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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 MARCH 31, 2005

 

— OR —

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 333-108876

 


 

TXU Energy Company LLC

 


 

A Delaware Limited Liability Company   75-2967817
(State of Organization)   (I.R.S. Employer Identification No.)
1601 Bryan Street, Dallas TX, 75201-3411   (214) 812-4600
(Address of Principal Executive Offices)(Zip Code)   (Registrant’s Telephone Number)

 


 

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

 

As of May 12, 2005, all outstanding common membership interests in TXU Energy Company LLC were held by TXU US Holdings Company.

 

TXU Energy Company LLC 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.

 



Table of Contents

TABLE OF CONTENTS

 

         PAGE

GLOSSARY

       ii

PART I.

  FINANCIAL INFORMATION     

Item 1.

  Financial Statements     
    Condensed Statements of Consolidated Income – Three Months Ended March 31, 2005 and 2004    1
    Condensed Statements of Consolidated Comprehensive Income – Three Months Ended March 31, 2005 and 2004    1
    Condensed Statements of Consolidated Cash Flows – Three Months Ended March 31, 2005 and 2004    2
    Condensed Consolidated Balance Sheets – March 31, 2005 and December 31, 2004    3
    Notes to Condensed Consolidated Financial Statements    4
    Report of Independent Registered Public Accounting Firm    16

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    17

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk    29

Item 4.

  Controls and Procedures    40

PART II.

  OTHER INFORMATION     

Item 1.

  Legal Proceedings    41

Item 6.

  Exhibits    41
SIGNATURE    42

 

Periodic reports on Form 10-K and Form 10-Q and current reports on Form 8-K that contain financial information of TXU Energy Company LLC and its subsidiaries 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 Energy Company LLC 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.

 

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GLOSSARY

 

When the following terms and abbreviations appear in the text of this report, they have the meanings indicated below.

 

1999 Restructuring Legislation    legislation that restructured the electric utility industry in Texas to provide for retail competition
2004 Form 10-K    TXU Energy Company LLC’s Annual Report on Form 10-K for the year ended December 31, 2004
Bcf    billion cubic feet
Capgemini    Capgemini Energy LP, a subsidiary of Cap Gemini North America Inc. that provides business support services to TXU Energy Holdings
Commission    Public Utility Commission of Texas
EITF    Emerging Issues Task Force
EITF 04-6    EITF Issue No. 04-6, “Accounting for Stripping Costs Incurred during Production in the Mining Industry”
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 47    FIN No. 47, “Accounting for Conditional Asset Retirement Obligations – An Interpretation of FASB Statement No. 143”
Fitch    Fitch Ratings, Ltd.
GW    gigawatts
GWh    gigawatt-hours
historical service territory    the territory, largely in north Texas, being served by TXU Corp. as a regulated utility at the time of entering retail competition on January 1, 2002
kWh    kilowatt-hours
Moody’s    Moody’s Investors Services, Inc.
MW    megawatts
MWh    megawatt-hours
NRC    United States Nuclear Regulatory Commission

 

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price-to-beat rate    residential and small business customer electricity rates established by the Commission that (i) were required to be charged in a REP’s historical service territories until the earlier of January 1, 2005 or the date when 40% of the electricity consumed by such customer classes is supplied by competing REPs, adjusted periodically for changes in fuel costs, and (ii) are required to be made available to those customers until January 1, 2007
REP    retail electric provider
S&P    Standard & Poor’s, a division of the McGraw Hill Companies
Sarbanes-Oxley    Sarbanes – Oxley Act of 2002
SEC    United States Securities and Exchange Commission
SFAS    Statement of Financial Accounting Standards issued by the FASB
SFAS 34    SFAS No. 34, “Capitalization of Interest Cost”
SFAS 133    SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”
SFAS 140    SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement 125”
SFAS 143    SFAS No. 143, “Accounting for Asset Retirement Obligations”
SG&A    selling, general and administrative
TXU Corp.    refers to TXU Corp., a holding company, and/or its consolidated subsidiaries, depending on context
TXU Electric Delivery    refers to TXU Electric Delivery Company, a subsidiary of US Holdings, and/or its consolidated bankruptcy remote financing subsidiary, TXU Electric Delivery Transition Bond Company LLC, depending on context
TXU Energy Holdings    refers to TXU Energy Company LLC, a subsidiary of US Holdings, and/or its consolidated subsidiaries, depending on context
TXU Fuel    TXU Fuel Company, a former subsidiary of TXU Energy Holdings
TXU Gas    TXU Gas Company, a former subsidiary of TXU Corp.
TXU Mining    TXU Mining Company LP, a subsidiary of TXU Energy Holdings
TXU Portfolio Management    TXU Portfolio Management Company LP, a subsidiary of TXU Energy Holdings
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. and parent of TXU Energy Holdings and TXU Electric Delivery

 

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PART I. FINANCIAL INFORMATION

 

Item 1. FINANCIAL STATEMENTS

 

TXU ENERGY COMPANY LLC

CONDENSED STATEMENTS OF CONSOLIDATED INCOME

(Unaudited)

 

     Three Months Ended
March 31,


 
     2005

    2004

 
     (millions of dollars)  

Operating revenues

   $ 1,803     $ 1,957  

Costs and expenses:

                

Cost of energy sold and delivery fees

     1,056       1,254  

Operating costs

     152       167  

Depreciation and amortization

     79       97  

Selling, general and administrative expenses

     113       148  

Franchise and revenue-based taxes

     26       26  

Other income

     (2 )     (1 )

Other deductions

     1       20  

Interest income

     (9 )     (2 )

Interest expense and related charges

     91       79  
    


 


Total costs and expenses

     1,507       1,788  
    


 


Income from continuing operations before income taxes

     296       169  

Income tax expense

     93       53  
    


 


Income from continuing operations

     203       116  

Loss from discontinued operations, net of tax benefit (Note 2)

     (3 )     (3 )
    


 


Net income

   $ 200     $ 113  
    


 


 

TXU ENERGY COMPANY LLC

CONDENSED STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME

(Unaudited)

 

     Three Months Ended
March 31,


 
     2005

    2004

 
     (millions of dollars)  

Components related to continuing operations:

                

Income from continuing operations

   $ 203     $ 116  

Other comprehensive income (loss), net of tax effects:

                

Cash flow hedges:

                

Net change in fair value of derivatives (net of tax (expense) benefit of $(8) and $31)

     15       (58 )

Amounts realized in earnings during the period (net of tax expense of $10 and $3)

     17       5  
    


 


Total

     32       (53 )
    


 


Comprehensive income from continuing operations

     235       63  

Comprehensive loss from discontinued operations

     (3 )     (3 )
    


 


Comprehensive income

   $ 232     $ 60  
    


 


 

See Notes to Financial Statements.

 

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TXU ENERGY COMPANY LLC

CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS

(Unaudited)

 

     Three Months Ended
March 31,


 
     2005

    2004

 
     (millions of dollars)  

Cash flows – operating activities:

                

Income from continuing operations

   $ 203     $ 116  

Adjustments to reconcile income from continuing operations to cash provided by operating activities:

                

Depreciation and amortization

     94       115  

Deferred income taxes and investment tax credits – net

     39       25  

Net effect of unrealized mark-to-market valuations of commodity contracts

     24       18  

Decrease in accrued lease liability for out-of-service assets

     (15 )     —    

Change in regulatory-related liabilities

     (16 )     (17 )

Charge for contract counterparty nonperformance

     12       —    

Net equity loss from unconsolidated affiliates

     2       —    

Stock-based compensation expense

     4       —    

Bad debt expense

     11       26  

Changes in operating assets and liabilities

     (115 )     138  
    


 


Cash provided by operating activities

     243       421  

Cash flows – financing activities:

                

Issuances of long-term debt

     71       —    

Retirements/repurchases of debt

     (1 )     —    

Increase in notes payable to banks

     135       75  

Net change in advances from affiliates

     (175 )     (243 )

Distribution paid to parent

     (175 )     (175 )

Debt premium, discount, financing and reacquisition expenses

     (8 )     —    
    


 


Cash used in financing activities

     (153 )     (343 )

Cash flows – investing activities:

                

Capital expenditures

     (58 )     (35 )

Nuclear fuel

     (26 )     (47 )

Proceeds from sale of assets

     2       —    

Other

     (7 )     10  
    


 


Cash used in investing activities

     (89 )     (72 )

Discontinued Operations

                

Cash provided by (used in) operating activities

     (3 )     4  

Cash used in financing activities

     —         (5 )

Cash used in investing activities

     —         (1 )
    


 


Cash used in discontinued operations

     (3 )     (2 )
    


 


Net change in cash and cash equivalents

     (2 )     4  

Cash and cash equivalents – beginning balance

     70       18  
    


 


Cash and cash equivalents – ending balance

   $ 68     $ 22  
    


 


 

See Notes to Financial Statements.

 

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TXU ENERGY COMPANY LLC

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

     March 31,
2005


    December 31,
2004


 
     (millions of dollars)  
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 68     $ 70  

Restricted cash

     6       6  

Advances to affiliates

     844       686  

Accounts receivable — trade

     766       1,139  

Inventories

     296       284  

Commodity contract assets

     1,047       546  

Other current assets

     322       233  
    


 


Total current assets

     3,349       2,964  

Investments:

                

Restricted cash

     15       15  

Other investments

     540       538  

Property, plant and equipment — net

     9,909       9,920  

Goodwill

     517       517  

Commodity contract assets

     319       315  

Cash flow hedge and other derivative assets

     35       8  

Assets held for sale (Note 2)

     14       17  

Other noncurrent assets

     218       221  
    


 


Total assets

   $ 14,916     $ 14,515  
    


 


LIABILITIES AND MEMBERSHIP INTERESTS                 

Current liabilities:

                

Notes payable – banks

   $ 345     $ 210  

Long-term debt due currently

     431       31  

Accounts payable – trade:

                

Affiliates (principally TXU Electric Delivery)

     196       191  

All other

     724       861  

Notes or other liabilities due TXU Electric Delivery

     32       49  

Commodity contract liabilities

     810       491  

Accrued taxes

     155       190  

Other current liabilities

     628       708  
    


 


Total current liabilities

     3,321       2,731  

Accumulated deferred income taxes

     1,970       1,927  

Investment tax credits

     338       342  

Commodity contract liabilities

     451       347  

Cash flow hedge and other derivative liabilities

     160       178  

Notes or other liabilities due TXU Electric Delivery

     386       386  

Other noncurrent liabilities and deferred credits

     1,230       1,270  

Long-term debt, less amounts due currently

     2,891       3,226  

Exchangeable preferred membership interest, net of discount ($235 and $239)

     515       511  

Liabilities held for sale

     5       6  
    


 


Total liabilities

     11,267       10,924  

Contingencies (Note 5)

                

Membership interests (Note 4):

                

Capital account

     3,768       3,742  

Accumulated other comprehensive loss

     (119 )     (151 )
    


 


Total membership interests

     3,649       3,591  
    


 


Total liabilities and membership interests

   $ 14,916     $ 14,515  
    


 


 

See Notes to Financial Statements.

 

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TXU ENERGY COMPANY LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS

 

Description of Business — TXU Energy Holdings is a wholly-owned subsidiary of US Holdings, which is a wholly-owned subsidiary of TXU Corp. TXU Energy Holdings is engaged in electricity generation and retail and wholesale energy sales. There are no reportable business segments within TXU Energy Holdings.

 

Discontinued Businesses – Note 2 presents detailed information regarding the discontinued New Jersey generation operations and the strategic retail services business. The condensed consolidated financial statements for all periods presented reflect the reclassification of the results of these businesses as discontinued operations.

 

Basis of Presentation — The condensed consolidated financial statements of TXU Energy Holdings have been prepared in accordance with US GAAP and on the same basis as the audited financial statements included in its 2004 Form 10-K, except with respect to pension and other postretirement benefits as discussed in Note 7, as well as the changes in composite depreciation rates discussed immediately below. In the opinion of management, all other adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the results of operations and financial position have been included therein. All intercompany items and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with US GAAP have been omitted pursuant to the rules and regulations of the SEC. Because the 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 2004 Form 10-K. The results of operations for an interim period may not give a true indication of results for a full year.

 

Effective January 1, 2005, TXU Energy Holdings adjusted the composite depreciation rates related to lignite-fired generation facilities to better reflect their useful lives, resulting in lower depreciation expense for the three months ended March 31, 2005 of approximately $3 million ($2 million after-tax).

 

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 47 was issued in March 2005. This interpretation clarifies the term “conditional asset retirement” and requires recognition of a liability for the fair value of the conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated.

 

In March 2005, the FASB ratified the consensus reached in EITF 04-6 “Accounting for Stripping Costs in the Mining Industry.” The consensus concludes that stripping costs incurred after a mine enters the production phase be treated as variable inventory production cost, which makes such costs subject to inventory costing procedures in the period they are incurred.

 

TXU Energy Holdings is currently evaluating the potential impact of these standards.

 

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2. DISCONTINUED OPERATIONS

 

The following summarizes the historical consolidated financial information of the businesses reported as discontinued operations for the three months ended March 31, 2005 and 2004:

 

    

Pedrick-

town


 

2005


      

Operating revenues

   $ 5  

Operating costs and expenses

     7  
    


Operating loss before income taxes

     (2 )

Income tax benefit

     (1 )

Charges related to exit (after-tax)

     (2 )
    


Loss from discontinued operations

   $ (3 )
    


 

    

Pedrick-

town


   

Strategic

Retail

Services


    Total

 

2004


      

Operating revenues

   $ 10     $ 5     $ 15  

Operating costs and expenses

     12       5       17  

Other deductions (income) — net

     —         (1 )     (1 )
    


 


 


Operating income (loss) before income taxes

     (2 )     1       (1 )

Income tax expense (benefit)

     (1 )     1       —    

Charges related to exit (after-tax)

     —         (2 )     (2 )
    


 


 


Loss from discontinued operations

   $ (1 )   $ (2 )   $ (3 )
    


 


 


 

Pedricktown — In the second quarter of 2004, TXU Energy Holdings initiated a plan to sell the Pedricktown, New Jersey 122 MW power production facility and exit the related power supply and gas transportation agreements.

 

Strategic Retail Services — In December 2003, TXU Energy Holdings finalized a formal plan to sell its strategic retail services business, which was engaged principally in providing energy management services. Substantially all disposition activities have been completed.

