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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, 2004
--OR--
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
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Commission File Number 1-3183
TXU Gas Company
(Exact Name of Registrant as Specified in its Charter)
Texas 75-0399066
(State of Incorporation) (I.R.S. Employer Identification No.)
1601 Bryan Street, Dallas TX, 75201-3411 (214) 812-4600
(Address of Principal Executive Offices) (Registrant's Telephone Number)
(Zip Code)
---------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Common Stock outstanding at August 10, 2004: 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 (Loss) and Comprehensive Income (Loss)--
Three and Six Months Ended June 30, 2004 and 2003.................................. 1
Condensed Statements of Consolidated Cash Flows --
Six Months Ended June 30, 2004 and 2003............................................ 2
Condensed Consolidated Balance Sheets --
June 30, 2004 and December 31, 2003................................................ 3
Notes to Condensed Financial Statements............................................ 4
Report of Independent Registered Public Accounting Firm............................ 13
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................................... 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................... 22
Item 4. Controls and Procedures............................................................ 22
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................... 22
SIGNATURE......................................................................................... 24
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.
1999 Restructuring Legislation................. Legislation that restructured the electric utility industry
in Texas to provide for competition
2003 Form 10-K................................. TXU Gas' Annual Report on Form 10-K for the year ended
December 31, 2003
Bcf............................................ billion cubic feet
Commission..................................... Public Utility Commission of Texas
Electric Delivery.............................. refers to TXU Electric Delivery Company (formerly Oncor
Electric Delivery Company), a subsidiary of US Holdings,
or Electric Delivery and its consolidated bankruptcy
remote financing subsidiary, TXU Electric Delivery
Transition Bond Company LLC (formerly Oncor Electric
Delivery Transition Bond Company LLC), depending on
context
Energy......................................... refers to TXU Energy Company LLC, a subsidiary of US
Holdings, and/or its consolidated subsidiaries, depending on
context
ERCOT.......................................... Electric Reliability Council of Texas, the Independent
System Operator and the regional reliability
coordinator of the various electricity systems within
Texas
FASB........................................... Financial Accounting Standards Board, the designated organization in
the private sector for establishing standards for financial accounting
and reporting
FIN............................................ Financial Accounting Standards Board Interpretation
FIN 46......................................... FIN No. 46, "Consolidation of Variable Interest Entities"
FIN 46R........................................ FIN No. 46 (Revised 2003), "Consolidation of Variable
Interest Entities - An Interpretation of ARB No. 51"
Fitch.......................................... Fitch Ratings, Ltd.
IRS............................................ Internal Revenue Service
Moody's........................................ Moody's Investors Services, Inc.
RRC............................................ 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 issued by the
FASB
SFAS 140....................................... SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, a
replacement of FASB Statement 125"
ii
TCEQ........................................... Texas Commission on Environmental Quality
TXU Business Services.......................... TXU Business Services Company, a subsidiary of TXU Corp.
TXU Corp....................................... refers to TXU Corp., a holding company, and/or its
consolidated subsidiaries, depending on context
TXU Gas........................................ refers to TXU Gas Company, a subsidiary of TXU Corp., and
/or its subsidiaries, depending on 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 (LOSS)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ----------------------
2004 2003 2004 2003
------ ------- ------ ------
(millions of dollars)
Operating revenues......................................... $ 216 $ 199 $ 724 $ 820
------- ------- ------- -------
Operating expenses:
Gas purchased for resale.............................. 102 89 428 519
Operation and maintenance............................. 137 72 206 139
Depreciation and amortization......................... 19 19 38 37
Income tax expense (benefit).......................... (13) (9) 4 16
Taxes other than income............................... 30 33 61 55
------- ------- ------- -------
Total operating expenses........................... 275 204 737 766
Operating income (loss).................................... (59) (5) (13) 54
Other income and deductions
Other income...................................... 2 1 4 3
Other deductions.................................. 125 - 125 -
Nonoperating income tax expense (benefit) ........ (29) - (27) 1
Interest income............................................ - - - 1
Interest expense and related charges....................... 8 11 16 22
------- ------- ------- -------
Net income (loss).......................................... (161) (15) (123) 35
Preferred stock dividends.................................. 1 1 2 2
------- ------- ------- -------
Net income (loss) applicable to common stock............... $ (162) $ (16) $ (125) $ 33
======== ======= ======== =======
CONDENSED STATEMENTS OF CONSOLIDATED
COMPREHENSIVE INCOME (LOSS)
(Unaudited)
Net Income (loss).......................................... $ (161) $ (15) $ (123) $ 35
-------- ------- -------- -------
Other comprehensive income:
Cash flow hedge activity, net of tax effect:
Amounts realized in earnings...................... - 1 - 2
------- ------- ------- -------
Total........................................... - 1 - 2
------- ------- ------- -------
Comprehensive income (loss)................................ $ (161) $ (14) $ (123) $ 37
======== ======= ======== =======
See Notes to Financial Statements.
1
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
-----------------------
2004 2003
------ -----
(millions of dollars)
Cash flows - operating activities:
Net income (loss)................................................ $ (123) $ 35
Adjustments to reconcile net income
to cash provided by operating activities:
Depreciation and amortization................................. 43 40
Deferred income taxes - net................................... (48) 7
Goodwill impairment........................................... 35 -
Charge for regulatory disallowances........................... 153 -
Equity in earnings of affiliates and joint ventures........... - (1)
Adjustments related to gas cost recovery...................... 6 34
Changes in operating assets and liabilities...................... (48) (9)
------- -------
Cash provided by operating activities...................... 18 106
Cash flows -- financing activities:
Retirements of long-term debt.................................... (150) (125)
Change in notes payable - commercial paper ...................... 300 -
Change in advances from affiliates............................... (116) 60
Cash dividends paid.............................................. (4) (2)
Debt premium, discount, financing and reacquisition expenses..... - (2)
------ -------
Cash provided by (used in) financing activities............ 30 (69)
Cash flows -- investing activities:
Capital expenditures............................................. (49) (48)
Other............................................................ 4 9
------ ------
Cash used in investing activities.......................... (45) (39)
------- ------
Net change in cash and cash equivalents............................ 3 (2)
Cash and cash equivalents-- beginning balance...................... 5 4
------ ------
Cash and cash equivalents-- ending balance......................... $ 8 $ 2
====== ======
See Notes to Financial Statements.
