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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, 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 1-12833
TXU Corp.
(Exact Name of Registrant as Specified in its Charter)
Texas 75-2669310
(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 X No X
--- ---
Common Stock outstanding at November 3, 2004: 291,200,409 shares, without
par value.
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TABLE OF CONTENTS
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PAGE
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GLOSSARY........................................................................................... ii
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Statements of Consolidated Income -
Three and Nine Months Ended September 30, 2004 and 2003.......................... 1
Condensed Statements of Consolidated Comprehensive Income -
Three and Nine Months Ended September 30, 2004 and 2003.......................... 2
Condensed Statements of Consolidated Cash Flows -
Nine Months Ended September 30, 2004 and 2003.................................... 3
Condensed Consolidated Balance Sheets -
September 30, 2004 and December 31, 2003......................................... 4
Notes to Financial Statements.................................................... 5
Report of Independent Registered Public Accounting Firm.......................... 33
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................................ 34
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................... 78
Item 4. Controls and Procedures ....................................................... 80
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................ 80
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...................... 80
Item 6. Exhibits......................................................................... 81
SIGNATURE.......................................................................................... 82
Periodic reports on Form 10-K and Form 10-Q and current reports on Form 8-K that
contain financial information of TXU Corp. 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
Corp. will provide copies of current reports not posted on the website upon
request. The information on TXU Corp.'s website shall not be deemed a part of,
or incorporated by reference into, this report on Form 10-Q.
i
GLOSSARY
When the following terms and abbreviations appear in the text of this report,
they have the meanings indicated below.
1999 Restructuring Legislation................. Legislation that restructured the electric utility industry
in Texas to provide for retail competition
2003 Form 10-K................................. TXU Corp.'s Annual Report on Form 10-K for the year ended
December 31, 2003
Bcf............................................ billion cubic feet
Commission..................................... Public Utility Commission of Texas
EITF........................................... Emerging Issues Task Force
EITF 98-10 .................................... EITF Issue No. 98-10, "Accounting for Contracts Involved in
Energy Trading and Risk Management Activities"
EITF 02-3 ..................................... EITF Issue No. 02-3, "Issues Involved in Accounting for
Derivative Contracts Held for Trading Purposes and Contracts
Involved in Energy Trading and Risk Management Activities"
Electric Delivery.............................. refers to TXU Electric Delivery Company (formerly Oncor
Electric Delivery Company), a subsidiary of US Holdings, or
Electric Delivery and its consolidated bankruptcy remote
financing subsidiary, TXU Electric Delivery Transition Bond
Company LLC (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 various electricity systems within Texas
ERISA.......................................... Employee Retirement Income Security Act
FASB........................................... Financial Accounting Standards Board, the designated
organization in the private sector for establishing
standards for financial accounting and reporting
FERC........................................... Federal Energy Regulatory Commission
FIN............................................ Financial Accounting Standards Board Interpretation
FIN 46......................................... FIN No. 46, "Consolidation of Variable Interest Entities -
An Interpretation of ARB No. 51"
FIN 46R........................................ FIN No. 46 (Revised 2003), "Consolidation of Variable
Interest Entities - An Interpretation of ARB No. 51"
Fitch.......................................... Fitch Ratings, Ltd.
GWh............................................ gigawatt-hours
Historical service territory................... US Holdings' historical service territory, largely in north
Texas, at the time of entering retail competition on January
1, 2002
IRS............................................ Internal Revenue Service
ii
Moody's........................................ Moody's Investors Services, Inc.
MW............................................. megawatts
NRC............................................ United States Nuclear Regulatory Commission
Pinnacle....................................... Pinnacle One Partners, L.P., formerly the holding company
for the telecommunications business and formerly a joint
venture
price-to-beat rate............................. residential and small business customer electricity rates
established by the Commission in the restructuring of the
Texas market that are required to be charged in a REP's
historical service territories until January 1, 2005 or when
40% of the electricity consumed by such customer classes is
supplied by competing REPs, adjusted periodically for
changes in fuel costs, and required to be available to those
customers until January 1, 2007
REP............................................ retail electric provider
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 133....................................... SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities"
SFAS 140....................................... SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, a
replacement of FASB Statement 125"
SFAS 143....................................... SFAS No. 143, "Accounting for Asset Retirement Obligations"
SFAS 150....................................... SFAS No. 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity"
SG&A........................................... selling, general and administrative
TXU Australia.................................. refers to TXU Australia Group Pty Ltd, formerly a subsidiary
of TXU Corp., and/or its consolidated subsidiaries,
depending on context
TXU Business Services.......................... TXU Business Services Company, a subsidiary of TXU Corp.
TXU Communications............................. TXU Communications Ventures Company, formerly a subsidiary
of Pinnacle
TXU Corp....................................... refers to TXU Corp., a holding company, and/or its
consolidated subsidiaries, depending on context
TXU Europe..................................... TXU Europe Limited, a former subsidiary of TXU Corp.
TXU Gas........................................ TXU Gas Company, a subsidiary of TXU Corp.
TXU Mining..................................... TXU Mining Company LP, a subsidiary of Energy
iii
TXU Portfolio Management....................... TXU Portfolio Management Company LP, a subsidiary of Energy
UK............................................. United Kingdom
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.
iv
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
TXU CORP. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2004 2003 2004 2003
------ ------ ------ ------
(millions of dollars, except per share amounts)
Operating revenues.................................................... $2,743 $2,615 $7,178 $6,691
Costs and expenses:
Cost of energy sold, including delivery fees....................... 1,134 1,102 3,053 2,879
Operating costs.................................................... 337 336 1,057 1,025
Depreciation and amortization...................................... 210 183 579 535
Selling, general and administrative expenses....................... 280 227 805 644
Franchise and revenue-based taxes.................................. 94 92 265 280
Other income....................................................... (48) (23) (73) (49)
Other deductions................................................... 20 7 477 30
Interest income.................................................... (14) (5) (20) (20)
Interest expense and related charges............................... 163 194 521 597
------ ------ ------ ------
Total costs and expenses....................................... 2,176 2,113 6,664 5,921
------ ------ ------ ------
Income from continuing operations before income taxes, extraordinary
gain and cumulative effect of changes in accounting principles.... 567 502 514 770
Income tax expense.................................................... 187 169 92 243
------ ------ ------ ------
Income from continuing operations before extraordinary gain and
cumulative effect of changes in accounting principles.............. 380 333 422 527
Income from discontinued operations, net of tax benefit (Note 3)...... 287 64 666 84
Extraordinary gain, net of tax (Note 1)............................... - - 16 -
Cumulative effect of changes in accounting principles, net of tax
benefit (Note 2).................................................. - - - (58)
------ ------ ------ -------
Net income ........................................................... $ 667 $ 397 $1,104 $ 553
Exchangeable preferred membership interest buyback premium (Note 1)... - - 849 -
Preference stock dividends ........................................... 5 5 16 16
------ ------ ------ ------
Net income available to common shareholders........................... $ 662 $ 392 $ 239 $ 537
====== ====== ====== ======
Average shares of common stock outstanding (millions):
Basic.............................................................. 295 322 313 321
Diluted............................................................ 295 379 313 378
Per share of common stock:
Basic earnings:
Income from continuing operations before extraordinary gain and
cumulative effect of changes in accounting principles......... $ 1.30 $ 1.04 $ 1.36 $1.64
Income from discontinued operations, net of tax effect.......... 0.97 0.20 2.13 0.26
Extraordinary gain, net of tax.................................. - - 0.05 -
Cumulative effect of changes in accounting principles, net of
tax benefit................................................... - - - (0.18)
Exchangeable preferred membership interest buyback premium...... - - (2.72) -
Preference stock dividends...................................... (0.02) (0.02) (0.05) (0.05)
Net income available to common shareholders..................... 2.25 1.22 0.77 1.67
Diluted earnings (Note 1):
Income from continuing operations before extraordinary gain and
cumulative effect of changes in accounting principles......... $ 0.39 $ 0.91 $ 0.50 $1.49
Income from discontinued operations, net of tax effect.......... 0.97 0.17 2.13 0.22
Extraordinary gain, net of tax.................................. - - 0.05 -
Cumulative effect of changes in accounting principles, net of - - - -
tax benefit.................................................. (0.15)
Exchangeable preferred membership interest buyback premium...... - - (2.72) -
Preference stock dividends...................................... (0.02) (0.01) (0.05) (0.04)
Net income available to common shareholders..................... 1.34 1.07 (0.09) 1.52
Dividends declared................................................ 0.125 0.125 0.375 0.375
See Notes to Financial Statements.
1
TXU CORP. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2004 2003 2004 2003
------ ------ ------ ------
(millions of dollars)
Components related to continuing operations:
Income from continuing operations before
extraordinary gain and cumulative effect of
changes in accounting principles......................... $380 $ 333 $ 422 $527
Other comprehensive income (loss), net of tax effects:
Cash flow hedges:
Net change in fair value of derivatives (net of tax
benefit of $5, $13, $41 and $83).................... (10) (23) (73) (155)
Amounts realized in earnings during the period
(net of tax expense of $8, $27 , $12 and $87) 16 53 24 162
---- ----- ----- -----
Total............................................. 6 30 (49) 7
---- ----- ------ -----
Comprehensive income related to continuing operations...... 386 363 373 534
Components related to discontinued operations:
Income from discontinued operations, net of tax.......... 287 64 666 84
Other comprehensive (loss) income, net of tax effects:
Foreign currency translation adjustment ................. (41) 19 (145) 180
Minimum pension liability adjustments (net of tax
(expense) benefit of $- and $-, $(4) and $3).......... 1 - 7 (6)
Cash flow hedges:
Net change in fair value of derivatives (net
of tax (expense) benefit of $(1), $(2), $-
and $21)............................................ 2 3 - (49)
Amounts realized in earnings during the period
(net of tax expense of $6, $6 , $- and $24)......... 13 11 - 55
---- ----- ----- -----
Total............................................. (25) 33 (138) 180
----- ----- ------ -----
Comprehensive income related to discontinued operations... 262 97 528 264
Extraordinary gain, net of tax................................ - - 16 -
Cumulative effect of changes in accounting principles, net of
tax benefit................................................. - - - (58)
---- ----- ----- ------
Comprehensive income.......................................... $648 $ 460 $ 917 $ 740
==== ===== ===== =====
See Notes to Financial Statements.
2
TXU CORP. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
------------------
2004 2003
------ ------
(millions of dollars)
Cash flows - operating activities:
Income from continuing operations before extraordinary gain and cumulative
effect of changes in accounting principles......................................... $ 422 $ 527
Adjustments to reconcile income from continuing operations before extraordinary gain
and cumulative effect of changes in accounting principles to cash provided by
operating activities:
Depreciation and amortization ..................................................... 627 591
Deferred income taxes and investment tax credits - net ............................ (96) 72
Loss on early extinguishment of debt............................................... 54 -
Asset writedown charges............................................................ 189 -
Net gain from sale of assets...................................................... (65) (40)
Net effect of unrealized mark-to-market valuations of commodity contracts.......... 46 (58)
Net equity loss from unconsolidated affiliates and joint ventures.................. 2 18
Reduction in regulatory liability.................................................. (1) (125)
Reduction in retail clawback accrual............................................... - (19)
Changes in operating assets and liabilities........................................... (94) 844
------ ------
Cash provided by operating activities.......................................... 1,084 1,810
Cash flows - financing activities:
Issuances of securities:
Long-term debt..................................................................... 1,590 2,425
Common stock....................................................................... 9 27
Retirements/repurchases of securities:
Long-term debt held by subsidiary trusts........................................... (237) -
Equity-linked debt securities...................................................... (423) -
Other long-term debt............................................................... (1,826) (1,585)
Exchangeable preferred membership interests........................................ (750) -
Preferred securities of subsidiary, subject to mandatory redemption................ - (91)
Common stock....................................................................... (1,226) -
Change in notes payable:
Banks.............................................................................. 565 (2,305)
Cash dividends paid:
Common stock....................................................................... (120) (120)
Preference stock................................................................... (16) (16)
Premium paid for redemption of exchangeable preferred membership interests............ (1,102) -
Redemption deposit applied to debt retirements........................................ - 210
Debt premium, discount, financing and other reacquisition expenses.................... (42) (26)
------ ------
Cash used in financing activities.............................................. (3,578) (1,481)
Cash flows - investing activities:
Capital expenditures.................................................................. (543) (489)
Disposition of businesses............................................................. 2,805 18
Acquisition of telecommunications partner's interest.................................. - (150)
Nuclear fuel.......................................................................... (46) (45)
Investment in collateral trust........................................................ - (525)
Other................................................................................. 183 (12)
------ -------
Cash provided by (used in) investing activities................................ 2,399 (1,203)
------ -------
Effect of exchange rate changes on cash and cash equivalents.......................... - 1
Cash contributions to discontinued operations........................................... (142) (19)
------- -------
Net change in cash and cash equivalents................................................. (237) (892)
Cash and cash equivalents - beginning balance........................................... 829 1,513
------ ------
Cash and cash equivalents - ending balance........................................ $ 592 $ 621
====== ======
See Notes to Financial Statements.
3
TXU CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2004 2003
------------- --------------
ASSETS (millions of dollars)
Current assets:
Cash and cash equivalents.................................................. $ 592 $ 829
Restricted cash............................................................ 29 12
Accounts receivable -- trade............................................... 1,086 1,063
Inventories................................................................ 330 419
Commodity contract assets.................................................. 707 548
Assets of telecommunications holding company............................... - 110
Other current assets....................................................... 483 303
-------- -------
Total current assets................................................ 3,227 3,284
Investments:
Restricted cash............................................................ 579 582
Other investments.......................................................... 675 632
Property, plant and equipment -- net......................................... 16,488 16,803
Goodwill..................................................................... 542 558
Regulatory assets -- net.................................................... 1,922 1,872
Commodity contract assets.................................................... 229 109
Cash flow hedge and other derivative assets.................................. 24 88
Other noncurrent assets...................................................... 301 214
Assets held for sale......................................................... 2,161 7,155
-------- -------
Total assets........................................................ $ 26,148 $31,297
======== =======
LIABILITIES, PREFERRED SECURITIES OF SUBSIDIARIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Notes payable -- banks..................................................... $ 565 $ -
Long-term debt held by subsidiary trusts due currently..................... 154 -
All other long-term debt due currently..................................... 1,704 678
Accounts payable -- trade.................................................. 910 790
Commodity contract liabilities............................................. 545 502
Liabilities of telecommunications holding company.......................... - 603
Other current liabilities.................................................. 1,759 1,242
-------- -------
Total current liabilities........................................... 5,637 3,815
Accumulated deferred income taxes............................................ 2,241 3,599
Investment tax credits....................................................... 413 430
Commodity contract liabilities............................................... 309 47
Cash flow hedge and other derivative liabilities............................. 226 240
Long-term debt held by subsidiary trusts, less amounts due currently......... 155 546
All other long-term debt, less amounts due currently......................... 9,394 10,608
Other noncurrent liabilities and deferred credits............................ 2,682 2,382
Liabilities held for sale.................................................... 258 2,952
-------- -------
Total liabilities................................................... 21,315 24,619
Preferred securities of subsidiaries (Note 6)................................ 113 759
Contingencies (Note 8)
Shareholders' equity (Note 7):
Preference stock - not subject to mandatory redemption..................... 300 300
Common stock without par value: Authorized shares: 1,000,000,000
Outstanding shares: 291,722,227 and 323,883,092......................... 63 48
Additional paid-in capital.............................................. 6,095 8,097
Retained deficit........................................................ (1,523) (2,498)
Accumulated other comprehensive loss.................................... (215) (28)
--------- -------
Total common stock equity.............................................. 4,420 5,619
-------- -------
Total shareholders' equity........................................... 4,720 5,919
-------- -------
Total liabilities, preferred securities of subsidiaries and
shareholders' equity.............................................. $ 26,148 $31,297
======== =======
See Notes to Financial Statements.
4
TXU CORP. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
Description of Business - TXU Corp. is a holding company conducting its
operations principally through its Energy and Electric Delivery subsidiaries.
Energy is engaged in electricity generation and retail and wholesale energy
sales. Electric Delivery engages in regulated electricity transmission and
distribution operations. On October 1, 2004, TXU Corp. and Atmos Energy
Corporation completed a merger by division (the TXU Gas transaction) in which
Atmos Energy Corporation acquired TXU Gas' operations for approximately
$1.905 billion in cash. See "TXU Gas Transaction" below.
Strategic Initiatives and Other Actions - Mr. C. John Wilder, who was
named president and chief executive of TXU Corp. in February 2004, and senior
management have been reviewing the operations of TXU Corp. and have formulated
certain strategic initiatives and continue to develop others. Areas being
reviewed include:
o Performance in competitive markets, including profitability in new
markets;
o Cost structure, including organizational alignments and headcount;
o Management of natural gas price risk and cost effectiveness of the
generation fleet; and
o Non-core business activities.
As discussed below, implementation of the strategic initiatives as well as
other actions taken to date have resulted in the following effects on income
from continuing operations before extraordinary gain:
o TXU Corp. has recorded total charges of $19 million ($12 million
after-tax) in the third quarter of 2004 and $469 million ($311
million after-tax) year-to-date, reported largely in other
deductions, related to asset writedowns, employee severance, debt
extinguishment losses and litigation.
o In addition, TXU Corp. has incurred consulting and professional fees
related to the strategic initiatives totaling $15 million ($10
million after-tax) in the third quarter of 2004 and $34 million ($22
million after-tax) year-to-date, reported in SG&A expenses, and
nonrecurring contractual executive compensation expense of $52
million year-to-date (without tax benefit), also reported in SG&A
expenses.
o A $75 million income tax benefit was recorded in the second quarter
of 2004 to recognize a portion of the previously reserved tax
benefit associated with the write-off of TXU Europe. Such
recognition was triggered by the tax effects of the sale of the
assets of TXU Fuel Company.
o In the third quarter of 2004, TXU Corp. recorded gains on the
disposition of Energy properties totaling $18 million ($12
million after-tax), reported in other income.
Additional effects of the strategic initiatives, including the
dispositions of TXU Australia and TXU Gas and additional tax benefits related to
the write-off of the investment in TXU Europe, are reflected in results from
discontinued operations.
Charges recorded in the three-month and nine-month periods ended September
30, 2004 and 2003 reported in other deductions are detailed in Note 12.
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.,
but 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, subject to adjustment
for volumes or other factors, include information technology, customer call
center, billing and collections, human resources, supply chain and certain
accounting activities.
5
As part of the agreements, TXU Corp. provided Capgemini a royalty-free
right, under an asset license arrangement, to use TXU Corp.'s information
technology assets, consisting primarily of capitalized software. A portion of
the software was in development and had not yet been placed in service by TXU
Corp. As a result of outsourcing its information technology activities, TXU
Corp. no longer intends to develop the majority of these projects and from TXU
Corp.'s perspective the software is abandoned. The agreements with Capgemini do
not require that any software in development be completed and placed in service.
Consequently, the carrying value of these software projects was written off,
resulting in a charge of $109 million ($71 million after-tax) for the nine
months ended September 30, 2004, reported in other deductions, essentially all
of which was recorded in the second quarter of 2004. TXU Corp. expects to rely
on Capgemini or other third parties for future enhancements and modifications to
the software in use at the time of the transaction.
TXU Corp. received a 2.9% limited partnership interest in Capgemini in
exchange for the asset license described above. TXU Corp. has the right to sell
(the "put option") all its interest in the partnership and the software to Cap
Gemini America Inc. for $200 million, plus TXU Corp.'s share of Capgemini's
undistributed earnings, upon expiration of the services agreement, or earlier
upon the occurrence of certain unexpected events. Cap Gemini North America Inc.
has the right to purchase TXU Corp.'s 2.9% limited partnership interest in
Capgemini under the same terms and conditions. The partnership interest has been
recorded at an initial value of $2.9 million and is being accounted for on the
cost method.
TXU Corp. has recorded the fair value of the put option as a noncurrent
asset largely offset by a reduction to the carrying value of the software, in
accordance with the accounting principles related to sales and licensing of
internally developed software described in AICPA Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." The remaining balance of the software is being amortized over the
estimated remaining lives.
Also as part of the 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
Corp. recorded a $40 million ($26 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. In addition, TXU Corp.
committed to pay up to $25 million for costs associated with transitioning the
outsourced activities to Capgemini. The transition costs are expected to be
largely recorded by TXU Corp. during the fourth quarter of 2004.
Subject to certain terms and conditions, Cap Gemini North America, Inc.
and its parent, Cap Gemini S.A., have guaranteed the performance and payment
obligations of Capgemini under the service agreements, as well as the payment of
$200 million in connection with the put option.
The transfer of employees to Capgemini triggered a curtailment with
respect to TXU Corp.'s pension and other post-employment benefit plans. In the
second quarter of 2004, TXU Corp. recorded a net pre-tax curtailment charge of
$3 million, reported in other deductions, related to these plans. The
curtailment required a remeasurement of liabilities under the plans as of the
employee transfer date. The estimated effect of the employee transfers, combined
with changes in the discount rate and other assumptions, was a reduction in
pension and other postretirement expenses of approximately $36 million on an
annualized basis effective July 1, 2004.
On July 1, 2004, TXU Corp. loaned Capgemini $25 million for working
capital purposes pursuant to a promissory note that bears interest at a
market-based annual rate of 4% and matures on July 1, 2019.
Sale of TXU Australia
---------------------
On July 30, 2004, TXU Corp. completed the sale of TXU Australia to
Singapore Power Ltd. for $3.6 billion, including $1.7 billion of assumed debt
and $1.9 billion in cash. The cash proceeds were used to repay short-term
borrowings. A gain on sale of $367 million ($239 million after-tax) was recorded
in the third quarter of 2004. The results of TXU Australia and the gain on sale
are reported as discontinued operations as discussed in Note 3.
6
Sale of TXU Fuel Company
------------------------
On June 2, 2004, TXU Corp. completed the sale of the assets of TXU Fuel
Company, the gas transportation subsidiary of Energy, to Energy Transfer
Partners, L.P. for $500 million in cash. The cash proceeds were used to repay
short-term borrowings. The assets of TXU Fuel Company consisted of approximately
1,900 miles of intrastate pipeline and a total system capacity of 1.3 Bcf/day.
As part of the transaction, Energy entered into a market-price based
transportation agreement with the new owner to transport gas to Energy's
generation plants. Because of the continuing involvement in the business through
the transportation agreement, the pre-tax gain related to the sale of $377
million will be recognized over the eight-year life of the transportation
agreement, and the business has not been accounted for as a discontinued
operation. The pre-tax gain is net of $16 million of Energy goodwill allocated
to TXU Fuel Company.
TXU Gas Transaction
-------------------
On October 1, 2004, Atmos Energy Corporation and TXU Gas completed a
merger by division, which resulted in the disposition of the operations of TXU
Gas for $1.905 billion in cash. The intent to dispose of the operations had been
previously disclosed. A pre-tax loss on the transaction of approximately $58
million is now expected, and this amount was recorded as a goodwill impairment
charge in the third quarter of 2004. This amount includes the effect of $19
million in discontinued depreciation expense in accordance with accounting rules
for assets held for sale. The balance of the loss reflects changes in the terms
of the transaction agreement and refinements of previous estimates. The results
of TXU Gas, as well as goodwill impairment charges recorded, are reported as
discontinued operations as discussed in Note 3.
On October 1, 2004, prior to the close of the TXU Gas transaction, TXU Gas
irrevocably deposited with the applicable trustees an aggregate of approximately
$450 million (principal and interest) for the legal defeasance of all of its
outstanding debt securities. A portion of this deposit was used to redeem the
$154 million principal amount of Floating Rate Junior Subordinated Debentures
on October 31, 2004. The remaining amount of this deposit will be used to redeem
the $125 million principal amount of the Remarketed Reset Notes on July 1, 2005,
and to repay the $150 million principal amount of the 7.125% Notes at maturity
on June 15, 2005. In addition, on October 1, 2004, prior to the close of the
TXU Gas transaction, TXU Gas irrevocably deposited with a Texas bank
approximately $75 million for the redemption of all of its outstanding preferred
stock. On November 5, 2004, all of the outstanding shares of TXU Gas'
preferred stock with a liquidation value of $75 million were redeemed.
Recognition of Income Tax Benefits
----------------------------------
On its US federal income tax return for calendar year 2002, TXU Corp.
claimed an ordinary loss deduction related to the worthlessness of TXU Corp.'s
investment in TXU Europe, the tax benefit of which is estimated to be $983
million (assuming the deduction is sustained on audit). Due to a number of
uncertainties regarding the proper tax treatment of the worthlessness loss, no
portion of the tax benefit related to TXU Corp.'s 2002 write-off of its
investment in TXU Europe was recognized in income prior to the second quarter of
2004.
In June 2004, the IRS issued a preliminary notice of proposed adjustment
proposing to disallow the 2002 worthlessness deduction and treat the
worthlessness as a capital loss (deductible only against capital gains).
Accordingly, in the second quarter of 2004, TXU Corp. recorded a tax benefit in
income of $711 million related to the utilization of a portion of the
worthlessness deduction. The tax benefit recognized reflects utilization of the
capital loss deduction against capital gains reported for 2002 and the 1999-2001
carryback periods and the capital gains on the 2004 sales of the TXU Australia,
TXU Fuel Company and the telecommunications businesses. The benefit recognized
also included $215 million for certain items related to the write-off of TXU
Corp.'s investment in TXU Europe expected to be sustained as ordinary deductions
as a result of the preliminary notice.
7
As a result of the TXU Gas transaction on October 1, 2004, TXU Corp.
expects to realize a capital gain for tax purposes. As a result of this gain,
TXU Corp. recognized an estimated tax benefit in the third quarter of 2004
related to the utilization of a portion of the 2002 worthlessness deduction
arising from the write-off of the TXU Europe investment. In addition, during the
third quarter of 2004, TXU Corp. revised certain estimates of capital gains and
ordinary deductions impacting the worthlessness deduction utilization. The net
tax benefit recognized in 2004 with respect to the write-off of the investment
in TXU Europe totals $76 million in the third quarter and $787 million
year-to-date.
Benefits arising from the resolution of uncertainty regarding utilization
of deductions in the year the TXU Europe investment was written-off or in a
prior year are reported in discontinued operations. Benefits arising from
resolution of uncertainty regarding utilization of deductions in subsequent
years are classified in the same manner as the source of the income resulting in
the recognition of the benefits. Accordingly, of the total $787 million
year-to-date benefit, $75 million was reported in continuing operations in the
second quarter of 2004 as this amount relates to the capital gain arising from
the sale of the assets of TXU Fuel Company, the historical operations of which
have been classified as continuing operations.
See Note 8 for discussion of income tax contingencies related to TXU
Europe and other matters.
Facility Closures and Other Actions Related to Generation Operations
--------------------------------------------------------------------
In the third quarter of 2004, Energy recorded gains totaling $18 million
($12 million after-tax) related to the sale of undeveloped land. The gains are
reported in other income.
In the second quarter of 2004, Energy initiated a plan to sell the
Pedricktown, New Jersey 122 MW power production facility and exit the related
power supply and gas transportation agreements. Accordingly, Energy recorded an
impairment charge of $26 million ($17 million after-tax) to write down the
facility to estimated fair market value. The results of the business and the
impairment charge are reported in discontinued operations as discussed in Note
3.
As part of Energy's review of its generation asset portfolio, Energy
completed a review of its spare parts and equipment inventory to determine the
appropriate level of such inventory. The review included nuclear, coal and
gas-fired generation-related facilities. As a result of this review, Energy
recorded a charge of $79 million ($51 million after-tax), reported in other
deductions, in the second quarter of 2004 to reflect excess inventory on hand
and to write down carrying values to scrap values.
In March 2004, Energy announced the planned permanent retirement,
completed in the second quarter of 2004, of eight gas-fired operating units due
to electric industry market conditions in Texas. Energy also temporarily closed
four other gas-fired units and placed them under evaluation for retirement. The
12 units represented a total of 1,471 MW, or more than 13%, of Energy's
gas-fired generation capacity in Texas. A majority of the 12 units were
designated as "peaking units" and operated only during the summer for many years
and have operated only sparingly during the last two years. Most of the units
were built in the 1950's. Energy also determined that it would close its
Winfield North Monticello lignite mine in Texas, and such closure has been
completed, as it is no longer economical to operate when compared to the cost of
purchasing coal to fuel the adjacent generation facility. A total charge of $8
million ($5 million after-tax) was recorded in the first quarter of 2004,
reported in other deductions, for production employee severance costs ($7
million pre-tax) and impairments related to the various facility closures ($1
million pre-tax).
Organizational Realignment and Headcount Reductions
---------------------------------------------------
During the second quarter of 2004, management completed a comprehensive
organizational review, including an analysis of staffing requirements. As a
result, TXU Corp. completed a self-nomination severance program and finalized a
plan for additional headcount reductions under an involuntary severance program,
which has been largely completed. Accordingly, in the second quarter of 2004,
TXU Corp. recorded severance charges totaling $53 million ($34 million
after-tax), reported in other deductions.
8
Liability and Capital Management
---------------------------------
As part of its debt and capital management program, on September 15, 2004,
TXU Corp. announced cash tender offers for certain outstanding equity-linked
debt securities and convertible notes. In October 2004, as a result of the
tender offers, TXU Corp. repurchased the following securities:
o 7,485,592, or 64.9%, of its outstanding Corporate Units for a
purchase price of $52.28 per Corporate Unit, including $187 million
principal amount of outstanding Series L Senior Notes, which were a
component of the purchased Corporate Units;
o 5,117,962, or 58.2%, of its outstanding Income PRIDES for $52.39 per
Income PRIDE, including $256 million principal amount of outstanding
Series M Senior Notes, which were a component of the purchased
Income PRIDES; and
o $482 million principal amount, or 91.8%, of its outstanding Floating
Rate Convertible Senior Notes due 2033, for $1,593.65 per $1,000
principal amount of Convertible Senior Notes. TXU Corp. intends to
settle any future conversion of the remaining outstanding notes in
common stock.
On August 16, 2004, the TXU Corp. Series K Senior Notes (aggregate
principal outstanding of $288 million) were remarketed. TXU Corp. participated
as an investor in the remarketing and purchased for retirement $238 million
principal amount of the notes for $241 million, resulting in a charge of $4
million ($3 million after-tax). The remaining $50 million principal amount
outstanding bears a new interest rate of 4.446% and matures in November 2006.
