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UNITED STATES
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 JUNE 30, 2003
--OR--
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Commission File Number 1-3183
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
--- ----
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
Common Stock outstanding at August 8, 2003: 451,000 shares, par value $0.01
per share.
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TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
----
Glossary ........................................................................................ ii
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Statements of Consolidated Income and Comprehensive Income--
Three and Six Months Ended June 30, 2003 and 2002.................................. 1
Condensed Statements of Consolidated Cash Flows --
Six Months Ended June 30, 2003 and 2002............................................ 2
Condensed Consolidated Balance Sheets --
June 30, 2003 and December 31, 2002................................................ 3
Notes to Financial Statements...................................................... 4
Independent Accountants' Report.................................................... 12
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................... 20
Item 4. Controls and Procedures............................................................ 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................. 20
Item 6. Exhibits and Reports on Form 8-K................................................... 21
SIGNATURE......................................................................................... 22
Periodic reports on Form 10-K and Form 10-Q and current reports on Form 8-K that
contain financial information of TXU Gas Company 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 Gas Company will provide copies of current reports not posted on the website
upon request.
i
GLOSSARY
When the following terms and abbreviations appear in the text of this report,
they have the meanings indicated below.
2002 Form 10-K........................TXU Gas' Annual Report on Form 10-K for
the year ended December 31, 2002
Commission............................Public Utility Commission of Texas
EITF..................................Emerging Issues Task Force
EITF 01-8.............................EITF Issue No. 01-8,"Determining Whether
an Arrangement Contains a Lease"
ERCOT.................................Electric Reliability Council of Texas
FIN...................................Financial Accounting Standards Board
Interpretation
FIN 45................................FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees,
Including Indirect Guarantees of
Indebtedness of Others - an Interpretation
of FASB Statements Nos. 5, 57, and 107
and Rescission of FIN No. 34"
FIN 46................................FIN No. 46, "Consolidation of Variable
Interest Entities"
Fitch.................................Fitch Ratings, Ltd.
IRS...................................Internal Revenue Service
Moody's...............................Moody's Investors Services, Inc.
Oncor.................................Oncor Electric Delivery Company
Oncor Utility Solutions...............Oncor Utility Solutions (Canada) Company,
Oncor Utility Solutions (North America)
Company, and Oncor Utility Solutions
(Texas) Company, all wholly-owned
subsidiaries of TXU Gas
POLR..................................provider of last resort
RRC...................................The Railroad Commission of Texas
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
SFAS 143..............................SFAS No. 143, "Accounting for Asset
Retirement Obligations"
SFAS 145..............................SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of
FASB Statement 13, and Technical
Corrections"
SFAS 146..............................SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal
Activities"
SFAS 149..............................SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and
Hedging Activities"
SFAS 150..............................SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics
of both Liabilities and Equity"
TXU Energy............................TXU Energy Company LLC
TXU Fuel..............................TXU Fuel Company
ii
TXU Gas...............................refers to TXU Gas Company, or TXU Gas
Company and its consolidated
subsidiaries, depending on the context
US....................................United States of America
US GAAP...............................accounting principles generally accepted
in the US
US Holdings...........................TXU US Holdings Company
iii
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
---- ---- ---- ----
(millions of dollars)
Operating revenues.............................................. $ 199 $ 160 $ 820 $ 504
------- -------- ------- --------
Operating expenses:
Gas purchased for resale................................... 89 73 519 253
Operation and maintenance.................................. 71 71 137 132
Depreciation and amortization.............................. 19 17 37 32
Taxes other than income.................................... 33 23 55 42
------- -------- ------- --------
Total operating expenses................................ 212 184 748 459
------- -------- ------- --------
Operating income (loss)......................................... (13) (24) 72 45
Other income.................................................... -- 4 1 --
Interest income................................................. -- -- 1 --
Interest expense and other charges.............................. 11 16 22 34
------- -------- ------- --------
Income (loss) before income taxes............................... (24) (36) 52 11
Income tax expense (benefit).................................... (9) (13) 17 3
------- -------- ------- --------
Net income (loss)............................................... (15) (23) 35 8
Preferred stock dividends....................................... 1 1 2 2
------- -------- ------- --------
Net income (loss) applicable to common stock.................... $ (16) $ (24) $ 33 $ 6
======= ======== ======= ========
CONDENSED STATEMENTS OF CONSOLIDATED
COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ----------------------
2003 2002 2003 2002
------- ------- ------- ------
(millions of dollars)
Net income (loss)............................................... $ (15) $ (23) $ 35 $ 8
Other comprehensive income, net of tax effect:
Cash flow hedge activity--
Net change in fair value of derivatives.................. -- (1) -- --
Amounts realized in earnings (net of tax expense of $- and $1) 1 -- 2 --
------- -------- ------- --------
Total................................................. 1 (1) 2 --
------- -------- ------- --------
Comprehensive income (loss)..................................... $ (14) $ (24) $ 37 $ 8
======= ======== ======= ========
See Notes to Financial Statements.
