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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
_____________________
Commission File Number 333-100240
TXU Electric Delivery Company
(Formerly Oncor Electric Delivery Company)
(Exact Name of Registrant as Specified in its Charter)
Texas 75-2967830
(State of Incorporation) (I.R.S. Employer Identification No.)
500 N. Akard Street, Dallas, TX 75201 (214) 486-2000
(Address of Principal Executive Offices) (Registrant's Telephone Number)
(Zip Code)
_____________________
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ----
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes No X
---- ----
Common Stock outstanding at November 11, 2004: 48,864,775 shares, without
par value
TXU Electric Delivery Company meets the conditions set forth in General
Instructions (H) (1) (a) and (b) of Form 10-Q and is therefore filing this
report with the reduced disclosure format.
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TABLE OF CONTENTS
- ---------------------------------------------------------------------------------------------------------------
Page
----
Glossary........................................................................................... ii
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Statements of Consolidated Income and Comprehensive Income--
Three and Nine Months Ended September 30, 2004 and 2003.................................... 1
Condensed Statements of Consolidated Cash Flows --
Nine Months Ended September 30, 2004 and 2003.............................................. 2
Condensed Consolidated Balance Sheets --
September 30, 2004 and December 31, 2003................................................... 3
Notes to Condensed Financial Statements.................................................... 4
Report of Independent Registered Public Accounting Firm.................................... 14
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................................................. 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................. 26
Item 4. Controls and Procedures.................................................................... 27
PART II. OTHER INFORMATION
Item 6. Exhibits .................................................................................. 28
SIGNATURE........................................................................................... 29
Periodic reports on Form 10-K and Form 10-Q and current reports on Form 8-K that
contain financial information of TXU Electric Delivery Company are made
available to the public, free of charge, on the TXU Corp. website at
http://www.txucorp.com, shortly after they have been filed with the Securities
and Exchange Commission. TXU Electric Delivery Company 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.
2003 Form 10-K................................. TXU Electric Delivery Company's Annual Report on Form 10-K
for the year ended December 31, 2003
Commission..................................... Public Utility Commission of Texas
Electric Delivery.............................. refers to TXU Electric Delivery Company, formerly Oncor
Electric Delivery Company, a subsidiary of US Holdings,
or Electric Delivery and its consolidated bankruptcy
remote financing subsidiary, TXU Electric Delivery
Transition Bond Company LLC, depending on context
Energy......................................... refers to Energy Company LLC, a subsidiary of US
Holdings, and/or its consolidated subsidiaries,
depending on context
ERCOT.......................................... Electric Reliability Council of Texas, the Independent
System Operator and the regional reliability
coordinator of the various electricity systems within
Texas
FASB........................................... Financial Accounting Standards Board, the designated
organization in the private sector for establishing standards
for financial accounting and reporting
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
Moody's........................................ Moody's Investors Services, Inc.
REP............................................ retail electric provider
S&P............................................ Standard & Poor's, a division of The McGraw Hill Companies
SEC............................................ United States Securities and Exchange Commission
SFAS........................................... Statement of Financial Accounting Standards issued by the
FASB
SFAS 140....................................... SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, a
replacement of FASB Statement 125"
SFAS 143....................................... SFAS No. 143, "Accounting for Asset Retirement Obligations"
TXU Business Services.......................... TXU Business Services Company, a subsidiary of TXU Corp.
TXU Corp....................................... refers to TXU Corp., a holding company, and/or its
consolidated subsidiaries, depending on context
TXU Gas........................................ TXU Gas Company, a subsidiary of TXU Corp.
ii
US............................................. United States of America
US GAAP........................................ accounting principles generally accepted in the US
US Holdings.................................... TXU US Holdings Company, a subsidiary of TXU Corp.
iii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TXU ELECTRIC DELIVERY COMPANY
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2004 2003 2004 2003
------ ------ ------ ------
(millions of dollars)
Operating revenues:
Affiliated............................................. $ 417 $ 441 $1,101 $1,167
Nonaffiliated.......................................... 231 172 587 438
----- ----- ------ ------
Total operating revenues............................. 648 613 1,688 1,605
Operating expenses:
Operation and maintenance.............................. 212 191 600 569
Depreciation and amortization.......................... 116 78 286 215
Income taxes........................................... 51 60 101 103
Taxes, other than income............................... 98 94 282 279
----- ----- ------ ------
Total operating expenses............................. 477 423 1,269 1,166
----- ----- ------ ------
Operating income.......................................... 171 190 419 439
Other income and deductions:
Other income........................................... -- 2 4 6
Other deductions....................................... 4 1 25 4
Nonoperating income tax expense........................ 5 5 8 16
Interest income .......................................... 16 14 42 43
Interest expense and related charges...................... 71 74 212 229
----- ----- ------ ------
Income before extraordinary gain.......................... 107 126 220 239
Extraordinary gain, net of tax (Note 1)................... -- -- 16 --
----- ----- ------ ------
Net income................................................ $ 107 $ 126 $ 236 $ 239
===== ===== ====== ======
CONDENSED STATEMENTS OF CONSOLIDATED
COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2004 2003 2004 2003
------ ------ ------ ------
(millions of dollars)
Net income................................................ $ 107 $ 126 $ 236 $ 239
Other comprehensive income -
Cash flow hedge activity, net of tax effect:
Amounts realized in earnings during the period, net of tax -- -- 1 1
----- ----- ------ ------
Total................................................ -- -- 1 1
----- ----- ------ ------
Comprehensive income...................................... $ 107 $ 126 $ 237 $ 240
===== ===== ====== ======
See Notes to Condensed Financial Statements.
1
TXU ELECTRIC DELIVERY COMPANY
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
---------------------
2004 2003
------ ------
(millions of dollars)
Cash flows -- operating activities:
Net income................................................................ $ 236 $ 239
Adjustments to reconcile net income to cash provided by operating
activities:
Depreciation and amortization ........................................ 286 221
Deferred income taxes and investment tax credits -- net .............. 45 109
Extraordinary gain, net of tax........................................ (16) -
Net equity loss from unconsolidated affiliate......................... 3 -
Net gain from sale of assets.......................................... (1) -
Changes in operating assets and liabilities............................... (130) (220)
------ ------
Cash provided by operating activities................................... 423 349
Cash flows -- financing activities:
Issuance of long-term debt.................................................. 790 500
Retirements/repurchases of debt............................................. (515) (676)
Capital contribution from parent............................................ - 250
Repurchase of common stock.................................................. (450) (263)
Net change in advances from affiliates...................................... (17) (31)
Decrease in note receivable from Energy related to a regulatory liability... - 161
Redemption deposit applied to debt retirement............................... - 210
Debt premium, discount, financing and reacquisition expenses................ (24) (23)
------ ------
Cash provided by (used in) financing activities......................... (216) 128
Cash flows -- investing activities:
Capital expenditures........................................................ (391) (356)
Other....................................................................... (35) (3)
------ ------
Cash used in investing activities....................................... (426) (359)
------ ------
Net change in cash and cash equivalents........................................ (219) 118
Cash and cash equivalents -- beginning balance.................................. 245 77
------- -------
Cash and cash equivalents -- ending balance..................................... $ 26 $ 195
======= =======
See Notes to Condensed Financial Statements.