On September 28, 2004, portions of the Brazos River Authority Pollution
Control Revenue Refunding Bonds related to the Twin Oak facility were redeemed
at par as follows: $57 million of Series 2001C; $21 million of Series 2003C; $16
million of Series 2002A; $4 million of series 1995B; and $3 million of Series
2001D.
In the second quarter of 2004, TXU Corp. repurchased $427 million carrying
amount ($423 million principal amount and $4 million in deferred costs) of
equity-linked debt securities for $404 million. The repurchase was in connection
with a settlement of related litigation and resulted in total charges of $34
million ($28 million after-tax), reported in other deductions, essentially
representing the premium for the debt component of the securities and an
additional repurchase premium. The repurchase also resulted in a credit to
additional paid-in capital of $57 million, which represented the holder's
out-of-the-money fair market value of the related equity purchase contracts. An
additional credit to additional paid-in capital of $18 million was recorded to
reverse the remaining liability for future contract adjustment payments to
holders of the securities. At the time of issuance of the securities, TXU Corp.
had recorded a liability for the present value of the contract adjustment
payments with an offsetting reduction to common stock equity.
In June 2004, TXU Corp. repurchased 20 million shares of its outstanding
common stock through an accelerated share repurchase agreement at an initial
price of $39.86 per share. As of September 30, 2004, the broker-dealer that
executed the repurchase transaction had completed the process of purchasing an
equal amount of shares in the open market, and TXU Corp. paid a purchase price
adjustment of $7 million based upon the actual cost of the shares repurchased by
such broker-dealer.
Also in the second quarter of 2004, TXU Corp. repurchased at par $237
million principal amount of 7.25% notes held by subsidiary trusts and $118
million principal amount of 6.375% senior notes for $125 million. These
transactions resulted in debt extinguishment losses totaling $15 million ($10
million after-tax), reported in other deductions.
In April 2004, TXU Corp. repurchased Energy's exchangeable preferred
membership interests with a liquidation amount of $750 million for $1.85 billion
(including transaction costs). The excess of the purchase price over the
carrying value of the securities, net of $384 million in income tax benefits
recorded as a deferred tax asset, was recorded as a charge to additional paid-in
capital in the amount of $849 million. The carrying value of the securities was
$617 million, which is the liquidation amount of $750 million net of $102
million in unamortized discount and $31 million in unamortized debt issuance
costs, both recorded at the time of issuance of the securities in November 2002.
The charge to additional paid-in capital is accounted for in a manner similar to
TXU Corp.'s preference share dividends, resulting in a reduction in net income
available to common shareholders.
9
TXU Corp. also repurchased 5.7 million of its common shares on the open
market for approximately $240 million during the third quarter of 2004, and 11.1
million shares for $434 million year-to-date.
See Notes 4, 5, and 6 for further detail of debt issuances and
retirements, financing arrangements and debt held by unconsolidated subsidiary
trusts.
Litigation Accrual
------------------
During the second quarter of 2004, management assessed the progress and
status of matters in litigation as described in Note 8 and recorded an accrual
of $100 million ($65 million after-tax), reported in other deductions, for the
expected resolution of certain cases.
Discontinued Businesses - Note 3 presents detailed information regarding
the TXU Australia, TXU Gas and other discontinued businesses. The condensed
consolidated financial statements for all periods presented reflect the
reclassification of the results of these businesses (for the periods they were
consolidated) as discontinued operations.
Basis of Presentation -- The condensed consolidated financial statements
of TXU Corp. have been prepared in accordance with US GAAP and on the same basis
as the audited financial statements included in its 2003 Form 10-K, except for
the changes in estimates of depreciable lives of assets discussed below and the
presentation of certain operations as discontinued. In the opinion of
management, all other adjustments (consisting of normal recurring accruals)
necessary for a fair presentation of the results of operations and financial
position have been included therein. All intercompany items and transactions
have been eliminated in consolidation. Certain information and footnote
disclosures normally included in annual consolidated financial statements
prepared in accordance with US GAAP have been omitted pursuant to the rules and
regulations of the SEC. Because the condensed consolidated interim financial
statements do not include all of the information and footnotes required by US
GAAP, they should be read in conjunction with the audited financial statements
and related notes included in the 2003 Form 10-K. The results of operations for
an interim period may not give a true indication of results for a full year.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
(the Medicare Act) was enacted in December 2003. TXU Corp. is accounting for the
effects of the Medicare Act in accordance with FASB Staff Position 106-2. For
the three and nine months ended September 30, 2004, the effect of adoption of
the Medicare Act was a reduction of approximately $7 million and $22 million,
respectively, in TXU Corp.'s postretirement benefit costs.
Certain reclassifications have been made to conform prior period data to
the current period presentation. All dollar amounts in the financial statements
and tables in the notes, except per share amounts, are stated in millions of
dollars unless otherwise indicated.
Depreciation of Energy Production Facilities -- Effective January 1, 2004,
the estimates of the depreciable lives of lignite-fired generation facilities
were extended an average of nine years to better reflect the useful lives of the
assets, and depreciation rates for the Comanche Peak nuclear generating plant
were decreased as a result of an increase in the estimated lives of boiler and
turbine generator components of the plant by an average of five years. The net
impact of these changes was a reduction in depreciation expense of $11 million
and $33 million ($7 million and $21 million after-tax) in the three and nine
months, respectively, ended September 30, 2004.
Effective April 1, 2003, the estimates of the depreciable lives of the
Comanche Peak nuclear generating plant and several gas generation plants were
extended to better reflect the useful lives of the assets. At the same time,
depreciation rates were increased on lignite and gas generation facilities to
reflect additional investments in equipment. The net impact of these changes was
an additional reduction in depreciation expense of $12 million ($8 million
after-tax) in the nine months ended September 30, 2004.
10
Changes in Accounting Standards -- FIN 46R was issued in December 2003 and
replaced FIN 46, which was issued in January 2003. FIN 46R expands and clarifies
the guidance originally contained in FIN 46, regarding consolidation of variable
interest entities. FIN 46R did not impact results of operations or financial
position for the first nine months of 2004.
Extraordinary gain -- An extraordinary gain of $16 million (net of tax of
$9 million) in 2004 represents an increase in the carrying value of Electric
Delivery's regulatory asset subject to securitization. The second and final
tranche of the securitization bonds was issued in June 2004. The increase in the
related regulatory asset, with a carrying value of $1.6 billion, is due to the
effect of higher interest rates on the bonds and therefore increased amounts to
be recovered from REPs through delivery fee surcharges to service the bonds.
Earnings Per Share -- Basic earnings per share available to common
shareholders are based on the weighted average number of common shares
outstanding during the quarter. Diluted earnings per share include the effect of
all potential issuances of common shares. Diluted earnings per share for the
third quarter and year-to-date 2004 reflect a reduction in earnings of $268
million or $0.91 per share for the quarter and $0.86 per share year-to-date
related to the $525 million principal amount Convertible Senior Notes. The
dilution arises because the conversion trigger price of $41.48 was reached in
the third quarter of 2004. Because of TXU Corp.'s stated intent to settle the
conversion in cash, the calculation of diluted earnings per share reflects a
reduction in earnings to reflect the assumed after-tax settlement expense based
on the fair market value of the embedded conversion option at September 30,
2004. Also see above discussion of the tender offer for these notes.
The exchangeable preferred membership interests in Energy were
anti-dilutive in 2004 for the period prior to TXU Corp.'s repurchase of these
securities in April 2004. However, the premium paid to buy back these securities
reduced earnings available for common stock by $849 million or $2.72 per share
for the nine months ended September 30, 2004. Assuming these securities were
converted to TXU Corp. common stock at the beginning of the periods at the
exercise price of $13.1242 per share, 57 million more shares for each of the
three and nine months ended September 30, 2003, respectively, would have been
issued and net income would have increased by $13 million and $26 million,
respectively, representing the after-tax distributions on the exchangeable
preferred membership interests and amortization of the related discount.
Additional dilutive shares would have resulted from approximately 7
million shares and 10 million shares of common stock issuable in connection with
equity-linked debt securities issued in 2002 and 2001, respectively, if the
average of the closing price per share of TXU Corp. common stock on each of the
twenty consecutive trading days ending on the third day immediately preceding
the end of a reporting period was equal to or above the threshold appreciation
price of $62.91 and $55.68 per share for the respective issuances. For the three
and nine months ended September 30, 2004 and 2003, the market price of TXU Corp.
common stock was below these prices. See discussion above under "Debt and
Capital Management" regarding repurchases of these securities.
2. CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES
The following summarizes the effect on results for 2003, reported in the
first quarter, of changes in accounting principles effective January 1, 2003:
Charge from rescission of EITF 98-10, net of tax effect of $34 million.... $(63)
Credit from adoption of SFAS 143, net of tax effect of $3 million......... 5
----
Total net charge..................................................... $(58)
=====
On October 25, 2002, the EITF, through EITF 02-3, rescinded EITF 98-10,
which required mark-to-market accounting for all trading activities. Pursuant to
this rescission, only financial instruments that are derivatives under SFAS 133
are subject to mark-to-market accounting. Financial instruments that may not be
derivatives under SFAS 133, but were marked-to-market under EITF 98-10, consist
primarily of gas transportation and storage agreements, power tolling, full
requirements and capacity contracts. This new accounting rule was effective for
11
new contracts entered into after October 25, 2002. Non-derivative contracts
entered into prior to October 26, 2002, continued to be accounted for at fair
value through December 31, 2002; however, effective January 1, 2003, such
contracts were required to be accounted for on a settlement basis. Accordingly,
a charge of $97 million ($63 million after-tax) was reported as a cumulative
effect of a change in accounting principles in the first quarter of 2003. Of the
total, $75 million reduced net commodity contract assets and liabilities and $22
million reduced inventory that had previously been marked-to-market as a trading
position. The cumulative effect adjustment represents the net gains previously
recognized for these contracts under mark-to-market accounting.
SFAS 143 became effective on January 1, 2003. SFAS 143 requires entities
to record the fair value of a legal liability for an asset retirement obligation
in the period of its inception. For TXU Corp., such liabilities primarily relate
to nuclear generation plant decommissioning, land reclamation related to lignite
mining and removal of lignite plant ash treatment facilities. The liability is
recorded at its net present value with a corresponding increase in the carrying
value of the related long-lived asset. The liability is accreted each period,
representing the time value of money, and the capitalized cost is depreciated
over the remaining useful life of the related asset.
As the new accounting rule required retrospective application to the
inception of the liability, the effects of the adoption reflect the accretion
and depreciation from the liability inception date through December 31, 2002.
Further, the effects of adoption take into consideration liabilities of $215
million (previously reflected in accumulated depreciation) TXU Corp. had
previously recorded as depreciation expense and $26 million (reflected in other
noncurrent liabilities) of unrealized net gains associated with the
decommissioning trusts.
The following table summarizes the impact as of January 1, 2003 of
adopting SFAS 143:
Increase in property, plant and equipment - net................ $488
Increase in other noncurrent liabilities and deferred credits.. (528)
Increase in accumulated deferred income taxes.................. (3)
Increase in regulatory assets - net............................ 48
----
Cumulative effect of change in accounting principles........... $ 5
====
The asset retirement liability at September 30, 2004 was $610 million,
comprised of a $599 million liability as of December 31, 2003 and $30 million of
accretion during the nine months ended September 30, 2004, reduced by $19
million in reclamation payments.
With respect to nuclear decommissioning costs, for TXU Corp. the adoption
of SFAS 143 results in timing differences in the recognition of asset retirement
costs that are being recovered through the regulatory process.
12
3. DISCONTINUED OPERATIONS
The following summarizes the historical consolidated financial information
of the businesses reported as discontinued operations:
Three Months Ended September 30, 2004
------------------------------------------------------------
Strategic
TXU TXU Retail Pedrick-
Gas Australia Services town Telecom Total
------- --------- --------- -------- ------- ------
Operating revenues............................... $ 186 $ 146 $ 3 $ 8 $ - $ 343
Operating costs and expenses..................... 168 108 4 8 - 288
Other deductions (income) -- net................. 3 (7) - - - (4)
Interest income.................................. - - - - - -
Interest expense and related charges............. 8 12 - - - 20
----- ----- ----- ----- ----- -----
Operating income (loss) before income taxes...... 7 33 (1) - - 39
Income tax expense (benefit) .................... (1) 16 1 - - 16
------ ----- ----- ----- ----- -----
Operating income (loss).......................... 8 17 (2) - - 23
Credits (charges) related to exit (after-tax).... (58) 244 (1) - 3 188
Recognition of tax benefits...................... - - - - - 76
----- ----- ----- ----- ----- -----
Income (loss) from discontinued operations.... $ (50) $ 261 $ (3) $ - $ 3 $ 287
====== ===== ====== ===== ===== =====
Nine Months Ended September 30, 2004
------------------------------------------------------------------------
Strategic
TXU TXU Retail Pedrick-
Gas Australia Services town Telecom Mexico Total
----- --------- -------- -------- ------- ------ ------
Operating revenues..................... $ 910 $ 835 $ 13 $ 27 $ 54 $ 4 $1,843
Operating costs and expenses........... 894 670 16 30 49 4 1,663
Other deductions (income) -- net....... 91 (3) 10 - 16 - 114
Interest income........................ - (2) - - (5) - (7)
Interest expense and related charges... 23 96 - - 19 - 138
----- ----- ----- ----- ----- ----- -----
Operating income (loss) before income
taxes............................... (98) 74 (13) (3) (25) - (65)
Income tax expense (benefit) .......... (21) 27 (4) (1) (8) (1) (8)
------ ----- ------ ------ ------ ------ ------
Operating income (loss)................ (77) 47 (9) (2) (17) 1 (57)
Credits (charges) related to exit
(after-tax)......................... (93) 127 (5) (17) 1 (2) 11
Recognition of tax benefits............ - - - - - - 712
----- ----- ----- ----- ----- ----- -----
Income (loss) from discontinued
operations........................ $(170) $ 174 $ (14) $ (19) $ (16) $ (1) $ 666
====== ===== ====== ====== ====== ====== =====
Three Months Ended September 30, 2003
----------------------------------------------------------------------
Strategic
TX Retail Pedrick-
TXU Gas Australia Services town Telecom Mexico Total
------- --------- -------- ---- ------- ------ -----
Operating revenues.............. $ 174 $ 321 $ 11 $ 10 $ 49 $ 22 $ 587
Operating costs and expenses.... 173 233 8 10 40 22 486
Other deductions (income) -- net. 1 (2) 4 - 8 - 11
Interest income................. - (1) - - (2) - (3)
Interest expense and related
charges...................... 9 36 - - 19 - 64
----- ----- ----- ----- ----- ----- -----
Operating income (loss) before
income taxes................. (9) 55 (1) - (16) - 29
Income tax expense (benefit) ... (3) 9 - - (4) - 2
------ ----- ----- ----- ------ ----- -----
Operating income (loss) (6) 46 (1) - (12) - 27
Credit related to exit
(after-tax).................. - - - - 37 - 37
----- ----- ----- ----- ----- ----- -----
Income (loss) from
discontinued operations.... $ (6) $ 46 $ (1) $ - $ 25 $ - $ 64
====== ===== ====== ===== ===== ===== =====
13
Nine Months Ended September 30, 2003
-------------------------------------------------------------------------------
Strategic
TXU TXU Retail Pedrick-
Gas Australia Services town Telecom Mexico Europe Total
----- --------- --------- -------- ------- ------- ------- ------
Operating revenues................ $ 993 $ 820 $ 54 $ 18 $ 117 $ 72 $ - $2,074
Operating costs and expenses...... 913 587 49 21 110 74 - 1,754
Other deductions (income) -- net.. (1) (12) 4 - 8 (2) - (3)
Interest income................... (1) (4) - - (5) - - (10)
Interest expense and related
charges........................ 31 107 - - 45 1 - 184
----- ----- ----- ----- ----- ----- ----- -----
Operating income (loss) before
income taxes................... 51 142 1 (3) (41) (1) - 149
Income tax expense (benefit)...... 18 34 1 (1) (11) (1) - 40
----- ----- ----- ------ ------ ------ ----- -----
Operating income (loss) 33 108 - (2) (30) - - 109
Charges related to exit
(after-tax)................... - - - - (23) - (2) (25)
----- ----- ----- ----- ------ ----- ------ ------
Income (loss) from
discontinued operations..... $ 33 $ 108 $ - $ (2) $ (53) $ - (2) $ 84
===== ===== ===== ====== ====== ===== ====== =====
The TXU Gas business was previously reported in the Energy Delivery (now
Electric Delivery) segment. The TXU Australia business was previously reported
in its own segment. The Pedricktown business and the strategic retail services
operations were previously reported in the Energy segment. The
telecommunications and Mexico operations were previously reported in corporate
and other activities.
Recognition of Tax Benefits - As discussed in Note 1, in connection with
an IRS preliminary notice of proposed adjustment issued in June 2004, TXU Corp.
has recognized income tax benefits arising from the utilization of the
previously unrecognized 2002 worthlessness deduction related to the write-off of
the investment in TXU Europe. The $712 million of tax benefits recognized in
discontinued operations relate primarily to capital gains generated in prior
years as well as the capital gains arising from the sales of TXU Communications,
TXU Australia, and TXU Gas, which can be offset by the 2002 worthlessness
deduction.
TXU Australia - On July 30, 2004, TXU Corp. completed the sale of TXU
Australia to Singapore Power Ltd. for $3.6 billion, including $1.7 billion of
assumed debt and $1.9 billion in cash. A gain on sale of $367 million ($239
million after-tax) was recorded in the third quarter of 2004.
Results of TXU Australia for the nine months ended September 30, 2004
include an income tax charge of $112 million to establish a deferred tax
liability for the excess of the carrying value of the investment in the business
over the related tax basis, in accordance with accounting rules, as a result of
the decision to sell the business.
TXU Gas - On October 1, 2004, Atmos Energy Corporation and TXU Gas
completed a merger by division, which resulted in the disposition of the
operations of TXU Gas for $1.905 billion in cash. The intent to dispose of the
operations had been previously disclosed. A pre-tax loss on the transaction of
approximately $58 million is now expected, and this amount was recorded as a
goodwill impairment charge in the third quarter of 2004. This amount includes
the effect of $19 million in discontinued depreciation expense in accordance
with accounting rules for assets held for sale. The balance of the loss reflects
changes in the terms of the transaction agreement and refinements of previous
estimates. Electric Delivery will continue to provide meter reading and shared
facilities services to Atmos Energy Corporation under a transition services
agreement.
Results of TXU Gas for year-to-date 2004 reflect an after-tax charge of
$99 million in the second quarter to reserve for disallowed regulatory and other
assets pursuant to a May 2004 regulatory ruling in connection with the
previously disclosed system-wide distribution rate case. TXU Gas has filed a
motion for rehearing with the regulatory authority.
In June 2004, the IRS Appeals Office rejected TXU Gas' appeal of proposed
adjustments to 1993 income tax returns of ENSERCH Corporation, the acquired
predecessor of TXU Gas. Additional reserves deemed required by TXU Gas for this
matter totaled $47 million, and in accordance with acquisition accounting rules,
$17 million was recorded as an expense in the second quarter of 2004 (as a tax
provision) and $30 million was recorded as additional goodwill.
14
In consideration of the additional goodwill amount recorded and the best
estimate at that time of the net proceeds from the expected sale of the business
and the expected carrying value of the assets 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.
Pedricktown - In the second quarter of 2004, Energy initiated a plan to
sell the Pedricktown, New Jersey 122 MW power production facility and exit the
related power supply and gas transportation agreements. Accordingly, results for
the second quarter of 2004 included a $17 million after-tax charge to write down
the facility to estimated fair market value.
Telecommunications -- In April 2004, TXU Corp. sold its telecommunications
business (TXU Communications) for $524 million in cash and $3 million of assumed
debt. In March 2004, TXU Corp. redeemed the remaining outstanding $560 million
senior notes of the Pinnacle telecommunications holding company. The business
was formerly a joint venture and was consolidated from March 1, 2003 through the
sale date.
Strategic Retail Services -- In December 2003, Energy finalized a formal
plan to sell its strategic retail services business, which is engaged
principally in providing energy management services. Energy expects to
substantially complete the sales of these operations to various parties by
year-end 2004. Results in 2004 reflect a $9 million ($6 million after-tax)
charge recorded in the second quarter to settle a contract dispute.
Mexico -- In January 2004, TXU Corp. completed the sale of its
majority-owned gas distribution operations in Mexico for $11 million in notes
receivable and recorded an after-tax loss of $2 million.
Balance sheet - The following details the assets and liabilities held for
sale as of September 30, 2004:
Strategic
Retail
TXU Gas Services Pedricktown Total
------- -------- ----------- -----
Current assets........................... $ 221 $ 4 $ 2 $ 227
Investments.............................. - 2 - 2
Goodwill................................. 246 - - 246
Property, plant and equipment............ 1,662 3 16 1,681
Other noncurrent assets.................. 5 - - 5
------ ------ ------ -------
Assets held for sale................ $2,134 $ 9 $ 18 $ 2,161
====== ====== ====== =======
Current liabilities...................... $ 100 $ - $ 4 $ 104
Noncurrent liabilities................... 150 - 4 154
------ ------ ------ -------
Liabilities held for sale........... $ 250 $ - $ 8 $ 258
====== ====== ====== =======
15
4. FINANCING ARRANGEMENTS
Short-term Borrowings -- At September 30, 2004, TXU Corp. had outstanding
short-term borrowings consisting of bank borrowings under the three-year
revolving credit facility of $565 million at a weighted average interest rate of
4.27%. At December 31, 2003, TXU Corp. had no outstanding short-term borrowings.
Credit Facilities -- At September 30, 2004, TXU Corp. had credit
facilities (some of which provide for long-term borrowings) as follows:
- ----------------------------------------------------------------------------------------------------------------
At September 30, 2004
----------------------------------------------
Maturity Authorized Facility Letters of Cash
Facility Date Borrowers Limit Credit Borrowings Availability
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
364-day Credit Facility June 2005 Energy, Electric $ 600 $ 80 $ - $ 520
Delivery
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Three-Year Revolving Credit Energy,Electric
Facility June 2007 Delivery 1,400 - 565 835
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Five-Year Revolving Credit
Facility August 2008 TXU Corp. 500 429 - 71
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Five-Year Revolving Credit Energy,Electric
Facility June 2009 Delivery 500 - - 500
------ ------ ------ --------
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Total $3,000 $ 509 $ 565 $ 1,926
====== ====== ====== =======
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
In June 2004, US Holdings, Energy and Electric Delivery replaced $2.25
billion of credit facilities scheduled to mature in 2005 with $2.5 billion of
credit facilities for Energy and Electric Delivery maturing in June 2005, 2007
and 2009. These facilities are used for working capital and general corporate
purposes and provide back-up for any future issuances of commercial paper by
Energy or Electric Delivery. At September 30, 2004, there was no such commercial
paper outstanding.
In April 2004, three credit facilities totaling $2.0 billion (364-day
credit facilities expiring in April 2005) were established to provide bridge
financing for the repurchase of Energy's exchangeable preferred membership
interests. In July 2004, borrowings under these facilities were repaid with the
proceeds from Energy's issuance of $800 million floating rate senior notes and
part of the proceeds from the TXU Australia sale and the facilities were
subsequently terminated.
TXU Corp.'s $500 million five-year revolving credit facility is with LOC
2003 Trust, a special purpose, wholly-owned subsidiary of TXU Corp. (LOC Trust).
LOC Trust, in turn, has a $500 million five-year secured credit facility with a
group of lenders. TXU Corp. capitalized LOC Trust with approximately $525
million of cash, which the lenders have invested in permitted investments as
directed by LOC Trust. This investment in LOC Trust is reflected on TXU Corp.'s
balance sheet as restricted cash (see Note 12). LOC Trust's assets, including
the investments, constitute collateral for the benefit of the lenders to secure
issuances of letters of credit or loans, and are owned by LOC Trust. LOC Trust
is included in the consolidated financial statements of TXU Corp. solely to
comply with US GAAP.
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, 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 (the funding entities). Funding under the program as of
September 30, 2004 was $700 million, the maximum amount allowed. Effective June
30, 2004, the program was extended through June 28, 2005. As part of the
extension, the maximum amount available under the program was increased from
$600 million to $700 million in recognition of seasonal power sales.
Additionally, the extension allows for increased availability of funding through
a credit ratings-based reduction (based on each originator's credit rating) of
customer deposits previously used to reduce the amount of undivided interests
that could be sold. Undivided interests will now be reduced by 100% of the
customer deposits for a Baa3/BBB- rating; 50% for a Baa2/BBB rating; and zero %
for a Baa1/BBB+ and above rating. Effective as of August 31, 2004, in order to
consummate the TXU Gas transaction, TXU Receivables Company repurchased from the
funding entities the receivables that related to TXU Gas, as an originator, and
subsequently assigned those receivables back to TXU Gas, terminating TXU Gas'
participation in the receivables program.
16
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 balance of the subordinated notes
payable was $396 million at September 30, 2004.
The discount from face amount on the purchase of receivables principally
funds program fees paid by TXU Receivables Company to the funding entities, as
well as a servicing fee paid by TXU Receivables Company to TXU Business
Services, a direct subsidiary of TXU Corp. The program fees (losses on sale),
which consist primarily of interest costs on the underlying financing, were
approximately $8 million and $9 million for the nine-month periods ending
September 30, 2004 and 2003 and approximated 1.9% and 2.5% for the first nine
months of 2004 and 2003, respectively, of the average funding under the program
on an annualized basis; these fees represent the net incremental costs of the
program to the originators and are reported in SG&A expenses. The servicing fee,
which totaled approximately $5 million and $6 million for the first nine months
of 2004 and 2003, respectively, compensates TXU Business Services for its
services as collection agent, including maintaining the detailed accounts
receivable collection records.
The September 30, 2004 balance sheet reflects $1.1 billion face amount of
trade accounts receivable of Energy and Electric Delivery, reduced by $700
million of undivided interests sold by TXU Receivables Company. Funding under
the program increased $100 million for the nine months ended September 30, 2004.
Funding under the program for the nine months ended September 30, 2003 increased
$229 million. Funding increases or decreases under the program are reflected as
operating cash flow activity in the statement of cash flows. The carrying amount
of the retained interests in the accounts receivable approximated fair value due
to the short-term nature of the collection period.
Activities of TXU Receivables Company for the nine months ended September
30, 2004 and 2003 were as follows:
Nine Months
Ended September 30,
---------------------
2004 2003
------ ------
Cash collections on accounts receivable............................................ $ 6,419 $ 6,349
Face amount of new receivables purchased........................................... (6,404) (6,300)
Discount from face amount of purchased receivables................................. 13 15
Program fees paid.................................................................. (8) (9)
Servicing fees paid................................................................ (5) (6)
Increase (decrease) in subordinated notes payable.................................. (115) (278)
-------- --------
Operating cash flows provided to TXU Corp. under the program....................... $ (100) $ (229)
======= =======
Upon termination of the program, cash flows to TXU Corp. 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:
17
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.
Long-Term Debt -- At September 30, 2004 and December 31, 2003, the
long-term debt of TXU Corp. consisted of the following:
September 30, December 31,
2004 2003
------------- -------------
Energy
------
Pollution Control Revenue Bonds:
Brazos River Authority:
3.000% Fixed Series 1994A due May 1, 2029, remarketing date May 1, 2005(a).......... $ 39 $ 39
5.400% Fixed Series 1994B due May 1, 2029, remarketing date May 1, 2006(a).......... 39 39
5.400% Fixed Series 1995A due April 1, 2030, remarketing date May 1, 2006(a)........ 50 50
5.050% Fixed Series 1995B due June 1, 2030, remarketing date June 19, 2006(a)....... 114 118
7.700% Fixed Series 1999A due April 1, 2033......................................... 111 111
6.750% Fixed Series 1999B due September 1, 2034, remarketing date April 1, 2013(a).. 16 16
7.700% Fixed Series 1999C due March 1, 2032......................................... 50 50
4.950% Fixed Series 2001A due October 1, 2030, remarketing date April 1, 2004(a).... -- 121
4.750% Fixed Series 2001B due May 1, 2029, remarketing date November 1, 2006(a)..... 19 19
5.750% Fixed Series 2001C due May 1, 2036, remarketing date November 1, 2011(a)..... 217 274
1.464% Floating Series 2001D due May 1, 2033........................................ 268 271
1.730% Floating Taxable Series 2001I due December 1, 2036(b)........................ 63 63
1.436% Floating Series 2002A due May 1, 2037(b)..................................... 45 61
6.750% Fixed Series 2003A due April 1, 2038, remarketing date April 1, 2013(a)...... 44 44
6.300% Fixed Series 2003B due July 1, 2032.......................................... 39 39
6.750% Fixed Series 2003C due October 1, 2038....................................... 52 72
5.400% Fixed Series 2003D due October 1, 2029, remarketing date October 1, 2014(a).. 31 31
Sabine River Authority of Texas:
6.450% Fixed Series 2000A due June 1, 2021.......................................... 51 51
5.500% Fixed Series 2001A due May 1, 2022, remarketing date November 1, 2011(a)..... 91 91
5.750% Fixed Series 2001B due May 1, 2030, remarketing date November 1, 2011(a)..... 107 107
5.800% Fixed Series 2003A due July 1, 2022.......................................... 12 12
6.150% Fixed Series 2003B due August 1, 2022........................................ 45 45
Trinity River Authority of Texas:
6.250% Fixed Series 2000A due May 1, 2028........................................... 14 14
5.000% Fixed Series 2001A due May 1, 2027, remarketing date November 1, 2006(a)..... 37 37
Other:
6.875% TXU Mining Fixed Senior Notes due August 1, 2005............................. 30 30
6.125% Fixed Senior Notes due March 15, 2008(c)..................................... 250 250
7.000% Fixed Senior Notes due March 15, 2013........................................ 1,000 1,000
2.380% Floating Rate Senior Notes due January 17, 2006.............................. 800 --
Capital lease obligations........................................................... 9 13
Other............................................................................... 1 8
Fair value adjustments related to interest rate swaps............................... 17 11
Unamortized discount............................................................... -- (2)
------- -----
Total Energy ................................................................... 3,661 3,085
18
September 30, December 31,
2004 2003
------------- -------------
Electric Delivery
- ----------------
8.250% Fixed First Mortgage Bonds due April 1, 2004...................................... -- 100
6.250% Fixed First Mortgage Bonds due October 1, 2004.................................... 121 121
6.750% Fixed First Mortgage Bonds due July 1, 2005....................................... 92 92
7.625% Fixed First Mortgage Bonds due July 1, 2025....................................... -- 215
7.375% Fixed First Mortgage Bonds due October 1, 2025.................................... -- 178
6.375% Fixed Senior Secured Notes due May 1, 2012........................................ 700 700
7.000% Fixed Senior Secured Notes due May 1, 2032........................................ 500 500
6.375% Fixed Senior Secured Notes due January 15, 2015................................... 500 500
7.250% Fixed Senior Secured Notes due January 15, 2033................................... 350 350
5.000% Fixed Debentures due September 1, 2007(c)......................................... 200 200
7.000% Fixed Debentures due September 1, 2022............................................ 800 800
Unamortized discount..................................................................... (19) (30)
TXU Electric Delivery Transition Bond Company LLC(e)
- ---------------------------------------------------
2.260% Fixed Series 2003 Bonds due in bi-annual installments through February 15, 2007.... 80 103
4.030% Fixed Series 2003 Bonds due in bi-annual installments through February 15, 2010.... 122 122
4.950% Fixed Series 2003 Bonds due in bi-annual installments through February 15, 2013.... 130 130
5.420% Fixed Series 2003 Bonds due in bi-annual installments through August 15, 2015...... 145 145
3.520% Fixed Series 2004 Bonds due in bi-annual installments through November 15, 2009.... 279 --
4.810% Fixed Series 2004 Bonds due in bi-annual installments through November 15, 2012.... 221 --
5.290% Fixed Series 2004 Bonds due in bi-annual installments through May 15, 2016......... 290 --
------ ------
Total TXU Electric Delivery Transition Bond Company LLC................................ 1,267 500
------ -------
Total Electric Delivery................................................................ 4,511 4,226
US Holdings
- -----------
7.170% Fixed Senior Debentures due August 1, 2007......................................... 10 10
9.580% Fixed Notes due in bi-annual installments through December 4, 2019................. 70 70
8.254% Fixed Notes due in quarterly installments through December 31, 2021................ 65 67
2.494% Floating Rate Junior Subordinated Debentures, Series D due January 30, 2037(d)..... 1 1
8.175% Fixed Junior Subordinated Debentures, Series E due January 30, 2037................ 8 8
------- -------
Total US Holdings .................................................................... 154 156
TXU Gas
- -------
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......................................................................... 275 426
TXU Corp.