1
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
--------------------
2003 2002
------ -----
(millions of dollars)
Cash flows - operating activities:
Net income....................................................... $ 35 $ 8
Adjustments to reconcile net income to cash provided by operating
activities:
Depreciation and amortization................................. 40 37
Deferred income taxes - net................................... 7 --
Equity in earnings of affiliates and joint ventures........... (1) (1)
Recovery of gas costs......................................... 34 67
Other......................................................... -- (1)
Changes in operating assets and liabilities...................... (9) 48
------ -------
Cash provided by operating activities of continuing operations 106 158
------ -------
Cash flows -- financing activities:
Retirements of long-term debt.................................... (125) --
Change in advances from affiliates............................... 60 (106)
Cash dividends paid.............................................. (2) (2)
Redemption deposits applied to debt retirements and other........ (2) --
------ -------
Cash used in financing activities of continuing operations. (69) (108)
------ -------
Cash flows -- investing activities:
Capital expenditures............................................. (48) (46)
Other............................................................ 9 (1)
------ -------
Cash used in investing activities of continuing operations. (39) (47)
------ -------
Cash provided by (used in) continuing operations................... (2) 3
------ -------
Cash used in discontinued operations -
Engineering and construction businesses sold..................... -- (2)
------ -------
Cash used in discontinued operations....................... -- (2)
------ -------
Net change in cash and cash equivalents............................ (2) 1
Cash and cash equivalents-- beginning balance...................... 4 3
------ -------
Cash and cash equivalents-- ending balance......................... $ 2 $ 4
====== =======
See Notes to Financial Statements.
2
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2003 2002
------------ --------
(millions of dollars)
ASSETS
Current assets:
Cash and cash equivalents...................................................... $ 2 $ 4
Accounts receivable............................................................ 50 118
Inventories.................................................................... 128 125
Other current assets........................................................... 32 28
------- -------
Total current assets....................................................... 212 275
Investments:
Restricted cash.............................................................. 10 8
Other investments............................................................ 26 29
Property, plant and equipment - net............................................... 1,528 1,520
Goodwill.......................................................................... 305 305
Regulatory assets................................................................. 110 142
Other noncurrent assets........................................................... 14 10
------- -------
Total assets............................................................. $ 2,205 $ 2,289
======= =======
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Advances from affiliates....................................................... $ 169 $ 110
Long-term debt due currently................................................... 150 125
Accounts payable............................................................... 75 125
Other current liabilities...................................................... 75 87
------- -------
Total current liabilities.................................................. 469 447
Accumulated deferred income taxes and investment tax credits...................... 204 193
Other noncurrent liabilities and deferred credits................................. 246 248
Long-term debt, less amounts due currently........................................ 276 426
Mandatorily redeemable, preferred securities of subsidiary trust
holding solely junior subordinated debentures of TXU Gas Company............... 147 147
Contingencies (Note 5)
Shareholder's equity (Note 4)..................................................... 863 828
------- -------
Total liabilities and shareholder's equity............................... $ 2,205 $ 2,289
======= =======
See Notes to Financial Statements.
3
TXU GAS COMPANY AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Description of Business -- TXU Gas, a Texas corporation, is a largely
regulated business (see Note 6) engaged in the purchase, transmission,
distribution and sale of natural gas in the north-central, eastern and western
parts of Texas, and also provides energy asset management services. TXU Gas is a
wholly-owned subsidiary of TXU Corp.
Operating units of TXU Gas include TXU Gas Distribution Division, a retail
gas distribution business serving over 1.4 million residential, commercial and
industrial customers through over 26,000 miles of distribution mains, TXU Lone
Star Pipeline Division, which operates approximately 6,800 miles of transmission
and gathering pipeline in Texas, and Oncor Utility Solutions, which offers
utility asset management services to cooperatives and municipally-owned and
investor-owned utilities in North America.
TXU Gas' operations are managed as an integrated business; accordingly,
there are no separate reportable business segments.
Basis of Presentation -- The condensed consolidated financial statements
of TXU Gas and its subsidiaries have been prepared in accordance with US GAAP
and on the same basis as the audited financial statements included in its 2002
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. 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 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 2002 Form 10-K. The
results of operations for an interim period may not give a true indication of
results for a full year. All dollar amounts in the financial statements and
tables in the notes are stated in millions of US dollars unless otherwise
indicated. Certain previously reported amounts have been reclassified to conform
to current classifications.
Changes in Accounting Standards - 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. The adoption
of SFAS 143 did not impact TXU Gas' results of operations for the six months
ended June 30, 2003.
SFAS 145, regarding classification of items as extraordinary, became
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." The adoption of SFAS 145 does not result in a reclassification of results
for the six months ended June 30, 2002.
As a result of the implementation of SFAS 145 as of January 1, 2003, the
previously reported annual after-tax losses on the early extinguishment of debt
of $23 million in the year ended December 31, 2002 (as described in the Notes to
Financial Statements in the 2002 Form 10-K) will be reclassified from
extraordinary items to other deductions and income tax expense as such losses do
not meet the criteria of an extraordinary item. There was no effect on net
income as a result of the implementation of SFAS 145.
SFAS 146, regarding exit costs, became effective on January 1, 2003. SFAS
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. The adoption of SFAS 146 did not materially impact
results of operations for the six months ended June 30, 2003.
4
FIN 45 requires recording the fair value of guarantees upon issuance or
modification after December 31, 2002. The interpretation also requires expanded
disclosures of guarantees (see Note 5 under Guarantees). The adoption of FIN 45
did not materially impact results of operations for the six months ended June
30, 2003.
FIN 46 was issued in January 2003. FIN 46 provides guidance related to
identifying variable interest entities and determining whether such entities
should be consolidated. This guidance will be effective for existing variable
interest entities in the quarter ending September 30, 2003 and immediately for
any new variable interest entities. TXU Gas is evaluating the potential impact
of FIN 46 on its financial position.