2
TXU GAS COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
2004 2003
------------ ------------
(millions of dollars)
ASSETS
Current assets:
Cash and cash equivalents...................................................... $ 8 $ 5
Accounts receivable............................................................ 29 101
Inventories.................................................................... 135 144
Other current assets........................................................... 50 27
------- ---------
Total current assets....................................................... 222 277
Investments:
Restricted cash.............................................................. 10 10
Other investments............................................................ 31 35
Property, plant and equipment - net............................................... 1,624 1,685
Goodwill.......................................................................... 300 305
Other noncurrent assets........................................................... 12 16
------- ---------
Total assets............................................................. $ 2,199 $ 2,328
======= =========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Notes payable - banks.......................................................... $ 300 -
Advances from affiliates....................................................... 38 154
Long-term debt due currently................................................... 150 150
Accounts payable............................................................... 51 148
Other current liabilities...................................................... 130 88
------- ---------
Total current liabilities.................................................. 669 540
Accumulated deferred income taxes and investment tax credits...................... 32 79
Long-term debt held by subsidiary trust........................................... 155 155
All other long-term debt, less amounts due currently.............................. 125 276
Regulatory liabilities............................................................ 113 35
Other noncurrent liabilities and deferred credits................................. 354 364
------- ---------
Total liabilities.......................................................... 1,448 1,449
Contingencies (Note 5)
Shareholder's equity :
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.......... - -
Additional paid in capital............................................... 815 815
Retained deficit......................................................... (135) (7)
Accumulated other comprehensive loss..................................... (4) (4)
-------- -------
Total common stock equity.............................................. 676 804
------- -------
Total shareholder's equity........................................... 751 879
------- -------
Total liabilities and shareholder's equity......................... $ 2,199 $ 2,328
======= =========
See Notes to Financial Statements.
3
TXU GAS COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
Description of Business -- TXU Gas, a Texas corporation, is a largely
regulated business engaged in the purchase, transmission, distribution and sale
of natural gas in the north-central, eastern and western parts of Texas. TXU Gas
is a wholly-owned subsidiary of TXU Corp. The TXU Gas business is held for sale
as described below.
TXU Gas serves more than 1.4 million retail gas customers and owns and
operates gas distribution mains, gas transportation and gathering pipelines and
underground storage reservoirs. TXU Gas also provides transportation services to
gas distribution companies, electricity generation plants, end-use industrial
customers and through-system shippers.
TXU Gas' natural gas pipeline, gas distribution and asset management
services operations are managed as one integrated business; accordingly, there
are no separate reportable business segments.
Strategic Initiatives and Other Actions - As previously reported, on
February 23, 2004, C. John Wilder was named president and chief executive of TXU
Corp. Mr. Wilder was formerly executive vice president and chief financial
officer of Entergy Corporation. Mr. Wilder has been reviewing the operations of
TXU Corp. and has formulated certain strategic initiatives and continues to
develop others. The review has resulted in the decision to sell TXU Gas. Other
actions taken that impact TXU Gas relate to TXU Corp.'s cost structure,
including organizational alignments and headcount as well as non-core business
activities.
Sale of TXU Gas
---------------
On June 17, 2004, TXU Gas entered into a definitive merger agreement with
an acquisition subsidiary of Atmos Energy Corporation (Atmos) pursuant to which
Atmos will acquire the operations of TXU Gas for $1.925 billion in cash. The
intent to sell the business had been previously disclosed. The transaction is
expected to close by the end of the year, subject to the satisfaction of
customary closing conditions and Atmos obtaining limited state regulatory
approvals.
Based on June 30, 2004 balance sheet amounts, estimated assets totaling
$111 million and liabilities totaling $1.23 billion would not be assumed by the
buyer. The assets consist largely of prepayments related to revenue-related
taxes and employee deferred compensation-related investments. The liabilities
consist largely of short and long-term debt, pension, post retirement benefits
and deferred compensation obligations, and income tax liabilities including
deferred income taxes.
Capgemini Energy Agreement
--------------------------
On May 17, 2004, TXU Corp. entered into a services agreement with a
subsidiary of Cap Gemini North America Inc., Capgemini Energy LP (Capgemini), a
new company initially providing business process support services to TXU Corp.
and subsidiaries, and immediately implementing a plan to offer similar services
to other utility companies. Under the ten-year agreement, over 2,500 employees
transferred from subsidiaries of TXU Corp. to Capgemini effective July 1, 2004.
Outsourced base support services performed by Capgemini for a fixed fee include
information technology, customer call center, billing, human resources, supply
chain and certain accounting activities.
As part of the services agreements, TXU Corp. agreed to indemnify
Capgemini for severance costs incurred by Capgemini for former employees
terminated within 18 months of their transfer to Capgemini. Accordingly, TXU Gas
recorded a $7 million ($5 million after-tax) charge for severance expense in the
second quarter of 2004, which represents a reasonable estimate of the indemnity
and is reported in other deductions. The charge consists principally of an
allocation of severance related to TXU Business Services employees. In addition,
TXU Corp. committed to pay for costs associated with transitioning the
outsourced activities to Capgemini. The transition costs allocable to TXU Gas
are expected to be recorded during the remainder of 2004.
4
Basis of Presentation -- The condensed consolidated financial statements
of TXU Gas have been prepared in accordance with US GAAP and on the same basis
as the audited financial statements included in its 2003 Form 10-K. In the
opinion of management, all other adjustments (consisting of normal recurring
accruals) necessary for a fair presentation of the results of operations and
financial position have been included therein. All intercompany items and
transactions have been eliminated in consolidation. Certain information and
footnote disclosures normally included in annual consolidated financial
statements prepared in accordance with US GAAP have been omitted pursuant to the
rules and regulations of the SEC. Because the condensed consolidated interim
financial statements do not include all of the information and footnotes
required by US GAAP, they should be read in conjunction with the audited
financial statements and related notes included in the 2003 Form 10-K. The
results of operations for an interim period may not give a true indication of
results for a full year.
Certain reclassifications have been made to conform prior period data to
the current period presentation. The income statement presentation, which is a
regulatory format, differs from previous disclosures in that income tax expense
and benefit is presented as a component of both operating and nonoperating
results. All dollar amounts in the financial statements and tables in the
notes are stated in millions of dollars unless otherwise indicated.
Changes in Accounting Standards -- FIN 46R was issued in December 2003 and
replaced FIN 46, which was issued in January 2003. FIN 46R expands and clarifies
the guidance originally contained in FIN 46, regarding consolidation of variable
interest entities. FIN 46R did not impact results of operations or financial
position for the first six months of 2004.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
(the Medicare Act) was enacted in December 2003. TXU Corp. is accounting for the
effects of the Medicare Act in accordance with FASB Staff Position 106-2. For
the three and six months ended June 30, 2004, the effect of adoption of the
Medicare Act was a reduction of approximately $1 million and $2 million,
respectively, in TXU Gas' postretirement benefit costs.
2. GAS DISTRIBUTION RATE CASE
In May 2003, TXU Gas filed, for the first time, a system-wide rate case
for the distribution and pipeline operations. The case was filed in all 437
incorporated cities served by the distribution operations, and at the RRC for
the pipeline business and for unincorporated areas served by the distribution
operations. The TXU Gas filing requested an annual revenue increase of $69.5
million or 7.24%. All 437 cities took action on the case within their statutory
time frame, and TXU Gas appealed these actions to the RRC. Twelve parties
intervened in the case.
On May 25, 2004, the RRC issued a final order in TXU Gas' system-wide rate
case granting an $11.7 million or 1.22% increase in TXU Gas' rates.
Additionally, as a result of the RRC order, TXU Gas recorded a charge of
approximately $153 million ($99 million after-tax) in the second quarter 2004 to
reserve for certain regulatory disallowances contained within the RRC's order.