- --------
6.375% Fixed Senior Notes Series B due October 1, 2004.................................... 175 175
6.375% Fixed Senior Notes Series C due January 1, 2008(c)................................. 200 200
4.050% Fixed Senior Notes Series E due August 16, 2004.................................... -- 2
6.375% Fixed Senior Notes Series J due June 15, 2006(c)................................... 683 800
4.446% Fixed Senior Notes Series K due November 16, 2006 (f).............................. 50 500
5.450% Fixed Senior Notes Series L due November 16, 2007 remarketing date
August 16, 2005(f)...................................................................... 288 500
5.800% Fixed Senior Notes Series M due May 16, 2008 remarketing date
February 16, 2006(f).................................................................... 440 440
6.000% Fixed Pinnacle Overfund Trust Debt due bi-annually through August 15, 2004......... -- 91
8.820% Building Financing due bi-annually through February 11, 2022....................... 120 130
3.100% Floating Convertible Senior Notes due July 15, 2033(d)............................. 525 525
Fair value adjustments related to interest rate swaps..................................... 17 32
Unamortized discount...................................................................... (1) (2)
------- -------
Total TXU Corp....................................................................... 2,497 3,393
------- -------
Total TXU Corp. consolidated................................................................ 11,098 11,286
Less amount due currently................................................................... 1,704 678
------- -------
Total long-term debt....................................................................... $ 9,394 $10,608
======= =======
- ------------
(a) These series are in the multiannual mode and are subject to mandatory
tender prior to maturity on the mandatory remarketing date. On such date,
the interest rate and interest rate period will be reset for the bonds.
(b) Interest rates in effect at September 30, 2004. These series are in a
flexible or weekly rate mode and are classified as long-term as they are
supported by long-term irrevocable letters of credit. Series in the
flexible mode will be remarketed for periods of less than 270 days.
(c) Interest rates swapped to floating on an aggregate $1.3 billion principal
amount.
(d) Interest rates in effect at September 30, 2004.
(e) These bonds are nonrecourse to Electric Delivery.
(f) Equity-linked.
19
See discussion under "Debt and Capital Management Program" in Note 1
regarding debt retirement activity.
As a result of the cash tender offers for certain debt securities and the
legal defeasance of TXU Gas debt securities in October 2004 as discussed in Note
1, $1.2 billion principal amount of debt was classified as long-term debt due
currently in the September 30, 2004 balance sheet.
In July 2004, Energy issued $800 million of floating rate senior notes in
a private placement offering with registration rights. The net proceeds of $798
million were used to repay, in part, borrowings outstanding under its fully
drawn $1.0 billion 364 day credit facility, which was subsequently terminated.
The Notes will bear interest at an annual rate equal to 3-month LIBOR, reset
quarterly, plus 0.78% and will mature on January 17, 2006.
In June 2004, Electric Delivery's wholly-owned, special purpose
bankruptcy-remote subsidiary, TXU Electric Delivery Transition Bond Company LLC,
issued $790 million aggregate principal amount of transition (securitization)
bonds in accordance with a settlement agreement with the Commission and a
financing order related to the transition to competition. The bonds were issued
in three classes that require bi-annual interest and principal installment
payments beginning in November 2004 through specified dates in 2009 through
2016. The transition bonds bear interest at fixed annual rates ranging from
3.52% to 5.29%. Electric Delivery used the proceeds to retire two series of
mortgage bonds with an aggregate principal amount of $393 million due in 2025
and repurchase shares of common stock from US Holdings for $375 million. US
Holdings used the proceeds it received to repay short-term borrowings. As a
result of the retirement of these two series of mortgage bonds, Electric
Delivery will be able to release the liens on its outstanding senior secured
notes, making them rank equally with Electric Delivery's other senior unsecured
debt. No decision has been made as to the timing of such release.
In April 2004, the Brazos River Authority Series 2001A pollution control
revenue bonds with an aggregate principal amount of $121 million were purchased
upon mandatory tender. Energy intends to remarket these bonds at a later date.
Other retirements of long-term debt in 2004 totaling $388 million
represent payments at scheduled maturity dates.
Fair Value Hedges -- TXU Corp. uses fair value hedging strategies to
manage its exposure to fixed interest rates on long-term debt. At September 30,
2004, $1.3 billion of fixed rate debt was effectively converted to variable
rates through interest rate swap transactions, expiring through 2008. These
swaps qualified for and have been designated as fair value hedges using the
short-cut method of hedge accounting provided by SFAS 133, as such, the company
assumes that changes in the value of the derivative are perfectly offset by
changes in the value of the debt; therefore, there is no hedge ineffectiveness
recognized.
In August 2004, fixed-to-variable swaps related to $1.2 billion debt were
settled for a gain of $8 million, which will be amortized to offset interest
expense over the remaining life of the related debt. In April 2004,
fixed-to-variable interest rate swaps related to $100 million of debt were
settled for a gain of $3.5 million, which will be amortized to offset interest
expense over the remaining life of the debt. In March 2004, fixed-to-variable
interest rate swaps related to $400 million of debt were settled for a gain of
$18 million, which will also be amortized to offset interest expense over the
remaining life of the related debt.
20
5. LONG-TERM DEBT HELD BY SUBSIDIARY TRUSTS
Statutory business trusts have been established as wholly-owned financing
subsidiaries of TXU Corp. and TXU Gas. The assets of the trusts consist solely
of Junior Subordinated Debentures issued by TXU Corp. or TXU Gas, and the trusts
have issued preferred interests, as presented below:
Trust Assets (Long-Term Debt
Trust Preferred Interests of TXU Corp. or TXU Gas)
------------------------------ ------------------------------
September 30, December 31, September 30, December 31,
2004 2003 2004 2003
------------- -------------- -------------- -------------
TXU Corp.
- ---------
Capital I Trust
(9.2 million units of 7.25% Series due 2029).. $ -- $ 223 $ - $ 237
Capital II Trust
(6.0 million units of 8.70% Series due 2034).. 145 145 155 155
------ ------ -------- -------
Total........................................ 145 368 155 392
TXU Gas
- -------
Capital I Trust
(150 thousand units of Floating Rate Series
due 2028)................................. 147 147 154 154
------ ------ -------- -------
Total...................................... $ 292 $ 515 $ 309 $ 546
====== ====== ======== =======
TXU Corp. and TXU Gas, as the parent companies, own the subsidiary trusts'
common interests, which are reported in investments in the balance sheet, and
each has effectively issued a full and unconditional guarantee of its trusts'
preferred interests.
The subsidiary trusts have been deconsolidated since the adoption of FIN
46 in the fourth quarter of 2003.
On October 1, 2004, TXU Gas legally defeased all of the $154 million
principal amount TXU Gas Floating Rate Junior Subordinated Debentures, Series A,
and this amount is reported in the September 30, 2004 balance sheet as due
currently. See Note 1 regarding the TXU Gas transaction.
In April 2004, TXU Corp. redeemed all of the 7.25% Junior Subordinated
Debentures, Series A, at an amount equal to 100% of the outstanding principal
amount plus accrued and unpaid interest, for a total of $238 million. The TXU
Corp. Capital I Trust used the proceeds to redeem all of the outstanding 7.25%
Cumulative Trust Preferred Capital Securities due 2029 at an amount equal to $25
per trust security plus accumulated and unpaid distributions, for a total of
$231 million.
6. PREFERRED SECURITIES OF SUBSIDIARIES
Preferred securities of consolidated subsidiaries consist of the
following:
September 30, December 31,
2004 2003
------------- ------------
Exchangeable preferred membership interests of Energy, net of
$104 unamortized discount............................................. $ - $ 646
Preferred stock of TXU Gas............................................... 75 75
Preferred stock of US Holdings........................................... 38 38
------ ------
Total.................................................................... $ 113 $ 759
====== ======
Exchangeable Preferred Membership Interests of Energy -- In April 2004,
TXU Corp. purchased these securities as discussed in Note 1.
Preferred Stock of TXU Gas At September 30, 2004, TXU Gas had 75,000
shares of Adjustable Rate Series F Preferred Stock outstanding which are
entitled upon liquidation to the stated value of $1,000 per share. All of TXU
Gas' preferred stock was redeemed on November 5, 2004 in connection with the TXU
Gas transaction. See Note 1 for further discussion.
21
Preferred Stock of US Holdings -- At September 30, 2004, US Holdings had
379,231 shares of cumulative, preferred stock without par value outstanding with
dividend rates ranging from $4.00 to $5.08 per share. The preferred stock can be
redeemed at prices ranging from $101.79 per share to $112.00 per share. The
preferred stock is not mandatorily redeemable.
7. SHAREHOLDERS' EQUITY
The Board of Directors of TXU Corp., at its August 2004 meeting, declared
a quarterly dividend of $0.125 a share, payable October 1, 2004, to shareholders
of record on September 3, 2004, and at its May 2004 meeting, declared a
quarterly dividend of $0.125 a share, payable July 1, 2004, to shareholders of
record on June 4, 2004.
Certain debt instruments, preference, preferred and other securities
contain provisions that restrict payment of dividends during any interest or
distribution payment deferral period or while any payment default exists. At
September 30, 2004, TXU Corp. was in compliance with these provisions. An
Electric Delivery mortgage restricts the payment of dividends to the amount of
Electric Delivery's retained earnings.
The following table presents the changes during the nine months ended
September 30, 2004 to common stock equity:
Accumulated Total
Additional Other Common
Common Paid-in Retained Comprehensive Stock
Stock Capital Deficit Gain (Loss) Equity
----- ------- ------- ----------- ------
Balance at December 31, 2003................. $ 48 $8,097 $(2,498) $ (28) $5,619
Common stock repurchases................ -- (1,226) -- -- (1,226)
Common stock issuances.................. 15 -- -- -- 15
Exchangeable preferred membership
interests buyback..................... -- (849) -- -- (849)
Equity -linked securities repurchased.. -- 75 -- -- 75
Cash flow hedges........................ -- -- -- (49) (49)
Foreign currency translation............ -- -- -- (145) (145)
Dividends............................... -- -- (131) -- (131)
Net income.............................. -- -- 1,104 -- 1,104
Other................................... -- (2) 2 7 7
------- ------ ------- ----- ------
Balance at September 30, 2004............... $ 63 $6,095 $(1,523) $(215) $4,420
======= ====== ======= ===== ======
8. CONTINGENCIES
Request from Commodities Futures Trading Commission (CFTC) On April 13,
2004, the CFTC issued a subpoena requiring TXU Corp. to produce information
about storage of natural gas, including weekly and monthly storage reports to
the Energy Information Administration submitted by TXU Fuel Company and TXU Gas.
The request sought information for the period of October 31, 2003 through
January 2, 2004. TXU Corp. cooperated with the CFTC by producing the requested
information and believes that TXU Gas and TXU Fuel Company have not engaged in
any activity that would justify action against them by the CFTC. On August 30,
2004, the CFTC issued a press release confirming that its investigation, which
included the investigation regarding gas storage reports, had been closed, and
TXU Corp. has received nothing from the CFTC to indicate that the CFTC will take
any action against TXU Gas or TXU Fuel.
Guarantees -- TXU Corp. 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.
22
Project development guarantees -- In 1990, US Holdings repurchased an
electric co-op's minority ownership interest in the Comanche Peak nuclear
generation plant and assumed the co-op's indebtedness to the US government for
the facilities. US Holdings is making principal and interest payments to the
co-op in an amount sufficient for the co-op to make payments on its
indebtedness. US Holdings guaranteed the co-op's payments, and in the event that
the co-op fails to make its payments on the indebtedness, the US government
would assume the co-op's rights under the agreement, and such payments would
then be owed directly by US Holdings. At September 30, 2004, the balance of the
indebtedness was $134 million with maturities of principal and interest
extending to December 2021. The indebtedness is secured by a lien on the
facilities.
Residual value guarantees in operating leases -- TXU Corp. is the lessee
under various operating leases, entered into prior to January 1, 2003 that
obligate it to guarantee the residual values of the leased facilities. At
September 30, 2004, the aggregate maximum amount of residual values guaranteed
was approximately $262 million with an estimated residual recovery of
approximately $158 million. The average life of the lease portfolio is
approximately seven years.
Shared saving guarantees -- As part of the operations of the strategic
retail services business, which Energy intends to sell (see Note 3), Energy has
guaranteed that certain customers will realize specified annual savings
resulting from energy management services it has provided. In aggregate, the
average annual savings have exceeded the annual savings guaranteed. The maximum
potential annual payout is approximately $1 million and the maximum total
potential payout is approximately $6 million. No shared savings guarantees were
issued during the nine months ended September 30, 2004 that required recording a
liability. The average remaining life of the portfolio is approximately seven
years. These guarantees will be transferred or eliminated as part of expected
transactions for the sale of the strategic retail services business.
Letters of credit -- Energy has entered into various agreements that
require letters of credit for financial assurance purposes. Approximately $384
million of letters of credit were outstanding at September 30, 2004 to support
existing floating rate pollution control revenue bond debt of approximately $376
million. The letters of credit are available to fund the payment of such debt
obligations. These letters of credit expire in 2008.
US Holdings has outstanding letters of credit in the amount of $12 million
for miscellaneous credit support requirements. Although the average life of the
letters of credit is for approximately one year, the obligation to provide
guarantees is ongoing.
Energy has outstanding letters of credit in the amount of $113 million to
support hedging and risk management margin requirements in the normal course of
business. As of September 30, 2004, approximately 84% of the obligations
supported by these letters of credit mature within one year, and substantially
all of the remainder mature in the next six years.
Surety bonds -- TXU Corp. has outstanding surety bonds of approximately
$30 million to support performance under various subsidiary contracts and legal
obligations in the normal course of business. The term of the surety bond
obligations is approximately one year.
Other -- US Holdings has entered into contracts with public agencies to
purchase cooling water for use in the generation of electric energy and has
agreed, in effect, to guarantee the principal, $7 million at September 30, 2004,
and interest on bonds issued by the agencies to finance the reservoirs from
which the water is supplied. The bonds mature at various dates through 2011 and
have interest rates ranging from 5.5% to 7.0%. US Holdings is required to make
periodic payments equal to such principal and interest, including amounts
assumed by a third party and reimbursed to US Holdings. In addition, US Holdings
is obligated to pay certain variable costs of operating and maintaining the
reservoirs. US Holdings has assigned to a municipality all its contract rights
and obligations in connection with $8 million remaining principal amount of
bonds at September 30, 2004, issued for similar purposes, which had previously
been guaranteed by US Holdings. US Holdings is, however, contingently liable in
the event of default by the municipality.
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 $104 million. No claims have been asserted under the guarantee and
none are anticipated. TXU Corp. retains this contingent liability under the
terms of the TXU Gas transaction agreement.
23
Income Tax Contingencies -- TXU Corp. is currently under audit by the IRS
with respect to tax returns for various tax periods subsequent to 1992 and prior
to 2003, and are subject to audit by other taxing authorities and by the IRS for
subsequent tax periods. The amount and timing of any tax assessments resulting
from these audits are uncertain, and could have a material effect on the
company's liquidity and results of operations. Certain material audit matters as
to which management believes there is a reasonable possibility of a future tax
assessment are discussed below.
TXU Europe -- On its US federal income tax return for calendar year 2002,
TXU Corp. claimed an ordinary loss deduction related to the worthlessness of TXU
Corp.'s investment in TXU Europe, the tax benefit of which is estimated to be
$983 million (assuming the deduction is sustained on audit). Due to a number of
uncertainties regarding the proper tax treatment of the worthlessness loss, no
portion of the tax benefit related to TXU Corp.'s 2002 write-off of its
investment in TXU Europe was recognized in income prior to the second quarter of
2004. As discussed in Note 1, $711 million of the tax benefit was recognized in
the second quarter of 2004, and an additional $76 million was recognized in the
third quarter.
In June 2004, the IRS issued a preliminary notice of proposed adjustment
proposing to disallow the 2002 worthlessness deduction and treat the
worthlessness as a capital loss (deductible only against capital gains). The
preliminary notice was finalized in September 2004. The notice of proposed
adjustment is not binding on the IRS; therefore, it is uncertain what positions
the IRS might ultimately assert or what, if any, tax liability might result.
The tax benefits recognized by TXU Corp. during the second and third
quarters of 2004 were based on the capital loss and ordinary deductions allowed
by the IRS in accordance with the IRS notice of proposed adjustment, adjusted to
exclude the effects of elements of the IRS notice that TXU Corp. believes are
without merit and unlikely to be sustained. Based on the assumptions used to
calculate the tax benefit, TXU Corp. would be required to repay $463 million in
tax refunds previously received (including interest through September 30, 2004).
No material earnings charge is expected with respect to any such repayment. TXU
Corp. is unable to predict the timing of any such repayment.
TXU Corp. believes that its original tax reporting of the worthlessness of
its investment in TXU Europe as an ordinary deduction was proper and intends to
protest the IRS's proposed adjustments. If TXU Corp.'s position is sustained, it
would recognize in income the remaining $196 million benefit of the deduction.
TXU Gas -- 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
returned the case to the Examination Division to address loss carryback claims
from subsequent years. If the matter is resolved against TXU Gas, TXU Gas would
be assessed a deficiency of $66 million (including penalty and interest through
September 30, 2004, before taking into account carryback claims). 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 second quarter of 2004 to account for
the excess of the tax, penalty, and interest asserted by the IRS over the amount
of tax reserves previously recorded. 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) was charged to income. TXU Gas has the right
to appeal the IRS's proposed adjustments through a court proceeding, and is
currently evaluating its legal options. The results of TXU Gas are presented as
discontinued operations as discussed in Note 3. Management believes that
reserves recorded related to these matters are adequate. Under the definitive
transaction agreement, the buyer of the TXU Gas operations will not assume
liabilities, among others, related to ENSERCH tax returns contested by the IRS.
24
Legal Proceedings -- Management had assessed the progress and status of
matters in litigation, and in the second quarter of 2004 recorded an accrual of
$100 million ($65 million after-tax), reported in other deductions, for the
expected resolution of certain of these cases.
On July 7, 2003, a lawsuit was filed by Texas Commercial Energy (TCE) in
the United States District Court for the Southern District of Texas, Corpus
Christi Division, against Energy and certain of its subsidiaries, as well as
various other wholesale market participants doing business in ERCOT, claiming
generally that defendants engaged in market manipulation, in violation of
antitrust and other laws, primarily during the period of extreme weather
conditions in late February 2003. An amended complaint was filed in February
2004 that joined additional, unaffiliated defendants. Three retail electric
providers filed motions for leave to intervene in the action alleging claims
substantially identical to TCE's. In addition, approximately 25 purported former
customers of TCE filed a motion to intervene in the action alleging claims
substantially identical to TCE's, both on their own behalf and on behalf of a
putative class of all former customers of TCE. An order granting Energy's Motion
to Dismiss based on the filed rate doctrine was entered on June 24, 2004. TCE
has appealed the dismissal, however, Energy believes the dismissal of the
antitrust claims was proper and that it has not committed any violation of the
antitrust laws. Further, the Commission's investigation of the market conditions
in late February 2003 has not resulted in any findings adverse to TXU Corp.
Accordingly, TXU Corp. believes that TCE's and the interveners' claims against
Energy and its subsidiary companies are without merit and Energy and its
subsidiaries intend to vigorously defend the lawsuit on appeal. TXU Corp. is,
however, unable to estimate any possible loss or predict the outcome of this
action.
On April 28, 2003, a lawsuit was filed by a former employee of TXU
Portfolio Management in the United States District Court for the Northern
District of Texas, Dallas Division, against TXU Corp., Energy and TXU Portfolio
Management. The Court has reset this case for trial on June 6, 2005 and
discovery in the case is proceeding. Plaintiff asserts claims under Section 806
of Sarbanes-Oxley arising from plaintiff's employment termination and claims for
breach of contract relating to payment of certain bonuses. Plaintiff seeks back
pay, payment of bonuses and alternatively, reinstatement or future compensation,
including bonuses. TXU Corp. believes the plaintiff's claims are without merit.
The plaintiff was terminated as the result of a reduction in force, not as a
reaction to any concerns the plaintiff had expressed, and plaintiff was not in a
position with TXU Portfolio Management such that he had knowledge or information
that would qualify the plaintiff to evaluate TXU Corp.'s financial statements or
assess the adequacy of TXU Corp.'s financial disclosures. Thus, TXU Corp. does
not believe that there is any merit to the plaintiff's claims under
Sarbanes-Oxley. TXU Corp., Energy and TXU Portfolio Management dispute the
plaintiff's claims and intend to vigorously defend the litigation.
On March 10, 2003, a lawsuit was filed by Kimberly P. Killebrew in the
United States District Court for the Eastern District of Texas, Lufkin Division,
against TXU Corp. and TXU Portfolio Management, asserting generally that
defendants engaged in manipulation of the wholesale electric market, in
violation of antitrust and other laws. This case was transferred to the Beaumont
Division of the Eastern District of Texas and on March 24, 2004 subsequently
transferred to the Northern District of Texas, Dallas Division. This action is
brought by an individual, alleged to be a retail consumer of electricity, on
behalf of herself and as a proposed representative of a putative class of retail
purchasers of electricity that are similarly situated. Defendants have filed a
motion to dismiss the lawsuit which is pending before the court; however, as a
result of the dismissal of the antitrust claims in the litigation described
above brought by TCE, the parties have agreed to stay this litigation until the
appeal in the TCE case has been decided. TXU Corp. believes that the plaintiff
lacks standing to assert any antitrust claims against TXU Corp. or TXU Portfolio
Management, and that defendants have not violated antitrust laws or other laws
as claimed by plaintiff. Therefore, TXU Corp. believes that plaintiff's claims
are without merit and plans to vigorously defend the lawsuit. TXU Corp. is,
however, unable to estimate any possible loss or predict the outcome of this
action.
In November 2002 and February and March 2003, three lawsuits were filed in
the United States District Court for the Northern District of Texas asserting
claims under ERISA on behalf of a putative class of participants in and
beneficiaries of various employee benefit plans of TXU Corp. These ERISA
lawsuits have been consolidated, and a consolidated complaint was filed in
February 2004 against TXU Corp., the directors of TXU Corp., Erle Nye, Peter B.
Tinkham, Kirk R. Oliver, Biggs C. Porter, Diane J. Kubin, Barbara B. Curry and
25
Richard Wistrand. On February 10, 2004, the plaintiffs filed their motion for
and memorandum in support of class certification. After class certification
discovery was completed the Court denied Plaintiffs' initial class certification
motion without prejudice and granted Plaintiffs' leave to amend their complaint.
Plaintiffs' second class certification motion remains pending and TXU Corp. and
the individual defendants oppose class certification. The plaintiffs seek to
represent a class of participants in such employee benefit plans during the
period between April 26, 2001 and October 11, 2002. TXU Corp. believes the
claims are without merit and intends to vigorously defend the lawsuit.
On October 23, 2002, a derivative lawsuit was filed by a purported
shareholder on behalf of TXU Corp. in the 116th Judicial District Court of
Dallas County, Texas, against TXU Corp., Erle Nye, Michael J. McNally, David W.
Biegler, J.S. Farrington, William M. Griffin, Kerney Laday, Jack E. Little,
Margaret N. Maxey, J.E. Oesterreicher, Charles R. Perry and Herbert H.
Richardson. The plaintiff alleges breach of fiduciary duty, abuse of control,
mismanagement, waste of corporate assets, and breach of the duties of loyalty
and good faith. The named individual defendants are current or former officers
and/or directors of TXU Corp. No amount of damages has been specified.
Furthermore, plaintiffs in such suit have failed to make a demand upon the
directors as is required by law, and this case is currently stayed.
In October, November and December 2002 and January 2003, a number of
lawsuits were filed in, removed to or transferred to the United States District
Court for the Northern District of Texas against TXU Corp., and certain of its
officers. These lawsuits have all been consolidated and lead plaintiffs have
been appointed by the Court. On July 21, 2003, the lead plaintiffs filed an
amended consolidated complaint naming Erle Nye, Michael J. McNally, V.J. Horgan
and Brian N. Dickie and directors Derek C. Bonham, J.S. Farrington, William M.
Griffin, Kerney Laday, Jack E. Little, Margaret N. Maxey, J.E. Oesterreicher,
Herbert H. Richardson and Charles R. Perry, as defendants. The named individual
defendants are current or former officers and/or directors of TXU Corp. The
plaintiffs seek to represent classes of certain purchasers of TXU Corp. common
stock and equity-linked debt securities during a proposed class period from
April 26, 2001 to October 11, 2002. No class or classes have been certified. The
complaint alleges violations of the provisions of Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated
thereunder, and Sections 11 and 12 of the Securities Act of 1933, as amended
(Securities Act), relating to alleged materially false and misleading
statements, including statements in prospectuses related to the offering by TXU
Corp. of its equity-linked debt securities and common stock in May and June
2002. On September 24, 2003, TXU Corp. and its officer and director defendants
filed a motion to dismiss the plaintiffs' Amended Complaint. The plaintiffs have
filed their response to the motion and the defendants have filed their reply
brief, however, the court has not yet ruled on the motion to dismiss. TXU Corp.
believes the claims are without merit and intends to vigorously defend this
lawsuit.
Other Contingencies --In October 2003, the former directors and officers
of TXU Europe Limited and subsidiaries that are now in administration
(collectively TXU Europe), who include current and former officers of TXU Corp.
and subsidiary companies, received notices from certain creditors and the
administrators of TXU Europe of various claims or potential claims relating to
losses incurred by creditors, including claims for alleged omissions from a
securities offering document and alleged breaches by directors of their English
law duties as directors of these companies in failing to minimize the potential
losses to the creditors of TXU Europe. Under the terms of the indemnification
agreements and bylaw and charter provisions that provide for indemnification of
corporate officers and directors, TXU Corp. or one of its subsidiaries will be
obligated to indemnify these persons from these and similar claims, unless it is
determined that the directors or corporate officer's acts were committed in bad
faith, were the result of active and deliberate dishonesty or that the
individual personally gained a financial profit to which he was not legally
entitled. Similar claims have been asserted directly against TXU Corp. as well.
The administrators of certain of the TXU Europe companies have also given TXU
Corp. written notice of the basis for the claims alleged against TXU Corp. and
certain individual TXU Corp. officers and directors and TXU Corp. has been in
contact with the administrators regarding such claims. TXU Corp. believes that
these claims are without merit and intends to vigorously defend any such claims
if they are ultimately asserted. TXU Corp. is, however, unable to estimate any
possible loss or predict the outcome of this action.
26
General -- In addition to the above, TXU Corp. is 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 its financial position, results of operations or cash flows.
9. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS
Net pension and other postretirement benefit costs recognized during the
three and nine months ended September 30, 2004 and 2003 are comprised of the
following:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
------ ------ ------ ------
Components of Net Pension Costs:
Service cost..................................................... $ 9 $ 12 $ 34 $37
Interest cost.................................................... 34 29 98 98
Expected return on assets........................................ (40) (33) (106) (110)
Amortization of unrecognized prior service cost.................. 1 1 3 4
Amortization of net loss......................................... - 2 8 4
Curtailment loss................................................. 1 - 5 -
---- ---- ---- ---
Net periodic pension cost...................................... $ 5 $ 11 $ 42 $33
==== ==== ==== ===
Components of Net Periodic Postretirement Benefit Costs:
Service cost..................................................... $ 4 $ 4 $ 12 $13
Interest cost.................................................... 13 17 44 49
Expected return on assets........................................ (4) (4) (13) (11)
Amortization of unrecognized net transition asset................ - 2 1 4
Amortization of unrecognized prior service cost.................. (1) - (2) -
Amortization of net loss......................................... 6 7 20 22
Curtailment gain................................................. - - (1) -
---- ---- ----- ---
Net postretirement benefit cost................................ $ 18 $ 26 $ 61 $77
==== ==== ==== ===
The Capgemini outsourcing transaction (see Note 1) caused a curtailment of
the retirement and postretirement benefit plans as of June 30, 2004, which
combined with a change in discount rate and other assumptions, is expected to
result in an annualized reduction in pension and other postretirement costs of
approximately $36 million.
At September 30, 2004, TXU Corp. estimates that its total cash
contributions to the pension and other postretirement benefit plans for the
remainder of 2004 will not be materially different than previously disclosed in
the 2003 Form 10-K.