 

Balance sheet — The following details the assets and liabilities of the Pedricktown operations held for sale:

 

     March 31,
2005


   December 31,
2004


Current assets

   $ 2    $ 2

Property, plant and equipment

     12      15
    

  

Assets held for sale

   $ 14    $ 17
    

  

Current liabilities

   $ 1    $ 3

Noncurrent liabilities

     4      3
    

  

Liabilities held for sale

   $ 5    $ 6
    

  

 

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3. FINANCING ARRANGEMENTS

 

Short-term Borrowings — At March 31, 2005, TXU Energy Holdings had outstanding short-term borrowings consisting of bank borrowings of $345 million at a weighted average interest rate of 3.29%. At December 31, 2004, TXU Energy Holdings had outstanding short-term borrowings consisting of bank borrowings of $210 million at a weighted average interest rate of 5.25%.

 

Credit FacilitiesAt March 31, 2005, TXU Energy Holdings had access to credit facilities (some of which provide for long-term borrowings) as follows:

 

               At March 31, 2005

Facility


  

Maturity

Date


  

Authorized

Borrowers


  

Facility

Limit


  

Letters of

Credit


  

Cash

Borrowings


   Availability

Three-Year Revolving Credit Facility

   June 2008    TXU Energy Holdings, TXU Electric Delivery    $ 1,400    $ 164    $ 350    $ 886

Five-Year Revolving Credit Facility

   March 2010    TXU Energy Holdings, TXU Electric Delivery      1,600      —        —        1,600

Five-Year Revolving Credit Facility

   June 2010    TXU Energy Holdings, TXU Electric Delivery      500      —        —        500

Five-Year Revolving Credit Facility

   December 2009    TXU Energy Holdings      500      455      45      —  

Total

             $ 4,000    $ 619    $ 395    $ 2,986

 

As reflected in the above table, in March 2005 TXU Energy Holdings and TXU Electric Delivery amended their joint credit facilities, increasing the capacity from $2.5 billion to $3.5 billion, extending the maturity dates and reducing the borrowing costs. The amended and restated credit facilities provide an aggregate borrowing and letter of credit capacity of $3.5 billion (with a maximum amount of $2.8 billion directly available for TXU Electric Delivery). The amended and restated facilities can be used for working capital and general corporate purposes, including providing back-up for any future issuances of commercial paper by TXU Energy Holdings or TXU Electric Delivery and letters of credit. At March 31, 2005, there was no commercial paper outstanding.

 

In January 2005, TXU Corp.’s $425 million credit facility was terminated and $419 million of related outstanding letters of credit were effectively transferred to other facilities.

 

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). Funding under the program to TXU Energy Holdings as of March 31, 2005 was $435 million.

 

The maximum amount of funding availability under the program is $700 million. Funding availability is increased through a credit ratings-based reduction (based on each originator’s credit rating) of customer deposits used to reduce the amount of undivided interests that could be sold. Undivided interests will be reduced by 100% of the customer deposits for a Baa3/BBB- rating; 50% for a Baa2/BBB rating; and zero % for a Baa1/BBB+ and above rating.

 

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

 

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paid to the originators that was funded by the sale of the undivided interests. The balance of the subordinated notes receivable, which is reported in accounts receivable, was $238 million at March 31, 2005 and $293 million at December 31, 2004.

 

The discount from face amount on the purchase of receivables principally funds program fees paid by TXU Receivables Company to the funding entities, as well as a servicing fee paid by TXU Receivables Company to TXU Business Services, a direct subsidiary of TXU Corp. The program fees (losses on sale), which consist primarily of interest costs on the underlying financing, were approximately $4 million and $2 million for the three-month periods ending March 31, 2005 and 2004 and approximated 3.5% and 2.1% for the first three months of 2005 and 2004, respectively, of the average funding under the program on an annualized basis; these fees represent the net incremental costs of the program to the originators and are reported in SG&A expenses. The servicing fee, which totaled approximately $1 million in the first quarters of 2005 and 2004, compensates TXU Business Services for its services as collection agent, including maintaining the detailed accounts receivable collection records.

 

The March 31, 2005 balance sheet reflects $673 million face amount of trade accounts receivable reduced by $435 million of undivided interests sold by TXU Receivables Company. Funding under the program increased $24 million for the three months ended March 31, 2005 and decreased $52 million for the three months ended March 31, 2004. 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 TXU Energy Holdings for the three months ended March 31, 2005 and 2004 were as follows:

 

     Three Months Ended March 31,

 
     2005

    2004

 

Cash collections on accounts receivable

   $ 1,445     $ 1,549  

Face amount of new receivables purchased

     (1,414 )     (1,447 )

Discount from face amount of purchased receivables

     5       3  

Program fees paid

     (4 )     (2 )

Servicing fees paid

     (1 )     (1 )

Decrease in subordinated notes payable

     (55 )     (50 )
    


 


Operating cash flows used by (provided to) TXU Energy Holdings under the program

   $ (24 )   $ 52  
    


 


 

Upon termination of the program, cash flows to TXU Energy Holdings 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.

 

Under terms of the receivables sale program, all the originators are required to maintain specified fixed charge coverage and leverage ratios (or provide a guarantee from 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.

 

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Table of Contents

Long-term Debt — At March 31, 2005 and December 31, 2004, the long-term debt of TXU Energy Holdings and its consolidated subsidiaries consisted of the following:

 

     March 31,
2005


  

December 31,

2004


Pollution Control Revenue Bonds:

             

Brazos River Authority:

             

3.000% Fixed Series 1994A due May 1, 2029, remarketing date May 1, 2005(a)

   $ 39    $ 39

5.400% Fixed Series 1994B due May 1, 2029, remarketing date May 1, 2006(a)

     39      39

5.400% Fixed Series 1995A due April 1, 2030, remarketing date May 1, 2006(a)

     50      50

5.050% Fixed Series 1995B due June 1, 2030, remarketing date June 19, 2006(a)

     114      114

7.700% Fixed Series 1999A due April 1, 2033

     111      111

6.750% Fixed Series 1999B due September 1, 2034, remarketing date April 1, 2013(a)

     16      16

7.700% Fixed Series 1999C due March 1, 2032

     50      50

2.350% Floating Series 2001A due October 1, 2030(b)

     71      —  

4.750% Fixed Series 2001B due May 1, 2029, remarketing date November 1, 2006(a)

     19      19

5.750% Fixed Series 2001C due May 1, 2036, remarketing date November 1, 2011(a)

     217      217

2.330% Floating Series 2001D due May 1, 2033(b)

     268      268

2.850% Floating Taxable Series 2001I due December 1, 2036(b)

     62      62

2.350% Floating Series 2002A due May 1, 2037(b)

     45      45

6.750% Fixed Series 2003A due April 1, 2038, remarketing date April 1, 2013(a)

     44      44

6.300% Fixed Series 2003B due July 1, 2032

     39      39

6.750% Fixed Series 2003C due October 1, 2038

     52      52

5.400% Fixed Series 2003D due October 1, 2029, remarketing date October 1, 2014(a)

     31      31

Sabine River Authority of Texas:

             

6.450% Fixed Series 2000A due June 1, 2021

     51      51

5.500% Fixed Series 2001A due May 1, 2022, remarketing date November 1, 2011(a)

     91      91

5.750% Fixed Series 2001B due May 1, 2030, remarketing date November 1, 2011(a)

     107      107

5.800% Fixed Series 2003A due July 1, 2022

     12      12

6.150% Fixed Series 2003B due August 1, 2022

     45      45

Trinity River Authority of Texas:

             

6.250% Fixed Series 2000A due May 1, 2028

     14      14

5.000% Fixed Series 2001A due May 1, 2027, remarketing date November 1, 2006(a)

     37      37

Other:

             

6.875% TXU Mining Fixed Senior Notes due August 1, 2005

     30      30

6.125% Fixed Senior Notes due March 15, 2008(c)

     250      250

7.000% Fixed Senior Notes due March 15, 2013

     1,000      1,000

3.920% Floating Rate Senior Notes due January 17, 2006(d)

     400      400

Capital lease obligations

     8      9

Fair value adjustments related to interest rate swaps

     10      15
    

  

Total TXU Energy Holdings

     3,322      3,257

Less amount due currently

     431      31
    

  

Total long-term debt

   $ 2,891    $ 3,226
    

  


 

(a) These series are in the multiannual mode and are subject to mandatory tender prior to maturity on the mandatory remarketing date. On such date, the interest rate and interest rate period will be reset for the bonds.
(b) Interest rates in effect at March 31, 2005. These series are in a weekly rate mode and are classified as long-term as they are supported by long-term irrevocable letters of credit.
(c) Interest rates swapped to floating on an aggregate $250 million principal amount.
(d) Interest rates in effect at March 31, 2005.

 

In January 2005, TXU Energy Holdings remarketed and converted to floating rate mode the Brazos River Authority Series 2001A pollution control revenue bonds with an aggregate principal amount of $71 million. The bonds were purchased upon mandatory tender in April 2004.

 

Fair Value Hedges — TXU Energy Holdings uses fair value hedging strategies to manage its exposure to fixed interest rates on long-term debt. At March 31, 2005, $250 million of fixed rate debt had been effectively converted to variable rates through interest rate swap transactions, expiring through 2008. These swaps qualified for and have been designated as fair value hedges using the short-cut method of hedge accounting provided by SFAS 133. As such, TXU Energy Holdings assumes that changes in the value of the derivative are exactly offset by changes in the value of the debt; therefore, there is no hedge ineffectiveness recognized.

 

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4. MEMBERSHIP INTERESTS

 

In November 2004, TXU Energy Holdings approved a cash distribution of $175 million that was paid to US Holdings in January 2005. In February 2005, TXU Energy Holdings approved a cash distribution of $175 million that was paid to US Holdings in April 2005.

 

The following table presents the changes in Membership Interests for the three months ended March 31, 2005:

 

     Capital
Accounts


    Accumulated
Other
Comprehensive
Gain (Loss)


    Total
Membership
Interests


 

Balance at December 31, 2004

   $ 3,742     $ (151 )   $ 3,591  

Distributions paid to parent

     (175 )     —         (175 )

Net income

     200       —         200  

Cash flow hedges

     —         32       32  

Other

     1       —         1  
    


 


 


Balance at March 31, 2005

   $ 3,768     $ (119 )   $ 3,649  
    


 


 


 

5. CONTINGENCIES

 

Guarantees — TXU Energy Holdings has entered into contracts that contain guarantees to outside parties that could require performance or payment under certain conditions. These guarantees are described below.

 

Residual value guarantees in operating leases — TXU Energy Holdings is the lessee under various operating leases that obligate it to guarantee the residual values of the leased assets. Accounting rules require the recording of a liability for all guarantees entered into subsequent to December 31, 2002. At March 31, 2005, the aggregate maximum amount of residual values guaranteed was approximately $171 million with an estimated residual recovery of approximately $108 million. The substantial majority of the maximum guarantee amount relates to leases entered into prior to December 31, 2002. The average life of the lease portfolio is approximately five years.

 

Debt obligations of the parent – TXU Energy Holdings has provided a guarantee of the obligations under TXU Corp.’s financing lease (approximately $115 million at March 31, 2005) for its headquarters building.

 

Letters of credit — TXU Energy Holdings has entered into various agreements that require letters of credit for financial assurance purposes. Approximately $455 million of letters of credit were outstanding at March 31, 2005 to support existing floating rate pollution control revenue bond debt of approximately $445 million. The letters of credit are available to fund the payment of such debt obligations. These letters of credit have expiration dates in 2009.

 

TXU Energy Holdings has outstanding letters of credit in the amount of $9 million for miscellaneous credit support requirements. Although the average life of the letters of credit is approximately one year, the obligation to provide guarantees is ongoing.

 

TXU Energy Holdings has outstanding letters of credit in the amount of $119 million to support hedging and risk management margin requirements in the normal course of business. As of March 31, 2005, approximately 62% of the obligations supported by these letters of credit mature within one year, and substantially all of the remainder mature in the next two years.

 

Surety bonds — TXU Energy Holdings has outstanding surety bonds of approximately $29 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.

 

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Legal Proceedings — On March 18, 2005, TXU Corp. received a subpoena from the SEC. The subpoena requires TXU Corp. to produce documents and other information for the period from January 1, 2001 to March 31, 2003 relating to, among other things, the financial distress at TXU Europe during 2002 and the resulting financial condition of TXU Corp., TXU Corp.’s reduction of its quarterly dividend in October 2002, and the following two previously disclosed claims against TXU Corp. and certain other persons named in such claims: (i) a lawsuit brought in April 2003 by a former employee of TXU Portfolio Management, William J. Murray (Murray Litigation) and (ii) various consolidated lawsuits brought by various shareholders of TXU Corp. during late 2002 and January 2003 (Shareholders’ Litigation). The documents accompanying the subpoena state that (i) the SEC is conducting a fact-finding inquiry for purposes of allowing it to determine whether there have been any violations of the federal securities laws and (ii) the request does not mean the SEC has concluded that TXU Corp. or any other person has violated the law. Although TXU Corp. cannot predict the outcome of the SEC inquiry, as previously disclosed, TXU Corp. does not believe that there is any merit to the claims made in the Murray Litigation and it intends to vigorously defend such litigation. In addition, TXU Corp. has executed a memorandum of understanding regarding the settlement of the Shareholders’ Litigation. TXU Corp. expects to execute a final agreement containing the terms of such settlement during the second quarter of 2005. TXU Corp. intends to cooperate with the SEC and is in the process of responding to the subpoena.

 

On February 18, 2005, a lawsuit was filed by Utility Choice, L.P. and Cirro Group, Inc. in the United States District Court for the Southern District of Texas, Houston Division, against TXU Corp. and certain of its subsidiaries, as well as various other wholesale market participants doing business in ERCOT, claiming generally that defendants engaged in a variety of anticompetitive conduct, including market manipulation in violation of antitrust and other laws. TXU Corp. believes that claims against it and its subsidiary companies are without merit, and TXU Corp. and its subsidiaries intend to vigorously defend the lawsuit. TXU Energy Holdings is, however, unable to estimate any possible loss or predict the outcome of this action.

