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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 SEPTEMBER 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 November 7, 2003: 449,631 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 Nine Months Ended September 30, 2003 and 2002............................ 1
Condensed Statements of Consolidated Cash Flows --
Nine Months Ended September 30, 2003 and 2002...................................... 2
Condensed Consolidated Balance Sheets --
September 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.................................................................. 21
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
FASB .................................Financial Accounting Standards Board,
the designated organization in the private
sector for establishing standards for
financial accounting and reporting
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 of electricity to
certain customers under the Commission
rules interpreting the 1999 Restructuring
Legislation that restructured the
electric utility industry in Texas to
provide for competition
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 140..............................SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and
Extinguishments of Liabilities -
a Replacement of FASB Statement No. 125"
SFAS 142..............................SFAS No. 142, "Goodwill and Other
Intangible Assets"
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"
ii
SFAS 146..............................SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal
Activities"
SFAS 150..............................SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics
of both Liabilities and Equity"
TXU Energy............................TXU Energy Company LLC, a subsidiary of
US Holdings
TXU Fuel..............................TXU Fuel Company, a subsidiary of
TXU Energy
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, a subsidiary of
TXU Corp.
iii
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,
------------------ ------------------
2003 2002 2003 2002
---- ---- ---- ----
(millions of dollars)
Operating revenues.............................................. $ 173 $ 137 $ 993 $ 641
------- -------- ------- --------
Operating expenses:
Gas purchased for resale................................... 65 45 584 298
Operation and maintenance.................................. 74 66 213 198
Depreciation and amortization.............................. 18 17 55 49
Taxes other than income.................................... 19 17 74 59
------- -------- ------- --------
Total operating expenses................................ 176 145 926 604
------- -------- ------- --------
Operating income (loss)......................................... (3) (8) 67 37
Other income.................................................... -- 3 3 4
Other deductions................................................ -- 3 -- 4
Interest income................................................. -- -- 1 --
Interest expense and related charges............................ 10 16 32 50
------- -------- ------- --------
Income (loss) before income taxes............................... (13) (24) 39 (13)
Income tax expense (benefit).................................... (5) (8) 12 (5)
------- -------- ------- --------
Net income (loss)............................................... (8) (16) 27 (8)
Preferred stock dividends....................................... 1 1 3 3
------- -------- ------- --------
Net income (loss) applicable to common stock.................... $ (9) $ (17) $ 24 $ (11)
======= ======== ======= ========
CONDENSED STATEMENTS OF CONSOLIDATED
COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2003 2002 2003 2002
---- ---- ---- ----
(millions of dollars)
Net income (loss)............................................... $ (8) $ (16) $ 27 $ (8)
Other comprehensive income, net of tax effect:
Cash flow hedge activity--
Net change in fair value of derivatives.................. -- (1) -- (1)
Amounts realized in earnings (net of tax expense
of $--and $1).......................................... 1 1 3 1
------- -------- ------- --------
Total................................................. 1 -- 3 --
------- -------- ------- --------
Comprehensive income (loss)..................................... $ (7) $ (16) $ 30 $ (8)
======= ======== ======= ========
See Notes to Financial Statements.
1
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
--------------------
2003 2002
---- ----
(millions of dollars)
Cash flows - operating activities:
Net income....................................................... $ 27 $ (8)
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation and amortization................................. 59 54
Deferred income taxes - net................................... 10 20
Equity in earnings of affiliates and joint ventures........... -- (1)
Adjustments related to gas cost recovery...................... 47 67
Other......................................................... -- (2)
Changes in operating assets and liabilities...................... (59) (9)
------ -------
Cash provided by operating activities of continuing
operations............................................... 84 121
------ -------
Cash flows -- financing activities:
Retirements of long-term debt.................................... (125) --
Change in advances from affiliates............................... 107 15
Cash dividends paid.............................................. (3) (3)
------ -------
Cash provided by (used in) financing activities of
continuing operations.................................... (21) 12
------ -------
Cash flows -- investing activities:
Capital expenditures............................................. (73) (75)
Other............................................................ 8 10
------ -------
Cash used in investing activities of continuing operations. (65) (65)
------ -------
Cash provided by (used in) continuing operations................... (2) 68
------ -------
Cash used in discontinued operations -
Engineering and construction businesses sold..................... -- (6)
------ -------
Cash used in discontinued operations....................... -- (6)
------ -------
Net change in cash and cash equivalents............................ (2) 62
Cash and cash equivalents-- beginning balance...................... 4 3
------ -------
Cash and cash equivalents-- ending balance......................... $ 2 $ 65
====== =======
See Notes to Financial Statements.