27
10. SEGMENT INFORMATION
TXU Corp.'s operations are aligned into two reportable segments: Energy
and Electric Delivery. The segments are managed separately because they are
strategic business units that offer different products or services. TXU
Australia was previously reported as a separate segment.
Energy - consists of operations, principally in the competitive Texas
market, involving power production (electricity generation), retail and
wholesale energy sales, and hedging and risk management activities.
Electric Delivery - consists of regulated operations involving the
transmission and distribution of electricity in Texas.
Corporate and Other - Remaining non-segment operations consisting
primarily of discontinued operations, general corporate expenses, equity
earnings or losses of unconsolidated affiliates and interest on debt at the TXU
Corp. level.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. TXU Corp. evaluates performance
based on income from continuing operations before extraordinary items and
cumulative effect of changes in accounting principles. TXU Corp. accounts for
intersegment sales and transfers as if the sales or transfers were to third
parties, that is, at current market prices.
No customer provided more than 10% of consolidated revenues.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
------ ------ ------ ------
Operating revenues:
Energy............................................................ $2,517 $2,437 $6,589 $6,243
Electric Delivery................................................. 648 613 1,688 1,605
Corporate and other .............................................. 7 5 24 10
Eliminations...................................................... (429) (440) (1,123) (1,167)
------ ------ ------ ------
Consolidated................................................... $2,743 $2,615 $7,178 $6,691
====== ====== ====== ======
Regulated revenues included in operating revenues:
Energy ........................................................... $ - $ - $ - $ -
Electric Delivery................................................. 648 613 1,688 1,605
Corporate and other............................................... - - - -
Eliminations...................................................... (417) (441) (1,101) (1,167)
------ ------ ------ ------
Consolidated................................................... $ 231 $ 172 $ 587 $ 438
====== ====== ====== ======
Affiliated revenues included in operating revenues:
Energy ........................................................... $ 8 $ (1) $ 7 $ -
Electric Delivery................................................. 417 441 1,101 1,167
Corporate and other............................................... 4 - 15 -
Eliminations...................................................... (429) (440) (1,123) (1,167)
------ ------ ------ ------
Consolidated................................................... $ - $ - $ - $ -
====== ====== ====== ======
Income (loss) from continuing operations before extraordinary gain and
cumulative effect of changes in accounting principles:
Energy ........................................................... $ 309 $ 250 $ 408 $ 440
Electric Delivery................................................. 107 125 220 239
Corporate and other............................................... (36) (42) (206) (152)
------ ------ ------ ------
Consolidated................................................... $ 380 $ 333 $ 422 $ 527
====== ====== ====== =====
28
11. DERIVATIVES AND HEDGES
As of September 30, 2004, it is expected that $78 million of after-tax net
losses accumulated in other comprehensive income will be reclassified into
earnings during the next twelve months. Of this amount, $62 million relates to
commodity hedges and $16 million relates to financing-related hedges.
TXU Corp. experienced net hedge ineffectiveness of $4 million and $21
million, reported as a loss in revenues, for the three and nine months ended
September 30, 2004, respectively. For the three and nine months ended September
30, 2003, there were no hedge ineffectiveness losses.
The net effect of unrealized mark-to-market ineffectiveness accounting
(versus settlement accounting), which includes the above amounts as well as the
effect of reversing unrealized gains and losses recorded in previous periods to
offset realized gains and losses in the current period, totaled $3 million and
$20 million, respectively, in net losses for the three and nine months ended
September 30, 2004 and $10 and $24 million in net gains for the three and nine
months ended September 30, 2003.
12. SUPPLEMENTARY FINANCIAL INFORMATION
Regulated Versus Unregulated Operations --
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- ------------------
2004 2003 2004 2003
------ ------ ------ ------
Operating revenues:
Regulated.................................................. $ 648 $ 613 $1,688 $ 1,605
Unregulated................................................ 2,524 2,442 6,613 6,254
Intercompany sales eliminations-regulated.................. (417) (441) (1,101) (1,167)
Intercompany sales eliminations-unregulated ............... (12) 1 (22) (1)
------ ----- ----- -----
Total operating revenues............................. 2,743 2,615 7,178 6,691
Costs and operating expenses:
Cost of energy sold and delivery fees-unregulated*......... 1,134 1,102 3,053 2,879
Operating costs-regulated.................................. 193 175 547 524
Operating costs-unregulated................................ 144 161 510 501
Depreciation and amortization-regulated.................... 116 78 286 215
Depreciation and amortization-unregulated.................. 94 105 293 320
Selling, general and administrative expenses-regulated..... 48 49 141 145
Selling, general and administrative expenses-unregulated... 232 178 664 499
Franchise and revenue-based taxes-regulated................ 66 63 183 183
Franchise and revenue-based taxes-unregulated.............. 28 29 82 97
Other income............................................... (48) (23) (73) (49)
Other deductions........................................... 20 7 477 30
Interest income............................................ (14) (5) (20) (20)
Interest expense and related charges....................... 163 194 521 597
----- ----- ----- -----
Total costs and expenses............................. 2,176 2,113 6,664 5,921
----- ----- ----- -----
Income (loss) from continuing operations before income
taxes and cumulative effect of changes in accounting
principles................................................. $ 567 $ 502 $ 514 $ 770
===== ===== ===== =====
- -----------
*Includes cost of fuel consumed of $308 million and $402 million for
the three months ended September 30, 2004 and 2003, respectively, and
$770 million and $1.2 billion for the nine months ended September 30,
2004 and 2003, respectively. The balance in each period represents
energy purchased for resale and delivery fees.
The operations of the Energy segment are included above as unregulated, as
the Texas market is open to competition. However, retail pricing to residential
customers in its historical service territory continues to be subject to
transitional regulatory provisions.
29
Other Income and Deductions --
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -----------------
2004 2003 2004 2003
------ ------ ------ ------
Other income:
Net gain on sale of businesses and other properties...... $ 47 $ 20 $ 65 $ 41
Equity portion of allowance for funds used during
construction........................................... - 1 1 3
Other.................................................... 1 2 7 5
----- ----- ----- -----
Total other income..................................... $ 48 $ 23 $ 73 $ 49
===== ===== ===== =====
Other deductions:
Software write-off....................................... $ (2) $ - $ 109 $ -
Litigation charge........................................ - - 100 -
Employee severance charges............................... 3 - 111 -
Spare parts inventory writedown.......................... - - 79 -
Debt extinguishment losses............................... 11 1 54 -
Equity in debt extinguishment losses of financing trusts. - - 6 -
Equity in losses of telecommunications joint venture..... - - - 17
Transaction-related fees................................. 1 - 4 -
Expenses related to impaired construction projects....... 1 2 5 4
Write-off of frequency licenses.......................... - - - 3
Casualty loss (gas storage explosion).................... 5 - 5 -
Premium on redemption of preferred stock................. - 3 - 3
Other.................................................... 1 1 4 3
----- ----- ----- -----
Total other deductions................................. $ 20 $ 7 $ 477 $ 30
===== ===== ===== =====
Severance Liability Related to Restructuring Activities
Electric Corp
Energy Delivery & Other Total
------ -------- ------ -----
Liability for severance costs accrued as of June 30, 2004.... $ 84 $ 18 $ 4 $ 106
Additions to liability................................... 3 - - 3
Payments charged against liability....................... (53) (7) (3) (63)
Other adjustments to the liability....................... - - (1) (1)
----- ----- ------ ------
Liability for severance costs accrued as of September 30,
2004................................................... $ 34 $ 11 $ - $ 45
===== ===== ===== =====
The above table excludes severance capitalized as a regulatory asset or
included in discontinued operations.
Interest Expense and Related Charges --
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2004 2003 2004 2003
------ ------ ------ ------
Interest (a)...................................................... $ 156 $ 165 $ 470 $ 537
Distributions on exchangeable preferred membership interests of - -17 22 17
Energy (a)........................................................
Interest on long-term debt held by subsidiary trust............... 3 7 15 23
Preferred stock dividends of subsidiaries......................... 1 1 1 5
Amortization of debt discounts, premiums and issuance cost........ 7 7 22 24
Allowance for borrowed funds used during construction and (4) (3) (9) (9)
------- ------ ------- ------
capitalized interest..............................................
Total interest expense and related charges.................. $ 163 $ 194 $ 521 $ 597
====== ====== ====== ======
(a)Interest for the nine months ended September 30, 2003, includes $34 million
related to the exchangeable subordinated notes that were exchanged for
exchangeable preferred membership interests in July 2003. Distributions on
preferred membership interests in the 2004 periods include amounts through
April 2004, when these securities were purchased by TXU Corp.
30
Regulatory Assets and Liabilities --
September 30, December 31,
2004 2003
------------- ------------
Regulatory Assets:
Generation-related regulatory assets securitized by transition bonds........ $1,640 $1,654
Securities reacquisition costs.............................................. 127 121
Recoverable deferred income taxes -- net.................................... 98 96
Other regulatory assets..................................................... 162 95
------ ------
Total regulatory assets................................................. 2,027 1,966
Regulatory Liabilities:
Investment tax credits and protected excess deferred taxes................. 81 88
Over collection of transition bond (securitization) revenues ............... 24 6
------ ------
Total regulatory liabilities............................................ 105 94
------ ------
Net regulatory assets................................................ $1,922 $1,872
====== ======
Included in net regulatory assets are assets of $121 million at September
30, 2004 and December 31, 2003, that are earning a return. The regulatory
assets, other than those subject to securitization, have a remaining recovery
period of 15 to 47 years.
Included in other regulatory assets as of September 30, 2004 was $42
million related to nuclear decommissioning liabilities.
Restricted Cash -- At September 30, 2004, TXU Corp. had a $525 million
investment in LOC Trust, accounted for as restricted cash, representing
collateral to support a $500 million credit facility (see Note 4). The remaining
restricted cash reported in investments on the balance sheet as of September 30,
2004 included $39 million held as collateral for letters of credit issued and
$10 million principally related to payment of fees associated with the
securitization bonds and $5 million in reserve for shortfalls of transition
charges. At September 30, 2004, the TXU Electric Delivery Transition Bond
Company LLC had $29 million of restricted cash, representing collections from
customers that secure its securitization bonds and may be used only to service
its debt and pay its expenses.
Accounts Receivable -- At September 30, 2004 and December 31, 2003,
accounts receivable of $1.1 billion are stated net of allowance for
uncollectible accounts of $42 million and $56 million, respectively. During the
nine months ended September 30, 2004, bad debt expense was $76 million, account
write-offs were $90 million and other activity increased the allowance for
uncollectible accounts by $3 million. During the nine months ended September 30,
2003, bad debt expense was $69 million, account write-offs were $65 million and
other activity decreased the allowance for uncollectible accounts by $5 million.
Allowances related to receivables sold are reported in other current liabilities
and totaled $36 million and $42 million at September 30, 2004 and December 31,
2003, respectively.
Accounts receivable included $454 million and $438 million of unbilled
revenues at September 30, 2004 and December 31, 2003, respectively.
Intangible Assets -- Intangible assets other than goodwill are comprised
of the following:
As of September 30, 2004 As of December 31, 2003
----------------------------- ----------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
------ ------------ --- ------ ------------ ---
Intangible assets subject to amortization
included in property, plant and equipment:
Capitalized software placed in service.... $ 439 $ 299 $ 140 $ 512 $ 248 $ 264
Land easements............................ 172 61 111 176 66 110
Other..................................... 31 22 9 31 21 10
----- ----- ----- ----- ----- -----
Total................................... $ 642 $ 382 $ 260 $ 719 $ 335 $ 384
===== ===== ===== ===== ===== =====
31
Aggregate TXU Corp. amortization expense for intangible assets for the
nine months ended September 30, 2004 and 2003 was $50 million and $52 million,
respectively. At September 30, 2004, the weighted average useful lives of
capitalized software, land easements and other were 7 years, 70 years and 40
years, respectively.
During the second quarter of 2004, TXU Corp. wrote-off certain software
projects, resulting in a charge of $110 million ($72 million after-tax). See
Note 1 for further discussion.
Goodwill of $542 million reported in the consolidated balance sheet as of
September 30, 2004, relates to Energy ($517 million) and Electric Delivery ($25
million). Assets held for sale reported in the consolidated balance sheet
include goodwill of $246 million related to TXU Gas. Goodwill was reduced by $16
million in the second quarter of 2004, reflecting an allocation of Energy
goodwill to the disposed TXU Fuel Company business.
Commodity Contracts -- At September 30, 2004 and December 31, 2003,
current and noncurrent commodity contract assets, arising largely from
mark-to-market accounting, totaled $936 million and $657 million, respectively,
and are stated net of applicable credit (collection) and performance reserves
totaling $23 million and $18 million, respectively. Performance reserves are
provided for direct, incremental costs to settle the contracts. Current and
non-current commodity contract liabilities totaled $854 million and $549 million
at September 30, 2004 and December 31, 2003, respectively.
Inventories by Major Category --
September 30, December 31,
2004 2003
------------- ------------
Materials and supplies......................................................... $ 167 $ 258
Fuel stock..................................................................... 79 78
Gas stored underground......................................................... 84 83
------ ------
Total inventories......................................................... $ 330 $ 419
====== ======
As described in Note 1, Energy recorded a charge of $79 million ($51
million after-tax) in the second quarter of 2004 to write down spare parts and
equipment inventory.
Property, Plant and Equipment -- As of September 30, 2004 and December 31,
2003, property, plant and equipment of $16.5 billion and $16.8 billion,
respectively, is stated net of accumulated depreciation and amortization of
$11.1 billion and $11.0 billion, respectively.
As of September 30, 2004, substantially all of Electric Delivery's
electric utility property, plant and equipment (with a net book value of $6.5
billion) was pledged as collateral for Electric Delivery's first mortgage bonds
and senior secured notes.
Supplemental Cash Flow Information --
The consolidation of Pinnacle in 2003 was a noncash activity. The sale of
TXU Australia included the assumption of debt by the purchaser, a noncash
activity.
See Note 2 for the effects of adopting SFAS 143, which were noncash in
nature.
32
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TXU Corp.:
We have reviewed the accompanying condensed consolidated balance sheet of TXU
Corp. and subsidiaries (TXU Corp.) as of September 30, 2004, and the related
condensed statements of consolidated income and of comprehensive income for the
three-month and nine-month periods ended September 30, 2004 and 2003, and the
condensed statements of consolidated cash flows for the nine-month periods ended
September 30, 2004 and 2003. These interim financial statements are the
responsibility of TXU Corp.'s 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 Corp. as of December 31, 2003, and the related statements of consolidated
income, comprehensive income, cash flows and shareholders' equity for the year
then ended (not presented herein); and in our report (which includes an
explanatory paragraph related to the rescission of Emerging Issues Task Force
Issue No. 98-10) 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
November 4, 2004
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BUSINESS
TXU Corp. is a holding company conducting its operations principally
through its Energy and Electric Delivery subsidiaries. Energy is engaged in
electricity generation and retail and wholesale energy sales. Electric Delivery
engages in regulated electricity transmission and distribution operations. On
October 1, 2004, TXU Corp. and Atmos Energy Corporation completed a merger by
division (the TXU Gas transaction) in which Atmos Energy Corpration acquired TXU
Gas' operations for approximately $1.905 billion in cash. See "TXU Gas
Transaction" below
TXU Corp. has two reportable segments: Energy and Electric Delivery. (See
Note 10 to Financial Statements for further information concerning reportable
business segments.)
Changes in Business
- -------------------
Strategic Initiatives and Other Actions -Mr. C. John Wilder, who was named
president and chief executive of TXU Corp. in February 2004, and senior
management have been reviewing the operations of TXU Corp. and have formulated
certain strategic initiatives and continue to develop others. Areas being
reviewed include:
o Performance in competitive markets, including profitability in new
markets;
o Cost structure, including organizational alignments and headcount;
o Management of natural gas price risk and cost effectiveness of the
generation fleet; and
o Non-core business activities.
TXU Corp. anticipates performance improvements as a result of various
strategic initiatives, including lower administrative support costs, more
efficient and cost-effective utilization of generation-related assets and
increased return on investments. As discussed below, implementation of the
strategic initiatives as well as other actions taken to date have resulted in
the following effects on income from continuing operations before extraordinary
gain:
o TXU Corp. has recorded total charges of $19 million ($12 million
after-tax) in the third quarter of 2004 and $469 million ($311
million after-tax) year-to-date, reported largely in other
deductions, related to asset writedowns, employee severance, debt
extinguishment losses and litigation.
o In addition, TXU Corp. has incurred consulting and professional fees
related to the strategic initiatives totaling $15 million ($10
million after-tax) in the third quarter of 2004 and $34 million ($22
million after-tax) year-to-date, reported in SG&A expenses, and
nonrecurring contractual executive compensation expense of $52
million year-to-date (without tax benefit), also reported in SG&A
expenses.
o A $75 million income tax benefit was recorded in the second quarter
of 2004 to recognize a portion of the previously reserved tax
benefit associated with the write-off of TXU Corp.'s investment in
TXU Europe. Such recognition was triggered by the tax effects of the
sale of the assets of TXU Fuel Company.
o In the third quarter of 2004, TXU Corp. recorded gains on the
disposition of Energy properties totaling $18 million ($12
million after-tax), reported in other income.
Additional effects of the strategic initiatives, including the
dispositions of TXU Australia and TXU Gas and additional tax benefits related to
the write-off of the investment in TXU Europe, are reflected in results from
discontinued operations.
Charges recorded in the three-month and nine-month periods ended September
30, 2004 and 2003 reported in other deductions are detailed in Note 12 to
Financial Statements.
34
The review of TXU Corp.'s operations and formulation of strategic
initiatives is ongoing, and additional charges are expected. The phases of the
plan resulting in the charges to date are anticipated to be largely completed in
2004. Upon completion of each phase of the plan, TXU Corp. expects to fully
describe the actions intended to improve the financial performance of its
operations. Certain of the strategic initiatives described below could result in
additional material charges that TXU Corp. is currently unable to predict. In
addition, other new strategic initiatives are likely to be undertaken that could
also materially affect TXU Corp.'s financial results.
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.,
but 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, subject to adjustment
for volumes or other factors, include information technology, customer call
center, billing, human resources, supply chain and certain accounting
activities. TXU Corp. expects that the Capgemini arrangement will result in
lower costs and improved service levels.
As part of the agreements, TXU Corp. provided Capgemini a royalty-free
right, under an asset license arrangement, to use TXU Corp.'s information
technology assets, consisting primarily of capitalized software. A portion of
the software was in development and had not yet been placed in service by TXU
Corp. As a result of outsourcing its information technology activities, TXU
Corp. no longer intends to develop the majority of these projects and from TXU
Corp.'s perspective the software is abandoned. The agreements with Capgemini do
not require that any software in development be completed and placed in service.
Consequently, the carrying value of these software projects was written off in
the second quarter of 2004, resulting in a charge of $109 million ($71 million
after-tax), reported in other deductions, essentially all of which was recorded
in the second quarter of 2004. TXU Corp. expects to rely on Capgemini for future
enhancements and modifications to the software in use at the time of the
transaction.
TXU Corp. received a 2.9% limited partnership interest in Capgemini in
exchange for the asset license described above. TXU Corp. has the right to sell
(the "put option") all its interest in the partnership and the software to Cap
Gemini America Inc. for $200 million, plus TXU Corp.'s share of Capgemini's
undistributed earnings, upon expiration of the services agreement, or earlier
upon the occurrence of certain unexpected events. Cap Gemini North America Inc.
has the right to purchase TXU Corp.'s 2.9% limited partnership interest in
Capgemini under the same terms and conditions. The partnership interest has been
recorded at an initial value of $2.9 million and is being accounted for on the
cost method.
TXU Corp. has recorded the fair value of the put option as a noncurrent
asset largely offset by a reduction to the carrying value of the software, in
accordance with the accounting principles related to sales and licensing of
internally developed software described in AICPA Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." The remaining balance of the software is being amortized over the
estimated remaining lives.
Also as part of the 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
Corp. recorded a $40 million ($26 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. In addition, TXU Corp.
committed to pay up to $25 million for costs associated with transitioning the
outsourced activities to Capgemini. The transition costs are expected to be
largely recorded by TXU Corp. during the fourth quarter of 2004.
Subject to certain terms and conditions, Cap Gemini North America, Inc.
and its parent, Cap Gemini S.A., have guaranteed the performance and payment
obligations of Capgemini under the services agreement, as well as the payment of
$200 million in connection with the put option.
35
The transfer of employees to Capgemini triggered a curtailment with
respect to TXU Corp.'s pension and other post-employment benefit plans. In the
second quarter of 2004, TXU Corp. recorded a net pre-tax curtailment charge of
$3 million, reported in other deductions, related to these plans. The
curtailment required a remeasurement of liabilities under the plans as of the
employee transfer date. The estimated effect of the employee transfers, combined
with changes in the discount rate and other assumptions, was a reduction in
pension and other postretirement expenses of approximately $36 million on an
annualized basis effective July 1, 2004.
On July 1, 2004, TXU Corp. loaned Capgemini $25 million for working
capital purposes pursuant to a promissory note that bears interest at a
market-based annual rate of 4% and matures on July 1, 2019.
Sale of TXU Australia
---------------------
On July 30, 2004, TXU Corp. completed the sale of TXU Australia to
Singapore Power Ltd. for $3.6 billion, including $1.7 billion of assumed debt
and $1.9 billion in cash. The cash proceeds were used to repay short-term
borrowings. A gain on sale of $367 million ($239 million after-tax) was recorded
in the third quarter of 2004. The results of TXU Australia and the gain on sale
are reported as discontinued operations as discussed in Note 3 to Financial
Statements.
Sale of TXU Fuel Company
------------------------
On June 2, 2004, TXU Corp. completed the sale of the assets of TXU Fuel
Company, the gas transportation subsidiary of Energy, to Energy Transfer
Partners, L.P. for $500 million in cash. The cash proceeds were used to repay
short-term borrowings. The assets of TXU Fuel Company consisted of approximately
1,900 miles of intrastate pipeline and a total system capacity of 1.3 Bcf/day.
As part of the transaction, Energy entered into a market-price based
transportation agreement with the new owner to transport gas to Energy's
generation plants. Because of the continuing involvement in the business through
the transportation agreement, the pre-tax gain related to the sale of $377
million will be recognized over the eight-year life of the transportation
agreement, and the business has not been accounted for as a discontinued
operation. The pre-tax gain is net of $16 million of Energy goodwill allocated
to TXU Fuel Company.
TXU Gas Transaction
-------------------
On October 1, 2004, Atmos Energy Corporation and TXU Gas completed a
merger by division, which resulted in the disposition of the operations of TXU
Gas for $1.905 billion in cash. The intent to dispose of the operations had been
previously disclosed. A pre-tax loss on the transaction of approximately $58
million is now expected, and this amount was recorded as a goodwill impairment
charge in the third quarter of 2004. This amount includes the effect of $19
million in discontinued depreciation expense in accordance with accounting rules
for assets held for sale. The balance of the loss reflects changes in the terms
of the transaction agreement and refinements of previous estimates. The results
of TXU Gas, as well as goodwill impairment charges recorded, are reported as
discontinued operations as discussed in Note 3.
On October 1, 2004, prior to the close of the TXU Gas transaction, TXU Gas
irrevocably deposited with the applicable trustees an aggregate of approximately
$450 million (principal and interest) for the legal defeasance of all of its
outstanding debt securities. A portion of this deposit was used to redeem the
$154 million principal amount of Floating Rate Junior Subordinated Debentures on
October 31, 2004. The remaining amount of this deposit will be used to redeem
the $125 million principal amount of the Remarketed Reset Notes on July 1, 2005,
and to repay the $150 million principal amount of the 7.125% Notes at maturity
on June 15, 2005. In addition, on October 1, 2004, prior to the close of the TXU
Gas transaction, TXU Gas irrevocably deposited with a Texas bank approximately
$75 million for the redemption of all of its outstanding preferred stock. On
November 5, 2004, all of the outstanding shares of TXU Gas' preferred stock with
a liquidation value of $75 million were redeemed.
36
Recognition of Income Tax Benefits
----------------------------------
On its US federal income tax return for calendar year 2002, TXU Corp.
claimed an ordinary loss deduction related to the worthlessness of TXU Corp.'s
investment in TXU Europe, the tax benefit of which is estimated to be $983
million (assuming the deduction is sustained on audit). Due to a number of
uncertainties regarding the proper tax treatment of the worthlessness loss, no
portion of the tax benefit related to TXU Corp.'s 2002 write-off of its
investment in TXU Europe was recognized in income prior to the second quarter of
2004.
In June 2004, the IRS issued a preliminary notice of proposed adjustment
proposing to disallow the 2002 worthlessness deduction and treat the
worthlessness as a capital loss (deductible only against capital gains).
Accordingly, in the second quarter of 2004, TXU Corp. recorded a tax benefit in
income of $711 million related to the utilization of a portion of the
worthlessness deduction. The tax benefit recognized reflects utilization of the
capital loss deduction against capital gains reported for 2002 and the 1999-2001
carryback periods and the capital gains on the 2004 sales of the TXU Australia,
TXU Fuel Company and the telecommunications businesses. The benefit recognized
also included $213 million for certain items related to the write-off of TXU
Corp.'s investment in TXU Europe expected to be sustained as ordinary deductions
as a result of the preliminary notice.
As a result of the TXU Gas transaction on October 1, 2004, TXU Corp.
expects to realize a capital gain for tax purposes. As a result of this gain,
TXU Corp. recognized an estimated tax benefit in the third quarter of 2004
related to the utilization of a portion of the 2002 worthlessness deduction
arising from the write-off of the TXU Europe investment. In addition, during the
third quarter of 2004, TXU Corp. revised certain estimates of capital gains and
ordinary deductions impacting the worthlessness deduction utilization. The net
tax benefit recognized in 2004 with respect to the write-off of the investment
in TXU Europe totals $76 million in the third quarter and $787 million
year-to-date.
Benefits arising from the resolution of uncertainty regarding utilization
of deductions in the year the TXU Europe investment was written-off or in a
prior year are reported in discontinued operations. Benefits arising from
resolution of uncertainty regarding utilization of deductions in subsequent
years are classified in the same manner as the source of the income resulting in
the recognition of the benefits. Accordingly, of the total $787 million
year-to-date benefit, $75 million was reported in continuing operations in the
second quarter of 2004 as this amount relates to the capital gain arising from
the sale of the assets of TXU Fuel Company, the historical operations of which
have been classified as continuing operations. Additional tax benefits may be
recognized in future periods to the extent capital gains are realized.
See Note 8 to Financial Statements for discussion of income tax
contingencies related to TXU Europe and other matters.
Facility Closures and Other Actions Related to Generation Operations
--------------------------------------------------------------------
On October 1, 2004, Energy entered into an agreement to terminate the
operating lease for certain mining equipment for approximately $28 million in
cash, effective November 1, 2004. The lease termination will result in an
estimated net charge of approximately $21 million ($13 million after-tax) to be
recorded in other deductions in the fourth quarter of 2004.
In the third quarter of 2004, Energy recorded gains totaling $18 million
($12 million after-tax) on the sale of largely undeveloped land. The gains are
reported in other income.
In the second quarter of 2004, Energy initiated a plan to sell the
Pedricktown, New Jersey 122 MW power production facility and exit the related
power supply and gas transportation agreements. Accordingly, Energy recorded an
impairment charge of $26 million ($17 million after-tax) to write down the
facility to estimated fair market value. The results of the business and the
impairment charge are reported in discontinued operations, as discussed in Note
3 to Financial Statements.
37
As part of Energy's review of its generation asset portfolio, Energy
completed a review of its spare parts and equipment inventory to determine the
appropriate level of such inventory. The review included nuclear, coal and
gas-fired generation-related facilities. As a result of this review, Energy
recorded a charge of $79 million ($51 million after-tax), reported in other
deductions, in the second quarter of 2004 to reflect excess inventory on hand
and to write down carrying values to scrap values.
In March 2004, Energy announced the planned permanent retirement,
completed in the second quarter of 2004, of eight gas-fired operating units due
to electric industry market conditions in Texas. Energy also temporarily closed
four other gas-fired units and placed them under evaluation for retirement. The
12 units represented a total of 1,471 MW, or more than 13%, of Energy's
gas-fired generation capacity in Texas. A majority of the 12 units were
designated as "peaking units" and operated only during the summer for many years
and have operated only sparingly during the last two years. Most of the units
were built in the 1950's. Energy also determined that it would close its
Winfield North Monticello lignite mine in Texas, and such closure has been
completed, as it is no longer economical to operate when compared to the cost of
purchasing coal to fuel the adjacent generation facility. A total charge of $8
million ($5 million after-tax) was recorded in the first quarter of 2004,
reported in other deductions, for production employee severance costs ($7
million pre-tax) and impairments related to the various facility closures ($1
million pre-tax).
Organizational Realignment and Headcount Reductions
---------------------------------------------------
TXU Corp. intends to realign its operations along three core business
segments consisting of:
o Electric Delivery - the regulated electric delivery business;
o Power - the electric power production business; and
o Energy - the retail and wholesale energy sales and portfolio
management operations.
Processes are currently being developed to report operating results of the
Power and Energy business segments. (Operating results of the Electric Delivery
segment and the current combined Energy segment are provided in this report.)
Results are expected to be reported under the new segment alignment no later
than the first quarter of 2005.
During the second quarter of 2004, management completed a comprehensive
organizational review, including an analysis of staffing requirements. As a
result, TXU Corp. completed a self-nomination severance program and finalized a
plan for additional headcount reductions under an involuntary severance program,
which have been completed. Accordingly, in the second quarter of 2004, TXU Corp.
recorded severance charges totaling $53 million ($34 million after-tax),
reported in other deductions.
Liability and Capital Management
--------------------------------
Over the past several months, TXU Corp. has utilized cash proceeds from
the sale of TXU Australia, TXU Gas and TXU Fuel Company and other assets sales
as well as cash provided from operations to increase value and reduce risks
through an ongoing liability management initiative. Under this initiative,
through November 1, 2004, TXU Corp. has repurchased or legally defeased
approximately $2.5 billion of debt securities (including equity-linked debt
securities) and $2.1 billion of equity securities.