The disallowances consisted of the following:
o Gas utility plant investment associated with the replacement of
polyethylene pipe ("poly pipe") in the amount of $77 million, with
the related charge reported in other deductions;
o Regulatory asset relating to costs incurred for identifying
locations requiring polyethylene pipe ("poly pipe") replacements
in the amount of $40 million, with the related charge reported in
operation and maintenance expense;
o Regulatory asset relating to the costs of employee severance
programs occurring in 1997 and again in 1999 in the amount of $31
million, with the related charge reported in operation and
maintenance expense;
o Gains on sales of land and cushion gas in the combined approximate
amount of $5 million, with the related charge reported in
other deductions.
5
TXU Gas believes that the final order does not follow applicable law or
precedent in many important respects and filed a motion for rehearing requesting
the RRC to reconsider and reverse significant judgments that TXU Gas believes
are in error. The RRC has denied the motion for rehearing. TXU Gas is filing an
appeal in district court.
3. FINANCING ARRANGEMENTS
Short-term Borrowings -- At June 30, 2004, TXU Gas had outstanding
short-term borrowings consisting of bank borrowings of $300 million at a
weighted average interest rate of 2.18% and $38 million of short-term advances
from affiliates at a weighted average interest rate of 2.85%. At March 31, 2004,
TXU Gas had outstanding short-term advances from affiliates of $231 million at a
weighted average interest rate of 2.86%.
Credit Facilities -- On April 26, 2004, TXU Gas entered into a new $300
million, 364-day credit facility. At June 30, 2004, the facility was fully drawn
and borrowings were used to repay advances from affiliates. In July 2004, this
facility was repaid and has been terminated.
Sale of Receivables -- TXU Corp. has established an accounts receivable
securitization program. The activity under this program is accounted for as a
sale of accounts receivable in accordance with SFAS 140. Under the program,
subsidiaries of TXU Corp. (originators) sell trade accounts receivable to TXU
Receivables Company, a consolidated wholly-owned bankruptcy remote direct
subsidiary of TXU Corp., which sells undivided interests in the purchased
accounts receivable for cash to special purpose entities established by
financial institutions (the funding entities). As of June 30, 2004, $47 million
of undivided interests in TXU Gas' accounts receivable had been sold by TXU
Receivables Company. Effective June 30, 2004, the program was extended through
June 28, 2005. Additionally, the extension allows for increased availability of
funding through a credit ratings-based reduction of customer deposits previously
used to reduce the amount of undivided interests that could be sold. Undivided
interests will now be reduced by 100% of the customer deposit for a Baa3/BBB-
rating; 50% for a Baa2/BBB rating; and zero % for a Baa1/BBB+ and above rating
(based on each originator's credit rating).
All new trade receivables under the program generated by the originators
are continuously purchased by TXU Receivables Company with the proceeds from
collections of receivables previously purchased. Changes in the amount of
funding under the program, through changes in the amount of undivided interests
sold by TXU Receivables Company, are generally due to seasonal variations in the
level of accounts receivable and changes in collection trends. TXU Receivables
Company has issued subordinated notes payable to the originators for the
difference between the face amount of the uncollected accounts receivable
purchased, less a discount, and cash paid to the originators that was funded by
the sale of the undivided interests.
The discount from face amount on the purchase of receivables principally
funds program fees paid by TXU Receivables Company to the funding entities, as
well as a servicing fee paid by TXU Receivables Company to TXU Business
Services. The program fees (losses on sale), which consist primarily of interest
costs on the underlying financing, were $1 million for each of the six-month
periods ending June 30, 2004 and 2003 and approximated 2.1% and 3.6% for the
first six months of 2004 and 2003, respectively, of the average funding under
the program on an annualized basis; these fees represent the net incremental
costs of the program to TXU Gas and are reported in operation and maintenance
expenses. The servicing fee, which totaled approximately $1 million and $2
million, for the first six months of 2004 and 2003, respectively, compensates
TXU Business Services for its services as collection agent, including
maintaining the detailed accounts receivable collection records.
The June 30, 2004 balance sheet reflects $85 million face amount of trade
accounts receivable reduced by $47 million of undivided interests sold by TXU
Receivables Company. Funding under the program decreased $6 million for the six
months ended June 30, 2004, primarily due to the effect of seasonal
fluctuations. Funding under the program for the six months ended June 30, 2003
increased $22 million. Funding increases or decreases under the program are
reflected as operating cash flow activity in the statement of cash flows. The
carrying amount of the retained interests in the accounts receivable
approximated fair value due to the short-term nature of the collection period.
6
Activities of TXU Receivables Company related to TXU Gas for the six
months ended June 30, 2004 and 2003 were as follows:
Six Months Ended June 30,
-------------------------
2004 2003
------ ------
Cash collections on accounts receivable...................................... $ 885 $ 915
Face amount of new receivables purchased..................................... (872) (938)
Discount from face amount of purchased receivables........................... 2 3
Program fees paid............................................................ (1) (1)
Servicing fees paid.......................................................... (1) (2)
Increase in subordinated notes payable....................................... (7) 1
------- ------
TXU Gas' operating cash flows (provided)/utilized under the program..... $ 6 $ (22)
======= ======
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.
Contingencies Related to Sale of Receivables Program -- Although TXU
Receivables Company expects to be able to pay its subordinated notes from the
collections of purchased receivables, these notes are subordinated to the
undivided interests of the financial institutions in those receivables, and
collections might not be sufficient to pay the subordinated notes. The program
may be terminated if either of the following events occurs:
1) all of the originators cease to maintain their required fixed charge
coverage ratio and debt to capital (leverage) ratio;
2) the delinquency ratio (delinquent for 31 days) for the sold
receivables, the default ratio (delinquent for 91 days or
deemed uncollectible), the dilution ratio (reductions for discounts,
disputes and other allowances) or the days collection outstanding
ratio exceed stated thresholds and the financial institutions do not
waive such event of termination. The thresholds apply to the entire
portfolio of sold receivables, not separately to the receivables of
each originator.
The delinquency and dilution ratios exceeded the relevant thresholds
during the first four months of 2003, but waivers were granted. These ratios
were affected by issues related to the transition to competition. Certain
billing and collection delays arose due to implementation of new systems and
processes within Energy and ERCOT for clearing customers' switching and billing
data. Strengthened credit and collection policies and practices have brought the
ratios into consistent compliance with the program requirement.
Under terms of the receivables sale program, all the originators are
required to maintain specified fixed charge coverage and leverage ratios (or
supply a parent guarantor that meets the ratio requirements). The failure, by an
originator or its parent guarantor, if any, to maintain the specified financial
ratios would prevent that originator from selling its accounts receivable under
the program. If all the originators and the parent guarantor, if any, fail to
maintain the specified financial ratios so that there are no eligible
originators, the facility would terminate.
7
Long-Term Debt -- At June 30, 2004 and December 31, 2003, the long-term
debt of TXU Gas and its consolidated subsidiaries consisted of the following:
June 30, December 31,
2004 2003
----------- -------------
6.375% Fixed Notes due February 1, 2004..................................................... $ -- $ 150
7.125% Fixed Notes due June 15, 2005........................................................ 150 150
6.564% Fixed Remarketed Reset Notes due January 1, 2008, remarketing date July 1, 2005 (a).. 125 125
Unamortized valuation adjustment............................................................ -- 1
------ ------
Total TXU Gas (b)........................................................................ 275 426
Less amount due currently........................................................................ 150 150
------- ------
Total long-term debt............................................................................. $ 125 $ 276
======= ======
- --------------
(a) These series are in the multiannual mode and are subject to mandatory
tender prior to maturity on the mandatory remarketing date. On such
date, the interest rate and interest rate period will be reset for the
notes.