2
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2003 2002
------------- ------------
(millions of dollars)
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 2 $ 4
Accounts receivable...................................................... 48 118
Inventories.............................................................. 149 125
Other current assets..................................................... 29 28
------- -------
Total current assets................................................. 228 275
Investments:
Restricted cash.......................................................... 10 8
Other investments........................................................ 21 29
Property, plant and equipment - net......................................... 1,535 1,520
Goodwill.................................................................... 305 305
Regulatory assets........................................................... 99 142
Other noncurrent assets..................................................... 16 10
------- -------
Total assets......................................................... $ 2,214 $ 2,289
======= =======
LIABILITIES, PREFERRED SECURITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Advances from affiliates................................................. $ 217 $ 110
Long-term debt due currently............................................. 150 125
Accounts payable......................................................... 47 125
Other current liabilities................................................ 74 87
------- -------
Total current liabilities............................................ 488 447
Accumulated deferred income taxes and investment tax credits................ 208 193
Other noncurrent liabilities and deferred credits........................... 243 248
Long-term debt, less amounts due currently.................................. 276 426
------- -------
Total liabilities ................................................... 1,215 1,314
Mandatorily redeemable preferred securities of subsidiary trust (Note 3).... 147 147
Contingencies (Note 5)
Shareholder's equity (Note 4):
Preferred stock not subject to mandatory redemption ..................... 75 75
Common stock (par value - $.01 per share):
Authorized shares - 100,000,000, Outstanding shares - 449,631
and 451,000.......................................................... -- --
Paid in capital.......................................................... 814 820
Deficit.................................................................. (20) (47)
Accumulated other comprehensive loss..................................... (17) (20)
------- -------
Total common stock equity.............................................. 777 753
------- -------
Total shareholder's equity........................................... 852 828
------- -------
Total liabilities, preferred securities and shareholder's equity... $ 2,214 $ 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 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., a Texas corporation.
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; consequently,
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, except for the effect of adopting SFAS 145, described below.
In the opinion of management, all other adjustments (consisting of normal
recurring accruals) necessary for a fair presentation of the results of
operations and financial position have been included therein. All intercompany
items and transactions have been eliminated in consolidation. Certain
information and footnote disclosures normally included in annual consolidated
financial statements prepared in accordance with US GAAP have been omitted
pursuant to the rules and regulations of the SEC. Because the 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. Certain previously reported amounts have been
reclassified to conform to current classifications.
All dollar amounts in the financial statements and tables in the notes are
stated in millions of US dollars unless otherwise indicated.
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 nine months
ended September 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".
As a result of the implementation of SFAS 145 as of January 1, 2003, the
previously reported 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.
4
SFAS 146 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 impact results of operations for the nine months
ended September 30, 2003.
FIN 46, which was issued in January 2003, provides guidance related to
identifying variable interest entities and determining whether such entities
should be consolidated. On October 8, 2003, the FASB decided to defer
implementation of FIN 46 until the fourth quarter of 2003. This deferral only
applies to variable interest entities that existed prior to February 1, 2003.
The adoption of FIN 46 did not and is not expected to impact results 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 mandatorily redeemable preferred securities be classified as
liabilities beginning July 1, 2003. A FASB Staff Position (FSP 150-3) issued
November 7, 2003 defers the applicability of SFAS 150 to the mandatorily
redeemable preferred securities of subsidiary trusts. As a result, SFAS 150 had
no impact on the results of operations or financial condition of TXU Gas.
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 requires 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. The adoption of
this change did not impact results of operations for the nine months ended
September 30, 2003.
2. FINANCING ARRANGEMENTS
TXU Gas expects to meet its short-term liquidity needs through advances
from TXU Corp. and affiliates. At September 30, 2003 and December 31, 2002,
advances from TXU Corp. totaled $217 million and $110 million, respectively, and
the weighted average interest rates on these short-term borrowings were 2.87%
and 2.63%, respectively.
