securities market conditions, no changes
are expected in trends or commitments other than those discussed in the TXU Gas
2001 Form 10-K and this Form 10-Q, which might significantly alter TXU Gas'
financial position, results of operations or cash flows. See Note 7 to Financial
Statements.
CHANGES IN ACCOUNTING STANDARDS
Changes in Accounting Standards -- See Note 2 to Financial Statements
for a discussion of changes in accounting standards.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
The following risk factors are being presented in consideration of
industry practice with respect to disclosure of such information in filings
under the Securities Exchange Act of 1934, as amended.
Some important factors, in addition to others specifically addressed in
Management's Discussion and Analysis of Financial Condition and Results of
Operations, that could have a significant impact on TXU Gas' operations and
financial results, and could cause TXU Gas' actual results or outcomes to differ
materially from those discussed in the forward-looking statements set forth
below, include:
TXU Gas' businesses operate in changing market environments influenced
by various legislative and regulatory initiatives. TXU Gas will need to adapt to
these changes.
21
As a result of the energy crisis in California during the summer of 2001,
the recent volatility of natural gas prices in North America, the bankruptcy
filing by the Enron Corporation, recently discovered accounting irregularities
of public companies, and investigations by governmental authorities into energy
trading activities, companies in the regulated and non-regulated utility
businesses have been under a generally increased amount of public and regulatory
scrutiny. Recently discovered accounting irregularities at certain companies in
the industry have caused regulators and legislators to review current accounting
practices and financial disclosures. The capital markets and ratings agencies
also have increased their level of scrutiny. Additionally, allegations against
various energy trading companies of "round trip" or "wash" transactions, which
involve the simultaneous buying and selling of the same amount of power at the
same price and provide no true economic benefit, may have a negative effect on
the industry. TXU Gas believes that it is complying with all applicable laws,
but it is difficult or impossible to predict or control what effect these events
may have on TXU Gas' financial condition or access to the capital markets.
Additionally, it is unclear what laws or regulations may develop, and TXU Gas
cannot predict the ultimate impact of any future changes in accounting
regulations or practices in general with respect to public companies, the energy
industry or its operations specifically. Any such new accounting standards could
negatively impact reported financial results.
TXU Gas is subject to changes in laws or regulations, changing
governmental policies and regulatory actions, including those of the Railroad
Commission of Texas, with respect to matters including, but not limited to,
operation and construction of pipeline transmission facilities, acquisition,
disposal, depreciation and amortization of regulated assets and facilities,
recovery of purchased gas costs, and return on invested capital for TXU Gas'
businesses.
TXU Gas' businesses are subject to cost-of-service regulation. This
regulatory treatment does not provide any assurance as to achievement of
earnings levels.
TXU Gas relies on access to financial markets or advances from
affiliates as a significant source of liquidity for capital requirements not
satisfied by operating cash flows. The inability to raise capital on favorable
terms, particularly during times of uncertainty in the financial markets, could
impact TXU Gas' ability to sustain and grow its businesses, which are capital
intensive, and would likely increase its capital costs. Further, concerns on the
part of counterparties regarding TXU Gas' liquidity and credit could limit its
ability to enter into larger and longer-dated transactions.
TXU Gas uses derivative instruments, such as interest rate swaps, and
may use other instruments, such as options, futures and forwards, to manage its
commodity and financial market risks. TXU Gas could recognize financial losses
as a result of volatility in the market values of these contracts, or if a
counterparty fails to perform. TXU Gas' inability or failure to effectively
hedge its assets or positions against changes in commodity prices, interest
rates, counterparty credit risk or other risk measures could result in greater
volatility of and/or declines in future financial results.
The operation of gas transportation facilities involves many risks,
including breakdown or failure of equipment, pipelines, lack of sufficient
capital to maintain the facilities, the dependence on natural gas or the impact
of unusual or adverse weather conditions or other natural events, as well as the
risk of performance below expected levels of output or efficiency. This could
result in lost revenues and/or increased expenses. Insurance, warranties or
performance guarantees may not cover any or all of the lost revenues or
increased expenses. In addition to these risks, breakdown or failure of a TXU
Gas operating facility may prevent the facility from performing under applicable
sales agreements which, in certain situations, could result in termination of
those agreements or incurring a liability for liquidated damages.
Natural disasters, war, terrorist acts and other catastrophic events
may impact TXU Gas' operations in unpredictable ways, including disruption of
natural gas production and delivery activities, declines in customer demand,
commodity price increases and instability in the financial markets.
TXU Gas is subject to extensive federal, state and local environmental
statutes, rules and regulations relating to air quality, water quality, waste
management, natural resources and health and safety. There are capital,
operating and other costs associated with compliance with these environmental
statutes, rules and regulations, and those costs could increase in the future.
TXU Gas' ability to successfully and timely complete capital
improvements to existing facilities or other capital projects is contingent upon
many variables and subject to substantial risks. Should any such efforts be
unsuccessful, TXU Gas could be subject to additional costs and/or the write off
of its investment in the project or improvement.