Pursuant to a publicly announced tender offer, on October 15, 2004
TXU Corp. repurchased the following securities:
o 7,485,592, or 64.9%, of its outstanding Corporate Units for a
purchase price of $52.28 per Corporate Unit, including $187 million
principal amount of outstanding Series L Senior Notes which were a
component of the purchased Corporate Units;
o 5,117,962, or 58.2%, of its outstanding Income PRIDES for $52.39
per Income PRIDE, including $256 million principal amount of
outstanding Series M Senior Notes which were a component of the
purchased Income PRIDES; and
o $482 million principal amount or 91.8% of its outstanding Floating
Rate Convertible Senior Notes due 2033, for $1,593.65 per $1,000
principal amount of Convertible Senior Notes. TXU Corp. intends to
settle any future conversion of the remaining outstanding notes in
common stock.
38
TXU Corp. expects to record debt extinguishment losses related to these
repurchases of an estimated $329 million ($312 million after-tax) in the fourth
quarter of 2004.
TXU Corp. may repurchase additional outstanding Corporate Units, Income
PRIDES and Convertible Notes that were not tendered in the tender offers through
open market repurchases, through privately negotiated transactions or otherwise.
Future purchases of such securities may be on terms that are more or less
favorable than the tender offers. In addition, TXU Corp. may repurchase
additional shares of common stock to offset potential issuances of common stock
that may be made in connection with the settlement or conversion of these
securities. Future purchases, if any, will depend on many factors, which include
market conditions and the condition of TXU Corp.'s businesses.
On August 16, 2004, the TXU Corp. Series K Senior Notes (aggregate
principal outstanding of $288 million) were remarketed. TXU Corp. participated
as an investor in the remarketing and purchased for retirement $238 million
principal amount of the notes for $241 million, resulting in a charge of $4
million ($3 million after-tax). The remaining $50 million principal amount
outstanding bears a new interest rate of 4.446% and matures in November 2006.
On September 28, 2004, portions of the Brazos River Authority Pollution
Control Revenue Refunding Bonds related to the Twin Oak facility were redeemed
at par as follows: $57 million of Series 2001C; $21 million of Series 2003C; $16
million of Series 2002A; $4 million of series 1995B; and $3 million of Series
2001D.
In the second quarter of 2004, TXU Corp. repurchased $427 million carrying
amount ($423 million principal amount and $4 million in deferred costs) of
equity-linked debt securities for $404 million. The repurchase was in connection
with a settlement of related litigation and resulted in total charges of $34
million ($28 million after-tax), reported in other deductions, essentially
representing the premium for the debt component of the securities and an
additional repurchase premium. The repurchase also resulted in a credit to
additional paid-in capital of $57 million, which represented the holders'
out-of-the-money fair market value of the related equity purchase contracts. An
additional credit to additional paid-in capital of $18 million was recorded to
reverse the remaining liability for future contract adjustment payments to
holders of the securities. At the time of issuance of the securities, TXU Corp.
had recorded a liability for the present value of the contract adjustment
payments with an offsetting reduction to common stock equity.
In June 2004, TXU Corp. repurchased 20 million shares of its outstanding
common stock through an accelerated share repurchase agreement at an initial
price of $39.86 per share. As of September 30, 2004, the broker-dealer that
executed the repurchase transaction had completed the process of purchasing an
equal amount of shares in the open market, and TXU Corp. paid a purchase price
adjustment of $7 million based upon the actual cost of the shares repurchased
by such broker-dealer.
Also in the second quarter of 2004, TXU Corp. repurchased at par $237
million principal amount of 7.25% Notes held by subsidiary trusts and $118
million principal amount of 6.375% Senior Notes for $125 million. These
transactions resulted in debt extinguishment losses totaling $15 million ($10
million after-tax), reported in other deductions.
In April 2004, TXU Corp. repurchased Energy's exchangeable preferred
membership interests with a liquidation amount of $750 million for $1.85 billion
(including transaction costs). The excess of the purchase price over the
carrying value of the securities, net of $384 million in income tax benefits
recorded as a deferred tax asset, was recorded as a charge to additional paid-in
capital in the amount of $849 million. The carrying value of the securities was
$617 million, which is the liquidation amount of $750 million net of $102
million in unamortized discount and $31 million in unamortized debt issuance
costs, both recorded at the time of issuance of the securities in November 2002.
The charge to additional paid-in capital is accounted for in a manner similar to
TXU Corp.'s preference share dividends, resulting in a reduction in net income
available to common shareholders.
39
TXU Corp. also repurchased approximately $240 million of its common equity
securities in open market purchases during the third quarter of 2004 and $434
million year-to-date. Shares purchased on the open market by TXU Corp. totaled
5.7 million in the third quarter of 2004 and 11.1 million year-to-date.
As part of its capital allocation strategy, TXU Corp. intends to utilize
cash provided by operating activities in accordance with the following
priorities:
o First, investments to preserve and enhance the quality of customer
service and production and delivery reliability;
o Second, reinvestments in its businesses, applying stringent
expectations for cash payback timelines and minimum return on
investment;
o Third, to reduce debt and other liabilities, with the objective of
strengthening the balance sheet and increasing financial flexibility.
o Fourth, to be returned to shareholders, through the payment of
dividends; and
o Fifth, to be returned to shareholders through common stock share
repurchases, or retained for investment in TXU Corp.'s business.
As part of its capital management program and the restructuring
initiatives and considering current business and market conditions, on October
22, 2004, the Board of Directors adopted a revised dividend and cash
distribution policy. The new policy sets the dividend on TXU Corp.'s common
stock at an annual rate of $2.25 per share, with an expectation of 5% annual
dividend growth. The dividend rate will be subject to regular review by the
Board of Directors and may be changed based upon a number of factors, including
TXU Corp.'s profit levels, operating cash flows and capital requirements as well
as financial and other business conditions existing at the time. In addition,
the policy provides that, in any year, the Board of Directors may authorize cash
distributions to TXU Corp.'s shareholders in the form of share repurchases or
special dividends, subject to a cap of 75% of TXU Corp.'s operational earnings
(income from continuing operations excluding unusual or nonrecurring charges or
credits, and net of preference share dividends) in that year. Consistent with
this policy, the Board of Directors declared a regular quarterly dividend of
56.25 cents per share, payable on January 3, 2005 to shareholders of record as
of December 3, 2004. In addition, the Board of Directors authorized the
repurchase of 50 million shares of TXU Corp.'s common stock. The 50 million
shares replace any previously authorized but not executed share repurchases. TXU
Corp. has the ability to use the bridge facilities described below to fund any
such share repurchases.
On November 4, 2004, TXU Corp. entered into a one-year term loan credit
facility totaling $2.3 billion. All of the borrowings from the facility may be
used by TXU Corp. to repurchase its common stock, and up to $1.0 billion of the
borrowings may be used for working capital and other general corporate purposes.
TXU Corp. may make up to five drawings under the facility at any time on or
prior to December 4, 2004. On December 4, 2004, the total commitments under the
facility will be reduced to the then outstanding aggregate principal balance of
the loans under the facility. In addition, the credit facility provides, in
certain circumstances, for mandatory prepayments. In particular, TXU Corp. will
be required to repay its obligations under the facility, upon the receipt of
proceeds by TXU Corp. or its subsidiaries from certain issuances of securities
and from certain asset sales. Upon any such prepayment, the total commitment
under the credit facility will be reduced by an amount equal to such prepayment.
Also on November 4, 2004, TXU Energy entered into a five-year revolving
credit facility that allows for (i) bridge loans, (ii) revolving loans and (iii)
letters of credit having a maturity of one year. Bridge loans may total up to
$500 million and will mature no later than October 31, 2005. Letters of credit
may total up to $500 million, but in some instances require prepayment of bridge
loans in an amount equal to the face value of the letter of credit. Revolving
loans may total up to $250 million, but are only available after all bridge
loans have been repaid. The aggregate amount of borrowings outstanding at any
one time may not exceed $500 million. TXU Energy intends to use this facility
for general and corporate purposes, including, in the case of letters of credit,
support for pollution control revenue bonds. In addition, pursuant to the terms
of the five-year revolving credit facility, bridge loans may be used to loan or
distribute funds to TXU Corp. for the repurchase of its common stock.
40
See Notes 4, 5, and 6 to Financial Statements for further detail of debt
issuances and retirements, financing arrangements, debt held by unconsolidated
subsidiary trusts and capitalization.
Investment in New Trading Entity
--------------------------------
In May 2004, Energy and Credit Suisse First Boston (USA), Inc. announced
they had entered into a memorandum of understanding to establish a 50/50
investment in an energy marketing and trading entity. After a detailed review of
the proposed venture, the parties were unable to agree on an economic
arrangement that met each party's strategic objectives and in September 2004
announced a mutual agreement not to pursue the joint venture. Energy will
continue to leverage its internal wholesale marketing and risk management
capabilities to manage its purchased power needs and economically dispatch its
generation fleet in the Texas market.
Strategic Review of Nuclear Assets
----------------------------------
Energy is currently undertaking a strategic review of its nuclear assets,
comprised of two electricity generating units at Comanche Peak, each with a
capacity of 1,150 MW. The objectives of this strategic review are to evaluate
potential means to reduce the cost risk of outages of these low marginal cost
facilities and improve the long-term availability and certainty of electricity
supply for Energy's customers. Energy continues to identify and evaluate various
potential initiatives as part of this review. Energy expects to complete the
review within six months, and no determination has been made as to the
likelihood of implementing any of the initiatives.
Litigation Accrual
------------------
During the second quarter of 2004, management assessed the progress and
status of matters in litigation as described in Note 8 to Financial Statements
and recorded an accrual of $100 million ($65 million after-tax), reported in
other deductions, for the expected resolution of certain cases.
Consolidation of Real Estate
----------------------------
Currently, TXU Corp. owns or leases more than 1.3 million square feet in
various management and support office locations, which exceeds its anticipated
needs. TXU Corp. has evaluated alternatives to reduce current office space and
intends to consolidate into its existing headquarters building in Dallas, Texas,
enhancing the facility to enable better employee communication and collaboration
and cost effectiveness. Implementation of this initiative is expected to result
in charges related to existing leased facilities in the fourth quarter of 2004
and the first quarter of 2005, but the amounts are not yet estimable.
Initiatives to Improve System Reliability and Performance
---------------------------------------------------------
TXU Corp. is undertaking a number of initiatives to improve customer
service, electric delivery and production reliability, and operational
performance. These initiatives include:
o Investment for vegetation management across the electricity
distribution network, estimated at $45 million over the next three
years, an increase of 70% over the last three years;
o Investment in key electricity transmission projects to further
improve reliability and reduce congestion, estimated on average to be
$80 million annually over the next three years, a 35% increase over
the 2003 investment level;
o Investment of an additional $275 million over the next three years to
improve reliability of coal and nuclear production assets, a 45%
increase in annual spending over the 2003 investment level; and
o Replacement of four steam generators in one of the two units of the
Comanche Peak nuclear plant in order to maintain the operating
efficiency of the unit. Estimated capital requirements for this
project are $175 million to $225 million, to be spent largely over
the next three years.
41
RESULTS OF OPERATIONS
All dollar amounts in Management's Discussion and Analysis of Financial
Condition and Results of Operations and the tables therein, except per share
amounts, are stated in millions of US dollars unless otherwise indicated.
The results of operations and the related management's discussion of those
results for all periods presented reflect the discontinuance of certain
operations of TXU Corp. (See Note 3 to Financial Statements regarding
discontinued operations.)
TXU Corp. Consolidated
- ----------------------
Three Months Ended September 30, 2004 compared to Three Months Ended
September 30, 2003
- -----------------------------------------------------------------------------
Reference is made to the consolidated income statements presented in the
financial statements and the comparisons of results by business segment
following the discussion of consolidated results immediately below. The business
segment comparisons provide additional detail and quantification of items
affecting financial results.
TXU Corp.'s operating revenues increased $128 million, or 5%, to $2.7
billion in 2004. Operating revenues rose $80 million, or 3%, to $2.5 billion in
the Energy segment driven by higher retail and wholesale pricing, partially
offset by lower retail volumes due to competitive activity and milder weather.
Operating revenues in the Electric Delivery segment rose $35 million, or 6%, to
$648 million driven by higher transmission and distribution fees (tariffs),
partially offset by lower volumes due to milder weather. Consolidated revenue
growth also reflected an $11 million reduction in the intercompany sales
elimination, primarily reflecting lower sales by Electric Delivery to Energy as
sales to nonaffiliated REPs increased.
Gross Margin
Three Months Ended September 30,
-----------------------------------------------
% of % of
2004 Revenue 2003 Revenue
------ ---------- ------ ---------
Operating revenues..................................... $ 2,743 100% $ 2,615 100%
Costs and expenses:
Cost of energy sold, including delivery fees...... 1,134 41% 1,102 42%
Operating costs................................... 337 12% 336 13%
Depreciation and amortization related to operating
assets........................................ 204 8% 164 6%
------- ----- ------- -------
Gross margin........................................... $ 1,068 39% $ 1,013 39%
======= ===== ======= =======
Gross margin is considered a key operating metric as it measures the
effect of changes in sales volumes and pricing versus the variable and fixed
costs of energy sold, as well as the costs to deliver energy.
Gross margin increased $55 million, or 5%, to $1.1 billion in 2004. The
Energy segment's gross margin increased $89 million, or 14%, to $734 million
reflecting higher average pricing, partially offset by lower results from
hedging and risk management activities, the unfavorable effects of a volume mix
shift from higher margin retail sales to wholesale sales, higher delivery fees
and milder weather. The average cost of total power produced and purchased was
up slightly, reflecting improved utilization of base load (nuclear and
lignite-fired) production and improved sourcing of purchased power versus
gas-fired generation. The Electric Delivery segment's gross margin decreased $24
million, or 7%, to $339 million reflecting lower volumes and an increase in
operating costs, partially offset by an increase in transmission-related
tariffs.
Operating costs were flat at $337 million reflecting increased costs in
the Electric Delivery segment primarily for vegetation management to improve
system reliability and increased third-party transmission costs, offset by lower
costs in the Energy segment related to customer care support services for TXU
Gas now performed by Capgemini (largely offset by lower related revenues) and
the absence of costs from the gas transportation subsidiary sold in June 2004
(largely offset by higher cost of energy sold related to gas-fired production).
42
Depreciation and amortization included in gross margin, which relates to
assets directly used in the generation and delivery of power, rose $40 million,
or 24%, to $204 million in 2004. This increase reflected higher regulatory asset
amortization in 2004 of $38 million associated with Electric Delivery
securitization bonds issued in August 2003 and June 2004, normal additions and
replacements of equipment and increased coal mining-related activities,
partially offset by a $11 million impact of lower depreciation related to
Energy's generation fleet, due primarily to extensions of estimated depreciable
lives to better reflect useful lives. (See Note 1 to Financial Statements.)
Depreciation and amortization not included in gross margin totaled $6
million and $19 million for the three months ended September 30, 2004 and 2003,
respectively. This decline primarily reflected a decrease in amortization due to
a reduction in the carrying values of software assets in connection with the
Capgemini outsourcing transaction.
SG&A expense increased $53 million, or 23%, to $280 million in 2004. The
increase reflected approximately $25 million in higher deferred incentive
compensation expense due to the increase in the price of TXU Corp. common stock,
$15 million related to consulting and professional fees in conjunction with the
formulation and execution of strategic initiatives and $14 million in special
compensation incentive program expense related to trading activities.
Other income increased by $25 million to $48 million in 2004. Other income
in 2004 reflected a $18 million gain on sale of undeveloped land and $12 million
of amortization of a gain on the June 2004 sale of the gas transportation
subsidiary. Other income in both 2004 and 2003 reflected $18 million in
amortization of the gain on the sale of two generation plants in 2002.
Other deductions increased $13 million to $20 million in 2004. The 2004
amount primarily reflected $11 million in debt retirement costs, a $5 million
natural gas inventory loss resulting from an explosion at a third-party storage
facility and $3 million to settle a power purchase agreement. The 2003 amount
included a $3 million premium on the retirement of the preferred stock of a
subsidiary and $2 million related to canceled construction projects.
Interest expense and related charges decreased $31 million, or 16%, to
$163 million in 2004, reflecting a $24 million decrease due to lower average
interest rates and a $7 million decrease due to lower average borrowings.
The effective income tax rate on results from continuing operations before
extraordinary items was 33.0% in 2004 and 33.7% in 2003. There were no material
unusual items affecting the comparison.
Income from continuing operations before extraordinary gain (an after-tax
measure) increased $47 million, or 14%, to $380 million in 2004. This
performance reflected an increase of $59 million, or 24%, to $309 million in the
Energy segment driven by higher gross margin partially offset by higher SG&A
expenses. Earnings in the Electric Delivery segment decreased $18 million, or
14%, to $107 million reflecting lower revenues due to milder weather and
increased operating expenses. Corporate and other expenses decreased $7 million
to $36 million in 2004, primarily reflecting (all amounts after-tax):
o interest income of $11 million on Energy's exchangeable preferred
membership interest acquired by TXU Corp.
o lower net external and affiliate interest expense (net of interest
income) of $8 million due to financing-related activity
o amortization of deferred gain on sale of TXU Fuel Company of $8
million
43
partially offset by:
o consulting fees of $10 million
o increased compensation expense of $6 million related to higher
stock prices
o debt extinguishment losses of $7 million.
Net pension and postretirement benefit costs reduced results from
continuing operations by $9 million in 2004 and $17 million in 2003. The
decrease in these costs reflects a remeasurement of these liabilities as a
result of the transfer of 2,500 employees to Capgemini and an increase of 0.25%
in the discount rate due to higher interest rates, as well as the effects of the
Medicare Act enacted in December 2003.
Income from discontinued operations (an after-tax measure) totaled $287
million in 2004 and $64 million in 2003. Results from discontinued operations
primarily reflected the effects of the TXU Australia and TXU Gas businesses.
Income from TXU Australia, which was sold on July 30, 2004, totaled $261 million
in 2004, which included a gain on sale of $239 million after-tax, and $46
million in 2003. Losses from TXU Gas totaled $50 million in 2004 and $6 million
in 2003. The 2004 amount reflected a goodwill impairment charge of $58 million
to adjust the carrying values of assets and liabilities for the terms of the
sales agreement, partially offset by $8 million in earnings. The earnings
reflected a $12 million after-tax benefit from cessation of depreciation
required under accounting rules for assets held for sale. The discontinuance of
depreciation increased the amount of the goodwill impairment charge.
Discontinued operations results also included the recognition of $76 million in
net tax benefits related to the 2002 write-off of the investment in TXU Europe.
This benefit reflected the capital gain on the TXU Gas transaction, partially
offset by changes in estimates of TXU Europe-related tax benefits expected to be
realized, principally related to capital gains on previous transactions.
Additional discussion of the above items and a detailed analysis of discontinued
operations results are presented in Note 3 to Financial Statements.
Diluted net income per share of common stock was $1.34 in 2004 compared to
$1.07 in 2003. Per share results in 2004 included a dilutive effect of
Convertible Senior Notes of $268 million after-tax or $0.91 per share. The
Convertible Senior Notes, 92% of which were repurchased in October 2004, are
dilutive because the conversion trigger price of $41.48 was reached in the third
quarter of 2004. Because of TXU Corp.'s stated intent to settle the conversion
in cash, the calculation of diluted earnings per share reflects a reduction in
earnings to reflect the assumed after-tax settlement expense based on the fair
market value of the embedded conversion option at September 30, 2004.
The comparison of diluted net income per share benefited from a $0.30 per
share impact of 84 million fewer average shares outstanding. The decline in
average diluted shares outstanding reflected the repurchase of Energy's
exchangeable preferred membership interests and purchases of outstanding common
stock.
Nine Months Ended September 30, 2004 compared to Nine Months Ended
September 30, 2003
- -------------------------------------------------------------------------------
TXU Corp.'s operating revenues increased $487 million, or 7%, to $7.2
billion in 2004. Operating revenues rose $346 million, or 6%, to $6.6 billion in
the Energy segment reflecting higher retail and wholesale pricing, partially
offset by lower retail volumes due to competitive activity and milder weather.
Operating revenues in the Electric Delivery segment increased by $83 million, or
5%, to $1.7 billion driven by higher transmission and distribution fees
(tariffs), partially offset by lower volumes due to milder weather and, to a
lesser extent, consumer usage efficiencies. Consolidated revenue growth also
reflected a $44 million reduction in the intercompany sales elimination,
primarily reflecting lower sales by Electric Delivery to Energy as sales to
nonaffiliated REPs increased.
44
Gross Margin
Nine Months Ended September 30,
-----------------------------------------------
% of % of
2004 Revenue 2003 Revenue
------ --------- ------ ---------
Operating revenues..................................... $ 7,178 100% $ 6,691 100%
Costs and expenses:
Cost of energy sold, including delivery fees...... 3,053 43% 2,879 43%
Operating costs................................... 1,057 15% 1,025 16%
Depreciation and amortization related to operating
assets........................................ 537 7% 483 7%
------- ----- ------- -------
Gross margin........................................... $ 2,531 35% $ 2,304 34%
======= ===== ======= =======
Gross margin increased $227 million, or 10%, to $2.5 billion in 2004. The
Energy segment's gross margin increased $250 million, or 18%, to $1.7 billion
reflecting higher average pricing, partially offset by lower results from
hedging and risk management activities, the unfavorable effects of a volume mix
shift from higher margin retail sales to wholesale sales, higher delivery fees
and milder weather. Gross margin was also favorably impacted by lower average
costs of total power produced and purchased, reflecting improved utilization of
base load (nuclear and lignite-fired) production and improved sourcing of
purchased power versus gas-fired generation. The Electric Delivery segment's
gross margin decreased $17 million, or 2%, to $858 million reflecting lower
volumes and an increase in operating costs, partially offset by an increase in
transmission-related tariffs.
Operating costs increased $32 million, or 3%, to $1.1 billion in 2004,
driven by $23 million in incremental costs primarily associated with a planned
outage for refueling at the nuclear generation facility.
Depreciation and amortization included in gross margin, which relates to
assets directly used in the generation and delivery of power, rose $54 million,
or 11%, to $537 million in 2004. This increase reflected regulatory asset
amortization in 2004 of $66 million associated with Electric Delivery
securitization bonds issued in August 2003 and June 2004, normal additions and
replacements of equipment and the effect of higher asset retirement obligations
due to new mining activity. These increases were partially offset by a $45
million impact of lower depreciation related to Energy's generation fleet, due
primarily to extensions of estimated depreciable lives to better reflect useful
lives. (See Note 1 to Financial Statements.)
Depreciation and amortization not included in gross margin totaled $42
million and $52 million for the nine months ended September 30, 2004 and 2003,
respectively. This decline primarily reflects a decrease in amortization due to
a reduction in the carrying values of software assets in connection with the
Capgemini outsourcing transaction.
SG&A expense increased $161 million, or 25%, to $805 million in 2004. The
increase reflected $56 million in higher deferred incentive compensation expense
for senior executives and $38 million in compensation earned by Mr. Wilder under
his employment agreement, both due to the increase in the price of TXU Corp.
common stock, $34 million related to consulting and professional fees in
conjunction with the formulation and execution of strategic initiatives, $14
million in compensation expense under Mr. Wilder's employment agreement at the
date of his employment, $14 million in special compensation incentive program
expense in the third quarter related to trading activities, $11 million in
incremental staffing and other costs to improve customer call center service
levels and $8 million in higher bad debt expense, partially offset by $4 million
in reduced marketing expenses.
Other income increased $24 million to $73 million in 2004. Other income in
2004 reflected a $18 million gain on sale of undeveloped land and $16 million of
amortization of a gain on the June 2004 sale of the gas transportation
subsidiary. Other income in both 2004 and 2003 reflected $30 million in
amortization of the gain on the sale of two generation plants in 2002.
Other deductions increased $447 million to $477 million in 2004. The 2004
amount reflected the initiatives discussed above under "Strategic Initiatives
and Other Actions" and included $188 million in asset writedowns, $100 million
in accruals for the anticipated resolution of outstanding litigation, $111
million in charges for employee severance and $54 million in debt extinguishment
losses, primarily related to the equity-linked securities. The 2003 period
includes $17 million of equity losses of Pinnacle prior to its consolidation in
March 2003 and several individually insignificant items.
45
Interest expense and related charges decreased $76 million, or 13%, to
$521 million in 2004, primarily reflecting a $65 million decrease due to lower
average interest rates and a $11 million decrease due to lower average
borrowings.
The effective income tax rate on income from continuing operations before
extraordinary gain was 17.9% in 2004 and 31.6% on income in 2003. The decrease
was driven by several factors, including the $75 million tax benefit arising
from the recognition of tax benefits related to the 2002 write-off of the
investment in TXU Europe and the ongoing benefits of lignite depletion and
investment tax credit amortization on a lower income base, partially offset by
the non-deductibility of certain executive compensation and the limited
deductibility of expenses recorded in connection with the repurchase of
equity-linked securities.
Income from continuing operations before extraordinary gain and cumulative
effect of changes in accounting principles (an after-tax measure) decreased $105
million to $422 million in 2004. This performance reflected a decrease of $32
million in the Energy segment. Results in the Energy segment reflected $122
million after-tax of asset write-offs and $59 million after-tax of severance
costs, partially offset by higher gross margin. Earnings in the Electric
Delivery segment declined $19 million driven by lower volumes and $12 million
after-tax of severance-related charges. Corporate and other expenses increased
$54 million, primarily reflecting (all amounts after-tax):
o litigation accrual of $65 million
o non-recurring executive compensation expenses of $52 million
o debt extinguishment losses of $46 million
o consulting fees of $21 million
partially offset by:
o recognition of a $75 million tax benefit related to the TXU Fuel
Company capital gain
o the effect of $11 million in equity losses in 2003 related to the
telecommunications business, then a joint venture
o lower net external and affiliate interest expense (net of interest
income) of $20 million due to financing-related activity
o interest income of $19 million on Energy's exchangeable preferred
membership interests acquired by TXU Corp.
Net pension and postretirement benefit costs reduced income from
continuing operations by $46 million in 2004 and $52 million in 2003. The
decrease in these costs reflected a remeasurement of these liabilities as a
result of the transfer of 2,500 employees to Capgemini and an increase of 0.25%
in the discount rate due to higher interest rates, as well as the effects of the
Medicare Act enacted in December 2003.
Income from discontinued operations (an after-tax measure) totaled $666
million in 2004 and $84 million in 2003. Income of the discontinued TXU
Australia business, which was sold on July 30, 2004, totaled $174 million in
2004 and $108 million in 2003. TXU Australia's results in 2004 included the gain
on sale of $239 million after-tax and a deferred tax charge of $112 million to
recognize a deferred tax liability for the excess of the carrying value of the
TXU Australia investment over the related tax basis. Results of the TXU Gas
business totaled a loss of $170 million in 2004 and income of $33 million in
2003. Results in 2004 included a loss of $99 million after-tax related to
regulatory disallowances arising from a system-wide distribution rate case
ruling, an income tax charge of $17 million due to a ruling related to a prior
year disputed deduction and a goodwill impairment charge of $92 million (pre and
after-tax) to adjust the carrying values of assets and liabilities for the terms
of the sales agreement. Discontinued operations results also reflected the
recognition of $712 million in tax benefits associated with the 2002 write-off
of the investment in TXU Europe. The tax benefit primarily reflected the
utilization of the worthlessness deduction against capital gains arising from
46
the TXU Gas transaction and the sale of TXU Australia as well as transactions
completed in prior years. Finally, discontinued operations results in 2004
included a $17 million after-tax impairment charge arising from a June 2004
decision to sell the Pedricktown, New Jersey generation facility and discontinue
related operations, and a $6 million after-tax charge to settle a contract
dispute related to the strategic retail services business. Additional discussion
of the above items and a detailed analysis of discontinued operations results
are presented in Note 3 to Financial Statements.
An extraordinary gain of $16 million (net of tax of $9 million) in 2004
represents an increase in the carrying value of Electric Delivery's regulatory
asset subject to securitization. The second and final tranche of the
securitization bonds was issued in June 2004. The increase in the related
regulatory asset is due to the effect of higher interest rates on the bonds and
therefore increased amounts to be recovered from REPs through delivery fee
surcharges to service the bonds.
A cumulative effect of changes in accounting principles, representing an
after-tax charge of $58 million in 2003, reflects the impact on commodity
contract mark-to-market accounting from rescission of EITF 98-10 and the
recording of asset retirement obligations under SFAS 143. (See Note 2 to
Financial Statements.)
Diluted results per share of common stock were a net loss of $0.09 in 2004
compared to net income of $1.52 in 2003. Results in 2004 were unfavorably
impacted by a $2.72 per share effect from TXU Corp.'s repurchase of Energy's
exchangeable preferred membership interests in April 2004. The amounts paid in
excess of the carrying value of these instruments, net of an associated income
tax benefit, totaled $849 million. This premium was charged to additional
paid-in capital and treated in a manner similar to preference share dividends in
computing earnings per share. Per share results in 2004 also include a dilutive
effect of Convertible Senior Notes of $268 million after-tax or $0.86 per
diluted share, as discussed above in the analysis of results for the quarter.
The year-to-date per share results for 2004 do not reflect the dilutive impacts
of the shares issuable under the exchangeable preferred membership interests
because of antidilution accounting rules.
Commodity Contracts and Mark-to-Market Activities
- -------------------------------------------------
The table below summarizes the changes in commodity contract assets and
liabilities for the three and nine months ended September 30, 2004 (excluding
the discontinued TXU Australia business). The net change in these assets and
liabilities, excluding "other activity" as described below, represents the net
effect of recording unrealized gains/(losses) under mark-to-market accounting,
versus settlement accounting, for positions in the commodity contract portfolio.
These positions consist largely of economic hedge transactions, with speculative
trading representing a small fraction of the activity.
Three Months Nine Months
Ended Ended
September 30, September 30,
2004 2004
------------- -------------
Balance of net commodity contract assets at beginning of period............... $ 87 $ 108
Settlements of positions included in the opening balance (1).................. (7) (46)
Unrealized mark-to-market valuations of positions held at end of period (2)... (5) 20
Net other activity (3)........................................................ 7 -
----- -----
Balance of net commodity contract assets at end of period..................... $ 82 $ 82
===== =====
--------------------------
(1) Represents unrealized mark-to-market valuations of these positions
recognized in earnings as of the beginning of the period.
(2) There were no significant changes in fair value attributable to
changes in valuation techniques.
(3) Includes initial values of positions involving the receipt or
payment of cash or other consideration, such as option premiums
and the amortization of such values. These activities have no
effect on unrealized mark-to-market valuations.