Long-Term Debt -- At September 30, 2003 and December 31, 2002, the
long-term debt of TXU Gas and its consolidated subsidiaries consisted of the
following:
September 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 (a)...................... 125 125
Unamortized fair value adjustments............................................... 1 1
------- -------
Total TXU Gas ............................................................... 426 551
Less amount due currently........................................................ 150 125
------- -------
Total long-term debt............................................................. $ 276 $ 426
======= =======
(a) These bonds are in the multiannual mode and are subject to mandatory
tender prior to maturity on the mandatory remarketing date. On such date,
the interest rate and interest rate period will be reset for the bonds.
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.
Sale of Receivables -- TXU Corp. has established an accounts receivable
securitization program. The activity under this program is accounted for as a
sale of accounts receivable in accordance with SFAS 140. Under the program, TXU
Gas and other US subsidiaries of TXU Corp. (originators) sell trade accounts
receivable to TXU Receivables Company, a consolidated wholly-owned bankruptcy
remote direct subsidiary of TXU Corp., which sells undivided interests in the
purchased accounts receivable for cash to special purpose entities established
by financial institutions. In September 2003, the maximum amount of undivided
interests that could be sold by TXU Receivables Company was increased by
$100 million to $700 million. In November 2003, this amount decreased to
$600 million.
5
All new trade receivables under the program generated by the originators
are continuously purchased by TXU Receivables Company with the proceeds from
collections of receivables previously purchased. Changes in the amount of
funding under the program, through changes in the amount of undivided interests
sold by TXU Receivables Company, are generally due to seasonal variations in the
level of accounts receivable and changes in collection trends. TXU Receivables
Company has issued subordinated notes payable to the originators for the
difference between the face amount of the uncollected accounts receivable
purchased, less a discount, and cash paid that was funded by the sale of the
undivided interests.
The discount from face amount on the purchase of receivables funds a
servicing fee paid by TXU Receivables Company to TXU Business Services Company,
a direct subsidiary of TXU Corp., as well as program fees paid by TXU
Receivables Company to the financial institutions. The servicing fee compensates
TXU Business Services Company for its services as collection agent, including
maintaining the detailed accounts receivable collection records. TXU Business
Services Company charges the affiliated businesses for its servicing
costs, net of the servicing fee income. The program fees paid to financial
institutions, which consist primarily of interest costs on the underlying
financing, were $1 million for each of the nine-month periods ending September
30, 2003 and 2002 and approximated 2.4% of the average funding under the
program on an annualized basis in each period; these fee amounts represent
the net incremental costs of the program to TXU Gas and are reported in
operation and maintenance expense.
The September 30, 2003 balance sheet reflects funding under the program of
$33 million, through sale of undivided interests in receivables by TXU
Receivables Company, related to $69 million face amount of TXU Gas trade
accounts receivable. Funding under the program increased $9 million for the nine
month period ended September 30, 2003, primarily due to the program capacity
increase of $100 million and the effect of improved collection trends. Funding
under the program for the nine month period ended September 30, 2002 decreased
$41 million. Funding increases or decreases under the program are reflected as
cash provided by or used in operating activities in the statement of cash flows.
Upon termination of the program, cash flows to TXU Gas would be delayed as
collections of sold receivables would be used by TXU Receivables Company to
repurchase the undivided interests sold instead of purchasing new receivables.
The level of cash flows would normalize in approximately 16 to 31 days. The
trade accounts receivable balances on TXU Gas' balance sheets represent the face
amount of the receivables less the funding under the program and allowances for
uncollectible accounts.
In June 2003, the program was amended to provide temporarily higher
delinquency and default compliance ratios and temporary relief from the loss
reserve formula, which allowed for increased funding under the program. 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. 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.
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.
6
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 have brought the ratios into consistent compliance with the
program.
Under terms of the receivables sale program, all the originators are
required to maintain specified fixed charge coverage and leverage ratios
(or supply a parent guarantor that meets the ratio requirements). The failure
by an originator or its parent guarantor, if any, to maintain the specified
financial ratios would prevent that originator from selling its accounts
receivable under the program. If all the originators and the parent guarantor,
if any, fail to maintain the specified financial ratios so that there are no
eligible originators, the facility would terminate. 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 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.
3. MANDATORILY REDEEMABLE, PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING
SOLELY JUNIOR SUBORDINATED DEBENTURES OF TXU GAS
A statutory business trust, TXU Gas Capital I (the Trust), which is a
wholly owned financing subsidiary of TXU Gas, was established for the purpose of
issuing mandatorily redeemable preferred securities of the Trust (Trust
Securities) and holding Junior Subordinated Series A Debentures issued by TXU
Gas (Series A Debentures). The only assets of the Trust are the Series A
Debentures.