 

Between October 19 and December 30, 2004, ten lawsuits were filed in various California superior courts by purported customers against TXU Corp., TXU Energy Trading Company and TXU Energy Services and other marketers, traders, transporters and sellers of natural gas in California. Plaintiffs allege that beginning at least by the summer of 2000, defendants manipulated and fixed at artificially high levels natural gas prices in California in violation of the Cartwright Act and other California state laws. These lawsuits have been coordinated in the San Diego Superior Court with numerous other natural gas actions as “In re Natural Gas Anti-Trust Cases I, II, III, IV and V.” TXU Corp. believes the claims against TXU Corp. and its subsidiaries are without merit, and intends to vigorously defend the lawsuits. TXU Energy Holdings is, however, unable to estimate any possible loss or predict the outcome of these actions.

 

On July 7, 2003, a lawsuit was filed by Texas Commercial Energy (TCE) in the United States District Court for the Southern District of Texas, Corpus Christi Division, against TXU Energy Holdings and certain of its subsidiaries, as well as various other wholesale market participants doing business in ERCOT, claiming generally that defendants engaged in market manipulation, in violation of antitrust and other laws, primarily during the period of extreme weather conditions in late February 2003. An amended complaint was filed in February 2004 that joined additional, unaffiliated defendants. Three retail electric providers filed motions for leave to intervene in the action alleging claims substantially identical to TCE’s. In addition, approximately 25 purported former customers of TCE filed a motion to intervene in the action alleging claims substantially identical to TCE’s, both on their own behalf and on behalf of a putative class of all former customers of TCE. An order granting TXU Energy Holdings’ Motion to Dismiss based on the filed rate doctrine was entered on June 24, 2004. TCE has appealed the dismissal; however, TXU Corp. believes the dismissal of the antitrust claims was proper and that it has not committed any violation of the antitrust laws. The appeal remains pending before the Fifth Circuit Court of Appeals and is set for oral argument on May 10, 2005. Further, the Commission’s investigation of the market conditions in late February 2003 has not resulted in any finding adverse to TXU Corp. Accordingly, TXU Corp. believes that TCE’s and the intervenors’ claims are without merit, and intends to vigorously defend the lawsuit on appeal. TXU Energy Holdings is, however, unable to estimate any possible loss or predict the outcome of this action.

 

On April 28, 2003, a lawsuit was filed by a former employee of TXU Portfolio Management in the United States District Court for the Northern District of Texas, Dallas Division, against TXU Corp., TXU Energy Holdings and TXU Portfolio Management. The case is set for trial on June 6, 2005 and discovery in the case is substantially complete. In the case, the plaintiff asserts claims under Section 806 of Sarbanes-Oxley arising

 

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from the termination of plaintiff’s employment and claims for breach of contract relating to payment of certain bonuses. Plaintiff seeks back pay, payment of bonuses and alternatively, reinstatement or future compensation, including bonuses. TXU Corp. believes the plaintiff’s claims are without merit. The plaintiff was terminated as the result of a reduction in force, not as a reaction to any concerns the plaintiff had expressed, and plaintiff was not in a position to evaluate TXU Corp.’s financial statements or assess the adequacy of TXU Corp.’s financial disclosures. Thus, TXU Corp. does not believe that there is any merit to the plaintiff’s claims under Sarbanes-Oxley. TXU Corp. disputes the plaintiff’s claims and intends to vigorously defend the litigation. TXU Energy Holdings is, however, unable to estimate any possible loss or predict the outcome of this action.

 

On March 10, 2003, a lawsuit was filed by Kimberly P. Killebrew in the United States District Court for the Eastern District of Texas, Lufkin Division, against TXU Corp. and TXU Portfolio Management, asserting generally that defendants engaged in manipulation of the wholesale electric market, in violation of antitrust and other laws. This case was transferred to the Beaumont Division of the Eastern District of Texas and on March 24, 2004 was transferred to the Northern District of Texas, Dallas Division. This action is brought by an individual, alleging to be a retail consumer of electricity, on behalf of herself and as a proposed representative of a putative class of retail purchasers of electricity that are similarly situated. Defendants have filed a motion to dismiss the lawsuit which is pending before the court; however, as a result of the dismissal of the antitrust claims in the litigation described above brought by TCE, the parties have agreed to stay this litigation until the appeal in the TCE case has been decided. TXU Corp. believes that the plaintiff lacks standing to assert any antitrust claims and that defendants have not violated antitrust laws or other laws as claimed by plaintiff. Therefore, TXU Corp. believes that plaintiff’s claims are without merit and plans to vigorously defend the lawsuit. TXU Energy Holdings is, however, unable to estimate any possible loss or predict the outcome of this action.

 

General — In addition to the above, TXU Energy Holdings is involved in various other 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.

 

6. DERIVATIVES AND HEDGES

 

As of March 31, 2005, it is expected that $50 million of after-tax net losses accumulated in other comprehensive income will be reclassified into earnings during the next twelve months. This amount primarily represents amortization of dedesignated hedge losses as the hedged transactions are settled. Of this amount, $44 million relates to commodity hedges and $6 million relates to financing-related hedges.

 

TXU Energy Holdings experienced net hedge ineffectiveness of $1 million, reported as a gain in revenues, for the three months ended March 31, 2005. For the three months ended March 31, 2004, TXU Energy Holdings experienced net hedge ineffectiveness of $12 million, reported as a loss in revenues.

 

The net effect of unrealized mark-to-market ineffectiveness accounting (versus settlement accounting), which includes the above amounts as well as the effect of reversing unrealized gains and losses recorded in previous periods to offset realized gains and losses in the current period, totaled $3 million in net gains for the three months ended March 31, 2005 and $15 million in net losses for the three months ended March 31, 2004.

 

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7. SUPPLEMENTARY FINANCIAL INFORMATION

 

Other Deductions —

 

    

Three Months Ended

March 31,


     2005

    2004

Other deductions:

              

Charge related to coal contract counterparty nonperformance

   $ 12     $ —  

Capgemini outsourcing transition costs

     3       —  

Equity losses of unconsolidated entities

     2       —  

Employee severance and asset writedowns

     (2 )     17

Decrease in lease liability (a)

     (15 )     —  

Other

     1       3
    


 

Total other deductions

   $ 1     $ 20
    


 


(a) In December 2004, TXU Energy Holdings committed to immediately cease operating for its own benefit nine leased gas-fired combustion turbines, and recorded a charge of $157 million reported in other deductions. The charge represented the present value of the future lease payments related to the turbines, net of estimated sublease proceeds. An adjustment of $15 million was recorded in the first quarter of 2005 to reflect indicative sublease bids received that exceeded the originally estimated sublease proceeds.

 

Severance Liability Related to Restructuring Activities —

 

Liability for severance costs as of January 1, 2005

   $ 42  

Additions to liability

     1  

Payments charged against liability

     (10 )

Other adjustments to the liability

     (3 )
    


Liability for severance costs as of March 31, 2005

   $ 30  
    


 

Interest Expense and Related Charges —

 

    

Three Months Ended

March 31,


 
     2005

    2004

 

Interest

   $ 67     $ 58  

Distributions on preferred membership interests (a)

     17       17  

Amortization of discount and debt issuance costs

     10       6  

Interest capitalized in accordance with SFAS 34

     (3 )     (2 )
    


 


Total interest expense and related charges

   $ 91     $ 79  
    


 



(a) In April 2004, TXU Corp. purchased from the holders TXU Energy Holdings’ preferred membership interests, and subsequent to this purchase, TXU Energy Holdings has paid distributions on the preferred membership interests to TXU Corp.

 

Affiliate Transactions – The following represent the significant affiliate transactions of TXU Energy Holdings:

 

    TXU Energy Holdings incurs electricity delivery fees charged by TXU Electric Delivery. For the three months ended March 31, 2005 and 2004, these fees totaled $311 million and $349 million, respectively.

 

    TXU Energy Holdings records interest expense to TXU Electric Delivery with respect to TXU Electric Delivery’s generation-related regulatory assets, which have been securitized through the issuance of transition bonds by TXU Electric Delivery. The interest expense reimburses TXU Electric Delivery for its interest expense on the transition bonds. For the three months ended March 31, 2005 and 2004, this interest expense totaled $14 million and $12 million, respectively.

 

    The incremental income taxes TXU Electric Delivery will pay on the increased delivery fees to be charged to TXU Electric Delivery’s customers related to the transition bonds will be reimbursed by TXU Energy Holdings. Therefore, TXU Energy Holdings’ financial statements reflect a $418 million non-interest bearing payable to TXU Electric Delivery ($32 million of which is due currently) that will be extinguished as TXU Electric Delivery pays the related income taxes.

 

    The average daily balances of short-term advances to affiliates during the three months ended March 31, 2005 and 2004 was $661 million and $214 million, respectively. Interest income earned on the advances for the three months ended March 31, 2005 and 2004 was $6 million and $2 million, respectively. The weighted average interest rate for the three months ended March 31, 2005 and 2004 was 3.7% and 2.9%, respectively. Advances to affiliates may be settled in the form of dividends to US Holdings.

 

 

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    TXU Corp. charges TXU Energy Holdings for certain administrative services at cost. These costs, which are primarily included in SG&A expenses, totaled $14 million and $51 million for the three months ended March 31, 2005 and 2004, respectively. Effective July 1, 2004, under the ten year services agreement with Capgemini, several of the services previously performed by TXU Corp. are now provided to TXU Energy Holdings by Capgemini.

 

    TXU Energy Holdings received payments from TXU Gas under a service agreement that began in 2002 and ended June 30, 2004 and covered customer billing and customer support services provided for TXU Gas. These revenues totaled $7 million for the three months ended March 31, 2004, and are included in other revenues. On October 1, 2004, TXU Corp. and Atmos Energy Corporation completed a merger by division in which Atmos Energy Corporation acquired TXU Gas’ operations.

 

    Under Texas regulatory provisions, the trust fund for decommissioning the Comanche Peak nuclear generation facility, reported in investments on TXU Energy Holdings’ balance sheet, is funded by a delivery fee surcharge collected from REPs by TXU Electric Delivery and remitted to TXU Energy Holdings, with the intent that the trust fund assets will be sufficient to fund the decommissioning liability, reported in noncurrent liabilities on TXU Energy Holdings’ balance sheet. Income and expenses associated with the trust fund and decommissioning liability incurred by TXU Energy Holdings are offset by a net change in the intercompany receivable/payable with TXU Electric Delivery, which in turn results in a change in a net regulatory asset/liability. The regulatory asset, which totaled $41 million at March 31, 2005 and is reported on TXU Electric Delivery’s balance sheet, represents the excess of the decommissioning liability over the trust fund balance.

 

    In April 2004, TXU Corp. purchased from the holders TXU Energy Holdings’ exchangeable preferred membership interests, and as a result TXU Energy Holdings has paid distributions to TXU Corp. on these securities, which remain outstanding, since the purchase. Interest expense and related charges associated with these securities, including amortization of the related discount, totaled $17 million for the three months ended March 31, 2005.

 

    See Note 3 for information regarding the accounts receivable securitization program and the related subordinated notes receivable.

 

    Also see discussion immediately below regarding a change in allocation of pension and other postretirement benefit costs.

 

Pension and Other Postretirement Benefits — TXU Energy Holdings is a participating employer in the pension plan sponsored by TXU Corp. TXU Energy Holdings also participates with TXU Corp. and other subsidiaries of TXU Corp. to offer health care and life insurance benefits to eligible employees and their eligible dependents upon the retirement of such employees. The allocated net periodic pension cost and net periodic postretirement benefits cost other than pensions applicable to TXU Energy Holdings was $8 million and $17 million for the three month periods ended March 31, 2005 and 2004, respectively.

 

The discount rate reflected in net pension and other postretirement benefit costs in 2005 is 6.0%. The expected rate of return on plan assets reflected in the 2005 cost amounts is 8.75% for the pension plan and 8.66% for other postretirement benefits.

 

Effective January 1, 2005, TXU Electric Delivery and TXU Energy Holdings entered into an agreement whereby on a prospective basis TXU Electric Delivery assumed responsibility for pension and other postretirement benefit costs for applicable TXU Energy Holdings’ active and retired employees (i.e., former employees of the prederegulation regulated utility) related to employee service prior to the unbundling of TXU Corp.’s electric utility business and the deregulation of the Texas electricity industry effective January 1, 2002. As a result of this agreement, TXU Energy Holdings estimates that its pension and other postretirement benefit costs will decrease approximately $23 million for the full year of 2005, of which $6 million was recognized in the first quarter.

 

Restricted CashAt March 31, 2005, TXU Energy Holdings had $21 million in restricted cash ($6 million reported in current assets and $15 million reported in investments) for demolition and relocation work to be performed by TXU Energy Holdings related to the sale of land.

 

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Accounts Receivable — At March 31, 2005 and December 31, 2004, accounts receivable of $766 million and $1.1 billion are stated net of allowance for uncollectible accounts of $32 million and $15 million, respectively. During the three months ended March 31, 2005, bad debt expense was $11 million, account write-offs were $7 million and changes related to receivables sold increased the allowance for uncollectible accounts by $13 million. During the three months ended March 31, 2004, bad debt expense was $26 million, account write-offs were $41 million and other changes related to receivables sold increased the allowance for uncollectible accounts by $8 million. Allowances related to receivables sold are reported in current liabilities and totaled $32 million and $45 million at March 31, 2005 and December 31, 2004, respectively.

 

Accounts receivable included $292 million and $387 million of unbilled revenues at March 31, 2005 and December 31, 2004, respectively.

 

Commodity Contracts — At March 31, 2005 and December 31, 2004, current and noncurrent commodity contract assets totaled $1.4 billion and $861 million, respectively, and are stated net of applicable credit (collection) and performance reserves totaling $24 million and $15 million, respectively. Performance reserves are provided for direct, incremental costs to settle the contracts.

 

Intangible Assets — Intangible assets other than goodwill are comprised of the followings:

 

     As of March 31, 2005

   As of December 31, 2004

     Gross
Carrying
Amount


   Accumulated
Amortization


   Net

   Gross
Carrying
Amount


   Accumulated
Amortization


   Net

Intangible assets subject to amortization included in property, plant and equipment:

                                         

Capitalized software placed in service

   $ 3    $ 2    $ 1    $ 3    $ 1    $ 2

Land easements

     2      1      1      2      1      1

Other

     31      23      8      31      23      8
    

  

  

  

  

  

Total

   $ 36    $ 26    $ 10    $ 36    $ 25    $ 11
    

  

  

  

  

  

 

Aggregate TXU Energy Holdings amortization expense for intangible assets for the three months ended March 31, 2005 and 2004 was approximately $474,000 and $14 million, respectively. At March 31, 2005, the weighted average useful lives of capitalized software, land easements and other were 5 years, 54 years and 40 years, respectively.