2
TXU ELECTRIC DELIVERY COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2004 2003
-------------- ------------
(millions of dollars)
ASSETS
Current assets:
Cash and cash equivalents.................................................. $ 26 $ 245
Restricted cash............................................................ 29 12
Accounts receivable:
Affiliates (principally Energy)......................................... 223 189
All other .............................................................. 69 58
Notes or other receivables due from Energy currently....................... 30 13
Materials and supplies inventories -- at average cost ...................... 30 29
Other current assets....................................................... 56 33
--------- ---------
Total current assets.................................................... 463 579
Investments................................................................... 67 44
Property, plant and equipment - net........................................... 6,467 6,333
Notes or other receivables due from Energy.................................... 407 423
Regulatory assets - net....................................................... 1,922 1,872
Other noncurrent assets....................................................... 97 65
--------- ---------
Total assets............................................................ $ 9,423 $ 9,316
========= =========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Advances from affiliates................................................... $ 8 $ 25
Long-term debt due currently............................................... 283 243
Accounts payable - trade................................................... 46 43
Accrued taxes.............................................................. 175 153
Accrued interest........................................................... 70 88
Other current liabilities.................................................. 119 146
--------- ---------
Total current liabilities .............................................. 701 698
Investment tax credits........................................................ 64 68
Accumulated deferred income taxes............................................. 1,469 1,432
Other noncurrent liabilities and deferred credits............................. 317 279
Long-term debt, less amounts due currently.................................... 4,228 3,983
--------- ---------
Total liabilities....................................................... 6,779 6,460
Contingencies (Note 4)
Shareholder's equity (Note 3): Common stock without par value:
Authorized shares - 100,000,000 shares;
Outstanding shares: 48,864,775 shares and
60,112,000 shares..................................................... 2,051 2,501
Retained earnings.......................................................... 616 380
Accumulated other comprehensive loss....................................... (23) (25)
--------- ---------
Total shareholder's equity.............................................. 2,644 2,856
--------- ---------
Total liabilities and shareholder's equity.............................. $ 9,423 $ 9,316
========= =========
See Notes to Condensed Financial Statements.
3
TXU ELECTRIC DELIVERY COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
Description of Business - Electric Delivery, formerly Oncor Electric
Delivery Company, is a wholly-owned subsidiary of US Holdings, which is a
wholly-owned subsidiary of TXU Corp. Electric Delivery is a regulated
electricity transmission and distribution company principally engaged in
providing delivery services to REPs that sell power in the north-central,
eastern and western parts of Texas. A majority of Electric Delivery's revenues
represented fees for delivery services provided to Energy, also a subsidiary of
US Holdings. For the three and nine months ended September 30, 2004, affiliated
revenues represented 64% and 65%, respectively, of Electric Delivery's total
revenues and 69% and 72%, respectively of Electric Delivery's revenues billed to
REPs. Electric Delivery is managed as an integrated business; consequently there
are no separate reportable business segments.
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. As described
below, actions taken that impact Electric Delivery relate to TXU Corp.'s cost
structure, including organizational alignments and headcount as well as non-core
business activities.
As discussed below, implementation of the strategic initiatives as well as
other actions taken to date have resulted in total charges, reported in other
deductions, of $1 million in the third quarter of 2004 and $20 million
($13 million after-tax) year-to-date related largely to employee severance.
Capgemini Energy Agreement
---------------------------
On May 17, 2004, Electric Delivery 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 TXU Corp. employees
(including over 200 from Electric Delivery) transferred 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.
As part of the agreement, Electric Delivery provided Capgemini a
royalty-free right, under an asset license arrangement, to use Electric
Delivery'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 Electric Delivery. As a result of outsourcing its
information technology activities, Electric Delivery no longer intends to
develop the majority of these projects and from Electric Delivery's perspective
the software is abandoned. The agreement 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 $1 million (after-tax), reported in other
deductions. The remaining assets, totaling $58 million, were transferred to a
subsidiary of TXU Corp. at book value in exchange for an interest in that
subsidiary. Such interest is accounted for by Electric Delivery on the equity
method, and Electric Delivery recorded equity losses (representing depreciation
expense) of $3 million in the third quarter of 2004, reported in other
deductions.
The TXU Corp. subsidiary received a 2.9% limited partnership interest in
Capgemini in exchange for the asset license described above. Energy and Electric
Delivery have the right to sell (the "put option") their interests in the
subsidiary to Cap Gemini America Inc. for $200 million, plus the subsidiary'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 Energy's and Electric
Delivery's interests 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.
4
Electric Delivery 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.
Also as part of the services agreement, 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, Electric Delivery recorded an $11 million ($7 million after-tax)
charge for severance expense, in the second quarter of 2004, which represents a
reasonable estimate of the indemnity and is reported in other deductions. The
charge consists primarily of an allocation of severance related to TXU Business
Services employees. The transition costs applicable to Electric Delivery are
expected to be largely recorded during the fourth quarter of 2004.
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, Electric Delivery recorded
severance charges totaling $7 million ($5 million after-tax) in the second
quarter of 2004 and $1 million in the third quarter of 2004, reported in other
deductions. The charges consist primarily of an allocation of
termination-related costs associated with TXU Business Services employees.
Additionally, Electric Delivery recorded $7 million of employee severance costs
as a regulatory asset in the second quarter of 2004.
Basis of Presentation -- The condensed consolidated financial statements
of Electric Delivery, which included the results of operations of TXU Electric
Delivery Transition Bond Company LLC, have been prepared in accordance with US
GAAP and on the same basis as the audited financial statements included in its
2003 Form 10-K. In the opinion of management, all other adjustments (consisting
of normal recurring accruals) necessary for a fair presentation of the results
of operations and financial position have been included therein. All
intercompany items and transactions have been eliminated in consolidation.
Certain information and footnote disclosures normally included in annual
consolidated financial statements prepared in accordance with US GAAP have been
omitted pursuant to the rules and regulations of the SEC. Because the condensed
consolidated interim financial statements do not include all of the information
and footnotes required by US GAAP, they should be read in conjunction with the
audited financial statements and related notes included in the 2003 Form 10-K.
The results of operations for an interim period may not give a true indication
of results for a full year.
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 $3 million and $8 million,
respectively, in Electric Delivery's postretirement benefit costs.
All dollar amounts in the financial statements and tables in the notes are
stated in millions of dollars unless otherwise indicated.
Changes in Accounting Standards -- FIN 46R was issued in December 2003 and
replaced FIN 46, which was issued in January 2003. FIN 46R expands and clarifies
the guidance originally contained in FIN 46, regarding consolidation of variable
interest entities. FIN 46R did not impact results of operations or financial
position for the first 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.