At September 30, 2003 and December 31, 2002, the Trust had $147 million of
floating rate Trust Securities outstanding and $155 million principal amount of
Series A Debentures held as assets. Distributions on the 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 interest income on the
Series A Debentures matches the distributions on the Trust Securities and a
return on TXU Gas' common equity investment in the Trust. 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 effective July 1, 2003. TXU Gas has effectively issued a full and
unconditional guarantee of the Trust Securities. Effective July 1, 2003, TXU Gas
elected not to renew two interest rate swaps related to these Trust Securities
and will pay variable interest rates on the Trust Securities based on the
three-month LIBOR rate plus a margin of 135 basis points.
7
4. SHAREHOLDER'S EQUITY
Effective September 30, 2003, TXU Gas exchanged its shares of TXU
Receivables Company, a wholly-owned bankruptcy remote subsidiary, for 1,369
shares of TXU Gas common stock held by TXU Corp. The value of the exchange was
$2.4 million, representing the aggregate fair market value of the outstanding
shares of TXU Receivables Company.
Dividends on preferred stock are being declared out of paid in capital, in
accordance with state law.
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 $95 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 acquired predecessor of TXU Gas) for the 1993 calendar year. The
adjustments proposed would increase TXU Gas' 1993 taxable income by
approximately $257 million. Taking into account offsetting net operating loss
carryovers, the income adjustments result in additional tax payable for 1993 of
$46 million, which includes penalties ($9 million) and interest through
September 30, 2003 ($24 million). TXU Gas has protested the IRS proposed
adjustments to its 1993 tax returns and is awaiting a hearing with the Appeals
Office of the IRS. Although TXU Gas is vigorously contesting the IRS proposed
adjustments, it is possible that the matter will be resolved against TXU Gas
during 2004 and that the 1993 tax deficiency ($46 million plus additional
interest through the date of payment) will be payable at that time.
The utilization of net operating loss carryovers to offset the 1993
income adjustments is expected to result in additional taxes payable related to
other years of approximately $77 million (excluding penalties and interest). If
this matter is resolved against TXU Gas, those liabilities are not expected to
be paid until 2005 or later.
Any tax, penalty, and interest accruing for periods prior to August 5,
1997 (the date on which ENSERCH Corporation was acquired by TXU Corp.) will be
charged first to tax reserves acquired as part of the ENSERCH acquisition
(approximately $45 million), and then to goodwill. Interest for periods after
August 5, 1997 will be charged to income from continuing operations. The
post-acquisition period interest on the 1993 tax deficiency is $11 million
(after-tax) through September 30, 2003. The post-acquisition period interest on
tax deficiencies for other years is estimated to be $3 million (after-tax)
through September 30, 2003.
Other - TXU Gas employs a continuing program of rate review for all
classes of customers in its regulatory jurisdictions. In July and August of
2001, TXU Gas filed two cases with the RRC, 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
partial 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.
In August 2003, TXU Gas filed its annual gas cost reconciliation for the
twelve month period ending June 30, 2003 with the RRC and the incorporated
cities served by TXU Gas. TXU Gas reconciled $797 million of gas costs.
Including interest and prior period adjustments, TXU Gas under-recovered $6
million of gas costs which will be recovered via a surcharge for nine months
starting October 2003.
8
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
Unregulated Operations -- TXU Gas' operations are substantially regulated.
Unregulated operations are primarily those of Oncor Utility Solutions. The
results of operations of TXU Gas for the nine months ended September 30, 2003
include $14 million in operating revenue and $17 million in operation and
maintenance expense related to Oncor Utility Solutions' operations.
Other Income and Other Deductions -- There were no individually
significant items reflected in other income and other deductions.
Interest Expense and Related Charges --
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------- ----------------------
2003 2002 2003 2002
---- ---- ---- ----
Interest .................................... $ 9 $ 15 $ 26 $ 45
Distributions on mandatorily redeemable
preferred securities of subsidiary trust
(see Note 3).............................. 1 2 6 7
Amortization of debt issuance expense and
premiums.................................. -- (1) -- (2)
---- ----- ----- -----
Total interest expense and related charges $ 10 $ 16 $ 32 $ 50
==== ===== ===== =====
Accounts Receivable -- At September 30, 2003 and December 31, 2002,
accounts receivable of $48 million and $118 million are stated net of allowance
for uncollectible accounts of $4 million and $3 million, respectively. During
the nine months ended September 30, 2003, bad debt expense was $8 million and
account write-offs and other activity was $7 million.