22
TXU Gas is subject to costs and other effects of legal and
administrative proceedings, settlements, investigations and claims.
TXU Gas is subject to the effects of new, or changes in, income tax
rates or policies and increases in taxes related to property, plant and
equipment and gross receipts and other taxes. Further, TXU Gas is subject to
audit and reversal of its tax positions by the Internal Revenue Service and
state taxing authorities.
TXU Gas' ability to obtain insurance, and the cost of and coverage
provided by such insurance, could be affected by events outside its control.
TXU Gas is subject to employee workforce factors, including loss or
retirement of key executives, availability of qualified personnel, collective
bargaining agreements with union employees or work stoppage.
The issues and associated risks and uncertainties described above are
not the only ones TXU Gas may face. Additional issues may arise or become
material as the energy industry evolves. The risks and uncertainties associated
with these additional issues could impair TXU Gas' businesses in the future.
Reference is made to the discussion under Liquidity and Capital Resources.
FORWARD-LOOKING STATEMENTS
This report and other presentations made by TXU Gas contain
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended. Although TXU Gas believes that in making any
such statement its expectations are based on reasonable assumptions, any such
statement involves uncertainties and is qualified in its entirety by reference
to factors contained in the Forward-Looking Statements section of Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations in the TXU Gas 2001 Form 10-K, as well as general industry trends;
natural gas costs and availability; changes in business strategy, development
plans or vendor relationships; availability of qualified personnel; changes in,
or the failure or inability to comply with, governmental regulations, including,
without limitation, environmental regulations; changes in tax laws;
implementation of new accounting standards; commercial paper market and capital
market conditions; actions of credit rating agencies; and access to adequate
transmission facilities to meet changing demand, among others, that could cause
the actual results of TXU Gas and/or its subsidiaries to differ materially from
those projected in such forward-looking statements.
Any forward-looking statement speaks only as of the date on which such
statement is made, and TXU Gas undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time, and it is not possible for TXU Gas
to predict all of such factors, nor can it assess the impact of each such factor
or the extent to which any factor, or combination of factors, may cause results
to differ materially from those contained in any forward-looking statement.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required hereunder is not significantly different from
the information set forth in Item 7A. Quantitative and Qualitative Disclosures
about Market Risk included in TXU Gas' 2001 Form 10-K and is, therefore, not
presented herein.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of TXU Gas' management, including the principal executive officer
and principal financial officer, of the effectiveness of the design and
operation of the disclosure controls and procedures in effect within 90 days of
the filing date of this quarterly report. Based on the evaluation performed, TXU
Gas' management, including the principal executive officer and principal
financial officer, concluded that the disclosure controls and procedures were
effective. There were no significant changes in TXU Gas' internal controls or in
other factors that could significantly affect internal controls subsequent to
their evaluation.
23
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
In July 1999, the City of Gatesville, Texas filed suit in the State
District Court of Coryell County, Texas, 52nd Judicial District. The suit has
been amended to assert claims against TXU Gas and TXU Corp. The plaintiff sought
to represent a class of plaintiffs consisting of more than 300 Texas cities,
towns and other municipalities to which TXU Gas Distribution had paid municipal
franchise fees since January 1, 1987. The plaintiff alleged that TXU Gas
Distribution failed to properly pay franchise fees by omitting miscellaneous
revenues from the franchise fee payment base used for determining the municipal
franchise fees owed to the plaintiff. This case has been settled by TXU Gas for
$45,000 as reimbursement for attorneys' fees, plus an agreement to specifically
include the disputed categories of revenue in the franchise fee calculation, as
may be elected by the City of Gatesville.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits filed as a part of Part II are:
15 Letter from independent accountants as to unaudited interim
financial information
99(a) Condensed Statements of Consolidated Income - Twelve Months
Ended September 30, 2002
99(b) Chief Executive Officer Certification
99(c) Chief Financial Officer Certification
99(d) Detail of Long-Term Debt as of September 30, 2002
(b) Reports on Form 8-K filed since June 30, 2002:
November 5, 2002 Item 5. Other Information
24
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
TXU GAS COMPANY
By /s/ Biggs C. Porter
-----------------------------------
Biggs C. Porter
Vice President,
Principal Accounting Officer
Date: November 14, 2002
25
TXU GAS COMPANY
CERTIFICATION OF CEO
I, Erle Nye, Chairman of the Board and Chief Executive of TXU Gas
Company (the "Company"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of TXU Gas Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the period presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002 /s/ Erle Nye
--------------------------------------------------
Signature: Erle Nye
Title: Chairman of the Board and Chief Executive
26
TXU GAS COMPANY
CERTIFICATION OF PFO
I, Scott Longhurst, Principal Financial Officer of TXU Gas Company
(the "Company"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of TXU Gas Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the period presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002 /s/ Scott Longhurst
--------------------------------------------------
Signature: Scott Longhurst
Title: Principal Financial Officer
27