(b) Upon the sale of TXU Gas' operations, under the current definitive
agreement, TXU Gas would be required to provide for the satisfaction of
the outstanding long-term debt obligations.
4. LONG-TERM DEBT HELD BY SUBSIDIARY TRUST
At June 30, 2004 and December 31, 2003, a statutory business trust
established as a wholly-owned financing subsidiary of TXU Gas, had 150 units
($147 million) of floating rate mandatorily redeemable preferred securities
outstanding. Distributions on these preferred securities are payable quarterly
based on an annual floating rate determined quarterly with reference to a
three-month LIBOR rate plus a margin. The only assets held by the trust are $155
million principal amount of Floating Rate Junior Subordinated Debentures Series
A issued by TXU Gas. The interest on the debentures matches the distributions on
the preferred trust securities. The debentures will mature on July 1, 2028. TXU
Gas has the right to redeem the debentures and cause the redemption of the
preferred securities in whole or in part. TXU Gas owns the common securities
issued by its subsidiary trust and has effectively issued a full and
unconditional guarantee of the trust's preferred securities.
As a result of the adoption of FIN 46R in the fourth quarter of 2003, the
subsidiary trust has been deconsolidated. As a result, TXU Gas' balance sheet
reflects the $155 million of long-term debt held by the trust and an investment
in the trust of $8 million, instead of the former presentation of $147 million
of preferred interests of subsidiaries. Upon the sale of TXU Gas' operations,
under the current definitive agreement, TXU Gas would be required to provide for
the satisfaction of these securities.
5. PREFERRED STOCK
At June 30, 2004, TXU Gas had 75,000 shares of Adjustable Rate Series F
Preferred Stock outstanding (2,000,000 total shares authorized) which is
entitled upon liquidation to the stated value of $1,000 per share. The preferred
stock series is the underlying preferred stock for depositary shares that were
issued to the public. Each depositary share of $25 per share, represents
one-fortieth of a share of underlying preferred stock. The dividend rate is
determined quarterly, in advance, based on US Treasury rates and was 4.5% at
June 30, 2004. Upon the sale of TXU Gas' operations, under the current
definitive agreement, TXU Gas would be required to redeem the preferred stock.
At June 8, 2004, the Board of Directors declared a dividend of $11.25 per
share on the outstanding Adjustable Rate Cumulative Preferred Stock, Series F
payable on August 1, 2004 to shareholders of record at the close of business on
July 16, 2004.
8
6. CONTINGENCIES
On April 13, 2004, the US Commodity Futures Trading Commission (CFTC)
issued a subpoena requiring TXU Corp. to produce information about storage of
natural gas, including weekly and monthly storage reports submitted to the
Energy Information Administration by TXU Gas. This request seeks information for
the period of October 31, 2003 through January 2, 2004. TXU Corp. has cooperated
with the CFTC, provided the requested information, and believes that TXU Gas has
not engaged in any activity that would justify action against it by the CFTC.
Guarantees -- TXU Gas has entered into contracts that contain guarantees
to outside parties that could require performance or payment under certain
conditions. These guarantees have been grouped based on similar characteristics
and are described in detail below.
Other - 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 $106 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. TXU Gas
appealed the proposed adjustments to the IRS Appeals Office and in June 2004,
the IRS Appeals Office rejected the substance of TXU Gas' appeal of the IRS
proposed adjustments, refused to consider a settlement of the disputed issues,
and indicated that the IRS will issue a statutory notice of deficiency for the
tax, penalty, and interest due. If the matter is resolved against TXU Gas, TXU
Gas would be assessed a deficiency of $65 million (including penalty and
interest through June 30, 2004). In addition, TXU Gas would have tax liabilities
of $40 million (plus any interest and penalty assessed) related to subsequent
years, for which audits have not yet been completed.
Based on the unsuccessful settlement negotiations, additional tax reserves
of $47 million were recorded during the current period to account for the excess
of the tax, penalty, and interest asserted by the IRS over the amount of tax
reserves previously recorded. In accordance with acquisition accounting rules,
the portion of the additional tax reserve related to the pre-acquisition tax,
penalty, and interest ($30 million) has been charged to goodwill, and the
remaining portion related to interest for periods after August 5, 1997 ($17
million) has been charged to income. TXU Gas has the right to appeal the IRS'
proposed adjustments through a court proceeding, and its currently evaluating
its legal options. Management believes that reserves recorded related to these
matters are adequate. Under the definitive sales agreement, the buyer of the TXU
Gas operations will not assume liabilities, among others, related to ENSERCH tax
returns contested by the IRS.
General -- In addition to the above, TXU Gas and its subsidiaries are
involved in various other legal and administrative proceedings in the normal
course of business the ultimate resolution of which, in the opinion of each,
should not have a material effect upon their financial position, results of
operations or cash flows.
9
7. SUPPLEMENTARY FINANCIAL INFORMATION
Other Deductions --
Three Months Six Months
Ended June 30, Ended June 30,
----------------------- --------------------
2004 2003 2004 2003
------ ------ ------ -------
Other deductions
Reserve for regulatory allowance (Note 2). $ 77 $ -- $ 77 --
Goodwill impairment ...................... 35 -- 35 --
Employee severance (Note 1).............. 7 -- 7 --
Regulatory disallowance (Note 2).......... 5 -- 5 --
Other..................................... 1 -- 1 --
------ ------ ------- -------
Total other deductions................. $ 125 $ -- $ 125 $ --
====== ====== ======= =======
An additional goodwill amount of $30 million was recorded in the second
quarter of 2004 in connection with income tax contingencies related to the
acquired predecessor of TXU Gas (see Note 6 to Financial Statements). In
consideration of the current best estimate of the net proceeds from the expected
sale of the business and the expected carrying value of the assets (including
goodwill) to be sold under the definitive sales agreement, a goodwill impairment
charge of $35 million (pre and after-tax) was recorded in the second quarter of
2004.
Interest Expense and Related Charges --
Three Months Six Months
Ended June 30, Ended June 30,
-------------------------- ----------------------
2004 2003 2004 2003
------- ------- ------ ------
Interest (a)................................. $ 7 $ 10 $ 13 $ 20
Interest-affiliated debt..................... 1 1 3 2
------ ------ ------- -------
Total interest expense and related
charges ..................................... $ 8 $ 11 $ 16 $ 22
====== ====== ======= =======
(a) Includes interest on long-term debt held by subsidiary trust.
Retirement Plan And Other Postretirement Benefits - TXU Gas is a
participating employer in the TXU Retirement Plan, a defined benefit pension
plan sponsored by TXU Corp. TXU Gas also participates with TXU Corp. and other
affiliated subsidiaries of TXU Corp. to offer health care and life insurance
benefits to eligible employees and their eligible dependents upon the retirement
of such employees. The allocated net periodic pension cost and net periodic
postretirement benefits cost other than pensions applicable to TXU Gas was $5
million and $4 million for the three months ended June 30, 2004 and 2003,
respectively, and $10 million and $9 million for the six months ended June 30,
2004 and 2003, respectively.
