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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 2003
-- 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
(Exact Name of Registrant as Specified in its Charter)
A Delaware Limited Liability Company 75-2967817
(State of Incorporation) (I.R.S. Employer
Identification No.)
1601 Bryan Street Dallas, TX 75201-3411 (214) 812-4600
(Address of Principal Executive Offices) (Registrant's Telephone Number)
(Zip Code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrants (1) have 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
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X No
--- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Securities Exchange Act). Yes No X
-- --
Aggregate market value of TXU Energy Company LLC common membership interests
held by non-affiliates: None
TXU Corp. indirectly owns all the common members' interests of TXU Energy
Company LLC.
TXU Energy Company LLC meets the conditions set forth in General Instructions
(I) (1) (a) and (b) of Form 10-K and is therefore filing this report with the
reduced disclosure format.
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DOCUMENTS INCORPORATED BY REFERENCE - None
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TABLE OF CONTENTS
Page
----
Glossary............................................................................................ ii
PART I
Items 1. and 2. BUSINESS and PROPERTIES............................................................ 1
TXU ENERGY COMPANY LLC AND SUBSIDIARIES.................................................... 1
TEXAS ELECTRIC INDUSTRY RESTRUCTURING...................................................... 1
DESCRIPTION OF OPERATIONS.................................................................. 3
ENVIRONMENTAL MATTERS...................................................................... 7
Item 3. LEGAL PROCEEDINGS.......................................................................... 9
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................................ 10
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................................................ 11
Item 6. SELECTED FINANCIAL DATA.................................................................... 11
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS...................................................................... 11
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................. 11
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................................ 11
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE................................................................... 11
Item 9A. CONTROLS AND PROCEDURES.................................................................... 11
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......................................... 12
Item 11. EXECUTIVE COMPENSATION..................................................................... 12
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................. 12
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................. 12
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES..................................................... 12
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K............................ 14
APPENDIX A - Financial Information of TXU Energy Company LLC
APPENDIX B - Exhibits to 2003 Form 10-K
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 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.
i
GLOSSARY
When the following terms and abbreviations appear in the text of this report,
they have the meanings indicated below.
1999 Restructuring Legislation........Legislation that restructured the electric
utility industry in Texas to provide
for competition
2002 Form 8-K.........................US Holdings' Current Report on Form 8-K
filed on February 26, 2003 for TXU Energy
with respect to its financial information
for the year ended December 31, 2002, and
Form 8-K filed September 16, 2003 to
reflect the impact of adopting SFAS 145 on
the financial information reported in the
Form 8-K filed on February 26, 2003
2002 Form 10-K........................US Holdings' Annual Report on Form 10-K
for the year ended December 31, 2002
2003 Form 10-K........................TXU Energy's Annual Report on Form 10-K
for the year ended December 31, 2003
APB Opinion 30........................Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events
and Transactions"
Bcf...................................billion cubic feet
Commission............................Public Utility Commission of Texas
EITF..................................Emerging Issues Task Force
EITF 98-10 ...........................EITF Issue No. 98-10, "Accounting for
Contracts Involved in Energy Trading and
Risk Management Activities"
EITF 01-8.............................EITF Issue No. 01-8, "Determining Whether
an Arrangement Contains a Lease"
EITF 02-3 ............................EITF Issue No. 02-3, "Issues Involved in
Accounting for Derivative Contracts Held
for Trading Purposes and Contracts
Involved in Energy Trading and Risk
Management Activities"
EITF 03-11............................EITF Issue No. 03-11, "Reporting Realized
Gains and Losses on Derivative Instruments
That Are Subject to FASB Statement No. 133
and Not `Held for Trading Purposes' As
Defined in EITF No. 02-3"
EPA...................................Environmental Protection Agency
ERCOT.................................Electric Reliability Council of Texas, the
Independent System Operator and the
regional reliability coordinator of the
various electricity systems within Texas
ERISA.................................Employee Retirement Income Security Act
FASB..................................Financial Accounting Standards Board, the
designated organization in the private
sector for establishing standards for
financial accounting and reporting
FERC..................................Federal Energy Regulatory Commission
FIN...................................Financial Accounting Standards Board
Interpretation
FIN 45................................FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees,
Including Indirect Guarantees of
Indebtedness of Others - an Interpretation
of FASB Statements No. 5, 57, and 107 and
Rescission of FIN No. 34"
FIN 46................................FIN No. 46, "Consolidation of Variable
Interest Entities"
Fitch.................................Fitch Ratings, Ltd.
ii
GWh...................................gigawatt-hours
historical service territory..........US Holdings historical service territory,
largely in north Texas, at the time of
entering competition on January 1, 2002
IRS...................................Internal Revenue Service
kv....................................kilovolt
Moody's...............................Moody's Investors Services, Inc.
MW....................................megawatts
NRC...................................United States Nuclear Regulatory
Commission
Oncor.................................refers to Oncor Electric Delivery Company,
a subsidiary of US Holdings, and/or its
consolidated bankruptcy remote financing
subsidiary, Oncor Electric Delivery
Transition Bond Company LLC, depending on
context
POLR..................................provider of last resort of electricity to
certain customers under the Commission
rules interpreting the 1999 Restructuring
Legislation
Price-to-beat rate....................residential and small business customer
electricity rates established by the
Commission in the restructuring of the
Texas market that are required to be
charged in a REP's historical service
territories until January 1, 2005 or when
40% of the electricity consumed by such
customer classes is supplied by competing
REPs, adjusted periodically for changes
in fuel costs, and required to be
available to those customers until
January 1, 2007
REP...................................retail electric provider
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
Settlement Plan.......................regulatory settlement plan that received
final approval by the Commission in
January 2003
SFAS..................................Statement of Financial Accounting
Standards issued by the FASB
SFAS 4................................SFAS No. 4, "Reporting Gains and Losses
from Extinguishment of Debt"
SFAS 34...............................SFAS No. 34, "Capitalization of Interest
Cost"
SFAS 71...............................SFAS No. 71, "Accounting for the Effect
of Certain Types of Regulation"
SFAS 87...............................SFAS No. 87, "Employers' Accounting for
Pensions"
SFAS 101..............................SFAS No. 101, "Regulated Enterprises -
Accounting for the Discontinuance of the
Application of FASB Statement No. 71"
SFAS 106..............................SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than
Pensions"
SFAS 109..............................SFAS No. 109, "Accounting for Income
Taxes"
SFAS 121..............................SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of"
SFAS 132..............................SFAS No. 132, "Employers' Disclosures
about Pensions and Postretirement
Benefits"
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 142..............................SFAS No. 142, "Goodwill and Other
Intangible Assets"
iii
SFAS 143..............................SFAS No. 143, "Accounting for Asset
Retirement Obligations"
SFAS 144..............................SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived
Assets"
SFAS 145..............................SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of
FASB Statement 13, and Technical
Corrections"
SFAS 146..............................SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal
Activities"
SFAS 149..............................SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging
Activities"
SFAS 150..............................SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics
of both Liabilities and Equity"
SG&A..................................selling, general and administrative
SOP 98-1..............................American Institute of Certified Public
Accountants Statement of Position 98-1,
"Accounting for the Cost of Computer
Software Developed or Obtained for
Internal Use"
TCEQ..................................Texas Commission on Environmental Quality
TXU Business Services.................TXU Business Services Company, a
subsidiary of TXU Corp.
TXU Corp..............................refers to TXU Corp. and/or its
consolidated subsidiaries, depending on
context
TXU Energy............................TXU Energy Company LLC, a subsidiary of
US Holdings, and refers to TXU Energy
and/or its consolidated subsidiaries,
depending on context
TXU Fuel..............................TXU Fuel Company, a subsidiary of
TXU Energy
TXU Gas...............................TXU Gas Company, a subsidiary of TXU Corp.
TXU Mining............................TXU Mining Company LP, a subsidiary of
TXU Energy
TXU Portfolio Management..............TXU Portfolio Management Company LP, a
subsidiary of TXU Energy
TXU SESCO.............................TXU SESCO Company, a subsidiary of TXU
Energy, which serves as a REP in ten
counties in the eastern and central parts
of Texas
US....................................United States of America
US GAAP...............................accounting principles generally accepted
in the US
US Holdings...........................TXU US Holdings Company, a subsidiary
of TXU Corp.
iv
PART I
Items 1. and 2. BUSINESS and PROPERTIES
TXU ENERGY COMPANY LLC AND SUBSIDIARIES
---------------------------------------
TXU Energy is engaged in power production (electricity generation) and
retail and wholesale sales of electricity and natural gas, primarily in the
state of Texas. TXU Energy engages in hedging and risk management activities to
mitigate commodity price risk.
TXU Energy's operations are conducted principally through the following
subsidiaries: TXU Generation Holdings Company LLC; TXU Portfolio Management
Company LP; TXU Energy Retail Company LP; TXU Fuel Company; and two coal mining
subsidiaries.
TXU Energy is managed as a single, integrated business; consequently,
there are no reportable business segments. At December 31, 2003, TXU Energy had
5,939 full-time employees, including 1,874 in a collective bargaining unit.
TEXAS ELECTRIC INDUSTRY RESTRUCTURING
-------------------------------------
RESTRUCTURING LEGISLATION
The 1999 Restructuring Legislation restructured the electric utility
industry in Texas and provided for a transition to competition in the generation
and retail sale of electricity. TXU Corp. disaggregated its electric utility
business, as required by the legislation, and restructured certain of its US
businesses as of January 1, 2002 resulting in two new business operations:
o Oncor - a utility regulated by the Commission that holds electricity
transmission and distribution assets and engages in electricity
delivery services.
o TXU Energy - a competitive business that holds the power generation
assets and engages in wholesale and retail energy sales and
hedging/risk management activities.
The relationships of these entities and their rights and obligations with
respect to their collective assets and liabilities are contractually described
in a master separation agreement executed in December 2001.
The operating assets of Oncor and TXU Energy are located principally in
the north-central, eastern and western parts of Texas.
A settlement of outstanding issues and other proceedings related to
implementation of the 1999 Restructuring Legislation received final and
non-appealable approval by the Commission in January 2003. See Note 14 for
further discussion.
In addition, as of January 1, 2002, certain other businesses within the
TXU Corp. system were transferred to TXU Energy, including TXU Gas' hedging and
risk management business and its unregulated retail commercial/industrial
(business) gas supply operation, as well as the fuel transportation and coal
mining subsidiaries that primarily service the generation operations.
Effective January 1, 2002, REPs affiliated with electricity delivery
utilities are required to charge residential and small business customers
located in their historical service territories "price-to-beat" rates
established by the Commission. TXU Energy, as a REP affiliated with an
electricity delivery utility, could not charge prices to customers in either of
those classes in the historical service territory that are different from the
price-to-beat rate, adjusted for fuel factor changes, until the earlier of
January 1, 2005 or the date on which 40% of the electricity consumed by
customers in that class is supplied by competing REPs. Thereafter, TXU Energy
may offer rates different from the price-to-beat rate to customers in that
class, but it must also continue to make the price-to-beat rate available for
residential and small business customers until January 1, 2007. Twice a year,
affiliated REPs may request that the Commission adjust the fuel factor component
of the price-to-beat rate based on changes in the market price of natural gas.
1
In December 2003, the Commission found that TXU Energy had met the 40%
requirement to be allowed to offer alternatives to the price-to-beat rate for
small business customers in the historical service territory.
Under amended Commission rules, effective in April 2003, affiliated REPs
of utilities are allowed to petition the Commission for an increase in the fuel
factor component of their price-to-beat rates if the average price of natural
gas futures increases more than 5% (10% if the petition is filed after November
15 of any year) from the level used to set the existing price-to-beat fuel
factor rate.
-- In January 2003, TXU Energy filed a request with the Commission under
the prior rules to increase the fuel factor component of its
price-to-beat rates. This request was approved and became effective in
early March 2003. As a result, average monthly residential bills rose
approximately 12%. Appeals of the Commission's order have been filed
and are currently pending in the Travis County, Texas District Court.
-- On July 23, 2003, TXU Energy filed another request with the Commission
to increase the fuel factor component of its price-to-beat rates. This
request was approved and became effective in late August 2003. As a
result, average monthly residential bills rose approximately 4%.
Appeals of the Commission's order have been filed and are currently
pending in the Travis County, Texas District Court.
Also, effective January 1, 2002, power generation companies affiliated
with electricity delivery utilities may charge unregulated prices in connection
with ERCOT wholesale power transactions. Estimated costs associated with nuclear
power plant decommissioning obligations continue to be recovered by Oncor as an
electricity delivery charge over the life of the plant.
REGULATORY SETTLEMENT PLAN
On December 31, 2001, US Holdings filed a Settlement Plan with the
Commission. It resolved all major pending issues related to US Holdings'
transition to competition pursuant to the 1999 Restructuring Legislation. The
Settlement Plan does not remove regulatory oversight of Oncor's business nor
does it eliminate TXU Energy's price-to-beat rates and related fuel adjustments.
The Settlement Plan became final in January 2003.
The major elements of the Settlement Plan are:
Excess Mitigation Credit -- Over the two-year period ended December 31,
2003, Oncor implemented a stranded cost excess mitigation credit in the amount
of $389 million (originally estimated to be $350 million), plus $26 million in
interest, applied as a reduction to delivery fees charged to all REPs, including
TXU Energy. The credit was funded by TXU Energy.
Regulatory Asset Securitization -- US Holdings received a financing order
authorizing the issuance of securitization bonds in the aggregate principal
amount of up to $1.3 billion to recover regulatory asset stranded costs and
other qualified costs. Accordingly, Oncor Electric Delivery Transition Bond
Company LLC, a bankruptcy remote financing subsidiary of Oncor, issued an
initial $500 million of securitization bonds in 2003 and is expected to issue
approximately $790 million in the first half of 2004. The principal and interest
on the bonds is recoverable through a delivery fee surcharge (transition charge)
to all REPs, including TXU Energy.
Retail Clawback Credit -- A retail clawback credit related to residential
customers was implemented in January 2004. The amount of the credit is equal to
the number of residential customers retained by TXU Energy in the historical
service territory on January 1, 2004, less the number of new residential
customers TXU Energy has added outside of the historical service territory as of
January 1, 2004, multiplied by $90. The estimated credit of $173 million will be
applied to delivery fees charged by Oncor to all REPs, including TXU Energy,
over a two-year period. TXU Energy funds the credit provided by Oncor. As the
amount of the credit will be based on numbers of customers over the related
two-year period, the liability is subject to future adjustments.
Stranded Costs and Fuel Cost Recovery -- TXU Energy's stranded costs, not
including regulatory assets, are fixed at zero. US Holdings will not seek to
recover its unrecovered fuel costs which existed at December 31, 2001. Also, it
will not conduct a final fuel cost reconciliation, which would have covered the
period from July 1998 until the beginning of competition in January 2002.
2
PROVIDER OF LAST RESORT
Through 2002, TXU Energy was the POLR for residential and small business
customers in those areas of ERCOT where customer choice was available outside
the historical service territory and was the POLR for large business customers
in the historical service territory. Under new POLR rules effective in September
2002, instead of being transferred to the POLR, non-paying residential and small
business customers served by affiliated REPs are subject to disconnection.
Non-paying residential and small business customers served by non-affiliated
REPs are transferred to the affiliated REP. Non-paying large business customers
can be disconnected by any REP if the customer's contract does not preclude it.
Thus, within the new POLR framework, the POLR provides electric service only to
customers who request POLR service, whose selected REP goes out of business, or
who are transferred to the POLR by other REPs for reasons other than
non-payment. No later than October 1, 2004, the Commission is expected to decide
whether all REPs should be permitted to disconnect non-paying customers.
Through a competitive bid process, the Commission selected a POLR to serve
for a two-year term beginning January 1, 2003, for several areas within Texas.
In areas for which no bids were submitted, the Commission selected the POLR by
lottery. TXU Energy did not bid to be the POLR, but was designated POLR through
lottery for residential and small business customers in certain West Texas
service areas and for small business customers in the Houston service area.
DESCRIPTION OF OPERATIONS
-------------------------
TXU Energy serves 2.6 million retail electric customers, of which 2.4
million are in the historical service territory. This territory, which is
located in the north-central, eastern and western parts of Texas, has an
estimated population in excess of 7 million, about one-third of the population
of Texas, and comprises 92 counties and 370 incorporated municipalities,
including Dallas/Fort Worth and surrounding suburbs, as well as Waco, Wichita
Falls, Odessa, Midland, Tyler and Killeen. The Dallas/Fort Worth area is a
diversified commercial and industrial center with substantial banking,
insurance, telecommunications, electronics, aerospace, petrochemical and
specialized steel manufacturing, and automotive and aircraft assembly. The
historical service territory served includes major portions of the oil and gas
fields in the Permian Basin and East Texas, as well as substantial farming and
ranching sections of the state. TXU Energy also provides retail electric service
in other areas of ERCOT now open to competition, including the Houston and
Corpus Christi areas.
Texas is one of the fastest growing states in the nation and is considered
by many to be one of the more successful deregulated energy markets in the U.S.
As a result, competition is expected to continue to increase.
POWER PRODUCTION
TXU Energy's power generating facilities provide TXU Energy with the
capability to supply a significant portion of the wholesale power market demand
in Texas, particularly in the North Texas market, at competitive production
costs. As part of TXU Energy's integrated business portfolio, much of the low
cost nuclear powered and lignite/coal-fired (base load) generation is available
to supply the power demands of its retail customers and other competitive REPs.
The power fleet in Texas consists of 22 owned or leased plants with
generating capacity fueled as follows: 2,300 MW nuclear; 5,837 MW coal/lignite;
and 10,881 MW gas/oil. TXU Energy supplies its retail customer base from its
power fleet as well as through long-term power supply agreements and purchases
in the wholesale markets. The power generating plants and other important
properties of TXU Energy are located primarily on land owned in fee simple. TXU
Energy has sold and may from time to time sell generation assets to reduce its
position in the Texas market and provide funds for other investments or to
reduce debt.
TXU Energy is one of the largest purchasers of wind-generated energy in
Texas and the US. TXU Energy currently purchases energy from over 579 MW of wind
projects located in West Texas. TXU Energy expects to continue to add additional
wind generation to its portfolio as commercial opportunities become available.
Nuclear-Powered Production Assets -- TXU Energy owns and operates two
nuclear-fueled electricity generation units at the Comanche Peak plant, each of
which is designed for a capacity of 1,150 MW.
3
TXU Energy has on hand, or has contracted for, enrichment services through
mid-2006 and fabrication services through 2011 for its nuclear units. TXU Energy
is finalizing supply contracts for the purchase of uranium and conversion to
meet its needs through mid-2006 and does not anticipate any problems in
completing the contracts. TXU Energy does not anticipate any difficulties
procuring raw materials and services beyond these dates.
TXU Energy's onsite spent nuclear fuel storage capability is sufficient to
accommodate the operation of Comanche Peak through the year 2017, while
maintaining the capability to off-load the core of one of the nuclear-fueled
generating units.
Under current regulatory licenses, nuclear decommissioning activities are
projected to begin in 2030 for Comanche Peak Unit 1 and 2033 for Unit 2 and
common facilities. Since January 1, 2002, projected decommissioning costs are
being recovered from Oncor's customers through a delivery charge based upon a
1997 site-specific study, adjusted for changes in the value of trust fund
assets, through rates placed into effect under the 2001 Unbundled Cost of
Service filing.
The Comanche Peak nuclear-powered generation units were originally
estimated to have a useful life of 40 years, based on the life of the operating
licenses granted by the NRC. Over the last several years, the NRC has granted
20-year extensions to the initial 40-year terms for several commercial power
reactors. Based on these extensions and current expectations of industry
practice, the useful life of the Comanche Peak nuclear-powered generation units
is now estimated to be 60 years. TXU Energy expects to file a license extension
request in accordance with timing and other provisions established by the NRC.
(See Note 1 to Financial Statements under Property, Plant and Equipment, for a
discussion of the change in depreciable lives for accounting purposes).
Lignite/Coal -Fired Production Assets -- Lignite is used as the primary
fuel for two units at the Big Brown generating plant, three units at the
Monticello generating plant, three units at the Martin Lake generating plant,
and one unit at the Sandow generating plant, having an aggregate capacity of
5,837 MW. TXU Energy's lignite units have been constructed adjacent to surface
minable lignite reserves. TXU Energy owns in fee simple or has under lease
proven reserves dedicated to the Big Brown, Monticello and Martin Lake
generating plants. TXU Energy utilizes owned and/or leased equipment to remove
the overburden and recover the lignite. Approximately 75% of the fuel used at
TXU Energy's lignite plants in 2003 was supplied from owned or leased lignite.
TXU Energy supplements its lignite fuel at Big Brown, Monticello and
Martin Lake with western coal from the Powder River Basin in Wyoming. The coal
is purchased from multiple suppliers under contracts of various lengths and is
transported from the Powder River Basin to TXU Energy's generating plants by
railcar. Approximately 25% of the fuel used at TXU Energy's lignite plants in
2003 was supplied from western coal under these contracts. Based on its current
usage, which includes the use of western coal to supplement its lignite
reserves, TXU Energy believes that it has sufficient lignite reserves and access
to western coal resources for its generating needs in the foreseeable future.
Gas/Oil-Fired Production Assets -- TXU Energy has eighteen gas/oil-fueled
plants, including a plant located in Pedricktown, New Jersey, with an aggregate
capacity of 11,003 MW. A significant portion of the gas/oil generating plants
have the ability to switch between gas and fuel oil. Gas/oil fuel requirements
for 2003 were provided through a mix of contracts with producers at the wellhead
and contracts with commercial suppliers. Fuel oil can be stored at 15 of the
principally gas-fueled generating plants. At January 1, 2004, TXU Energy had
fuel oil storage capacity sufficient to accommodate approximately 5.5 million
barrels of oil and had approximately one million barrels of oil in inventory.
Capacity Auction -- To encourage competition in the ERCOT region, each
power generation company owning 400 MW or more of installed generating capacity
must annually offer to sell at auction entitlements to 15% of the output of its
installed generating capacity. Such auction sales cannot be to an affiliated
REP. The obligation of TXU Energy to sell capacity entitlements at auction
continues until the earlier of January 1, 2007 or the date the Commission
determines that 40% or more of the electric power consumed by residential and
small business customers within the affiliated delivery utility certificated
service area before the onset of customer choice is provided by non-affiliated
REPs. The October 2002 auction offered one-year and monthly entitlements for
2003 only. Not all of the entitlements offered in the October auction were sold;
however, TXU Energy did re-offer these unsold entitlements in subsequent
auctions held in November 2002 and throughout 2003. In 2003, TXU Energy held
capacity auctions in March, July and August for 2003 capacity, and in September
and November for 2004 capacity. TXU Energy met its capacity auction obligations
for 2003. The next auctions for the remaining 2004 capacity obligations are
scheduled for March and July 2004.
4
NATURAL GAS OPERATIONS
TXU Energy's natural gas operations in Texas include pipelines, storage
facilities, well-head production contracts, transportation agreements and
storage leases. Natural gas is purchased for internal use in the generation of
power, as well as for sale in wholesale markets and to large business customers.
Transportation services are provided to TXU Energy's generation operations and
third parties. Because of the correlation of natural gas and power prices, TXU
Energy's natural gas operations provide opportunities to hedge its margins on
power sales.
TXU Energy owns and operates an intrastate natural gas pipeline system
with approximately 1,900 miles of pipeline facilities which extends from the
gas-producing area of the Permian Basin in West Texas to the East Texas gas
fields and southward to the Gulf Coast area. The pipeline facilities were
originally built solely to serve US Holdings' generating plants. In keeping with
deregulation principles, this network now offers transportation service to third
parties at competitive prices.
TXU Energy also owns and operates two underground gas storage facilities
with a usable capacity of 14.0 Bcf. TXU Energy holds a portion of this storage
capacity for use during periods of peak demand to meet seasonal and other
fluctuations or interruption of deliveries by gas suppliers. Under normal
operating conditions, up to 400 million cubic feet can be withdrawn each day for
a ten-day period, with withdrawals at lower rates thereafter.
RETAIL
Regulatory restructuring in Texas has resulted in competitive markets
within the state, thus presenting additional opportunities for growth
accompanied by the introduction of competitive pressures. Texas is one of the
fastest growing states in the nation with a diverse and resilient economy and,
as a result, has attracted a number of competitors into the retail electricity
market. TXU Energy, as an active participant in this competitive market, is
marketing its services in Texas to add new customers and to retain its existing
customers.
Based on the latest data provided by ERCOT (November 2003), approximately
14% of all customers in ERCOT areas open to customer choice had elected to
switch providers. At the present time, 53 REPs are certified to compete within
the state of Texas.
TXU Energy believes that the scale derived from a large retail portfolio
provides the platform for a profitable operation by, among other things,
reducing the costs of service and billing per customer. TXU Energy emphasizes
its identification with the TXU brand and reputation. TXU Energy uses a value
pricing approach by customizing its products to each customer segment with
service enhancements that are known to be valued by customers in those segments.
With its approach, TXU Energy intends to achieve substantially higher customer
loyalty and enhanced profit margins, while reducing the costs associated with
customers frequently switching suppliers.
TXU Energy has invested in customer-related infrastructure and uses its
customer relationships, technology operating platforms, marketing, customer
service operations and customer loyalty to actively compete to retain its
customer base and to add customers.
5
PORTFOLIO MANAGEMENT
Portfolio management refers to risk management and value creation
activities undertaken to balance customer demand for energy with the supply of
energy in an economically efficient and effective manner. Retail and wholesale
demand is generally greater than volumes that can be supplied by TXU Energy's
base load production. Portfolio management acts to provide additional supply
balancing through TXU Energy's gas/oil-fired generation or purchases of power.
The portfolio management operation manages the commodity volume and price risks
inherent in TXU Energy's generation and sales operations through supply
structuring, pricing and risk management activities. Risk management activities
include hedging both future power sales and purchases of fuel supplies for the
generation plants. The portfolio management operation also is responsible for
the efficient dispatch of power from its generation plants.
In its risk management activities, TXU Energy enters into physical
delivery contracts, financial contracts that are traded on exchanges and
"over-the-counter" and bilateral contracts with customers. Physical delivery
contracts relate to the purchase and sale of electricity and gas primarily in
the wholesale markets in Texas and to a limited extent in select Northeast
markets in North America. TXU Energy's risk management activities consist
largely of hedging transactions, with speculative trading representing a small
fraction of such activity.
TXU Energy manages its exposure to price risk within established
transactional policies and limits. TXU Energy targets best practices in risk
management and risk control by employing proven principles used by financial
institutions. These controls have been structured so that they are practical in
application and consistent with stated business objectives. Portfolio management
revalues TXU Energy's exposures daily using integrated energy systems to capture
value and mitigate risks. A risk management forum meets regularly to ensure that
transactional practices comply with its prior approval of commodities,
instruments, exchanges and markets. Transactional risks are monitored and limits
are enforced to comply with established TXU Corp. policy requirements. Risk
assessment is segregated and operated separately from compliance and enforcement
to ensure independence, accountability and integrity of actions. TXU Corp. has a
strict disciplinary program to address any violations of its risk management
policy requirements. TXU Energy also periodically reviews these policies to
ensure they are responsive to changing market and business conditions. These
policies are designed to protect earnings, cash flows and credit ratings.
COMPETITIVE STRATEGY
TXU Energy's strategy is to defend and build its customer base in the
competitive Texas market and to accomplish this through the operation of a
single, integrated energy business managing a portfolio of assets. Achieving
operational excellence, more cost efficient processes and enhanced credibility
and reputation are all critical elements for executing on that strategy.
TXU Energy will continue to focus on sustaining its leading position in
the Texas market and being in position to move quickly toward capturing new
opportunities outside of Texas as they arise.
One of TXU Energy's key competitive strengths is its ability to produce
electricity at low variable costs in a market in which power prices are set by
gas-fired generation. New gas-fired capacity, while generally more efficient to
operate than existing gas/oil-fired capacity due to technological advances, is
subject to the volatility and increasing cost of natural gas fuel. On the other
hand, base load nuclear and lignite/coal plants have lower variable production
costs than even new gas-fired plants at current average market gas prices.
Another competitive strength for TXU Energy is the diversity of its generation
fleet. Due to the higher variable operating and fuel costs of its gas/oil-fired
units, as compared to its lignite/coal and nuclear units, production from TXU
Energy's gas/oil units is more susceptible to being displaced by the more
efficient units being constructed. This positions TXU Energy's gas/oil units to
run during intermediate and peak load periods when prices are higher and
provides more opportunities for hedging activities and increased market
liquidity.
Retail competition has remained steady in Texas with several large
participants broadly extending their marketing across all customer segments and
all geographic areas of competition. TXU Energy has successfully executed
similar marketing programs while retaining the majority of its incumbent
residential customer base.