5
2. FINANCING ARRANGEMENTS
Short-term Borrowings -- At September 30, 2004, Electric Delivery had
short-term advances from affiliates of $8 million at a weighted average interest
rate of 2.77%. At December 31, 2003 Electric Delivery had outstanding short-term
advances from affiliates of $25 million at a weighted average interest rate of
2.92%.
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
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
Energy, Electric
364-day Credit Facility June 2005 Delivery $ 600 $ 80 $ - $ 520
- ----------------------------------- ------------ ---------------- --------- ---------- ------------ ------------
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.
TXU Corp.'s $500 million five-year revolving credit facility provides for
up to $500 million in letters of credit and/or up to $250 million of loans ($500
million in the aggregate). To the extent capacity is available under this
facility, it may be made available to US Holdings, Energy or Electric Delivery
for borrowings, letters of credit or other purposes.
Sale of Receivables -- TXU Corp. has established an accounts receivable
securitization program. The activity under this program is accounted for as a
sale of accounts receivable in accordance with SFAS 140. Under the program,
subsidiaries of TXU Corp. (originators) sell trade accounts receivable to TXU
Receivables Company, a consolidated wholly-owned bankruptcy remote direct
subsidiary of TXU Corp., which sells undivided interests in the purchased
accounts receivable for cash to special purpose entities established by
financial institutions (the funding entities). As of September 30, 2004, $71
million of undivided interests in Electric Delivery's accounts receivable had
been sold by TXU Receivables Company. 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 deposit for a Baa3/BBB-
rating; 50% for a Baa2/BBB rating; and zero % for a Baa1/BBB+ and above rating.
All new trade receivables under the program generated by the originators
are continuously purchased by TXU Receivables Company with the proceeds from
collections of receivables previously purchased. Changes in the amount of
funding under the program, through changes in the amount of undivided interests
sold by TXU Receivables Company, are generally due to seasonal variations in the
level of accounts receivable and changes in collection trends. TXU Receivables
Company has issued subordinated notes payable to the originators for the
difference between the face amount of the uncollected accounts receivable
purchased, less a discount, and cash paid to the originators that was funded by
the sale of the undivided interests.
6
The discount from face amount on the purchase of receivables principally
funds program fees paid by TXU Receivables Company to the funding entities. The
program fees (losses on sale), which consist primarily of interest costs on the
underlying financing, were approximately $1 million for both 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 Electric Delivery and are reported in
operation and maintenance expenses.
The September 30, 2004 balance sheet reflects $112 million face amount of
trade accounts receivable reduced by $71 million of undivided interests sold by
TXU Receivables Company. Funding under the program increased $27 million for the
nine months ended September 30, 2004. Funding under the program for the nine
months ended September 30, 2003 increased $23 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 related to Electric Delivery 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...................................... $ 462 $ 277
Face amount of new receivables purchased..................................... (492) (305)
Discount from face amount of purchased receivables........................... 1 1
Program fees paid............................................................ (1) (1)
Increase in subordinated notes payable....................................... 3 5
------- ------
Operating cash flows provided to Electric Delivery under the program.... $ (27) $ (23)
======= ======
Upon termination of the program, cash flows to Electric Delivery would be
delayed as collections of sold receivables would be used by TXU Receivables
Company to repurchase the undivided interests sold instead of purchasing new
receivables. The level of cash flows would normalize in approximately 16 to 31
days.
Contingencies Related to Sale of Receivables Program -- Although TXU
Receivables Company expects to be able to pay its subordinated notes from the
collections of purchased receivables, these notes are subordinated to the
undivided interests of the financial institutions in those receivables, and
collections might not be sufficient to pay the subordinated notes. The program
may be terminated if either of the following events occurs:
1) all of the originators cease to maintain their required fixed charge
coverage ratio and debt to capital (leverage) ratio;
2) the delinquency ratio (delinquent for 31 days) for the sold
receivables, the default ratio (delinquent for 91 days or
deemed uncollectible), the dilution ratio (reductions for discounts,
disputes and other allowances) or the days collection outstanding
ratio exceed stated thresholds and the financial institutions do not
waive such event of termination. The thresholds apply to the entire
portfolio of sold receivables, not separately to the receivables of
each originator.
The delinquency and dilution ratios exceeded the relevant thresholds
during the first four months of 2003, but waivers were granted. These ratios
were affected by issues related to the transition to competition. Certain
billing and collection delays arose due to implementation of new systems and
processes within Energy and ERCOT for clearing customers' switching and billing
data. Strengthened credit and collection policies and practices have brought the
ratios into consistent compliance with the program requirement.
Under terms of the receivables sale program, all the originators are
required to maintain specified fixed charge coverage and leverage ratios (or
supply a parent guarantor that meets the ratio requirements). The failure, by an
originator or its parent guarantor, if any, to maintain the specified financial
ratios would prevent that originator from selling its accounts receivable under
the program. If all the originators and the parent guarantor, if any, fail to
maintain the specified financial ratios so that there are no eligible
originators, the facility would terminate.
7
Long-term Debt -- At September 30, 2004 and December 31, 2003, the
long-term debt of Electric Delivery and its consolidated subsidiary consisted of
the following:
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.................................... 200 200
7.000% Fixed Debentures due September 1, 2022.................................... 800 800
Unamortized discount............................................................. (19) (30)
------- ------
Sub-total.................................................................... 3,244 3,726
------- -------
TXU Electric Delivery Transition Bond Company LLC (a)
- -----------------------------------------------------
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
Less amount due currently............................................................ 283 243
------- -------
Total long-term debt................................................................. $ 4,228 $ 3,983
======= =======
(a) These bonds are nonrecourse to Electric Delivery.
In June 2004, Electric Delivery through its 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.
Other retirements of long-term debt in 2004 totaling $123 million
represent payments at scheduled maturity dates.
3. SHAREHOLDER'S EQUITY
In June 2004, Electric Delivery repurchased 9,372,225 shares of its common
stock from US Holdings for $375 million upon issuance of the securitization
bonds. In April 2004, Electric Delivery repurchased 937,500 shares of its common
stock from US Holdings for $37.5 million. In January 2004, Electric Delivery
repurchased 937,500 shares of its common stock from US Holdings for $37.5
million.
The legal form of cash distributions to US Holdings has been common stock
repurchases; however, for accounting purposes, these cash distributions are
recorded as a return of capital.
8
The Electric Delivery mortgage restricts its payment of dividends to the
amount of its retained earnings. Certain debt instruments of Electric Delivery
contain provisions that restrict payment of dividends during any interest
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.
4. CONTINGENCIES
Guarantees -- Electric Delivery 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.
Residual value guarantees in operating leases -- Electric Delivery 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 $48 million with an estimated residual recovery of
approximately $48 million. The average life of the lease portfolio is
approximately four years.
Surety bonds -- Electric Delivery has outstanding surety bonds of
approximately $1 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.
General -- Electric Delivery is involved in various legal and
administrative proceedings in the normal course of business the ultimate
resolution of which, in the opinion of management, should not have a material
effect upon its financial position, results of operations or cash flows.