SFAS 149 was issued in April 2003 and became effective for contracts
entered into or modified after June 30, 2003. SFAS 149 clarifies what contracts
may be eligible for the normal purchase and sale exception, the definition of a
derivative and the treatment in the statement of cash flows when a derivative
contains a financing component. The adoption of SFAS 149 is not expected to
materially impact TXU Gas' financial position or result of operations.
SFAS 150 was issued in May 2003 and became effective June 1, 2003 for new
financial instruments and July 1, 2003 for existing financial instruments. SFAS
150 requires that certain mandatorily redeemable preferred securities (see Note
3) be classified as liabilities beginning July 1, 2003. TXU Gas is evaluating
the potential impact of SFAS 150 on its financial position.
EITF 01-8 was issued in May 2003 and is effective prospectively for
arrangements that are new, modified or committed to beginning July 1, 2003. This
guidance may require that certain types of arrangements be accounted for as
leases, including tolling and power supply contracts, take-or-pay contracts and
service contracts involving the use of specific property and equipment. TXU Gas
is evaluating the potential impact of the adoption of EITF 01-8 on its financial
position and results of operations.
2. FINANCING ARRANGEMENTS
TXU Gas expects to meet its short-term liquidity needs through advances
from TXU Corp. and affiliates. At June 30, 2003 and December 31, 2002, advances
from TXU Corp. totaled $169 million and $110 million, respectively, and the
weighted average interest rates on these short-term borrowings were 3.07% and
2.63%, respectively.
Long-Term Debt -- At June 30, 2003 and December 31, 2002, the long-term
debt of TXU Gas consisted of the following:
June 30, December 31,
2003 2002
------- -----------
6.250% Fixed Notes due January 1, 2003........................................... $ -- $ 125
6.375% Fixed Notes due February 1, 2004.......................................... 150 150
7.125% Fixed Notes due June 15, 2005............................................. 150 150
6.564% Fixed Remarketed Reset Notes due January 1, 2008.......................... 125 125
Unamortized fair value adjustments............................................... 1 1
------- -------
Total ....................................................................... 426 551
------- -------
Less amount due currently........................................................ 150 125
------- -------
Total long-term debt............................................................. $ 276 $ 426
======= =======
In January 2003, TXU Gas redeemed, at par value, $125 million principal
amount of its 6.25% Notes at maturity. TXU Gas used cash advances from TXU Corp.
and cash on hand to fund the redemption of these notes.
5
Sale of Receivables -- Certain subsidiaries of TXU Corp. sell trade
accounts receivable to TXU Receivables Company, a wholly-owned bankruptcy remote
subsidiary of TXU Gas, which sells undivided interests in accounts receivable it
purchases to financial institutions. As of June 30, 2003, TXU Energy (through
certain subsidiaries), 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. The June 30, 2003 financial statements
reflect the sale of $99 million face amount of TXU Gas' receivables to TXU
Receivables Company under the program in exchange for cash of $46 million and
$52 million in subordinated notes, with $1 million of losses on sales for the
six months ended June 30, 2003 that principally represents the interest costs on
the underlying financing. These losses approximated 6% of the cash proceeds from
the sale of undivided interests in accounts receivable on an annualized basis.
Funding under the program increased $23 million for the six month period ended
June 30, 2003 primarily due to reserve requirements that were reduced through a
temporary amendment in recognition of improving collection trends. Funding
increases or decreases under the program are reflected as cash provided by or
used in operating activities.
Upon termination, cash flows to the originators would be delayed as
collections of sold receivables would be 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, a subsidiary of TXU
Corp., 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 Corp.'s subsidiaries' retained interests 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.
In August 2003, the program was amended to extend the term to July 2004,
as well as to extend the period providing temporarily higher delinquency and
default compliance ratios through December 31, 2003. The program was also
amended to coincide with the credit facilities' covenants by removing investment
grade credit ratings as a requirement of an eligible originator and substituting
maintenance of fixed charge coverage ratios and debt to capital ratios as
requirements of an eligible originator. In June 2003, the program was amended to
provide temporarily higher delinquency and default compliance ratios and
temporary relief from the loss reserve formula. The June amendment reflected the
billing and collection delays previously experienced as a result of new systems
and processes in TXU Energy and ERCOT for clearing customers' switching and
billing data upon the transition to competition.
Contingencies Related to 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 deregulation. Certain
billing and collection delays arose due to implementation of new systems and
processes within TXU Energy and ERCOT for clearing customers' switching and
billing data. The billing delays have been resolved but, while improving, the
lagging collection issues continue to impact the ratios. The implementation of
new POLR rules by the Commission and strengthened credit and collection policies
and practices are expected to bring the ratios into consistent compliance with
the program.
6
Under 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. Prior to the August 2003 amendment extending the
program, originator eligibility was predicated on the maintenance of an
investment grade credit rating.
Cross Default Provisions -- Certain financing arrangements of TXU Gas
contain provisions that would result in an event of default 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.
The accounts receivable program also contains a cross default provision
with a threshold of $50 million applicable to each of the originators under the
program. TXU Receivables Company and TXU Business Services Company each have a
cross default threshold of $50,000. If either an originator, TXU Business
Services Company or TXU Receivables Company defaults on indebtedness of the
applicable threshold, the facility could terminate.
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 $300 million
TXU Gas senior notes due 2004 and 2005.