47
In addition to the net effect of recording unrealized mark-to-market gains
and losses that are reflected in changes in commodity contract assets and
liabilities, similar effects arise in the recording of unrealized
ineffectiveness mark-to-market gains and losses associated with
commodity-related cash flow hedges, which are reflected in changes in cash flow
hedge and other derivative assets and liabilities. The total net effect of
recording unrealized gains and losses under mark-to-market accounting, versus
settlement accounting, is summarized as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
------ ------ ------ ------
Operating revenues:
Unrealized gains/(losses) related to commodity contract portfolio... $ (12) $ 1 $ (26) $ 34
Ineffectiveness gains/(losses) related to cash flow hedges ......... (3) 10 (20) 24
------ ----- ------ -----
Total unrealized gains/(losses)..................................... $ (15) $ 11 $ (46) $ 58
====== ===== ====== =====
These amounts are included in the "hedging and risk management activities"
component of revenues.
Maturity Table -- Of the net commodity contract asset balance above at
September 30, 2004, the amount representing unrealized mark-to-market net gains
that have been recognized in current and prior years' earnings is $96 million.
The offsetting net liability of $14 million included in the September 30, 2004
balance sheet is comprised principally of amounts representing current and prior
years' net receipts of cash or other consideration, including option premiums,
associated with contract positions, net of any amortization. The following table
presents the unrealized mark-to-market balance at September 30, 2004, scheduled
by contractual settlement dates of the underlying positions.
Maturity dates of unrealized net mark-to-market balances at September 30, 2004
-----------------------------------------------------------------------------------
Maturity less Maturity in
than Maturity of Maturity of Excess of
Source of fair value 1 year 1-3 years 4-5 years 5 years Total
- --------------------------------- ------------- ----------- ------------ ----------- ------
Prices actively quoted........... $ 88 $ - $ - $ - $ 88
Prices provided by other
external sources............. 76 (86) 10 (3) (3)
Prices based on models........... 12 (1) - - 11
---- ----- --- ---- -----
Total............................ $176 $(87) $10 $ (3) $ 96
==== ===== === ===== =====
Percentage of total fair value... 183% (90)% 10% (3)% 100%
As the above table indicates, 93% of the unrealized mark-to-market
valuations at September 30, 2004 mature within three years. This is reflective
of the terms of the positions and the methodologies employed in valuing
positions for periods where there is less market liquidity and visibility. The
"prices actively quoted" category reflects only exchange traded contracts with
active quotes available. The "prices provided by other external sources"
category represents forward commodity positions at locations for which
over-the-counter broker quotes are available. Over-the-counter quotes for power
and natural gas generally extend through 2005 and 2010, respectively. The
"prices based on models" category contains the value of all non-exchange traded
options, valued using industry accepted option pricing models. In addition, this
category contains other contractual arrangements which may have both forward and
option components. In many instances, these contracts can be broken down into
their component parts and modeled as simple forwards and options based on prices
actively quoted. As the modeled value is ultimately the result of a combination
of prices from two or more different instruments, it has been included in this
category.
48
Energy
- ------
Financial Results
- -----------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- -------------------
2004 2003(a) 2004 2003(a)
------ -------- ------ --------
Operating revenues.......................................... $ 2,517 $ 2,437 $ 6,589 $ 6,243
Costs and expenses:
Cost of energy sold, including delivery fees........... 1,556 1,539 4,157 4,037
Operating costs........................................ 145 164 513 506
Depreciation and amortization.......................... 83 100 268 306
Selling, general and administrative expenses........... 182 166 491 456
Franchise and revenue-based taxes ..................... 28 29 80 84
Other income .......................................... (36) (20) (50) (43)
Other deductions....................................... 20 4 301 9
Interest income........................................ (13) (1) (21) (3)
Interest expense and related charges................... 91 83 263 246
------- ------- ------- -------
Total costs and expenses........................... 2,056 2,064 6,002 5,598
------- ------- ------- -------
Income from continuing operations before income taxes and
cumulative effect of changes in accounting principles..... 461 373 587 645
Income tax expense.......................................... 152 123 179 205
------- ------- ------- -------
Income from continuing operations before cumulative effect
of changes in accounting principles (b)................... $ 309 $ 250 $ 408 $ 440
======= ======= ======= =======
- -----------------
The segment includes the electricity generation, wholesale and retail
energy sales, and hedging and risk management operations of Energy,
operating principally in the competitive Texas market.
(a)Prior year amounts reflect the reclassification of the strategic retail
services business and the Pedricktown, New Jersey generation operations as
discontinued operations (see Note 3 to Financial Statements).
(b)See Note 2 to Financial Statements regarding changes in accounting
principles.
49
Energy
- -------
Operating Data
- ---------------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
2004 2003 2004 2003
------ ------ ------ ------
Operating statistics - volumes:
Retail electricity sales volumes (GWh):
Historical service territory (a):
Residential.............................................. 9,760 10,991 24,246 27,242
Small business (b)....................................... 3,260 3,233 8,335 9,798
-------- ------- ------- -------
Total historical service territory..................... 13,020 14,224 32,581 37,040
Other territories (a):
Residential.............................................. 1,096 648 2,345 1,446
Small business (b)....................................... 127 77 277 225
-------- ------- ------- -------
Total other territories................................ 1,223 725 2,622 1,671
Large business and other customers....................... 6,412 8,501 19,891 23,941
-------- ------- ------- -------
Total retail electricity............................... 20,655 23,450 55,094 62,652
Wholesale electricity (GWh)................................. 11,929 10,402 36,653 26,145
-------- ------- ------- -------
Total retail and wholesale electricity sales volumes... 32,584 33,852 91,747 88,797
======== ======= ======= =======
Production and purchased power volumes (GWh):
Nuclear (base load)...................................... 5,036 4,455 13,882 13,608
Lignite/coal (base load)................................. 11,437 11,441 31,863 30,272
Gas/oil.................................................. 1,988 4,048 4,300 11,870
Purchased power.......................................... 15,196 15,673 44,665 37,536
-------- ------- ------- -------
Total energy supply.................................... 33,657 35,617 94,710 93,286
Less line loss and other................................. 1,073 1,765 2,963 4,489
-------- ------- ------- -------
Net energy supply volumes.............................. 32,584 33,852 91,747 88,797
======== ======= ======= =======
Base load capacity factors (%):
Nuclear ................................................. 99.5% 87.8% 92.1% 90.4%
Lignite/coal ............................................ 92.5% 92.8% 86.8% 83.2%
Customer counts:
Retail electricity customers (end of period and in
thousands - based on
number of meters):
Historical service territory (a):
Residential.............................................. 1,997 2,096
Small business (b)....................................... 313 318
------- -------
Total historical service territory..................... 2,310 2,414
Other territories (a)
Residential.............................................. 195 129
Small business (b)....................................... 6 4
------- -------
Total other territories................................ 201 133
Large business and other customers....................... 76 70
------- -------
Total retail electricity customers..................... 2,587 2,617
======= =======
(a) Historical service and other territory data for 2003 are best estimates.
(b) Customers with demand of less than 1 MW annually.
50
Energy
- --------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
2004 2003 2004 2003
------- ------ ------ -------
Operating revenues (millions of dollars):
Retail electricity revenues:
Historical service territory (a):
Residential.............................................. $1,073 $ 1,086 $ 2,472 $ 2,506
Small business (b)....................................... 352 289 867 922
------ ------- ------- -------
Total historical service territory..................... 1,425 1,375 3,339 3,428
Other territories (a):
Residential.............................................. 113 54 228 126
Small business (b)....................................... 12 6 25 17
------ -------- ------- --------
Total other territories................................ 125 60 253 143
Large business and other customers....................... 458 551 1,366 1,488
------ ------- ------- -------
Total retail electricity revenues........................... 2,008 1,986 4,958 5,059
Wholesale electricity revenues.............................. 487 399 1,429 914
Hedging and risk management activities...................... (64) 4 (61) 139
Other revenues.............................................. 86 48 263 131
------ ------- ------- -------
Total operating revenues............................... $2,517 $ 2,437 $ 6,589 $ 6,243
====== ======= ======= =======
Weather (average for service territory) (c)
Percent of normal:
Cooling degree days.................................... 85.5% 94.0% 87.9% 94.6%
Heating degree days.................................... - - 91.8% 109.4%
(a)Historical service and other territory data for 2003 are best estimates.
(b)Customers with demand of less than 1 MW annually.
(c)Weather data is obtained from Weatherbank, Inc., an independent company
that collects and archives weather data from reporting stations of the
National Oceanic and Atmospheric Administration (a federal agency under
the US Department of Commerce).
51
Energy
- ------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
2004 2003 2004 2003
------ ----- ----- ------
Fuel and purchased power costs ($/MWh of supply)
Nuclear generation....................................... $ 4.32 $ 4.75 $ 4.33 $ 4.47
Lignite/coal generation.................................. $ 12.33 $ 11.89 $ 12.64 $12.54
Gas/oil generation and purchased power................... $ 53.03 $ 48.38 $ 48.05 $48.34
Average total electricity supply....................... $ 31.95 $ 31.23 $ 29.77 $30.35
Average retail volume (KWh)/customer
(calculated using average no. of customers for period)
Residential.............................................. 4,921 5,204 12,091 12,673
Small business........................................... 10,530 10,183 26,905 30,599
Large business and other customers....................... 83,907 119,337 274,470 325,248
Average revenues ($/MWh)
Residential.............................................. $109.21 $ 97.99 $101.56 $91.72
Small business........................................... $107.45 $ 89.13 $103.57 $93.71
Large business and other customers....................... $ 71.47 $ 64.85 $ 68.67 $62.14
Average delivery fees ($/MWh) $ 22.06 $ 18.19 $ 21.76 $18.59
Estimated share of ERCOT retail markets
(based on number of meters)
Historical service territory (a):
Residential (b).......................................... 83% 88%
Small business (b)....................................... 81% 84%
Total ERCOT
Residential (b).......................................... 45% 46%
Small business (b)....................................... 32% 33%
Large business and other customers (c)................... 33% 39%
Hedging and risk management activities
Net unrealized mark-to-market gains/(losses)............. $ (15) $ 11 $ (46) $ 58
Realized gains/(losses).................................. (49) (7) (15) 81
------- ------ ------ ------
Total.................................................. $ (64) $ 4 $ (61) $ 139
======= ===== ====== ======
(a) Historical service and other territory data for 2003 are best estimates.
(b) Estimated market share is based on the number of customers that have
choice.
(c) Estimated market share is based on the annualized consumption for
this overall market.
52
Energy
- ------
Three Months Ended September 30, 2004 compared to Three Months Ended
September 30, 2003
- -------------------------------------------------------------------------------
Operating revenues increased $80 million, or 3%, to $2.5 billion in 2004.
Retail electricity revenues increased $22 million, or 1%, to $2.0 billion
reflecting a $258 million increase due to higher average pricing, partially
offset by a $236 million decline due to lower volumes. A 12% drop in sales
volumes was driven by the effect of competitive activity, primarily in the large
business market, and milder weather. Lower business market volumes also
reflected a strategy to target higher margin customer segments. Milder weather
contributed an estimated 6 percentage points to the volume decline. Higher
pricing reflected increased price-to-beat rates, reflecting regulatory approved
fuel factor increases, and higher pricing in the competitive large business
market, both resulting from higher natural gas prices. Retail electricity
customer counts at September 30, 2004 declined 1% from September 30, 2003.
Wholesale electricity revenues grew $88 million, or 22%, to $487 million
reflecting a $58 million increase attributable to a 15% rise in sales volumes
and a $30 million increase due to the effect of increased natural gas prices on
wholesale prices. The increase in wholesale sales volumes also reflected a
partial shift in the customer base from retail to wholesale services,
particularly in the business market.
Net results from hedging and risk management activities, which are
reported in revenues and include both realized and unrealized gains and losses,
declined $68 million from a net gain of $4 million in 2003 to a net loss of $64
million in 2004. Because the hedging activities are intended to mitigate the
risk of commodity price movements on revenues and cost of energy sold, the
changes in such results should not be viewed in isolation, but taken together
with the effects of pricing and cost changes on gross margin. Changes in these
results reflect market price movements on commodity positions held to hedge
gross margin. The decline included $22 million in mark-to-market losses
associated with required capacity auctions, $17 million primarily reflecting
increased credit reserves due to the effect of increased natural gas prices on
contracts and $15 million in mark-to-market losses associated with market price
movements against hedges of gas in storage. Results from these activities
included the net effect of recording unrealized gains and losses under
mark-to-market accounting, versus settlement accounting, of $15 million in net
losses in 2004 and net gains of $11 million in 2003. The majority of Energy's
natural gas physical sales and purchases are in the wholesale markets and
essentially represent hedging activities. These activities are accounted for on
a net basis with the exception of retail sales to business customers, which
effective October 1, 2003 are reported gross in accordance with new accounting
rules and totaled $38 million in revenues for the third quarter of 2004. The
increase in other revenues of $38 million to $86 million was driven by this
change.
Gross Margin
Three Months Ended
September 30,
----------------------------------------------
% of % of
2004 Revenue 2003 Revenue
------ --------- ------ --------
Operating revenues..................................... $ 2,517 100% $ 2,437 100%
Costs and expenses:
Cost of energy sold, including delivery fees...... 1,556 62% 1,539 63%
Operating costs................................... 145 6% 164 7%
Depreciation and amortization related to generation
assets........................................ 82 3% 89 4%
------- ----- ------- ------
Gross margin........................................... $ 734 29% $ 645 26%
======= ===== ======= ======
Gross margin increased $89 million, or 14%, to $734 million in 2004. The
margin increase was driven by the higher average pricing, partially offset by
lower results from hedging and risk management activities, and the unfavorable
effects of a volume mix shift from higher margin retail sales to wholesale
sales, higher delivery fees and milder weather. The average cost of total power
produced and purchased was up 2%, reflecting improved utilization of
base-load (nuclear and lignite-fired) production and improved sourcing of
purchased power versus gas-fired generation. Gross margin was also favorably
impacted by lower depreciation as discussed immediately below.
Operating costs decreased $19 million, or 12%, to $145 million in 2004.
The decrease reflected $10 million related to customer care support services
previously provided to TXU Gas (largely offset by lower related revenues), and
$5 million due to the absence of the gas transportation subsidiary sold in June
2004 (largely offset by higher cost of energy sold related to gas-fired
53
production). Other changes in operating costs were individually immaterial and
largely offsetting.
Depreciation and amortization related to generation assets decreased $7
million, or 8%, to $82 million, reflecting a decrease of $11 million due to
extensions of estimated average depreciable lives of lignite and nuclear
generation facilities' assets to better reflect their useful lives, partially
offset by the effect of mining activity and the related asset retirement
obligation.
Depreciation and amortization not included in gross margin totaled $1
million and $11 million for the three months ended September 30, 2004 and 2003,
respectively. This decline primarily reflected the transfer of information
technology assets, principally capitalized software, to an affiliate in
connection with the Capgemini transaction.
SG&A expenses increased $16 million, or 10%, to $182 million in 2004
primarily reflecting a $14 million special compensation incentive program
expense related to trading activities and $12 million in higher deferred
incentive compensation expense due to the increase in the price of TXU Corp.
common stock, partially offset by $6 million in reduced marketing costs outside
the historical service territory and a $4 million decrease in bad debt expense.
Other income increased by $16 million to $36 million in 2004. Other income
in 2004 included a $18 million gain on sale of undeveloped land. Other income in
both 2004 and 2003 reflected $18 million of amortization of a gain on the sale
of two generation plants in 2002.
Other deductions increased by $16 million to $20 million in 2004. Other
deductions in 2004 consisted largely of $8 million in equity losses
(representing depreciation expense) in the TXU Corp. entity holding the
capitalized software licensed to Capgemini, a $5 million natural gas inventory
loss resulting from an explosion at a third-party storage facility and
approximately $3 million to settle a power purchase agreement.
Interest income increased by $12 million to $13 million in 2004 primarily
due to higher average advances to affiliates.
Interest expense and related charges increased by $8 million, or 10%, to
$91 million in 2004. The increase reflected $18 million due to higher average
debt levels and $2 million representing lower reimbursement to Electric Delivery
in 2003 for carrying costs related to securitized regulatory assets partially
offset by $11 million due to lower average interest rates and $1 million in
interest reimbursed to Electric Delivery in 2003 related to the excess
mitigation credit that ceased at the end of 2003.
The effective income tax rate was 33.0% in 2004 and 2003. There were no
material unusual items affecting the comparison.
Results from continuing operations increased $59 million to $309 million
in 2004, reflecting the increase in gross margin partially offset by higher
SG&A.
Nine Months Ended September 30, 2004 compared to Nine Months Ended
September 30, 2003
- -------------------------------------------------------------------------------
Operating revenues increased $346 million, or 6%, to $6.6 billion in 2004.
Retail electricity revenues decreased $101 million, or 2%, to $5.0 billion. This
decline reflected a $611 million decrease attributable to a 12% drop in sales
volumes, driven by the effect of competitive activity and milder weather,
partially offset by a $510 million increase due to higher average pricing. Lower
business market volumes also reflected a strategy to target higher margin
customer segments. Higher pricing reflected increased price-to-beat rates,
reflecting regulatory approved fuel factor increases, and higher pricing in the
competitive large business market, both resulting from higher natural gas
prices. Retail electricity customer counts at September 30, 2004 declined 1%
from September 30, 2003. Wholesale electricity revenues grew $515 million, or
56%, to $1.4 billion reflecting a $367 million increase attributable to a 40%
rise in sales volumes and a $148 million increase due to the effect of increased
natural gas prices on wholesale prices. Higher wholesale electricity sales
volumes reflected the establishment of the new northeast zone in ERCOT. Because
Energy has a generation plant and a relatively small retail customer base in the
new zone, wholesale sales have increased, and wholesale power purchases also
increased to meet retail sales demand in other zones. The increase in wholesale
sales volumes also reflected a partial shift in the customer base from retail to
wholesale services, particularly in the business market.
54
Net results from hedging and risk management activities, which are
reported in revenues and include both realized and unrealized gains and losses,
declined $200 million from a net gain of $139 million in 2003 to a net loss of
$61 million in 2004. Because the hedging activities are intended to mitigate the
risk of commodity price movements on revenues and cost of energy sold, the
changes in such results should not be viewed in isolation, but rather taken
together with the effects of pricing and cost changes on gross margin. Changes
in these results reflect market price movements on commodity positions held to
hedge gross margin. The decline included $22 million in mark-to-market losses
associated with required capacity auctions, $17 million in increased reserves,
primarily reflecting increased credit reserves due to the effect of increased
natural gas prices on contracts and $15 million in mark-to-market losses
associated with market price movements against hedges of gas in storage. The
comparison also reflected $34 million of additional gas storage and retail gas
business margin in 2003, primarily related to businesses sold in late 2003, $18
million due to a favorable settlement with a counterparty in 2003 and $11
million in gains on contracts that are no longer marked-to-market. Results from
these activities included the net effect of recording unrealized gains and
losses under mark-to-market accounting, versus settlement accounting, of $46
million in net losses in 2004 and net gains of $58 million in 2003. The majority
of Energy's natural gas physical sales and purchases are in the wholesale
markets and essentially represent hedging activities. These activities are
accounted for on a net basis with the exception of retail sales to business
customers, which effective October 1, 2003 are reported gross in accordance with
new accounting rules and totaled $126 million in revenues for the first nine
months of 2004. The increase in other revenues of $132 million to $263 million
in 2004 was primarily driven by this change.
Gross Margin
Nine Months Ended
September 30,
---------------------------------------------------
% of % of
2004 Revenue 2003 Revenue
------ --------- ------ ---------
Operating revenues..................................... $ 6,589 100% $ 6,243 100%
Costs and expenses:
Cost of energy sold and delivery fees............. 4,157 63% 4,037 65%
Operating costs................................... 513 8% 506 8%
Depreciation and amortization related to generation
assets........................................ 246 4% 277 4%
------- ----- ------- ------
Gross margin........................................... $ 1,673 25% $ 1,423 23%
======= ===== ======= ======
Gross margin increased $250 million, or 18%, to $1.7 billion in 2004. The
margin increase was driven by the higher average pricing, partially offset by
lower results from hedging and risk management activities, and the unfavorable
effects of a volume mix shift from higher margin retail sales to wholesale
sales, delivery fees and milder weather. The average cost of total
power produced and purchased declined 2%, reflecting improved utilization of
base load (nuclear and lignite-fired) production and improved sourcing of
purchased power versus gas-fired generation. Gross margin was also favorably
impacted by lower depreciation as discussed below.
Operating costs increased $7 million, or 1%, to $513 million in 2004. The
increase reflected $31 million in incremental testing, inspection and component
repair costs associated with the planned outage for refueling at the nuclear
facility, partially offset by lower spending for other repair and maintenance
projects. Operating costs reflected decline of $10 million related to customer
care support services previously provided to TXU Gas (largely offset by lower
related revenues), and $7 million due to the absence of the gas transportation
subsidiary sold in June 2004 (largely offset by higher costs of energy sold
related to gas-fired production). Other changes in operating costs were
individually immaterial and largely offsetting.
Depreciation and amortization related to generation assets decreased $31
million, or 11%, to $246 million, reflecting a decrease of $45 million due to
extensions of estimated average depreciable lives of lignite and nuclear
generation facilities' assets to better reflect their useful lives, partially
offset by the effect of mining activity and the related asset retirement
obligation.
55
Depreciation and amortization not included in gross margin totaled $22
million and $29 million for the nine months ended September 30, 2004 and 2003,
respectively. The decrease reflected the effect of the transfer of information
technology assets, principally capitalized software, to an affiliate in
connection with the Capgemini transaction, partially offset by acceleration of
the amortization of certain software to reflect a shorter useful life.
SG&A expenses increased $35 million, or 8%, to $491 million in 2004
reflecting $29 million of higher deferred incentive compensation expense due to
the increase in the price of TXU Corp. common stock, a $14 million special
incentive compensation program expense related to trading activities, $11
million in staffing and other costs to improve customer call center service and
higher bad debt expense of $8 million primarily reflecting a favorable
settlement in 2003, partially offset by $4 million in reduced marketing costs
outside the historical service territory.
Other income increased by $7 million to $50 million in 2004. Other income
in 2004 included a $18 million gain on sale of undeveloped property. Other
income in both 2004 and 2003 reflected $30 million of amortization of a gain on
the sale of two generation plants in 2002.
Other deductions increased $292 million to $301 million in 2004. Other
deductions in 2004 consist largely of $107 million for software writedowns, $89
million for employee severance and $79 million in spare parts inventory
writedowns, all discussed above under "Strategic Initiatives and Other Actions."
Other deductions also reflected $8 million in equity losses (representing
depreciation expense) in the TXU Corp. entity holding the capitalized software
licensed to Capgemini, a $5 million natural gas inventory loss resulting from an
explosion at a third-party storage facility and approximately $3 million to
settle a power purchase agreement.
Interest income increased by $18 million to $21 million in 2004 primarily
due to higher average advances to affiliates.
Interest expense and related charges increased by $17 million, or 7%, to
$263 million in 2004. The increase reflected $28 million due to higher average
debt levels and $4 million representing lower interest reimbursement to Electric
Delivery in 2003 for carrying costs related to securitized regulatory assets,
partially offset by 9 million due to lower average interest rates and $6 million
in interest reimbursed to Electric Delivery in 2003 related to the excess
mitigation credit that ceased at the end of 2003.
The effective income tax rate decreased to 30.5% in 2004 from 31.8% in
2003 driven by the effects of ongoing tax benefits of depletion allowances and
amortization of investment tax credits on a lower income base in 2004.
Income from continuing operations before cumulative effect of changes in
accounting principles decreased $32 million to $408 million in 2004, reflecting
the increase in other deductions and SG&A expenses, partially offset by the
higher gross margin.
56
Electric Delivery
- -----------------
Financial Results
- -----------------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2004 2003 2004 2003
------ ------ ------ ------
Operating revenues.......................................... $ 648 $ 613 $1,688 $1,605
Costs and expenses:
Operating costs........................................ 193 175 547 524
Depreciation and amortization.......................... 116 78 286 215
Selling, general and administrative expenses........... 53 49 154 145
Franchise and revenue-based taxes ..................... 66 63 183 183
Other income .......................................... - (2) (4) (6)
Other deductions ...................................... 3 - 23 -
Interest income........................................ (17) (14) (42) (43)
Interest expense and related charges................... 71 74 212 229
----- ----- ------ ------
Total costs and expenses........................... 485 423 1,359 1,247
----- ----- ------ ------
Income before income taxes.................................. 163 190 329 358
Income tax expense.......................................... 56 65 109 119
----- ----- ------ ------
Income before extraordinary gain............................ $ 107 $ 125 $ 220 $ 239
===== ===== ====== ======
- --------------
This segment consists of the electricity transmission and distribution business,
which is subject to regulation by Texas authorities.
57
Electric Delivery
- -----------------
Operating Data
- --------------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
2004 2003 2004 2003
------ ------ ------ ------
Operating statistics - volumes:
Electric energy delivered (GWh)..................................... 30,868 31,881 79,399 80,167
Reliability statistics:
System Average Interruption Duration Index (SAIDI) (non-storm)(a)... 74.58 74.19
System Average Interruption Frequency Index (SAIFI)(non-storm)(a)... 1.09 1.19
Customer Average Interruption Duration Index (CAIDI)(non-storm)(a).. 68.25 62.46
Electricity points of delivery (end of period and in thousands):
Electricity distribution points of delivery (based on number
of meters)(b).................................................... 2,963 2,920
Operating revenues (millions of dollars):
Electricity transmission and distribution:
Affiliated (Energy).................................... $ 417 $ 441 $1,101 $1,167
Non-affiliated......................................... 231 172 587 438
----- ----- ------ ------
Total operating revenues............................. $ 648 $ 613 $1,688 $1,605
===== ===== ====== ======
- --------------------------
(a) SAIDI is the average number of total electric service outage minutes per
customer in the past year. SAIFI is the average number of electric service
interruptions per customer in the past year. CAIDI is the average number of
electric service outage minutes per interruption in the past year.
(b) Includes lighting sites, principally guard lights, for which Energy is the
REP but are not included in Energy's customer count. Such sites totaled
96,499 and 102,267 at September 30, 2004 and 2003, respectively.
58
Electric Delivery
- -----------------
Change in Business-- On June 17, 2004, TXU Corp. announced the TXU Gas
transaction, which closed on October 1, 2004. TXU Gas is reported as a
discontinued operation, and therefore is no longer included in the Electric
Delivery (formerly Energy Delivery) segment. Prior period financial information
has been reclassified to reflect the discontinued business.
Three Months Ended September 30, 2004 compared to Three Months Ended
September 30, 2003
- -------------------------------------------------------------------------------
Operating revenues increased $35 million, or 6%, to $648 million in 2004.
Higher tariffs provided an increase of $48 million, reflecting delivery fee
surcharges associated with the issuance of securitization bonds in August 2003
and June 2004 ($38 million), an increase in distribution tariffs to recover
higher transmission costs ($8 million) and transmission rate increases approved
in 2003 and 2004 ($2 million). Delivery fee surcharges associated with the
second issuance of securitization bonds in June 2004 were billed to customers
starting on July 1, 2004. The impact of surcharges related to securitization
bonds is an increase to revenues and an increase in amortization of the related
regulatory asset in the same amount. Lower volumes in 2004, primarily due to
milder weather, resulted in an estimated $13 million decrease in revenue.
Gross Margin
Three Months Ended September 30,
------------------------------------------------
% of % of
2004 Revenue 2003 Revenue
------ --------- ------ ---------
Operating revenues..................................... $ 648 100% $ 613 100%
Costs and expenses:
Operating costs................................... 193 30% 175 29%
Depreciation and amortization..................... 116 18% 75 12%
------- ----- ------- ------
Gross margin........................................... $ 339 52% $ 363 59%
======= ===== ======= ======
Gross margin decreased $24 million, or 7%, to $339 million in 2004, driven
by the lower volumes and an increase in operating costs, partially offset by an
increase in transmission-related tariffs. The increase in operating costs of $18
million, or 10%, to $193 million, reflected a $9 million increase in vegetation
management to improve system reliability, a $5 million increase in third-party
transmission costs and a $2 million increase in property taxes due to property
additions and increased values. Depreciation and amortization included in gross
margin reflected depreciation of assets directly used in the delivery of
electricity and amortization of regulatory assets. The increase in depreciation
and amortization of $41 million, or 55%, to $116 million reflected $38 million
in higher amortization of regulatory assets associated with the issuance of
securitization bonds (offsetting the same amount of revenue increase) and $3
million in higher depreciation due to normal additions and replacements of
equipment.
Depreciation and amortization not included in gross margin totaled $3
million for the three months ended September 30, 2003, compared to essentially
zero in the 2004 period. This decline reflected a transfer of information
technology assets, principally capitalized software, to an affiliate in
connection with the Capgemini outsourcing transaction (see Note 1 to Financial
Statements).
SG&A expenses increased $4 million, or 8%, to $53 million in 2004
reflecting approximately $6 million increase in deferred and long-term incentive
compensation expense due primarily to a higher TXU Corp. common stock price and
$2 million in increases in various other cost categories that were individually
not significant, partially offset by a $4 million decrease in pension and
retiree medical benefits expense.
Other deductions of $3 million in 2004 consisted largely of TXU Electric
Delivery's portion of the equity losses (representing depreciation expense) in
the TXU Corp. entity holding the capitalized software licensed to Capgemini. See
the discussion above under "Strategic Initiatives and Other Actions" for
additional information.
59
Interest income increased by $3 million, or 21%, to $17 million in 2004
primarily representing lower reimbursement from Energy in 2003 for carrying
costs related to securitized regulatory assets.
Interest expense and related charges decreased $3 million, or 4%, to $71
million in 2004. The decrease reflected a $6 million impact of lower average
rates, partially offset by a $3 million impact of higher average borrowings.
The effective income tax rate increased to 34.4% in 2004 from 34.0% in
2003. There were no significant unusual items affecting this comparison.
Net income decreased $18 million, or 14%, to $107 million in 2004,
primarily reflecting lower revenues due to milder weather and increased
operating expenses.
Electric Delivery
- ------------------
Nine Months Ended September 30, 2004 compared to Nine Months Ended
September 30, 2003
- -------------------------------------------------------------------------------
Operating revenues increased $83 million, or 5%, to $1.7 billion in 2004.