At June 30, 2004, TXU Gas estimates that its total contributions to the
pension plan and other postretirement benefit plans for the remainder of 2004
will not be materially different than previously disclosed in the 2003 Form
10-K.
10
Regulatory Assets (Liabilities) --
June 30, December 31,
2004 2003
-------- ------------
Asset retirement obligations - removal cost............... $ (135) $ (129)
Over-collected gas costs.................................. (13) (2)
Distribution safety compliance costs(See Note 2).......... -- 41
Rate case costs........................................... 27 17
Other regulatory assets................................... 8 38
------- -------
Regulatory liabilities............................... $ (113) $ (35)
======== ========
Included above are assets of $51 million at December 31, 2003 that were
earning a return. There are no regulatory assets at June 30, 2004 that are
earning a return. The regulatory assets have an average remaining recovery
period of approximately 15 years (see Note 2 to Financial Statements).
At June 30, 2004 and December 31, 2003, accounts receivable are stated net
of allowance for uncollectible accounts of $5 million and $3 million,
respectively. During the six months ended June 30, 2004, bad debt expense was $5
million and account write-offs were $3 million. During the six months ended June
30, 2003, bad debt expense was $7 million. Allowances related to receivables
sold are reported in other current liabilities and totaled $2 million at June
30, 2004 and December 31, 2003.
Accounts receivable included $12 million and $27 million of unbilled
revenues at June 30, 2004 and December 31, 2003, respectively.
Intangible assets other than goodwill are comprised of the following:
As of June 30, 2004 As of December 31, 2003
------------------------------------ ------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
------ ------------ --- ------ ------------ ---
Amortized intangible assets
Capitalized software.............. $ 33 $ 18 $ 15 $ 32 $ 15 $ 17
Land easements.................... 15 8 7 16 9 7
----- ----- ----- ----- ----- -----
Total....................... $ 48 $ 26 $ 22 $ 48 $ 24 $ 24
===== ===== ===== ===== ===== =====
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 for
each of the six month periods ended June 30, 2004 and 2003.
11
Inventories by Major Category--
June 30, December 31,
2004 2003
---------- ------------
Materials and supplies, at cost................................... $ 6 $ 5
Gas stored underground, primarily at weighted average cost........ 129 139
---- -----
Total inventories............................................ $ 135 $ 144
==== =====
Property, Plant and Equipment-- At June 30, 2004, property, plant and
equipment totaling $1.6 billion was stated net of accumulated depreciation and
amortization of $307 million and net of a $77 million reserve for regulatory
allowances, and at December 31, 2003, property, plant and equipment totaling
$1.7 billion was stated net of accumulated depreciation and amortization of $275
million.
Derivatives and Hedges - TXU Gas had interest rate swaps related to the
preferred securities of the subsidiary financing trust that expired on July 1,
2003. 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. TXU Gas
had no cash flow hedges during 2004.
Affiliate 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, 2004 and 2003 were $114 million and $152 million,
respectively, and for the six months ended June 30, 2004 and 2003, were
$145 million and $160 million, respectively. Interest expense incurred
on the advances for the three months ended June 30, 2004 and 2003 was
approximately $1 million in each period, and for the six months ended
June 30, 2004 and 2003 was $2 million in each period. The weighted
average interest rate for the three months ended June 30, 2004 and 2003
was 2.85% and 3.07%, respectively. The weighted average interest rate
for the six months ended June 30, 2004 and 2003 was 2.85% and 2.83%,
respectively.
o Energy charges TXU Gas for customer and administrative services at
cost. For the three months ended June 30, 2004 and 2003, these costs
totaled $8 million and $7 million, respectively. For the six months
ended June 30, 2004 and 2003, these charges totaled $15 million and $14
million, respectively. These charges are reported in operation and
maintenance expenses.
o Electric Delivery charges TXU Gas for customer and administrative
services at cost. For the three months ended June 30, 2004 and 2003,
these costs totaled $5 million and $7 million, respectively. For the
six months ended June 30, 2004 and 2003 these charges totaled $10
million and $15 million, respectively. These charges are reported in
operation and maintenance expenses.
o Included in reported revenues were $3 million and $5 million from the
sale and transportation of gas to other TXU Corp. subsidiaries for the
three months ended June 30, 2004 and 2003, respectively. For the six
months ended June 30, 2004 and 2003, these revenues totaled $4 million
and $8 million, respectively.
o Affiliated interest expense includes $600 thousand for the six months
ended June 30, 2004, related to interest expense allocated to TXU Gas
for the LOC 2003 Trust, a special purpose, wholly-owned subsidiary of
TXU Corp. (LOC Trust). LOC Trust's assets constitute collateral for the
benefit of the lenders to secure issuances of letters of credit or
loans to TXU Corp. and its subsidiaries.
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, 2004 and 2003, these costs totaled $12
million and $8 million, respectively. For the six months ended June 30,
2004 and 2003, these costs totaled $21 million and $17 million,
respectively. These costs are largely reported in operation and
maintenance expense.
12
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TXU Gas Company:
We have reviewed the accompanying condensed consolidated balance sheet of TXU
Gas and subsidiaries as of June 30, 2004, and the related condensed statements
of consolidated income (loss) and of comprehensive income (loss) for the
three-month and six-month periods ended June 30, 2004 and 2003, and the
condensed statements of consolidated cash flows for the six-month periods ended
June 30, 2004 and 2003. These interim financial statements are the
responsibility of TXU Gas' management.
We conducted our review in accordance with standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit in accordance with
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated interim 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 standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
TXU Gas as of December 31, 2003, 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 dated March 11, 2004, 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, 2003, 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 13, 2004
13
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 engaged
primarily in the purchase, transmission, distribution and sale of natural gas in
the north-central, eastern and western parts of Texas. TXU Gas is a wholly-owned
subsidiary of TXU Corp. The TXU Gas business is held for sale as described
below.
TXU Gas serves more than 1.4 million retail gas customers and owns and
operates gas distribution mains, gas transportation and gathering pipelines and
underground storage reservoirs. TXU Gas also provides transportation services to
gas distribution companies, electricity generation plants, end-use industrial
customers and through-system shippers.
Strategic Initiatives and Other Actions - As previously reported, on
February 23, 2004, C. John Wilder was named president and chief executive of TXU
Corp. Mr. Wilder was formerly executive vice president and chief financial
officer of Entergy Corporation. Mr. Wilder has been reviewing the operations of
TXU Corp. and has formulated certain strategic initiatives and continues to
develop others. The review has resulted in the decision to sell TXU Gas. Other
actions taken that impact TXU Gas relate to TXU Corp.'s cost structure,
including organizational alignments and headcount as well as non-core business
activities.
Sale of TXU Gas
---------------
On June 17, 2004, TXU Gas entered into a definitive merger agreement
with an acquisition subsidiary of Atmos Energy Corporation (Atmos) pursuant to
which Atmos will acquire the operations of TXU Gas for $1.925 billion in cash.