6
TXU Energy believes that the ERCOT region presents an attractive
competitive electric service market due to the following factors:
o gas-fired plants are expected to set the price of generation during a
substantial portion of the year, providing an opportunity for TXU
Energy to benefit from its nuclear and lignite/coal units' fuel cost
advantages;
o peak demand is expected to grow at an average rate of approximately
3% per year;
o it is a sizeable market with approximately 62 gigawatts (GW) of peak
demand and approximately 35 GW of average demand; and
o there is no mandatory power pool structure.
Reserve margins for ERCOT, based upon existing capacity and planned
capacity with interconnection agreements, are expected to be 29% in 2004, 25% in
2005, 22% in 2006, 18% in 2007, and 15% in 2008.
Outside Texas -- Energy industry restructuring, although proceeding well
in Texas, has not had similar success in other parts of the U.S. As early as
2000, optimism for national legislation and increased opening of competitive
markets began to alter the strategy of many industry participants. The
establishment of Regional Transmission Organizations and open access for both
wholesale and retail customers were on the horizon. Together with increasing
customer demand for lower priced electricity and other energy services, these
measures were expected to have accelerated the industry's movement toward a
more competitive pricing and cost structure.
Many states, faced with this increasing pressure from legislative bodies
(federal and state) to become more competitive while adhering to certain
continued regulatory requirements, along with changing economic conditions and
rapid technological changes, put forth deregulation plans that have since been
deferred or changed. The result is delayed restructuring. New entry by retailers
as well as by merchant generators in states other than Texas has been slowed.
The continued uncertainty regarding many FERC policies as well as Federal
legislation have delayed the opening of new retail markets and decreased the
economic viability for merchant generation.
Customers -- There are no individually significant customers upon which
TXU Energy's business or results of operations are highly dependent.
REGULATION AND RATES
See Texas Electric Industry Restructuring above for a description of the
significant regulatory provisions relating to the deregulation of the Texas
electric industry.
TXU Energy is exempt from the provisions of the Public Utility Holding
Company Act of 1935, except Section 9(a)(2) which relates to the acquisition of
securities of public utility companies and Section 33 which relates to the
acquisition of foreign (non-US) utility companies.
TXU Energy is an exempt wholesale generator under the Federal Power Act
and is subject to the jurisdiction of the NRC with respect to its nuclear power
plant. NRC regulations govern the granting of licenses for the construction and
operation of nuclear power plants and subject such plants to continuing review
and regulation. TXU Energy also holds a power marketer license from FERC.
ENVIRONMENTAL MATTERS
---------------------
TXU Energy is subject to extensive environmental regulation by
governmental authorities. In operating its facilities, TXU Energy is required to
comply with numerous environmental laws and regulations, and to obtain numerous
governmental permits and approvals. If TXU Energy fails to comply with these
requirements, it could be subject to civil or criminal liability and fines.
Existing environmental laws and regulations could be revised or reinterpreted
and new laws and regulations could be adopted or become applicable to TXU Energy
or its facilities, including potential regulatory and enforcement developments
related to air emissions.
7
TXU Energy 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 fails to obtain,
maintain or comply with the terms of any such approval, the operation of its
facilities could be stopped or become subject to additional costs. Further, at
some of TXU Energy's older facilities, including base load lignite and coal
plants, it may be uneconomical for TXU Energy to install the necessary
compliance equipment, which may cause TXU Energy to shut down those facilities.
In addition, TXU Energy 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 acquisitions and sales of assets, TXU Energy may
obtain, or be required to provide, indemnification against certain environmental
liabilities. Another party could fail to meet its indemnification obligations to
TXU Energy.
Air -- Under the Texas Clean Air Act, the TCEQ has jurisdiction over the
permissible level of air contaminant emissions from, and permitting requirements
for, generating, mining and gas delivery facilities located within the State of
Texas. The New Jersey Department of Environmental Protection has jurisdiction
over the emissions from TXU Energy's generation facility in New Jersey. In
addition, the new source performance standards of the EPA promulgated under the
Federal Clean Air Act, as amended (Clean Air Act), are being implemented by the
TCEQ, and are applicable to certain generating units and ancillary equipment.
TXU Energy's generation plants and mining equipment operate in compliance with
applicable regulations, permits and emission standards promulgated pursuant to
these acts.
The Clean Air Act includes provisions which, among other things, place
limits on the sulfur dioxide (SO2) and nitrogen oxides (NOx) emissions produced
by certain generation plants. In addition to the new source performance
standards applicable to SO2 and NOx, the Clean Air Act requires that
fossil-fueled plants have sufficient SO2 emission allowances and meet certain
NOx emission standards. TXU Energy's generation plants meet the SO2 allowance
requirements and NOx emission rates. In addition, the EPA recently proposed new
requirements calling for electricity generation facilities in 28 states and the
District of Columbia to further reduce emissions of NOx and SO2. TXU Energy will
be required to make additional emissions reductions and incur associated costs
under this proposal if it is finalized in its current form.
In January 2004, the EPA issued a proposed rule to regulate mercury
emissions from power plants with the expectation that a final rule will be
issued by December 2004 with an implementation date in 2008. Two different
regulatory approaches are considered in the announcement and the final form of
the rule is unknown, It is likely that some costs, which could be material, will
be incurred for installation of additional control equipment and for facility
operations and maintenance.
The EPA has also issued rules for controlling regional haze; the impact of
these rules is unknown at this time because the TCEQ has not yet implemented the
regional haze requirements.
The Bush Administration is addressing greenhouse gas emissions through its
greenhouse gas emissions intensity reduction Climate VISION program. The Bush
Administration and EPA have proposed the Clear Skies legislative initiative
calling for reductions of SO2, NOx, and mercury from electricity generation
facilities over a 15-year period. Some legislative proposals for additional
regulation of SO2, NOx, mercury and carbon dioxide recently have been considered
at the federal level and it is expected that additional similar proposals will
be made in the future. TXU Energy continues to participate in a voluntary
greenhouse gas emission reduction program and since 1995 has reported the
results of its program annually to the U.S. Department of Energy. TXU Energy is
also participating in a new voluntary electric utility industry sector climate
change initiative in partnership with the Department of Energy. TXU Energy
continues to assess the financial and operational risks posed by future
regulatory or policy changes pertaining to greenhouse gas emissions and multiple
emissions, but because these proposals are in the formative stages, TXU Energy
is unable to predict their future impacts on the financial condition and
operations of TXU Energy.
Major air pollution control provisions of the 1999 Restructuring
Legislation required a 50% reduction in NOx emissions and a 25% reduction in SO2
emissions from "grandfathered" electric utility generation plants. The first
compliance period is for the year beginning May 1, 2003 through April 30, 2004.
TXU Energy has obtained all permits required for the "grandfathered" plants by
the 1999 Restructuring Legislation and has completed a construction program to
install control equipment to achieve the required reductions. TXU Energy fully
anticipates that it will be in compliance with the requirements at the end of
the first compliance period.
8
In 2001, the Texas Clean Air Act was amended to require that
"grandfathered" facilities, other than electric utility generation plants, apply
for permits. TXU Energy anticipates that the permits can be obtained for their
"grandfathered" facilities without significant effects on the costs of operating
these facilities.
The TCEQ has also adopted revisions to its State Implementation Plan (SIP)
rules that require an 89% reduction in NOx emissions from electricity generation
plants in the Dallas-Fort Worth ozone non-attainment area and a 51% reduction in
NOx emissions from electricity generation plants in East and Central Texas. Full
compliance is required by May 1, 2005. TXU Energy has already made significant
NOx emissions reductions to achieve the 51% reduction requirements of the 1999
Restructuring Legislation, but anticipates that additional reductions and/or
modifications in plant operations will be required to achieve the 89% reductions
called for in the SIP rules. Additionally, the TCEQ is expected to propose new
SIP rules in 2004 to deal with 1-hour and 8-hour ozone standards. These rules
could require further NOx emissions reductions from certain TXU Energy
facilities.
Water -- The TCEQ and the EPA have jurisdiction over water discharges
(including storm water) from all domestic facilities. Facilities of TXU Energy
are presently in compliance with applicable state and federal requirements
relating to discharge of pollutants into the water. TXU Energy holds all
required waste water discharge permits from the TCEQ for facilities in operation
and has applied for or obtained necessary permits for facilities under
construction. TXU Energy believes it can satisfy the requirements necessary to
obtain any required permits or renewals. Clean Water Act Section 316(b)
regulations pertaining to existing water intake structures are being developed
by the EPA with publication scheduled for early 2004. TXU Energy is unable to
predict at this time the impacts of these regulations.
Other -- Diversion, impoundment and withdrawal of water for cooling and
other purposes are subject to the jurisdiction of the TCEQ. TXU Energy possesses
all necessary permits for these activities from the TCEQ for its present
operations.
Treatment, storage and disposal of solid and hazardous waste are regulated
at the state level under the Texas Solid Waste Disposal Act and at the federal
level under the Resource Conservation and Recovery Act of 1976, as amended, and
the Toxic Substances Control Act. The EPA has issued regulations under the
Resource Conservation and Recovery Act of 1976 and the Toxic Substances Control
Act, and the TCEQ have issued regulations under the Texas Solid Waste Disposal
Act applicable to facilities of TXU Energy. TXU Energy has registered solid
waste disposal sites and has obtained or applied for such permits as are
required by such regulations.
Under the federal Low-Level Radioactive Waste Policy Act of 1980, as
amended, the State of Texas is required to provide, either on its own or jointly
with other states in a compact, for the disposal of all low-level radioactive
waste generated within the state. The State of Texas has agreed to a compact
with the States of Maine and Vermont for a disposal facility that would be
located in Texas. That compact was ratified by Congress and signed by the
President in 1998. The State of Texas had proposed to license a disposal site in
Hudspeth County, Texas, but in October 1998, the TCEQ denied that license
application. In 2003, the State of Texas enacted legislation allowing a private
entity to be licensed to accept low-level radioactive waste for disposal. TXU
Energy intends to continue to ship low-level waste material off-site for as long
as an alternative disposal site is available. Should existing off-site disposal
become unavailable, the low-level waste material will be stored on-site. TXU
Energy's on-site storage capacity is expected to be adequate until other
off-site facilities become available. (See Power Production - Nuclear Production
Assets above.)
Environmental Capital Expenditures -- Capital expenditures for TXU
Energy's environmental projects were $27 million in 2003 and are expected to be
about $18 million in 2004.
Item 3. LEGAL PROCEEDINGS
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 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 on February 3,
2004 that joined additional, unaffiliated defendants. Three retail electric
providers have filed motions for leave to intervene in the action alleging
claims substantially identical to TCE's. In addition, approximately 25 purported
9
former customers of TCE have 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. TXU Energy believes that it
has not committed any violation of the antitrust laws and the Commission's
investigation of the market conditions in late February 2003 has not resulted in
any findings adverse to TXU Energy. Accordingly, TXU Energy believes that TCE's
and the interveners' claims against TXU Energy and its subsidiary companies are
without merit and TXU Energy and its subsidiaries intend to vigorously defend
the lawsuit. TXU Energy is 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 and TXU
Portfolio Management. Plaintiff asserts claims under Section 806 of
Sarbanes-Oxley arising from plaintiff's employment termination and claims for
breach of contract relating to payment of certain bonuses. Plaintiff seeks back
pay, payment of bonuses and alternatively, reinstatement or future compensation,
including bonuses. TXU Corp. believes the plaintiff's claims are without merit.
The plaintiff was terminated as the result of a reduction in force, not as a
reaction to any concerns the plaintiff had expressed, and plaintiff was not in a
position with TXU Portfolio Management such that he had knowledge or information
that would qualify the plaintiff to evaluate TXU Corp.'s financial statements or
assess the adequacy of TXU Corp.'s financial disclosures. Thus, TXU Corp. does
not believe that there is any merit to the plaintiff's claims under
Sarbanes-Oxley. Accordingly, TXU Corp., TXU Energy and TXU Portfolio Management
intend to vigorously defend the litigation. While TXU Corp., TXU Energy and TXU
Portfolio Management dispute the plaintiff's claims, TXU Corp. is unable to
predict the outcome of this litigation or the possible loss in the event of an
adverse judgment.
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 has been transferred to the
Beaumont Division of the Eastern District of Texas. This action is brought by an
individual, alleged to be a retail consumer of electricity, on behalf of herself
and as a proposed representative of a putative class of retail purchasers of
electricity that are similarly situated. On September 15, 2003, defendants filed
a motion to dismiss the lawsuit and a motion to transfer the case to the
Northern District of Texas, Dallas Division. TXU Corp. believes that the
plaintiff lacks standing to assert any antitrust claims against TXU Corp. or TXU
Portfolio Management, and that defendants have not violated antitrust laws or
other laws as claimed by the plaintiff. Therefore, TXU Corp. believes that
plaintiff's claims are without merit and plans to vigorously defend the lawsuit.
TXU Corp. is unable to estimate any possible loss or predict the outcome of this
action.
General -- In addition to the above, TXU Energy and its subsidiaries are
involved in various other legal and administrative proceedings the ultimate
resolution of which, in the opinion of each, should not have a material effect
upon their financial position, results of operations or cash flows.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
10
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Not applicable. All of TXU Energy's common membership interests are owned
by US Holdings.
Item 6. SELECTED FINANCIAL DATA
The information required hereunder for TXU Energy is set forth under
Selected Financial Data included in Appendix A to this report.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required hereunder for TXU Energy is set forth under
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in Appendix A to this report.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required hereunder for TXU Energy is set forth in
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in Appendix A to this report.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required hereunder for TXU Energy is set forth under
Statement of Responsibility, Independent Auditors' Report, Statements of
Consolidated Income, Statements of Consolidated Comprehensive Income, Statements
of Consolidated Cash Flows, Consolidated Balance Sheets, Statements of
Consolidated Members Interests and Notes to Financial Statements included in
Appendix A to this report.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
Item 9A. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of TXU Energy's management, including the principal executive
officer and principal financial officer, of the effectiveness of the design and
operation of the disclosure controls and procedures in effect as of December 31,
2003. Based on the evaluation performed, TXU Energy's management, including the
principal executive officer and principal financial officer, concluded that the
disclosure controls and procedures were effective.
There have been no significant changes in TXU Energy's internal controls
over financial reporting for its continuing operations that have occurred during
the most recent fiscal quarter that has materially affected, or is reasonably
likely to materially affect, TXU Corp.'s internal control over financial
reporting.
11
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Item 10 is not presented herein as TXU Energy meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 11. EXECUTIVE COMPENSATION
Item 11 is not presented herein as TXU Energy meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Item 12 is not presented herein as TXU Energy meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13 is not presented herein as TXU Energy meets the conditions set
forth in General Instruction (I) (1) (a) and (b).
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
TXU Energy has no Audit Committee of its own, but relies upon the TXU
Corp. Audit Committee (Committee). The Committee has adopted a policy relating
to the engagement of TXU Corp.'s independent auditors. The policy provides that
in addition to the audit of the financial statements, related quarterly reviews
and other audit services, Deloitte & Touche LLP may be engaged to provide
non-audit services as described herein. Prior to engagement, all services to be
rendered by the independent auditors must be authorized by the Committee in
accordance with pre-approval procedures which are defined in the policy. The
pre-approval procedures require (i) the annual review and pre-approval by the
Committee of all anticipated audit and non-audit services; and (ii) the
quarterly pre-approval by the Committee of services, if any, not previously
approved and the review of the status of previously approved services. The
Committee may also approve certain on-going non-audit services not previously
approved in the limited circumstances provided for in the SEC rules. All
services performed by the independent auditor were pre-approved.
The policy defines those non-audit services which Deloitte & Touche may
also be engaged to provide as follows: (i) audit related services (e.g. due
diligence related to mergers, acquisitions and divestitures; employee benefit
plan audits; accounting and financial reporting standards consultation; internal
control reviews; and the like); (ii) tax services (e.g. Federal and state tax
returns; regulatory rulings preparation; general tax, merger, acquisition and
divestiture consultation and planning; and the like); and (iii) other services
(e.g. process improvement, review and assurance; litigation and rate case
assistance; general research; and the like). The policy prohibits the engagement
of Deloitte & Touche to provide: (i) bookkeeping or other services related to
the accounting records or financial statements of the Company; (ii) financial
information systems design and implementation services; (iii) appraisal or
valuation services, fairness opinions, or contribution-in-kind reports; (iv)
actuarial services; (v) internal audit outsourcing services; (vi) management or
human resource functions; (vii) broker-dealer, investment advisor, or investment
banking services; (viii) legal and expert services unrelated to the audit; and
(ix) any other service that the Public Company Accounting Oversight Board
determines, by regulation, to be impermissible.
Compliance with the Committee's policy relating to the engagement of
Deloitte & Touche will be monitored on behalf of the Committee by TXU Corp.'s
chief internal audit executive. Reports from Deloitte & Touche and the chief
internal audit executive describing the services provided by the firm and fees
for such services will be provided to the Committee no less often than
quarterly.
12
For the years ended December 31, 2003 and 2002, fees billed to the Company
by Deloitte & Touche were as follows:
2003 2002
------------- --------------
Audit Fees. Fees for services necessary to perform the annual audit, review
Securities and Exchange Commission filings, fulfill statutory and other attest
service requirements, provide comfort letters and consents................. $ 1,248,000 $ 1,299,000
Audit-Related Fees. Fees for services including employee benefit plan audits,
due diligence related to mergers, acquisitions and divestitures, accounting
consultations and audits in connection with acquisitions, internal control
reviews, attest services that are not required by statute or regulation, and
consultation concerning financial accounting
and reporting standards.................................................... 165,000 243,000
Tax Fees. Fees for tax compliance, tax planning, and tax advice related
to mergers and acquisitions, divestitures, and communications with and
requests for rulings from taxing authorities............................... 0 0
All Other Fees. Fees for services including process improvement
reviews, forensic accounting reviews, litigation and rate case assistance.. 102,000 140,000
------------- --------------
Total...................................................................... $1,515,000 $1,682,000
============= ==============
13
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Page
----
(a) Documents filed as part of this Report:
Financial Statements (included in Appendix A to this report):
Selected Financial Data .............................................................. A- 2
Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................................... A- 3
Statement of Responsibility........................................................... A-33
Independent Auditors' Report.......................................................... A-34
Statements of Consolidated Income for each of the three years in the
period ended December 31, 2003..................................................... A-35
Statements of Consolidated Comprehensive Income for each of the
three years in the period ended December 31, 2003.................................. A-35
Statements of Consolidated Cash Flows for each of the three years in
the period ended December 31, 2003................................................. A-36
Consolidated Balance Sheets, December 31, 2003 and 2002............................... A-37
Statements of Consolidated Membership Interests for each of the three years in
the period ended December 31, 2003................................................. A-38
Notes to Financial Statements......................................................... A-39
The consolidated financial statement schedules are omitted because of the
absence of the conditions under which they are required or because the required
information is included in the consolidated financial statements or notes
thereto.
(b) Reports on Form 8-K filed or furnished since September 30, 2003, are as
follows:
None
(c) Exhibits:
Included in Appendix B to this report.
14
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, TXU Energy Company LLC has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
TXU ENERGY COMPANY LLC
Date: March 16, 2004
By: /s/ T. L. BAKER
------------------------------
(T. L. Baker, President and
Chief Executive)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of TXU Energy
Company LLC and in the capacities and on the date indicated.
Signature Title Date
--------- ----- ----
/s/ T. L. BAKER Principal Executive
-------------------------------------------------------- Officer and Manager March 16, 2004
(T. L. Baker, President and Chief Executive)
/s/ PAUL O' MALLEY Principal Financial Officer March 16, 2004
--------------------------------------------------------
(Paul O'Malley, Senior Vice President - Principal
Financial Officer)
/s/ DAVID H. ANDERSON Principal Accounting Officer March 16, 2004
--------------------------------------------------------
(David H. Anderson, Vice President)
/s/ C. JOHN WILDER Manager March 16, 2004
--------------------------------------------------------
(C. John Wilder, Chairman of the Board)
/s/ H. DAN FARELL Manager March 16, 2004
--------------------------------------------------------
(H. Dan Farell)
/s/ MICHAEL J. MCNALLY Manager March 16, 2004
--------------------------------------------------------
(Michael J. McNally)
/s/ ERLE NYE Manager March 16, 2004
--------------------------------------------------------
(Erle Nye)
/s/ ERIC H. PETERSON Manager March 16, 2004
--------------------------------------------------------
(Eric H. Peterson)
/s/ MICHAEL W. RANGER Manager March 16, 2004
--------------------------------------------------------
(Michael W. Ranger)
15
Supplemental Information to be Furnished with Reports Filed
Pursuant to Section 15(d) of the Act by Registrants Which Have Not Registered
Securities Pursuant to Section 12 of the Act
No annual report, proxy statement, form of proxy or other proxy soliciting
material has been sent to security holders of TXU Energy Company LLC during the
period covered by this Annual Report on Form 10-K for the fiscal year ended
December 31, 2003.
16
Appendix A
TXU ENERGY COMPANY LLC AND SUBSIDIARIES
INDEX TO FINANCIAL INFORMATION
December 31, 2003
Page
Selected Financial Data .................................................................... A-2
Management's Discussion and Analysis of Financial Condition and Results of Operations....... A-3
Statement of Responsibility................................................................. A-33
Independent Auditors' Report................................................................ A-34
Financial Statements:
Statements of Consolidated Income and Comprehensive Income............................... A-35
Statements of Consolidated Cash Flows.................................................... A-36
Consolidated Balance Sheets.............................................................. A-37
Statements of Consolidated Membership Interests.......................................... A-38
Notes to Financial Statements............................................................ A-39
A-1
TXU ENERGY COMPANY LLC AND SUBSIDIARIES
SELECTED FINANCIAL DATA
Year Ended December 31,
------------------------------------------
2003 2002 2001 2000
---- ---- ---- ----
(Millions of Dollars, except ratios)
Total assets -- end of year................................ $14,572 $15,789 $13,905 $14,775
Property, plant and equipment - net -- end of year......... $10,381 $10,380 $10,530 $10,650
Capital expenditures................................... $ 163 $ 284 $ 327 $ 254
Capitalization -- end of year
Long-term debt, less amounts due currently ............ $ 3,084 $ 2,378 $ 3,454 $ 3,196
Exchangeable preferred membership interests............ 497 - - -
Membership interests................................... 3,999 4,273 4,212 4,121
------- ------- ------- -------
Total..................................... $ 7,580 $ 6,651 $ 7,666 $ 7,317
======= ======= ======= =======
Capitalization ratios -- end of year
Long-term debt, less amounts due currently............. 40.7% 35.8% 45.1% 43.7%
Exchangeable preferred membership interests............ 6.6 - - -
Membership interests................................... 52.7 64.2 54.9 56.3
------- ------- ------ -------
Total..................................... 100.0% 100.0% 100.0% 100.0%
======= ======= ====== =======
Embedded interest cost on long-term debt and exchangeable
preferred membership interests -- end of year (a)........ 7.2% 6.8% 4.5% 5.9%
Operating revenues......................................... $ 7,995 $ 7,691 $ 7,404 $ 7,392
Income from continuing operations before extraordinary loss
and cumulative effect of changes in accounting
principles................................................ 493 319 591 581
Net income.................................................. 421 270 507 576
Ratio of earnings to fixed charges........................ 2.93 2.63 3.96 3.64
(a) Represents the annual interest and amortization of any discounts, premiums,
issuance costs and any deferred gains/losses on reacquisitions divided by
the carrying value of the debt plus or minus the unamortized balance of any
discounts, premiums, issuance costs and gains/losses on reacquisitions at
the end of the year.
Certain previously reported financial statistics have been reclassified to
conform to current classifications.
Prior year amounts have been restated to reflect the retail strategic business
as discontinued operations. (See Note 3 to Financial Statements.)
A-2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS
Use of the term "TXU Energy", unless otherwise noted, refers to TXU Energy
Company LLC, a holding company, and/or its consolidated subsidiaries.
TXU Energy engages in power production (electricity generation) and retail
and wholesale sales of electricity and natural gas. TXU Energy engages in
hedging and risk management activities to mitigate commodity price risk.
TXU Energy has no reportable segments.
Changes in Business
- -------------------
In December 2003, TXU Energy finalized a formal plan to sell its strategic
retail services business, which is engaged principally in providing energy
management services. The consolidated financial statements for all years
presented reflect the reclassification of the results of this business as
discontinued operations. (See Note 3 to Financial Statements for more detailed
information about discontinued operations.)
All dollar amounts in Management's Discussion and Analysis of Financial
Condition and Results of Operations and the tables therein, except per share
amounts, are stated in millions of US dollars unless otherwise indicated.
MANAGEMENT'S CHALLENGES AND INITIATIVES
Management Change
- -----------------
On February 23, 2004, C. John Wilder was named president and chief
executive of TXU Corp. Mr. Wilder was formerly executive vice president and
chief financial officer of Entergy Corporation. Mr. Wilder is in the process of
reviewing the operations of TXU Corp. and formulating strategic initiatives.
This review is expected to take up to six months. Upon completion, TXU Corp.
expects to fully describe the results of the review and subsequent actions
intended to improve the financial performance of its operations.
Areas to be reviewed include:
o Performance in competitive markets, including profitability in new
markets
o Cost structure, including organizational alignments and headcount
o Management of natural gas price risk
o Non-core business activities
If any new strategic initiatives are undertaken, TXU Corp.'s financial
results could be materially affected.
Competitive Markets
- -------------------
In the Texas market, 2003 was the second full year of competitive
activity, and that activity has impacted customer counts and sales volumes. The
area representing the historical service territory prior to deregulation,
largely in north Texas, consisted of approximately 2.8 million consumers
(measured by meter counts) as of year-end of 2003. TXU Energy currently has
approximately 2.4 million customers in that territory and has acquired
approximately 200,000 customers in other competitive areas in Texas. Total
customer counts declined 4% in 2003 and 0.5% in 2002. Retail sales volumes
declined 12% in 2003 and 9% in 2002, reflecting competitive activity in the
business market segment and to a lesser extent in the residential market. While
wholesale sales volumes have increased significantly, gross margins have been
compressed by the loss of the higher-margin retail volumes. TXU Energy intends
to aggressively compete, in terms of price and customer service, in all segments
of the retail market, both within and outside the historical service territory.
In particular, TXU Energy anticipates regaining volumes in the large business
market, reflecting contracting activity in late 2003. Because of the customer
service and marketing costs associated with entering markets outside of the
historical service territory, TXU Energy has experienced operating losses in
these new markets. TXU Energy expects to be profitable in these markets as the
customer base grows and economies of scale are achieved, but uncertainties
remain and objectives may not be achieved.
A-3
Effect of Natural Gas
- ---------------------
Wholesale electricity prices in the Texas market generally move with the
price of natural gas because marginal demand is met with gas-fired generation
plants. Natural gas prices increased significantly in 2003, but historically the
price has moved up and down due to the effects of weather, industrial demand,
supply availability and other economic factors. Consequently, sales price
management and hedging activities are critical in achieving targeted gross
margins. TXU Energy continues to have price flexibility in the large business
market and effective January 1, 2004, has price flexibility in the small
business market including the historical service territory. With respect to
residential customers in the historical service territory, TXU Energy is subject
to regulated "price-to-beat" rates, but such rates can be adjusted up or down
twice a year at TXU Energy's option, subject to approval by the Commission,
based on changes in natural gas prices. The challenge in adjusting these rates
is determining the appropriate timing, considering past and projected movements
in natural gas prices, such that targeted margins can be achieved while
remaining competitive with other retailers who have price flexibility. TXU
Energy increased the price-to-beat rates twice in 2003, and these actions
combined with unregulated price increases and hedging activities essentially
offset higher costs of energy sold as compared to 2002.
In its portfolio management activities, TXU Energy enters into physical
and financial energy-related (power and natural gas) contracts to hedge gross
margins. TXU Energy hedges prices of anticipated power sales against falling
natural gas prices and, to a lesser extent, hedges costs of energy sold against
rising natural gas prices. The results of hedging and risk management activities
can vary significantly from one reporting period to the next as a result of
market price movements on the values of hedging instruments. Such activity
represents an effective management tool to reduce cash gross margin risk over
time. The challenge, among others, with these activities is managing the
portfolio of positions in a market in which prices can move sharply in a short
period of time.
One of TXU Energy's cost advantages, particularly in a time of rising
natural gas prices, is its nuclear-powered and coal/lignite-fired generation
assets. Variable costs of this "base load" generation, which provided
approximately 50% of sales volumes in 2003, have in recent history been, and are
expected to be, less than the costs of gas-fired generation. Consequently,
maintaining the efficiency and reliability of the base load assets is of
critical importance in managing gross margin risk. Completing scheduled
maintenance outages at the nuclear-powered facility on a timely basis, for
example, is a critical management process. Because of the correlation of power
and natural gas prices in the Texas market, structural decreases or increases in
natural gas prices that are sustained over a multi-year period result in a
correspondingly lower or higher value of TXU Energy's base load generation
assets.