3. TXU GAS OBLIGATED, MANDATORILY REDEEMABLE, PREFERRED SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF TXU GAS
(TRUST SECURITIES)
At June 30, 2003 and December 31, 2002, TXU Gas Capital I, a consolidated
statutory business trust, 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 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 June 30, 2003, TXU Gas had two interest rate swap agreements with respect to
floating rate trust securities of TXU Gas Capital I, with notional principal
amounts of $100 million and $50 million, respectively, that effectively fixed
the rate at 6.629% and 6.444%, respectively, per annum to July 1, 2003. TXU Gas
elected not to renew these swaps and will pay variable interest rates on these
Trust Securities based on the three-month LIBOR rate plus a margin of 135
basis points.
4. SHAREHOLDER'S EQUITY
June 30, December 31,
2003 2002
------------- ---------
Preferred stock.................................................... $ 75 $ 75
-------- -------
Common stock (par value - $.01 per share):
Authorized shares - 100,000,000, Outstanding shares - 451,000... -- --
Paid in capital.................................................... 818 820
Deficit............................................................ (12) (47)
Accumulated other comprehensive loss............................... (18) (20)
-------- -------
Total common stock equity....................................... 788 753
-------- -------
Total shareholder's equity.................................... $ 863 $ 828
======== =======
7
5. CONTINGENCIES
Guarantees -- In 1992, a discontinued engineering and construction
business of TXU Gas completed construction of a plant, the performance of which
is warranted by TXU Gas through 2008. The maximum contingent liability under the
guarantee is approximately $96 million. No claims have been asserted under the
guarantee and none are anticipated.
Income Tax Contingencies -- In April 2003, the IRS proposed to TXU Gas
certain adjustments to the US federal income tax returns of ENSERCH Corporation
(the predecessor of TXU Gas) for the 1993 calendar year. The adjustments
proposed would result in taxes payable for that year of $22 million excluding
interest, but including penalties of $9 million. TXU Gas has protested the
proposed audit adjustments and is awaiting a hearing with the Appeals Office of
the IRS. In the event that TXU Gas is unsuccessful in defending its position,
earnings would be impacted by the interest expense on the deficiency, which
would total $6 million after-tax through June 30, 2003.
Legal Proceedings -- In September 1999, Quinque Operating Company 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, a subsidiary of TXU Energy, as a defendant in this
litigation. Quinque Operating Company has dismissed its claims and a new lead
plaintiff filed an amended petition in which the plaintiffs sought 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. The petition alleged that the defendants
mismeasured both the volume and heat content of natural gas delivered into their
pipelines resulting in underpayments to plaintiffs. On April 10, 2003, the
District Court entered an order denying the plaintiffs' motion seeking
certification of a class. On May 12, 2003, plaintiffs filed a motion to amend
their petition to narrow the defendants sued and the claims asserted. The
amended petition omits TXU Gas and TXU Fuel as defendants.
TXU Gas employs a continuing program of rate review for all classes of
customers in its regulatory jurisdictions. In July 2001 and August 2001, TXU Gas
filed two cases, a gas cost review and a gas cost reconciliation, covering the
period between November 1997 and June 2001, seeking to recover $29 million of
under-recovered gas costs. On August 6, 2002, a settlement was approved by the
RRC authorizing TXU Gas to recover $18 million of this amount, which has been
recovered through a surcharge, while $11 million in under-recovered gas costs
remains pending.
General -- In addition to the above, TXU Gas is involved in various legal
and administrative proceedings, the ultimate resolution of which should not have
a material effect upon its financial position, results of operations or cash
flows.
6. SUPPLEMENTARY FINANCIAL INFORMATION
Deregulated Operations -- TXU Gas' operations are substantially regulated.
Deregulated operations are primarily those of Oncor Utility Solutions. The
results of operations of TXU Gas for the six months ended June 30, 2003 include
$5 million in operating revenue and $6 million in operation and maintenance
expense related to Oncor Utility Solutions' operations.
8
Other Income --
Three Months Six Months
Ended June 30, Ended June 30,
-------------------------- -------------------
2003 2002 2003 2002
--------- --------- --------- -------
Other income:
Equity earnings in unconsolidated subsidiaries $ -- $ 1 $ 1 $ --
Gains on sale of properties............... -- 1 -- --
Other..................................... -- 2 -- --
------ ------- ------ -------
Total other income...................... $ -- $ 4 $ 1 $ --
====== ======= ====== =======
Interest Expense and Other Charges --
Three Months Six Months
Ended June 30, Ended June 30,
-------------------------- -------------------
2003 2002 2003 2002
--------- --------- --------- -------
Interest .................................... $ 9 $ 14 $ 17 $ 30
Distributions on TXU Gas obligated, mandatorily
redeemable, preferred securities of
subsidiary trustholding solely junior
subordinated debentures of TXU Gas......... 2 2 5 5
Amortization of debt issuance expense and
premiums................................... -- -- -- (1)
------ ------- ------ -------
Total interest expense and other charges $ 11 $ 16 $ 22 $ 34
====== ======= ====== =======
Accounts Receivable -- At June 30, 2003 and December 31, 2002, accounts
receivable of $50 million and $118 million are stated net of allowance for
uncollectible accounts of $7 million and $3 million, respectively.
Accounts receivable included $14 million and $27 million of unbilled
revenues at June 30, 2003 and December 31, 2002, respectively.