Accounts receivable included $14 million and $27 million of unbilled
revenues at September 30, 2003 and December 31, 2002, respectively.
Intangible Assets -- SFAS 142 became effective for TXU Gas on January 1,
2002. SFAS 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. SFAS 142 also requires additional
disclosures regarding intangible assets (other than goodwill) that are amortized
or not amortized:
As of September 30, 2003 As of December 31, 2002
-------------------------------- ---------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
------ ------------ --- ------ ------------ ---
Intangible assets subject to amortization:
Capitalized software.............. $ 30 $ 14 $ 16 $ 29 $ 11 $ 18
Land easements.................... 16 9 7 15 8 7
----- ----- ----- ----- ----- -----
Total.......................... $ 46 $ 23 $ 23 $ 44 $ 19 $ 25
===== ===== ===== ===== ===== =====
Intangible asset balances subject to amortization are classified as
property, plant and equipment in the balance sheet. TXU Gas has no intangible
assets (other than goodwill) that are not subject to amortization. At September
30, 2003, the average useful lives of capitalized software and land easements
noted above were 8 years and 64 years, respectively
9
Aggregate amortization expense for intangible assets was $4 million and $2
million for the nine month periods ended September 30, 2003 and 2002,
respectively.
At September 30, 2003 and December 31, 2002, goodwill of $305 million was
stated net of previously recorded accumulated amortization of $37 million.
Inventories by Major Category--
September 30, December 31,
2003 2002
-------------- -------------
Materials and supplies, at cost............................. $ 7 $ 7
Gas stored underground, primarily at weighted average cost.. 142 118
------- -------
Total inventories........................................ $ 149 $ 125
======= =======
The carrying value of gas stored underground at September 30, 2003
reflects a $4 million inventory adjustment to increase the volumes recorded in
natural gas storage fields as a result of a scheduled physical inventory.
Property, Plant and Equipment -- As of September 30, 2003 and December 31,
2002, property, plant and equipment of $1.5 billion in both periods is stated
net of accumulated depreciation and amortization of $386 million and $333
million, respectively.
Regulatory Assets --
September 30, December 31,
2003 2002
------------ -----------
Under-collected gas costs.......................... $ 3 $ 49
Distribution safety compliance costs............... 41 43
Rate case costs.................................... 10 12
Other regulatory assets............................ 45 38
------- -------
Regulatory assets............................... $ 99 $ 142
======= =======
Included above are assets of $62 million at September 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 - On July 1, 2003, TXU Gas' existing interest rate
swaps on its Trust Securities expired. The terms of these interest rate swap
agreements, which had been designated as cash flow hedges, matched the terms of
the underlying hedged indebtedness. As a result, TXU Gas experienced no hedge
ineffectiveness.
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 September 30, 2003 and 2002 were $205 million and $172 million,
respectively, and for the nine months ended September 30, 2003 and 2002
were $175 million and $143 million, respectively. Interest expense
incurred on the advances for the three months ended September 30, 2003
and 2002 was $2 million, and for the nine months ended September 30,
2003 and 2002 was $4 million. The average interest rate for the three
months ended September 30, 2003 and 2002 was 2.86% and 3.08%,
respectively. The average interest rate for the nine months ended
September 30, 2003 and 2002 was 2.84% and 3.10%, respectively.
10
o US Holdings charges TXU Gas for customer and administrative services at
cost. For the three months ended September 30, 2003 and 2002 these
charges totaled $14 million and $16 million, respectively. For the nine
months ended September 30, 2003 and 2002 these charges totaled $43
million and $45 million, respectively. These charges are reported in
operation and maintenance expenses.
o Included in reported revenues were $6 million and $8 million from the
sale and transportation of gas to other TXU Corp. subsidiaries for the
three months ended September 30, 2003 and 2002, respectively. For the
nine months ended September 30, 2003 and 2002, these revenues totaled
$14 million and $18 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 September 30, 2003 and 2002, these costs totaled $8
million and $12 million, respectively. For the nine months ended
September 30, 2003 and 2002, these costs totaled $25 million and $38
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 September 30, 2003, and the related
condensed statements of consolidated income and of comprehensive income for the
three-month and nine-month periods ended September 30, 2003 and 2002, and the
condensed statements of consolidated cash flows for the nine-month periods ended
September 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
November 11, 2003
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BUSINESS
Description of Business -- TXU Gas 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., a Texas corporation.