Operating Costs and SG&A Expenses
- ---------------------------------
With the transition from a fully regulated environment to competition in
the retail and wholesale electricity markets, TXU Energy continues to seek
opportunities to enhance productivity, reduce complexity and improve the
effectiveness of its operating processes. Such efforts are balanced against the
need to support growth and maintain the reliability, efficiency, and security of
its generation fleet. Cost reduction initiatives have resulted in lower
headcounts, the exiting of marginal business activities and reduced
discretionary spending. Total operating costs and SG&A expenses in TXU Energy's
continuing operations declined $149 million, or 10%, in 2003. These costs
include TXU Corp. corporate expenses allocated to TXU Energy. While upward cost
pressures are expected for competitive sales and marketing initiatives, customer
care and support activities, and employee and retiree benefits, increasing
productivity levels will continue to be a management priority.
CRITICAL ACCOUNTING POLICIES
TXU Energy's significant accounting policies are detailed in Note 1 to
Financial Statements. TXU Energy follows accounting principles generally
accepted in the United States of America. In applying these accounting policies
in the preparation of TXU Energy's consolidated financial statements, management
is required to make estimates and assumptions about future events that affect
the reporting and disclosure of assets and liabilities at the balance sheet
dates and revenue and expense during the periods covered. The following is a
summary of certain critical accounting policies of TXU Energy that are impacted
by judgments and uncertainties and for which different amounts might be reported
under a different set of conditions or using different assumptions.
A-4
Financial Instruments and Mark-to-Market Accounting -- TXU Energy enters
into financial instruments, including options, swaps, futures, forwards and
other contractual commitments primarily to hedge market risks related to changes
in commodity prices as well as changes in interest rates. These financial
instruments are accounted for in accordance with SFAS 133 as well as, prior to
October 26, 2002, EITF 98-10. The majority of financial instruments entered into
by TXU Energy and used in hedging activities are derivatives as defined in SFAS
133.
SFAS 133 requires the recognition of derivatives in the balance sheet, the
measurement of those instruments at fair value and the recognition in earnings
of changes in the fair value of derivatives. This recognition is referred to as
"mark-to-market" accounting. SFAS 133 provides exceptions to this accounting if
(a) the derivative is deemed to represent a transaction in the normal course of
purchasing from a supplier and selling to a customer, or (b) the derivative is
deemed to be a cash flow or fair value hedge. In accounting for cash flow
hedges, derivative assets and liabilities are recorded on the balance sheet at
fair value with an offset in other comprehensive income. Amounts are
reclassified from other comprehensive income to earnings as the underlying
transactions occur and realized gains and losses are recognized in earnings.
Fair value hedges are recorded as derivative assets or liabilities with an
offset to the carrying value of the related asset or liability. Any hedge
ineffectiveness related to cash flow and fair value hedges is recorded in
earnings.
TXU Energy documents designated commodity, debt-related and other hedging
relationships, including the strategy and objectives for entering into such
hedge transactions and the related specific firm commitments or forecasted
transactions. TXU Energy applies hedge accounting in accordance with SFAS 133
for these non-trading transactions, providing the underlying transactions remain
probable of occurring. Effectiveness is assessed based on changes in cash flows
of the hedges as compared to changes in cash flows of the hedged items. In its
risk management activities, TXU Energy hedges future electricity revenues using
natural gas instruments; such cross-commodity hedges are subject to
ineffectiveness calculations that can result in mark-to-market gains and losses.
Pursuant to SFAS 133, the normal purchase or sale exception and the cash
flow hedge designation are elections that can be made by management if certain
strict criteria are met and documented. As these elections can reduce the
volatility in earnings resulting from fluctuations in fair value, results of
operations could be materially affected by such elections.
Interest rate swaps entered into in connection with indebtedness to manage
interest rate risks are accounted for as cash flow hedges if the swap converts
rates from variable to fixed and are accounted for as fair value hedges if the
swap converts rates from fixed to variable.
EITF 98-10 required mark-to-market accounting for energy-related
contracts, whether or not derivatives under SFAS 133, that were deemed to be
entered into for trading purposes as defined by that rule. The majority of
commodity contracts and energy-related financial instruments entered into by TXU
Energy to manage commodity price risk represented trading activities as defined
by EITF 98-10 and were therefore marked-to-market. On October 25, 2002, the EITF
rescinded EITF 98-10. Pursuant to this rescission, only financial instruments
that are derivatives under SFAS 133 are subject to mark-to-market accounting.
In June 2002, in connection with the EITF's consensus on EITF 02-3,
additional guidance on recognizing gains and losses at the inception of a
trading contract was provided. In November 2002, this guidance was extended to
all derivatives. As a result, effective in 2003, TXU Energy discontinued
recording mark-to-market gains on inception of energy contracts. See discussion
below in Results of Operations - "Commodity Contracts and Mark-to-Market
Activities."
Mark-to-market accounting recognizes changes in the value of financial
instruments as reflected by market price fluctuations. In the energy market, the
availability of quoted market prices is dependent on the type of commodity
(e.g., natural gas, electricity, etc.), time period specified and location of
delivery. In computing the mark-to-market valuations, each market segment is
split into liquid and illiquid periods. The liquid period varies by region and
commodity. Generally, the liquid period is supported by broker quotes and
frequent trading activity. In illiquid periods, little or no market information
may exist, and the fair value is estimated through market modeling techniques.
A-5
For those periods where quoted market prices are not available, forward
price curves are developed based on available information or through the use of
industry accepted modeling techniques and practices based on market fundamentals
(e.g., supply/demand, replacement cost, etc.). TXU Energy does not recognize any
income or loss from the illiquid periods unless credible price discovery exists.
TXU Energy recorded net unrealized losses arising from mark-to-market
accounting, including hedge ineffectiveness, of $100 million and $113 million in
2003 and 2002, respectively. The 2003 amount excludes the cumulative effect of
changes in accounting principles discussed in Note 2 to Financial Statements.
Revenue Recognition -- TXU Energy records revenue for retail and wholesale
energy sales under the accrual method. Retail electric revenues are recognized
when electricity is provided to customers on the basis of periodic cycle meter
readings and include an estimated accrual for the value of electricity consumed
from the meter reading date to the end of the period. The unbilled revenue is
calculated at the end of the period based on estimated daily consumption after
the meter read date to the end of the period. Estimated daily consumption is
derived using historical customer profiles adjusted for weather and other
measurable factors affecting consumption. Unbilled revenues reflected in
accounts receivable totaled $388 million and $489 million at December 31, 2003
and 2002, respectively.
Realized and unrealized gains and losses from transacting in
energy-related contracts, principally for the purpose of hedging margins on
sales of energy, are reported as a component of revenues. As discussed above
under "Financial Instruments and Mark-to-Market Accounting," recognition of
unrealized gains and losses involves a number of assumptions and estimates that
could have a significant effect on reported revenues and earnings.
Accounting for Contingencies -- The financial results of TXU Energy may be
affected by judgments and estimates related to loss contingencies. Accruals for
loss contingencies are recorded when management determines that it is probable
that an asset has been impaired or a liability has been incurred and that such
economic loss can be reasonably estimated. Such determinations are subject to
interpretations of current facts and circumstances, forecasts of future events
and estimates of the financial impacts of such events.
A significant contingency that TXU Energy accounts for is the loss
associated with uncollectible trade accounts receivable. The determination of
such bad debts expense is based on factors such as historical write-off
experience, agings of accounts receivable balances, changes in operating
practices, regulatory rulings, general economic conditions and customers'
behaviors. With the opening of the Texas electricity market to competition, many
historical measures used to estimate bad debt experience may be less reliable.
The changing environment, including recent regulatory changes that allow REPs in
their historical service territories to disconnect non-paying customers, and
customer churn due to competitor actions has added a level of complexity to the
estimation process. Bad debt expense totaled $114 million and $155 million for
the years ended December 31, 2003 and 2002, respectively.
In connection with the opening of the Texas market to competition, the
Texas Legislature established a retail clawback provision intended to incent
affiliated REPs of utilities to actively compete for customers outside their
historical service territories. A retail clawback liability arises unless 40% of
the electricity consumed by residential and small business customers in the
historical service territory is supplied by competing REPs after the first two
years of competition. This threshold was reached for small business customers in
2003, but not for residential customers. The amount of the liability is equal to
the number of such customers retained by TXU Energy as of January 1, 2004, less
the number of new customers from outside the historical service territory,
multiplied by $90. The credit, which will be funded by TXU Energy, will be
applied to delivery fees charged by Oncor to REPs, including TXU Energy, over a
two-year period beginning January 1, 2004. In 2002, TXU Energy recorded a charge
to cost of energy sold and delivery fees of $185 million ($120 million
after-tax) to accrue an estimated retail clawback liability. In 2003, TXU Energy
reduced the liability to $173 million, with a credit to cost of energy sold and
delivery fees of $12 million ($8 million after-tax), to reflect the calculation
of the estimated liability applicable only to residential customers in
accordance with the Settlement Plan.
ERCOT Settlements - ERCOT's responsibilities include the balancing and
settlement of electricity volumes and related ancillary services among the
various participants in the deregulated Texas market. ERCOT settles balancing
energy with market participants through a load and resource imbalance charge or
credit for any differences between actual and scheduled volumes. Ancillary
services and various fees are allocated to market participants based on each
participant's load.
A-6
Settlement information is due from ERCOT within two months after the
operating day, and true-up settlements are due from ERCOT within twelve months
after the operating day. The ERCOT settlement process has been delayed several
times to address operational data management problems between ERCOT, the
transmission and distribution service providers and the REPs. These operational
data management issues are related to new processes and systems associated with
opening the ERCOT market to competition, which have continued to improve.
True-up settlements have been received for 2002, but true-up settlements for the
year 2003 are currently scheduled to start on June 1, 2004. All periods continue
to be subject to a dispute resolution process.
As a result of the delay in the ERCOT settlements and the normal time lags
described above, TXU Energy's operating revenues and costs of energy sold
contain estimates for load and resource imbalance charges or credits with ERCOT
and for ancillary services and related fees that are subject to change and may
result in charges or credits impacting future reported results of operations.
The amounts recorded represent the best estimate of these settlements based on
available information. During 2003, TXU Energy recorded a net expense of $20
million to adjust amounts previously recorded for 2002 and 2001 ERCOT
settlements.
Impairment of Long-Lived Assets -- TXU Energy evaluates long-lived assets
for impairment whenever indications of impairment exist, in accordance with the
requirement of SFAS 144. One of those indications is a current expectation that
"more likely than not" a long-lived asset will be sold or otherwise disposed of
significantly before the end of its previously estimated useful life. The
determination of the existence of this and other indications of impairment
involves judgments that are subjective in nature and in some cases requires the
use of estimates in forecasting future results and cash flows related to an
asset or group of assets. Further, the unique nature of TXU Energy's property,
plant and equipment, which includes a fleet of generation assets using different
fuels and individual plants that have varying utilization rates, requires the
use of significant judgments in determining the existence of impairment
indications and grouping assets for impairment testing.
In 2002, TXU Energy recorded an impairment charge of $237 million ($154
million after-tax) for the writedown of two generation plant construction
projects as a result of weaker wholesale electricity market conditions and
reduced planned developmental capital spending. Fair value was determined based
on appraisals of property and equipment. The charge is reported in other
deductions.
Goodwill and Intangible Assets - TXU Energy evaluates goodwill for
impairment at least annually (as of October 1) in accordance with SFAS 142. The
impairment tests performed are based on discounted cash flow analyses. Such
analyses require a significant number of estimates and assumptions regarding
future earnings, working capital requirements, capital expenditures, discount
rate, terminal year growth factor and other modeling factors. No goodwill
impairment has been recognized for consolidated reporting units reflected in
results from continuing operations.
Defined Benefit Pension Plans and Other Postretirement Benefit Plans-- TXU
Energy is a participating employer in the defined benefit pension plan sponsored
by TXU Corp. TXU Energy also participates with TXU Corp. and other affiliated
subsidiaries of TXU Corp. to offer health care and life insurance benefits to
eligible employees and their eligible dependents upon the retirement of such
employees. See Note 11 to Financial Statements for information regarding
retirement plans and other postretirement benefits.
These costs are impacted by actual employee demographics (including age,
compensation levels and employment periods), the level of contributions made to
retiree plans and earnings on plan assets. TXU Corp.'s retiree plan assets are
primarily made up of equity and fixed income investments. Changes made to the
provisions of the plans may also impact current and future benefit costs.
Fluctuations in actual equity market returns as well as changes in general
interest rates may result in increased or decreased benefit costs in future
periods. Benefit costs may also be significantly affected by changes in key
actuarial assumptions, including anticipated rates of return on plan assets and
the discount rates used in determining the projected benefit obligation.
In accordance with accounting rules, changes in benefit obligations
associated with these factors may not be immediately recognized as costs on the
income statement, but are recognized in future years over the remaining average
service period of plan participants. As such, significant portions of benefit
costs recorded in any period may not reflect the actual level of cash benefits
provided to plan participants. Costs allocated from the plans are also impacted
by movement of employees between participating companies. TXU Energy recorded
allocated pension and other postretirement benefits expense of $58 million in
2003, $32 million in 2002 and $19 million in 2001. TXU Energy's funding
requirements for these plans were $29 million, $20 million and $20 million in
2003, 2002 and 2001, respectively.
A-7
During 2003, key assumptions of the US pension and other postretirement
benefit plans were revised, including decreasing the assumed discount rate in
2003 from 6.75% to 6.25% to reflect current interest rates. The expected rate of
return on pension plan assets remained at 8.5%, but declined to 8.01% from 8.26%
for the other postretirement benefit plan assets.
Based on current assumptions, pension and other postretirement benefits
expense for TXU Energy is expected to increase $9 million to approximately $67
million in 2004, and TXU Energy's funding requirements for these plans are
expected to increase $16 million to approximately $45 million.
As a result of the pension plan asset return experience, at December 31,
2002, TXU Corp. recognized a minimum pension liability as prescribed by SFAS 87.
TXU Energy's allocated portion of the liability, which totaled $60 million ($39
million after-tax), was recorded as a reduction to shareholders' equity through
a charge to Other Comprehensive Income. At December 31, 2003, the minimum
pension liability reflects a reduction of $37 million ($25 million after-tax) as
a result of improved returns on the plan assets. The changes in the minimum
pension liability do not affect net income.
TXU Corp. has elected not to defer accounting for the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 (the Medicare Act)
as allowed for under FASB Staff Position 106-1. TXU Corp. believes that the plan
in which TXU Energy is a participant meets the actuarial equivalency as required
by the Medicare Act and therefore a reduction in future postretirement benefit
costs is expected. Further information related to the impact of the Medicare Act
can be found in the 2003 TXU Corp. Form 10-K The Medicare Act had no effect on
TXU Energy's results of operations for 2003, but is expected to reduce TXU
Energy's postretirement benefits expense other than pensions by approximately
$11 million in 2004.
A-8
RESULTS OF OPERATIONS
Operating Data
- --------------
Year Ended December 31,
------------------------------------
2003 2002 2001(a)(b)
---- ---- ----------
Operating statistics - volumes:
Retail electricity (GWh)
Residential.............................................. 35,981 37,692
Small business(c)........................................ 12,986 15,907
Large business and other................................. 30,955 36,982
------ ------
Total retail electricity............................... 79,922 90,581 99,151
====== ====== ======
Wholesale electricity (GWh)................................. 37,362 29,649 6,409
====== ====== ======
Production and purchased power (GWh):
Nuclear and lignite/coal (base load)..................... 59,028 54,738 57,828
Gas/oil and purchased power.............................. 63,319 70,321 52,925
------ ------ ------
Total production and purchased power .................. 122,347 125,059 110,753
======= ======= =======
Customer counts:
Retail electricity customers (end of period & in thousands -
based on number of meters):
Residential.............................................. 2,207 2,302
Small business........................................... 321 333
Large business and other................................. 69 78
------ ------ ------
Total retail electricity customers..................... 2,597 2,713 2,728
====== ====== ======
Operating revenues (millions of dollars):
Retail electricity revenues:
Residential.............................................. $3,311 $3,108 $3,255
Business and other ...................................... 3,173 3,415 3,837
------ ------ -----
Total retail electricity revenues...................... 6,484 6,523 7,092
Wholesale electricity revenues ............................. 1,274 857 96
Hedging and risk management activities...................... 18 142 358
Other revenues.............................................. 219 169 (142)
------ ------ ------
Total operating revenues............................... $7,995 $7,691 $7,404
====== ====== ======
Weather (average for service territory) (d)
Percent of normal:
Cooling degree days.................................... 103.1% 99.8% 100.5%
Heating degree days.................................... 94.0% 102.0% 97.5%
- --------------------------
(a) Data for 2001 is included above for the purpose of providing historical
financial information about TXU Energy after giving effect to the
restructuring transactions and unbundling allocations described in
Note 1 to Financial Statements. Allocations reflected in 2001
data did not necessarily result in amounts reported in individual
line items that are comparable to actual results in 2002 and 2003.
Had TXU Energy existed as a separate entity in 2001, its results
of operations and financial position could have differed materially
from those reflected above.
(b) Retail volume and customer count data for 2001 not available by class.
(c) Customers with demand of less than 1MW annually.
(d) Weather data is obtained from Meteorlogix, an independent company that
collects weather data from reporting stations of the National Oceanic
and Atmospheric Administration (a federal agency under the US Department
of Commerce).
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 (see Note 3 to Financial Statements regarding
discontinued operations) and the reclassifications of losses in 2001 on early
extinguishments of debt from extraordinary loss to other deductions in
accordance with SFAS 145. (See Note 1 to Financial Statements.)
A-9
TXU Energy
- ----------
2003 compared to 2002
- ---------------------
Operating revenues increased $304 million, or 4%, to $8.0 billion in 2003.
Total retail and wholesale electricity revenues rose $378 million, or 5%, to
$7.8 billion. This growth reflected higher retail and wholesale pricing,
partially offset by the effects of a mix shift to lower-price wholesale sales
and a 2% decline in total sales volumes. Retail electricity revenues decreased
$39 million, or 1%, to $6.5 billion reflecting a $768 million decline
attributable to a 12% drop in sales volumes, driven by the effect of competitive
activity in the business market, largely offset by a $730 million increase due
to higher pricing. Higher prices reflected increased price-to-beat rates, due to
approved fuel factor increases, and higher contract pricing in the competitive
large business market, both resulting from higher natural gas prices. Retail
electricity customer counts declined 4% from year-end 2002. Wholesale
electricity revenues grew $417 million, or 49%, to $1.3 billion reflecting a
$223 million increase attributable to a 26% rise in sales volumes and a $194
million increase due to the effect of increased natural gas prices on wholesale
prices. Higher wholesale electricity sales volumes reflected a partial shift in
the customer base from retail to wholesale services, particularly in the
business market.
Net gains from hedging and risk management activities, which are reported
in revenues and include both realized and unrealized gains and losses, declined
$124 million to $18 million in 2003. Changes in these results reflect market
price movements on commodity contracts entered into to hedge gross margin; the
comparison to 2002 also reflects a decline in activities in markets outside of
Texas. 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 from these
activities include net unrealized losses arising from mark-to-market accounting
of $100 million in 2003 and $113 million in 2002. The majority of TXU Energy's
natural gas physical sales and purchases are in the wholesale markets and
essentially represent hedging activities. These activities are accounted for on
a net basis with the exception of retail sales to business customers, which
effective October 1, 2003 are reported gross in accordance with new accounting
rules and totaled $39 million in revenues since that date. The increase in other
revenues of $50 million to $219 million in 2003 was driven by this change.
Gross Margin
Year Ended December 31,
------------------------------------------------
% of % of
2003 Revenue 2002 Revenue
---- ------- ---- -------
Operating revenues..................................... $ 7,995 100% $ 7,691 100%
Costs and expenses:
Cost of energy sold and delivery fees............. 5,124 64% 4,783 62%
Operating costs................................... 691 9% 701 9%
Depreciation and amortization related to generation
assets........................................ 370 4% 409 5%
------- ----- ------- -------
Gross margin........................................... $ 1,810 23% $ 1,798 24%
======= ===== ======= =======
Gross margin is considered a key operating metric as it measures the
effect of changes in sales volumes and pricing versus the variable and fixed
costs of energy sold, whether generated or purchased.
The depreciation and amortization expense reported in the gross margin
amounts above excludes $39 million and $41 million of such expense for the years
ended December 31, 2003 and 2002, respectively, related to assets that are not
directly used in the generation of electricity.
Gross margin increased $12 million, or 1%, to $1.8 billion in 2003. The
gross margin comparison was favorably impacted by $197 million due to
regulatory-related retail clawback accrual adjustments (a $185 million charge,
$120 million after-tax, in 2002 and a $12 million credit in 2003), as described
in Note 14 to Financial Statements, and $49 million in lower operating costs and
depreciation and amortization. Adjusting for these effects, margin declined $234
million, driven by the effect of lower retail sales volumes. The combined effect
of higher costs of energy sold and lower results from hedging and risk
management activities was essentially offset by higher sales prices. Higher
costs of energy sold were driven by higher natural gas prices, but were
mitigated by increased sourcing of retail and wholesale sales demand from TXU
Energy's base load (nuclear-powered and coal-fired) generation plants. Base load
supply of sales demand increased by four percentage points to 50% in 2003. The
balance of sales demand in 2003 was met with gas-fired generation and purchased
power.
A-10
Operating costs decreased $10 million, or 1%, to $691 million in 2003. The
decline reflected $20 million due to one scheduled outage for nuclear generation
unit refueling and maintenance in 2003 compared to two in 2002 and $15 million
from various cost reduction initiatives, partially offset by $27 million in
higher employee benefits and insurance costs. Depreciation and amortization
related to generation assets decreased $39 million, or 10%, to $370 million. Of
this decline, $37 million represented the effect of adjusted depreciation rates
related to the generation fleet effective April 2003. The adjusted rates reflect
an extension in the estimated average depreciable life of the nuclear generation
facility's assets of approximately 11 years (to 2041) to better reflect its
useful life, partially offset by higher depreciation rates for lignite and gas
facilities to reflect investments in emissions equipment made in recent years.
A decrease in depreciation and amortization (including amounts shown in
the gross margin table above) of $41 million, or 9%, to $409 million in 2003 was
driven by the adjusted depreciation rates related to the generation fleet due
primarily to an extension of the estimated depreciable life of the nuclear
generation facility to better reflect its useful life.
SG&A expenses declined $139 million, or 18%, to $636 million in 2003.
Lower staffing and related administrative expenses contributed approximately $95
million to the decrease, reflecting cost reduction and productivity enhancing
initiatives and a focus on activities in the Texas market. Lower SG&A expenses
also reflected a $40 million decline in bad debt expense. In the retail
electricity business, the effect of enhanced credit and collection activities
was largely offset by increased write-offs arising from disconnections now
allowed under new regulatory rules and increased churn of non-paying customers.
The decrease in bad debt expense primarily reflected the wind down of retail gas
(business customer supply) activities outside of Texas and the recording of
related reserves in 2002.
Other income increased $15 million to $48 million in 2003. Other income in
both periods included approximately $30 million of amortization of a gain on the
sale of two generation plants in 2002. The 2003 period also included a $9
million gain on the sale of contracts related to retail gas activities outside
of Texas.
Other deductions decreased $232 million to $22 million in 2003, reflecting
a $237 million ($154 million after-tax) writedown in 2002 of an investment in
two generation plant construction projects. In addition, both periods include
several individually immaterial items.
Interest expense and related charges increased $108 million, or 50%, to
$323 million in 2003. The increase reflects $108 million due to higher average
interest rates as short-term borrowings were replaced with higher-rate long-term
financing. An $11 million full-year effect of the amortization of the discount
on the exchangeable subordinated notes issued in 2002 (subsequently exchanged by
TXU Energy for exchangeable preferred membership interests) was largely offset
by the effect of lower average borrowing levels.
The effective income tax rate increased to 31.7% in 2003 from 26.8% in
2002. The increase was driven by the effect of comparable (to 2002) tax benefit
amounts of depletion allowances and amortization of investment tax credits on a
higher income base in 2003. (See Note 10 to Financial Statements for analysis of
the effective tax rate.)
Income from continuing operations before extraordinary loss and cumulative
effect of changes in accounting principles increased $174 million, or 55%, to
$493 million in 2003. Results in 2002 included an impairment charge related to
generation plant construction projects and an accrual for retail clawback of
$154 million after-tax and $120 million after-tax, respectively. Excluding these
items, earnings declined on gross margin compression due to lower retail sales
volumes as well as higher interest expense, partially offset by lower SG&A
expenses. Net pension and postretirement benefit costs reduced net income by $36
million in 2003 and by $21 million in 2002.
Loss from the discontinued strategic retail services operations (see Note
3 to Financial Statements) was $14 million in 2003 and $49 million in 2002. The
decline reflected reductions in headcount and other SG&A-related expenses.
A cumulative effect of changes in accounting principles, representing an
after-tax charge of $58 million in 2003, reflects the impact on commodity
contract mark-to-market accounting from rescission of EITF 98-10 and the
recording of asset retirement obligations under SFAS 143. (See Note 2 to
Financial Statements.)
A-11
TXU Energy
- ----------
2002 compared to 2001
- ---------------------
TXU Energy's operating revenues increased $287 million, or 4%, to $7.7
billion in 2002. Total retail and wholesale electricity revenues rose $192
million, or 3%, to $7.4 billion driven by higher wholesale volumes. Wholesale
electric revenues increased $761 million to $857 million, reflecting the
substantial increase in wholesale sales volumes due to the opening of the Texas
market to competition. Retail electric revenues declined $569 million, or 8%, to
$6.5 billion, reflecting a $613 million reduction due to lower volumes partially
offset by a $44 million increase due to higher average pricing. The price
variance reflects a shift in customer mix, partially offset by the effect of
lower rates. A 9% decline in overall retail electric sales volumes was primarily
due to the effects of increased competitive activity in the small business and
large business market. Year-end residential electricity customer counts,
reflecting losses in the historical service territory and gains in new
territories due to competition, were about even with the prior year. The
increase in revenues also reflects certain revenues and related retail and
generation expenses that were the responsibility of the Energy Delivery segment
in 2001, but are included in Energy revenues in 2002.
Net gains from hedging and risk management activities, which are reported
in revenues and include both realized and unrealized gains and losses, declined
$216 million to $142 million in 2002. Changes in these results reflect market
price movements on commodity contracts entered into to hedge gross margin.
Results from these activities included net unrealized losses of $113 million in
2002 and net unrealized gains of $318 million in 2001 arising from
mark-to-market accounting.
Gross Margin
Year Ended December 31,
------------------------------------------------
% of % of
2002 Revenue 2001 Revenue
---- ------- ---- -------
Operating revenues..................................... $ 7,691 100% $ 7,404 100%
Costs and expenses:
Cost of energy sold and delivery fees............. 4,783 62% 4,800 65%
Operating costs.................................. 701 9% 671 9%
Depreciation and amortization related to generation
assets........................................ 409 5% 391 5%
------- ------ ------- -------
Gross margin........................................... $ 1,798 24% $ 1,542 21%
======= ====== ======= =======
The depreciation and amortization expense included in gross margin
excludes $41 million and $4 million of such expense for 2002 and 2001,
respectively, related to assets that are not directly used in the generation of
electricity.
Gross margin increased $256 million, or 17%, to $1.8 billion in 2002. The
increase was driven by the net favorable effect of lower average costs of energy
sold, higher retail pricing and lower results from hedging and risk management
activities. Higher gross margin also reflected significant growth in wholesale
electricity sales volumes in the newly deregulated ERCOT, largely offset by the
effect of lower retail electricity volumes. Gross margin in 2002 was negatively
affected by the accrual of $185 million ($120 million after-tax) for
regulatory-related retail clawback, which is reported in cost of energy sold and
delivery fees. Operating costs rose $30 million, or 4%, to $701 million
primarily due to the costs of refueling two units, compared to one in 2001, at
the nuclear-powered generation plant.
An increase in depreciation and amortization (including amounts shown in
the gross margin table above), of $55 million, or 14%, to $450 million was
primarily due to investments in computer systems required to operate in the
newly deregulated market and expansion of office facilities.
An increase in SG&A expenses of $464 million, or 149%, to $775 million
reflected the effect of retail customer support costs and bad debt expense of
approximately $150 million that were the responsibility of Oncor in 2001. The
increase in SG&A expenses also reflected $199 million in higher staffing and
other administrative costs, related to expanded retail sales operations and
hedging activities, and higher bad debt expense of $90 million, all due largely
to the opening of the Texas electricity market to competition. With the
completion of the transition to competition in Texas, the industry-wide decline
in portfolio management activities, and the expected deferral of deregulation of
energy markets in other states, TXU Energy initiated several cost savings
initiatives in 2002. Such actions resulted in $31 million in severance charges
in 2002, which contributed to the increase in SG&A expense.
A-12
Franchise and revenue-based taxes rose $106 million to $120 million due to
state gross receipts taxes that were the responsibility of Oncor in 2001.