 

The estimated aggregate amortization expense for each of the five succeeding fiscal years from December 31, 2004 is $1 million in 2005 and 2006 and declining thereafter.

 

Goodwill of $517 million at March 31, 2005 and December 31, 2004 was stated net of previously recorded accumulated amortization of $60 million.

 

Inventories by Major Category

 

     March 31,
2005


   December 31,
2004


Materials and supplies

   $ 147    $ 133

Fuel stock

     76      79

Gas stored underground

     73      72
    

  

Total inventories

   $ 296    $ 284
    

  

 

Inventories are carried at average cost.

 

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Table of Contents

Property, Plant and Equipment — At March 31, 2005 and December 31, 2004, property, plant and equipment of $9.9 billion is stated net of accumulated depreciation and amortization of $7.6 billion and $7.5 billion, respectively.

 

Asset Retirement Obligations — SFAS 143 became effective on January 1, 2003. SFAS 143 requires entities to record the fair value of a legal liability for an asset retirement obligation in the period of its inception. For TXU Energy Holdings, such liabilities primarily relate to nuclear generation plant decommissioning, land reclamation related to lignite mining and removal of lignite/coal-fired plant ash treatment facilities. The liability is recorded at its net present value with a corresponding increase in the carrying value of the related long-lived asset. The liability is accreted each period, representing the time value of money, and the capitalized cost is depreciated over the remaining useful life of the related asset.

 

The asset retirement liability at March 31, 2005 was $635 million, comprised of a $631 million liability as of December 31, 2004 and $10 million of accretion during the three months ended March 31, 2005, reduced by $6 million in reclamation payments.

 

With respect to nuclear decommissioning costs, for TXU Energy Holdings the adoption of SFAS 143 results in timing differences in the recognition of asset retirement costs that are being recovered through the regulatory process. Also see discussion above in this Note under “Affiliate Transactions”.

 

Supplemental Cash Flow Information

 

     Three Months Ended
March 31,


 
     2005

   2004

 

Cash payments (receipts) related to continuing operations:

               

Interest (net of amounts capitalized)

   $ 89    $ 73  

Income taxes

   $ 73    $ (1 )

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

TXU Energy Company LLC:

 

We have reviewed the accompanying condensed consolidated balance sheet of TXU Energy Company LLC and subsidiaries (TXU Energy Holdings) as of March 31, 2005, and the related condensed statements of consolidated income, comprehensive income, and cash flows for the three-month periods ended March 31, 2005 and 2004. These interim financial statements are the responsibility of TXU Energy Holdings’ management.

 

We conducted our review in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of TXU Energy Holdings as of December 31, 2004, and the related statements of consolidated income, comprehensive income, cash flows and membership interests for the year then ended (not presented herein); and in our report (which includes explanatory paragraphs related to the Company’s change in method of accounting for stock based compensation with the election to early adopt Statement of Financial Accounting Standards No. 123 (revised 2004) Share-Based Payment and the rescission of Emerging Issues Task Force Issue No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities), dated March 21, 2005, 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, 2004, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

 

/s/ DELOITTE & TOUCHE LLP

 

Dallas, Texas

May 12, 2005

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

BUSINESS

 

TXU Energy Holdings is a wholly-owned subsidiary of US Holdings, which is a wholly-owned subsidiary of TXU Corp. TXU Energy Holdings is engaged in electricity generation and retail and wholesale energy sales. There are no reportable business segments within TXU Energy Holdings.

 

Discontinued operations – See Note 2 to Financial Statements. The sale of the Pedricktown, New Jersey 122 MW power production facility, which is subject to regulatory approval, is expected to close no later than July 2005. Under the definitive sales agreement, proceeds from the transaction are expected to be approximately $8.5 million.

 

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.

 

The results of operations and the related management’s discussion of those results for all periods presented reflect the discontinuance of certain operations of TXU Energy Holdings (see Note 2 to Financial Statements regarding discontinued operations).

 

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Table of Contents

Sales Volume and Customer Count Data

 

     Three Months Ended
March 31,


 
     2005

    2004

 

Sales volumes:

            

Retail electricity sales volumes (GWh):

            

Historical service territory:

            

Residential

   6,317     7,119  

Small business (a)

   2,034     2,533  
    

 

Total historical service territory

   8,351     9,652  

Other territories:

            

Residential

   628     518  

Small business (a)

   139     61  
    

 

Total other territories

   767     579  

Large business and other customers

   4,362     6,709  
    

 

Total retail electricity

   13,480     16,940  

Wholesale electricity sales volumes

   11,480     12,553  
    

 

Total retail and wholesale electricity sales volumes

   24,960     29,493  
    

 

              

Average volume (kWh) per retail customer (b):

            

Residential

   3,256     3,452  

Small business

   7,002     8,084  

Large business and other customers

   63,906     91,240  

Weather (service territory average) – percent of normal (c):

            

Percent of normal:

            

Cooling degree days

   71.1 %   158.4 %

Heating degree days

   87.7 %   93.1 %

Customer counts:

            

Retail electricity customers (end of period and in thousands) (d):

            

Historical service territory:

            

Residential

   1,925     2,054  

Small business (a)

   299     316  
    

 

Total historical service territory

   2,224     2,370  

Other territories:

            

Residential

   195     163  

Small business (a)

   7     5  
    

 

Total other territories

   202     168  

Large business and other customers

   61     78  
    

 

Total retail electricity customers

   2,487     2,616  
    

 


(a) Customers with demand of less than 1 MW annually.
(b) Calculated using average number of customers for period.
(c) Weather data is obtained from Weatherbank, Inc., an independent company that collects and archives weather data from reporting stations of the National Oceanic and Atmospheric Administration (a federal agency under the US Department of Commerce).
(d) Based on number of meters.

 

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Table of Contents

Revenue and Market Share Data

 

     Three Months Ended
March 31,


 
     2005

    2004

 

Operating revenues (millions of dollars):

                

Retail electricity revenues:

                

Historical service territory:

                

Residential

   $ 636     $ 650  

Small business (a)

     228       256  
    


 


Total historical service territory

     864       906  

Other territories:

                

Residential

     57       43  

Small business (a)

     12       6  
    


 


Total other territories

     69       49  

Large business and other customers

     327       453  
    


 


Total retail electricity revenues

     1,260       1,408  

Wholesale electricity revenues

     516       466  

Hedging and risk management activities

     (53 )     (8 )

Other revenues

     80       91  
    


 


Total operating revenues

   $ 1,803     $ 1,957  
    


 


Hedging and risk management activities:

                

Net realized gains (losses)

   $ (29 )   $ 10  

Reversal of previously recognized net unrealized gains

     (9 )     (28 )

Net unrealized gains (losses) on open positions

     (15 )     10  
    


 


Total

   $ (53 )   $ (8 )
    


 


Average revenues per MWh:

                

Residential

   $ 99.74     $ 90.70  

Small business

   $ 110.44     $ 100.83  

Large business and other customers

   $ 75.05     $ 67.53  

Estimated share of ERCOT retail markets (b):

                

Historical service territory:

                

Residential (c)

     79 %     86 %

Small business (c)

     76 %     83 %

Total ERCOT:

                

Residential

     43 %     46 %

Small business

     30 %     32 %

Large business and other customers

     25 %     41 %

(a) Customers with demand of less than 1 MW annually.
(b) Based on number of meters, except large business which is based upon annualized consumption.
(c) Estimated market share is based on the number of customers that have choice.

 

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Table of Contents

Cost of Energy Sold Data

 

     Three Months Ended
March 31,


 
     2005

    2004

 

Fuel and purchased power costs (cost of energy sold, which excludes generation plant operating costs) per MWh:

                

Nuclear generation

   $ 4.18     $ 4.41  

Lignite/coal generation

   $ 11.93     $ 13.28  

Gas/oil generation and purchased power

   $ 51.55     $ 43.90  

Delivery fees per MWh

   $ 25.16     $ 22.34  

Production and purchased power volumes (GWh):

                

Nuclear (baseload)

     4,797       4,854  

Lignite/coal (baseload)

     10,520       10,203  

Gas/oil

     260       910  

Purchased power

     9,806       14,232  
    


 


Total energy supply

     25,383       30,199  

Less line loss and other

     423       706  
    


 


Net energy supply volumes

     24,960       29,493  
    


 


Baseload capacity factors (%):

                

Nuclear

     96.9 %     97.0 %

Lignite/coal

     87.8 %     83.7 %

 

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Table of Contents

Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004

 

Operating revenues declined $154 million, or 8%, to $1.8 billion in 2005. Retail electricity revenues decreased $148 million, or 11%, to $1.3 billion.

 

    This decline reflected a $288 million decrease attributable to a 20% drop in sales volumes, primarily reflecting loss of customers due to competitive activity, particularly in the large business market, as well as milder weather. Lower business market volumes also reflected a strategy to target higher margin customer segments.

 

    The effect of lower retail volumes was partially offset by $140 million in higher average pricing due to increased price-to-beat rates, reflecting regulatory-approved fuel factor increases in 2004 and higher pricing in the competitive business market, both resulting from higher natural gas prices.

 

    Retail electricity customer counts at March 31, 2005 declined 4.9% from March 31, 2004.

 

    Wholesale electricity revenues grew $50 million, or 11%, to $516 million reflecting a $90 million increase due to the effect of increased natural gas prices on wholesale prices, partially offset by a $40 million decrease attributable to a 9% decline in sales volumes.

 

    The comparison to 2004 reflects an increase in wholesale electricity sales volumes in the first quarter of 2004 due to the establishment of the new northeast zone in ERCOT. Because TXU Energy Holdings has a generation plant and a relatively small retail customer base in the new zone, wholesale sales volumes increased, and wholesale power purchases also increased to meet retail sales demand in other zones and minimize congestion costs. Completion of transmission projects later in 2004 reduced congestion costs, resulting in normalized sales and purchase volumes in the first quarter of 2005.

 

    The decrease in other revenues of $11 million primarily reflected the sale of the gas transportation business in June 2004.

 

Results from hedging and risk management activities, which are reported in revenues and include both realized and unrealized gains and losses, totaled $53 million in net losses in 2005 and $8 million in net losses in 2004. Because the hedging activities are intended to mitigate the risk of commodity price movements on revenues and cost of energy sold, the changes in such results should not be viewed in isolation, but rather taken together with the effects of pricing and cost changes on gross margin. Results in 2005 included:

 

    $24 million in net losses reclassified from accumulated other comprehensive income; and

 

    $20 million in net unrealized losses from hedges against lower natural gas prices.

 

Gross Margin

 

     Three Months Ended March 31,

 
     2005

   % of
Revenue


    2004

   % of
Revenue


 

Operating revenues

   $ 1,803    100 %   $ 1,957    100 %

Costs and expenses:

                          

Cost of energy sold and delivery fees

     1,056    59 %     1,254    64 %

Generation plant operating costs

     152    8 %     167    9 %

Depreciation and amortization

     78    4 %     82    4 %
    

  

 

  

Gross margin

   $ 517    29 %   $ 454    23 %
    

  

 

  

 

Gross margin is considered a key operating metric as it measures the effect of changes in sales volumes and pricing versus the variable and fixed costs to generate and deliver energy. Cost of energy sold consists of fuel and purchased power costs. Operating costs relate directly to generation plants. Depreciation and amortization expense included in gross margin relates to assets that are directly used in the generation of electricity.

 

Gross margin increased $63 million, or 14%, to $517 million in 2005.

 

    Higher gross margin reflected initiatives taken to respond to higher wholesale power prices that were driven by higher natural gas prices, including retail pricing actions and more cost effective sourcing of power. The gross margin increase reflected higher retail and wholesale prices partially offset by the effect of lower volumes and lower results from hedging and risk management activities.

 

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    A favorable effect on gross margin of lower cost of energy sold (fuel and purchased power costs) was largely offset by higher delivery fees on a per MWh basis.

 

    Cost of energy sold reflected the favorable effect of lower purchased power volumes (due to lower sales volumes), improved efficiency of coal/lignite-fired generation plants and lower use of gas-fired generation, partially offset by higher per MWh cost of purchased power due to rising wholesale prices.

 

Operating costs decreased $15 million, or 9%, to $152 million in 2005. The decline reflected an $8 million effect of no longer providing customer care support to TXU Gas (largely offset by lower related revenues), the operations of which were sold in October 2004, and the absence of $4 million of costs associated with the gas transportation business sold in June 2004. The decline also reflects $3 million in lower pension and other postretirement benefit costs (see discussion in SG&A expenses below regarding these costs).

 

Depreciation and amortization (including amounts shown in the gross margin table above) decreased $18 million, or 19%, to $79 million. The decline included $14 million due to the effect of the transfer of information technology assets, principally capitalized software, to a TXU Corp. affiliate in connection with the Capgemini outsourcing transaction and $3 million due to the reduction of 2005 depreciation rates for lignite/coal-fired plants due to an increase in the estimated useful lives.

 

SG&A expenses decreased by $35 million, or 24%, to $113 million in 2005. The decline reflected:

 

    $15 million in lower bad debt expense reflecting stricter disconnect policies, more focused collection activities, targeted customer marketing and lower accounts receivable balances;

 

    a net $12 million decline due to cost reduction initiatives, including the effects of the Capgemini agreement;

 

    a $3 million net decrease in employee retirement-related expenses due to the assumption by TXU Electric Delivery of $6 million in pension and other postretirement benefit costs related to service of TXU Energy Holdings’ employees prior to the unbundling of TXU Corp.’s electric utility business and the deregulation of the Texas electricity industry effective January 1, 2002. This change in retirement-related expense allocation was based on an agreement between TXU Energy Holdings and TXU Electric Delivery effective January 1, 2005 (also see Note 7 to Financial Statements); and

 

    $2 million in reduced incentive compensation expense.