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; consequently,
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 Nine Months Ended
September 30, September 30,
------------------- --------------------
2003 2002 2003 2002
---- ---- ---- ----
Operating statistics
Gas distribution sales volumes (billion cubic feet -- Bcf):
Residential............................................... 6 6 59 57
Commercial, industrial and electric generation............ 8 8 43 43
------ ------ ------ -----
Total gas distribution................................. 14 14 102 100
====== ====== ====== =====
Pipeline transportation volumes (Bcf, non-affiliated)......... 97 129 275 347
====== ====== ====== =====
Operating revenues (millions of dollars)
Gas distribution:
Residential............................................... $ 75 $ 64 $ 570 $ 363
Commercial, industrial and electric generation............ 64 44 333 198
------ ------ ------ -----
Total gas distribution................................. 139 108 903 561
Pipeline transportation (non-affiliated)...................... 15 20 43 48
Other revenues, net of intercompany eliminations.............. 19 9 47 32
------ ------ ------ -----
Total operating revenues............................... $ 173 $ 137 $ 993 $ 641
====== ====== ====== =====
Heating degree days (% of normal)................................ - % - % 102.6% 98.8%
13
Three Months Ended September 30, 2003 Compared to the Three Months Ended
September 30, 2002
- ------------------------------------------------------------------------
Operating revenues increased $36 million, or 26%, to $173 million in 2003.
The revenue growth reflected $27 million due to the effects of higher gas costs
passed on to customers and $2 million in higher base distribution rates. The
average cost of gas rose 43% while sales volumes were flat. Revenues in the
utility asset management services business rose $8 million on new contract
activity.
Gross margin (operating revenues less gas purchased for resale) rose $16
million, or 17%, to $108 million in 2003. The increase reflected the higher
revenues, as certain costs directly related to the revenues, principally costs
related to utility asset management contracts and gross receipts taxes, are
reported below gross margin, the higher base distribution rates and a $4
million favorable inventory adjustment resulting from a scheduled physical
inventory of a natural gas storage field.
Gross margin is considered a key operating metric as it measures the
effect of changes in sales volumes and pricing versus the cost of gas purchased
for resale.
Operation and maintenance expense increased $8 million, or 12%, to $74
million in 2003, primarily due to increased activity in the utility asset
management services business.
Depreciation and amortization expense increased $1 million, or 6%, to $18
million in 2003. The increase reflects higher depreciation of distribution
system assets due to equipment additions to support growth, as well as
amortization of a regulatory asset related to distribution safety compliance
costs.
Taxes other than income increased $2 million, or 12%, to $19 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 $3 million to none in 2003. Other income in 2002
included a $1 million adjustment related to a sold business and a $1 million
settlement of workers' compensation claims.
Other deductions declined $3 million to none in 2003. The 2002 period
primarily reflected a charge related to a sold business.
Interest expense and related charges decreased $6 million, or 38%, to $10
million in 2003. The decrease reflects $3 million due to lower average debt
levels, primarily due to conversions of advances from affiliates to paid-in
capital, and $1 million due to lower average interest rates. As a result of the
expiration on July 1, 2003 of fixed interest rate swaps, interest on the
preferred trust securities is accrued at current market rates (see Note 3),
which resulted in a reduction of interest expense of $2 million.
The effective income tax rate was 38.5% in 2003 and 33.3% in 2002. The
increase primarily reflects the changes in results of unconsolidated entities,
which are recorded net of tax in other income or other deductions.
Net loss improved by $8 million, to a loss of $8 million in 2003,
reflecting improved gross margin and lower interest expense. Net pension and
postretirement benefit costs reduced net income by $3 million in 2003 and $2
million in 2002.