5. SUPPLEMENTARY FINANCIAL INFORMATION
Other Income and Other Deductions --
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
----- ------ ------ ------
Other income:
Equity portion of allowance for funds used during
construction........................................... $ -- $ 1 $ 1 $ 3
Net gain on sale of property............................. -- -- 1 --
Other.................................................... -- 1 2 3
------ ----- ----- -----
Total other income..................................... $ -- $ 2 $ 4 $ 6
====== ===== ===== =====
Other deductions:
Employee severance charges............................... $ 1 $ -- $ 18 $ --
Equity losses of entity holding investment in Capgemini
(See Note 1)........................................... 3 -- 3 --
Software write-off....................................... -- -- 1 --
Other.................................................... -- 1 3 4
----- ----- ----- -----
Total other deductions................................. $ 4 $ 1 $ 25 $ 4
===== ===== ===== =====
9
Severance Liability Related to Restructuring Activities --
Liability for severance costs accrued as of June 30, 2004............... $ 18
Additions to liability .............................................. 1
Payments charged against liability................................... (8)
-----
Liability for severance costs accrued as of September 30, 2004.......... $ 11
=====
The above table excludes severance capitalized as a regulatory asset.
Interest Expense and Related Charges --
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2004 2003 2004 2003
----- ------ ------ ------
Interest............................................. $ 70 $ 74 $ 210 $ 227
Amortization of debt discounts and issuance costs.... 2 1 4 5
Allowance for borrowed funds used during construction
and capitalized interest........................... (1) (1) (2) (3)
------ ------ ------ ------
Total interest expense and related charges..... $ 71 $ 74 $ 212 $ 229
====== ====== ====== ======
Pension and Other Postretirement Benefits -- Electric Delivery is a
participating employer in the TXU Retirement Plan, a defined benefit pension
plan sponsored by TXU Corp. Electric Delivery also participates with TXU Corp.
and other affiliated subsidiaries of TXU Corp. to offer health care and life
insurance benefits to eligible employees and their eligible dependents upon the
retirement of such employees. The allocated net periodic pension cost and net
periodic postretirement benefits cost other than pensions applicable to Electric
Delivery was $10 million and $12 million for the three-month periods ended
September 30, 2004 and 2003, respectively, and $33 million and $36 million for
the nine months ended September 30, 2004 and 2003, respectively.
The Capgemini outsourcing transaction on July 1, 2004, (see Note 1 to
Financial Statements) triggered a curtailment of the pension and postretirement
plans and a remeasurement of the related liabilities. The effects of the
remeasurement, which include an increase in the discount rate of 0.25%, as well
as the Medicare Act enacted in December 2003, have resulted in lower pension and
postretirement benefits expense.
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 credit 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
======= ======
10
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, Electric Delivery had $29
million of restricted cash reported in current assets, representing collections
from customers that secure its securitization bonds and may be used only to
service its debt and pay its expenses. Restricted cash reported in investments
on the balance sheet as of September 30, 2004 included $10 million principally
related to payment of fees associated with securitization bonds and $5 million
in reserves for shortfalls of transition charges.
Accounts Receivable -- At September 30, 2004 and December 31, 2003,
accounts receivable are stated net of allowance for uncollectible accounts of $2
million. During the nine months ended September 30, 2004, Electric Delivery had
$81 thousand in bad debt expense and no material accounts receivable write-offs.
During the nine months ended September 30, 2003, bad debt expense was $1 million
and account write-offs and other activity decreased the allowance for
uncollectible accounts by $1 million. Allowances related to receivables sold are
reported in other current liabilities and totaled $1 million at both September
30, 2004 and December 31, 2003.
Accounts receivable at September 30, 2004 and December 31, 2003 included
unbilled revenues of $114 million and $96 million, 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
(unrelated to outsourced activities at
September 30, 2004) ................... $ 58 $ 25 $ 33 $ 160 $ 72 $ 88
Land easements............................ 169 59 110 165 58 107
----- ----- ----- ----- ----- -----
Total................................... $ 227 $ 84 $ 143 $ 325 $ 130 $ 195
===== ===== ===== ===== ===== =====
Amortized intangible asset balances are classified as property, plant and
equipment in the balance sheet. Electric Delivery has no intangible assets
(other than goodwill) that are not amortized.
Aggregate amortization expense for intangible assets for the nine months
ended September 30, 2004 and 2003 was $9 million and $14 million, respectively.
Property, Plant and Equipment -- At September 30, 2004 and December 31,
2003, property, plant and equipment totaling $6.5 billion and $6.3 billion,
respectively, is stated net of accumulated depreciation and amortization of $3.4
billion and $3.3 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.
Derivatives and Hedges -- Electric Delivery's derivative financial
instruments that have been designated as cash flow hedges match the terms of the
underlying hedged items. As a result, Electric Delivery experienced no hedge
ineffectiveness during the three or nine months ended September 30, 2004 or
2003. These hedges relate to financing transactions.
11
As of September 30, 2004, it is expected that $1 million of after-tax net
losses accumulated in other comprehensive income will be reclassified into
earnings during the next twelve months. This amount represents the amortization
of the value of terminated interest payment hedges over the next twelve months.
Affiliate Transactions -- The following represent significant affiliate
transactions of Electric Delivery:
o Electric Delivery records revenue from Energy for electricity delivery
fees and other miscellaneous revenues, which totaled $417 million and
$441 million for the three months ended September 30, 2004 and 2003,
respectively, and $1.1 billion and $1.2 billion for the nine months
ended September 30, 2004 and 2003, respectively. These amounts included
$221 thousand and $740 thousand for the three months ended September
30, 2004 and 2003, respectively, and $709 thousand and $1.6 million for
the nine months ended September 30, 2004 and 2003, respectively,
pursuant to a transformer maintenance agreement.
o Electric Delivery records interest income from Energy to reimburse
Electric Delivery for interest on debt associated with
generation-related regulatory assets, which now consists entirely of
the securitization bonds. For the three months ended September 30, 2004
and 2003, this interest income totaled $15 million and $12 million,
respectively. For the nine months ended September 30, 2004 and 2003,
this interest income totaled $40 million and $36 million, respectively.
o The incremental income taxes Electric Delivery will pay on the
increased delivery fees to be charged to Electric Delivery's customers
related to the securitization bonds will be reimbursed by Energy.