Higher tariffs provided a $103 million increase, reflecting delivery fee
surcharges associated with the issuance of securitization bonds in August 2003
and June 2004 ($66 million), an increase in distribution tariffs to recover
higher transmission costs ($19 million) and transmission rate increases approved
in 2003 and 2004 ($18 million). Revenue growth also included $6 million in
increased disconnect/reconnect fees, reflecting disconnections initiated by REPs
on uncollected accounts. Lower volumes delivered in 2004, primarily due to
milder weather, resulted in an estimated $26 million decrease in revenue.
Gross Margin
Nine Months Ended September 30,
-----------------------------------------------
% of % of
2004 Revenue 2003 Revenue
------ -------- ------ ---------
Operating revenues..................................... $ 1,688 100% $ 1,605 100%
Costs and expenses:
Operating costs................................... 547 32% 524 33%
Depreciation and amortization..................... 283 17% 206 13%
------- ----- ------- ------
Gross margin........................................... $ 858 51% $ 875 54%
======= ===== ======= ======
Gross margin decreased $17 million, or 2%, to $858 million in 2004, driven
by lower volumes and an increase in operating costs, partially offset by a
increase in transmission-related tariffs. The increase in operating costs of $23
million, or 4%, to $547 million, reflected a $9 million increase in third-party
transmission costs, a $6 million increase in metering-related costs associated
with the increased disconnect/reconnect activity, a $6 million increase in
vegetation management to improve system reliability and a $5 million increase in
property taxes due to property additions and increased values. Depreciation and
amortization included in gross margin reflected depreciation of assets directly
used in the delivery of electricity and amortization of regulatory assets. The
increase in depreciation and amortization of $77 million, or 37%, to $283
million reflected $66 million in higher amortization of regulatory assets
associated with the issuance of securitization bonds (offsetting the same amount
of revenue increase) and $10 million in higher depreciation due to normal
additions and replacements of equipment.
Depreciation and amortization not included in gross margin totaled $3
million and $9 million for the nine months ended September 30, 2004 and 2003,
respectively. This decline reflected a transfer of information technology
assets, principally capitalized software, to an affiliate in connection with the
Capgemini outsourcing transaction (see Note 1 to Financial Statements).
60
SG&A expenses increased $9 million, or 6%, to $154 million in 2004, driven
by a $13 million increase in deferred incentive compensation expense due
primarily to a higher TXU Corp. common stock price, partially offset by a $3
million decrease in pension and retiree medical benefits expense.
Other deductions of $23 million in 2004 consisted largely of $18 million
of severance-related charges in connection with the Capgemini outsourcing
transaction and other cost reduction initiatives and $3 million related to TXU
Electric Delivery's portion of the equity losses (representing depreciation
expense) in the TXU Corp. entity holding the capitalized software licensed to
Capgemini. See the discussion above under "Strategic Initiatives and Other
Actions" for additional information.
Interest income decreased by $1 million, or 2%, to $42 million in 2004
driven by a $6 million decrease in interest income from Energy related to excess
mitigation credit that ceased at the end of 2003 and a $4 million increase
representing lower reimbursement from Energy in 2003 for carrying costs related
to securitized regulatory assets.
Interest expense and related charges decreased $17 million, or 7%, to $212
million in 2004. The decrease reflected a $16 million impact of lower average
interest rates and $6 million in interest paid to REPs in 2003 related to the
excess mitigation credit that ceased at the end of 2003, partially offset by a
$5 million impact of higher average borrowings.
The effective income tax rate decreased to 33.1% in 2004 from 33.2% in
2003. There were no significant unusual items affecting this comparison.
Income before extraordinary gain decreased $19 million, or 8%, to $220
million in 2004, primarily reflecting lower volumes, the other deductions and
increased operating expenses, partially offset by lower interest expense and
higher transmission-related revenues.
COMPREHENSIVE INCOME - Continuing Operations
Cash flow hedge activity reported in other comprehensive income from
continuing operations included:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- -------------------
2004 2003 2004 2003
------- ------ ------ ------
Cash flow hedge activity (net of tax):
Net change in fair value of hedges-gains/(losses):
Commodities.............................................. $ (11) $ (20) $ (86) $ (118)
Financing - interest rate swaps.......................... 1 (3) 13 (37)
------- -------- ------- --------
(10) (23) (73) (155)
-------- -------- -------- --------
Losses (gains) realized in earnings (net of tax):
Commodities.............................................. 8 43 20 112
Financing - interest rate swaps.......................... 8 10 4 50
------- ------- ------- -------
16 53 24 162
------- ------- ------- -------
Effect of cash flow hedges reported in comprehensive results
related to continuing operations......................... $ 6 $ 30 $ (49) $ 7
======= ======= ======== =======
61
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows - Cash flows provided by operating activities in 2004 were $1.1
billion compared to $1.8 billion in 2003. The principal driver of the $726
million decrease in 2004 was a $616 million tax refund in 2003, primarily
related to tax benefits associated with the write-off of the investment in
Europe and a $132 million decrease in working capital (accounts receivable,
accounts payable and inventory) changes reflecting the improvements in 2003 due
to higher collections following billing delays experienced during the transition
to competition.
Cash flows used in financing activities were $3.6 billion in 2004 compared
to $1.5 billion in 2003. Net cash used in the repayment and issuance of
borrowings totaled $373 million in 2004 compared to $1.3 billion in 2003. Net
cash used in repurchase of common stock totaled $1.2 billion in 2004. The
exchangeable preferred membership interests were repurchased in 2004 for $1.9
billion. Common stock dividends of $120 million were paid in both 2004 and 2003.
Cash flows provided by investing activities totaled $2.4 billion in 2004
compared to $1.2 billion used during 2003. Capital expenditures, including
nuclear fuel, were $589 million in 2004 and $534 million in 2003. Capital
expenditures are expected to total $1.0 billion in 2004. Cash flows provided by
investing activities in 2004 included $1.9 billion from the sale of TXU
Australia, $496 million from the sale of TXU Fuel Company and $495 million from
the sale of the telecommunications business (see Note 3 to Financial
Statements). Cash flows used by investing activities in 2003 included $525
million invested in a trust to support a credit facility and $150 million to
acquire the partners' interest in the telecommunications joint venture.
Depreciation and amortization expense reported in the statement of cash
flows exceeds the amount reported in the statement of income by $48 million for
2004. This difference represents amortization of nuclear fuel, which is reported
as cost of energy sold in the statement of income consistent with industry
practice, and amortization of certain regulatory assets, which is reported as
operating costs in the statement of income.
Income tax -- TXU Corp. does not expect to incur federal income tax
payments in 2004 because available net operating loss carryforwards will fully
offset taxable income earned in 2004. TXU Corp. estimates that remaining net
operating loss carryforwards will be fully utilized against taxable income
earned in 2005. In addition, TXU Corp. may be required to make payments in
future periods with respect to tax audit adjustments. The amount and timing of
such payments, which could be material, are uncertain.
(Also see Note 8 to Financial Statements.)
62
Financing Activities
- --------------------
Reference is made to the discussion of TXU Corp.'s Debt and Capital
Management Program under "Strategic Initiatives and Other Actions" above.
Long-Term Debt Activity -- During the nine months ended September 30,
2004, TXU Corp. issued, redeemed, reacquired or made scheduled principal
payments on long-term debt as follows:
Issuances Retirements
--------- ------------
TXU Corp.:
Long-term debt ................................................................ $ -- $ 12
Senior Notes.................................................................... -- 358
Equity-linked securities........................................................ -- 423
Senior Notes included in liabilities of telecommunications holding company...... -- 560
Energy:
Pollution control revenue bonds................................................. -- 222
Senior Notes.................................................................... 800 --
Other .......................................................................... -- 7
Electric Delivery:
Transition bonds................................................................ 790 23
First mortgage bonds............................................................ -- 492
TXU Gas:
Senior notes.................................................................... -- 150
US Holdings:
Long-term debt................................................................. -- 2
------ ------
Total.......................................................................... $1,590 $2,249
====== ======
See Notes 4, 5, and 6 to Financial Statements for further detail of debt
issuance and retirements, financing arrangements, fair value hedges and debt
held by unconsolidated subsidiary trusts.
Equity --TXU Corp. or its predecessor has declared common stock dividends
payable in cash in each year since incorporation in 1945. The Board of Directors
of TXU Corp., at its August 2004 meeting, declared a quarterly dividend of
$0.125 a share, payable October 1, 2004, to shareholders of record on September
4, 2004. TXU Corp. paid quarterly dividends of $0.125 a share throughout 2003
and the first and second quarters of 2004. See discussion above under "Strategic
Initiatives and Other Actions" regarding the adoption of a new dividend and cash
distribution policy and an increase in the dividend rate.
The mortgage of Electric Delivery restricts its payment of dividends to
the amount of its retained earnings. Certain other debt instruments and
preferred securities of TXU Corp. contain provisions that restrict payment of
dividends during any interest or distribution payment deferral period or while
any payment default exists. At September 30, 2004, there were no restrictions on
the payment of dividends under these provisions.
See Note 7 to Financial Statements for an analysis of changes in common
stock equity.
Capitalization -- The capitalization ratios of TXU Corp. at September 30,
2004, consisted of 1.1% long-term debt held by subsidiary trusts, 2.0%
equity-linked debt securities, 63.3% other long-term debt, less amounts due
currently, 2.1% preference stock, 0.8% preferred stock of subsidiaries and 30.7%
common stock equity. Total debt to capitalization, including short-term debt,
was 66.4% and 62.0% at September 30, 2004 and December 31, 2003, respectively.
Short-term Borrowings -- At September 30, 2004, TXU Corp. had outstanding
short-term borrowings consisting of bank borrowings under the three-year
revolving credit facility of $565 million at a weighted average interest rate of
4.27%. At December 31, 2003, TXU Corp. had no short-term borrowings outstanding.
63
Credit Facilities -- TXU Corp. had credit facilities totaling $3 billion
of which $1.9 billion was unused at September 30, 2004. These credit facilities
are used for working capital and general corporate purposes and support
issuances of letters of credit. See Note 4 to Financial Statements for details
of the arrangements.
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, 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. 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 under the
program at September 30, 2004 and December 31, 2003 totaled $700 million and
$600 million, respectively. See Note 4 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.
Registered Financing Arrangements --Additional debt and equity securities
may be issued and sold as needed, including: (i) issuances by TXU Corp. of up to
approximately $2.0 billion of equity securities, equity-linked securities, debt
securities and/or preferred securities of subsidiary trusts and (ii) issuances
by US Holdings of up to $25 million of cumulative preferred stock and up to an
aggregate of $924 million of additional cumulative preferred stock, 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.
Cash and Cash Equivalents -- Cash on hand totaled $592 million and $829
million at September 30, 2004 and December 31, 2003, respectively. The decline
primarily reflects repayments of borrowings.
Restricted Cash -- At September 30, 2004, TXU Corp. had a $525 million
investment in LOC Trust, accounted for as restricted cash, representing
collateral to support a $500 million credit facility (see Note 4 to Financial
Statements). The remaining restricted cash reported in investments on the
balance sheet as of September 30, 2004 included $39 million held as collateral
for letters of credit issued and $10 million principally related to payment of
fees associated with the securitization bonds and $5 million in reserve for
shortfalls of transition charges. At September 30, 2004, the TXU Electric
Delivery Transition Bond Company LLC had $29 million of restricted cash,
representing collections from customers that secure its securitization bonds and
may be used only to service its debt and pay its expenses.
Credit Ratings -- The current credit ratings for TXU Corp. and certain of
its subsidiaries are presented below:
TXU Corp. US Holdings Electric Delivery Electric Delivery Energy
---------------- ----------------- ----------------- ----------------- ----------------
(Senior Unsecured) (Senior Unsecured) (Secured) (Senior Unsecured) (Senior Unsecured)
S&P............... BBB- BBB- BBB BBB- BBB
Moody's........... Ba1 Baa3 Baa1 Baa2 Baa2
Fitch............. BBB- BBB- A-/BBB+ BBB+ BBB
Moody's and Fitch currently maintain a stable outlook for TXU Corp., US
Holdings, Energy and Electric Delivery. Electric Delivery first mortgage bonds
are rated A- and its senior secured notes are rated BBB+ by Fitch. S&P currently
maintains a negative outlook for each such 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.
64
Financial Covenants, Credit Rating Provisions and Cross Default Provisions
- -- The terms of certain financing arrangements contain financial covenants that
require maintenance of specified fixed charge coverage ratios, shareholders'
equity to total capitalization ratios and leverage ratios and/or contain minimum
net worth covenants. As of September 30, 2004, TXU Corp. was in compliance with
all such applicable covenants.
Certain financing and other arrangements of TXU Corp. and its subsidiaries
contain provisions that are specifically affected by changes in credit ratings
and also include cross default provisions. The material credit rating and cross
default provisions are described below.
Other agreements of TXU Corp., including some of the credit facilities
discussed above, contain terms pursuant to which the interest rates charged
under the agreements may be adjusted depending on the credit ratings of TXU
Corp. or its subsidiaries.
Credit Rating Covenants
-----------------------
Energy has provided a guarantee of the obligations under TXU Corp.'s lease
(approximately $120 million at September 30, 2004) for its headquarters
building. In the event of a downgrade of Energy's credit rating to below
investment grade, a letter of credit would need to be provided within 30 days of
any such rating decline.
Energy has entered into certain commodity contracts and lease arrangements
that in some instances give the other party the right, but not the obligation,
to request Energy to post collateral in the event that its credit rating falls
below investment grade. Based on its current commodity contract positions, if
Energy were downgraded below investment grade by any specified rating agency,
counterparties would have the option to request Energy to post additional
collateral of approximately $182 million.
In addition, Energy has a number of other contractual arrangements under
which the counterparties would have the right to request Energy to post
collateral. The amount Energy would post under these transactions depends in
part on the value of the contracts at that time and Energy's rating by each of
the three rating agencies. As of September 30, 2004, based on current contract
values, the maximum Energy would post for these transactions is $170 million. Of
this amount, $150 million relates to one specific counterparty that would
require Energy to post collateral if all three rating agencies downgraded Energy
to below investment grade.
Energy is also the obligor on leases aggregating $158 million. Under the
terms of those leases, if Energy's credit rating were downgraded to below
investment grade by any specified rating agency, Energy could be required to
sell the assets, assign the leases to a new obligor that is investment grade,
post a letter of credit or defease the leases.
Cross Default Provisions
------------------------
Certain 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.
A default by TXU Corp. on indebtedness with a principal amount in excess
of $50 million would result in a cross default under its $500 million five-year
revolving credit facility expiring August 2008 and its new $2.3 billion 364 day
credit facility.
A default by TXU Corp., Energy or Electric Delivery in respect of
indebtedness in a principal amount in excess of $50 million would result in a
cross default under TXU Corp.'s new $2.3 billion, 364 day credit facility.
A default by Energy or Electric Delivery or any subsidiary thereof in
respect of indebtedness in a principal amount in excess of $50 million would
result in a cross default for such party under the $2.5 billion joint credit
facilities expiring in June 2005, 2007 and 2009. Under these credit facilities,
a default by Energy or any subsidiary thereof would cause the maturity of
outstanding balances under such facility to be accelerated as to Energy but not
as to Electric Delivery. Also, under this credit facility, a default by Electric
Delivery or any subsidiary thereof would cause the maturity of outstanding
balances under such facility to be accelerated as to Electric Delivery but not
as to Energy.
65
A default by US Holdings or any subsidiary thereof on financing
arrangements of $50 million or more would result in a cross default under the
$30 million of TXU Mining (a subsidiary of Energy) senior notes, which have a $1
million cross default threshold.
Energy has entered into certain mining and equipment leasing arrangements
aggregating $109 million that would terminate upon the default of any other
obligations of Energy owed to the lessor. In the event of a default by TXU
Mining on indebtedness in excess of $1 million, a cross default would result
under the $30 million TXU Mining leveraged lease and the lease could terminate.
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.
Energy enters into energy-related contracts, the master forms of which
contain provisions whereby an event of default would occur if Energy were to
default under an obligation in respect of borrowings in excess of thresholds,
which vary, stated in the contracts.
Other arrangements, including leases, have cross default provisions, the
triggering of which would not result in a significant effect on liquidity.
Long-term Contractual Obligations and Commitments -- The table below
reflects updates of amounts presented in TXU Corp.'s 2003 Form 10-K to reflect
the obligation under the business services outsourcing agreement with Capgemini,
the sale of TXU Australia and TXU Gas resulting in changes in purchase
obligations, and the repayment of debt and other instruments as discussed in
Note 1 to Financial Statements.
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................ $2,420 $2,964 $1,955 $10,872
Operating leases and capital lease obligations......... 105 184 169 434
Purchase obligations................................... 2,272 1,606 491 455
Business services outsourcing obligations.............. 249 458 458 1,088
Pension and other postretirement liabilities........... 98 196 196 98
------ ------ ------ -------
Total Contractual Cash Obligations $5,144 $5,408 $3,269 $12,947
====== ====== ====== =======
OFF BALANCE SHEET ARRANGEMENTS, INCLUDING VARIABLE INTEREST ENTITIES
TXU Corp.'s accounts receivable securitization program is discussed in
Note 4 to Financial Statements.
TXU Corp. has ownership interests in unconsolidated (under FIN 46)
financing trusts as discussed in Note 5 to Financial Statements.
Also see Note 1 to Financial Statements for discussion of TXU Corp.'s
business process outsourcing arrangement with Capgemini, an unconsolidated
(under FIN 46) entity in which an ownership interest is held. Also see related
contractual cash obligations immediately above.
COMMITMENTS AND CONTINGENCIES
See Note 8 to Financial Statements for details of contingencies, including
guarantees.
In connection with the TXU Gas transaction, on October 1, 2004, TXU Corp.
agreed to guaranty certain indemnity obligations that TXU Gas may have to Atmos
Energy Corporation. TXU Gas agreed, for a period of three years, to indemnify
Atmos Energy Corporation for certain qualified environmental claims that may
arise in relation to the assets acquired by Atmos Energy Corporation. TXU Gas is
not required to indemnify Atmos Energy Corporation until the aggregate of all
such qualified claims exceeds $10 million, and TXU Gas is only required to
indemnify Atmos Energy Corporation for 50% of qualified claims between $10
million and $20 million. The maximum amount that TXU Gas (or TXU Corp. via the
66
guaranty) would be required to pay Atmos Energy Corporation pursuant to this
environmental indemnity is $192.5 million. In addition, TXU Gas agreed to
indemnify Atmos Energy Corporation for any liability related to assets retained
by TXU Gas including certain manufactured gas plants (MGPs) not acquired by
Atmos Energy Corporation as well as pre-closing tax and employee related
liabilities. While TXU Gas' indemnity obligation with respect to these matters
is unlimited in amount and duration, TXU Corp.'s guaranty with respect to these
matters is limited. TXU Corp.'s guaranty is limited to $500 million for
liabilities associated with MGPs, and is limited to $1.4 billion for liabilities
associated with pre-closing tax and employee related matters. In each case, TXU
Corp.'s guaranty is limited to 10 years. The maximum aggregate amount that TXU
Corp. may be required to pay under the guaranty is $1.925 billion. The estimated
fair value of the guaranty recorded upon completion of the TXU Gas transaction
is $2.5 million.
REGULATION AND RATES
Price-to-Beat Rates - Under the 1999 Restructuring Legislation, Energy is
required to continue to charge a "price-to-beat" rate established by the
Commission to residential customers in the historical service territory. Energy
must continue to make price-to-beat rates available to small business customers,
however, it may offer rates other than price-to-beat, since it met the
requirements of the 40% threshold target calculation in December 2003. The
price-to-beat rate can be adjusted upward or downward twice a year, subject to
approval by the Commission, for changes in the market price of natural gas.
In March 2004, Energy filed a request with the Commission to increase the
fuel factor component of its price-to-beat rates. This request was approved May
13, 2004. In accordance with the Commission's order, the new rate became
effective on May 20, 2004. This adjustment raised the average monthly
residential electric bill of a customer using 1,000 kilowatt hours by 3.4% or
$3.39 per month.
In June 2004, Energy filed its second request for this year with the
Commission to increase the fuel factor component of its price-to-beat rates.
This request was approved July 28, 2004 and became effective on August 4, 2004.
The filing reflects an increase of 12.7% in the market price of natural gas
since the March 2004 filing. This adjustment raised the average monthly
residential electric bill of a customer using 1,000 kilowatt hours by 5.7% or
$5.87 per month.
Transmission Rates -- In April 2004, Electric Delivery's new wholesale
transmission rate was approved by the Commission and will generate a total
annualized revenue increase of $14 million. Approximately $8.5 million of this
increase would be recovered through transmission rates charged to wholesale
customers, with the remaining $5.5 million to be recovered from REPs through the
retail transmission cost recovery factor (TCRF) of Electric Delivery's retail
delivery rate.
In March 2004, the Commission approved an estimated annualized increase of
$9 million in the TCRF component of Electric Delivery's distribution rates
charged to REPs. In September 2004, Electric Delivery implemented a second
increase in the TCRF component of its retail delivery rates charged to REPs. The
request will increase annual revenues by an estimated $29.5 million. The effect
of Electric Delivery's wholesale transmission rate increase described in the
preceding paragraph was included in Electric Delivery's September 2004 TCRF
update. With respect to the impact on TXU Corp.'s consolidated results, the
higher TCRF results in reduced margin on Energy's sales to those retail
customers with pricing that does not provide for recovery of higher delivery
fees, principally price-to-beat customers.
Other Commission Matters -- On May 27, 2004, the Commission opened an
investigation to gather information regarding Electric Delivery's and its
affiliates' compliance with the Commission's affiliate code of conduct rules.
Conversations with the Commission indicate that this investigation was prompted
in large part by the utility's change in its legal corporate name from Oncor
Electric Delivery Company back to TXU Electric Delivery Company. Those
discussions indicate a reasonable expectation that the Commission will focus its
investigation on Energy's implementation of a disclaimer rule that requires
Energy to place a disclaimer in certain advertisements and on business cards to
explain the distinction between Energy and Electric Delivery.
Electric Delivery filed formal notice of its name change at the Commission
on June 1, 2004, by filing for approval re-issued tariffs that display the new
company name but are in all other respects identical to the pre-existing
tariffs. On August 9, 2004, the Commission Policy Development Division approved
the re-issued tariffs and ordered Electric Delivery to implement use of a
disclaimer regarding the difference between Electric Delivery and its
competitive affiliates.
67
Several Texas cities, acting in their role as a regulatory authority, have
initiated an inquiry to determine if the rates of Electric Delivery, which have
been established by the Commission, are just and reasonable. Electric Delivery
expects to file information responsive to the inquiries by the end of 2004, with
city actions, if any, to take place in 2005. TXU Corp. does not believe any
reasonable outcome would have a material effect on TXU Corp.'s consolidated
results.
Energy, along with several ERCOT wholesale market participants, has filed
an appeal at the Court of Appeals for the Third District of Texas (Austin)
contesting certain aspects of a recently adopted Commission rule regarding
enforcement standards applicable to the wholesale power market. Energy believes
that certain portions of the rule as adopted are unconstitutionally vague and
other portions may exact an unconstitutional taking of private property without
just compensation. There is no statutory deadline by which the court must act on
the appeal.
In August 2004, Energy proposed a tiered pricing program for
out-of-territory customers (i.e., those customers outside of Energy's
traditional North Texas service area) that would provide the lowest prices to
customers that Energy has determined will pose the lowest risk of poor payment
behavior, and higher prices to customers who will pose a higher risk of poor
payment behavior. Energy's proposed tiered pricing program would have made use
of credit information obtained from a credit reporting agency to make the
payment risk determination. On September 8, 2004, the Texas Office of Public
Utility Counsel ("OPC") filed a complaint at the Commission alleging generally
that the use of credit information is unlawfully discriminatory. Subsequently,
on September 14, 2004, Energy filed its response to the OPC complaint and in
that response, in addition to asserting that the proposed pricing plan is
lawful, notified the Commission that, pursuant to the Commission Staff's
request, Energy would suspend implementation of the proposed tiered pricing
program for at least 45 days, so that Energy could engage in discussions with
Commission Staff, OPC, and others regarding other tools to address the pressing
issue of mounting bad debt (uncollectibles). OPC requested, and the Commission
granted, the dismissal of the complaint without prejudice to refiling. These
discussions began shortly thereafter and are continuing.
ERCOT Market Issues - The Texas Public Utility Regulatory Act ("PURA") and
the Commission are subject to "sunset review" by the Texas Legislature in the
2005 legislative session. Sunset review entails, generally, a comprehensive
review of the need for and efficacy of an administrative agency (e.g., the
Commission), along with an evaluation of the advisability of any changes to that
agency's authorizing legislation (e.g., PURA). As part of the sunset review
process, the legislative Sunset Advisory Commission has recommended that the
Legislature re-authorize the Commission for at least 6 years, and has
recommended other changes to PURA that are not expected to have a material
adverse impact upon the Company's operations. The Legislature could consider and
enact other changes to PURA and the Company cannot predict whether any such
changes might have a material adverse impact on its operations.
In addition to sunset review, the Texas Legislature and other Texas
governmental entities have initiated investigations into alleged improprieties
regarding some contracting practices of ERCOT, the non-governmental entity that
has operational control of the electric grid for much of Texas. To date, these
activities have not resulted in actions that are expected to have a material
impact on the Company's operations, but the company cannot predict whether the
culmination of these or other governmental activities that may affect the ERCOT
market may result in any such material adverse effect.
Wholesale market design In August 2003, the Commission adopted a rule
that, if fully implemented, would alter the wholesale market design in ERCOT.
The rule requires ERCOT:
o to use a stakeholder process to develop a new wholesale market mode;
o to operate a voluntary day-ahead energy market;
o to directly assign all congestion rents to the resources that caused
the congestion;
o to use nodal energy prices for resources;
68
o to provide information for energy trading hubs by aggregating nodes;
o to use zonal prices for loads; and
o to provide congestion revenue rights (but not physical rights).
Under the rule, the proposed market design and associated cost-benefit
analysis is to be filed with the Commission by November 1, 2004 and is to be
implemented by October 1, 2006. On September 17, 2004, the Commission opened a
rulemaking project to possibly delay the filing date of the proposed market
design from November 1, 2004 to March 1, 2005. On October 28, the Commission
adopted a rule change that would delay the filing date for the proposed market
design until March 18, 2005. Additionally, the Commission approved an extension
until December 31, 2004 for the filing of the cost-benefit analysis. TXU Energy
is currently unable to predict the cost or impact of implementing any proposed
change to the current wholesale market design.
Environmental Matters -- On October 1, 2004, TXU Corp. released an
independent study by NERA Economic Consulting in collaboration with Marc
Goldsmith & Associates. The study evaluated TXU Corp.'s processes for following
and evaluating air emissions and climate policies and reviewed the company's
actions regarding previous major air emissions policies and compliance.
Additionally, the study considered the financial consequences and related risks
to TXU Corp. of prospective air emissions and climate change policies, including
an assessment of the financial effects of reducing emissions now in anticipation
of future requirements. The study concluded that TXU Corp. has the appropriate
processes and procedures in place and uses appropriate economic methodologies to
evaluate financial consequences of environmental regulatory policy changes and
scenarios. The study also concluded that absent certain specific circumstances,
TXU Corp.'s shareholders would not benefit if the company devoted major
financial resources now to reduce its carbon dioxide emissions in advance of
uncertain future emission regulations. In addition, the study concluded that TXU
Corp.'s efforts have consistently resulted in compliance with air emission
limits. The study is available on TXU Corp.'s website at
http://www.txucorp.com/envcom/default.asp.
Summary -- Although TXU Corp. 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 discussion of changes in
accounting standards.
69
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 Corp.'s operations,
financial results and financial condition, and could cause TXU Corp.'s actual
results or outcomes to differ materially from any projected outcome contained in
any forward-looking statement in this report, include:
The implementation of performance improvement initiatives identified by
management may not produce the desired results and may result in disruptions
arising from employee displacements and the rapid pace of changes to
organizational structure and operating practices and processes.
ERCOT is the independent system operator that is responsible for
maintaining reliable operation of the bulk electric power supply system in the
ERCOT region. Its responsibilities include the clearing and settlement of
electricity volumes and related ancillary services among the various
participants in the deregulated Texas market. Because of new processes and
systems associated with the opening of the market to competition, which continue
to be improved, there have been delays in finalizing these settlements. As a
result, TXU Corp. is subject to settlement adjustments from ERCOT related to
prior periods, which may result in charges or credits impacting future reported
results of operations.
TXU Corp.'s businesses operate in changing market environments influenced
by various legislative and regulatory initiatives regarding deregulation,
regulation or restructuring of the energy industry, including deregulation of
the production and sale of electricity. TXU Corp. will need to adapt to these
changes and may face increasing competitive pressure.
TXU Corp.'s businesses are subject to changes in laws (including PURA, the
Federal Power Act, as amended, the Atomic Energy Act, as amended, the Public
Utility Regulatory Policies Act of 1978, as amended, the Clean Air Act, as
amended, and the Public Utility Holding Company Act of 1935, as amended) and
changing governmental policy and regulatory actions (including those of the
Commission, the RRC, the FERC, the EPA and the NRC) with respect to matters
including, but not limited to, market structure and design, operation of nuclear
power facilities, construction and operation of other power generation
facilities, construction and operation of transmission facilities, acquisition,
disposal, depreciation, and amortization of regulated assets and facilities,
decommissioning costs, and return on invested capital for TXU Corp.'s regulated
businesses, and present or prospective wholesale and retail competition. In
particular, PURA and the Commission are subject to "sunset review" by the Texas
Legislature in the upcoming 2005 legislative session. See "ERCOT Market Issues"
and "Wholesale Market Design" above.
Energy, along with other market participants, is subject to oversight by
the Commission. In that connection, Energy and other market participants may be
subject to various competition-related rules and regulations, including but not
limited to possible price-mitigation rules, as well as rules related to market
behavior.
TXU Corp. is not guaranteed any rate of return on its capital investments
in unregulated businesses. TXU Corp. markets and trades power, including power
from its own production facilities, as part of its wholesale energy sales
business and portfolio management operation. TXU Corp.'s results of operations
are likely to depend, in large part, upon prevailing retail rates, which are
set, in part, by regulatory authorities, and market prices for electricity, gas
and coal in its regional market and other competitive markets. Market prices may
fluctuate substantially over relatively short periods of time. Demand for
electricity can fluctuate dramatically, creating periods of substantial under-
or over-supply. During periods of over-supply, prices might be depressed. Also,
at times there may be political pressure, or pressure from regulatory
authorities with jurisdiction over wholesale and retail energy commodity and
transportation rates, to impose price limitations, bidding rules and other
mechanisms to address volatility and other issues in these markets.