Nine Months Ended September 30, 2003 Compared to the Nine Months Ended
September 30, 2002
- ----------------------------------------------------------------------
TXU Gas' operating revenues increased by $352 million, or 55%, to $993
million in 2003. The growth reflected $308 million due to the effects of higher
gas costs passed on to customers, $13 million from increased volumes and an
estimated $11 million from higher base distribution rates. Revenues in the
utility asset management services business were $11 million higher. The balance
of the revenue growth reflected normal recurring changes in estimates for
unbilled revenues and gas costs. The average cost of gas rose 83% while sales
volumes increased 2% due to colder weather.
14
Gross margin (operating revenues less gas purchased for resale) rose $66
million, or 19%, to $409 million in 2003. The increase reflected the higher
revenues, as certain costs directly related to the revenues, principally costs
related to utility asset management contracts and gross receipts taxes, are
reported below gross margin, increased base distribution rates and the benefits
of the higher volumes.
Operation and maintenance expense increased $15 million, or 8%, to $213
million in 2003. The increase reflected $12 million related to increased
activity in the utility asset management services business, $2 million in
increased pension and employee benefits and $3 million in increased bad debt
expense associated with higher revenues, partially offset by the effect of cost
reduction initiatives.
Depreciation and amortization expense increased $6 million, or 12%, to $55
million in 2003. The increase reflects higher depreciation of distribution
system assets based 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 $15 million, or 25%, to $74 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 related charges decreased $18 million, or 36%, to $32
million in 2003. The decrease reflects $11 million due to lower average debt
levels, which was primarily due to the conversions of advances from affiliates
to paid-in capital, and a $6 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. As a result of the expiration on July 1,
2003 of fixed interest rate swaps (see Note 3), interest on the preferred trust
securities is accrued at current market rates, which resulted in a reduction of
interest expense of $2 million.
The effective income tax rate was 30.8% in 2003 versus 38.5% in 2002. The
decrease primarily reflects changes in results of unconsolidated entities, which
are recorded net of tax in other income or other deductions.
Net income was $27 million in 2003 compared to a net loss of $8 million in
2002. The improvement reflected higher gross margin and lower interest expense.
Net pension and postretirement benefit costs reduced net income by $7 million in
2003 and $6 million in 2002.
FINANCIAL CONDITION
Liquidity and Capital Resources
Cash provided by operating activities for the nine months ended September
30, 2003 was $84 million compared with $121 million for the same period last
year. The decrease in cash flows provided by operating activities of $37 million
reflected unfavorable working capital (accounts receivable, inventory and
accounts payable) changes of $50 million, primarily driven by the effect of
higher gas prices. Partially offsetting this decline was higher cash earnings
(net income adjusted for the significant noncash items identified in the
statement of cash flows) of $13 million.
Cash used in financing activities was $21 million in 2003 compared with
cash provided by financing activities of $12 million in 2002. The change
reflected $18 million net repayment of borrowings in 2003 compared to increased
borrowings of $15 million in 2002.
Cash used in investing activities was $65 million in both 2003 and 2002.
Activity in 2003 reflected capital expenditures of $73 million and cash provided
by other investing activity of $8 million, both essentially unchanged from 2002.
15
Financing Arrangements
TXU Gas expects to meet its short-term liquidity needs through advances
from TXU Corp. and affiliates. At September 30, 2003 and December 31, 2002,
advances from TXU Corp. totaled $217 million and $110 million, respectively, and
the weighted average interest rates on these short-term borrowings were 2.87%
and 2.63%, respectively.
Sale of Receivables -- TXU Corp. has established an accounts receivable
securitization program. The activity under this program is accounted for as a
sale of accounts receivable in accordance with SFAS 140. Under the program, TXU
Gas and other US subsidiaries of TXU Corp. (originators) sell trade accounts
receivable to TXU Receivables Company, a consolidated wholly-owned bankruptcy
remote direct subsidiary of TXU Corp., which sells undivided interests in the
purchased accounts receivable for cash to special purpose entities established
by financial institutions. In September 2003, the maximum amount of undivided
interests that could be sold by TXU Receivables Company was increased by $100
million to $700 million. In November 2003, this amount decreased to
$600 million.
All new trade receivables under the program generated by the originators
are continuously purchased by TXU Receivables Company with the proceeds from
collections of receivables previously purchased. Changes in the amount of
funding under the program, through changes in the amount of undivided interests
sold by TXU Receivables Company, are generally due to seasonal variations in the
level of accounts receivable and changes in collection trends. TXU Receivables
Company has issued subordinated notes payable to the originators for the
difference between the face amount of the uncollected accounts receivable
purchased, less a discount, and cash paid that was funded by the sale of the
undivided interests.