Therefore, at September 30, 2004 and December 31, 2003, Electric
Delivery's financial statements reflect a receivable of $437 million
from Energy that will be extinguished as Electric Delivery pays the
related income taxes.
o For the three and nine months ended September 30, 2003, the principal
payments received on the note receivable from Energy related to the
excess mitigation credit, which ceased at the end of 2003, totaled $62
million and $161 million, respectively, and the interest income totaled
$1 million and $6 million, respectively.
o The average daily balances of short-term advances from affiliates for
the three months ended September 30, 2004 and 2003 were $50 million and
$48 million, respectively, and the weighted average interest rate for
the respective periods was 2.62% and 2.86%. The average daily balances
of short-term advances from affiliates for the nine months ended
September 30, 2004 and 2003 were $49 million and $106 million,
respectively, and the weighted average interest rate for the respective
periods was 2.77% and 2.76%. Interest expense incurred on the advances
for the three months ended September 30, 2004 and 2003 was
approximately $327 thousand and $353 thousand, respectively, and for
the nine months ended September 30, 2004 and 2003 was $1 million and $2
million, respectively.
o TXU Business Services charges Electric Delivery for certain financial,
accounting, information technology, environmental, procurement and
personnel services and other administrative services at cost. For the
three months ended September 30, 2004 and 2003, these costs totaled
$8 million and $26 million and are reported in operation and
maintenance expenses. For the nine months ended September 30, 2004 and
2003, these costs totaled $77 million and $81 million. Effective
July 1, 2004, under the ten year services agreement with Capgemini,
several of the functions previously performed by TXU Business Services
are now provided by Capgemini. Outsourced base support services
performed by Capgemini for a fixed fee, subject to adjustments for
volumes or other factors, include information technology, customer
call center, billing and collections, human resources, supply chain
and certain accounting activities (see Note 1 for further discussion).
o Electric Delivery charges TXU Gas for meter reading and certain
customer and administrative services at cost. For the three months
ended September 30, 2004 and 2003, these charges totaled $4 million and
$6 million, respectively, and are largely reported as a reduction in
operation and maintenance expenses. For the nine months ended September
30, 2004 and 2003, these charges totaled $14 million and $21 million,
respectively. On October 1, 2004, TXU Corp. and Atmos Energy
Corporation completed a merger by division in which Atmos Energy
Corporation acquired TXU Gas' operations. Electric Delivery will
continue to provide meter reading services and shared facility services
to Atmos Energy Corporation under a transition service agreement.
12
o Electric Delivery has recorded a regulatory asset and a corresponding
noncurrent affiliate payable to Energy for the Asset Retirement
Obligation (ARO) pursuant to SFAS 143, related to the retirement and
decommissioning of nuclear generation plant assets. Periodically,
regulatory proceedings are conducted to review any over or
under-recovered decommissioning costs for the purpose of adjusting
Electric Delivery's distribution rates. As of September 30, 2004, the
balance of the ARO nuclear regulatory asset was $42 million.
13
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TXU Electric Delivery Company:
We have reviewed the accompanying condensed consolidated balance sheet of TXU
Electric Delivery Company and subsidiaries (Company) 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 the Company'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
the Company 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 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 11, 2004
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BUSINESS
Electric Delivery, formerly Oncor Electric Delivery Company, is a
wholly-owned subsidiary of US Holdings, which is a wholly-owned subsidiary of
TXU Corp. Electric Delivery is a regulated electricity transmission and
distribution company principally engaged in providing delivery services to REPs
that sell power in the north-central, eastern and western parts of Texas. A
majority of Electric Delivery's revenues represented fees for delivery services
provided to Energy, also a subsidiary of US Holdings. For the three and nine
months ended September 30, 2004, such affiliated revenues represented 64% and
65%, respectively, of Electric Delivery's total revenues and 69% and 72%,
respectively, of Electric Delivery's revenues billed to REPs. Electric Delivery
is managed as an integrated business; consequently, there are no separate
reportable business segments.
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. As described
below, actions taken that impact Electric Delivery relate to TXU Corp.'s cost
structure, including organizational alignments and headcount and non-core
business activities.
As discussed below, implementation of the strategic initiatives as well as
other actions taken to date have resulted in total charges, reported in other
deductions, of $1 million in the third quarter of 2004 and $20 million
($13 million after-tax) year-to-date related largely to employee severance.
The review of Electric Delivery'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, Electric Delivery 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 Electric Delivery is currently unable to
predict. In addition, other new strategic initiatives are likely to be
undertaken that could also materially affect Electric Delivery's financial
results.
Capgemini Energy Agreement
--------------------------
On May 17, 2004, Electric Delivery 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 TXU Corp. employees
(including over 200 from Electric Delivery) transferred 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. Electric Delivery
expects that the Capgemini arrangement will result in lower costs and improved
service levels.
As part of the agreement, Electric Delivery provided Capgemini a
royalty-free right, under an asset license arrangement, to use Electric
Delivery'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 Electric Delivery. As a result of outsourcing its
information technology activities, Electric Delivery no longer intends to
develop the majority of these projects and from Electric Delivery's perspective
the software is abandoned. The agreement 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 $1 million (after-tax), reported in other
deductions. The remaining assets, totaling $58 million, were transferred to a
subsidiary of TXU Corp. at book value in exchange for an interest in that
subsidiary. Such interest is accounted for by Electric Delivery on the equity
method, and Electric Delivery recorded equity losses of $3 million, representing
depreciation expense, in the third quarter of 2004, reported in other
deductions.
15
The TXU Corp. subsidiary received a 2.9% limited partnership interest in
Capgemini in exchange for the asset license described above. Energy and Electric
Delivery have the right to sell (the "put option") their interests in the
subsidiary to Cap Gemini America Inc. for $200 million, plus the subsidiary'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 Energy's and Electric
Delivery's interests 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.
Electric Delivery 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."
Also as part of the services agreement, 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, Electric Delivery recorded an $11 million ($7 million after-tax)
charge for severance expense, in the second quarter of 2004, which represents a
reasonable estimate of the indemnity and is reported in other deductions. The
charge consists primarily of an allocation of severance related to TXU Business
Services employees. In addition, TXU Corp. committed to pay up to $25 million
for costs associated with transitioning the outsourced activities to Capgemini.
The transition costs applicable to Electric Delivery are expected to be largely
recorded during the fourth quarter of 2004.
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, Electric Delivery recorded
severance charges totaling $7 million ($5 million after-tax) in the second
quarter of 2004 and $1 million in the third quarter of 2004, reported in other
deductions. The charges consist primarily of an allocation of
termination-related costs associated with TXU Business Services employees.
Additionally, Electric Delivery recorded $7 million of employee severance costs
as a regulatory asset in the second quarter of 2004.
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 first quarter of 2005
related to Electric Delivery's headquarters building, but the amount is not yet
estimable.
Initiatives to Improve System Reliability and Performance
---------------------------------------------------------
Electric Delivery is undertaking a number of initiatives to improve
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; and
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.
Issuance of Securitization Bonds -- Electric Delivery issued the remaining
$790 million in securitization bonds on June 7, 2004 under a financing order
issued by the Commission and recorded an extraordinary gain of approximately $16
million after-tax. The gain arose because of an increase in the carrying value
of the regulatory asset subject to securitization 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.
16
RESULTS OF OPERATIONS
All dollar amounts in Management's Discussion and Analysis of Financial
Condition and Results of Operations and the tables therein are stated in
millions of US dollars unless otherwise indicated.
Electric Delivery is managed as an integrated business; consequently,
there are no separate reportable business segments.