Atmos has guaranteed all of the obligations of its subsidiary under the
agreement.
Based on June 30, 2004 balance sheet amounts, estimated assets totaling
$111 million and liabilities totaling $1.23 billion would not be assumed by the
buyer. The assets consist largely of prepayments related to revenue-related
taxes and employee deferred compensation-related investments. The liabilities
consist largely of short and long-term debt, pension, post retirement benefits
and deferred compensation obligations, and income tax liabilities including
deferred income taxes.
The agreement does not contain any financing contingency. The
transaction is, however, subject to several customary closing conditions most
notably (i) Atmos obtaining state regulatory approval in Missouri, Virginia and
Iowa (ii) the absence of any material adverse effect with respect to the
business of TXU Gas and its subsidiaries taken together as a whole and (iii) TXU
Gas providing for the satisfaction of all of its outstanding debt securities and
preferred stock. The parties are working to satisfy the closing conditions and
the transaction is expected to close by the end of the year.
The agreement may be terminated in certain circumstances most notably
(i) by the mutual consent of the parties, (ii) by either party 30 days after
giving written notice to the other party of a material breach of the agreement
and the breach has not been cured or waived and (iii) by either party if the
transaction has not closed on or before December 31, 2004. Under the terms of
the agreement, if TXU Gas has satisfied all of its applicable closing conditions
and Atmos is unable to close the transaction by December 31, 2004 then Atmos
will be required to pay $15 million to TXU Gas.
The agreement contains certain operating covenants with respect to the
operations of TXU Gas' business pending the consummation of the acquisition.
Generally, TXU Gas must carry on its business in the ordinary course consistent
with past practice and TXU Gas must cooperate with Atmos to effect an orderly
transition of the business.
TXU Corp. has filed the agreement with the SEC, and it is publicly
available.
14
Capgemini Energy Agreement
--------------------------
On May 17, 2004, TXU Corp. entered into a services agreement with a
subsidiary of Cap Gemini North America Inc., Capgemini Energy LP (Capgemini), a
new company initially providing business process support services to TXU Corp.
and subsidiaries and immediately implementing a plan to offer similar services
to other utility companies. Under the ten-year agreement, over 2,500 employees
transferred from subsidiaries of TXU Corp. to Capgemini effective July 1, 2004.
Outsourced base support services performed by Capgemini for a fixed fee include
information technology, customer call center, billing, human resources, supply
chain and certain accounting activities. TXU Gas expects that the Capgemini
arrangement will result in improved service levels and significant cost savings,
as a result of lower allocated costs from TXU Corp. and its subsidiaries.
As part of the services agreements, TXU Corp. agreed to indemnify
Capgemini for severance costs incurred by Capgemini for former TXU Corp.
employees terminated within 18 months of their transfer to Capgemini.
Accordingly, TXU Gas recorded a $7 million ($5 million after-tax) charge for
severance expense in the second quarter of 2004, which represents a reasonable
estimate of the indemnity and is reported in other deductions. The charge
consists principally of an allocation of severance related to TXU Business
Services employees. In addition, TXU Corp. committed to pay for costs associated
with transitioning the outsourced activities to Capgemini. The transition costs
allocable to TXU Gas are expected to be recorded during the remainder of 2004.
RESULTS OF OPERATIONS
All dollar amounts in Management's Discussion and Analysis of Financial
Condition and Results of Operations and the tables therein are stated in
millions of US dollars unless otherwise indicated.
Results of operations of TXU Gas are subject to seasonal variation,
reflecting higher gas usage in the first and fourth quarters due to colder
weather. These variations generally result in higher net income and cash flow
from operations during these periods.
Operating Data
- --------------
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
2004 2003 2004 2003
------ ------ ------ ------
Operating statistics - volumes:
Retail gas distribution (Bcf):
Residential............................... 9 8 46 53
Business and other........................ 10 9 32 35
-------- -------- ------- -------
Total gas distribution................. 19 17 78 88
======== ======== ======= =======
Pipeline transportation (Bcf)................. 92 92 180 178
======== ======== ======= =======
Retail gas distribution customers (in thousands). 1,478 1,458
Operating revenues (millions of dollars):
Retail gas distribution:
Residential............................... $ 114 $ 94 $ 426 $ 495
Business and other (a).................... 77 76 236 269
-------- -------- ------- -------
Total gas distribution (a)............. 191 170 662 764
Pipeline transportation (a)................... 14 12 30 28
Other revenues, net of eliminations (a)....... 11 17 32 28
-------- -------- ------- -------
Total operating revenues............... $ 216 $ 199 $ 724 $ 820
======== ======== ======= =======
Weather (average for service territory) (b)
Percent of normal:
Heating degree days....................... 82.0% 53.0% 87.6% 102.3%
- --------------------------
(a) Prior periods reclassified to conform to current year presentation.
(b) Weather data is obtained from Meteorlogix, an independent company that
collects weather data from reporting stations of the National Oceanic and
Atmospheric Administration (a federal agency under the US Department of
Commerce).
15
Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003
- ------------------------------------------------------------------------------
TXU Gas' operating revenues increased $17 million, or 9%, to $216 million.
The increase reflected $20 million from a 20% increase in the average cost of
gas and $3 million from a 3% increase in distribution sales volumes. These
increases were partially offset by $5 million from decreased revenue in the
utility asset management services on lower contract activity.
Gross margin (operating revenue less gas purchased for resale) increased
$4 million, or 4%, to $114 million in 2004. The increase reflected a favorable
benefit of $8 million resulting from the annual reconciliation of the estimated
lost and unaccounted for volumes for the twelve month periods ending June 30,
2004 and 2003, partially offset by a decrease in revenues from the utility asset
management services business of $5 million.
Gross margin is considered a key operating metric as it generally measures
the contribution of distribution service rates to recover the operating and
other costs of the business.
Operation and maintenance expense increased $65 million, or 90%, to $137
million in 2004. The increase reflects $71 million in charges arising from
disallowances of regulatory assets (see Note 2 to Financial Statements),
partially offset by $5 million related to decreased activity in the utility
asset management services business.
Taxes other than income decreased $3 million, or 9%, to $30 million in
2004. The decrease was primarily driven by lower gross receipts taxes of $4
million, reflecting lower prior period revenues on which these taxes are based,
partially offset by an increase in ad valorem / property taxes of $1 million due
to increased property values and tax rates.
Other deductions in 2004 of $125 million include $77 million in charges
arising from regulatory disallowances of capitalized poly pipe assets (see Note
2 to Financial Statements), $35 million for the impairment of goodwill (see Note
7 to Financial Statements), $7 million in severance charges due to strategic
actions initiated by TXU Corp. (see Note 1 to Financial Statements), and $5
million due to regulatory disallowances (see Note 2 to Financial Statements).
Interest expense and related charges decreased $3 million, or 27%, to $8
million in 2004. The decrease reflects $2 million in lower average debt levels,
and a $1 million decrease due to lower average interest rates in 2004, primarily
due to the expiration of an interest rate swap (see Note 7 to Financial
Statements).