Effective in 2002, state gross receipts taxes related to electricity revenues
are an expense of TXU Energy, while local gross receipts taxes are an expense of
Oncor.
Other income increased by $31 million to $33 million, reflecting
amortization of $30 million of a gain on the sale in 2002 of two generation
plants.
Other deductions increased by $58 million to $254 million, reflecting a
$237 million ($154 million after-tax) writedown in 2002 of an investment in two
generation plant construction projects. Amounts in 2001 included $149 million
($97 million after-tax) in losses on the early extinguishment of debt under the
debt restructuring and refinancing plan pursuant to the requirements of the 1999
Restructuring Legislation, a $22 million regulatory asset write-off pursuant to
a regulatory order and $18 million in various asset writedowns.
Interest income declined by $28 million, or 74%, to $10 million primarily
due to the recovery of under-collected fuel revenue on which interest income had
been accrued under regulation in 2001.
Interest expense and other charges decreased $9 million, or 4%, to $215
million reflecting lower average debt levels, partially offset by higher rates
and a decrease in capitalized interest.
The effective tax rate decreased to 26.8% in 2002 from 29.5% in 2001. The
decrease was driven by the effect of comparable (to 2001) tax benefit amounts of
depletion allowances and amortization of investment tax credits on a lower
income base in 2002.
Income from continuing operations before extraordinary loss and cumulative
effect of changes in accounting principles decreased $272 million, or 46%, to
$319 million in 2002. The decline was driven by an increase in SG&A expenses and
higher franchise and revenue-based taxes, partially offset by the improved gross
margin (net of the $120 million effect of the retail clawback accrual). The $154
million effect of the generation plant construction project writedown was
partially offset by the $97 million effect of losses on early extinguishment of
debt in 2001. Net pension and postretirement benefit costs reduced net income by
$20 million in 2002 and $12 million in 2001.
The loss from the discontinued strategic retail services business was $49
million in 2002 and $28 million in 2001. Results in 2002 included approximately
$10 million after-tax in asset writedowns.
TXU Energy recorded an extraordinary loss in 2001 of $56 million (net of
income tax benefit of $62 million) consisting of net charges related to the
Settlement Plan to resolve all major open items related to the transition to
deregulation. (See Note 4 to Financial Statements).
A-13
Commodity Contracts and Mark-to-Market Activities
- -------------------------------------------------
The table below summarizes the changes in commodity contract assets and
liabilities for the years ended December 31, 2003, 2002 and 2001. The net
changes in these assets and liabilities, excluding "cumulative effect of change
in accounting principle" and "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.
2003 2002 2001
---- ---- ----
Balance of net commodity contract assets at beginning of year. $316 $371 $27
Cumulative effect of change in accounting principle (1)....... (75) - -
Settlements of positions included in the opening balance (2) . (145) (225) (54)
Unrealized mark-to-market valuations of positions held at
end of period (3) ........................................... 9 153 368
Other activity (4)............................................ 3 17 30
----- ------ ------
Balance of net commodity contract assets at end of year ...... $ 108 $316 $371
===== ==== ====
- --------------------------
(1) Represents a portion of the pre-tax cumulative effect of the
rescission of EITF 98-10 (see Note 2 to Financial Statements).
(2) Represents unrealized mark-to-market valuations of these positions
recognized in earnings as of the beginning of the period.
(3) There were no significant changes in fair value attributable to
changes in valuation techniques. Includes $14 million in
origination gains recognized in 2002 related to nonderivative
wholesale contracts.
(4) Includes initial values of positions involving the receipt or
payment of cash or other consideration, such as option premiums,
the amortization of such values and the exit of certain retail gas
activities in 2003. Also includes $71 million of contract-related
liabilities to Enron Corporation reclassified to other current
liabilities in 2002. These activities have no effect on unrealized
mark-to-market valuations.
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 that are reflected in changes in cash flow
hedges 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 (excludes cumulative effect of change in accounting
principle):
2003 2002 2001
---- ---- ----
Unrealized gains/(losses) in commodity contract portfolio..... $(136) $(72) $314
Ineffectiveness gains/(losses) related to cash flow hedges.... 36 (41) 4
------ ----- -------
Total unrealized gains/(losses)............................... $(100) $(113) $318
===== ===== ====
These amounts are included in the "hedging and risk management activities"
component of revenues.
As a result of guidance provided in EITF 02-3, TXU Energy has not
recognized origination gains on energy contracts in 2003. TXU Energy recognized
origination gains on retail sales contracts of $40 million in 2002 and $88
million in 2001. Because of the short-term nature of these contracts, a portion
of these gains would have been recognized on a settlement basis in the year the
origination gain was recorded.
Maturity Table -- Of the net commodity contract asset balance above at
December 31, 2003, the amount representing unrealized mark-to-market net gains
that have been recognized in current and prior years' earnings is $121 million.
The offsetting net liability of $13 million included in the December 31, 2003
balance sheet is comprised principally of amounts representing current and prior
years' net receipts of cash or other consideration, including option premiums,
associated with contract positions, net of any amortization. The following table
presents the unrealized mark-to-market balance at December 31, 2003, scheduled
by contractual settlement dates of the underlying positions.
A-14
Maturity dates of unrealized net mark-to-market balances at December 31, 2003
-----------------------------------------------------------------------------
Maturity Maturity in
less than Maturity of Maturity Excess of
Source of fair value 1 year 1-3 years of 4-5 years 5 years Total
- ---------------------- --------- ------------ ------------- --------- -----
Prices actively quoted........... $ 36 $ 12 $(2) $ - $ 46
Prices provided by other
external sources............. 21 53 1 (2) 73
Prices based on models........... (2) 4 - - 2
----- ---- --- ---- -----
Total............................ $ 55 $ 69 $(1) $ (2) $ 121
==== ==== === ==== =====
Percentage of total fair value... 45% 57% -% (2)% 100%
As the above table indicates, essentially all of the unrealized
mark-to-market valuations at December 31, 2003 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 through 2008. The "prices provided by
other external sources" category represents forward commodity positions at
locations for which over-the-counter broker quotes are available.
Over-the-counter quotes for power and natural gas generally extend through 2005
and 2010, respectively. The "prices based on models" category contains the value
of all non-exchange traded options, valued using industry accepted option
pricing models. In addition, this category contains other contractual
arrangements which may have both forward and option components. In many
instances, these contracts can be broken down into their component parts and
modeled as simple forwards and options based on prices actively quoted. As the
modeled value is ultimately the result of a combination of prices from two or
more different instruments, it has been included in this category.
COMPREHENSIVE INCOME
Cash flow hedge activity reported in other comprehensive income from
continuing operations included:
Year Ended December 31,
-------------------------------
2003 2002 2001
---- ---- ----
Cash flow hedge activity (net of tax):
Net change in fair value of hedges -
gains/(losses):
Commodities............................................... $ (137) $ (96) $ 16
Financing - interest rate swaps........................... - (63) -
------- ------- -------
(137) (159) 16
Losses realized in earnings (net of tax):
Commodities............................................... 162 15 -
Financing - interest rate swaps........................... 5 2 -
------- ------- -------
167 17 -
Net income (loss) effect of cash flow hedges reported in other
comprehensive income...................................... $ 30 $ (142) $ 16
======= ======= =======
TXU Energy has historically used, and expects to continue to use,
derivative financial instruments that are highly effective in offsetting future
cash flow volatility in interest rates and energy commodity prices. The amounts
included in accumulated other comprehensive income are expected to offset the
impact of rate or price changes on forecasted transactions. Amounts in
accumulated other comprehensive income include (i) the value of the cash flow
hedges (for the effective portion), based on current market conditions and (ii)
the value of dedesignated and terminated cash flow hedges at the time of such
dedesignation, less amortization, providing the transaction that was hedged is
still probable. The effects of the hedge will be recorded in the statement of
income as the hedged transactions are actually settled.
Other comprehensive income also included adjustments related to minimum
pension liabilities. Minimum pension liability adjustments were a gain of $37
million ($25 million after-tax) in 2003 and a loss of $60 million ($39 million
after-tax) in 2002. The gain in 2003 reflected the impact of improved returns on
plan assets. The minimum pension liability represents the difference between the
excess of the accumulated benefit obligation over the plans' assets and the
liability in the balance sheet. The recording of the liability did not affect
TXU Energy's financial covenants in any of its credit agreements.
A-15
Gains and losses on cash flow hedges are realized in earnings as the
underlying hedged transactions are settled.
TXU Energy adopted SFAS 133 effective January 1, 2001, and recorded a $1
million charge to other comprehensive income to reflect the fair value of
derivatives effective as cash flow hedges at transition.
See also Note 13 to Financial Statements.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
Cash Flows -- Cash flows provided by operating activities for the year
ended December 31, 2003 were $1.4 billion compared to $994 million and $1.2
billion for the years ended December 31, 2002 and 2001, respectively. The
increase in cash flows provided by operating activities in 2003 of $372 million,
or 37%, reflected favorable working capital (accounts receivable, accounts
payable and inventories) changes of $483 million, partially offset by payments
of $102 million related to counterparty default events and the termination and
liquidation of outstanding positions. Lower cash earnings of $215 million (net
income adjusted for the significant noncash items identified in the statement of
cash flows) were largely offset by the effect of timing of interest and federal
income tax payments. The improved working capital primarily reflects the effect
of billing and collection delays in 2002, due to data compilation and
reconciliation issues among ERCOT and the market participants in the newly
deregulated market, and includes $75 million in increased funding under the
accounts receivable sale program.
The decrease in cash flows in 2002 from 2001 of $176 million reflected the
effect of a return in 2001 of $227 million in margin deposits related to hedging
and risk management activities (in exchange for letters of credit).
Cash flows used in financing activities were $1.7 billion, $407 million
and $773 million during 2003, 2002 and 2001, respectively. The activity in 2003
reflected use of proceeds from the issuance of long-term debt, operating cash
flows and cash on hand to reduce short and long-term borrowings. Net cash used
in issuances and repayments of borrowings, including advances from affiliates,
totaled $827 million in 2003 compared to net cash provided of $550 million in
2002. The note payable to Oncor related to a regulatory liability was paid off
in 2003 (payments of $170 million in 2003 and $180 million in 2002).
Distributions paid to US Holdings totaled $750 million and $777 million in 2003
and 2002, respectively. Activity in 2001 reflected $404 million in repurchase of
US Holdings' member interest and $369 million in net repayments of borrowings.
Cash flows used in investing activities were $202 million in 2003 and $403
million in 2001. There was no net cash provided or used for investing activities
in 2002. Capital expenditures, including nuclear fuel, were $207 million in
2003, $336 million in 2002 and $366 million in 2001. Capital expenditures are
expected to total $325 million in 2004; the increase is due to a change in
timing of activity originally planned to occur in 2003. Proceeds from asset
sales in 2003 included $14 million from the sale of retail gas activities
outside of Texas. Proceeds from asset sales in 2002 of $443 million reflected
the sale of two generation plants in Texas. Acquisitions in 2002 included $36
million for a cogeneration and wholesale production business in New Jersey.
Depreciation and amortization expense reported in the statement of cash
flows exceeds the amount reported in the statement of income by $62 million.
This difference represents the amortization of nuclear fuel, which is reported
as cost of energy sold in the statement of income, consistent with industry
practice.
Financing Activities
- --------------------
Over the next twelve months, TXU Energy and its subsidiaries will need to
fund ongoing working capital requirements and maturities of debt. TXU Energy and
its subsidiaries have funded or intend to fund these requirements through cash
on hand, cash flows from operations, the sale of assets, short-term credit
facilities and the issuance of long-term debt or other securities.
A-16
Long-Term Debt Activity -- During the year ended December 31, 2003, TXU
Energy issued, redeemed, reacquired or made scheduled principal payments on
long-term debt as follows:
Issuances Retirements
Fixed rate senior notes..................... $ 1,250 $ 72
Pollution control revenue bonds............. 567 639
Other long-term debt........................ 3 -
-------- --------
Total..................................... $ 1,820 $ 711
======== ========
See Note 8 to Financial Statements for further detail of debt issuance and
retirements, financing arrangements and capitalization.
Credit Facilities -- At December 31, 2003, TXU Corp. and its US
subsidiaries had credit facilities totaling $2.8 billion and expiring in 2005
and 2008, of which $2.3 billion was unused. These credit facilities support
issuances of letters of credit and are available to TXU Energy and Oncor for
borrowings. (See Note 7 to Financial Statements for details of arrangements.)
Exchangeable Preferred Membership Interests -- In July 2003, TXU Energy
exercised its right, in a noncash transaction, to exchange its $750 million 9%
Exchangeable Subordinated Notes due November 22, 2012 for exchangeable preferred
membership interests with identical economic and other terms. These securities
are exchangeable into TXU Corp. common stock at an exchange price of $13.1242
per share. The market price of TXU Corp. common stock on December 31, 2003 was
$23.64. Any exchange of these securities into common stock would result in a
proportionate write-off of the related unamortized discount as a charge to
earnings. If all the securities had been exchanged into common stock on December
31, 2003, TXU Energy would have recognized a pre-tax charge of $253 million.
Capitalization -- The capitalization ratios of TXU Energy at December 31,
2003, consisted of long-term debt (less amounts due currently) of 41%,
exchangeable preferred membership interests (net of unamortized discount balance
of $253 million) of 6% and common membership interests of 53%.
Sale of Receivables -- TXU Corp. has established an accounts receivable
securitization program. The activity under this program is accounted for as a
sale of accounts receivable in accordance with SFAS 140. Under the program, US
subsidiaries of TXU Corp. (originators) sell trade accounts receivable to TXU
Receivables Company, a consolidated wholly-owned bankruptcy remote direct
subsidiary of TXU Corp., which sells undivided interests in the purchased
accounts receivable for cash to special purpose entities established by
financial institutions. All new trade receivables under the program generated by
the originators are continuously purchased by TXU Receivables Company with the
proceeds from collections of receivables previously purchased. Funding to TXU
Energy under the program totaled $504 million and $429 million for 2003 and
2002, respectively. The increase of $75 million primarily reflects billing and
collection delays in 2002 due to data compilation and reconciliation issues
among ERCOT and the market participants in the newly deregulated market. See
Note 7 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.
Cash and Cash Equivalents - Cash on hand totaled $18 million and $603
million at December 31, 2003 and 2002, respectively. The decline reflects
repayments of borrowings.
Credit Ratings of TXU Corp. and its US Subsidiaries -- The current credit
ratings for TXU Corp., US Holdings and certain of its US subsidiaries are
presented below:
TXU Corp. US Holdings Oncor TXU Energy
------------------ ---------------- ------- ----------------
(Senior Unsecured) (Senior Unsecured) (Secured) (Senior Unsecured)
S&P......... BBB- BBB- BBB BBB
Moody's..... Ba1 Baa3 Baa1 Baa2
Fitch....... BBB- BBB- BBB+ BBB
Moody's currently maintains a negative outlook for TXU Corp. and a stable
outlook for US Holdings, TXU Energy and Oncor. Fitch currently maintains a
stable outlook for each such entity. S&P currently maintains a negative outlook
for each such entity.
A-17
These ratings are investment grade, except for Moody's rating of TXU
Corp.'s senior unsecured debt, which is one notch below investment grade.
A rating reflects only the view of a rating agency, and is not a
recommendation to buy, sell or hold securities. Any rating can be revised upward
or downward at any time by a rating agency if such rating agency decides that
circumstances warrant such a change.
Financial Covenants, Credit Rating Provisions and Cross Default Provisions
- -- The terms of certain financing arrangements of TXU Energy and its
subsidiaries contain financial covenants that require maintenance of specified
fixed charge coverage ratios, membership interests to total capitalization
ratios and leverage ratios and/or contain minimum net worth covenants. TXU
Energy's exchangeable preferred membership interests also limit its incurrence
of additional indebtedness unless a leverage ratio and interest coverage test
are met on a pro forma basis. As of December 31, 2003, TXU Energy and its
subsidiaries were in compliance with all such applicable covenants.
Certain financing and other arrangements of TXU Energy and its
subsidiaries contain provisions that are specifically affected by changes in
credit ratings and also include cross default provisions. The material credit
rating and cross default provisions are described below.
Other agreements of TXU Energy, including some of the credit facilities
discussed above, contain terms pursuant to which the interest rates charged
under the agreements may be adjusted depending on the credit ratings of TXU
Energy or its subsidiaries.
Credit Rating Covenants
- -----------------------
TXU Energy has provided a guarantee of the obligations under TXU Corp.'s
lease (approximately $130 million at December 31, 2003) for its headquarters
building. In the event of a downgrade of TXU Energy's credit rating to below
investment grade, a letter of credit would need to be provided within 30 days of
any such ratings decline.
TXU Energy has entered into certain commodity contracts and lease
arrangements that in some instances give the other party the right, but not the
obligation, to request TXU Energy to post collateral in the event that its
credit rating falls below investment grade.
Based on its current commodity contract positions, if TXU Energy were
downgraded below investment grade by any specified rating agency, counterparties
would have the option to request TXU Energy to post additional collateral of
approximately $145 million.
In addition, TXU Energy has a number of other contractual arrangements
where the counterparties would have the right to request TXU Energy to post
collateral if its credit rating was downgraded below investment grade by all
three rating agencies. The amount TXU Energy would post under these transactions
depends in part on the value of the contracts at that time. As of December 31,
2003, based on current market conditions, the maximum TXU Energy would post for
these transactions is $247 million. Of this amount, $228 million relates to one
specific counterparty.
TXU Energy is also the obligor on leases aggregating $161 million. Under
the terms of those leases, if TXU Energy's credit rating were downgraded to
below investment grade by any specified rating agency, TXU Energy could be
required to sell the assets, assign the leases to a new obligor that is
investment grade, post a letter of credit or defease the leases.
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's credit rating were downgraded to below investment grade by any
specified rating agency, TXU Energy could be required to post collateral of
approximately $32 million.
A-18
Cross Default Provisions
- ------------------------
Certain financing arrangements of TXU Energy 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 US Holdings or any subsidiary thereof on financing
arrangements of $50 million or more would result in a cross default under the
$1.4 billion US Holdings five-year revolving credit facility, the $400 million
US Holdings credit facility and $30 million of TXU Mining senior notes (which
have a $1 million cross default threshold).
A default by TXU Energy or Oncor or any subsidiary thereof in respect of
indebtedness in a principal amount in excess of $50 million would result in a
cross default for such party under the TXU Energy/Oncor $450 million revolving
credit facility. Under this credit facility, a default by TXU Energy or any
subsidiary thereof would cause the maturity of outstanding balances under such
facility to be accelerated as to TXU Energy, but not as to Oncor. Also, under
this credit facility, a default by Oncor or any subsidiary thereof would cause
the maturity of outstanding balances under such facility to be accelerated as to
Oncor, but not as to TXU Energy.
A default by TXU Corp. on indebtedness of $50 million or more would result
in a cross default under the new $500 million five-year revolving credit
facility.
A default or similar event under the terms of the TXU Energy exchangeable
preferred membership interests that results in the acceleration (or other
mandatory repayment prior to the mandatory redemption date) of such security or
the failure to pay such security at the mandatory redemption date would result
in a default under TXU Energy's $1.25 billion senior unsecured notes.
TXU Energy has entered into certain mining and equipment leasing
arrangements aggregating $118 million that would terminate upon the default of
any other obligations of TXU Energy owed to the lessor. In the event of a
default by TXU Mining on indebtedness in excess of $1 million, a cross default
would result under the $31 million TXU Mining leveraged lease and the lease
could terminate.
The accounts receivable program also contains a cross default provision
with a threshold of $50 million applicable to each of the originators under the
program. TXU Receivables Company and TXU Business Services each have a cross
default threshold of $50,000. If either an originator, TXU Business Services or
TXU Receivables Company defaults on indebtedness of the applicable threshold,
the facility could terminate.
TXU Energy enters into energy-related contracts, the master forms of which
contain provisions whereby an event of default would occur if TXU Energy were to
default under an obligation in respect of borrowings in excess of thresholds
stated in the contracts, which thresholds vary.
TXU Energy and its subsidiaries have other arrangements, including
interest rate swap agreements and leases with cross default provisions, the
triggering of which would not result in a significant effect on liquidity.
A-19
Long-term Contractual Obligations and Commitments -- The following table
summarizes the contractual cash obligations of TXU Energy under specified
contractual obligations in effect as of December 31, 2003 (see Notes 8 and 15 to
Financial Statements for additional disclosures regarding terms of these
obligations.)
Payment Due
-----------------------------------------
Contractual Cash Obligations More
- ----------------------------- Less One to Three to Than
Than Three Five Five
One Year Years Years Years
-------- ----- ----- -----
Long-term debt and preferred
membership interest - principal
and interest/dividends................ $ 222 $ 471 $ 678 $5,962
Operating leases and capital lease
obligations........................... 68 141 144 461
Purchase obligations(b).................. 2,349 1,255 545 502
Other liabilities on the balance
sheet
Notes or other liabilities due Oncor... 25 72 72 268
Pension and postretirement
liabilities - plan contributions(c)... 45 95 91 45
------ ------ ------ ------
Total contractual cash obligations $2,709 $2,034 $1,530 $7,238
====== ====== ====== ======
(a) Includes short-term non-cancelable leases.
(b) Amounts presented for variable priced contracts assumed the year-end 2003
price remained in effect for all periods except where contractual price
adjustments or index-based prices were specified.
(c) Projections of cash contributions to qualified pension and other
postretirement benefit plans for the years ended 2004-2009.
The following contractual obligations were excluded from the purchase
obligations disclosure in the table above:
(1) individual contracts that have an annual cash requirement of less than $1
million. (However, multiple contracts with one counterparty that are
individually less than $1 million have been aggregated.)
(2) contracts that are cancelable without payment of a substantial
cancellation penalty.
(3) employment contracts with management.
Guarantees -- See Note 15 to Financial Statements for details of
guarantees.
Investing Activities
- --------------------
In April 2002, TXU Energy acquired a cogeneration and wholesale energy
production business in New Jersey for $36 million in cash. The acquisition
included a 122 megawatt (MW) combined-cycle power production facility and
various contracts, including electric supply and gas transportation agreements.
The acquisition was accounted for as a purchase business combination, and its
results of operations are reflected in the consolidated financial statements
from the acquisition date.
In May 2002, TXU Energy acquired a 260 MW combined-cycle power generation
facility in northwest Texas through a settlement agreement which dismissed a
lawsuit previously filed related to the plant, and included a nominal cash
payment. TXU Energy previously purchased all of the electrical output of this
plant under a long-term contract.
In April 2002, TXU Energy completed the sale of two electricity generation
plants in the Dallas-Fort Worth area with total capacity of 2,334 MW for $443
million in cash. Concurrent with the sale, TXU Energy entered into a tolling
agreement to purchase power during the summer months through 2006. The terms of
the tolling agreement include above-market pricing, representing a fair value
liability of $190 million. A pretax gain on the sale of $146 million, net of the
effects of the tolling agreement, was deferred and is being recognized in other
income during summer months over the five-year term of the tolling agreement.
Both the value of the tolling agreement and the deferred gain are reported in
other liabilities in the balance sheet. The amount of the gain recognized in
other income in 2003 was approximately $30 million.
TXU Energy may pursue potential investment opportunities if it concludes
that such investments are consistent with its business strategies and will
dispose of nonstrategic assets to allow redeployment of resources into faster
growing opportunities in an effort to enhance the long-term return to its
shareholders.
A-20
Future Capital Requirements -- Capital expenditures are estimated at $325
million for 2004, substantially all of which are for major repairs and organic
growth of existing operations.
Consistent with industry practices, TXU Energy has decided to replace the
four steam generators in one of two generation units of the Comanche Peak
nuclear plant in order to maintain the operating efficiency of the unit. An
agreement for the manufacture and delivery of the equipment was completed in
October 2003, and delivery is scheduled for late 2006. Estimated project capital
requirements, including purchase and installation, are $175 million to $225
million. Cash outflows are expected to occur in 2004 through 2007, with the
significant majority after 2004.
COMMITMENTS AND CONTINGENCIES
See Note 15 to Financial Statements for commitments and contingencies.
OFF BALANCE SHEET ARRANGEMENTS
See discussion above under Sale of Receivables and in Note 7 to Financial
Statements.
REGULATION AND RATES
Information Request From CFTC -- In October 2003, TXU Corp. received an
informal request for information from the US Commodity Futures Trading
Commission (CFTC) seeking voluntary production of information concerning
disclosure of price and volume information furnished by TXU Portfolio Management
Company LP to energy industry publications. The request seeks information for
the period from January 1, 1999 to the present. TXU Corp. has cooperated with
the CFTC, and is in the process of completing its response to such information
request. TXU Corp. believes that TXU Portfolio Management Company LP was not
engaged in any reporting of price or volume information that would in any way
justify any action by the CFTC.
1999 Restructuring Legislation and Settlement Plan -- On December 31,
2001, US Holdings filed the Settlement Plan with the Commission. It resolved all
major pending issues related to US Holdings' transition to electricity
competition pursuant to the 1999 Restructuring Legislation. The Settlement Plan
does not remove regulatory oversight of Oncor's business nor does it eliminate
TXU Energy's price-to-beat rates and related fuel adjustments. The Settlement
Plan became final and non-appealable in January 2003. See Note 14 to Financial
Statements for the major elements of the Settlement Plan, the most significant
of which on a go-forward basis are the retail clawback credit and the issuance
of securitization bonds to recover regulatory asset stranded costs.
Price-to-Beat Rates - Under the 1999 Restructuring Legislation, TXU Energy
is required to continue to charge a "price-to-beat" rate established by the
Commission to residential customers (and to offer, along with other pricing
alternatives, this rate to small business customers) in the historical service
territory. The rate can be adjusted upward or downward twice a year, subject to
approval by the Commission, for changes in the market price of natural gas. TXU
Energy increased its price-to-beat rate in March and August of 2003.
Wholesale market design - In August 2003, the Commission adopted a rule
that, if fully implemented, would alter the wholesale market design in ERCOT.
The rule requires ERCOT:
o to use a stakeholder process to develop a new wholesale market model;
o to operate a voluntary day-ahead energy market;
o to directly assign all congestion rents to the resources that caused
the congestion;
o to use nodal energy prices for resources;
o to provide information for energy trading hubs by aggregating nodes;
o to use zonal prices for loads; and
o to provide congestion revenue rights (but not physical rights).
Under the rule, the proposed market design and associated cost-benefit
analysis is to be filed with the Commission by November 1, 2004 and is to be
implemented by October 1, 2006. TXU Energy is currently unable to predict the
cost or impact of implementing any proposed change to the current wholesale
market design.
A-21
Summary -- Although TXU Energy 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.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market risk is the risk that TXU Energy may experience a loss in value as
a result of changes in market conditions such as commodity prices and interest
rates, which TXU Energy is exposed to in the ordinary course of business. TXU
Energy's 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 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 in its portfolio
management activities.
RISK OVERSIGHT
TXU Energy's portfolio management operation manages the market, credit and
operational risk of the unregulated energy business within limitations
established by senior management and in accordance with TXU Corp.'s overall risk
management policies. Market risks are monitored daily by risk management groups
that operate and report independently of the portfolio management operations,
utilizing industry accepted practices and analytical methodologies. These
techniques measure the risk and 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 the
VaR limits by region, including the respective policies and procedures to ensure
compliance with such limits and evaluates the risks inherent in the various
businesses of 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 transactions, portfolio
valuation and daily portfolio reporting, including mark-to-market valuation, VaR
and other risk measurement metrics.
In connection with Mr. Wilder's review of operations, as discussed above
under Management Change, TXU Energy has engaged a consulting firm to review its
portfolio management activities. The review, which commenced in March 2004, will
cover governance and risk policies, the control environment and management
processes. The purpose of the review is primarily to identify opportunities, if
any, to improve the effectiveness of portfolio management operations.
COMMODITY PRICE RISK
TXU Energy 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 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, as well as any participant in the market, cannot 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 enters into short- and long-term
physical contracts, financial contracts that are traded on exchanges and
over-the-counter, and bilateral contracts with customers. Speculative trading
activities represent a small fraction of the portfolio management process. The
portfolio management 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 strives to use consistent assumptions regarding forward market
price curves in evaluating and recording the effects of commodity price risk.
A-22
One measure of commodity price risk is the effect of a change in natural
gas prices on operating results. For every $0.50 per million British thermal
units (Btu) reduction in natural gas prices, there would be a $250 million
reduction in annual pre-tax earnings assuming sales prices of electricity
declined accordingly, no hedges were in place and other non-price conditions
were unchanged. This effect would be mitigated in the near-term by the impact of
regulatory mechanisms that affect the timing and frequency of price-to-beat rate
changes, as well as the contractual nature of revenues related to large business
customers. Further, hedging positions in place would partially offset the
near-term effect of a decline in natural gas prices. The near-term and
longer-term effects of lower gas prices would also depend on competitors'
pricing actions and TXU Energy's actions to reduce operating and SG&A costs. TXU
Energy's base load power production costs would be largely unaffected by a
decline in gas prices. A $0.50 move in gas prices represents a change of
approximately 10% in the current forward price.