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
Nonaffiliated............................................... 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.
17
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.
Operation and maintenance cost increased $21 million, or 11%, to $212
million in 2004. The increase reflects a $9 million increase in vegetation
management costs to improve reliability, $6 million in higher deferred and
long-term incentive compensation expense due primarily to a higher TXU Corp.
common stock price, a $5 million increase in third-party transmission
costs, $5 million in increases in various other costs that were individually
insignificant, partially offset by a $4 million decrease in pension and retiree
medical benefits expense.
Depreciation and amortization increased $38 million, or 49%, to $116
million, reflecting $38 million in higher amortization of regulatory assets
associated with the issuance of the securitization bonds (offsetting the
same amount of revenue increase).
Other deductions of $4 million in 2004 included $3 million of 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 increased by $2 million, or 14%, to $16 million in 2004
primarily representing higher reimbursements from Energy related to the
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 due to lower average
interest rates, partially offset by a $3 million increase due to increased
average borrowings.
Income tax expense was $56 million in 2004 (including $51 million related
to operating income and $5 million related to nonoperating expense),
representing an effective tax rate of 34.4% in 2004, compared to the 2003
effective tax rate of 34.0%. There were no significant unusual items affecting
this comparison.
Net income decreased $19 million, or 15%, to $107 million in 2004,
primarily reflecting the effect of milder weather on revenues and increased
operating expenses.
Net pension and postretirement benefit costs reduced income before
extraordinary gain by $3 million in 2004 and $5 million in 2003. The decrease in
these costs reflects a remeasurement of these liabilities as a result of the
transfer of 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.
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.
18
Operation and maintenance cost increased $31 million, or 5%, to $600
million in 2004. The increase reflects $14 million in higher deferred and
long-term incentive compensation expense due primarily to a higher TXU Corp.
common stock price, a $9 million increase in third-party transmission costs, a
$6 million increase in metering-related costs associated with the increased
disconnect/reconnect activity, and a $6 million increase in vegetation
management expenses to improve reliability, partially offset by a $4 million
decrease in pension and retiree medical benefit costs.
Depreciation and amortization increased $71 million, or 33%, to $286
million, driven by $66 million in higher amortization of regulatory assets
associated with the issuance of securitization bonds (offsetting the same amount
of revenue increase).
Other deductions of $25 million in 2004 consist largely of $18 million of
severance-related charges in connection with the Capgemini outsourcing
transaction and other cost reduction initiatives and $3 million of 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
reflecting a $6 million decrease in interest income from Energy related to the
excess mitigation credit that ceased at the end of 2003, partially offset by a
$4 million increase in interest income from Energy related to the 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.
Income tax expense was $109 million in 2004 (including $101 million
related to operating income and $8 million related to nonoperating income),
representing an effective tax rate of 33.1% in 2004, compared to the 2003
effective tax rate of 33.2%. 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 delivered volumes, the other
deductions and increased operating expenses, partially offset by lower interest
expense and higher transmission-related revenues.
Net pension and postretirement benefit costs reduced income before
extraordinary gain by $12 million in 2004 and $14 million in 2003. The decrease
in these costs reflects a remeasurement of these liabilities as a result of the
transfer of employees to Capgemini and an increase of 0.25% in the discount rate
due to higher interest rates, as well as the Medicare Act enacted in
December 2003.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows -- Cash flows provided by operating activities for the nine
months ended September 30, 2004 were $423 million, compared to $349 million for
the nine months ended September 30, 2003. The $74 million increase was primarily
driven by the absence of the excess mitigation credit to REPs that ceased at the
end of 2003 (offset in financing activities due to the absence of collections on
a related note receivable from Energy), partially offset by $47 million in costs
related to storm damage repairs, recorded as a regulatory asset.
Cash flows used by financing activities were $216 million in 2004,
compared to cash flows provided of $128 million in 2003. Cash provided from net
issuances and repayments of debt totaled $234 in 2004 compared to net cash used
totaling $20 million in 2003. Electric Delivery repurchased $450 million of
common stock from its parent in 2004 compared to $263 million in 2003. In 2003
Electric Delivery received a $250 million capital contribution from its parent
and $161 million in collections on a note receivable from Energy related to the
excess mitigation credit.
19
Cash flows used in investing activities totaled $426 million and $359
million for the nine months ended September 30, 2004 and 2003, respectively.
Capital expenditures rose $35 million, reflecting increased spending to improve
system reliability and performance and increased investment in transmission
projects to reduce congestion. The increase in investing activities also
reflected $13 million in higher removal costs on property retirements and $19
million in higher restricted cash balances related to the transition charge
collections.
Financing Activities
- --------------------
Over the next twelve months, Electric Delivery will need to fund ongoing
working capital requirements and maturities of debt. Electric Delivery has
funded or intends to fund these requirements through cash on hand, cash flows
from operations, short-term credit facilities and the issuance of long-term debt
or other securities.
Long-term Debt Activity -- During the nine months ended September 30,
2004, Electric Delivery issued $790 million in securitization bonds and made
scheduled principal payments of $100 million on its 8.25% First Mortgage Bonds
and $23 million on its 2.26% Fixed Series 2003 Bond. Electric Delivery used the
proceeds from the securitization bonds 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 its parent for $375 million.
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.
Equity -- Electric Delivery's cash distributions may take the legal form
of common stock share repurchases or the payment of dividends on outstanding
shares of its common stock. The form of the distributions is primarily
determined by current and forecasted levels of retained earnings as well as
state tax implications. The common stock share repurchases made subsequent to
January 1, 2002, are cash distributions to US Holdings that for financial
reporting purposes have been recorded as a return of capital. Any future cash
distributions to US Holdings will be reported (i) as a return of capital if made
through repurchases or (ii) as a dividend if so declared by the board of
directors. Any future common stock share repurchases will reduce the amount of
Electric Delivery's equity, but will not change US Holdings' 100% ownership of
Electric Delivery.
Capitalization -- The capitalization of Electric Delivery at September 30,
2004, consisted of 61.5% long-term debt, less current maturities, and 38.5%
shareholder's equity.
Short-term Borrowings -- At September 30, 2004, Electric Delivery had
short-term advances from affiliates of $8 million at a weighted average interest
rate of 2.77%. At December 31, 2003 Electric Delivery had outstanding short-term
advances from affiliates of $25 million at a weighted average interest rate of
2.92%.