Intangible Assets -- SFAS No. 142, "Goodwill and Other Intangible Assets,"
became effective for TXU Gas on January 1, 2002. SFAS No. 142 requires the
discontinuance of goodwill amortization and additional disclosures regarding
intangible assets (other than goodwill) that are amortized or not amortized:
As of June 30, 2003 As of December 31, 2002
------------------------------------ ------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
-------- ------------ ---- -------- ------------ ---
Amortized intangible assets
Capitalized software.............. $ 30 $ 13 $ 17 $ 29 $ 11 $ 18
Land easements.................... 16 8 8 15 8 7
----- ----- ----- ----- ----- -----
Total....................... $ 46 $ 21 $ 25 $ 44 $ 19 $ 25
===== ===== ===== ===== ===== =====
Amortized intangible asset balances are classified as property, plant
and equipment in the balance sheet. TXU Gas has no intangible assets (other than
goodwill) that are not amortized.
Aggregate amortization expense for intangible assets was $2 million and $1
million for the six month periods ended June 30, 2003 and 2002, respectively.
9
Inventories by major category--
June 30, December 31,
2003 2002
---------- -------
Materials and supplies, at cost.................... $ 7 $ 7
Gas stored underground, primarily at weighted average cost 121 118
------- -------
Total inventories............................... $ 128 $ 125
======= =======
Property, Plant and Equipment -- As of June 30, 2003 and December 31,
2002, property, plant and equipment of $1.5 billion in both years is stated net
of accumulated depreciation and amortization of $368 million and $333 million,
respectively.
Regulatory Assets --
June 30, December 31,
2003 2002
-------- ------------
Under-collected gas costs.......................... $ 15 $ 49
Distribution safety compliance costs............... 42 43
Rate case costs.................................... 10 12
Other regulatory assets............................ 43 38
------- -------
Regulatory assets............................... $ 110 $ 142
======= =======
Included above are assets of $63 million at June 30, 2003 and $57 million
at December 31, 2002 that were not earning a return. The regulatory assets have
an average remaining recovery period of approximately 15 years.
Derivatives and Hedges - The terms of TXU Gas' interest rate swap
agreements that have been designated as cash flow hedges match the terms of the
underlying hedged indebtedness. As a result, TXU Gas experienced no hedge
ineffectiveness during the three or six months ended June 30, 2003 or 2002. On
July 1, 2003, TXU Gas' existing interest rate swaps expired.
As of June 30, 2003, it was expected that $1 million of after-tax net
losses accumulated in other comprehensive income would 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 loss 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. In July
of 2003, as a result of the interest rate swaps discussed above, $1 million of
after-tax losses were recognized in earnings (reclassified from other
comprehensive income). TXU Gas has no other cash flow hedges at this time.
Affiliated Transactions -- The following represent significant affiliate
transactions of TXU Gas:
o Average daily short-term advances from affiliates for the three months
ended June 30, 2003 and 2002 were $152 million and $111 million,
respectively, and for the six months ended June 30, 2003 and 2002 were
$160 million and $129 million, respectively. Interest expense incurred
on the advances for the three months ended June 30, 2003 and 2002 was
$1 million, and for the six months ended June 30, 2003 and 2002 was $2
million. The average interest rate for the three months ended June 30,
2003 and 2002 was 3.07% and 3.10%, respectively. The average interest
rate for the six months ended June 30, 2003 and 2002 was 2.83% and
2.93%, respectively.
o US Holdings, a subsidiary of TXU Corp., charges TXU Gas for customer
and administrative services. For the three months ended June 30, 2003
and 2002 these charges totaled $14 million and $15 million,
respectively. For the six months ended June 30, 2003 and 2002 these
charges totaled $29 million for both periods. These charges are
reported in operation and maintenance expenses.
10
o Included in reported revenues were $5 million and $7 million from the
sale and transportation of gas to other TXU Corp. subsidiaries for the
three months ended June 30, 2003 and 2002, respectively. For the six
months ended June 30, 2003 and 2002, these revenues totaled $8 million
and $10 million, respectively.
o TXU Business Services charges TXU Gas for certain financial,
accounting, information technology, environmental, procurement and
personnel services and other administrative services at cost. For the
three months ended June 30, 2003 and 2002, these costs totaled $8
million and $13 million, respectively. For the six months ended June
30, 2003 and 2002, these costs totaled $17 million and $25 million,
respectively. These costs are reported in operations and maintenance
expense.
11
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 June 30, 2003, and the related
condensed statements of consolidated income and of comprehensive income for the
three-month and six-month periods ended June 30, 2003 and 2002, and the
condensed statements of consolidated cash flows for the six-month periods ended
June 30, 2003 and 2002. These financial statements are the responsibility of TXU
Gas' management.
We conducted our reviews 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 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 reviews, 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, 2002, and the related statements of consolidated income,
comprehensive income, cash flows and shareholder's equity for the year then
ended (not presented herein); and in our report (which includes an explanatory
paragraph related to the adoption of Statement of Financial Accounting Standards
No. 142) dated February 14, 2003, 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, 2002,
is fairly stated in all material respects in relation to the consolidated
balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Dallas, Texas
August 12, 2003
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BUSINESS
TXU Gas, a Texas corporation, is a largely regulated business (see Note 6)
engaged in the purchase, transmission, distribution and sale of natural gas in
the north-central, eastern and western parts of Texas, and also provides energy
asset management services. TXU Gas is a wholly-owned subsidiary of TXU Corp.
Operating units of TXU Gas include TXU Gas Distribution Division, a retail
gas distribution business serving over 1.4 million residential, commercial and
industrial customers through over 26,000 miles of distribution mains, TXU Lone
Star Pipeline Division, which operates approximately 6,800 miles of transmission
and gathering pipeline in Texas, and Oncor Utility Solutions, which offers
utility asset management services to cooperatives and municipally-owned and
investor-owned utilities in North America.