To supplement the discussion of sensitivities of commodity price risk, VaR
and related measures are presented below. The value of TXU Energy's long-term
asset portfolio cannot be easily extrapolated under conventional VaR
methodologies. Because of the correlation of power and natural gas prices in the
Texas market, structural decreases or increases in natural gas prices that are
sustained over a multi-year period result in a correspondingly lower or higher
value of TXU Energy's base load generation assets.
VaR Methodology -- A VaR methodology is used to measure the amount of
market risk that exists within a 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.
December 31, December 31,
2003 2002
---- ----
Period-end MtM VaR.............................. $ 15 $ 23
Average Month-end MtM VaR (year-to-date) ....... $ 25 $ 38
Portfolio VaR -- Represents the estimated potential loss in value, due to
changes in market conditions, of the entire energy portfolio, including owned
generation assets, estimates of retail sales load and all contractual positions
(the portfolio assets). The Portfolio VaR calculations for TXU Energy represent
a ten year view of owned assets based on the nature of its particular market. If
the life of an asset extends beyond the ten year duration period, the VaR
calculation does not measure the associated risk inherent in the asset over its
full life. Assumptions in determining the total Portfolio VaR include using a
95% confidence level and a five-day holding period and includes both
mark-to-market and accrual positions.
A-23
December 31, December 31,
2003 2002
---- ----
Period-end Portfolio VaR..................... $199 $144
Average Month-end Portfolio VaR (a).......... $181 N/A
(a) Comparable information on an average VaR basis is not available for
the full year 2002.
Other Risk Measures -- The metrics appearing below provide information
regarding the effect of changes in energy market conditions on earnings and cash
flow of TXU Energy.
Earnings at Risk (EaR) -- EaR measures the estimated potential loss of
expected pretax earnings for the year presented due to changes in market
conditions. EaR metrics include the owned generation assets, estimates of retail
load and all contractual positions except for accrual positions expected to be
settled beyond the fiscal year. Assumptions include using a 95% confidence level
over a five-day holding period under normal market conditions.
Cash Flow at Risk (CFaR) -- CFaR measures the estimated potential loss of
expected cash flow over the next six months, due to changes in market
conditions. CFaR metrics include all owned generation assets, estimates of
retail load and all contractual positions that impact cash flow during the next
six months. Assumptions include using a 99% confidence level over a six-month
holding period under normal market conditions.
December 31, December 31,
2003 2002
---- ----
EaR ..................................... $ 15 $ 28
CFaR .................................... $ 67 $178
A-24
INTEREST RATE RISK
The table below provides information concerning TXU Energy's financial
instruments as of December 31, 2003 and 2002 that are sensitive to changes in
interest rates. The weighted average rate is based on the rate in effect at the
reporting date. Capital leases and the effects of unamortized premiums and
discounts are excluded from the table. See Note 8 to Financial Statements for a
discussion of changes in debt obligations.
Expected Maturity Date
-------------------------------------------------
(Million of Dollars, Except Percentages)
2003 2002
There- 2003 Fair 2002 Fair
2004 2005 2006 2007 2008 After Total Value Total Value
---- ---- ---- ---- ---- ----- ----- ----- ----- -----
Long-term debt
(including current
maturities)
Fixed rate $ - $ 30 $ - $ - $ 251 $2,386 $2,668 $2,878 $1,523 $1,480
Average interest rate - 6.88% - - 6.13% 6.34% 6.32% - 5.24% -
Variable rate - - - - - $ 395 $ 395 $ 395 $ 432 $ 432
Average interest rate - - - - - 1.24% 1.24% - 1.46% -
Exchangeable preferred
membership interests
Fixed rate $ - $ - $ - $ - $ - $ 750 $ 750 $1,580 $ 750 $1,076
Average interest rate - - - - - 9.00% 9.00% - 9.00% -
Interest rate swaps
(notional amounts)
Fixed to variable $ - $ - $ - $ - $ - $ 500 $ 500 $ 10 $ - $ -
Average pay rate - - - - - 3.31% 3.31% - - -
Average receive rate - - - - - 7.00% 7.00% - - -
CREDIT RISK
Credit risk relates to the risk of loss associated with non-performance by
counterparties.
Gross Credit Exposure -- TXU Energy's gross exposure to credit risk as of
December 31, 2003 was $2.1 billion, representing trade accounts receivable (net
of allowance of uncollectible accounts receivable of $51 million), as well as
commodity contract assets and other derivative assets that arise primarily from
hedging activities.
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
non-performance by these customers is unlikely based upon historical experience.
Allowances for uncollectible accounts receivable are established for the
potential loss from non-payment by these customers based on historical
experience and market or operational conditions.
Most of the remaining trade accounts receivable are with large business
customers and hedging counterparties. These counterparties include major energy
companies, financial institutions, gas and 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 December 31, 2003, is $1.1 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 (cash,
letters of credit and other security interests), the net credit exposure is $965
million. Of this amount, approximately 86% 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's internal credit evaluation process. Those customers and counterparties
without an S&P rating of at least BBB- or similar rating from another major
rating agency are rated using internal credit methodologies and credit scoring
models to estimate an S&P equivalent rating. TXU Energy routinely monitors and
manages its credit exposure to these customers and counterparties on this basis.
A-25
Concentration of Credit Risk -- The following table presents the
distribution of credit exposure as of December 31, 2003, for trade accounts
receivable from large business customers, commodity contract assets and other
derivative assets that arise primarily from hedging activities, by investment
grade and noninvestment grade, credit quality and maturity.
Exposure by Maturity
------------------------------------------
Exposure
before Greater
Credit Credit Net 2 years or Between than 5
Collateral Collateral Exposure less 2-5 years years Total
---------- ---------- -------- ---- --------- ----- -----
Investment grade $832 $ 5 $ 827 $ 579 $ 129 $ 119 $ 827
Noninvestment grade 250 112 138 107 18 13 138
------- ----- ----- ----- ----- ----- -----
Totals $ 1,082 $ 117 $ 965 $ 686 $ 147 $ 132 $ 965
======= ===== ===== ===== ===== ===== =====
Investment grade 77% 4% 86%
Noninvestment grade 23% 96% 14%
TXU Energy had no exposure to any one customer or counterparty greater
than 10% of the net exposure of $965 million at December 31, 2003. Additionally,
approximately 71% of the credit exposure, net of collateral held, has a maturity
date of two years or less. TXU Energy does not anticipate any material adverse
effect on its financial position or results of operations as a result of
non-performance by any customer or counterparty.
RISKS FACTORS THAT MAY AFFECT FUTURE RESULTS
The following risk factors are being presented in consideration of
industry practice with respect to disclosure of such information in filings
under the Securities Exchange Act of 1934, as amended.
Some important factors, in addition to others specifically addressed in
this MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS, that could have a material impact on TXU Energy's operations,
financial results and financial condition, and could cause TXU Energy's actual
results or outcomes to differ materially from any projected outcome contained in
any forward-looking statement in this report, include:
ERCOT is the independent system operator that is responsible for
maintaining reliable operation of the bulk electric power supply system in the
ERCOT region. Its responsibilities include the clearing and settlement of
electricity volumes and related ancillary services among the various
participants in the deregulated Texas market. Because of new processes and
systems associated with the opening of the market to competition, which continue
to be improved, there have been delays in finalizing these settlements. As a
result, TXU Energy 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's businesses operate in changing market environments influenced
by various legislative and regulatory initiatives regarding deregulation,
regulation or restructuring of the energy industry, including deregulation of
the production and sale of electricity. TXU Energy will need to adapt to these
changes and may face increasing competitive pressure.
TXU Energy's businesses are subject to changes in laws (including the
Federal Power Act, as amended, the Texas Public Utility Regulatory Act, as
amended, the Atomic Energy Act, as amended, and the Public Utility Regulatory
Policies Act of 1978, as amended) and changing governmental policy and
regulatory actions (including those of the Commission, the FERC and the NRC)
with respect to matters including, but not limited to, operation of nuclear
power facilities, construction and operation of other power generation
facilities, decommissioning costs, and present or prospective wholesale and
retail competition.
A-26
TXU Energy believes that the electricity market in ERCOT is workably
competitive. TXU Energy is the largest owner of generation and has the largest
retail position in ERCOT, and, along with other market participants, is subject
to oversight by the Commission. In that connection, TXU Energy and other market
participants may be subject to various competition-related rules and
regulations, including but not limited to possible price-mitigation rules, as
well as rules related to market behavior.
Existing laws and regulations governing the market structure in Texas
could be reconsidered, revised or reinterpreted, or new laws or regulations
could be adopted.
TXU Energy is not guaranteed any rate of return on its capital investments
in unregulated businesses. TXU Energy markets and trades power, including power
from its own production facilities, as part of its wholesale energy sales
business and portfolio management operation. TXU Energy's results of operations
are likely to depend, in large part, upon prevailing retail rates, which are
set, in part, by regulatory authorities, and market prices for electricity, gas
and coal in its regional market and other competitive markets. Market prices may
fluctuate substantially over relatively short periods of time. Demand for
electricity can fluctuate dramatically, creating periods of substantial under-
or over-supply. During periods of over-supply, prices might be depressed. Also,
at times there may be political pressure, or pressure from regulatory
authorities with jurisdiction over wholesale and retail energy commodity and
transportation rates, to impose price limitations, bidding rules and other
mechanisms to address volatility and other issues in these markets.
Some of the fuel for TXU Energy's power production facilities is purchased
under short-term contracts or on the spot market. Prices of fuel, including
natural gas, may also be volatile, and the price TXU Energy can obtain for power
sales may not change at the same rate as changes in fuel costs. In addition, TXU
Energy markets and trades natural gas and other energy related commodities, and
volatility in these markets may affect TXU Energy's costs incurred in meeting
its obligations.
Volatility in market prices for fuel and electricity may result from:
o severe or unexpected weather conditions,
o seasonality,
o changes in electricity usage,
o illiquidity in the wholesale power or other markets,
o transmission or transportation constraints, inoperability or
inefficiencies,
o availability of competitively priced alternative energy sources,
o changes in supply and demand for energy commodities,
o changes in power production capacity,
o outages at TXU Energy's power production facilities or those of its
competitors,
o changes in production and storage levels of natural gas, lignite, coal
and crude oil and refined products,
o natural disasters, wars, sabotage, terrorist acts, embargoes and other
catastrophic events, and
o federal, state, local and foreign energy, environmental and other
regulation and legislation.
All but one of TXU Energy's facilities for power production in the US are
located in the ERCOT region, a market with limited interconnections to other
markets. Electricity prices in the ERCOT region are related 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's base load power production is dependent in significant
part upon the price of gas. TXU Energy cannot fully hedge the risk associated
with dependency on gas because of the expected useful life of TXU Energy's power
production assets and the size of its position relative to market liquidity.
To manage its near-term financial exposure related to commodity price
fluctuations, TXU Energy routinely enters into contracts to hedge portions of
its purchase and sale commitments, weather positions, fuel requirements and
inventories of natural gas, lignite, coal, crude oil and refined products, and
other commodities, within established risk management guidelines. As part of
this strategy, TXU Energy 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 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 has unhedged positions, fluctuating commodity prices can materially
impact TXU Energy's results of operations and financial position, either
favorably or unfavorably.
A-27
Although TXU Energy 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.
TXU Energy 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's hedging and risk management activities are exposed to the
risk that counterparties that owe TXU Energy 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 might be forced to acquire alternative
hedging arrangements or honor the underlying commitment at then-current market
prices. In such event, TXU Energy might incur losses in addition to amounts, if
any, already paid to the counterparties. ERCOT market participants are also
exposed to risks that another ERCOT market participant may default in its
obligations to pay ERCOT for power taken in the ancillary services market, in
which case such costs, to the extent not offset by posted security and other
protections available to ERCOT, may be allocated to various non-defaulting ERCOT
market participants.
The current credit ratings for TXU Energy's 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's ratings, borrowing costs would increase and the potential pool of
investors and funding sources would likely decrease. If the downgrade were below
investment grade, liquidity demands would be triggered by the terms of a number
of commodity contracts, leases and other agreements.
Most of TXU Energy's large customers, suppliers and counterparties require
sufficient creditworthiness in order to enter into transactions. If TXU Energy's
subsidiaries' ratings were to decline to below investment grade, costs to
operate the power and gas businesses 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's subsidiaries.
In addition, as discussed elsewhere in this report, the terms of certain
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 facilities involves many risks,
including start up risks, breakdown or failure of facilities, lack of sufficient
capital to maintain the facilities, the dependence on a specific fuel source or
the impact of unusual or adverse weather conditions or other natural events, as
well as the risk of performance below expected levels of output or efficiency,
the occurrence of any of which could result in lost revenues and/or increased
expenses. A significant portion of TXU Energy's facilities was constructed many
years ago. In particular, older generating equipment, even if maintained in
accordance with good engineering practices, may require significant capital
expenditures to keep it operating at peak efficiency. The risk of increased
maintenance and capital expenditures arises from (a) increased starting and
stopping of generation equipment due to the volatility of the competitive
market, (b) any unexpected failure to produce power, including failure caused by
breakdown or forced outage, and (c) repairing damage to facilities due to
storms, natural disasters, wars, terrorist acts and other catastrophic events.
Further, TXU Energy's ability to successfully and timely complete capital
improvements to existing facilities or other capital projects is contingent upon
many variables and subject to substantial risks. Should any such efforts be
unsuccessful, TXU Energy 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's ability to obtain insurance, and the cost of and
coverage provided by such insurance, could be affected by events outside its
control.
A-28
The ownership and operation of nuclear facilities, including TXU Energy's
ownership and operation of the Comanche Peak generation plant, involve certain
risks. These risks include: mechanical or structural problems; inadequacy or
lapses in maintenance protocols; the impairment of reactor operation and safety
systems due to human error; the costs of storage, handling and disposal of
nuclear materials; limitations on the amounts and types of insurance coverage
commercially available; and uncertainties with respect to the technological and
financial aspects of decommissioning nuclear facilities at the end of their
useful lives. The following are among the more significant of these risks:
o Operational Risk - Operations at any nuclear power production plant
could degrade to the point where the plant would have to be shut down.
If this were to happen, the process of identifying and correcting the
causes of the operational downgrade to return the plant to operation
could require significant time and expense, resulting in both lost
revenue and increased fuel and purchased power expense to meet supply
commitments. Rather than incurring substantial costs to restart the
plant, the plant may be shut down. Furthermore, a shut-down or failure
at any other nuclear plant could cause regulators to require a
shut-down or reduced availability at Comanche Peak.
o Regulatory Risk - The NRC may modify, suspend or revoke licenses and
impose civil penalties for failure to comply with the Atomic Energy
Act, the regulations under it or the terms of the licenses of nuclear
facilities. Unless extended, the NRC operating licenses for Comanche
Peak Unit 1 and Unit 2 will expire in 2030 and 2033, respectively.
Changes in regulations by the NRC could require a substantial increase
in capital expenditures or result in increased operating or
decommissioning costs.
o Nuclear Accident Risk - Although the safety record of Comanche Peak and
other nuclear reactors generally has been very good, accidents and
other unforeseen problems have occurred both in the US and elsewhere.
The consequences of an accident can be severe and include loss of life
and property damage. Any resulting liability from a nuclear accident
could exceed TXU Energy's resources, including insurance coverage.
TXU Energy is subject to extensive environmental regulation by
governmental authorities. In operating its facilities, TXU Energy is required to
comply with numerous environmental laws and regulations, and to obtain numerous
governmental permits. TXU Energy may incur significant additional costs to
comply with these requirements. If TXU Energy 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 or its
facilities, and future changes in environmental laws and regulations could
occur, including potential regulatory and enforcement developments related to
air emissions.
TXU Energy 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 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's older facilities, including base load lignite and coal plants, it may
be uneconomical for TXU Energy to install the necessary equipment, which may
cause TXU Energy to shut down those facilities.
In addition, TXU Energy 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 may obtain, or be required to provide, indemnification against
certain environmental liabilities. Another party could fail to meet its
indemnification obligations to TXU Energy.
TXU Energy is obligated to offer the price-to-beat rate to requesting
residential and small commercial customers in the historical service territory
of its incumbent utility through January 1, 2007. TXU Energy is not permitted to
offer electricity to the residential customers in the historical service
territory at a price other than the price-to-beat rate until January 1, 2005,
unless before that date the Commission determines that 40% or more of the amount
of electric power consumed by residential customers in that area is committed to
be served by REPs other than TXU Energy. Because TXU Energy will not have the
same level of residential customer price flexibility as competitors in the
historical service territory, TXU Energy could lose a significant number of
these customers to other providers. In addition, at times, during this period,
if the market price of power is lower than TXU Energy's cost to produce power,
TXU Energy would have a limited ability to mitigate the loss of margin caused by
its loss of customers by selling power from its power production facilities.
A-29
The initial price-to-beat rates for the affiliated REPs, including TXU
Energy's, were established by the Commission on December 7, 2001. Pursuant to
Commission regulations, the initial price-to-beat rate for each affiliated REP
was 6% less than the average rates in effect for its incumbent utility on
January 1, 1999, adjusted to take into account a new fuel factor as of December
31, 2001.
Other REPs are allowed to offer electricity to TXU Energy's residential
customers at any price. The margin or "headroom" available in the price-to-beat
rate for any REP equals the difference between the price-to-beat rate and the
sum of delivery charges and the price that REP pays for power. Headroom may be a
positive or negative number. The higher the amount of positive headroom for
competitive REPs in a given market, the more incentive those REPs would have to
compete in providing retail electric services in that market, which may result
in TXU Energy losing customers to competitive REPs.
The results of TXU Energy's retail electric operations in the historical
service territory are largely dependent upon the amount of headroom available to
TXU Energy and the competitive REPs in TXU Energy's price-to-beat rate. Since
headroom is dependent, in part, on power production and purchase costs, TXU
Energy does not know nor can it estimate the amount of headroom that it or other
REPs will have in TXU Energy's price-to-beat rate or in the price-to-beat rate
for the affiliated REP in each of the other Texas retail electric markets.
There is no assurance that future adjustments to TXU Energy's
price-to-beat rate will be adequate to cover future increases in its costs of
electricity to serve its price-to-beat rate customers or that TXU Energy's
price-to-beat rate will not result in negative headroom in the future.
In most retail electric markets outside the historical service territory,
TXU Energy's principal competitor may be the retail affiliate of the local
incumbent utility company. The incumbent retail affiliates have the advantage of
long-standing relationships with their customers. In addition to competition
from the incumbent utilities and their affiliates, TXU Energy 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 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. If there is inadequate margin in these retail
electric markets, it may not be profitable for TXU Energy. to enter these
markets.
TXU Energy depends on transmission and distribution facilities owned and
operated by other utilities, as well as Oncor's facilities, to deliver the
electricity it produces and sells to consumers, as well as to other REPs. If
transmission capacity is inadequate, TXU Energy's ability to sell and deliver
electricity may be hindered, it may have to forgo sales or it may have to buy
more expensive wholesale electricity that is available in the
capacity-constrained area. In particular, during some periods transmission
access is constrained to some areas of the Dallas-Fort Worth metroplex. TXU
Energy 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's customers could negatively impact the satisfaction
of its customers with its service.
TXU Energy 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 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 differ from TXU Energy's
underlying cost to obtain the commodities or services.
The information systems and processes necessary to support risk
management, sales, customer service and energy procurement and supply in
competitive retail markets in Texas and elsewhere are new, complex and
extensive. TXU Energy is refining these systems and processes, and they may
prove more expensive to refine than planned and may not function as planned.
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
A-30
technologies to compete effectively with electricity production from traditional
power plants like TXU Energy's. While demand for electric energy services is
generally increasing throughout the US, the rate of construction and development
of new, more efficient power production facilities may exceed increases in
demand in some regional electric markets. The commencement of commercial
operation of new facilities in the regional markets where TXU Energy has
facilities will likely increase the competitiveness of the wholesale power
market in those regions. In addition, the market value of TXU Energy's power
production facilities may 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's facilities.
Changes in technology could also alter the channels through which retail
electric customers buy electricity.
TXU Energy is a holding company and conducts its operations primarily
through wholly-owned subsidiaries. Substantially all of TXU Energy's
consolidated assets are held by these subsidiaries. Accordingly, TXU Energy's
cash flows and ability to meet its obligations and to pay dividends are largely
dependent upon the earnings of its subsidiaries and the distribution or other
payment of such earnings to TXU Energy in the form of distributions, loans or
advances, and repayment of loans or advances from TXU Energy. The subsidiaries
are separate and distinct legal entities and have no obligation to provide TXU
Energy with funds for its payment obligations, whether by dividends,
distributions, loans or otherwise.
Because TXU Energy is a holding company, its obligations to its creditors
are structurally subordinated to all existing and future liabilities and
existing and future preferred equity interests of its subsidiaries. Therefore,
TXU Energy's rights and the rights of its creditors to participate in the assets
of any subsidiary in the event that such a subsidiary is liquidated or
reorganized are subject to the prior claims of such subsidiary's creditors and
holders of its preferred equity interests. To the extent that TXU Energy may be
a creditor with recognized claims against any such subsidiary, its claims would
still be subject to the prior claims of such subsidiary's creditors to the
extent that they are secured or senior to those held by TXU Energy.
The inability to raise capital on favorable terms, particularly during
times of uncertainty in the financial markets, could impact TXU Energy's ability
to sustain and grow its businesses, which are capital intensive, and would
increase its capital costs. TXU Energy 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's access to the financial markets
could be adversely impacted by various factors, such as:
o changes in credit markets that reduce available credit or the ability
to renew existing liquidity facilities on acceptable terms;
o inability to access commercial paper markets;
o a deterioration of TXU Energy's credit or a reduction in TXU Energy's
credit ratings;
o extreme volatility in TXU Energy's markets that increases margin or
credit requirements;
o a material breakdown in TXU Energy's risk management procedures;
o prolonged delays in billing and payment resulting from delays in
switching customers from one REP to another; and
o the occurrence of material adverse changes in TXU Energy's businesses
that restrict TXU Energy's ability to access its liquidity facilities.
A lack of necessary capital and cash reserves could adversely impact the
evaluation of TXU Energy's credit worthiness by counterparties and rating
agencies. Further, concerns on the part of counterparties regarding TXU Energy's
liquidity and credit could limit its portfolio management activities.
As a result of the energy crisis in California during 2001, the recent
volatility of natural gas prices in North America, the bankruptcy filing by
Enron Corporation, accounting irregularities of public companies, and
investigations by governmental authorities into energy trading activities,
companies in the regulated and non-regulated utility businesses have been under
a generally increased amount of public and regulatory scrutiny. Accounting
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 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 believes
that it is complying with all applicable laws, but it is difficult or impossible
to predict or control what effect these events may have on TXU Energy's
financial condition or access to the capital markets. Additionally, it is
unclear what laws and regulations may develop, and TXU Energy 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.
A-31
The issues and associated risks and uncertainties described above are not
the only ones TXU Energy 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 and its
subsidiaries (collectively, TXU Energy) contain forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. Although TXU Energy believes that in making any such statement its
expectations are based on reasonable assumptions, any such statement involves
uncertainties and is qualified in its entirety by reference to the following
important factors, among others, that could cause the actual results of TXU
Energy to differ materially from those projected in such forward-looking
statements: (i) prevailing governmental policies and regulatory actions,
including those of the Federal Energy Regulatory Commission, the Commission, the
NRC, particularly with respect to allowed rates of return, industry, market and
rate structure, purchased power and investment recovery, operations of nuclear
generating facilities, acquisitions and disposal of assets and facilities,
operation and construction of plant facilities, decommissioning costs, present
or prospective wholesale and retail competition, changes in tax laws and
policies and changes in and compliance with environmental and safety laws and
policies, (ii) general industry trends, (iii) weather conditions and other
natural phenomena, and acts of sabotage, wars or terrorist activities, (iv)
unanticipated population growth or decline, and changes in market demand and
demographic patterns, (v) competition for retail and wholesale customers, (vi)
pricing and transportation of crude oil, natural gas and other commodities,
(vii) unanticipated changes in interest rates, commodity prices or rates of
inflation, (viii) unanticipated changes in operating expenses, liquidity needs
and capital expenditures, (ix) commercial bank market and capital market
conditions, (x) competition for new energy development opportunities, (xi) legal
and administrative proceedings and settlements, (xii) inability of the various
counterparties to meet their obligations with respect to TXU Energy's financial
instruments, (xiii) changes in technology used and services offered by TXU
Energy, and (xiv) significant changes in TXU Energy's relationship with its
employees and the potential adverse effects if labor disputes or grievances were
to occur, (xv) power costs and availability, (xvi) changes in business strategy,
development plans or vendor relationships, (xvii) availability of qualified
personnel, (xviii) implementation of new accounting standards, (xix) global
financial and credit market conditions, and credit rating agency actions and
(xx) access to adequate transmission facilities to meet changing demands.
Any forward-looking statement speaks only as of the date on which such
statement is made, and TXU Energy 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 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.
A-32
TXU ENERGY COMPANY LLC
STATEMENT OF RESPONSIBILITY
The management of TXU Energy Company LLC is responsible for the
preparation, integrity and objectivity of the consolidated financial statements
of TXU Energy Company and other information included in this report. The
consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America. As
appropriate, the statements include amounts based on informed estimates and
judgments of management.
The management of TXU Energy Company is responsible for establishing and
maintaining a system of internal control, which includes the internal controls
and procedures for financial reporting, that is designed to provide reasonable
assurance, on a cost-effective basis, that assets are safeguarded, transactions
are executed in accordance with management's authorization and financial records
are reliable for preparing consolidated financial statements. Management
believes that the system of control provides reasonable assurance that errors or
irregularities that could be material to the consolidated financial statements
are prevented or would be detected within a timely period. Key elements in this
system include the effective communication of established written policies and
procedures, selection and training of qualified personnel and organizational
arrangements that provide an appropriate division of responsibility. This system
of control is augmented by an ongoing internal audit program designed to
evaluate its adequacy and effectiveness. Management considers the
recommendations of the internal auditors and independent auditors concerning TXU
Energy Company's system of internal control and takes appropriate actions which
are cost-effective in the circumstances. Management believes that, as of
December 31, 2003, TXU Energy Company's system of internal control was adequate
to accomplish the objectives discussed herein.
The independent auditing firm of Deloitte & Touche LLP is engaged to
audit, in accordance with auditing standards generally accepted in the United
States of America, the consolidated financial statements of Oncor Electric
Delivery Company and its subsidiaries and to issue their report thereon.
/s/ T. L. BAKER /s/ PAUL O'MALLEY
- ---------------------------------- ---------------------------------------
T.L. Baker, President Paul O'Malley, Senior Vice President and
and Chief Executive Principal Financial Officer
/s/ DAVID H. ANDERSON
- --------------------------------------
David H. Anderson, Vice President and
Principal Accounting Officer
A-33
INDEPENDENT AUDITORS' REPORT
TXU Energy Company LLC:
We have audited the accompanying consolidated balance sheets of TXU Energy
Company LLC and subsidiaries (TXU Energy) as of December 31, 2003 and 2002, and
the related consolidated statements of income, comprehensive income, cash flows
and membership interests for each of the three years in the period ended
December 31, 2003. These financial statements are the responsibility of TXU
Energy's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of TXU Energy and subsidiaries as of
December 31, 2003 and 2002, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2003, in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 1 to the Notes to Financial Statements, TXU Energy changed
its method of accounting for certain contracts with the rescission of Emerging
Issues Task Force Issue 98-10, "Accounting for Contracts Involved in Energy
Trading and Risk Management Activities."
As discussed in Note 6 to the Notes to Financial Statements, in 2002 TXU Energy
adopted the provisions of Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets."
DELOITTE & TOUCHE LLP
Dallas, Texas
March 11, 2004
A-34
TXU ENERGY COMPANY LLC
STATEMENTS OF CONSOLIDATED INCOME
Year Ended December 31,
--------------------------------------
2003 2002 2001
---- ---- ----
Millions of Dollars
Operating revenues............................................ $ 7,995 $ 7,691 $ 7,404
-------- -------- --------
Costs and expenses:
Cost of energy sold and delivery fees...................... 5,124 4,783 4,800
Operating costs............................................ 691 701 671
Depreciation and amortization.............................. 409 450 395
Selling, general and administrative expenses............... 636 775 311
Franchise and revenue-based taxes.......................... 124 120 14
Other income............................................... (48) (33) (2)
Other deductions........................................... 22 254 196
Interest income............................................ (8) (10) (38)
Interest expense and related charges....................... 323 215 224
-------- -------- --------
Total costs and expenses............................... 7,273 7,255 6,571
Income from continuing operations before income taxes,
extraordinary loss and cumulative effect of changes in
accounting principles....................................... 722 436 833
Income tax expense............................................ 229 117 242
-------- -------- --------
Income from continuing operations before extraordinary loss
and cumulative effect of changes in accounting principles... 493 319 591
Loss from discontinued operations, net of tax effect.......... (14) (49) (28)
Extraordinary loss, net of income tax......................... - - (56)
Cumulative effect of changes in accounting principles,
net of tax effect........................................... (58) - -
-------- -------- --------
Net income.................................................... $ 421 $ 270 $ 507
======== ======== ========
STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
Year Ended December 31,
---------------------------------------
2003 2002 2001
---- ---- ----
Millions of Dollars
Net income.................................................. $ 421 $ 270 $ 507
Other comprehensive income (loss)--
Net change during period, net of tax effects:
Minimum pension liability adjustments (net of tax
expense of $12 and benefit of $21)..................... 25 (39) -
Cash flow hedges:
Net change in fair value of derivatives
(net of tax benefit of $74 and $86, and expense of
$9).................................................. (137) (159) 16
Amounts realized in earnings during the period (net
of tax expense of $90 and $9)........................ 167 17 -
-------- -------- --------
Total.................................................. 55 (181) 16
-------- --------- --------
Comprehensive income........................................ $ 476 $ 89 $ 523
======== ======== ========
See Notes to Financial Statements.