70
TXU Corp.'s regulated businesses are subject to cost-of-service regulation
and annual earnings oversight. This regulatory treatment does not provide any
assurance as to achievement of earnings levels. Electric Delivery's rates are
regulated by the Commission based on an analysis of Electric Delivery's costs,
as reviewed and approved in a regulatory proceeding. While rate regulation is
premised on the full recovery of prudently incurred costs and a reasonable rate
of return on invested capital, there can be no assurance that the Commission
will judge all of Electric Delivery's costs to have been prudently incurred or
that the regulatory process in which rates are determined will always result in
rates that will produce full recovery of Electric Delivery's costs and the
return on invested capital allowed by the Commission. In addition, a group of
cities is seeking to determine whether recent operational initiatives
implemented by TXU Corp. have reduced Electric Delivery's cost-of-service and
require a reduction in its rates.
Some of the fuel for TXU Corp.'s power production facilities is purchased
under short-term contracts or on the spot market. Prices of fuel, including
natural gas, may also be volatile, and the price TXU Corp. can obtain for power
sales may not change at the same rate as changes in fuel costs. In addition, TXU
Corp. purchases and sells natural gas and other energy related commodities, and
volatility in these markets may affect TXU Corp.'s costs incurred in meeting its
obligations.
Volatility in market prices for fuel and electricity may result from:
o severe or unexpected weather conditions,
o seasonality,
o changes in electricity usage,
o illiquidity in the wholesale power or other markets,
o transmission or transportation constraints, inoperability or
inefficiencies,
o availability of competitively priced alternative energy sources,
o changes in supply and demand for energy commodities,
o changes in power production capacity,
o outages at TXU Corp.'s power production facilities or those of its
competitors,
o changes in production and storage levels of natural gas, lignite,
coal and crude oil and refined products,
o natural disasters, wars, sabotage, terrorist acts, embargoes and
other catastrophic events, and
o federal, state, local and foreign energy, environmental and other
regulation and legislation.
All but one of TXU Corp.'s facilities for power production are located in
the ERCOT region, a market with limited interconnections to other markets.
Electricity prices in the ERCOT region are correlated to gas prices because
gas-fired plant is the marginal cost unit during the majority of the year in the
ERCOT region. Accordingly, the contribution to earnings and the value of TXU
Corp.'s base load power production is dependent in significant part upon the
price of gas. TXU Corp. cannot fully hedge the risk associated with dependency
on gas because of the expected useful life of TXU Corp.'s power production
assets and the size of its position relative to market liquidity.
To manage its near-term financial exposure related to commodity price
fluctuations, TXU Corp. routinely enters into contracts to hedge portions of its
purchase and sale commitments, weather positions, fuel requirements and
inventories of natural gas, lignite, coal, refined products, and other
commodities, within established risk management guidelines. As part of this
strategy, TXU Corp. routinely utilizes fixed-price forward physical purchase and
sales contracts, futures, financial swaps and option contracts traded in the
over-the-counter markets or on exchanges. However, TXU Corp. can normally cover
only a small portion of the exposure of its assets and positions to market price
volatility, and the coverage will vary over time. To the extent TXU Corp. has
unhedged positions, fluctuating commodity prices can materially impact TXU
Corp.'s results of operations and financial position, either favorably or
unfavorably.
Although TXU Corp. devotes a considerable amount of management time and
effort to the establishment of risk management procedures as well as the ongoing
review of the implementation of these procedures, the procedures it has in place
may not always be followed or may not always function as planned and cannot
eliminate all the risks associated with these activities. As a result of these
and other factors, TXU Corp. cannot predict with precision the impact that risk
management decisions may have on its business, results of operations or
financial position.
71
TXU Corp. or one of its subsidiaries has guaranteed or indemnified the
performance of a portion of the obligations of certain subsidiaries, including
those involved in hedging and risk management activities. TXU Corp. or its
subsidiary, as the case may be, might not be able to satisfy all of these
guarantees and indemnification obligations if they were to come due at the same
time.
TXU Corp.'s hedging and risk management activities are exposed to the risk
that counterparties that owe TXU Corp. money, energy or other commodities as a
result of market transactions will not perform their obligations. The likelihood
that certain counterparties may fail to perform their obligations has increased
due to financial difficulties, brought on by various factors including improper
or illegal accounting and business practices, affecting some participants in the
industry. Some of these financial difficulties have been so severe that certain
industry participants have filed for bankruptcy protection or are facing the
possibility of doing so. Should the counterparties to these arrangements fail to
perform, TXU Corp. might be forced to acquire alternative hedging arrangements
or honor the underlying commitment at then-current market prices. In such event,
TXU Corp. might incur losses in addition to amounts, if any, already paid to the
counterparties. ERCOT market participants are also exposed to risks that another
ERCOT market participant may default in its obligations to pay ERCOT for power
taken in the ancillary services market, in which case such costs, to the extent
not offset by posted security and other protections available to ERCOT, may be
allocated to various non-defaulting ERCOT market participants.
The current credit ratings for TXU Corp.'s and its subsidiaries' long-term
debt are investment grade, except for Moody's credit rating for long-term debt
of TXU Corp. (the holding company), which is one notch below investment grade. A
rating reflects only the view of a rating agency, and it is not a recommendation
to buy, sell or hold securities. Any rating can be revised upward or downward at
any time by a rating agency if such rating agency decides that circumstances
warrant such a change. If S&P, Moody's or Fitch were to downgrade TXU Corp.'s
and/or its subsidiaries' long-term ratings, particularly below investment grade,
borrowing costs would increase and the potential pool of investors and funding
sources would likely decrease. If the downgrade were below investment grade,
liquidity demands would be triggered by the terms of a number of commodity
contracts, leases and other agreements.
Most of TXU Corp.'s large customers, suppliers and counterparties require
sufficient creditworthiness in order to enter into transactions. If TXU Corp.'s
subsidiaries' ratings were to decline to below investment grade, costs to
operate the power business would increase because counterparties may require the
posting of collateral in the form of cash-related instruments, or counterparties
may decline to do business with TXU Corp.'s subsidiaries.
In addition, as discussed in TXU Corp.'s Annual Report on Form 10-K for
the year ended December 31, 2003, the terms of certain of TXU Corp.'s financing
and other arrangements contain provisions that are specifically affected by
changes in credit ratings and could require the posting of collateral, the
repayment of indebtedness or the payment of other amounts.
The operation of power production and energy transportation facilities
involves many risks, including start up risks, breakdown or failure of
facilities, lack of sufficient capital to maintain the facilities, the
dependence on a specific fuel source or the impact of unusual or adverse weather
conditions or other natural events, as well as the risk of performance below
expected levels of output or efficiency, the occurrence of any of which could
result in lost revenues and/or increased expenses. A significant portion of TXU
Corp.'s facilities was constructed many years ago. In particular, older
generating equipment, even if maintained in accordance with good engineering
practices, may require significant capital expenditures to keep it operating at
peak efficiency. The risk of increased maintenance and capital expenditures
arises from (a) increased starting and stopping of generation equipment due to
the volatility of the competitive market, (b) any unexpected failure to produce
power, including failure caused by breakdown or forced outage, and (c) repairing
damage to facilities due to storms, natural disasters, wars, terrorist acts and
other catastrophic events. Further, TXU Corp.'s ability to successfully and
timely complete capital improvements to existing facilities or other capital
projects is contingent upon many variables and subject to substantial risks.
Should any such efforts be unsuccessful, TXU Corp. could be subject to
additional costs and/or the write-off of its investment in the project or
improvement.
72
Insurance, warranties or performance guarantees may not cover all or any
of the lost revenues or increased expenses, including the cost of replacement
power. Likewise, TXU Corp.'s ability to obtain insurance, and the cost of and
coverage provided by such insurance, could be affected by events outside its
control.
The ownership and operation of nuclear facilities, including TXU Corp.'s
ownership and operation of the Comanche Peak generation plant, involve certain
risks. These risks include: mechanical or structural problems; inadequacy or
lapses in maintenance protocols; the impairment of reactor operation and safety
systems due to human error; the costs of storage, handling and disposal of
nuclear materials; limitations on the amounts and types of insurance coverage
commercially available; and uncertainties with respect to the technological and
financial aspects of decommissioning nuclear facilities at the end of their
useful lives. The following are among the more significant of these risks:
o Operational Risk - Operations at any nuclear power production plant
could degrade to the point where the plant would have to be shut down.
Over the next three years, certain equipment at Comanche Peak is
expected to be replaced. The cost of these actions is currently
expected to be material and could result in extended outages. If this
were to happen, the process of identifying and correcting the causes
of the operational downgrade to return the plant to operation could
require significant time and expense, resulting in both lost
revenue and increased fuel and purchased power expense to meet supply
commitments. Rather than incurring substantial costs to restart the
plant, the plant may be shut down. Furthermore, a shut-down or failure
at any other nuclear plant could cause regulators to require a
shut-down or reduced availability at Comanche Peak.
o Regulatory Risk - The NRC may modify, suspend or revoke licenses and
impose civil penalties for failure to comply with the Atomic Energy
Act, the regulations under it or the terms of the licenses of nuclear
facilities. Unless extended, the NRC operating licenses for Comanche
Peak Unit 1 and Unit 2 will expire in 2030 and 2033, respectively.
Changes in regulations by the NRC could require a substantial increase
in capital expenditures or result in increased operating or
decommissioning costs.
o Nuclear Accident Risk - Although the safety record of Comanche Peak and
other nuclear reactors generally has been very good, accidents and
other unforeseen problems have occurred both in the US and elsewhere.
The consequences of an accident can be severe and include loss of life
and property damage. Any resulting liability from a nuclear accident
could exceed TXU Corp.'s resources, including insurance coverage.
TXU Corp. is subject to extensive environmental regulation by governmental
authorities. In operating its facilities, TXU Corp. is required to comply with
numerous environmental laws and regulations, and to obtain numerous governmental
permits. TXU Corp. may incur significant additional costs to comply with these
requirements. If TXU Corp. fails to comply with these requirements, it could be
subject to civil or criminal liability and fines. Existing environmental
regulations could be revised or reinterpreted, new laws and regulations could be
adopted or become applicable to TXU Corp. or its facilities, and future changes
in environmental laws and regulations could occur, including potential
regulatory and enforcement developments related to air emissions.
TXU Corp. may not be able to obtain or maintain all required environmental
regulatory approvals. If there is a delay in obtaining any required
environmental regulatory approvals or if TXU Corp. fails to obtain, maintain or
comply with any such approval, the operation of its facilities could be stopped
or become subject to additional costs. Further, at some of TXU Corp.'s older
facilities, including base load lignite and coal plants, it may be uneconomical
for TXU Corp. to install the necessary equipment, which may cause TXU Corp. to
shut down those facilities.
In addition, TXU Corp. may be responsible for any on-site liabilities
associated with the environmental condition of facilities that it has acquired
or developed, regardless of when the liabilities arose and whether they are
known or unknown. In connection with certain acquisitions and sales of assets,
TXU Corp. may obtain, or be required to provide, indemnification against certain
environmental liabilities. Another party could fail to meet its indemnification
obligations to TXU Corp.
73
TXU Corp. is obligated to offer the price-to-beat rate to requesting
residential and small business customers in its historical service territory
within Texas through January 1, 2007. TXU Corp. is not permitted to offer
electricity to the residential customers in the historical service territory at
a price other than the price-to-beat rate until January 1, 2005, unless before
that date the Commission determines that 40% or more of the amount of electric
power consumed by residential customers in that area is committed to be served
by REPs other than TXU Corp. Because TXU Corp. will not have the same level of
residential customer price flexibility as competitors in the historical service
territory, TXU Corp. could lose a significant number of these customers to other
providers.
Other REPs are allowed to offer electricity to TXU Corp.'s residential
customers at any price. The margin or "headroom" available in the price-to-beat
rate for any REP equals the difference between the price-to-beat rate and the
sum of delivery charges and the price that REP pays for power. Headroom may be a
positive or a negative number. The higher the amount of positive headroom for
competitive REPs in a given market, the more incentive those REPs would have to
compete in providing retail electric services in that market, which may result
in TXU Corp. losing customers to competitive REPs.
The results of TXU Corp.'s retail electric operations in the historical
service territory is largely dependent upon the amount of headroom available to
TXU Corp. and the competitive REPs in TXU Corp.'s price-to-beat rate. Since
headroom is dependent, in part, on power production and purchase costs, TXU
Corp. does not know nor can it estimate the amount of headroom that it or other
REPs will have in TXU Corp.'s price-to-beat rate or in the price-to-beat rate
for the affiliated REP in each of the other Texas retail electric markets.
There is no assurance that future adjustments to TXU Corp.'s price-to-beat
rate will be adequate to cover future increases in its costs of electricity to
serve its price-to-beat rate customers or that TXU Corp.'s price-to-beat rate
will not result in negative headroom in the future.
In most retail electric markets outside the historical service territory,
TXU Corp.'s principal competitor may be the retail affiliate of the local
incumbent utility company. The incumbent retail affiliates have the advantage of
long-standing relationships with their customers. In addition to competition
from the incumbent utilities and their affiliates, TXU Corp. may face
competition from a number of other energy service providers, or other energy
industry participants, who may develop businesses that will compete with TXU
Corp. and nationally branded providers of consumer products and services. Some
of these competitors or potential competitors may be larger and better
capitalized than TXU Corp. If there is inadequate margin in these retail
electric markets, it may not be profitable for TXU Corp. to enter these markets.
TXU Corp. depends on transmission and distribution facilities owned and
operated by other utilities, as well as its own such facilities, to deliver the
electricity it produces and sells to consumers, as well as to other REPs. If
transmission capacity is inadequate, TXU Corp.'s ability to sell and deliver
electricity may be hindered, it may have to forgo sales or it may have to buy
more expensive wholesale electricity that is available in the
capacity-constrained area. In particular, during some periods transmission
access is constrained to some areas of the Dallas-Fort Worth metroplex. TXU
Corp. expects to have a significant number of customers inside these constrained
areas. The cost to provide service to these customers may exceed the cost to
provide service to other customers, resulting in lower headroom. In addition,
any infrastructure failure that interrupts or impairs delivery of electricity to
TXU Corp.'s customers could negatively impact the satisfaction of its customers
with its service.
TXU Corp. offers its customers a bundle of services that include, at a
minimum, the electric commodity itself plus transmission, distribution and
related services. The prices TXU Corp. charges for this bundle of services or
for the various components of the bundle, either of which may be fixed by
contract with the customer for a period of time, could fall below TXU Corp.'s
underlying cost to obtain the commodities or services.
The information systems and processes necessary to support risk
management, sales, customer service and energy procurement and supply in
competitive retail markets in Texas and elsewhere are new, complex and
extensive. These systems and processes require ongoing refinement, which may
prove more expensive than planned and may not work as planned. Delays in the
perfection of these systems and processes and any related increase in costs
could have a material adverse impact on TXU Corp.'s business and results of
operations.
74
Research and development activities are ongoing to improve existing and
alternative technologies to produce electricity, including gas turbines, fuel
cells, microturbines and photovoltaic (solar) cells. It is possible that
advances in these or other alternative technologies will reduce the costs of
electricity production from these technologies to a level that will enable these
technologies to compete effectively with electricity production from traditional
power plants like TXU Corp.'s. While demand for electric energy services is
generally increasing throughout the US, the rate of construction and development
of new, more efficient power production facilities may exceed increases in
demand in some regional electric markets. Consequently, where TXU Corp. has
facilities, the market value of TXU Corp.'s power production and/or energy
transportation facilities could be significantly reduced. Also, electricity
demand could be reduced by increased conservation efforts and advances in
technology, which could likewise significantly reduce the value of TXU Corp.'s
facilities. Changes in technology could also alter the channels through which
retail electric customers buy electricity.
TXU Corp. is a holding company and conducts its operations primarily
through wholly-owned subsidiaries. Substantially all of TXU Corp.'s consolidated
assets are held by these subsidiaries. Accordingly, TXU Corp.'s cash flows and
ability to meet its obligations and to pay dividends are largely dependent upon
the earnings of its subsidiaries and the distribution or other payment of such
earnings to TXU Corp. in the form of distributions, loans or advances, and
repayment of loans or advances from TXU Corp. The subsidiaries are separate and
distinct legal entities and have no obligation to provide TXU Corp. with funds
for its payment obligations, whether by dividends, distributions, loans or
otherwise.
Because TXU Corp. is a holding company, its obligations to its creditors
are structurally subordinated to all existing and future liabilities and
existing and future preferred stock of its subsidiaries. Therefore, TXU Corp.'s
rights and the rights of its creditors to participate in the assets of any
subsidiary in the event that such a subsidiary is liquidated or reorganized are
subject to the prior claims of such subsidiary's creditors and holders of its
preferred stock. To the extent that TXU Corp. may be a creditor with recognized
claims against any such subsidiary, its claims would still be subject to the
prior claims of such subsidiary's creditors to the extent that they are secured
or senior to those held by TXU Corp. Subject to restrictions contained in TXU
Corp.'s other financing arrangements, TXU Corp.'s subsidiaries may incur
additional indebtedness and other liabilities.
The inability to raise capital on favorable terms, particularly during
times of uncertainty in the financial markets, could impact TXU Corp.'s ability
to sustain and grow its businesses, which are capital intensive, and would
increase its capital costs. TXU Corp. relies on access to financial markets as a
significant source of liquidity for capital requirements not satisfied by cash
on hand or operating cash flows. TXU Corp.'s access to the financial markets
could be adversely impacted by various factors, such as:
o changes in credit markets that reduce available credit or the ability
to renew existing liquidity facilities on acceptable terms;
o inability to access commercial paper markets;
o a deterioration of TXU Corp.'s credit or the credit of its
subsidiaries or a reduction in TXU Corp.'s credit ratings or the
credit ratings of its subsidiaries;
o extreme volatility in TXU Corp.'s markets that increases margin or
credit requirements;
o a material breakdown in TXU Corp.'s risk management procedures;
o prolonged delays in billing and payment resulting from delays in
switching customers from one REP to another; and
o the occurrence of material adverse changes in TXU Corp.'s businesses
that restrict TXU Corp.'s ability to access its liquidity facilities.
A lack of necessary capital and cash reserves could adversely impact the
evaluation of TXU Corp.'s credit worthiness by counterparties and rating
agencies, and would likely increase its capital costs. Further, concerns on the
part of counterparties regarding TXU Corp.'s liquidity and credit could limit
its portfolio management activities.
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
75
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
Corp. believes that it is complying with all applicable laws, but it is
difficult or impossible to predict or control what effect events and
investigations in the energy industry may have on TXU Corp.'s financial
condition or access to the capital markets. Additionally, it is unclear what
laws and regulations may develop, and TXU Corp. 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 subject to costs and other effects of legal and
administrative proceedings, settlements, investigations and claims. Since
October 2002, a number of lawsuits have been filed in federal and state courts
in Texas against TXU Corp. and various of its officers, directors and
underwriters. In addition, the circumstances surrounding the insolvency of TXU
Corp.'s operations in Europe, as well as the administration proceeding, have
resulted in notices of various claims or potential claims and might result in
lawsuits by the creditors of or others associated with TXU Europe. In addition,
the administrators of certain of the TXU Europe companies have given TXU Corp.
written notice of the basis for the claims alleged against TXU Corp. and certain
individual TXU Corp. officers and directors and TXU Corp. has been in contact
with the administrators regarding such claims. Such current and potential legal
proceedings could result in payments of judgment or settlement amounts.
The market price of TXU Corp.'s common stock has been volatile in the
past, and a variety of factors could cause the price to fluctuate in the future.
In addition to the matters discussed above and in TXU Corp.'s other filings
under the Securities Exchange Act of 1934, as amended, the following could
impact the market price for TXU Corp.'s common stock:
o developments related to TXU Corp.'s businesses;
o fluctuations in TXU Corp.'s results of operations;
o the level of dividends and share repurchases;
o TXU Corp.'s debt to equity ratios and other credit metrics;
o effect of significant events relating to the energy sector in general;
o sales of TXU Corp. securities into the marketplace;
o general conditions in the industry and the energy markets in which
TXU Corp. is a participant;
o the worldwide economy;
o an outbreak of war or hostilities;
o a shortfall in revenues or earnings compared to securities analysts'
expectations;
o changes in analysts' recommendations or projections; and
o actions by credit rating agencies.
Fluctuations in the market price of TXU Corp.'s common stock may be
unrelated to TXU Corp.'s performance. General market declines or market
volatility could adversely affect the price of TXU Corp.'s common stock and the
current market price may not be indicative of future market prices.
The issues and associated risks and uncertainties described above are not
the only ones TXU Corp. 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 Corp. and its subsidiaries
(collectively, TXU Corp.) contain forward-looking statements within the meaning
of Section 21E of the Securities Exchange Act of 1934, as amended. Although TXU
Corp. 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 the following important factors,
among others, that could cause the actual results of TXU Corp. to differ
materially from those projected in such forward-looking statements:
76
o prevailing governmental policies and regulatory actions, including
those of the FERC, the Commission, the RRC and the NRC, with
respect to:
allowed rates of return;
industry, market and rate structure;
purchased power and recovery of investments;
operations of nuclear generating facilities;
acquisitions and disposal of assets and facilities;
operation and construction of plant facilities;
decommissioning costs;
present or prospective wholesale and retail competition;
changes in tax laws and policies;
and changes in and compliance with environmental and
safety laws and policies;
o continued implementation of and "sunset" provisions regarding the
1999 Restructuring Legislation;
o legal and administrative proceedings and settlements;
o general industry trends;
o power costs (including repair costs) and availability;
o weather conditions and other natural phenomena, and acts of sabotage,
wars or terrorist activities;
o unanticipated population growth or decline, and changes in market
demand and demographic patterns;
o changes in business strategy, development plans or vendor
relationships;
o TXU Corp.'s ability to execute the financing necessary to finance
its share repurchase plan and actions of its board of directors
with respect to future dividends and other cash distributions to
shareholders;
o TXU Corp.'s ability to implement the initiatives that are part of
its restructuring, operational improvement and cost reduction
program, and the terms upon which it executes those initiatives;
o competition for retail and wholesale customers;
o access to adequate transmission facilities to meet changing demands;
o pricing and transportation of crude oil, natural gas and other
commodities;
o unanticipated changes in interest rates, commodity prices, rates of
inflation or foreign exchange rates;
o unanticipated changes in operating expenses, liquidity needs and
capital expenditures;
o commercial bank market and capital market conditions;
o competition for new energy development and other business
opportunities;
o inability of various counterparties to meet their obligations
with respect to TXU Corp.'s financial instruments;
o changes in technology used by and services offered by TXU Corp.;
o significant changes in TXU Corp.'s relationship with its employees,
including the availability of qualified personnel, and the potential
adverse effects if labor disputes or grievances were to occur;
o significant changes in critical accounting policies material to
TXU Corp.; and
o actions by credit rating agencies.
Any forward-looking statement speaks only as of the date on which it is
made, and TXU Corp. 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 Corp. to predict all of them; nor
can TXU Corp. 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.
77
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. The risk information presented excludes TXU
Australia, which was sold on July 30, 2004.
TXU Corp. continuously reviews its disclosed risk analysis metrics. In the
course of this review, it was determined that the Portfolio VaR metric would no
longer be disclosed as it is not a meaningful measure of actionable commodity
price risk. Other metrics that measure the effect of such risk on earnings, cash
flows and the value of its mark-to-market contract portfolio continue to be
disclosed. TXU Corp. may in the future add or eliminate other metrics in its
disclosures of risks.
COMMODITY PRICE RISK
VaR for Energy Contracts Subject to Mark-to-Market Accounting -- This
measurement estimates the potential loss in value, due to changes in market
conditions, of all energy-related contracts subject to mark-to-market
accounting, based on a specific confidence level and an assumed holding period.
Assumptions in determining this VaR include using a 95% confidence level and a
five-day holding period. A probabilistic simulation methodology is used to
calculate VaR, and is considered by management to be the most effective way to
estimate changes in a portfolio's value based on assumed market conditions for
liquid markets.
September 30, December 31,
2004 2003
------------- -------------
Period-end MtM VaR..................................................... $ 15 $ 15
Average Month-end MtM VaR: over the nine and twelve month periods...... $ 19 $ 25
Other Risk Measures -- The metrics appearing below provide information
regarding the effect of changes in energy market conditions on earnings and cash
flow.
Earnings at Risk (EaR) -- EaR measures the estimated potential loss of
expected pretax earnings for the year presented due to changes in market
conditions. EaR metrics include the owned generation assets, estimates of retail
load and all contractual positions except for accrual positions expected to be
settled beyond the fiscal year. Assumptions include using a 95% confidence level
over a five-day holding period under normal market conditions.
Cash Flow at Risk (CFaR) -- CFaR measures the estimated potential loss of
expected cash flow over the next six months, due to changes in market
conditions. CFaR metrics include all owned generation assets, estimates of
retail load and all contractual positions that impact cash flow during the next
six months. Assumptions include using a 99% confidence level over a six-month
holding period under normal market conditions.
September 30, December 31,
2004 2003
------------- -------------
EaR .............................................................. $ 6 $ 15
CFaR ............................................................. $ 57 $ 67
INTEREST RATE RISK
See Note 4 to Financial Statements for a discussion of the issuance and
retirement of debt and interest rate swaps since December 31, 2003.
78
CREDIT RISK
Concentration of Credit Risk -- As of September 30, 2004, the exposure to
credit risk from large business customers and hedging counterparties, excluding
credit collateral, is $1.0 billion, net of standardized master netting contracts
and agreements that provide the right of offset of positive and negative credit
exposures with individual customers and counterparties. When considering
collateral currently held by TXU Corp. (cash, letters of credit and other
security interests), the net credit exposure is $914 million. Of this amount,
approximately 83% is with investment grade customers and counterparties, as
determined by using publicly available information including major rating
agencies' published ratings and TXU Corp.'s internal credit evaluation process.
Those customers and counterparties without an S&P rating of at least BBB- or
similar rating from another major rating agency are rated using internal credit
methodologies and credit scoring models to estimate an S&P equivalent rating.
TXU Corp. routinely monitors and manages its credit exposure to these customers
and counterparties on this basis.
The following table presents the distribution of credit exposure as of
September 30, 2004, for trade accounts receivable from large business customers,
commodity contract assets and other derivative assets that arise primarily from
hedging activities, by investment grade and noninvestment grade, credit quality
and maturity.
Exposure by Maturity
Exposure -----------------------------------------
before Greater
Credit Credit 2 years or Between than 5
Collateral Collateral Net Exposure less 2-5 years years Total
---------- ---------- ------------ ---- --------- ----- -----
Investment grade $ 805 $ 43 $ 762 $ 628 $ 72 $ 62 $ 762
Noninvestment grade 205 53 152 127 14 11 152
------- ------ ----- ----- ---- ----- -----
Totals $ 1,010 $ 96 $ 914 $ 755 $ 86 $ 73 $ 914
======= ====== ===== ===== ==== ===== =====
Investment grade 80% 44% 83%
Noninvestment grade 20% 56% 17%
TXU Corp. has exposure in the amount of $108 million to one customer or
counterparty that is 12% of the net exposure of $914 million at September 30,
2004. TXU Corp. holds a $75 million guaranty from this counterparty's investment
grade parent and is currently negotiating the increase of such guaranty amount.
Additionally, approximately 83% of the credit exposure, net of collateral held,
has a maturity date of two years or less. TXU Corp. does not anticipate any
material adverse effect on its financial position or results of operations as a
result of non-performance by any customer or counterparty.
79
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of TXU Corp.'s 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 Corp.'s 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
Corp.'s internal control over financial reporting that has materially affected,
or is reasonably likely to materially affect, TXU Corp.'s internal control over
financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Legal Proceedings -- Management has assessed the progress and status of
matters in litigation, and in the second quarter of 2004 recorded an accrual of
$100 million ($65 million after-tax), reported in other deductions, for the
expected resolution of certain of these cases.
Reference is made to the discussion in Note 8 regarding legal proceedings.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES
Total Number of Average Price
Period Shares Purchased(b) Paid per Share
July 1, 2004-July 31, 2004...................................... 850,900 $ 39.73
August 1, 2004-August 30, 2004(a)............................... 681,475 $ 40.27
September 1, 2004-September 30, 2004(a)......................... 4,121,851 $ 43.44
Total........................................................... 5,654,226 $ 42.50
- ----------------
(a) Includes 1,255,226 shares at an average price of $42.36 repurchased by
Mellon Trust as Trustee of the TXU Thrift Plan.
(b) All of the above repurchases were funded through cash on hand and bank
borrowings.
On September 15, 2004, TXU Corp. announced its intent to repurchase up to
10 million shares of its common stock through open-market purchases. On October
26, 2004, TXU Corp. announced its intent to repurchase 50 million shares of its
common stock. The 50 million shares included all previously announced share
repurchases, including the 10 million shares announced in September 2004 (of
which 2 million shares had been repurchased).
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits filed or furnished as part of Part II are:
Previously Filed*
-----------------
With File As
Exhibits Number Exhibit
-------- ------ -------
(10) Material Contracts.
10(a) -- Guaranty dated October 1, 2004 from TXU Corp. to Atmos
Energy Corporation.
10(b) -- Credit Agreement, dated November 4, 2004, by and among
TXU Corp., Citicorp North America, Inc., Merrill Lynch
Capital Corp., and Wachovia Bank, National Association.
10(c) -- Credit Agreement, dated November 4, 2004, by and between
TXU Energy Company LLC and Wachovia Bank, National Association.
(15) Letter re: Unaudited Interim Financial Information.
15 -- Letter from independent accountants as to unaudited
interim financial information.
(31) Rule 13a - 14(a)/15d - 14(a) Certifications.
31(a) -- Certification of C. John Wilder, President and Chief
Executive of TXU Corp., 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 Kirk R. Oliver, Chief Financial Officer
of TXU Corp., 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 C. John Wilder, President and Chief
Executive of TXU Corp., 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 Kirk R. Oliver, Chief Financial Officer
of TXU Corp., 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 Statements of Consolidated Income - Twelve
Months Ended September 30, 2004.
- -----------
* Incorporated herein by reference.
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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 CORP.
By /s/ Stanley J. Szlauderbach
------------------------------------------
Stanley J. Szlauderbach
Assistant Controller and Interim Controller
Date: November 5, 2004
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