The effective income tax rate on a combined operating and nonoperating
loss was 20.6% in 2004 and 37.5% in 2003. The decrease reflects a $17 million
charge related to additional tax reserves for a pre-acquisition tax dispute
(see Note 6 to Financial Statements) and $12 million due to the non-deductible
impairment of goodwill (see Note 7 to Financial Statements).
Net loss was $161 million in 2004 compared to $15 million in 2003. The
increased loss was driven by the regulatory disallowances, the goodwill
impairment and severance charges. Net pension and postretirement benefit costs
reduced net income by $2 million in both 2004 and 2003.
Six Months Ended June 30, 2004 Compared to the Six Months Ended June 30, 2003
- -----------------------------------------------------------------------------
TXU Gas' operating revenues decreased $96 million, or 12%, to $724
million. The decrease reflected $81 million from an 11% decline in distribution
sales volumes primarily due to warmer winter weather, $26 million due to a 5%
decrease in the average cost of gas, and $3 million from lower contract activity
in the utility asset management services business. These decreases were
partially offset by $8 million from the sale of pipeline inventory and $3
million of increased tariff revenue due to higher distribution rates.
16
Gross margin (operating revenue less gas purchased for resale) decreased
$5 million, or 2%, to $296 million in 2004. The decrease reflects $21 million
from the effect of lower distribution sales volumes and gas prices and a $3
million decrease in revenues in the utility asset management services business,
partially offset by improvements in lost and unaccounted for gas of $12 million,
a net $3 million gain from the sale of pipeline inventory and $3 million in
higher distribution rates.
Operation and maintenance expense increased $67 million, or 48%, to $206
million in 2004. The increase reflects $71 million in charges arising from
disallowances of regulatory assets (see Note 2 to Financial Statements),
partially offset by $4 million related to decreased activity in the utility
asset management services business.
Taxes other than income increased $6 million, or 11%, to $61 million in
2004. The increase was primarily driven by higher gross receipts taxes of $5
million, reflecting higher prior period revenues on which these taxes are based,
and an increase in taxes of $1 million due to increased plant, property values
and tax rates.
Other deductions in 2004 of $125 million include $77 million in charges
arising from regulatory disallowances of capitalized poly pipe assets, $35
million for the impairment of goodwill (see Note 7 to Financial Statements), and
$7 million in severance charges due to strategic actions initiated by TXU Corp.
(see Note 1 to Financial Statements), and $5 million due to regulatory
disallowances (see Note 2 to Financial Statements).
Interest expense and related charges decreased $6 million, or 27%, to $16
million in 2004. The decrease reflects $4 million in lower average debt levels,
and a $2 million decrease due to lower average interest rates, primarily due to
the expiration of an interest rate swap (see Note 7 to Financial Statements).
The effective income tax rate on a combined operating and nonoperating
loss was 15.8% in 2004 and 32.7% in 2003. The decrease reflects a $17 million
charge related to additional tax reserves for a pre-acquisition tax dispute
(see Note 6 to Financial Statements) and $12 million due to the non-deductible
impairment of goodwill (see Note 7 to Financial Statements).
Net loss was $123 million in 2004 compared to income of $35 million in
2003. The decline in results was driven by regulatory disallowances, the
goodwill impairment and severance charges. Net pension and postretirement
benefit costs reduced net income by $5 million in 2004 and by $4 million 2003.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows -- Cash provided by operating activities for the six months
ended June 30, 2004 was $18 million compared with $106 million for the same
period last year. The decrease in cash flows from operating activities of $88
million was driven by lower cash earnings (net income adjusted for the
significant non-cash items identified in the statement of cash flows) of $49
million, and $21 million in unfavorable working capital changes (accounts
receivable, accounts payable and inventory). The unfavorable working capital
change is primarily due to timing of payments of affiliate payables.
Cash provided by financing activities was $30 million in 2004 compared
with utilization of $69 million in 2003. Retirements of long-term debt were $150
million in 2004 compared to $125 million in 2003, reflecting payment of
scheduled debt maturities. A total of $116 million in affiliate advances was
repaid to TXU Corp. in 2004 compared to $60 million advanced from TXU Corp. in
2003. A $300 million credit facility was established and fully drawn in April
2004; the funds were advanced to TXU Corp. and contributed to the change in
affiliate advances.
17
Cash flows utilized by investing activities totaled $45 million in 2004,
compared to $39 million used by investing activities in 2003.
Depreciation and amortization expense reported in the statement of cash
flows exceeds the amount reported in the income statement for the six months
ended June 30, 2004 and 2003 by $5 million and $3 million, respectively. This
difference represents amortization of certain regulatory assets, which is
reported as operation and maintenance expense in the statement of income.
Financing Activities
- --------------------
See Notes 3, 4, and 5 to Financial Statements for further detail of
expected financing arrangements, debt issuance and retirements, debt held by
unconsolidated subsidiary trusts and preferred stock.
Capitalization -- Total capitalization at June 30, 2004 of $1 billion
consisted of approximately 12.1% long-term debt less amount due currently, 15%
long term debt held by subsidiary trust, 7.3% preferred stock, and 65.6% common
stock equity.
Short-term Borrowings -- At June 30, 2004, TXU Gas had outstanding
short-term borrowings consisting of bank borrowings of $300 million at a
weighted average interest rate of 2.18% and $38 million of short-term advances
from affiliates at a weighted average interest rate of 2.85%. At March 31, 2004,
TXU Gas had outstanding short-term advances from affiliates of $231 million at a
weighted average interest rate of 2.86%.
Credit Facilities -- On April 26, 2004, a new $300 million, 364-day credit
facility was established for TXU Gas. Borrowings of $300 million under this new
facility were used to repay advances from affiliates. This facility was repaid
and terminated in July 2004 with advances from affiliates.
Sale of Receivables -- TXU Corp. has established an accounts receivable
securitization program. The activity under this program is accounted for as a
sale of accounts receivable in accordance with SFAS 140. Under the program,
subsidiaries of TXU Corp. (originators) sell trade accounts receivable to TXU
Receivables Company, a consolidated wholly-owned bankruptcy remote direct
subsidiary of TXU Corp., which sells undivided interests in the purchased
accounts receivable for cash to special purpose entities established by
financial institutions. 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. Funding to TXU
Gas under the program at June 30, 2004 and December 31, 2003 totaled $47 million
and $53 million, respectively. See Note 2 to Financial Statements for a more
complete description of the program including the financial impact on earnings
and cash flows for the periods presented and the contingencies that could result
in termination of the program.
Credit Ratings -- The current credit ratings for TXU Corp. and TXU Gas are
presented below:
TXU Corp. TXU Gas
--------- ----------
(Senior (Senior
Unsecured) Unsecured)
S&P................... BBB- BBB
Moody's............... Ba1 Baa3
Fitch................. BBB- BBB-
Moody's and Fitch currently maintain a stable outlook for TXU Corp.
and a developing outlook for TXU Gas. S&P currently maintains a negative
outlook for TXU Corp. and a developing outlook for TXU Gas.
These ratings are investment grade, except for Moody's rating of TXU
Corp.'s senior unsecured debt, which is one notch below investment grade.
18
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 of TXU Gas' financing arrangements
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 material
provisions are described below.
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 TXU Gas' senior
notes.