 

Other deductions decreased $19 million to $1 million in 2005. This line item reflects:

 

    a $12 million charge related to nonperformance of a counterparty in connection with a trading coal contract;

 

    $2 million in equity losses (representing amortization expense) in the TXU Corp. entity holding the capitalized software licensed to Capgemini;

 

    $2 million in transition costs associated with the Capgemini outsourcing agreement;

 

    a $15 million credit arising from a change in estimated sublease proceeds, due to the receipt of indicative bids in the quarter, reflected in the net liability recorded in 2004 related to leased gas-fired combustion turbines no longer in service. As the original charge associated with this liability was recorded in this line item, the related credit is being similarly reported; and

 

    charges in 2004 totaling $17 million for employee severance and asset writedowns related to the restructuring actions.

 

Interest income increased by $7 million to $9 million in 2005 reflecting higher interest on short-term investments and higher average advances to affiliates.

 

Interest expense and related charges increased by $12 million, or 15%, to $91 million in 2005. The increase reflected $9 million due to higher average debt levels and $3 million representing higher interest reimbursement to TXU Electric Delivery for carrying costs related to securitized regulatory assets.

 

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Table of Contents

The effective income tax rate was 31.4% in both 2005 and 2004. There were no material unusual items affecting the comparison.

 

Income from continuing operations increased $87 million to $203 million in 2005 driven by improved gross margin and lower SG&A expenses. Net pension and postretirement benefit costs reduced net income by $5 million in 2005 and $10 million in 2004.

 

Energy-Related Commodity Contracts and Mark-to-Market Activities

 

The table below summarizes the changes in commodity contract assets and liabilities for the three months ended March 31, 2005. The net changes in these assets and liabilities, excluding “other activity” as described below, represent the net effect of recording unrealized gains/(losses) under mark-to-market accounting for positions in the commodity contract portfolio. These positions consist largely of economic hedge transactions, with speculative trading representing a small fraction of the activity.

 

     Three
Months
Ended
March 31,
2005


 

Balance of net commodity contract assets at beginning of period

   $ 23  

Settlements of positions included in the opening balance (1)

     (9 )

Unrealized mark-to-market valuations of positions held at end of period

     (18 )

Other activity (2)

     109  
    


Balance of net commodity contract assets at end of period

   $ 105  
    



(1) Represents unrealized mark-to-market valuations of these positions recognized in earnings as of the beginning of the period.
(2) These activities have no effect on unrealized mark-to-market valuations. Includes initial values of positions involving the receipt or payment of cash or other consideration, including $114 million related to natural gas physical swap transactions, as well as option premiums and related amortization. Also includes a $12 million charge related to nonperformance by a coal contract counterparty.

 

In addition to the net effect of recording unrealized mark-to-market gains and losses that are reflected in changes in commodity contract assets and liabilities, similar effects arise in the recording of unrealized ineffectiveness mark-to-market gains and losses associated with commodity-related cash flow hedges. These effects are reflected in the balance sheet as changes in cash flow hedge and other derivative assets and liabilities. The total net effect of recording unrealized gains and losses under mark-to-market accounting is summarized as follows:

 

     Three Months
Ended March
31,


 
     2005

    2004

 

Net unrealized losses in mark-to-market commodity contract portfolio

   $ (27 )   $ (3 )

Net ineffectiveness gains/(losses) related to cash flow hedges

     3       (15 )
    


 


Total net unrealized losses associated with energy-related commodity contracts

   $ (24 )   $ (18 )
    


 


 

These amounts are included in the “hedging and risk management activities” component of revenues.

 

Maturity Table — Of the net commodity contract asset balance above at March 31, 2005, the amount representing unrealized mark-to-market net losses that have been recognized in current and prior years’ earnings is $16 million. The offsetting net asset of $121 million included in the March 31, 2005 balance sheet is comprised principally of amounts representing current and prior years’ net payments of cash or other

 

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consideration, including option premiums, net of amortization, and natural gas physical swap transactions. The following table presents the unrealized mark-to-market balance at March 31, 2005, scheduled by contractual settlement dates of the underlying positions.

 

     Maturity dates of unrealized net mark-to-market balances at March 31, 2005

 

Source of fair value


  

Maturity less
than

1 year


   

Maturity of

1-3 years


   

Maturity of

4-5 years


   

Maturity in

Excess of

5 years


    Total

 

Prices actively quoted

   $ 29     $ 47     $  —       $  —       $ 76  

Prices provided by other external sources

     (87 )     (17 )     5       (3 )     (102 )

Prices based on models

     10       —         —         —         10  
    


 


 


 


 


Total

   $ (48 )   $ 30     $ 5     $ (3 )   $ (16 )
    


 


 


 


 


Percentage of total fair value

     300 %     (188 )%     (31 )%     19 %     100 %

 

As the above table indicates, 112% of the unrealized mark-to-market valuations at March 31, 2005 mature within three years. This is reflective of the terms of the positions and the methodologies employed in valuing positions for periods where there is less market liquidity and visibility. The “prices actively quoted” category reflects only exchange traded contracts with active quotes available. The “prices provided by other external sources” category represents forward commodity positions at locations for which over-the-counter broker quotes are available. Over-the-counter quotes for power and natural gas generally extend through 2006 and 2010, respectively. The “prices based on models” category contains the value of all nonexchange traded options, valued using industry accepted option pricing models. In addition, this category contains other contractual arrangements which may have both forward and option components. In many instances, these contracts can be broken down into their component parts and modeled as simple forwards and options based on prices actively quoted. As the modeled value is ultimately the result of a combination of prices from two or more different instruments, it has been included in this category.

 

COMPREHENSIVE INCOME

 

Cash flow hedge activity reported in other comprehensive income from continuing operations included:

 

     March 31,

 
     2005

   2004

 

Cash flow hedge activity (net of tax):

               

Net change in fair value of hedges – gains/(losses):

               

Commodities

   $ 15    $ (58 )
    

  


       15      (58 )

Losses realized in earnings (net of tax):

               

Commodities

     16      4  

Financing – interest rate swaps

     1      1  
    

  


       17      5  

Effect of cash flow hedges reported in comprehensive results related to continuing operations

   $ 32    $ (53 )
    

  


 

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Table of Contents

FINANCIAL CONDITION

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash Flows — Cash flows provided by operating activities for the three months ended March 31, 2005 were $243 million compared to $421 million for the three months ended March 31, 2004. The principal drivers of the $178 million decrease were a $73 million federal income tax payment to TXU Corp. related to 2004 and $114 million in gas purchases in connection with natural gas physical swap transactions. Substantially all of the proceeds from these swap transactions are expected to be received by year-end 2005.

 

Cash flows used in financing activities were $153 million in 2005 compared to $343 million used in 2004. The activity in 2005 reflected advances to affiliates of $175 million, distributions to US Holdings of $175 million and $197 million provided by net issuances and repayments of borrowings. The activity in 2004 reflected advances to affiliates of $243 million, distributions to US Holdings of $175 million and $75 million provided by bank borrowings.

 

Cash flows used in investing activities totaled $89 million in 2005 compared to $72 million used during 2004. Capital expenditures, including nuclear fuel, were $84 million in 2005 and $82 million in 2004. Capital expenditures in 2005 reflected increased spending for generation plant upgrades and normal major repairs, including the nuclear steam generator replacement.

 

Depreciation and amortization expense reported in the statement of cash flows exceeds the amount reported in the statement of income by $15 million for 2005. This difference represents amortization of nuclear fuel, which is reported as cost of energy sold in the statement of income consistent with industry practice.

 

Financing Activities

 

Long-term Debt Activity — During the three months ended March 31, 2005, TXU Energy Holdings remarketed and converted to floating rate mode the Brazos River Authority Series 2001A pollution control revenue bonds with an aggregate principal amount of $71 million. The bonds were purchased upon mandatory tender in April 2004.

 

On May 2, 2005, TXU Energy Holdings repurchased all of the Brazos River Authority Pollution Control Revenue (Refunding) Bonds Series 1994A, in aggregate principal amount of $39 million, at a price of 100% of the principal amount thereof, upon the scheduled mandatory tender date for this series. TXU Energy Holdings currently plans to remarket the bonds later this year.

 

Credit Facilities At May 5, 2005, TXU Energy Holdings had access to credit facilities totaling $4.0 billion of which $2.8 billion was unused. These credit facilities are used for working capital and general corporate purposes and to support issuances of letters of credit. See Note 3 to Financial Statements for details of the arrangements.

 

Short-term Borrowings — At March 31, 2005, TXU Energy Holdings had outstanding short-term borrowings consisting of bank borrowings of $345 million at a weighted average interest rate of 3.29%. At December 31, 2004, TXU Energy Holdings had outstanding short-term borrowings consisting of bank borrowings of $210 million at a weighted average interest rate of 5.25%.

 

Sale of Receivables — TXU Corp. has established an accounts receivable securitization program. The activity under this program is accounted for as a sale of accounts receivable in accordance with SFAS 140. Under the program, subsidiaries of TXU Corp. (originators) sell trade accounts receivable to TXU Receivables Company, a consolidated wholly-owned bankruptcy remote direct subsidiary of TXU Corp., which sells undivided interests in the purchased accounts receivable for cash to special purpose entities established by financial institutions. All new trade receivables under the program generated by the originators are continuously purchased by TXU Receivables Company with the proceeds from collections of receivables previously purchased. Funding to TXU Energy Holdings under the program totaled $435 million and $411 million at March 31, 2005 and December 31, 2004, respectively. See Note 3 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.

 

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Table of Contents

Credit Ratings — Current credit ratings for TXU Corp. and certain of its subsidiaries are presented below:

 

     TXU Corp.

   US Holdings

   TXU Electric
Delivery


   TXU Electric
Delivery


   TXU Energy
Holdings


     (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

 

TXU Electric Delivery’s first mortgage bonds are rated A- and its senior secured notes are rated BBB+ by Fitch. Moody’s currently maintains a stable outlook for TXU Corp., US Holdings, TXU Energy Holdings and TXU Electric Delivery. Fitch changed its outlook to negative for TXU Corp., US Holdings and TXU Energy Holdings and reaffirmed its stable outlook for TXU Electric Delivery on May 6, 2005. S&P placed each such entity on negative watch on May 6, 2005.

 

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.

 

It is anticipated that any downgrade by S&P would be one notch. The negative impact of such a downgrade on TXU Energy Holdings’ liquidity is currently estimated to be approximately $100 million.

 

Financial Covenants, Credit Rating Provisions and Cross Default Provisions — The terms of certain financing arrangements of TXU Energy Holdings contain financial covenants that require maintenance of specified fixed charge coverage ratios and leverage ratios and/or contain minimum net worth covenants. As of March 31, 2005, all such applicable covenants were complied with or waivers were obtained.

 

Material Credit Rating Covenants

 

TXU Energy Holdings has provided a guarantee of the obligations under TXU Corp.’s lease of its headquarters building (approximately $115 million at March 31, 2005). In the event of a downgrade of TXU Energy Holdings’ credit rating to below investment grade, a letter of credit would need to be provided within 30 days of any such rating decline.

 

Under the terms of leases aggregating $149 million in remaining lease payments, if TXU Energy Holdings’ credit rating were downgraded to below investment grade by any specified rating agency, TXU Energy Holdings could be required to sell the assets, assign the leases to a new obligor that is investment grade, post a letter of credit or defease the leases. In July 2005, a rail spur lease will terminate and result in a reduction of $97 million of the $149 million in remaining lease payments, which are subject to the rating downgrade provision.

 

TXU Energy Holdings has entered into certain commodity contracts and lease arrangements that in some instances give the other party the right, but not the obligation, to request TXU Energy Holdings to post collateral in the event that its credit rating falls below investment grade. Based on its current commodity contract positions, if TXU Energy Holdings were downgraded to below investment grade by specified rating agencies, counterparties would have the option to request TXU Energy Holdings to post additional collateral of up to approximately $148 million at March 31, 2005. The amount TXU Energy Holdings could be required to post under these transactions depends in part on the value of the contracts at that time.

 

ERCOT also has rules in place to assure adequate credit worthiness for parties that schedule power on the ERCOT System. Under those rules, if TXU Energy Holdings’ credit rating were downgraded to below investment grade by any specified rating agency, TXU Energy Holdings could be required to post collateral of approximately $6 million.

 

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Table of Contents

Other arrangements of TXU Energy Holdings, including credit facilities, contain terms pursuant to which the interest rates charged under the agreements may be adjusted depending on the credit ratings of TXU Energy Holdings or its subsidiaries.

 

Material Cross Default Provisions

 

Certain financing arrangements contain provisions that would result in an event of default if there were a failure under other financing arrangements to meet payment terms or to observe other covenants that would result in an acceleration of payments due. Such provisions are referred to as “cross default” provisions.

 

A default by TXU Energy Holdings or TXU 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 under the $3.5 billion joint credit facilities expiring in June 2008, March 2010 and June 2010. Under these credit facilities, a default by TXU Energy Holdings or any subsidiary thereof would cause the maturity of outstanding balances under such facility to be accelerated as to TXU Energy Holdings but not as to TXU Electric Delivery. Also, under this credit facility, a default by TXU Electric Delivery or any subsidiary thereof would cause the maturity of outstanding balances under such facility to be accelerated as to TXU Electric Delivery but not as to TXU Energy Holdings.

 

A default by US Holdings or any subsidiary thereof on indebtedness in the unpaid principal amount in excess of $1 million would result in a default of the TXU Mining (a subsidiary of TXU Energy Holdings) $30 million senior notes that mature August 1, 2005.

 

TXU Energy Holdings has entered into certain mining and related equipment leasing arrangements aggregating $81 million that would terminate upon the default of any other obligations of TXU Energy Holdings owed to the lessor.

 

The accounts receivable securitization program also contains a cross default provision with a threshold of $50 million applicable to each of the originators under the program. TXU Receivables Company and TXU Business Services Company each have a cross default threshold of $50 thousand. If either an originator, TXU Business Services or TXU Receivables Company defaults on indebtedness of the applicable threshold, the facility could terminate.

 

TXU Energy Holdings enters into energy-related and financial contracts, the master forms of which contain provisions whereby an event of default or acceleration of settlement would occur if TXU Energy Holdings were to default under an obligation in respect of borrowings in excess of thresholds, which vary, stated in the contracts.

 

Other arrangements, including leases, have cross default provisions, the triggering of which would not result in a significant effect on liquidity.