The discount from face amount on the purchase of receivables funds a
servicing fee paid by TXU Receivables Company to TXU Business Services Company,
a direct subsidiary of TXU Corp., as well as program fees paid by TXU
Receivables Company to the financial institutions. The servicing fee compensates
TXU Business Services Company for its services as collection agent, including
maintaining the detailed accounts receivable collection records. TXU
Business Services Company charges the affiliated businesses for its servicing
costs, net of the servicing fee income. The program fees paid to financial
institutions, which consist primarily of interest costs on the underlying
financing, were $1 million for each of the nine-month periods ending September
30, 2003 and 2002, respectively, and approximated 2.4% of the average funding
under the program on an annualized basis in each period; these fees represent
the net incremental costs of the program to TXU Gas and are reported in
operation and maintenance expense.
The September 30, 2003 balance sheet reflects funding under the program of
$33 million, through sale of undivided interests in receivables by TXU
Receivables Company, related to $69 million face amount of TXU Gas trade
accounts receivable. Funding under the program increased $9 million for the nine
month period ended September 30, 2003, primarily due to the program capacity
increase of $100 million and the effect of improved collection trends. Funding
under the program for the nine month period ended September 30, 2002 decreased
$41 million. Funding increases or decreases under the program are reflected as
cash provided by or used in operating activities in the statement of cash flows.
Upon termination of the program, cash flows to TXU Gas would be delayed as
collections of sold receivables would be used by TXU Receivables Company to
repurchase the undivided interests sold instead of purchasing new receivables.
The level of cash flows would normalize in approximately 16 to 31 days. The
trade accounts receivable balances on TXU Gas' balance sheets represent the face
amount of the receivables less the funding under the program and allowances for
uncollectible accounts.
In June 2003, the program was amended to provide temporarily higher
delinquency and default compliance ratios and temporary relief from the loss
reserve formula, which allowed for increased funding under the program. 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. 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.
16
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 have brought the ratios into consistent compliance with the
program.
Under terms of the receivables sale program, all the originators are
required to maintain specified fixed charge coverage and leverage ratios
(or supply a parent guarantor that meets the ratio requirements). The failure
by an originator or its parent guarantor, if any, to maintain the specified
financial ratios would prevent that originator from selling its accounts
receivable under the program. If all the originators and the parent guarantor,
if any, fail to maintain the specified financial ratios so that there are no
eligible originators, the facility would terminate. Prior to the August 2003
amendment extending the program, originator eligibility was predicated on the
maintenance of an investment grade credit rating.
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.
17
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,
including the discussion of income tax 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.
Gas Distribution Rates - TXU Gas employs a continuing program of rate
review for all classes of customers in its regulatory jurisdictions. In July and
August of 2001, TXU Gas filed two cases with the RRC, 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 partial 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 the TXU Gas
Distribution and TXU Lone Star Pipeline operations. The case was filed in all
437 cities served by TXU Gas Distribution and at the RRC for TXU Lone Star
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. TXU Gas has appealed the cases filed with the 437 incorporated
cities over TXU Gas Distribution rates to the RRC. Twelve parties have
intervened in the case. Based on the current procedural schedule, TXU Gas
expects a final order from the RRC in May 2004.
In August 2003, TXU Gas filed its annual gas cost reconciliation for the
twelve month period ending June 30, 2003 with the RRC and the incorporated
cities served by TXU Gas. TXU Gas reconciled $797 million of gas costs.
Including interest and prior period adjustments, TXU Gas under-recovered $6
million of gas costs which will be recovered via a surcharge for nine months
starting October 2003.
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.
18
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 outcome contained in any
forward-looking statement in this report, include:
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' 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 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.
TXU Gas has used and may use 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 where force majeure is not applicable, could possibly result in
termination of those agreements or incurring a liability for liquidated damages.
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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' ability to obtain insurance, and the cost of and coverage
provided by such insurance, could be affected by events outside its control.
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.
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.
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, except for the change in interest rate
swaps as described in Note 3 to Financial Statements, 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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to the 2002 Form 10-K and the Form 10-Q for the
quarterly period ended June 30, 2003 for discussions of legal proceedings.
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 Condensed Statements of Consolidated Income - Twelve Months
Ended September 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 furnished or filed since June 30, 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
November 12, 2003
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