TXU Gas' operations are managed as an integrated business; accordingly,
there are no separate reportable business segments.
RESULTS OF OPERATIONS
Results of operations of TXU Gas are subject to seasonal variations,
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.
Dollar amounts in the following tables are stated in millions of US
dollars unless otherwise stated.
Highlights
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ---------------
2003 2002 2003 2002
-------- -------- -------- -------
Operating statistics
Gas distribution sales volumes (billion cubic feet -- Bcf):
Residential..................................... 8 10 53 51
Commercial, industrial and electric generation.. 9 10 35 35
-------- -------- -------- --------
Total gas distribution....................... 17 20 88 86
======== ======== ======== ========
Pipeline transportation volumes (Bcf, non-affiliated) 92 116 178 218
======== ======== ======== ========
Operating revenues (millions of dollars)
Gas distribution:
Residential..................................... $ 94 $ 76 $ 495 $ 299
Commercial, industrial and electric generation.. 76 49 269 155
-------- -------- -------- --------
Total gas distribution....................... 170 125 764 454
Pipeline transportation (non-affiliated)............ 12 17 28 29
Other revenues, net of intercompany eliminations.... 17 18 28 21
-------- -------- -------- --------
Total operating revenues..................... $ 199 $ 160 $ 820 $ 504
======== ======== ======== ========
Heating degree days (% of normal)...................... 64.0% 69.0% 103.9% 99.2%
13
Three Months Ended June 30, 2003 Compared to the Three Months Ended
June 30, 2002
- ---------------------------------------------------------------------
Operating revenues for TXU Gas increased by $39 million, or 24%, to $199
million in 2003. Revenues increased $43 million due to the effects of higher gas
costs passed on to customers and $3 million in higher base distribution rates,
partly offset by the effect of lower gas sales volumes of $8 million. Higher
revenues in the utility asset management services business of $5 million were
offset by normal changes in estimates for unbilled revenues and gas costs. The
average cost of gas rose 63% while sales volumes decreased 15%, due to warmer
weather.
Gross margin (operating revenues less gas purchased for resale) rose $23
million, or 26%, to $110 million in 2003. The increase reflected the higher
revenues, as certain costs directly related to the revenues are reported below
gross margin, and higher base distribution rates.
Operation and maintenance expense was $71 million in 2003 and 2002.
Increased costs to support growth of the utility asset management services
business were offset by small declines in several other expense categories.
Depreciation and amortization expense increased $2 million, or 12%, to $19
million in 2003. The increase reflects higher depreciation of distribution
system assets on equipment additions to support growth, as well as amortization
of a regulatory asset related to distribution safety compliance costs.
Taxes other than income increased $10 million, or 43%, to $33 million in
2003. The increase was primarily driven by higher gross receipts taxes,
reflecting higher revenues on which these taxes are based.
Other income decreased to none in 2003 from $4 million in 2002. Other
income in 2002 included gains on the sale of property.
Interest expense and other charges decreased $5 million, or 31%, to $11
million in 2003. The decrease reflects a $4 million decrease due to lower
average debt levels, primarily due to the conversions of advances from
affiliates to paid-in capital, and $1 million due to lower average interest
rates.
The effective income tax rate was 37.5% in 2003 and 36.1% in 2002, with no
significant unusual items impacting the effective rates.
Net loss improved by $8 million, to a loss of $15 million in 2003,
reflecting lower interest expense, higher base distribution rates and operation
and maintenance cost controls. Net pension and postretirement benefit costs
reduced net income by $3 million in both 2003 and 2002.
Six Months Ended June 30, 2003 Compared to the Six Months Ended June 30, 2002
- -----------------------------------------------------------------------------
TXU Gas' operating revenues increased by $316 million, or 63%, to $820
million in 2003. The growth reflected $282 million due to the effects of higher
gas costs passed on to customers, $13 million from increased volumes and an
estimated $8 million from higher base distribution rates. The balance of the
revenue growth reflected normal recurring changes in estimates for unbilled
revenues and gas costs. The average cost of gas rose 91% while sales volumes
increased 2%.
Gross margin (operating revenues less gas purchased for resale) rose $50
million, or 20%, to $301 million in 2003. The increase reflected the higher
revenues, as certain costs directly related to the revenues are reported below
gross margin, increased base distribution rates and the benefits of the higher
volumes.
Operation and maintenance expense increased $5 million, or 4%, to $137
million in 2003. The increase primarily reflects increased costs to support
growth of the utility asset management services business and increased bad debt
expense associated with higher revenues, partially offset by small declines in
several other expense categories.
14
Depreciation and amortization expense increased $5 million, or 16%, to $37
million in 2003. The increase reflects higher depreciation of distribution
system assets on equipment additions to support growth, as well as amortization
of a regulatory asset related to distribution safety compliance costs.
Taxes other than income increased $13 million, or 31%, to $55 million in
2003. The increase was primarily driven by higher gross receipts taxes,
reflecting higher revenues on which these taxes are based.
Interest expense and other charges decreased $12 million, or 35%, to $22
million in 2003. The decrease reflects an $8 million decrease due to lower
average debt levels, which was primarily due to the conversions of advances from
affiliates to paid-in capital, and a $4 million decrease due to lower average
interest rates, which was primarily due to a higher proportion of lower interest
rate advances from TXU Corp. and affiliates.