Credit Facilities -- Electric Delivery has joint credit facilities (with
Energy) that allow for aggregate borrowings up to $2.5 billion. These facilities
expire in 2005 through 2009 and can be used for working capital and general
corporate purposes. At September 30, 2004, $565 million had been borrowed under
these facilities by Energy. In addition, TXU Corp. has a credit facility of $500
million that expires in 2008. At September 30, 2004, $71 million of this
facility was unused. Electric Delivery expects that, to the extent capacity is
available, TXU Corp.'s remaining credit facility will be made available to it
for borrowings, letters of credit and other purposes. See Note 2 to Financial
Statements for details of all of these 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,
subsidiaries of TXU Corp. (originators) sell trade accounts receivable to TXU
Receivables Company, a consolidated wholly-owned bankruptcy remote direct
subsidiary of TXU Corp., which sells undivided interests in the purchased
accounts receivable for cash to special purpose entities established by
financial institutions. All new trade receivables under the program generated by
the originators are continuously purchased by TXU Receivables Company with the
proceeds from collections of receivables previously purchased. Funding to
Electric Delivery under the program at September 30, 2004 and December 31, 2003
totaled $71 million and $44 million, respectively. See Note 2 to Financial
Statements for a more complete description of the program including the
financial impact on earnings and cash flows for the periods presented and the
contingencies that could result in termination of the program.
20
Restricted Cash -- At September 30, 2004, Electric Delivery had
$29 million of restricted cash reported in current assets, representing
collections from customers that secure its securitization bonds and
may be used only to service its debt and pay its expenses. Restricted cash
reported in investments on the balance sheet as September 30, 2004 included $10
million principally related to payment of fees associated with securitization
bonds and $5 million in reserve for shortfalls of transition charges, if any.
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.
Financial Covenants, Credit Rating Provisions and Cross Default Provisions
- -- The terms of certain financing arrangements of Electric Delivery contain
financial covenants that require maintenance of specified fixed charge coverage
ratios, shareholder's equity to total capitalization ratios and leverage ratios
and/or contain minimum net worth covenants. As of September 30, 2004, Electric
Delivery was in compliance with all such applicable covenants.
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 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.
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, which facility is also made
available to Electric Delivery.
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.
21
Electric Delivery has other arrangements, including interest rate swap
agreements and leases with 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 the 2003 Form 10-K to reflect the
obligation under the business services outsourcing agreement with Capgemini and
the repayment of debt and other instruments as discussed in Note 1 to Financial
Statements.
Contractual Cash Obligations
- -----------------------------
More
One to Three to Than
Less Than Three Five Five
One Year Years Years Years
---------- ------ --------- -------
Long-term debt -principal and interest................. $ 547 $ 894 $ 671 $6,099
Lease obligations...................................... 6 10 7 14
Business services outsourcing obligations.............. 67 124 124 295
Pension and other postretirement liabilities........... 41 82 82 41
------ ------ ------ ------
Total Contractual Cash Obligations................. $ 661 $1,110 $ 884 $6,449
OFF BALANCE SHEET ARRANGEMENTS
See discussion above under Sale of Receivables and in Note 2 to Financial
Statements.
COMMITMENTS AND CONTINGENCIES
See Note 4 to Financial Statements for details of contingencies, including
guarantees.
REGULATION AND RATES
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
new rate 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.
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.
22
The city of Denison, acting in its role as a regulatory authority,
initiated an inquiry on August 2, 2004 to determine if the rates of Electric
Delivery, which have been established by the Commission, are just and
reasonable. Approximately 20 cities have initiated similar requests and certain
other cities within the historical service territory are considering similar
requests. 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.
It is too early to determine whether these inquiries will have any material
effect on Electric Delivery's rates. Electric Delivery has the right to appeal
any city action to the Commission.
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 Electric Delivery's operations. The Legislature could
consider and enact other changes to PURA and Electric Delivery 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 Electric Delivery'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.
Summary -- Although Electric Delivery cannot predict future regulatory or
legislative actions or any changes in economic and securities market conditions,
no changes are expected in trends or commitments, other than those discussed in
this report, which might significantly alter its basic financial position,
results of operations or cash flows.
CHANGES IN ACCOUNTING STANDARDS
See Note 1 to Financial Statements for a discussion of changes in
accounting standards.
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 Electric Delivery's operations,
financial results and financial condition, and could cause Electric Delivery'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 displacement and the rapid pace of changes to
organizational structure and operating practices and processes.
Electric Delivery is subject to changes in laws or regulations, including
PURA, the Federal Power Act, as amended, the Clean Air Act, as amended, and the
Public Utility Holding Company Act of 1935, as amended, changing governmental
policies and regulatory actions, including those of the Commission, the EPA and
the FERC, with respect to matters including, but not limited to, market
structure and design, construction and operation of transmission facilities,
acquisition, disposal, depreciation and amortization of regulated assets and
facilities and return on invested capital. 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" above.
23
Electric Delivery's rates are regulated by the Commission and 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, such that a reduction in its rates is required.
A portion of Electric Delivery's revenues is derived from rates that
Electric Delivery collects from each REP based on the amount of electricity
Electric Delivery distributes on behalf of each such REP. Thus, Electric
Delivery's revenues and results of operations are subject to seasonality,
weather conditions and other changes in electricity usage. In addition, the
operation of electricity transmission and distribution facilities involves many
risks, including breakdown or failure of equipment and transmission lines, lack
of sufficient capital to maintain the facilities, the impact of unusual or
adverse weather conditions or other natural events, as well as the risk of
performance below expected levels of efficiency. This could result in lost
revenues and/or increased expenses. Insurance, warranties or performance
guarantees may not cover any or all of the lost revenues or increased expenses.
Natural disasters, war, terrorist acts and other catastrophic events may impact
Electric Delivery's operations in adverse ways, including disruption of power
production and energy delivery activities, declines in customer demand, cost
increases and instability in the financial markets. Electric Delivery's ability
to obtain insurance, and the cost of and coverage provided by such insurance
could be affected by events outside its control.
Electric Delivery's revenues from the distribution of electricity are
collected from approximately 44 REPs, including Energy, that sell the
electricity Electric Delivery distributes to these REPs' customers. Electric
Delivery depends on these REPs to timely remit these revenues to Electric
Delivery. Electric Delivery could experience delays or defaults in payment from
these REPs. Energy represents approximately 65% of Electric Delivery's revenue
base.
In addition to revenues, Electric Delivery is owed other significant
amounts from Energy. The incremental income taxes Electric Delivery will pay on
the increased delivery fees to be charged to Electric Delivery's customers
related to the aggregate issuance of approximately $1.3 billion in
securitization bonds will be reimbursed by Energy. Therefore, Electric
Delivery's financial statements reflect a $437 million receivable from Energy
that will be extinguished as Electric Delivery pays the related income taxes.
The continuous process of technological development may result in the
introduction to retail customers of economically attractive alternatives to
purchasing electricity through Electric Delivery's distribution facilities.
While not generally competitive now, manufacturers of self-generation facilities
continue to develop smaller-scale, more fuel-efficient generating units that can
be cost-effective options for certain customers.
TXU Corp. and US Holdings are not obligated to provide any loans, further
equity contributions or other funding to Electric Delivery. Electric Delivery
must compete with all of TXU Corp.'s and US Holdings' other subsidiaries for
capital and other resources. While, as a member of the TXU corporate group,
Electric Delivery operates within policies, including dividend policies,
established by TXU Corp. that impact the liquidity of Electric Delivery, the
regulation of Electric Delivery's rates provides economic disincentives to any
significant reduction of Electric Delivery's equity capitalization and prohibits
cross-subsidization of other TXU Corp. group members by Electric Delivery.