 

Long-term Contractual Obligations and Commitments There have been no significant changes in contractual cash obligations of TXU Energy Holdings’, since December 31, 2004 as disclosed in the 2004 Form 10-K.

 

OFF BALANCE SHEET ARRANGEMENTS

 

TXU Corp.’s accounts receivable securitization program is discussed above under “Sale of Receivables” and in Note 3 to Financial Statements.

 

In May 2004, as part of an overall arrangement initiated by and involving TXU Corp. and its subsidiaries, TXU Energy Holdings entered into a services agreement with Capgemini Energy LP (Capgemini). Outsourced base support services performed by Capgemini for a fixed fee, subject to adjustment for volumes or other factors, include information technology, customer call center, billing, human resources, supply chain and certain accounting activities.

 

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Table of Contents

As part of the agreement, Capgemini was provided a royalty-free right, under an asset license arrangement, to use TXU Corp.’s information technology assets, consisting primarily of capitalized software. The information technology assets 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 TXU Energy Holdings on the equity method.

 

TXU Corp. obtained a 2.9% limited partnership interest in Capgemini in exchange for the asset license. TXU Corp. has the right to sell (the put option) its interest and the licensed software to Cap Gemini North America Inc. for $200 million, plus its 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 these 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. TXU Energy Holdings recorded its share of the fair value of the put option, estimated at $103 million, as a noncurrent asset.

 

Also see Note 5 to Financial Statements regarding guarantees.

 

COMMITMENTS AND CONTINGENCIES

 

See Note 5 to Financial Statements for additional discussion of commitments and contingencies.

 

REGULATION AND RATES

 

Price-to-Beat Rates —On April 15, 2005, TXU Energy Holdings filed a request for a price-to-beat increase which was approved by the Commission on May 11, 2005. The increase was effective immediately. The price-to-beat increase raises the average monthly residential bill by 9.9%.

 

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 reauthorize the Commission for six years, and has recommended other changes to PURA that are not expected to have a material impact upon TXU Energy Holdings’ operations. The Legislature is currently considering additional legislation and could enact other changes to PURA, but TXU Energy Holdings cannot predict whether any such changes might have a material impact on its operations.

 

Texas Legislative Session – The Texas legislature is currently in session and is considering various matters, including changes to various tax provisions and changes to the Public Utilities Regulatory Act (PURA) resulting from the state-mandated sunset review of the Public Utility Commission of Texas. TXU Energy Holdings cannot predict the ultimate outcome of this or any other matters under consideration by the legislature.

 

Wholesale Market Design – In August 2003, the Commission adopted a rule that, if fully implemented, would alter the wholesale market design in ERCOT. The rule requires ERCOT:

 

    to use a stakeholder process to develop a new wholesale market model;

 

    to operate a voluntary day-ahead energy market;

 

    to directly assign all congestion rents to the resources that caused the congestion;

 

    to use nodal energy prices for resources;

 

    to provide information for energy trading hubs by aggregating nodes;

 

    to use zonal prices for loads; and

 

    to provide congestion revenue rights (but not physical rights).

 

In December 2004, a cost-benefit analysis prepared by a third-party consultant was filed with the Commission by ERCOT. ERCOT filed its description of the proposed market design on March 18, 2005, subject to a commitment to update the filing when the description of the financial settlement for the proposed market design is completed. TXU Energy Holdings is currently unable to predict the cost or impact of implementing any proposed change to the current wholesale market design.

 

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Wholesale Market Investigation — On December 8, 2004, the Commission Staff opened a project (PUC Project No. 30513) to facilitate an ongoing informal fact-finding review of the electric wholesale market activities of TXU Energy Holdings and its affiliates. Commission Staff indicated that it “created this project because of substantial concerns publicly expressed by the Commission and market participants about TXU’s recent activities.” TXU Energy Holdings’ discussions with Commission Staff and the requests for information indicate that the informal review is focused on TXU Energy Holdings’ offers to sell balancing energy services in ERCOT. Balancing energy constitutes only about five to ten percent of the energy sold at wholesale in ERCOT. TXU Energy Holdings has been fully cooperating with the Commission Staff in its review and has fully responded to Commission Staff’s requests for information. On April 26, 2005, the Commission Staff issued a report by its consultant, Potomac Economics, concerning the balancing energy transactions at issue. This report indicates no evidence of unlawful activities by TXU Energy Holdings. The Staff indicated in an accompanying memorandum that it does not intend to pursue any enforcement actions against market participants, including TXU Energy Holdings, in this matter.

 

Nuclear Decommissioning — Through December 31, 2001, decommissioning costs were recovered from consumers based upon a 1992 site-specific study through rates placed in effect under TXU Corp.’s January 1993 rate increase request. Effective January 1, 2002, decommissioning costs are recovered through a tariff charged to REPs by TXU Electric Delivery based upon a 1997 site-specific study, adjusted for trust fund assets, as a component of delivery fees effective under TXU Corp.’s 2001 Unbundled Cost of Service filing. During the first quarter of 2005, an updated study of the cost to decommission TXU Corp.’s nuclear generating facility was completed and options to fund the cost are being evaluated. Based on the study, changes in the tariff, if any, are expected to be filed with the PUC in mid-2005.

 

Summary — Although TXU Energy Holdings cannot predict future regulatory or legislative actions or any changes in economic and securities market conditions, no changes are expected in trends or commitments, other than those discussed in this report, which might significantly alter its basic financial position, results of operations or cash flows.

 

CHANGES IN ACCOUNTING STANDARDS

 

See Note 1 to Financial Statements for discussion of changes in accounting standards.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

Market risk is the risk that TXU Energy Holdings may experience a loss in value as a result of changes in market conditions affecting commodity prices and interest rates, which TXU Energy Holdings is exposed to in the ordinary course of business. TXU Energy Holdings’ exposure to market risk is affected by a number of factors, including the size, duration and composition of its energy and financial portfolio, as well as volatility and liquidity of markets. TXU Energy Holdings enters into financial instruments such as interest rate swaps to manage interest rate risks related to its indebtedness, as well as exchange traded, over-the-counter contracts and other contractual commitments to manage commodity price risk as part of its wholesale markets management activities.

 

RISK OVERSIGHT

 

TXU Corp.’s wholesale markets management operation manages the market, credit and operational risk related to commodity prices of the unregulated energy business within limitations established by senior management and in accordance with TXU Corp.’s overall risk management policies. Interest rate risks are managed centrally by the corporate treasury function. Market risks are monitored daily by risk management groups that operate and report independently of the wholesale markets management operations, utilizing industry accepted practices and analytical methodologies. These techniques measure the risk of change in value of the portfolio of contracts and the hypothetical effect on this value from changes in market conditions and include, but are not limited to, Value at Risk (VaR) methodologies.

 

TXU Corp. has a corporate risk management organization that is headed by a Chief Risk Officer. The Chief Risk Officer, through his designees, enforces all applicable risk limits, including the respective policies and procedures to ensure compliance with such limits and evaluates the risks inherent in the various businesses of

 

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TXU Corp. and their associated transactions. Key risk control activities include, but are not limited to, credit review and approval, operational and market risk measurement, validation of transaction capture, portfolio valuation and daily portfolio reporting, including mark-to-market valuation, VaR and other risk measurement metrics.

 

COMMODITY PRICE RISK

 

TXU Energy Holdings is subject to the inherent risks of market fluctuations in the price of electricity, natural gas and other energy-related products marketed and purchased. TXU Energy Holdings actively manages its portfolio of owned generation assets, fuel supply and retail sales load to mitigate the near-term impacts of these risks on its results of operations. TXU Energy Holdings, as well as any participant in the market, cannot fully manage the long-term value impact of structural declines or increases in natural gas, power and oil prices and spark spreads (differences between the market price of electricity and its cost of production).

 

In managing energy price risk, TXU Energy Holdings enters into short- and long-term physical contracts, exchange traded and over-the-counter financial contracts as well as bilateral contracts with customers. TXU Energy Holdings’ risk management activities also incorporate some speculative trading activity. The operation continuously monitors the valuation of identified risks and adjusts the portfolio based on current market conditions. Valuation adjustments or reserves are established in recognition that certain risks exist until full delivery of energy has occurred, counterparties have fulfilled their financial commitments and related financial instruments have either matured or are closed out.

 

TXU Energy Holdings strives to use consistent assumptions regarding forward market price curves in evaluating and recording the effects of commodity price risk.

 

VaR Methodology — A VaR methodology is used to measure the amount of market risk that exists within the portfolio under a variety of market conditions. The resultant VaR produces an estimate of a portfolio’s potential for loss given a specified confidence level and considers among other things, market movements utilizing standard statistical techniques given historical and projected market prices and volatilities. Stress testing of market variables is also conducted to simulate and address abnormal market conditions.

 

The use of this method requires a number of key assumptions, such as use of (i) an assumed confidence level; (ii) an assumed holding period (i.e. the time necessary for management action, such as to liquidate positions); and (iii) historical estimates of volatility and correlation data.

 

VaR for Energy Contracts Subject to Mark-to-Market Accounting — This measurement estimates the potential loss in value, due to changes in market conditions, of all energy-related contracts subject to mark-to-market accounting, based on a specific confidence level and an assumed holding period. Assumptions in determining this VaR include using a 95% confidence level and a five-day holding period. A probabilistic simulation methodology is used to calculate VaR, and is considered by management to be the most effective way to estimate changes in a portfolio’s value based on assumed market conditions for liquid markets.

 

     March 31,
2005


   December 31,
2004


Period-end MtM VaR:

   $ 21    $ 20

Average Month-end MtM VaR:

   $ 17    $ 20

 

Earnings at Risk (EaR) — EaR measures the estimated potential loss of expected pretax earnings for the year presented due to changes in market conditions. EaR metrics include the owned generation assets, estimates of retail load and all contractual positions except for accrual positions expected to be settled beyond the fiscal year. Assumptions include using a 95% confidence level over a five-day holding period under normal market conditions.

 

Cash Flow at Risk (CFaR) — CFaR measures the estimated potential loss of expected cash flow over the next six months, due to changes in market conditions. CFaR metrics include all owned generation assets, estimates of retail load and all contractual positions that impact cash flow during the next six months.

 

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Assumptions include using a 99% confidence level over a six-month holding period under normal market conditions.

 

     March 31,
2005


   December 31,
2004


EaR

   $ 24    $ 24

CFaR

   $ 62    $ 116

 

Natural Gas Price & Market Heat-Rate Exposure — Wholesale electricity prices in the Texas market generally move with the price of natural gas because marginal demand is generally met with gas-fired generation plants. Wholesale electricity prices also move with market heat rates, which are a measure of the efficiency of the marginal supplier (generally gas plants) in generating electricity.

 

TXU Energy Holdings is both a producer and a buyer of wholesale electricity. The generation operations supply power to the wholesale market and the retail business, which also purchases power in the wholesale market. The combination of these two businesses provides a partial natural hedge against near-term price volatility in wholesale electricity and natural gas markets. With this natural hedge and TXU Energy Holdings’ wholesale market positions, for 2005 TXU Energy Holdings’ portfolio position is substantially balanced with respect to changes in natural gas prices, given TXU Energy Holdings’ projections of baseload unit availability and customer churn and assuming no changes in the price-to-beat rates. The primary sensitivity to natural gas prices over the near term derives from the price-to-beat structure for residential and small business customers; higher price-to-beat rates triggered by higher gas prices could result in increased profitability but also more customer churn, and vice versa. In the near term, TXU Energy Holdings has more significant exposure to changes in market heat rates than natural gas prices, in part due to TXU Energy Holdings’ 8,825 MW of active gas-fired generation capacity in Texas that TXU Energy Holdings currently dispatches for its own use. TXU Energy Holdings expects that increases in heat rates would increase the profitability of its overall market position and its gas-fired generation fleet, and vice versa.

 

Over the longer term, TXU Energy Holdings’ exposure to changes in natural gas prices and market heat rates is expected to increase. The magnitude of this exposure is determined by several key assumptions including, but not limited to, baseload generation capacity factors, gas plant availability, the size of the retail business (both large business and residential), and the levels and stability of margins in the retail business. In the unlikely case that TXU Energy Holdings’ retail price changes exactly and immediately mirrored changes in wholesale electricity markets, TXU Energy Holdings could experience an approximate $250 million reduction in annual pretax earnings for every $0.50 per million British thermal units reduction in natural gas prices (approximate 7% change in current price) sustained over a full year. In the same scenario of retail price linkage to wholesale markets, if natural gas prices and other nonprice conditions remained unchanged, but ERCOT electricity prices declined by $5/MWh (approximate 8% change in current price) for a full year because of declining market heat rates, TXU Energy Holdings could experience an approximate $320 million reduction in annual pretax earnings.

 

INTEREST RATE RISK

 

See Note 3 to Financial Statements for a discussion of the issuance and retirement of debt since December 31, 2004.

 

CREDIT RISK

 

Credit Risk — Credit risk relates to the risk of loss associated with nonperformance by counterparties. TXU Corp. maintains credit risk policies with regard to its counterparties to minimize overall credit risk. These policies require an evaluation of a potential counterparty’s financial condition, credit rating, and other quantitative and qualitative credit criteria and specify authorized risk mitigation tools, including but not limited to use of standardized agreements that allow for netting of positive and negative exposures associated with a single counterparty. TXU Corp. has standardized documented processes for monitoring and managing its credit exposure, including methodologies to analyze counterparties’ financial strength, measurement of current and potential future credit exposures and standardized contract language that provides rights for netting and set-off. Credit enhancements such as parental guarantees, letters of credit, surety bonds and margin deposits are also utilized. Additionally, individual counterparties and credit portfolios are managed to preset limits and stress tested to assess potential credit exposure. This evaluation results in establishing credit limits or collateral

 

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requirements prior to entering into an agreement with a counterparty that creates credit exposure to TXU Corp. Additionally, TXU Corp. has established controls to determine and monitor the appropriateness of these limits on an ongoing basis. Any prospective material adverse change in the payment history or financial condition of a counterparty or downgrade of its credit quality will result in the reassessment of the credit limit with that counterparty. This process can result in the subsequent reduction of the credit limit or a request for additional financial assurances.

 

Credit Exposure — TXU Energy Holdings’ gross exposure to credit risk related to trade accounts receivable, as well as commodity contract assets and other derivative assets that arise primarily from hedging activities, totaled $2.2 billion at March 31, 2005.