A-35
TXU ENERGY COMPANY LLC
STATEMENTS OF CONSOLIDATED CASH FLOWS
Year Ended December 31,
----------------------------------
2003 2002 2001
---- ---- ----
Millions of Dollars
Cash flows-- operating activities
Income from continuing operations before extraordinary loss and
cumulative effect of changes in accounting principles................. $ 493 $ 319 $ 591
Adjustments to reconcile income from continuing operations before
extraordinary loss and cumulative effect of changes in accounting
principles to cash provided by operating activities:
Depreciation and amortization......................................... 471 501 508
Deferred income taxes and investment tax credits - net................ 11 (92) (209)
Losses on early extinguishment of debt................................ - - 149
Net gain from sale of assets.......................................... (45) (30) -
Reduction of revenues for earnings in excess of regulatory earnings
cap................................................................. - - 34
Net effect of unrealized mark-to-market valuations of commodity
contracts............................................................ 100 113 (318)
Asset impairment charge............................................... - 237 -
Retail clawback accrual increase (decrease)........................... (12) 185 -
Over/(under) recovery of gas costs.................................... - - 568
Changes in operating assets and liabilities:
Affiliate accounts receivable/payable - net........................ (41) 201 24
Accounts receivable - trade........................................ 386 (447) 228
Inventories........................................................ (58) (96) (4)
Accounts payable - trade........................................... (30) 116 (632)
Margin deposits.................................................... 25 (6) 227
Commodity contract assets and liabilities - net.................... 24 (45) (30)
Other assets ..................................................... (222) 4 (33)
Other liabilities.................................................. 264 34 67
------ ------ -------
Cash provided by operating activities............................ 1,366 994 1,170
------ ------ -------
Cash flows-- financing activities
Issuances of long-term debt.............................................. 1,820 811 2,788
Retirements/repurchases of debt.......................................... (711) (1,683) (2,428)
Increase (decrease) in notes payable to banks............................ (282) 282 -
Net change in advances from affiliates................................... (1,618) 1,169 (568)
Decrease in note payable to Oncor related to a regulatory liability...... (170) (180) -
Distribution paid to parent.............................................. (750) (777) -
Repurchase of member interests........................................... - - (404)
Debt premium, discount, financing and reacquisition expenses............. (36) (29) (161)
------ ------ -------
Cash used in financing activities.................................. (1,747) (407) (773)
------ ------ --------
Cash flows-- investing activities
Capital expenditures..................................................... (163) (284) (327)
Acquisition of a business................................................ - (36) -
Nuclear fuel............................................................. (44) (52) (39)
Proceeds from sale of assets............................................. 24 443 -
Other.................................................................... (19) (71) (37)
------ ------ -------
Cash used in investing activities.................................. (202) - (403)
------ ------ -------
Cash provided/(used) by discontinued operations............................ (2) (4) 7
Net change in cash and cash equivalents.................................... (585) 583 1
Cash and cash equivalents - beginning balance............................. 603 20 19
------ ------ -------
Cash and cash equivalents - ending balance................................ $ 18 $ 603 $ 20
====== ====== =======
See Notes to Financial Statements
A-36
TXU ENERGY COMPANY LLC
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31,
---------------------
2003 2002
---- ----
Millions of Dollars
Current assets:
Cash and cash equivalents....................................................... $ 18 $ 603
Advances to affiliates.......................................................... 289 -
Accounts receivable - trade..................................................... 943 1,328
Inventories..................................................................... 387 351
Commodity contract assets....................................................... 959 1,298
Other current assets............................................................ 225 266
------ ------
Total current assets......................................................... 2,821 3,846
------ ------
Investments....................................................................... 479 398
Property, plant and equipment-- net............................................... 10,381 10,380
Goodwill.......................................................................... 533 533
Commodity contract assets......................................................... 121 476
Cash flow hedges and other derivative assets...................................... 88 14
Assets held for sale.............................................................. 14 36
Other noncurrent assets........................................................... 135 106
------ ------
Total assets................................................................. $14,572 $15,789
======= =======
LIABILITIES AND MEMBERSHIP INTERESTS
Current liabilities:
Notes payable - banks........................................................... $ - $ 282
Long-term debt due currently.................................................... 1 73
Advances from affiliates........................................................ - 1,329
Accounts payable - trade:
Affiliates (principally Oncor Electric Delivery Company)..................... 211 248
All other.................................................................... 713 754
Notes or other liabilities due Oncor Electric Delivery Company.................. 13 170
Commodity contract liabilities.................................................. 913 1,138
Accrued taxes................................................................... 277 164
Other current liabilities....................................................... 566 640
------- -------
Total current liabilities.................................................... 2,694 4,798
------- -------
Accumulated deferred income taxes................................................. 1,965 1,931
Investment tax credits............................................................ 360 376
Commodity contract liabilities.................................................... 59 320
Cash flow hedges and other derivative liabilities................................. 140 150
Notes or other liabilities due Oncor Electric Delivery Company.................... 424 437
Other noncurrent liabilities and deferred credits................................. 1,350 1,126
Long-term debt, less amounts due currently........................................ 3,084 2,378
Exchangeable preferred membership interest, net of $253 discount.................. 497 -
------- -------
Total liabilities............................................................ 10,573 11,516
------- -------
Contingencies (Note 15)
Membership interests.............................................................. 3,999 4,273
------- -------
Total liabilities and membership interests................................... $ 14,572 $15,789
======== =======
See Notes to Financial Statements.
A-37
TXU ENERGY COMPANY LLC
STATEMENTS OF CONSOLIDATED MEMBERSHIP INTERESTS
Year Ended December 31,
------------------------------
2003 2002 2001
---- ---- ----
Millions of Dollars
Membership interests:
Capital accounts:
Balance at beginning of year.................................. $ 4,438 $ 4,196 $ 4,121
Net income................................................ 421 270 507
Reduction in membership interest - amount of repurchases
of common stock of US Holdings allocated to TXU Energy... - - (404)
Distribution paid to parent............................... (750) (777) -
Non-cash capital contribution related to issuance of
exchangeable subordinated notes......................... - 266 -
Non-cash goodwill capital contribution.................... - 468 -
Conversion of capital from (to) advances................. - 15 (28)
------- ------- -------
Balance at end of year........................................ 4,109 4,438 4,196
------- ------- -------
Accumulated other comprehensive income, net of tax effects:
Minimum Pension Liability Adjustment:
Balance at beginning of year ................................. (39) - -
Change during the year.................................... 25 (39) -
------- -------- -------
Balance at end of year........................................ (14) (39) -
------- -------- -------
Cash flow hedges (SFAS No. 133):
Balance at beginning of year.................................. (126) 16 -
Change during the year.................................... 30 (142) 16
------- -------- -------
Balance at end of year........................................ (96) (126) 16
------- -------- -------
Total membership interests................. $ 3,999 $ 4,273 $ 4,212
======= ======= =======
See Notes to Financial Statements.
A-38
TXU ENERGY COMPANY LLC
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES AND BUSINESS
Description of Business - TXU Energy is an energy company that engages in
power production (electricity generation) and retail and wholesale sales of
electricity and natural gas. TXU Energy engages in hedging and risk management
activities to mitigate commodity price risk. TXU Energy is managed as an
integrated business; consequently, there are no reportable business segments.
Discontinued Business - In December 2003, TXU Energy finalized a formal
plan to sell its strategic retail services business, which is engaged
principally in providing energy management services. The consolidated financial
statements for all years presented reflect the reclassification of the results
of this business as discontinued operations. ( See Note 3 for more detailed
information about discontinued operations.)
Business Restructuring - The 1999 Restructuring Legislation restructured
the electric utility industry in Texas and provided for a transition to
competition in the generation and retail sale of electricity. TXU Corp.
disaggregated its electric utility business, as required by the legislation, and
restructured certain of its US businesses as of January 1, 2002 resulting in two
new business operations:
o Oncor - a utility regulated by the Commission that holds electricity
transmission and distribution assets and engages in electricity
delivery services.
o TXU Energy - a competitive business that holds the power generation
assets and engages in wholesale and retail energy sales and
hedging/risk management activities.
The relationships of these entities and their rights and obligations with
respect to their collective assets and liabilities are contractually described
in a master separation agreement executed in December 2001.
The operating assets of Oncor and TXU Energy are located principally in
the north-central, eastern and western parts of Texas.
A settlement of outstanding issues and other proceedings related to
implementation of the 1999 Restructuring Legislation received final and
non-appealable approval by the Commission in January 2003. See Note 14 for
further discussion.
In addition, as of January 1, 2002, certain other businesses within the
TXU Corp. system were transferred to TXU Energy, including TXU Gas' hedging and
risk management business and its unregulated retail commercial/industrial
(business) gas supply operation, as well as the fuel transportation and coal
mining subsidiaries that primarily service the generation operations.
Other Business Changes - In April 2002, TXU Energy acquired a cogeneration
and wholesale energy production business in New Jersey for $36 million in cash.
The acquisition included a 122 megawatt (MW) combined-cycle power production
facility and various contracts, including electric supply and gas transportation
agreements. The acquisition was accounted for as a purchase business
combination, and its results of operations are reflected in the consolidated
financial statements from the acquisition date.
In May 2002, TXU Energy acquired a 260 MW combined-cycle power generation
facility in northwest Texas through a settlement agreement which dismissed a
lawsuit previously filed related to the plant, and included a nominal cash
payment. TXU Energy previously purchased all of the electrical output of this
plant under a long-term contract.
In April 2002, TXU Energy completed the sale of two electricity generation
plants in the Dallas-Fort Worth area with total capacity of 2,334 MW for $443
million in cash. Concurrent with the sale, TXU Energy entered into a tolling
agreement to purchase power during the summer months through 2006. The terms of
the tolling agreement include above-market pricing, representing a fair value
liability of $190 million. A pretax gain on the sale of $146 million, net of the
effects of the tolling agreement, was deferred and is being recognized in other
income during summer months over the five-year term of the tolling agreement.
Both the value of the tolling agreement and the deferred gain are reported in
other liabilities in the balance sheet. The amount of the gain recognized in
other income in 2003 was approximately $30 million.
A-39
Basis of Presentation -- The consolidated financial statements of TXU
Energy have been prepared in accordance with accounting principles generally
accepted in the US and, except for the discontinuance of the strategic retail
services business and the adoption of EITF 02-3 and SFAS 143, as discussed in
Note 2, on the same basis as the audited financial statements included in its
2002 Form 8-K. In the opinion of management, all other adjustments (consisting
of normal recurring accruals) necessary for a fair presentation of the results
of operations and financial position have been included therein. The financial
statements reflect reclassification of prior period amounts to conform to the
current period presentation. All intercompany items and transactions have been
eliminated in consolidation. All dollar amounts in the financial statements and
tables in the notes are stated in millions of US dollars unless otherwise
indicated.
The 2001 financial information includes information derived from the
historical financial statements of US Holdings. Reasonable allocation
methodologies were used to unbundle the financial statements of US Holdings
between its generation and transmission and distribution (delivery) operations.
Allocation of revenues reflected consideration of return on invested capital,
which continues to be regulated for the delivery operations. US Holdings
maintained expense accounts for each of its component operations. Costs of
energy and expenses related to operations and maintenance and depreciation and
amortization, as well as assets, such as property, plant and equipment,
materials and supplies and fuel, were specifically identified by component
operation and disaggregated. Various allocation methodologies were used to
disaggregate revenues, common expenses, assets and liabilities between US
Holdings' generation and delivery operations. Further, certain financial
information was deemed to be not reasonably allocable because of the changed
nature of TXU Energy's and Oncor's operations subsequent to the opening of the
market to competition, as compared to US Holdings' previous operations. Such
activities and related financial information consisted primarily of costs
related to retail customer support activities, including billing and related bad
debts expense, as well as regulated revenues associated with these costs.
Financial information related to these activities was reported in Oncor's
results of operations for the 2001 period. Interest and other financing costs
were determined based upon debt allocated. Allocations reflected in the
financial information for 2001 did not necessarily result in amounts reported in
individual line items that are comparable to actual results in 2002 and 2003.
Had the unbundled operations of US Holdings actually existed in 2001 as separate
entities in a deregulated environment, their results of operations could have
differed materially from those included in the historical financial statements
included herein.
The following information regarding the impact of adopting SFAS 145 was
previously provided in the 2002 Form 8-K.
Losses on Extinguishments of Debt -- As a result of the adoption of SFAS
145 as of January 1, 2003, any gain or loss on the early extinguishment of debt
that was classified as an extraordinary item in prior periods in accordance with
SFAS 4 is required to be reclassified if it does not meet the criteria of an
extraordinary item as defined by APB Opinion 30.
As a result of US Holdings' debt restructuring and refinancings in the
fourth quarter of 2001, TXU Energy recorded a loss on the early extinguishment
of debt of $97 million (net of income tax benefit of $52 million).
In accordance with SFAS 145, the income statement for the year ended
December 31, 2001 reflects the classification of these losses, previously
reported as extraordinary, as shown below:
2001:
Extraordinary loss, net of tax - as reported......... $ (153)
Reclassifications to:
Other deductions................................. 149
Income tax expense............................... (52)
------
Extraordinary loss, net of tax - as adjusted......... $ (56)
======
The reclassifications had no effect on net income. The discussion of
extraordinary loss in Note 4, income tax information in Note 10, and quarterly
results and components of other deductions in Note 16 reflect the
reclassifications.
A-40
Use of Estimates -- The preparation of TXU Energy's financial statements
requires management to make estimates and assumptions about future events that
affect the reporting and disclosure of assets and liabilities at the balance
sheet dates and the reported amounts of revenue and expense, including
mark-to-market valuation adjustments. In the event estimates and/or assumptions
prove to be different from actual amounts, adjustments are made in subsequent
periods to reflect more current information. No material adjustments, other than
those disclosed elsewhere herein, were made as a result of changes in previous
estimates or assumptions during the current year.
Financial Instruments and Mark-to-Market Accounting -- TXU Energy enters
into financial instruments, including options, swaps, futures, forwards and
other contractual commitments primarily to manage energy price risk and interest
rate risks. These financial instruments are accounted for in accordance with
SFAS 133 as well as, prior to October 26, 2002, EITF 98-10. See Note 2 for the
effects of EITF 02-3, under which only financial instruments that are
derivatives are subject to mark-to-market accounting.
SFAS 133 requires the recognition of derivatives in the balance sheet, the
measurement of those instruments at fair value and the recognition in earnings
of changes in the fair value of derivatives. This recognition is referred to as
"mark-to-market" accounting. SFAS 133 provides exceptions to this accounting if
(a) the derivative is deemed to represent a transaction in the normal course of
purchasing from a supplier and selling to a customer, or (b) the derivative is
deemed to be a cash flow or fair value hedge. In accounting for cash flow
hedges, derivative assets and liabilities are recorded on the balance sheet at
fair value with an offset in other comprehensive income. Amounts are
reclassified from other comprehensive income to earnings as the underlying
transactions occur and realized gains and losses are recognized in earnings.
Fair value hedges are recorded as derivative assets or liabilities with an
offset to the carrying value of the related asset or liability. Any hedge
ineffectiveness related to cash flow and fair value hedges is recorded in
earnings.
TXU Energy documents designated commodity, debt-related and other hedging
relationships, including the strategy and objectives for entering into such
hedge transactions and the related specific firm commitments or forecasted
transactions. TXU Energy applies hedge accounting in accordance with SFAS 133
for these non-trading transactions, providing the underlying transactions remain
probable of occurring. Effectiveness is assessed based on changes in cash flows
of the hedges as compared to changes in cash flows of the hedged items. In its
risk management activities, TXU Energy hedges future electricity revenues using
natural gas instruments; such cross-commodity hedges are subject to
ineffectiveness calculations that can result in mark-to-market gains and losses.
Interest rate swaps entered into in connection with indebtedness to manage
interest rate risks are accounted for as cash flow hedges if the swap converts
rates from variable to fixed and are accounted for as fair value hedges if the
swap converts rates from fixed to variable.
Revenue Recognition -- TXU Energy records revenue for retail and wholesale
energy sales under the accrual method. Retail electric revenues are recognized
when the commodity is provided to customers on the basis of periodic cycle meter
readings and include an estimated accrual for the value of the commodity
consumed from the meter reading date to the end of the period. The unbilled
revenue is estimated at the end of the period based on estimated daily
consumption after the meter read date to the end of the period. Estimated daily
consumption is derived using historical customer profiles adjusted for weather
and other measurable factors affecting consumption.
Realized and unrealized gains and losses (including hedge ineffectiveness)
from transacting in energy-related contracts, principally for the purpose of
hedging margins on sales of energy, are reported as a component of revenues.
The historical financial statements for 2001 included adjustments made to
revenues for over/under recovered fuel costs. To the extent fuel costs incurred
exceeded regulated fuel factor amounts included in customer billings, TXU Energy
recorded revenues on the basis of its ability and intent to obtain regulatory
approval for rate surcharges on future customer billings to recover such
amounts. Conversely, to the extent fuel costs incurred were less than amounts
included in customer billings, revenues were reduced. Following deregulation of
the Texas market on January 1, 2002, any changes to the fuel factor component of
the price-to-beat rates are recognized in revenues when power is provided to
customers.
A-41
Other than the purchase of fuel for gas-fired generation, the significant
majority of TXU Energy's physical natural gas purchases and sales represent
economic hedging activities; consequently, such transactions have been reported
net as a component of revenues. As a result of the issuance of EITF 03-11, sales
of natural gas to retail business customers are reported gross effective October
1, 2003.
Accounting for Contingencies - The financial results of TXU Energy may be
affected by judgments and estimates related to loss contingencies. Accruals for
loss contingencies are recorded when management determines that it is probable
that an asset has been impaired or a liability has been incurred and that such
economic loss can be reasonably estimated. These determinations are based on
management's interpretations of current facts and circumstances, forecasts of
future events and estimates of the financial impacts of such events.
Investments -- Deposits in a nuclear decommissioning trust fund are
carried at fair value in the balance sheet, with the cumulative increase in fair
value recorded as a liability to reflect the statutory nature of the trust.
Investments in unconsolidated business entities over which TXU Energy has
significant influence but does not maintain effective control, generally
representing ownership of at least 20% and not more than 50% of common equity,
are accounted for under the equity method. Assets related to employee benefit
plans are held to satisfy deferred compensation liabilities and are recorded at
market value. (See Note 5 - Investments.)
Property, Plant and Equipment --The cost of generation property additions
prior to July 1, 1999 includes labor and materials, applicable overhead and
payroll-related costs and an allowance for funds used during construction.
Generation property additions subsequent to July 1, 1999, and other property are
stated at cost.
Depreciation of TXU Energy's property, plant and equipment is calculated
on a straight-line basis over the estimated service lives of the properties.
Depreciation also includes an amount for decommissioning costs for the
nuclear-powered electricity generation plant (Comanche Peak), which is being
accrued over the lives of the units. Consolidated depreciation as a percent of
average depreciable property for TXU Energy approximated 2.2% for 2003, 2.6% for
2002 and 2.7% for 2001. See discussion below under Changes in Accounting
Standards regarding SFAS 143.
Effective April 1, 2003, the estimates of the depreciable lives of the
Comanche Peak nuclear generating plant and several gas generation plants were
extended to better reflect the useful lives of the assets. At the same time,
depreciation rates were increased on lignite and gas generation facilities to
reflect investments in emissions control equipment. The net impact of these
changes was a reduction in depreciation expense of $37 million (pre-tax) and an
increase in net income of $24 million for the year ended December 31, 2003.
The nuclear-powered generation units were originally estimated to have a
useful life of 40 years, based on the life of the operating licenses granted by
the NRC. Over the last several years, the NRC has granted 20-year extensions to
the initial 40-year terms for several commercial power reactors. Based on these
extensions and current expectations of industry practice, the useful life of the
nuclear-powered generation units is now estimated to be 60 years. TXU Corp.
expects to file a license extension request in accordance with timing and other
provisions established by the NRC.
TXU Energy capitalizes computer software costs in accordance with SOP
98-1. These costs are being amortized over periods ranging from three to ten
years. (See Note 6 under Intangible Assets for more information.)
Interest Capitalized and Allowance For Funds Used During Construction
(AFUDC) -- AFUDC is a cost accounting procedure whereby amounts based upon
interest charges on borrowed funds and a return on equity capital used to
finance construction are added to utility plant and equipment being constructed.
Prior to July 1, 1999, AFUDC was capitalized for all expenditures for ongoing
construction work in progress and nuclear fuel in process not otherwise included
in rate base by regulatory authorities. As a result of the 1999 Restructuring
Legislation, only interest is capitalized during any generation construction
since 1999. Interest on qualifying projects for businesses that no longer apply
SFAS 71 is capitalized in accordance with SFAS 34. See Note 16 for detail of
amounts. The amount of interest capitalized in 2003 and 2002 was $7 million and
$6 million, respectively.
Impairment of Long-Lived Assets -- TXU Energy evaluates the carrying value
of long-lived assets to be held and used when events and circumstances warrant
such a review. The carrying value of long-lived assets would be considered
impaired when the projected undiscounted cash flows are less than the carrying
value. In that event, a loss would be recognized based on the amount by which
the carrying value exceeds the fair value. Fair value is determined primarily by
available market valuations or, if applicable, discounted cash flows.
A-42
In 2002, TXU Energy recorded an impairment charge of $237 million ($154
million after-tax) for the writedown of two generation plant construction
projects as a result of weaker wholesale electricity market conditions and
reduced planned developmental capital spending. Fair value was determined based
on appraisals of property and equipment. The charge is reported in other
deductions.
Goodwill and Intangible Assets -- TXU Energy evaluates goodwill for
impairment at least annually (as of October 1) in accordance with SFAS 142. The
impairment tests performed are based on discounted cash flow analyses. No
goodwill impairment has been recognized.
Major Maintenance -- Major maintenance outage costs related to nuclear
fuel reloads, as well as the costs of other major maintenance programs, are
charged to expense as incurred.
Amortization of Nuclear Fuel -- The amortization of nuclear fuel in the
reactors is calculated on the units-of-production method and is included in cost
of energy sold.
Defined Benefit Pension Plans and Other Postretirement Benefit Plans-- TXU
Energy is a participating employer in the defined benefit pension plan sponsored
by TXU Corp. TXU Energy also participates with TXU Corp. and other affiliated
subsidiaries of TXU Corp. to offer health care and life insurance benefits to
eligible employees and their eligible dependents upon the retirement of such
employees. See Note 11 for information regarding retirement plans and other
postretirement benefits.
Franchise and Revenue-Based Taxes -- Franchise and revenue-based taxes
such as gross receipts taxes are not a "pass through" item such as sales and
excise taxes. Gross receipts taxes are assessed to TXU Energy and its
subsidiaries by state and local governmental bodies, based on revenues, as a
cost of doing business. TXU Energy records gross receipts tax as an expense.
Rates charged to customers by TXU Energy are intended to recover the taxes, but
TXU Energy is not acting as an agent to collect the taxes from customers.
Income Taxes -- TXU Corp. and its US subsidiaries file a consolidated
federal income tax return, and federal income taxes are allocated to
subsidiaries based upon their respective taxable income or loss. Investment tax
credits are amortized to income over the estimated service lives of the
properties. Deferred income taxes are provided for temporary differences between
the book and tax basis of assets and liabilities.
Cash Equivalents -- For purposes of reporting cash and cash equivalents,
temporary cash investments purchased with a remaining maturity of three months
or less are considered to be cash equivalents.
Changes in Accounting Standards -- In October 2002, the EITF, through EITF
02-3, rescinded EITF 98-10, which required mark-to-market accounting for all
trading activities. SFAS 143, regarding asset retirement obligations, became
effective on January 1, 2003. As a result of the implementation of these two
accounting standards, TXU Energy recorded a cumulative effect of changes in
accounting principles as of January 1, 2003. (See Note 2 for a discussion of the
impacts of these two accounting standards.)
As a result of guidance provided in EITF 02-3, in 2003 TXU Energy
discontinued recognizing origination gains on energy contracts. For 2002 and
2001, TXU Energy recognized $40 million and $88 million in origination gains on
retail sales contracts, respectively. Because of the short-term nature of these
contracts, a portion of these gains would have been recognized on a settlement
basis in the year the origination gain was recorded.
SFAS 146 became effective on January 1, 2003. SFAS 146 requires that a
liability for costs associated with an exit or disposal activity be recognized
only when the liability is incurred and measured initially at fair value. The
adoption of SFAS 146 did not materially impact results of operations for 2003.
FIN 45 was issued in November 2002 and requires recording the fair value
of guarantees upon issuance or modification after December 31, 2002. The
interpretation also requires expanded disclosures of guarantees (see Note 15
under Guarantees). The adoption of FIN 45 did not materially impact results of
operations for 2003.
A-43
FIN 46, which was issued in January 2003, provides guidance related to
identifying variable interest entities and determining whether such entities
should be consolidated. On October 8, 2003, the FASB decided to defer
implementation of FIN 46 until the fourth quarter of 2003. This deferral only
applies to variable interest entities that existed prior to February 1, 2003.
The implementation of FIN 46 in the fourth quarter 2003 did not impact results
of operations.
SFAS 149 was issued in April 2003 and became effective for contracts
entered into or modified after June 30, 2003. SFAS 149 clarifies what contracts
may be eligible for the normal purchase and sale exception, the definition of a
derivative and the treatment in the statement of cash flows when a derivative
contains a financing component. Also, EITF 03-11 was issued in July 2003 and
became effective October 1, 2003 and, among other things, discussed the nature
of certain power contracts. As a result of the issuance of SFAS 149 and EITF
03-11, certain commodity contract hedges were replaced with another type of
hedge that is subject to effectiveness testing. The adoption of these changes
did not materially impact results of operations for 2003.
EITF 03-11 also addressed the presentation in the income statement of
physically settled commodity derivatives, providing guidance as to whether such
transactions should be reported on a net or gross (sales and cost of sales)
basis. Effective October 1, 2003, TXU Energy began reporting certain retail
sales of natural gas to business customers on a gross basis. The effect of this
change was an increase in revenues, and cost of energy sold of $34 million for
the period since that date. Net income was unaffected by the change.
SFAS 150 was issued in May 2003 and became effective June 1, 2003 for new
financial instruments and July 1, 2003 for existing financial instruments. SFAS
150 requires that mandatorily redeemable preferred securities be classified as
liabilities beginning July 1, 2003. In July 2003, TXU Energy exercised its right
to exchange its $750 million 9% Exchangeable Subordinated Notes due 2012 for
exchangeable preferred membership interests with identical economic and other
terms (see Note 8). Because the exchangeability feature of these preferred
securities provides for the holders to exchange the securities with TXU Corp.
for TXU Corp. common stock, the securities are deemed to be mandatorily
redeemable by TXU Energy. Therefore, in accordance with SFAS 150, the December
31, 2003 balance sheet reflects the classification of these securities (net of
$253 million in unamortized discount) as liabilities.
EITF 01-8 was issued in May 2003 and is effective prospectively for
arrangements that are new, modified or committed to beginning July 1, 2003. This
guidance requires that certain types of arrangements be accounted for as leases,
including tolling and power supply contracts, take-or-pay contracts and service
contracts involving the use of specific property and equipment. The adoption of
this change did not materially impact results of operations for 2003.
2. CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES
The following summarizes the effect on results for 2003 for changes in
accounting principles effective January 1, 2003:
Charge from rescission of EITF 98-10, net of tax effect of $34 million..... $(63)
Credit from adoption of SFAS 143, net of tax effect of $3 million.......... 5
----
Total net charge..................................................... $(58)
====
On October 25, 2002, the EITF, through EITF 02-3, rescinded EITF 98-10,
which required mark-to-market accounting for all trading activities. Pursuant to
this rescission, only financial instruments that are derivatives under SFAS 133
are subject to mark-to-market accounting. Financial instruments that may not be
derivatives under SFAS 133, but were marked-to-market under EITF 98-10, consist
primarily of gas transportation and storage agreements, power tolling, full
requirements and capacity contracts. This new accounting rule was effective for
new contracts entered into after October 25, 2002. Non-derivative contracts
entered into prior to October 26, 2002, continued to be accounted for at fair
value through December 31, 2002; however, effective January 1, 2003, such
contracts were required to be accounted for on a settlement basis. Accordingly,
a charge of $97 million ($63 million after-tax) was reported as a cumulative
effect of a change in accounting principles in the first quarter of 2003. Of the
total, $75 million reduced net commodity contract assets and liabilities and $22
million reduced inventory that had previously been marked-to-market as a trading
position. The cumulative effect adjustment represents the net gains previously
recognized for these contracts under mark-to-market accounting.
A-44
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, such liabilities primarily
relate to nuclear generation plant decommissioning, land reclamation related to
lignite mining and removal of lignite plant ash treatment facilities. The
liability is recorded at its net present value with a corresponding increase in
the carrying value of the related long-lived asset. The liability is accreted
each period, representing the time value of money, and the capitalized cost is
depreciated over the remaining useful life of the related asset.
As the new accounting rule required retrospective application to the
inception of the liability, the effects of the adoption reflect the accretion
and depreciation from the liability inception date through December 31, 2002.
Further, the effects of adoption take into consideration liabilities of $215
million (previously reflected in accumulated depreciation) TXU Energy had
previously recorded as depreciation expense and $26 million (reflected in other
noncurrent liabilities) of unrealized net gains associated with the
decommissioning trusts.
The following table summarizes the impact as of January 1, 2003 of
adopting SFAS 143:
Increase in property, plant and equipment - net......... $488
Increase in other noncurrent liabilities and deferred
credits............................................... (528)
Increase in accumulated deferred income taxes........... (3)
Increase in affiliated receivable....................... 48
----
Cumulative effect of change in accounting principles.... $ 5
====
The asset retirement liability at December 31, 2003 was $599 million,
comprised of a $554 million liability as a result of adoption of SFAS 143, $36
million of accretion during the twelve months of 2003 and $2 million in new
asset retirement obligations, reduced by $19 million in reclamation payments.
The asset retirement obligations were adjusted upward by $26 million, or 5%, due
to revisions in estimated cash flows.
With respect to nuclear decommissioning costs, TXU Energy believes that
the adoption of SFAS 143 results primarily in timing differences in the
recognition of asset retirement costs that TXU Energy is currently recovering
through the regulatory process.
On a pro forma basis, assuming SFAS 143 had been adopted at the beginning
of the period, earnings for 2002 would have increased by $6.5 million after-tax,
and the liability for asset retirement obligations as of December 31, 2001 and
2002 would have been $522 million and $554 million, respectively. Earnings for
the year ended December 31, 2001 would not have been impacted by the adoption of
SFAS 143.
3. DISCONTINUED OPERATIONS
In December 2003, TXU Energy approved a plan to sell its strategic retail
services business, which is engaged principally in providing energy management
services to businesses and other organizations. Results of discontinued
operations reflect a charge in the fourth quarter of 2003 of $10.3 million ($6.7
million after-tax) to impair long-lived assets and accrue liabilities under
operating leases from which there will be no future benefit as a result of the
decision to exit the business.
The following summarizes the historical consolidated financial information
of the strategic retail services business to be sold:
A-45
Year Ended December 31,
-----------------------------------
2003 2002 2001
---- ---- ----
(millions of dollars)
Operating revenues................................................ $ 60 $ 47 $ 54
------- ------ ------
Operating costs and expenses...................................... 60 122 94
Other deductions (income) - net................................... 11 - 2
Interest income................................................... (1) - -
Interest expense and related charges.............................. 1 1 1
------- ------ ------
Loss before income taxes.......................................... (11) (76) (43)
Income tax benefit................................................ (4) (27) (15)
Charge related to exit (after-tax)................................ 7 - -
------- ------ ------
Loss from discontinued operations............................ $ (14) $ (49) $ (28)
======== ======= =======
Balance sheet - The following details the assets held for sale:
December 31,
2003
------------
Other current assets........................................................ $ 3
Investments................................................................. 4
Property, plant and equipment............................................... 5
Other noncurrent assets..................................................... 2
--------
Assets held for sale................................................... $ 14
========
4. EXTRAORDINARY LOSS
As a result of the implementation of SFAS 145, losses related to early
extinguishment of debt that were previously reported as extraordinary items have
been reclassified (see Note 1 under Losses on Extinguishments of Debt).
In the fourth quarter of 2001, US Holdings and the Commission reached
agreement on the Settlement Plan, which resolved a number of issues related to
transition to retail competition. As a result, TXU Energy recorded an
extraordinary loss of $56 million (net of income tax benefit of $62 million).
The loss was classified as an extraordinary item in accordance with SFAS 101.
The Settlement Plan addressed, among other items, unrecovered fuel cost,
stranded costs and other generation-related regulatory assets, and the
above-market pricing of certain power purchase contracts. See also Note 14.
5. INVESTMENTS
The following information is a summary of the investment balance as of
December 31, 2003 and 2002 (in millions):
December 31,
---------------------
2003 2002
---- ----
Nuclear decommissioning trust.............................................. $ 323 $ 266
Land....................................................................... 87 88
Assets related to employee benefit plans................................... 40 28
Miscellaneous other........................................................ 29 16
------ ------
Total investments.................................................... $ 479 $ 398
====== ======
Nuclear Decommissioning Trust -- Deposits in a trust fund for costs to
decommission the Comanche Peak nuclear-powered generation plant are carried at
fair value, with the cumulative increase in fair value recorded as a liability.
(Also see Note 15 - under Nuclear Decommissioning). Decommissioning costs are
being recovered from Oncor's customers as a transmission and distribution charge
over the life of the plant and deposited in the trust fund. Activity in the
trust fund was as follows:
A-46
December 31, 2003
--------------------------------------------------------------------------
Cost Unrealized gain Unrealized (loss) Fair market value
---- --------------- ----------------- -----------------
Debt securities............ $ 139 $ 6 $ (2) $ 143
Equity securities.......... 126 66 (12) 180
------- ------ ------- -------
$ 265 $ 72 $ (14) $ 323
======= ====== ======= =======
December 31, 2002
--------------------------------------------------------------------------
Cost Unrealized gain Unrealized (loss) Fair market value
---- --------------- ----------------- -----------------
Debt securities............ $ 128 $ 10 $ (1) $ 137
Equity securities.......... 111 37 (19) 129
------- ------ ------ -------
$ 239 $ 47 $ (20) $ 266
======= ====== ======- =======
Debt securities held at December 31, 2003 mature as follows: $56 million
in one to five years, $51 million in five to ten years and $36 million after ten
years.
Analysis of Certain Investments with Unrealized Losses at
December 31, 2003:
Investments That Have Been in a Continuous Unrealized Loss Position for:
---------------------------------------------------------------------------
Less than 12 months 12 months or longer Total
------------------------ ----------------------- --------------------------
Description of Securities Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
- ------------------------------------- ---------- ------------ ----------- ------------ ---------- --------------
Nuclear Decommissioning Trust:
Debt Securities.............. $12 $ -- $19 $(2) $31 $(2)
Equity Securities............ 4 (1) 24 (11) 28 (12)
--- ---- --- ---- --- ---
Total ................... $16 $ (1) $43 $(13) $59 $(14)
=== ==== === ==== === ====
The assets that have experienced unrealized losses are all high-quality
securities that are part of the long-term investment strategy and are expected
to recover within a reasonable period of time. Therefore they are not deemed to
be other-than-temporary impairments.
6. GOODWILL AND OTHER INTANGIBLE ASSETS
Intangible Assets -- SFAS 142 became effective for TXU Energy on January
1, 2002. SFAS 142 requires, among other things, the allocation of goodwill to
reporting units based upon the current fair value of the reporting units, and
the discontinuance of goodwill amortization. The amortization of TXU Energy's
existing goodwill ($1 million annually) ceased effective January 1, 2002. SFAS
142 also requires additional disclosures regarding intangible assets (other than
goodwill) that are amortized or not amortized:
As of December 31, 2003 As of December 31, 2002
------------------------------ -----------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
------ ------------ --- ------ ------------ ---
Amortized intangible assets (included in
property, plant and equipment):
Capitalized software............... $ 241 $ 112 $ 129 $ 220 $ 78 $ 142
Land easements..................... 11 8 3 12 9 3
Mineral rights and other........... 31 22 9 31 20 11
----- ----- ----- ----- ----- -----
Total............................ $ 283 $ 142 $ 141 $ 263 $ 107 $ 156
===== ===== ===== ===== ===== =====
Aggregate TXU Energy amortization expense for intangible assets, excluding
goodwill, for the years ended December 31, 2003, 2002 and 2001 was $37 million,
$44 million and $4 million, respectively. At December 31, 2003, the weighted
average useful lives of capitalized software, land easements and mineral rights
noted above were 6 years, 58 years and 40 years, respectively. Estimated amounts
of amortization expense for the next five years are as follows:
A-47
Year
- ----
2004................................... $37
2005................................... 25
2006................................... 20
2007................................... 16
2008................................... 13
At December 31, 2003 and 2002, goodwill of $533 million was stated net of
previously recorded accumulated amortization of $60 million. In connection with
the transfer of certain businesses from TXU Gas to TXU Energy as part of the
business restructuring described in Note 1, $468 million of goodwill arising
from TXU Corp.'s 1997 acquisition of ENSERCH Corporation was allocated to these
businesses and is reflected in the balance sheet of TXU Energy.
7. SHORT-TERM FINANCING
Credit Facilities -- At December 31, 2003, credit facilities available to
TXU Corp. and its US subsidiaries were as follows:
At December 31, 2003
-------------------------------------------------
Authorized Facility Letters of Cash
Facility Expiration Date Borrowers Limit Credit Borrowings Availability
- ---------------------------------- --------------- --------- ----- ------ ---------- ------------
Five-Year Revolving Credit Facility February 2005 US Holdings $ 1,400 $ 44 $ -- $1,356
Revolving Credit Facility February 2005 TXU Energy, Oncor 450 -- -- 450
Three-Year Revolving Credit Facility May 2005 US Holdings (a) 400 -- -- 400
Five-Year Revolving Credit Facility August 2008 TXU Corp. 500 422 -- 78
------- ------ ------ ------
Total $ 2,750 $ 466 $ -- $2,284
======= ====== ====== ======
(a) Previously TXU Corp.
In April 2003, TXU Energy and Oncor entered into a joint $450 million
revolving credit facility to be used for working capital and other general
corporate purposes. Up to $450 million of letters of credit may be issued under
the facility.
The US Holdings, TXU Energy and Oncor facilities provide back-up for any
future issuance of commercial paper by TXU Energy and Oncor. At December 31,
2003, there was no such outstanding commercial paper.
In addition to providing back-up of commercial paper issuance by TXU
Energy and Oncor, the credit facilities above are for general corporate and
working capital purposes, including providing collateral support for TXU
Energy's hedging and risk management activities.
Sale of Receivables -- TXU Corp. has established an accounts receivable
securitization program. The activity under this program is accounted for as a
sale of accounts receivable in accordance with SFAS 140. Under the program, US
subsidiaries of TXU Corp. (originators) sell trade accounts receivable to TXU
Receivables Company, a consolidated wholly-owned bankruptcy remote direct
subsidiary of TXU Corp., which sells undivided interests in the purchased
accounts receivable for cash to special purpose entities established by
financial institutions (the funding entities). As of December 31, 2003, the
maximum amount of undivided interests that could be sold by TXU Receivables
Company was $600 million.
All new trade receivables under the program generated by the originators
are continuously purchased by TXU Receivables Company with the proceeds from
collections of receivables previously purchased. Changes in the amount of
funding under the program, through changes in the amount of undivided interests
sold by TXU Receivables Company, are generally due to seasonal variations in the
level of accounts receivable and changes in collection trends. TXU Receivables
Company has issued subordinated notes payable to the originators for the
difference between the face amount of the uncollected accounts receivable
purchased, less a discount, and cash paid to the originators that was funded by
the sale of the undivided interests.
A-48
The discount from face amount on the purchase of receivables 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 Company,
a direct subsidiary of TXU Corp. The program fees (losses on sale), which
consist primarily of interest costs on the underlying financing, were $10
million and $20 million for 2003 and 2002, respectively, and approximated 2.6%
and 3.7% for 2003 and 2002, respectively, of the average funding under the
program on an annualized basis; these fees represent the net incremental costs
of the program to TXU Energy and are reported in SG&A expenses. The servicing
fee, which totaled $6 million and $8 million for 2003 and 2002, respectively,
compensates TXU Business Services Company for its services as collection agent,
including maintaining the detailed accounts receivable collection records.
The December 31, 2003 balance sheet reflects $933 million face amount of
trade accounts receivable reduced by $504 million of undivided interests sold by
TXU Receivables Company. Funding under the program increased $75 million for the
year ended December 31, 2003, primarily due to the effect of improved collection
trends. Funding under the program for the year ended December 31, 2002 decreased
$1 million. Funding increases or decreases under the program are reflected as
operating cash flow activity in the statement of cash flows. The carrying amount
of the retained interests in the accounts receivable approximated fair value due
to the short-term nature of the collection period.
Activities of TXU Receivables Company related to TXU Energy for the years
ended December 31, 2003 and 2002 were as follows:
Year Ended December 31,
------------------------
2003 2002
---- ----
(millions of dollars)
Cash collections on accounts receivable........................... $ 6,791 $5,611
Face amount of new receivables purchased.......................... (6,350) (6,300)
Discount from face amount of purchased receivables................ 16 28
Servicing fees paid............................................... (6) (8)
Program fees paid................................................. (10) (20)
Increase (decrease) in subordinated notes payable................. (516) 690
------- ------
TXU Energy's operating cash flows (provided) used under the
program.................................................... $ (75) $ 1
------- ------
Upon termination of the program, cash flows to TXU Energy 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.
In June 2003, the program was amended to provide temporarily higher
delinquency and default compliance ratios and temporary relief from the loss
reserve formula, which allowed for increased funding under the program. The June
amendment reflected the billing and collection delays previously experienced as
a result of new systems and processes in TXU Energy and ERCOT for clearing
customers' switching and billing data upon the transition to competition. In
August 2003, the program was amended to extend the term to July 2004, as well as
to extend the period providing temporarily higher delinquency and default
compliance ratios through December 31, 2003. The higher delinquency and default
compliance ratios were not extended after December 31, 2003 as no relief from
program delinquency and default compliance ratios is expected to be required.
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.
A-49
The delinquency and dilution ratios exceeded the relevant thresholds
during the first four months of 2003, but waivers were granted. These ratios
were affected by issues related to the transition to competition. Certain
billing and collection delays arose due to implementation of new systems and
processes within TXU Energy and ERCOT for clearing customers' switching and
billing data. The billing delays have been largely resolved. Strengthened credit
and collection policies and practices have brought the ratios into consistent
compliance with the program requirement.
Under terms of the receivables sale program, all the originators are
required to maintain specified fixed charge coverage and leverage ratios (or
supply a parent guarantor that meets the ratio requirements). The failure by an
originator or its parent guarantor, if any, to maintain the specified financial
ratios would prevent that originator from selling its accounts receivable under
the program. If all the originators and the parent guarantor, if any, fail to
maintain the specified financial ratios so that there are no eligible
originators, the facility would terminate. Prior to the August 2003 amendment
extending the program, originator eligibility was predicated on the maintenance
of an investment grade credit rating.
A-50
8. LONG-TERM DEBT
Long-Term Debt -- At December 31, 2003 and 2002, the long-term debt of TXU
Energy and its consolidated subsidiaries consisted of the following:
December 31,
--------------------
2003 2002
---- ----
Pollution Control Revenue Bonds:
Brazos River Authority:
Floating Taxable Series 1993 due June 1, 2023.................................... $ -- $ 44
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).... 118 118
7.700% Fixed Series 1999A due April 1, 2033...................................... 111 111
6.750% Fixed Series 1999B due September 1, 2034, remarketing date April 1,
2013(a)....................................................................... 16 16
7.700% Fixed Series 1999C due March 1, 2032...................................... 50 50
4.950% Fixed Series 2001A due October 1, 2030, remarketing date April 1, 2004(a). 121 121
4.750% Fixed Series 2001B due May 1, 2029, remarketing date November 1, 2006(a).. 19 19
5.750% Fixed Series 2001C due May 1, 2036, remarketing date November 1, 2011(a).. 274 274
1.250% Floating Series 2001D due May 1, 2033..................................... 271 271
Floating Taxable Series 2001F due December 31, 2036.............................. -- 39
Floating Taxable Series 2001G due December 1, 2036............................... -- 72
Floating Taxable Series 2001H due December 1, 2036............................... -- 31
1.180% Floating Taxable Series 2001I due December 1, 2036(b)..................... 63 63
1.250% Floating Series 2002A due May 1, 2037(b).................................. 61 61
6.750% Fixed Series 2003A due April 1, 2038, remarketing date April 1, 2013(a)... 44 --
6.300% Fixed Series 2003B due July 1, 2032....................................... 39 --
6.750% Fixed Series 2003C due October 1, 2038.................................... 72 --
5.400% Fixed Series 2003D due October 1, 2029, remarketing date October 1,
2014(a).......................................................................... 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
4.000% Fixed Series 2001C due May 1, 2028, remarketing date November 1, 2003(a).. -- 70
Floating Taxable Series 2001D due December 31, 2036.............................. -- 12
Floating Taxable Series 2001E due December 31, 2036.............................. -- 45
5.800% Fixed Series 2003A due July 1, 2022....................................... 12 --
6.150% Fixed Series 2003B due August 1, 2022..................................... 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:
7.000% Fixed Senior Notes - TXU Mining due May 1, 2003........................... -- 72
6.875% Fixed Senior Notes - TXU Mining due August 1, 2005........................ 30 30
9.000% Fixed Exchangeable Subordinated Notes due November 22, 2012............... -- 750
6.125% Fixed Senior Notes due March 15, 2008..................................... 250 --
7.000% Fixed Senior Notes due March 15, 2013 (c)................................. 1,000 --
Capital lease obligations........................................................ 13 10
Other............................................................................ 7 8
Unamortized premium and discount and fair value adjustments...................... 10 (264)
------- --------
Total TXU Energy ............................................................ 3,085 2,451
Less amount due currently........................................................... 1 73
------- -------
Total long-term debt................................................................ $ 3,084 $ 2,378
======= =======
- -----------------------------
(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 December 31, 2003. These series are in a
flexible or weekly rate mode and are classified as long-term as they are
supported by long-term irrevocable letters of credit. Series in the
flexible mode will be remarketed for periods of less than 270 days.
(c) Interest rates swapped to floating on $500 million principal amount.
A-51
New Debt Issuances in 2003:
In March 2003, TXU Energy issued $1.25 billion aggregate principal amount
of senior unsecured notes in two series in a private placement with registration
rights. One series in the amount of $250 million is due March 15, 2008, and
bears interest at the annual rate of 6.125%, and the other series in the amount
of $1 billion is due March 15, 2013, and bears interest at the annual rate of
7%. In August 2003, TXU Energy entered into interest rate swap transactions
through 2013, which are being accounted for as fair value hedges, to effectively
convert $500 million of the notes to floating interest rates.
Debt Repayments in 2003:
In May 2003, $72 million principal amount of the 7% TXU Mining fixed rate
senior notes were repaid at maturity.
Debt Remarketings and Other Activity:
In November 2003, the Brazos River Authority Series 2001D pollution
control revenue bonds (aggregate principal amount of $271 million) were
remarketed and converted from a multiannual mode to a weekly rate mode, and the
Sabine River Authority Series 2001C pollution control revenue bonds (aggregate
principal amount of $70 million) were purchased upon mandatory tender. TXU
Energy intends to remarket these bonds in the first quarter of 2004.
In October 2003, the Brazos River Authority issued $72 million aggregate
principal amount of Series 2003C pollution control revenue bonds and $31 million
aggregate principal amount of Series 2003D pollution control revenue bonds for
TXU Energy. The Series 2003C bonds will bear interest at an annual rate of 6.75%
until maturity in 2038. The Series 2003D bonds will bear interest at an annual
rate of 5.40% until their mandatory tender date in 2014, at which time they will
be remarketed. Proceeds from the issuance of the Series 2003C and Series 2003D
bonds were used to refund the $72 million aggregate principal amount of Brazos
River Authority Taxable Series 2001G and the $31 million aggregate principal
amount of Series 2001H variable rate pollution control revenue bonds, both due
December 1, 2036. The Sabine River Authority also issued $45 million aggregate
principal amount of Series 2003B pollution control revenue bonds for TXU Energy.
The Series 2003B bonds will bear interest at an annual rate of 6.15% until
maturity in 2022, however they become callable in 2013. Proceeds from the
issuance of the Series 2003B bonds were used to refund the $45 million aggregate
principal amount of Sabine River Authority Taxable Series 2001E variable rate
pollution control revenue bonds due December 1, 2036.
In July 2003, the Brazos River Authority issued $39 million aggregate
principal amount of Series 2003B pollution control revenue bonds for TXU Energy.
The bonds will bear interest at an annual rate of 6.30% until maturity in 2032.
Proceeds from the issuance of the bonds were used to refund the $39 million
aggregate principal amount of Brazos River Authority Taxable Series 2001F
variable rate pollution control revenue bonds due December 31, 2036. The Sabine
River Authority also issued $12 million aggregate principal amount of Series
2003A pollution control revenue bonds for TXU Energy. The bonds will bear
interest at an annual rate of 5.80% until maturity in 2022. Proceeds from the
issuance of these bonds were used to refund the $12 million aggregate principal
amount of Sabine River Authority Taxable Series 2001D pollution control revenue
bonds due December 31, 2036.
In May 2003, the Brazos River Authority Series 1994A and the Trinity River
Authority Series 2000A pollution control revenue bonds (aggregate principal
amount of $53 million) were purchased upon mandatory tender. In July 2003, the
bonds were remarketed and converted from a floating rate mode to a multiannual
mode at an annual rate of 3.00% and 6.25%, respectively. The rate on the 1994A
bonds will remain in effect until their mandatory remarketing date of May 1,
2005. The rate on the 2000A bonds will remain in effect until their maturity in
2028.
In April 2003, the Brazos River Authority Series 1999A pollution control
revenue bonds, with an aggregate principal amount of $111 million, were
remarketed. The bonds now bear interest at a fixed annual rate of 7.70% and are
callable beginning on April 1, 2013 at a price of 101% until March 31, 2014 and
at 100% thereafter.
A-52
In March 2003, the Brazos River Authority Series 1999B and 1999C pollution
control revenue bonds (aggregate principal amount of $66 million) were converted
from a floating rate mode to a multiannual mode at an annual rate of 6.75% and a
fixed rate of 7.70%, respectively. The rate on the 1999B bonds will remain in
effect until 2013 at which time they will be remarketed. The rate on the 1999C
bonds is fixed to maturity in 2032, however they become callable in 2013.
In March 2003, the Brazos River Authority issued $44 million aggregate
principal amount of pollution control revenue bonds Series 2003A for TXU Energy.
The bonds will bear interest at an annual rate of 6.75% until the mandatory
tender date of April 1, 2013. On April 1, 2013, the bonds will be remarketed.
Proceeds from the issuance of the bonds were used to repay the $44 million
principal amount of Brazos River Authority Series 1993 pollution control revenue
bonds due June 1, 2023.
The pollution control series variable rate debt of TXU Energy requires
periodic remarketing. Because TXU Energy intends to remarket these obligations,
and has the ability and intent to refinance if necessary, they have been
classified as long-term debt.
Debt Issuances and Retirements in 2002:
In 2002, TXU Energy and its consolidated subsidiaries issued $750 million
of 9% Exchangeable Subordinated Notes, which were exchanged for preferred
membership interests (see Note 9). In 2002, TXU Energy redeemed at par the
remaining $635 million principal amount of its floating rate debentures and TXU
Mining redeemed $123 million of its senior notes.
Maturities -- Maturity requirements for the years 2004 through 2008 under
long-term debt outstanding at December 31, 2003, were as follows:
Year
- ----
2004........................................................ $ -
2005........................................................ 30
2006........................................................ -
2007........................................................ -
2008........................................................ 251
Thereafter.................................................. 2,781
Capital lease............................................... 13
Unamortized discount........................................ 10
------
$3,085
9. MEMBERSHIP INTERESTS
In November 2003, TXU Energy approved a cash distribution of $175 million
to be paid to US Holdings in January 2004. TXU Energy paid total cash
distributions of $750 million to US Holdings in 2003 ($175 million in October
and July, and $200 million in April and January 2003) and $777 million in 2002.
In July 2003, TXU Energy exercised its right to exchange its $750 million
9% Exchangeable Subordinated Notes issued in November 2002 and due November 2012
for exchangeable preferred membership interests with identical economic and
other terms. The preferred membership interests bear distributions at the annual
rate of 9% and permit the deferral of such distributions. The preferred
membership interests may be exchanged at the option of the holders, subject to
certain restrictions, at any time for up to approximately 57 million shares of
TXU Corp. common stock at an exchange price of $13.1242 per share. The number of
shares of TXU Corp. common stock that may be issuable upon the exercise of the
exchange right is determined by dividing the aggregate liquidation value of
preferred membership interests to be exchanged by the exchange price. The
exchange price and the number of shares to be issued are subject to
anti-dilution adjustments. At issuance of the notes that were exchanged for the
preferred membership interests, TXU Energy recognized a discount on the
securities of $266 million, which represented the value of the exchange right as
TXU Corp. granted an irrevocable right to exchange the securities for TXU Corp.
common stock, recorded as a credit to capital. This discount is being amortized
to interest expense and related charges over the term of the securities. As a
result, the effective distribution rate on the preferred membership interests is
11.5%. At the time of any exchange of the preferred membership interests for
common stock, the unamortized discount will be proportionately written off as a
charge to earnings. If all the membership interests had been exchanged into
common stock on December 31, 2003, the pre-tax charge would have been $253
million. These securities are classified as liabilities in accordance with SFAS
150. See Note 1 under Changes in Accounting Standards.
A-53
The original purchasers of the notes that were exchanged for the preferred
membership interests were granted the right to nominate one member to the board
of directors of TXU Corp., and such nominee has been elected to fill a vacancy.
The original purchasers forfeit this right if they cease to hold at least 30% of
their original investment in the form of common stock and/or preferred
membership interests. In any event, this right expires on the later of (i)
November 2012 or, (ii) the date no membership interests remain outstanding. The
holders of the preferred membership interests are restricted from actions that
would increase their control of TXU Corp.
In connection with the transfer of certain businesses to TXU Energy, as
part of the business restructuring described in Note 1, $468 million of goodwill
arising from TXU Corp.'s 1997 acquisition of ENSERCH Corporation was allocated
to these businesses in 2002 and is reflected in the balance sheet of TXU Energy.
The offsetting credit is reflected in capital. In addition, $15 million of
advances from affiliates were converted to capital during 2002.
10. INCOME TAXES
The components of income tax expense are as follows:
Year Ended December 31,
------------------------------
2003 2002 2001
---- ---- ----
Current:
US Federal............................................... $ 207 $ 228 $ 424
State.................................................... 9 3 39
Non-US................................................... - 1 (5)
----- ----- -----
Total............................................... 216 232 458
----- ----- -----
Deferred:
US Federal............................................... 28 (99) (195)
State.................................................... - 4 (3)
Non-US................................................... 1 - (1)
----- ----- -----
Total............................................... 29 (95) (199)
----- ------ ------
Investment tax credits...................................... (16) (20) (17)
------ ----- -----
Total............................................... $ 229 $ 117 $ 242
===== ====== =====
Reconciliation of income taxes computed at the US federal statutory rate
to provision for income taxes:
Year Ended December 31,
------------------------------------
2003 2002 2001
---- ---- ----
Income from continuing operations before income taxes,
extraordinary loss and cumulative effect of changes in
accounting principles......................................... $ 722 $ 436 $ 833
===== ===== =====
Income taxes (benefit) at the federal statutory rate of 35%... $ 253 $ 153 $ 292
Depletion allowance..................................... (25) (25) (25)
Amortization of investment tax credits.................. (16) (20) (17)
Preferred securities cost............................... 6 - -
Redirected depreciation................................. - - (18)
State income taxes, net of federal tax benefit.......... 6 5 24
Other................................................... 5 4 (14)
----- ----- -----
Provision for income taxes.................................... $ 229 $ 117 $ 242
===== ===== =====
Effective tax rate........................................... 32% 27% 30%
A-54
The components of TXU Energy's deferred tax assets and liabilities are as
follows:
December 31,
----------------------------------------------------------------------
2003 2002
-------------------------------- --------------------------------
Total Current Noncurrent Total Current Noncurrent
----- ------- ---------- ----- ------- ----------
Deferred Tax Assets
Unamortized investment tax credits..... $ 126 - $ 126 132 - 132
Bad debt reserve....................... 20 20 - 30 30 -
Impairment of assets................... 168 - 168 181 - 181
Nuclear decommissioning asset retirement
obligation.......................... 150 - 150 - - -
Retail clawback liability.............. 61 - 61 65 - 65
Alternative minimum tax................ 335 - 335 307 - 307
Employee benefits..................... 113 - 113 109 - 109
Deferred benefit of state income taxes 14 13 1 11 10 1
Other.................................. 183 52 131 196 28 168
------- ------- ------- ------- ------- -------
Total deferred tax assets........... 1,170 85 1,085 1,031 68 963
------- ------- ------- ------- ------- -------
Deferred Tax Liabilities
Depreciation differences and capitalized
construction costs................... 2,930 - 2,930 2,756 - 2,756
Software development costs............. 82 - 82 90 - 90
Deferred state income tax ............. 2 - 2 2 - 2
Other.................................. 39 3 36 46 - 46
------- ------- ------- ------- ------- -------
Total deferred tax liability........ 3,053 3 3,050 2,894 - 2,894
------- ------- ------- ------- ------- -------
Net Deferred Tax Liability (Asset ) ...... $ 1,883 $ (82) $ 1,965 $ 1,863 $ (68) $ 1,931
======= ======== ======= ======= ======= =======
At December 31, 2003, TXU Energy had approximately $335 million of
alternative minimum tax credit carryforwards available to offset future tax
payments. These tax credit carryforwards do not have expiration dates.