The lack of necessary capital and cash reserves may adversely impact
Electric Delivery's growth plans, its ability to raise additional debt and the
evaluation of its creditworthiness by rating agencies.
Electric Delivery's ability to successfully and timely complete capital
improvements to existing facilities or other capital projects is contingent upon
many variables. If Electric Delivery's efforts to complete capital improvements
are unsuccessful, Electric Delivery could be subject to additional costs and/or
the write-off of its investment in the project or improvement.
24
The inability to raise capital on favorable terms, particularly during
times of uncertainty in the financial markets, could impact Electric Delivery's
ability to sustain and grow its business, which is capital intensive, and would
likely increase its capital costs. Electric Delivery 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. Electric Delivery'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 Electric Delivery's credit or a reduction in
Electric Delivery's credit ratings or the credit ratings of TXU
Corp. or its other subsidiaries;
o a material breakdown in Electric Delivery's risk management procedures;
and
o the occurrence of material adverse changes in Electric Delivery's
business that restrict Electric Delivery's ability to access its
liquidity facilities.
As a result of the energy crisis in California during 2001, the recent
volatility of natural gas prices in North America, the bankruptcy filing by
Enron Corporation, accounting irregularities of public companies, and
investigations by governmental authorities into energy trading activities,
companies in the regulated and non-regulated utility businesses have been under
a generally increased amount of public and regulatory scrutiny. Accounting
irregularities at certain companies in the industry have caused regulators and
legislators to review current accounting practices and financial disclosures.
The capital markets and ratings agencies also have increased their level of
scrutiny. Additionally, allegations against various energy trading companies of
"round trip" or "wash" transactions, which involve the simultaneous buying and
selling of the same amount of power at the same price and delivery location and
provide no true economic benefit, power market manipulation and inaccurate power
and commodity price reporting have had a negative effect on the industry.
Electric Delivery 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 Electric Delivery's financial
condition or access to the capital markets. Additionally, it is unclear what
laws and regulations may develop, and Electric Delivery 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.
The issues and associated risks and uncertainties described above are not
the only ones Electric Delivery may face. Additional issues may arise or become
material as the energy industry evolves.
FORWARD-LOOKING STATEMENTS
This report and other presentations made by Electric Delivery and its
subsidiaries (collectively, Electric Delivery) contain forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended. Although Electric Delivery 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 factors, among others, that could cause the actual results of
Electric Delivery to differ materially from those projected in such
forward-looking statements:
o prevailing governmental policies and regulatory actions, including
those of the FERC and the Commission, with respect to:
o allowed rate of return;
o industry, market, and rate structure;
o recovery of investments;
o acquisitions and disposal of assets and facilities;
o operation and construction of facilities
o changes in tax laws and policies; and
25
o changes in and compliance with environmental and safety laws and
polices;
o continued implementation of and "sunset" provisions regarding
the 1999 Restructuring Legislation;
o legal and administrative proceedings and settlements;
o general industry trends;
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 patters;
o changes in business strategy, development plans, or vendor
relationships;
o Electric Delivery's ability to implement the initiatives that are part
of its restructuring, operational improvement and cost reductions
program, and the terms upon which it executes those initiatives;
o unanticipated changes in interest rates, commodity prices or rate of
inflation;
o unanticipated changes in operating expenses, liquidity needs and capital
expenditures;
o commercial bank market and capital market conditions;
o inability of various counterparties to meet their obligations with
respect to Electric Delivery's financial instruments;
o changes in technology used by and services offered by Electric Delivery;
o significant changes in Electric Delivery's relationship with its
employees, including the availability of qualified personnel, and the
potential adverse effects of labor disputes or grievances were to
occur;
o significant changes in critical accounting policies material to
Electric Delivery; and
o actions by credit rating agencies.
Any forward-looking statement speaks only as of the date on which it is
made, and Electric Delivery 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 Electric Delivery
to predict all of them; nor can Electric Delivery assess the impact of each such
factor or the extent to which any factor, or combination of factors, may cause
results to differ materially from those contained in any forward-looking
statement.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Except as presented below, the information required hereunder is not
significantly different from the information set forth in Item 7A. Quantitative
and Qualitative Disclosures About Market Risk included in the 2003 Form 10-K and
is therefore not presented herein.
INTEREST RATE RISK
See Note 2 to Financial Statements for a discussion of the issuance and
retirement of debt since December 31, 2003.
CREDIT RISK
Credit risk relates to the risk of loss that Electric Delivery may incur
as a result of non-performance by its counterparties. Electric Delivery's
customers consist primarily of REPs. As a requisite for obtaining and
maintaining certification, a REP must meet the financial resource standards
established by the Commission. REP certificates granted by the Commission are
subject to suspension and revocation for significant violation of PURA and
Commission rules. Significant violations include failure to timely remit
payments for invoiced charges to a transmission and distribution utility
pursuant to the terms of tariffs adopted by the Commission. Since most of the
transmission and distribution services provided and invoiced by Electric
Delivery are to its affiliated REP, Energy, a material loss to Electric Delivery
arising from nonperformance by its customers is considered unlikely.
26
Electric Delivery's exposure to credit risk as of September 30, 2004
primarily represents trade accounts receivable from unaffiliated customers of
$69 million. Electric Delivery has two customers, each with a balance of $11
million, each of which represented greater than 10% of this amount at September
30, 2004. Both customers are non-investment grade quality; however, the
customers have consistently performed their obligations in accordance with their
agreements.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of Electric Delivery'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, Electric Delivery'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 Electric Delivery's internal control over financial
reporting that has materially affected, or is reasonably likely to materially
affect, Electric Delivery's internal control over financial reporting.
27
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
(a) Exhibits provided as part of Part II are:
As
Exhibits Exhibit
- -------- -------
(31) Rule 13a - 14(a)/15d - 14(a) Certifications.
31(a) -- Certification of Tom Baker, Chairman of the Board and
Chief Executive of TXU Electric Delivery Company,
pursuant to Rule 13a - 14(a)/15d - 14(a) of the
Securities Exchange Act of 1934, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31(b) -- Certification of Kirk R. Oliver, Executive Vice
President and Chief Financial Officer of TXU Electric
Delivery Company, pursuant to Rule 13a - 14(a)/15d -
14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
(32) Section 1350 Certifications.
32(a) -- Certification of Tom Baker, Chairman of the Board and
Chief Executive of TXU Electric Delivery Company,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32(b) -- Certification of Kirk R. Oliver, Executive Vice
President and Chief Financial Officer of TXU Electric
Delivery Company, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(99) Additional Exhibits.
99 -- Condensed Statements of Consolidated Income - Twelve
Months Ended September 30, 2004
28
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 ELECTRIC DELIVERY COMPANY
By /s/ Stanley J. Szlauderbach
------------------------------------
Name: Stanley J. Szlauderbach
Title: Assistant Controller
and Interim Controller
Date: November 11, 2004
29