 

A large share of gross assets subject to credit risk represents accounts receivable from the retail sale of electricity to residential and small business customers. The risk of material loss (after consideration of allowances) from nonperformance by these customers is unlikely based upon historical experience. Allowances for uncollectible accounts receivable are established for the potential loss from nonpayment by these customers based on historical experience and market or operational conditions.

 

Most of the remaining trade accounts receivable are with large business customers and hedging counterparties. These counterparties include major energy companies, financial institutions, electric utilities, independent power producers, oil and gas producers and energy trading companies. The exposure to credit risk from these customers and counterparties, excluding credit collateral, as of March 31, 2005, is $1.09 billion net of standardized master netting contracts and agreements that provide the right of offset of positive and negative credit exposures with individual customers and counterparties. When considering collateral currently held by TXU Energy Holdings (cash, letters of credit and other security interests), the net credit exposure is $860 million. Of this amount, approximately 85% of the associated exposure is with investment grade customers and counterparties, as determined using publicly available information including major rating agencies’ published ratings and TXU Energy Holdings’ internal credit evaluation process. Those customers and counterparties without an S&P rating of at least BBB- or similar rating from another major rating agency are rated using internal credit methodologies and credit scoring models to estimate an S&P equivalent rating. TXU Energy Holdings routinely monitors and manages its credit exposure to these customers and counterparties on this basis.

 

TXU Energy Holdings is also exposed to credit risk related to the Capgemini put option with a carrying value of $103 million. Subject to certain terms and conditions, Cap Gemini North America, Inc. and its parent, Cap Gemini S.A., have guaranteed the performance and payment obligations of Capgemini under the services agreement, as well as the payment in connection with the put option. S&P currently maintains a BB+ rating with a negative outlook for Cap Gemini S.A.

 

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The following table presents the distribution of credit exposure as of March 31, 2005, for trade accounts receivable from large business customers, commodity contract assets and other derivative assets that arise primarily from hedging activities, by investment grade and noninvestment grade, credit quality and maturity.

 

                       Exposure by Maturity

     Exposure
before
Credit
Collateral


    Credit
Collateral


    Net
Exposure


    2 years or
less


  

Between

2-5 years


   Greater
than 5
years


   Total

Investment grade

   $ 894     $ 166     $ 728     $ 554    $ 94    $ 80    $ 728

Noninvestment grade

     196       64       132       102      16      14      132
    


 


 


 

  

  

  

Totals

   $ 1,090     $ 230     $ 860     $ 656    $ 110    $ 94    $ 860
    


 


 


 

  

  

  

Investment grade

     82 %     72 %     85 %                           

Noninvestment grade

     18 %     28 %     15 %                           

 

TXU Energy Holdings had exposure with two counterparties each having exposure greater than 10% of the net exposure of $860 million at March 31, 2005. These two counterparties represent approximately 10% and 11% respectively of the net exposure and are viewed to be a minimal credit risk. Additionally, approximately 76% of the credit exposure, net of collateral held, has a maturity date of two years or less. TXU Energy Holdings does not anticipate any material adverse effect on its financial position or results of operations as a result of nonperformance by any customer or counterparty.

 

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

 

Some important factors, in addition to others specifically addressed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, that could have a material impact on TXU Energy Holdings’ operations, financial results and financial condition, and could cause TXU Energy Holdings’ actual results or outcomes to differ materially from any projected outcome contained in any forward-looking statement in this report, include:

 

The implementation of performance improvement initiatives identified by management may not produce the desired results and may result in disruptions arising from employee displacements and the rapid pace of changes to organizational structure and operating practices and processes. Most notably, TXU Energy Holdings is subject to the risk that the joint venture outsourcing arrangement with Capgemini may not produce the desired cost savings as well as potential transition costs, which would likely be significant, in the event TXU Energy Holdings needed to switch to another vendor if Capgemini failed to perform its obligations to TXU Energy Holdings.

 

ERCOT is the independent system operator that is responsible for maintaining reliable operation of the bulk electric power supply system in the ERCOT region. Its responsibilities include the clearing and settlement of electricity volumes and related ancillary services among the various participants in the deregulated Texas market. Settlement information is due from ERCOT within two months after the operating day, and true-up settlements are due from ERCOT within six months after the operating day. As a result, TXU Energy Holdings is subject to settlement adjustments from ERCOT related to prior periods, which may result in charges or credits impacting future reported results of operations.

 

TXU Energy Holdings’ businesses operate in changing market environments influenced by various legislative and regulatory initiatives regarding deregulation, regulation or restructuring of the energy industry, including deregulation of the production and sale of electricity. TXU Energy Holdings will need to adapt to these changes and may face increasing competitive pressure. For example, the Texas electricity market was deregulated as of January 1, 2002, and competition has resulted, and may continue to result in, declines in customer counts and sales volumes.

 

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TXU Energy Holdings’ businesses are subject to changes in laws (including PURA, the Federal Power Act, as amended, the Atomic Energy Act, as amended, the Public Utility Regulatory Policies Act of 1978, as amended, the Clean Air Act, as amended, and the Public Utility Holding Company Act of 1935, as amended) and changing governmental policy and regulatory actions (including those of the Commission, the FERC, the EPA and the NRC) with respect to matters including, but not limited to, market structure and design, operation of nuclear power facilities, construction and operation of other power generation facilities, recovery of purchased gas and power costs, decommissioning costs and present or prospective wholesale and retail competition. In particular, PURA and the Commission will be subject to sunset review by the Texas Legislature during this 2005 legislative session. See “ERCOT Market Issues” and “Wholesale Market Design” above.

 

TXU Energy Holdings, along with other market participants, is subject to oversight by the Commission. In that connection, TXU Energy Holdings and other market participants may be subject to various competition-related rules and regulations, including but not limited to possible price-mitigation rules, as well as rules related to market behavior.

 

TXU Energy Holdings is not guaranteed any rate of return on its capital investments in unregulated businesses. TXU Energy Holdings markets and trades power, including power from its own production facilities, as part of its wholesale markets management operation. TXU Energy Holdings’ results of operations are likely to depend in large part upon prevailing retail rates, which are set in part by regulatory authorities, and market prices for electricity, gas and coal in its regional market and other competitive markets. Market prices may fluctuate substantially over relatively short periods of time. Demand for electricity can fluctuate dramatically, creating periods of substantial under- or over-supply. During periods of over-supply, prices might be depressed. Also, at times there may be political pressure, or pressure from regulatory authorities with jurisdiction over wholesale and retail energy commodity and transportation rates, to impose price limitations, bidding rules and other mechanisms to address volatility and other issues in these markets.

 

Some of the fuel for TXU Energy Holdings’ power production facilities is purchased under short-term contracts or on the spot market. Prices of fuel, including natural gas, may also be volatile, and the price TXU Energy Holdings can obtain for power sales may not change at the same rate as changes in fuel costs. In addition, TXU Energy Holdings purchases and sells natural gas and other energy related commodities, and volatility in these markets may affect TXU Energy Holdings’ costs incurred in meeting its obligations.

 

Volatility in market prices for fuel and electricity may result from:

 

    severe or unexpected weather conditions,

 

    seasonality,

 

    changes in electricity usage,

 

    illiquidity in the wholesale power or other markets,

 

    transmission or transportation constraints, inoperability or inefficiencies,

 

    availability of competitively priced alternative energy sources,

 

    changes in supply and demand for energy commodities,

 

    changes in power production capacity and heat rate,

 

    outages at TXU Energy Holdings’ power production facilities or those of its competitors,

 

    changes in production and storage levels of natural gas, lignite, coal and crude oil and refined products,

 

    natural disasters, wars, sabotage, terrorist acts, embargoes and other catastrophic events, and

 

    federal, state, local and foreign energy, environmental and other regulation and legislation.

 

All but one of TXU Energy Holdings’ facilities for power production are located in the ERCOT region, a market with limited interconnections to other markets. Electricity prices in the ERCOT region are correlated to gas prices because gas-fired plant is the marginal cost unit during the majority of the year in the ERCOT region. Accordingly, the contribution to earnings and the value of TXU Energy Holdings’ baseload power production is dependent in significant part upon the price of natural gas. TXU Energy Holdings cannot fully hedge the risk associated with dependency on gas because of the expected useful life of TXU Energy Holdings’ power production assets and the size of its position relative to market liquidity.

 

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To manage its near-term financial exposure related to commodity price fluctuations, TXU Energy Holdings routinely enters into contracts to hedge portions of its purchase and sale commitments, weather positions, fuel requirements and inventories of natural gas, lignite, coal, refined products, and other commodities, within established risk management guidelines. As part of this strategy, TXU Energy Holdings routinely utilizes fixed-price forward physical purchase and sales contracts, futures, financial swaps and option contracts traded in the over-the-counter markets or on exchanges. However, TXU Energy Holdings can normally cover only a small portion of the exposure of its assets and positions to market price volatility, and the coverage will vary over time. To the extent TXU Energy Holdings has unhedged positions, fluctuating commodity prices can materially impact TXU Energy Holdings’ results of operations and financial position, either favorably or unfavorably.

 

Although TXU Energy Holdings devotes a considerable amount of management time and effort to the establishment of risk management procedures as well as the ongoing review of the implementation of these procedures, the procedures it has in place may not always be followed or may not always function as planned and cannot eliminate all the risks associated with these activities. As a result of these and other factors, TXU Energy Holdings cannot predict with precision the impact that risk management decisions may have on its business, results of operations or financial position.

 

TXU Energy Holdings might not be able to satisfy all of its guarantees and indemnification obligations, including those related to hedging and risk management activities, if they were to come due at the same time.

 

TXU Energy Holdings’ hedging and risk management activities are exposed to the risk that counterparties that owe TXU Energy Holdings money, energy or other commodities as a result of market transactions will not perform their obligations. The likelihood that certain counterparties may fail to perform their obligations has increased due to financial difficulties, brought on by various factors including improper or illegal accounting and business practices, affecting some participants in the industry. Some of these financial difficulties have been so severe that certain industry participants have filed for bankruptcy protection or are facing the possibility of doing so. Should the counterparties to these arrangements fail to perform, TXU Energy Holdings might be forced to acquire alternative hedging arrangements or honor the underlying commitment at then-current market prices. In such event, TXU Energy Holdings might incur losses in addition to amounts, if any, already paid to the counterparties. ERCOT market participants are also exposed to risks that another ERCOT market participant may default in its obligations to pay ERCOT for power taken in the ancillary services market, in which case such costs, to the extent not offset by posted security and other protections available to ERCOT, may be allocated to various nondefaulting ERCOT market participants.

 

The current credit ratings for TXU Energy Holdings’ long-term debt are investment grade. A rating reflects only the view of a rating agency, and it is not a recommendation to buy, sell or hold securities. Any rating can be revised upward or downward at any time by a rating agency if such rating agency decides that circumstances warrant such a change. If S&P, Moody’s or Fitch were to downgrade TXU Energy Holdings’ ratings, borrowing costs would increase, the potential pool of investors and funding sources would likely decrease and liquidity demands would be triggered by the terms of a number of commodity contracts, leases and other agreements.

 

Most of TXU Energy Holdings’ large customers, suppliers and counterparties require sufficient creditworthiness in order to enter into transactions. If TXU Energy Holdings’ ratings were to decline, particularly below investment grade, costs to operate the power business would increase because counterparties may require the posting of collateral in the form of cash-related instruments, or counterparties may decline to do business with TXU Energy Holdings.

 

In addition, as discussed in the 2004 Form 10-K, the terms of certain of TXU Energy Holdings’ financing and other arrangements contain provisions that are specifically affected by changes in credit ratings and could require the posting of collateral, the repayment of indebtedness or the payment of other amounts.

 

The operation of power production and energy transportation facilities involves many risks, including start up risks, breakdown or failure of facilities, lack of sufficient capital to maintain the facilities, the dependence on

 

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a specific fuel source or the impact of unusual or adverse weather conditions or other natural events, as well as the risk of performance below expected levels of output or efficiency, the occurrence of any of which could result in lost revenues and/or increased expenses. A significant portion of TXU Energy Holdings’ facilities was constructed many years ago. In particular, older generating equipment, even if maintained in accordance with good engineering practices, may require significant capital expenditures to keep it operating at peak efficiency. The risk of increased maintenance and capital expenditures arises from (a) increased starting and stopping of generation equipment due to the volatility of the competitive market, (b) any unexpected failure to produce power, including failure caused by breakdown or forced outage, and (c) repairing damage to facilities due to storms, natural disasters, wars, terrorist acts and other catastrophic events. Further, TXU Energy Holdings’ ability to successfully and timely complete capital improvements to existing facilities or other capital projects is contingent upon many variables and subject to substantial risks. Should any such efforts be unsuccessful, TXU Energy Holdings could be subject to additional costs and/or the write-off of its investment in the project or improvement.

 

Insurance, warranties or performance guarantees may not cover all or any of the lost revenues or increased expenses, including the cost of replacement power. Likewise, TXU Energy Holdings’ ability to obtain insurance, and the cost of and coverage provided by such insurance, could be affected by events outside its control.

 

The ownership and operation of nuclear facilities, including TXU Energy Holdings’ ownership and operation of the Comanche Peak generation plant, involve certain risks. These risks include: mechanical or structural problems; inadequacy or lapses in maintenance protocols; the impairment of reactor operation and safety systems due to human error; the costs of storage, handling and disposal of nuclear materials; limitations on the amounts and types of insurance coverage commercially available; and uncertainties with respect to the technological and financial aspects of decommissioning nuclear facilities at the end of their useful lives. The following are among the more significant of these risks:

 

    Operational Risk – Operations at any nuclear power production plant could degrade to the point where the plant would have to be shut down. Over the next three years, certain equipment at Comanche Peak is expected to be replaced. The cost of these actions is currently expected to be material and could result in extended outages. If this were to happen, the process of identifying and correcting the causes of the operational downgrade to return the plant to operation could require significant time and expense, resulting in both lost revenue and increased fuel and purchased power expense to meet supply commitments. Rather than incurring substantial costs to restart the plant, the plant may be shut down. Furthermore, a shut-down or failure at any other nuclear plant could cause regulators to require a shut-down or reduced availability at Comanche Peak.