The effective income tax rate was 32.7% in 2003 versus 27.3% in 2002.
Equity income of unconsolidated entities, which is not tax effected, represented
a greater portion of income before income taxes in 2002. Such equity income
totaled less than $1 million in 2002.
Net income increased by $27 million to $35 million in 2003, reflecting
lower interest expense and higher base distribution rates. Net pension and
postretirement benefit costs reduced net income by $6 million in 2003 and $5
million in 2002.
FINANCIAL CONDITION
Liquidity and Capital Resources
Cash provided by operating activities for the six months ended June 30,
2003 was $106 million compared with $158 million for the same period last year.
The decrease in cash flows provided by operating activities of $52 million
reflected unfavorable working capital (accounts receivable, inventory and
accounts payable) changes of $59 million, primarily driven by increased accounts
receivable balances related to higher gas costs. Partially offsetting this
decline was higher cash earnings (net income adjusted for the significant
noncash items identified in the statement of cash flows) of $4 million,
reflecting higher net income largely offset by the effect of greater gas cost
recovery in 2002 because of unusually cold weather and high gas prices in late
2001.
Cash used in financing activities was $69 million in 2003 compared with
$108 million in 2002. A total of $60 million was advanced from TXU Corp. in 2003
compared to $106 million repaid to TXU Corp. in 2002. Retirements of long-term
debt of $125 million in 2003 were funded by the funds advanced and cash on hand.
Cash used in investing activities was $39 million in 2003 compared with
$47 million in 2002. Capital expenditures of $48 million and $46 million in 2003
and 2002, respectively, were essentially unchanged. Cash provided by other
investing activity of $9 million in 2003, as compared to cash used of $1 million
in 2002, was primarily driven by small pipeline property and equipment sales.
Financing Arrangements
TXU Gas expects to meet its short-term liquidity needs through advances
from TXU Corp. and affiliates. At June 30, 2003 and December 31, 2002, advances
from TXU Corp. totaled $169 million and $110 million, respectively, and the
weighted average interest rates on these short-term borrowings were 3.07% and
2.63%, respectively.
Sale of Receivables -- Certain subsidiaries of TXU Corp. sell trade
accounts receivable to TXU Receivables Company, a wholly-owned bankruptcy remote
subsidiary of TXU Gas, which sells undivided interests in accounts receivable it
purchases to financial institutions. As of June 30, 2003, TXU Energy (through
certain subsidiaries), 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. The June 30, 2003 financial statements
reflect the sale of $99 million face amount of TXU Gas' receivables to TXU
15
Receivables Company under the program in exchange for cash of $46 million and
$52 million in subordinated notes, with $1 million of losses on sales for the
six months ended June 30, 2003 that principally represents the interest costs on
the underlying financing. These losses approximated 6% of the cash proceeds from
the sale of undivided interests in accounts receivable on an annualized basis.
Funding under the program increased $23 million for the six month period ended
June 30, 2003 primarily due to reserve requirements that were reduced through a
temporary amendment in recognition of improving collection trends. Funding
increases or decreases under the program are reflected as cash provided by or
used in operating activities.
Upon termination, cash flows to the originators would be delayed as
collections of sold receivables would be 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, a subsidiary of TXU
Corp., 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 Corp.'s subsidiaries' retained interests 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.
In August 2003, the program was amended to extend the term to July 2004,
as well as to extend the period providing temporarily higher delinquency and
default compliance ratios through December 31, 2003. The program was also
amended to coincide with the credit facilities' covenants by removing investment
grade credit ratings as a requirement of an eligible originator and substituting
maintenance of fixed charge coverage ratios and debt to capital ratios as
requirements of an eligible originator. In June 2003, the program was amended to
provide temporarily higher delinquency and default compliance ratios and
temporary relief from the loss reserve formula. The June amendment reflected the
billing and collection delays previously experienced as a result of new systems
and processes in TXU Energy and ERCOT for clearing customers' switching and
billing data upon the transition to competition.
Contingencies Related to 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 deregulation. Certain
billing and collection delays arose due to implementation of new systems and
processes within TXU Energy and ERCOT for clearing customers' switching and
billing data. The billing delays have been resolved but, while improving, the
lagging collection issues continue to impact the ratios. The implementation of
new POLR rules by the Commission and strengthened credit and collection policies
and practices are expected to bring the ratios into consistent compliance with
the program.
Under 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. Prior to the August 2003 amendment extending the
program, originator eligibility was predicated on the maintenance of an
investment grade credit rating.
16
Registered Financing Arrangements -- TXU Gas may issue and sell additional
debt and equity securities as needed, including issuances of up to an aggregate
of $400 million of debt securities and/or preferred securities of subsidiary
trusts, all of which are currently registered with the SEC for offering pursuant
to Rule 415 under the Securities Act of 1933.
Credit Ratings of TXU Corp. and TXU Gas-- The current credit ratings for
TXU Corp. and TXU Gas are presented below:
TXU Corp. TXU Gas
--------- -------
(Senior Unsecured) (Senior Unsecured)
S&P................. BBB- BBB
Moody's............. Ba1 Baa3
Fitch............... BBB- BBB-
Moody's currently maintains a negative outlook for TXU Corp. and TXU Gas.
Fitch currently maintains a stable outlook for each entity. S&P currently
maintains a negative outlook for each entity.
These ratings are investment grade, except for Moody's rating of TXU
Corp.'s senior unsecured debt, which is one notch below investment grade.