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 each have a cross
default threshold of $50,000. If either an originator, TXU Business Services or
TXU Receivables Company defaults on indebtedness of the applicable threshold,
the facility could terminate.
Long-term Contractual Obligations and Commitments -- The table below
reflects updates of amounts presented in the 2003 Form 10-K to reflect the
obligation for the repayment of debt and other instruments as discussed in Note
2 to the Financial Statements, and changes in gas purchase agreements.
Contractual Cash Obligations
- ----------------------------
One to Three to More
Less Than Three Five Than Five
One Year Years Years Years
-------- ----- ----- -----
Long-term debt - principal and interest........ $ 172 $ 24 $ 137 $ 228
Gas purchases.................................. 130 347 28 50
There have been no other significant changes in contractual cash
obligations of TXU Gas, since December 31, 2003 as disclosed in the 2003 Form
10-K.
OFF BALANCE SHEET ARRANGEMENTS
See discussion above under Sale of Receivables and in Note 3 to Financial
Statements.
COMMITMENTS AND CONTINGENCIES
See Note 6 to Financial Statements for details of contingencies, including
guarantees.
REGULATION AND RATES
Gas Distribution Rates - See Note 2 for discussion of system-wide rate
case filed in May 2003 and related RRC order issued in May 2004.
Summary -- 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
this report, 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.
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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' 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, the Natural Gas Act, as amended, the Clean Air Act,
as amended, the Natural Gas Policy Act, as amended) and changing governmental
policy and regulatory actions, including those of the RRC, TCEQ, and the EPA,
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 are subject to cost-of-service regulation. This
regulatory treatment does not provide any assurance as to achievement of
earnings levels.
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 relies on advances from affiliates and access to financial markets
to a lesser extent as a significant source of liquidity for capital requirements
not satisfied by operating cash flows. The inability to raise capital on
favorable terms, particularly during times of uncertainty in the financial
markets, could impact TXU Gas' ability to sustain and grow its businesses, which
are capital intensive, and would likely increase its capital costs.
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.
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.
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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.
As a result of the energy crisis in California during 2001, the recent
volatility of natural gas prices in North America, the bankruptcy filing by
Enron Corporation, accounting irregularities of public companies, and
investigations by governmental authorities into energy trading activities,
companies in the regulated and non-regulated utility businesses have been under
a generally increased amount of public and regulatory scrutiny. Accounting
irregularities at certain companies in the industry have caused regulators and
legislators to review current accounting practices and financial disclosures.
The capital markets and ratings agencies also have increased their level of
scrutiny. Additionally, allegations against various energy trading companies of
"round trip" or "wash" transactions, which involve the simultaneous buying and
selling of the same amount of power at the same price and delivery location and
provide no true economic benefit, power market manipulation and inaccurate power
and commodity price reporting have had a negative effect on the industry. TXU
Gas believes that it is complying with all applicable laws, but it is difficult
or impossible to predict or control what effect these events may have on TXU
Gas' financial condition or access to the capital markets. Additionally, it is
unclear what laws and regulations may develop, and TXU Gas cannot predict the
ultimate impact of any future changes in accounting regulations or practices in
general with respect to public companies, the energy industry or its operations
specifically. Any such new accounting standards could negatively impact reported
financial results.
TXU Corp. is not obligated to provide any loans, further equity
contributions or other funding to TXU Gas or any of its subsidiaries. TXU Gas
must compete with all of TXU Corp.'s other subsidiaries for capital and other
resources. As a member of the TXU corporate group, TXU Gas operates within
policies, including dividend policies, established by TXU Corp. that impact the
liquidity of TXU Gas.
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 and its subsidiaries
(collectively, 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 TXU Gas' 2003 Form
10-K, that could cause the actual results of TXU Gas to differ materially from
those projected in such forward-looking statements. In addition, such
forward-looking statements may be affected by TXU Gas' ability or inability to
complete the sale of its business to Atmos as contemplated.
Any forward-looking statement speaks only as of the date on which it is
made, and TXU Gas undertakes no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which it 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 them; nor can
TXU Gas assess the impact of each such factor or the extent to which any factor,
or combination of factors, may cause results to differ materially from those
contained in any forward-looking statement.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Except as presented below, 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 2003 Form 10-K and
is therefore not presented herein.
INTEREST RATE RISK
See Note 3 to Financial Statements for a discussion of the issuance and
retirement of debt since December 31, 2003.
CREDIT RISK
Credit risk relates to the risk of loss associated with non-performance by
non-affiliated counterparties. TXU Gas' gross exposure to credit risk, net of
receivable sales as of June 30, 2004 was $29 million, after reserves of $5
million, primarily representing trade accounts receivable associated with the
sale of natural gas to residential and business customers. TXU Gas had no
exposure to any one customer that represented greater than 10% of TXU Gas' trade
accounts receivable at June 30, 2004. Reserves for uncollectible accounts
receivable are established for the potential loss from non-payment by these
customers based on historical experience and market or operational conditions.
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. This evaluation took into
consideration the strategic initiatives described in Note 1 to Financial
Statements. 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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits provided as part of Part II are:
Previously Filed*
-----------------
With File As
Exhibits Number Exhibit
- -------- ----- -------
(10) Material Contracts.
10(a) 1-12833 -- $300,000,000 Credit Agreement dated as of April 26, 2004,
Form 10-Q among TXU Gas Company, the Lenders listed in Schedule 2.01
(filed August 6, thereto, and Credit Suisse First Boston as Administrative
2004) Agent.
10(b) 1-2833 -- Agreement and Plan of Merger by and between TXU Gas Company
Form 10-Q and LSG Acquisition Corporation dated June 17, 2004.
(filed August 6,
2004)
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Previously Filed*
-----------------
With File As
Exhibits Number Exhibit
- -------- ----- -------
(a) Exhibits provided as part of Part II are:
15 -- Letter from independent accountants as to unaudited interim
financial information.
(31) Rule 13a - 14(a)/15d - 14(a) Certifications.
31(a) -- Certification of M.S. Greene, principal executive officer of
TXU Gas Company, pursuant to Rule 13a - 14(a)/15d - 14(a) of
the Securities Exchange Act of 1934, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31(b) -- Certification of David Anderson, principal financial officer
of TXU Gas Company, pursuant to Rule 13a - 14(a)/15d - 14(a)
of the Securities Exchange Act of 1934, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
(32) Section 1350 Certifications.
32(a) -- Certification of M.S. Greene, principal executive officer of
TXU Gas Company, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32(b) -- Certification of David Anderson, principal financial officer
of TXU Gas Company, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(99) Additional Exhibits.
99 -- Condensed Statement of Consolidated Income - Twelve Months
Ended June 30, 2004
- ---------------------
* Incorporated herein by reference.
(b) Reports on Form 8-K furnished or filed since March 31, 2004:
Date of Report Item Reported
-------------- -------------
April 26, 2004 Item 5 Other Events and Regulation FD Disclosure
Item 12 Results of Operations and Financial Condition
April 27, 2004 Item 5 Other Events and Regulation FD Disclosure
May 27, 2004 Item 5 Other Events and Regulation FD Disclosure
June 18, 2004 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
Senior Vice President & Chief
Financial Officer
August 13, 2004
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