 

    Regulatory Risk The NRC may modify, suspend or revoke licenses and impose civil penalties for failure to comply with the Atomic Energy Act, the regulations under it or the terms of the licenses of nuclear facilities. Unless extended, the NRC operating licenses for Comanche Peak Unit 1 and Unit 2 will expire in 2030 and 2033, respectively. Changes in regulations by the NRC could require a substantial increase in capital expenditures or result in increased operating or decommissioning costs.

 

    Nuclear Accident Risk Although the safety record of Comanche Peak and other nuclear reactors generally has been very good, accidents and other unforeseen problems have occurred both in the US and elsewhere. The consequences of an accident can be severe and include loss of life and property damage. Any resulting liability from a nuclear accident could exceed TXU Energy Holdings’ resources, including insurance coverage.

 

TXU Energy Holdings is subject to extensive environmental regulation by governmental authorities. In operating its facilities, TXU Energy Holdings is required to comply with numerous environmental laws and regulations, and to obtain numerous governmental permits. TXU Energy Holdings may incur significant additional costs to comply with these requirements. If TXU Energy Holdings fails to comply with these requirements, it could be subject to civil or criminal liability and fines. Existing environmental regulations could be revised or reinterpreted, new laws and regulations could be adopted or become applicable to TXU Energy Holdings or its facilities, and future changes in environmental laws and regulations could occur, including potential regulatory and enforcement developments related to air emissions.

 

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TXU Energy Holdings may not be able to obtain or maintain all required environmental regulatory approvals. If there is a delay in obtaining any required environmental regulatory approvals or if TXU Energy Holdings fails to obtain, maintain or comply with any such approval, the operation of its facilities could be stopped or become subject to additional costs. Further, at some of TXU Energy Holdings’ older facilities, including baseload lignite and coal plants, it may be uneconomical for TXU Energy Holdings to install the necessary equipment, which may cause TXU Energy Holdings to shut down those facilities.

 

In addition, TXU Energy Holdings may be responsible for any on-site liabilities associated with the environmental condition of facilities that it has acquired or developed, regardless of when the liabilities arose and whether they are known or unknown. In connection with certain acquisitions and sales of assets, TXU Energy Holdings may obtain, or be required to provide, indemnification against certain environmental liabilities. Another party could fail to meet its indemnification obligations to TXU Energy Holdings.

 

While TXU Energy Holdings may now offer prices other than the price-to-beat, it is obligated to offer the price-to-beat rate to its residential and small business customers in its historical service territory through January 1, 2007. The results of TXU Energy Holdings’ retail electric operations in its historical service territory are largely dependent upon the amount of headroom available to TXU Energy Holdings in its price-to-beat rate. The margin or “headroom” available in the price-to-beat rate for any REP equals the difference between the price-to-beat rate and the sum of delivery charges and the price that REP pays for power. Headroom may be a positive or a negative number. Since headroom is dependent, in part, on power production and purchase costs, TXU Energy Holdings does not know nor can it estimate the amount of headroom that it will have in its price-to-beat rate. There is no assurance that future adjustments to TXU Energy Holdings’ price-to-beat rate will be adequate to cover future increases in its costs of electricity to serve its price-to-beat rate customers or that TXU Energy Holdings’ price-to-beat rate will not result in negative headroom in the future. In addition, TXU Corp. faces competition for customers within its historical service territory. Such competitors may be larger or better capitalized or have well known brand recognition. Such competition may also offer prices that are too low to be sustainable over the long-term, but attract customers away from TXU Energy Holdings.

 

In most retail electric markets outside its historical service territory, TXU Energy Holdings’ principal competitor may be the retail affiliate of the local incumbent utility company. The incumbent retail affiliates have the advantage of long-standing relationships with their customers. In addition to competition from the incumbent utilities and their affiliates, TXU Energy Holdings may face competition from a number of other energy service providers, or other energy industry participants, who may develop businesses that will compete with TXU Energy Holdings and nationally branded providers of consumer products and services. Some of these competitors or potential competitors may be larger and better capitalized than TXU Energy Holdings. If there is inadequate margin in these retail electric markets, it may not be profitable for TXU Energy Holdings to enter these markets.

 

TXU Energy Holdings depends on transmission and distribution facilities owned and operated by other utilities, as well as its affiliates’ facilities, to deliver the electricity it produces and sells to consumers, as well as to other REPs. If transmission capacity is inadequate, TXU Energy Holdings’ ability to sell and deliver electricity may be hindered, it may have to forgo sales or it may have to buy more expensive wholesale electricity that is available in the capacity-constrained area. In particular, during some periods transmission access is constrained to some areas of the Dallas-Fort Worth metroplex. TXU Energy Holdings expects to have a significant number of customers inside these constrained areas. The cost to provide service to these customers may exceed the cost to provide service to other customers, resulting in lower headroom. In addition, any infrastructure failure that interrupts or impairs delivery of electricity to TXU Energy Holdings’ customers could negatively impact the satisfaction of its customers with its service.

 

TXU Energy Holdings offers its customers a bundle of services that include, at a minimum, the electric commodity itself plus transmission, distribution and related services. The prices TXU Energy Holdings charges for this bundle of services or for the various components of the bundle, either of which may be fixed by contract with the customer for a period of time, could fall below TXU Energy Holdings’ underlying cost to obtain the commodities or services.

 

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Research and development activities are ongoing to improve existing and alternative technologies to produce electricity, including gas turbines, fuel cells, microturbines and photovoltaic (solar) cells. It is possible that advances in these or other alternative technologies will reduce the costs of electricity production from these technologies to a level that will enable these technologies to compete effectively with electricity production from traditional power plants like TXU Energy Holdings’. While demand for electric energy services is generally increasing throughout the US, the rate of construction and development of new, more efficient power production facilities may exceed increases in demand in some regional electric markets. Consequently, where TXU Energy Holdings has facilities, the market value of TXU Energy Holdings’ power production and/or energy transportation facilities could be significantly reduced. Also, electricity demand could be reduced by increased conservation efforts and advances in technology, which could likewise significantly reduce the value of TXU Energy Holdings’ facilities. Changes in technology could also alter the channels through which retail electric customers buy electricity.

 

TXU Energy Holdings is a holding company and conducts its operations primarily through wholly-owned subsidiaries. Substantially all of TXU Energy Holdings’ consolidated assets are held by these subsidiaries. Accordingly, TXU Energy Holdings’ cash flows and ability to meet its obligations and to pay distributions are largely dependent upon the earnings of its subsidiaries and the distribution or other payment of such earnings to TXU Energy Holdings in the form of distributions, loans or advances, and repayment of loans or advances from TXU Energy Holdings. The subsidiaries are separate and distinct legal entities and have no obligation to provide TXU Energy Holdings with funds for its payment obligations, whether by distributions, loans or otherwise.

 

The inability to raise capital on favorable terms, particularly during times of uncertainty in the financial markets, could impact TXU Energy Holdings’ ability to sustain and grow its businesses, which are capital intensive, and would increase its capital costs. TXU Energy Holdings relies on access to financial markets as a significant source of liquidity for capital requirements not satisfied by cash on hand or operating cash flows. TXU Energy Holdings’ access to the financial markets could be adversely impacted by various factors, such as:

 

    changes in credit markets that reduce available credit or the ability to renew existing liquidity facilities on acceptable terms;

 

    inability to access commercial paper markets;

 

    a deterioration of TXU Energy Holdings’ credit or a reduction in TXU Energy Holdings’ credit ratings;

 

    extreme volatility in TXU Energy Holdings’ markets that increases margin or credit requirements;

 

    a material breakdown in TXU Energy Holdings’ risk management procedures;

 

    prolonged delays in billing and payment resulting from delays in switching customers from one REP to another; and

 

    the occurrence of material adverse changes in TXU Energy Holdings’ businesses that restrict TXU Energy Holdings’ ability to access its liquidity facilities.

 

A lack of necessary capital and cash reserves could adversely impact the evaluation of TXU Energy Holdings’ credit worthiness by counterparties and rating agencies, and would likely increase its capital costs. Further, concerns on the part of counterparties regarding TXU Energy Holdings’ liquidity and credit could limit its wholesale markets management activities.

 

As a result of the energy crisis in California during 2001, the recent volatility of natural gas prices in North America, the bankruptcy filing by Enron Corporation, accounting irregularities of public companies, and investigations by governmental authorities into energy trading activities, companies in the regulated and nonregulated utility businesses have been under a generally increased amount of public and regulatory scrutiny. Accounting irregularities at certain companies in the industry have caused regulators and legislators to review current accounting practices and financial disclosures. The capital markets and ratings agencies also have increased their level of scrutiny. Additionally, allegations against various energy trading companies of “round trip” or “wash” transactions, which involve the simultaneous buying and selling of the same amount of power at the same price and delivery location and provide no true economic benefit, power market manipulation and inaccurate power and commodity price reporting have had a negative effect on the industry. TXU Energy Holdings believes that it is complying with all applicable laws, but it is difficult or impossible to predict or control what effect events and investigations in the energy industry may have on TXU Energy Holdings’ financial condition or access to the capital markets. Additionally, it is unclear what laws and regulations may

 

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develop, and TXU Energy Holdings 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 TXU Energy Holdings may face. Additional issues may arise or become material as the energy industry evolves.

 

FORWARD-LOOKING STATEMENTS

 

This report and other presentations made by TXU Energy Holdings contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, that are included in this report, or made in presentations, in response to questions or otherwise, that address activities, events or developments that TXU Energy Holdings expects or anticipates to occur in the future, including such matters as projections, capital allocation and cash distribution policy, future capital expenditures, business strategy, competitive strengths, goals, future acquisitions or dispositions, development or operation of power production assets, market and industry developments and the growth of TXU Energy Holdings’ business and operations (often, but not always, through the use of words or phrases such as “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimated,” “projection,” “target,” “outlook”), are forward-looking statements. Although TXU Energy Holdings believes that in making any such forward-looking statement its expectations are based on reasonable assumptions, any such forward-looking statement involves uncertainties and is qualified in its entirety by reference to the discussion of risk factors discussed above under “RISK FACTORS THAT MAY AFFECT FUTURE RESULTS” and the following important factors, among others, that could cause the actual results of TXU Energy Holdings to differ materially from those projected in such forward-looking statements:

 

    prevailing governmental policies and regulatory actions, including those of the FERC, the Commission and the NRC, with respect to:

 

    allowed rates of return;

 

    industry, market and rate structure;

 

    purchased power and recovery of investments;

 

    operations of nuclear generating facilities;

 

    acquisitions and disposal of assets and facilities;

 

    operation and construction of facilities;

 

    decommissioning costs;

 

    present or prospective wholesale and retail competition;

 

    changes in tax laws and policies; and

 

    changes in and compliance with environmental and safety laws and policies;

 

    continued implementation of, and “sunset provisions” regarding, the restructuring legislation passed by the Texas legislature in 1999;

 

    legal and administrative proceedings and settlements;

 

    general industry trends;

 

    power costs (including repair costs) and availability;

 

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    weather conditions and other natural phenomena, and acts of sabotage, wars or terrorist activities;

 

    unanticipated population growth or decline, and changes in market demand and demographic patterns;

 

    changes in business strategy, development plans or vendor relationships;

 

    TXU Energy Holdings’ ability to implement the initiatives that are part of its restructuring, operational improvement and cost reduction program, and the terms which those initiatives are executed;

 

    competition for retail and wholesale customers;

 

    access to adequate transmission facilities to meet changing demands;

 

    pricing and transportation of crude oil, natural gas and other commodities;

 

    unanticipated changes in interest rates, commodity prices or rates of inflation;

 

    unanticipated changes in operating expenses, liquidity needs and capital expenditures;

 

    commercial bank market and capital market conditions;

 

    competition for new energy development and other business opportunities;

 

    inability of various counterparties to meet their obligations with respect to TXU Energy Holdings’ financial instruments;

 

    changes in technology used by and services offered by TXU Energy Holdings;

 

    significant changes in TXU Energy Holdings’ relationship with its employees, including the availability of qualified personnel, and the potential adverse effects if labor disputes or grievances were to occur;

 

    significant changes in critical accounting policies material to TXU Energy Holdings; and

 

    actions of rating agencies.

 

Any forward-looking statement speaks only as of the date on which such statement is made, and TXU Energy Holdings undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time and it is not possible for TXU Energy Holdings to predict all of such factors, nor can it assess the impact of each such factor or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement.

 

ITEM 4. CONTROLS AND PROCEDURES

 

An evaluation was performed under the supervision and with the participation of TXU Energy Holdings’ management, including the principal executive officer and principal financial officer, of the effectiveness of the design and operation of the disclosure controls and procedures in effect as of the end of the current period included in this quarterly report. Based on the evaluation performed, TXU Energy Holdings’ management, including the principal executive officer and principal financial officer, concluded that the disclosure controls and procedures were effective. During the most recent fiscal quarter covered by this quarterly report, there has been no change in TXU Energy Holdings’ internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, TXU Energy Holdings’ internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

Reference is made to the discussion in Note 5 regarding legal proceedings.

 

ITEM 6. EXHIBITS

 

  (a) Exhibits provided as part of Part II are:

 

Exhibits

  

Previously Filed*

With File

Number


  

As
Exhibit


         
10   

1-12833

Form 8-K

filed April 1, 2005

   10       $3.5 billion Amended and Restated Credit Agreement, dated March 31, 2005, by and among TXU Electric Delivery, TXU Energy Holdings, JPMorgan Chase Bank, N.A., Citibank, N.A., Wachovia Bank, National Association, Bank of America, N.A., Calyon New York Branch and certain other lenders party thereunto
(15)    Letter re: Unaudited Interim Financial Information.
15                   Letter from independent registered public accounting firm as to unaudited interim financial information.
(31)    Rule 13a - 14(a)/15d - 14(a) Certifications.
31(a)                 Certification of Paul O’Malley, principal executive officer of TXU Energy Company LLC, pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31(b)                 Certification of Kirk R. Oliver, principal financial officer of TXU Energy Company LLC, pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(32)    Section 1350 Certifications.
32(a)                 Certification of Paul O’Malley, principal executive officer of TXU Energy Company LLC, 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, principal financial officer of TXU Energy Company LLC, 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 March 31, 2005.


* Incorporated herein by reference.

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

TXU ENERGY COMPANY LLC
By  

/s/ Stan Szlauderbach


   

Stan Szlauderbach

   

Senior Vice President and Controller

 

Date: May 12, 2005

 

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