A rating reflects only the view of a rating agency, and 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.
Cross Default Provisions -- Certain financing arrangements of TXU Gas
contain provisions that would result in an event of default if there were 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.
The accounts receivable program also contains a cross default provision
with a threshold of $50 million applicable to each of the originators under the
program. TXU Receivables Company and TXU Business Services Company each have a
cross default threshold of $50,000. If either an originator, TXU Business
Services Company or TXU Receivables Company defaults on indebtedness of the
applicable threshold, the facility could terminate.
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 $300 million
TXU Gas senior notes due 2004 and 2005.
COMMITMENTS AND CONTINGENCIES
See Note 5 to Financial Statements for discussion of contingencies. There
were no material changes in cash commitments from those discussed in the 2002
Form 10-K.
REGULATION AND RATES
The city gate rate for the cost of gas TXU Gas Distribution ultimately
delivers to residential and commercial customers is established by the RRC and
provides for full recovery of the actual cost of gas delivered, including
out-of-period costs such as gas purchase contract settlement costs. The
distribution service rates TXU Gas Distribution charges its residential and
commercial customers are generally established by the municipal governments of
the cities and towns served, with the RRC having appellate, or in some
instances, primary jurisdiction.
17
TXU Gas employs a continuing program of rate review for all classes of
customers in its regulatory jurisdictions. In July 2001 and August 2001, TXU Gas
filed two cases, a gas cost review and a gas cost reconciliation, covering the
period between November 1997 and June 2001, seeking to recover $29 million of
under-recovered gas costs. On August 6, 2002, a settlement was approved by the
RRC authorizing TXU Gas to recover $18 million of this amount, which has been
recovered through a surcharge, while $11 million in under-recovered gas costs
remains pending.
On May 23, 2003, TXU Gas filed a system-wide rate case for TXU Gas
Distribution and TXU Pipeline operations. The case was filed in all 437 cities
served by TXU Gas Distribution and at the RRC for TXU Pipeline and
unincorporated cities. The RRC assigned the case Gas Utilities Docket 9400. TXU
Gas is seeking an annual revenue increase of $69.5 million or 7.24% overall
increase. TXU Gas has asked the 437 incorporated cites with original
jurisdiction over TXU Gas Distribution rates to either deny or cede jurisdiction
to the RRC. Eleven parties have intervened in the case. TXU Gas expects a final
order from the RRC late in the first quarter or early in the second quarter of
2004.
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 2002 Form
10-K and this Form 10-Q, which might significantly alter its basic financial
position, results of operations or cash flows.
CHANGES IN ACCOUNTING STANDARDS
See Note 1 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
this MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS, that could have a material impact on TXU Gas' operations, financial
results and financial condition, and could cause TXU Gas' actual results or
outcomes to differ materially from any projected outcomes contained in any
forward-looking statements in this report, 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.
TXU Gas is subject to changes in laws (including the Texas Gas Utility
Regulatory Act, as amended) or regulations, changing governmental policies and
regulatory actions, including those of the RRC, 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.
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' 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 advances from affiliates as a significant source of
liquidity for capital requirements not satisfied by operating cash flows and
access to financial markets to a lesser extent. 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.
18
TXU Gas uses derivative financial instruments, such as interest rate
swaps, and may use other instruments, such as options, futures and forwards, to
manage 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 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, or the impact of unusual or adverse weather
conditions or other natural events, as well as the risk of performance below
expected levels of throughput 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 supply and delivery activities, declines in customer demand and
instability in the financial markets.
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 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.
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 IRS 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.
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 the risks discussed above under RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
and 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 2002 Form 10-K, that could cause the actual results of TXU Gas
to differ materially from those projected in such forward-looking statements.
19
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 actual
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 the 2002 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 as of the end of
the current period included in 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. During the most recent fiscal quarter covered by this
quarterly report, there has been no change in TXU Gas' internal control over
financial reporting that has materially affected, or is reasonably likely to
materially affect, TXU Gas' internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Legal Proceedings -- In September 1999, Quinque Operating Company 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, a subsidiary of TXU Energy, as a defendant in this
litigation. Quinque Operating Company has dismissed its claims and a new lead
plaintiff filed an amended petition in which the plaintiffs sought 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. The petition alleged that the defendants
mismeasured both the volume and heat content of natural gas delivered into their
pipelines resulting in underpayments to plaintiffs. On April 10, 2003, the
District Court entered an order denying the plaintiffs' motion seeking
certification of a class. On May 12, 2003, plaintiffs filed a motion to amend
their petition to narrow the defendants sued and the claims asserted. The
amended petition omits TXU Gas and TXU Fuel as defendants.
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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
31(a) Section 302 Certification of Chief Executive Officer
31(b) Section 302 Certification of Principal Financial Officer
32(a)* Section 906 Certification of Chief Executive Officer
32(b)* Section 906 Certification of Principal Financial Officer
99(a) Condensed Statements of Consolidated Income - Twelve Months
Ended June 30, 2003
* Pursuant to Item 601(b)(32)(ii) of Regulation S-K, this
Certificate is not being "filed" for purposes of Section 18 of
the Securities Act of 1934
(b) Reports on Form 8-K filed since March 31, 2003:
Date of Report Item Reported
-------------- -------------
July 31, 2003 Item 5. Other Events and
Regulation FD Disclosure
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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/ David H. Anderson
-------------------------------
David H. Anderson
Vice President and
Principal Accounting Officer
August 13, 2003
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