TXU Energy's income tax returns are subject to examination by applicable
tax authorities. The IRS is currently examining the returns of TXU Corp. and its
subsidiaries for the tax years ended 1993 through 2002. In management's opinion,
an adequate provision has been made for any future taxes that may be owed as a
result of any examinations.
11. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS
TXU Energy is a participating employer in the TXU Retirement Plan
(Retirement Plan), a defined benefit pension plan sponsored by TXU Corp. The
Retirement Plan is a qualified pension plan under Section 401(a) of the Internal
Revenue Code of 1986, as amended (Code) and is subject to the provisions of the
Employee Retirement Income Security Act of 1974, as amended (ERISA). Employees
are eligible to participate in the Retirement Plan upon their completion of one
year of service and the attainment of age 21. All benefits are funded by the
participating employers. The Retirement Plan provides benefits to participants
under one of two formulas: (i) a cash balance formula under which participants
earn monthly contribution credits based on their compensation and a combination
of their age and years of service, plus monthly interest credits, or (ii) a
traditional defined benefit formula based on years of service and the average
earnings of the three years of highest earnings.
All eligible employees hired after January 1, 2002, will participate under
the cash balance formula. Certain employees who, prior to January 1, 2002,
participated under the traditional defined benefit formula, continue their
participation under that formula. Under the cash balance formula, future
increases in earnings will not apply to prior service costs. It is TXU Corp.'s
policy to fund the plans on a current basis to the extent deductible under
existing federal tax regulations. Such contributions, when made, are intended to
provide not only for benefits attributed to service to date, but also those
expected to be earned in the future.
A-55
The allocated net periodic pension cost (benefit) applicable to TXU Energy
was $17 million for 2003, $3 million for 2002 and ($5) million for 2001.
Contributions were $13 million, $9 million and $1 million in 2003, 2002 and
2001, respectively.
In addition to the Retirement Plan and the Thrift Plan, TXU Energy
participates with TXU Corp. and certain other affiliated subsidiaries of TXU
Corp. to offer certain health care and life insurance benefits to eligible
employees and their eligible dependents upon the retirement of such employees.
For employees retiring on or after January 1, 2002, the retiree contributions
required for such coverage vary based on a formula depending on the retiree's
age and years of service. The estimated net periodic postretirement benefits
cost other than pensions applicable to TXU Energy was $38 million for 2003, $26
million for 2002 and $25 million for 2001. Contributions paid by TXU Energy to
fund postretirement benefits other than pensions were $16 million, $11 million
and $19 million in 2003, 2002 and 2001, respectively.
In addition, TXU Energy employees are eligible to participate in a
qualified savings plan, the TXU Thrift Plan (Thrift Plan). This plan is a
participant-directed defined contribution profit sharing plan qualified under
Section 401(a) of the Code, and is subject to the provisions of ERISA. The
Thrift Plan includes an employee stock ownership component. Under the terms of
the Thrift Plan, as amended effective in January 1, 2002, employees who do not
earn more than the IRS threshold compensation limit used to determine highly
compensated employees may contribute, through pre-tax salary deferrals and/or
after-tax payroll deductions, the maximum amount of their regular salary or
wages permitted under law. Employees who earn more than such threshold may
contribute from 1% to 16% of their regular salary or wages. Employer matching
contributions are also made in an amount equal to 100% of the first 6% of
employee contributions for employees who are covered under the cash balance
formula of the Retirement Plan, and 75% of the first 6% of employee
contributions for employees who are covered under the traditional defined
benefit formula of the Retirement Plan. Employer matching contributions are
invested in TXU Corp. common stock. Energy's contributions to the Thrift Plan,
aggregated $13 million in 2003, $14 million in 2002, and $7 million in 2001.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and related estimated fair values of TXU Energy's
significant financial instruments were as follows:
December 31, 2003 December 31, 2002
------------------ ------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
On balance sheet liabilities:
Long-term debt (including current maturities)(a)............... $3,072 $3,273 $1,955 $1,912
Exchangeable preferred membership interests, net of discount(b) 497 1,580 486 1,076
Financial guarantees........................................... 2 1 - -
Off balance sheet liabilities:
Financial guarantees........................................... - 12 - 81
(a) Excludes capital leases.
(b) Exchanged for preferred membership interest in 2003. Amount presented net of
discount.
In accordance with SFAS 133, financial instruments that are derivatives
are recorded on the balance sheet at fair value.
The fair values of on balance sheet instruments are estimated at the
lesser of either the call price or the market value as determined by quoted
market prices, where available, or, where not available, at the present value of
future cash flows discounted at rates consistent with comparable maturities with
similar credit risk.
The fair values of each financial guarantee is based on the difference
between the credit spread of the entity responsible for the underlying
obligation and a financial counterparty applied, on a net present value basis,
to the notional amount of the guarantee.
The carrying amounts for financial assets classified as current assets and
the carrying amounts for financial liabilities classified as current liabilities
approximate fair value due to the short maturity of such instruments. The fair
values of other financial instruments for which carrying amounts and fair values
have not been presented are not materially different than their related carrying
amounts.
A-56
13. DERIVATIVE FINANCIAL INSTRUMENTS
For derivative instruments designated as cash flow hedges, TXU Energy
recognized a net unrealized ineffectiveness gain of $6 million ($4 million
after-tax) in 2003 and a net loss of $41 million ($27 million after-tax) in
2002. The ineffectiveness gains and losses in 2003 and 2002 related to commodity
hedges and were reported as a component of revenues. In 2001, TXU Energy
experienced net hedge ineffectiveness of $4 million ($3 million after-tax),
recorded as an increase in revenues.
The net effect of unrealized mark-to-market ineffectiveness 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 $36 million in net gains in 2003 and $41
million in net losses in 2002.
The maximum length of time TXU Energy hedges its exposure to the
variability of future cash flows for forecasted energy-related transactions is
approximately four years.
Cash flow hedge amounts reported in accumulated other comprehensive income
will be recognized in earnings as the related forecasted transactions are
settled or are deemed to be no longer probable of occurring. No amounts were
reclassified into earnings in 2003, 2002, or 2001 as a result of the
discontinuance of cash flow hedges because of the probability a hedged
forecasted transaction would not occur.
As of December 31, 2003, TXU Energy expects that $42 million ($27 million
after-tax) in accumulated other comprehensive loss will be recognized in
earnings over the next twelve months. This amount represents the projected value
of the hedges over the next twelve months relative to what would be recorded if
the hedge transactions had not been entered into. The amount expected to be
reclassified is not a forecasted loss incremental to normal operations, but
rather it demonstrates the extent to which volatility in earnings (which would
otherwise exist) is mitigated through the use of cash flow hedges. The following
table summarizes balances currently recognized in accumulated other
comprehensive gain/(loss):
Accumulated
Other Comprehensive Loss
Year Ended December 31, 2003
--------------------------------
Energy-related All other Total
-------------- --------- -------
Dedesignated hedges (amounts fixed) $ 56 $ 29 $ 85
Hedges subject to market price fluctuations......... - 11 11
------- ------- -------
Total.......................................... $ 56 $ 40 $ 96
======= ======= =======
14. TEXAS ELECTRIC INDUSTRY RESTRUCTURING
As a result of the 1999 Restructuring Legislation, on January 1, 2002, US
Holdings and certain other electric utilities in Texas disaggregated (unbundled)
their business activities into a power generation company, a retail electric
provider (REP) and a transmission and distribution (electricity delivery)
utility. Unbundled electricity delivery utilities within ERCOT, such as Oncor,
remain regulated by the Commission.
Effective January 1, 2002, REPs affiliated with electricity delivery
utilities are required to charge "price-to-beat" rates established by the
Commission to residential and small business customers located in their
historical service territories. TXU Energy, as a REP affiliated with an
electricity delivery utility, could not charge prices to customers in either of
those classes in the historical service territory that are different from the
price-to-beat rate, adjusted for fuel factor changes, until the earlier of
January 1, 2005 or the date on which 40% of the electricity consumed by
customers in a class is supplied by competing REPs. Thereafter, TXU Energy may
offer rates different from the price-to-beat rate to customers in that class,
but it must also continue to make the price-to-beat rate available for
residential and small business customers until January 1, 2007. Twice a year,
TXU Energy may request that the Commission adjust the fuel factor component of
the price-to-beat rate up or down based on changes in the market price of
natural gas. In March and August of 2003, the Commission approved price-to-beat
rate increases requested by TXU Energy.
In December 2003, the Commission found that TXU Energy had met the 40%
requirement to be allowed to offer alternatives to the price-to-beat rate for
small business customers in the historical service territory.
A-57
Also, effective January 1, 2002, power generation companies affiliated
with electricity delivery utilities may charge unregulated prices in connection
with ERCOT wholesale power transactions.
Regulatory Settlement Plan
On December 31, 2001, US Holdings filed a Settlement Plan with the
Commission. It resolved all major pending issues related to US Holdings'
transition to competition pursuant to the 1999 Restructuring Legislation. The
Settlement Plan does not remove regulatory oversight of Oncor's business nor
does it eliminate TXU Energy's price-to-beat rates and related fuel adjustments.
The Settlement Plan became final and non-appealable in January 2003.
The major elements of the Settlement Plan are:
Excess Mitigation Credit -- Over the two-year period ended December 31,
2003, Oncor implemented a stranded cost excess mitigation credit in the amount
of $389 million (originally estimated to be $350 million), plus $26 million in
interest, applied as a reduction to delivery fees charged to all REPs, including
TXU Energy. The credit was funded by TXU Energy in the form of a note payable to
Oncor.
Regulatory Asset Securitization -- US Holdings received a financing order
authorizing the issuance of securitization bonds in the aggregate principal
amount of $1.3 billion to recover regulatory asset stranded costs and other
qualified costs. Accordingly, Oncor Electric Delivery Transition Bond Company
LLC, a bankruptcy remote financing subsidiary of Oncor, issued an initial $500
million of securitization bonds in 2003 and is expected to issue $790 million in
the first half of 2004. The principal and interest payments of the bonds are
secured through a delivery fee surcharge (transition charge) to all REPs,
including TXU Energy.
Retail Clawback Credit -- The Settlement Plan provides that a retail
clawback credit will be implemented unless 40% of the electricity consumed by
residential and small business customers in the historical service territory is
supplied by competing REPs after the first two years of competition. This
threshold was reached for small business customers, as discussed above, but not
for residential customers. The amount of the credit is equal to the number of
residential customers retained by TXU Energy in the historical service territory
as of January 1, 2004, less the number of new customers TXU Energy has added
outside of the historical service territory as of January 1, 2004, multiplied by
$90. The credit, which will be funded by TXU Energy, will be applied to delivery
fees charged by Oncor to REPs, including TXU Energy, over a two-year period
beginning January 1, 2004. In 2002, TXU Energy recorded a charge to cost of
energy sold of $185 million ($120 million after-tax) to accrue an estimated
retail clawback liability. In 2003, TXU Energy reduced the liability to $173
million, with a credit to earnings of $12 million ($8 million after-tax) to
reflect the calculation of the estimated liability applicable only to
residential customers in accordance with the Settlement Plan. As the amount of
the credit will be based on numbers of customers over the related two-year
period, the liability is subject to future adjustments.
Stranded Costs and Fuel Cost Recovery -- TXU Energy's stranded costs, not
including regulatory assets, are fixed at zero. US Holdings will not seek to
recover its unrecovered fuel costs which existed at December 31, 2001. Also, it
will not conduct a final fuel cost reconciliation, which would have covered the
period from July 1998 until the beginning of competition in January 2002.
See Note 4 for a discussion of extraordinary charges recorded in 2001 in
connection with the Settlement Plan.
15. COMMITMENTS AND CONTINGENCIES
Request from CFTC - In October 2003, TXU Corp. received an informal
request for information from the US Commodity Futures Trading Commission (CFTC)
seeking voluntary production of information concerning disclosure of price and
volume information furnished by TXU Portfolio Management Company LP to energy
industry publications. The request seeks information for the period from January
1, 1999 to the present. TXU Corp. intends to cooperate with the CFTC, and the
Company is preparing to respond to such information request. While TXU Corp. is
just beginning to compile the data requested, TXU Corp. believes that TXU
Portfolio Management Company LP has properly reported such information to
industry publications.
A-58
Clean Air Act -- The Federal Clean Air Act, as amended (Clean Air Act)
includes provisions which, among other things, place limits on SO2 and NOx
emissions produced by electricity generation plants. TXU Energy's capital
requirements have not been significantly affected by the requirements of the
Clean Air Act. In addition, all permits required for the air pollution control
provisions of the 1999 Restructuring Legislation have been applied for and TXU
Energy has initiated a construction program to install control equipment to
achieve the required reductions.
Power Purchase Contracts -- Certain contracts to purchase electricity
provide for capacity payments to ensure availability and provide for adjustments
based on the actual power taken under the contracts. Capacity payments paid
under these contracts for the years ended December 31, 2003, 2002 and 2001 were
$230 million, $296 million and $189 million, respectively.
Expected future capacity payments under existing agreements are estimated
as follows:
2004................................................... $238
2005................................................... 162
2006................................................... 117
2007................................................... 18
2008................................................... -
Thereafter............................................. -
-----
Total capacity payments.......................... $535
====
At December 31, 2003, TXU Energy had commitments for pipeline
transportation and storage reservation fees as shown in the table below:
2004.................................................... $24
2005.................................................... 7
2006.................................................... 6
2007.................................................... 4
2008.................................................... 1
Thereafter.............................................. 6
---
Total pipeline transportation and storage reservation
fees........................................... $48
===
On the basis of TXU Energy's current expectations of demand from its
electricity customers as compared with its capacity payments, management does
not consider it likely that any material payments will become due for
electricity not taken beyond capacity payments.
A-59
Coal Contracts -- TXU Energy has coal purchase agreements and coal
transportation agreements. Commitments under these contracts for the next five
years and thereafter are as follows:
2004................................................. $78
2005.................................................. 23
2006.................................................. 18
2007.................................................. -
2008.................................................. -
Thereafter............................................ -
----
Total ......................................... $119
====
Leases -- TXU Energy has entered into operating leases covering various
facilities and properties including generation plant facilities, combustion
turbines, transportation equipment, mining equipment, data processing equipment
and office space. Certain of these leases contain renewal and purchase options
and residual value guarantees. Lease costs charged to operating expense totaled
$124 million, $134 million and $117 million for 2003, 2002 and 2001,
respectively.
As of December 31, 2003, future minimum lease payments under both capital
leases and operating leases (with initial or remaining noncancellable lease
terms in excess of one year) were as follows:
Capital Operating
Year Leases Leases
- --- -------- --------
2004................................................ $ 2 $ 66
2005................................................ 2 70
2006................................................ 3 66
2007................................................ 3 70
2008................................................ 2 69
Thereafter.......................................... 5 456
------ -------
Total future minimum lease payments............ 17 $ 797
=======
Less amounts representing interest.................. 2
------
Present value of future minimum lease payments...... 15
------
Less current portion................................ 2
------
Long-term capital lease obligation.................. $ 13
======
Guarantees -- TXU Energy has entered into contracts that contain
guarantees to outside parties that could require performance or payment under
certain conditions. These guarantees have been grouped based on similar
characteristics and are described in detail below.
Residual value guarantees in operating leases -- TXU Energy is the lessee
under various operating leases that obligate it to guarantee the residual values
of the leased facilities. At December 31, 2003, the aggregate maximum amount of
residual values guaranteed was approximately $208 million with an estimated
residual recovery of approximately $140 million. The average life of the lease
portfolio is approximately six years.
Debt obligations of the parent -- TXU Energy has provided a guarantee
of the obligations under TXU Corp.'s finance lease (approximately $130 million
at December 31, 2003) for its headquarters building.
Shared saving guarantees -- As part of the operations of the strategic
retail services business, which TXU Energy intends to sell, TXU Energy has
guaranteed that certain customers will realize specified annual savings
resulting from energy management services it has provided. In aggregate, the
average annual savings have exceeded the annual savings guaranteed. The maximum
potential annual payout is approximately $8 million and the maximum total
potential payout is approximately $56 million. The fair value of guarantees
issued during the year ended December 31, 2003 was $1.8 million with a maximum
potential payout of $42 million. The average remaining life of the portfolio is
approximately nine years. These guarantees will be transferred or eliminated as
part of expected transactions for the sale of strategic retail services
operations.
Letters of credit -- TXU Energy has entered into various agreements that
require letters of credit for financial assurance purposes. Approximately $403
million of letters of credit were outstanding at December 31, 2003 to support
existing floating rate pollution control revenue bond debt of approximately $395
million. The letters of credit are available to fund the payment of such debt
obligations. These letters of credit have expiration dates in 2008.
A-60
TXU Energy has outstanding letters of credit in the amount of $37 million
to support hedging and risk management margin requirements in the normal course
of business. As of December 31, 2003, approximately 82% of the obligations
supported by these letters of credit mature within one year, and substantially
all of the remainder mature in the next six years.
Surety bonds -- TXU Energy has outstanding surety bonds of approximately
$32 million to support performance under various contracts and legal obligations
contracts in the normal course of business. The term of the surety bond
obligations is approximately one year.
Nuclear Insurance -- With regard to liability coverage, the Price-Anderson
Act (Act) provides financial protection for the public in the event of a
significant nuclear power plant incident. The Act sets the statutory limit of
public liability for a single nuclear incident at $10.6 billion currently and
requires nuclear power plant operators to provide financial protection for this
amount. The Act is being considered by the United States Congress for
modification and extension. The terms of a modification, if any, are not
presently known and therefore TXU Corp. is unable, at this time, to determine
any impact it may have on nuclear liability coverage. As required, TXU Corp.
provides this financial protection for a nuclear incident at Comanche Peak
resulting in public bodily injury and property damage through a combination of
private insurance and industry-wide retrospective payment plans. As the first
layer of financial protection, TXU Corp. has $300 million of liability insurance
from American Nuclear Insurers (ANI), which provides such insurance on behalf of
a major stock insurance company pool, Nuclear Energy Liability Insurance
Association. The second layer of financial protection is provided under an
industry-wide retrospective payment program called Secondary Financial
Protection (SFP).
Under the SFP, each operating licensed reactor in the US is subject to an
assessment of up to $100.6 million, subject to increases for inflation every
five years, in the event of a nuclear incident at any nuclear plant in the US.
Assessments are limited to $10 million per operating licensed reactor per year
per incident. All assessments under the SFP are subject to a 3% insurance
premium tax, which is not included in the above amounts.
With respect to nuclear decontamination and property damage insurance, NRC
regulations require that nuclear plant license-holders maintain not less than
$1.1 billion of such insurance and require the proceeds thereof to be used to
place a plant in a safe and stable condition, to decontaminate it pursuant to a
plan submitted to and approved by the NRC before the proceeds can be used for
plant repair or restoration or to provide for premature decommissioning. TXU
Corp. maintains nuclear decontamination and property damage insurance for
Comanche Peak in the amount of $3.4 billion, above which TXU Corp. is
self-insured. The primary layer of coverage of $500 million is provided by
Nuclear Electric Insurance Limited (NEIL), a nuclear electric utility industry
mutual insurance company. The remaining coverage includes premature
decommissioning coverage and is provided by NEIL in the amount of $2.25 billion
and $610 million from other insurance markets and foreign nuclear insurance
pools. TXU Corp. is subject to a maximum annual assessment from NEIL of $26.7
million.
TXU Corp. maintains Extra Expense Insurance through NEIL to cover the
additional costs of obtaining replacement power from another source if one or
both of the units at Comanche Peak are out of service for more than twelve weeks
as a result of covered direct physical damage. The coverage provides for weekly
payments of $3.5 million for the first fifty-two weeks and $2.8 million for the
next 110 weeks for each outage, respectively, after the initial twelve-week
period. The total maximum coverage is $490 million per unit. The coverage
amounts applicable to each unit will be reduced to 80% if both units are out of
service at the same time as a result of the same accident. Under this coverage,
TXU Corp. is subject to a maximum annual assessment of $8.6 million.
There have been some revisions made to the nuclear property and nuclear
liability insurance policies regarding the maximum recoveries available for
multiple terrorism occurrences. Under the NEIL policies, if there were multiple
terrorism losses occurring within a one-year time frame, NEIL would make
available one industry aggregate limit of $3.24 billion plus any amounts it
recovers from other sources up to the limits for each claimant. If terrorism
losses occurred beyond the one-year period, a new set of limits and resources
would apply. Under the ANI liability policy, the liability arising out of
A-61
terrorist acts will be subject to one industry aggregate limit of $300 million
which could be reinstated at ANI's option depending on prevailing risk
circumstances and the balance in the Industry Credit Rating Plan reserve fund.
Under the US Terrorism Risk Insurance Act of 2002, the US government provides
reinsurance with respect to acts of terrorism in the US for losses caused by an
individual or individuals acting on behalf of foreign parties. In such
circumstances, the NEIL and ANI terrorism aggregates would not apply.
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 Energy's January 1993 rate increase request.
Effective January 1, 2002, decommissioning costs are recovered through a tariff
charged to REPs by Oncor based upon a 1997 site-specific study, adjusted for
trust fund assets, as a component of delivery fees effective under US Holdings'
2001 Unbundled Cost of Service filing. Amounts recovered through regulated rates
are deposited in external trust funds (see Note 5 under Investments). With the
adoption of FAS 143, the liability for the decommissioning costs was recorded at
discounted net present value.
See Note 1 (under Changes in Accounting Standards) for a discussion of the
impact of SFAS 143 on accounting for nuclear decommissioning costs.
Also see Note 1 (under Property, Plant and Equipment) for a discussion of
an extension of the nuclear plant license.
Legal Proceedings - 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 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 on February 3, 2004 that joined additional, unaffiliated defendants.
Three retail electric providers have 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 have filed a motion to
intervene in the action alleging claims substantially identical to TCE's, both
on their behalf and on behalf of a putative class of all former customers of
TCE. TXU Energy believes that it has not committed any violation of the
antitrust laws and the Commission's investigation of the market conditions in
late February 2003 has not resulted in any findings adverse to TXU Energy.
Accordingly, TXU Energy believes that TCE's and the interveners' claims against
TXU Energy and its subsidiary companies are without merit and TXU Energy and its
subsidiaries intend to vigorously defend the lawsuit. TXU Energy is 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 and TXU
Portfolio Management. Plaintiff asserts claims under Section 806 of
Sarbanes-Oxley arising from plaintiff's employment termination and claims for
breach of contract relating to payment of certain bonuses. Plaintiff seeks back
pay, payment of bonuses and alternatively, reinstatement or future compensation,
including bonuses. TXU Corp. believes the plaintiff's claims are without merit.
The plaintiff was terminated as the result of a reduction in force, not as a
reaction to any concerns the plaintiff had expressed, and plaintiff was not in a
position with TXU Portfolio Management such that he had knowledge or information
that would qualify the plaintiff to evaluate TXU Corp.'s financial statements or
assess the adequacy of TXU Corp.'s financial disclosures. Thus, TXU Corp. does
not believe that there is any merit to the plaintiff's claims under
Sarbanes-Oxley. Accordingly, TXU Corp., TXU Energy and TXU Portfolio Management
intend to vigorously defend the litigation. While TXU Corp., TXU Energy and TXU
Portfolio Management dispute the plaintiff's claims, TXU Corp. is unable to
predict the outcome of this litigation or the possible loss in the event of an
adverse judgment.
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 has been transferred to the
Beaumont Division of the Eastern District of Texas. This action is brought by an
individual, alleged to be a retail consumer of electricity, on behalf of herself
and as a proposed representative of a putative class of retail purchasers of
electricity that are similarly situated. On September 15, 2003, defendants filed
a motion to dismiss the lawsuit and a motion to transfer the case to the
Northern District of Texas, Dallas Division. TXU Corp. believes that the
plaintiff lacks standing to assert any antitrust claims against TXU Corp. or TXU
Portfolio Management, and that defendants have not violated antitrust laws or
other laws as claimed by the plaintiff. Therefore, TXU Corp. believes that
plaintiff's claims are without merit and plans to vigorously defend the lawsuit.
TXU Corp. is unable to estimate any possible loss or predict the outcome of this
action.
A-62
General - In addition to the above, TXU Energy is involved in various
other legal and administrative proceedings in the normal course of business the
ultimate resolution of which, in the opinion of TXU Energy, should not have a
material effect upon its financial position, results of operations or cash
flows.
16. SUPPLEMENTARY FINANCIAL INFORMATION
The operations of TXU Energy are unregulated, as the Texas market is now
open to competition. However, retail pricing to residential customers in the
historical service territory continues to be subject to certain price controls
as discussed in Note 14.
Other Income and Deductions --
Year Ended December 31,
-----------------------------
2003 2002 2001
---- ---- ----
Other income
Net gain on sale of properties and businesses...... $ 45 $ 30 $ 1
Other.............................................. 3 3 1
-------- --------- ---------
Total other income............................. $ 48 $ 33 $ 2
======= ======== ========
Other deductions
Loss on sale of properties......................... $ - $ 2 $ 8
Loss on retirement of debt......................... 3 - 149
Regulatory asset write-off......................... - - 22
Asset impairment................................... 2 237 -
Other.............................................. 17 15 17
-------- --------- ---------
Total other deductions......................... $ 22 $ 254 $ 196
======= ======== ========
Credit Risk -- Credit risk relates to the risk of loss associated with
non-performance by counterparties. TXU Energy 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 Energy 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 requirements
prior to entering into an agreement with a counterparty that creates credit
exposure to TXU Energy. Additionally, TXU Energy 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's gross exposure to credit risk as of
December 31, 2003 was $2.1 billion, representing trade accounts receivable (net
of allowance of uncollectible accounts receivable of $51 million), as well as
commodity contract assets and other derivative assets that arise primarily from
hedging activities.
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
non-performance by these customers is unlikely based upon historical experience.
Allowances for uncollectible accounts receivable are established for the
potential loss from non-payment by these customers based on historical
experience and market or operational conditions.
Most of the remaining trade accounts receivable are with large business
customers and hedging counterparties. These counterparties include major energy
companies, financial institutions, gas and electric utilities, independent power
producers, oil and gas producers and energy trading companies.
A-63
The exposure to credit risk from these customers and counterparties,
excluding credit collateral, as of December 31, 2003, is $1.1 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 (cash,
letters of credit and other security interests), the net credit exposure is $965
million. Of this amount, approximately 86% 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's internal credit evaluation process. Those customers and counterparties
without an S&P rating of at least BBB- or similar rating from another major
rating agency are rated using internal credit methodologies and credit scoring
models to estimate an S&P equivalent rating. TXU Energy routinely monitors and
manages its credit exposure to these customers and counterparties on this basis.
TXU Energy had no exposure to any one customer or counterparty greater
than 10% of the net exposure of $965 million at December 31, 2003. Additionally,
approximately 71% of the credit exposure, net of collateral held, has a maturity
date of two years or less. TXU Energy does not anticipate any material adverse
effect on its financial position or results of operations as a result of
non-performance by any customer or counterparty.
Interest Expense and Related Charges --
Year Ended December 31,
-----------------------------
2003 2002 2001
---- ---- ----
Interest ........................................................ $ 306 $ 213 $ 229
Amortization of debt expense..................................... 24 8 7
Capitalized interest............................................. (7) (6) (12)
--------- ---------- --------
Total interest expense and related charges ...................... $ 323 $ 215 $ 224
======== ======== =======
Affiliate Transactions -- The following represent the significant
affiliate transactions of TXU Energy:
o TXU Energy incurs electricity delivery fees charged by Oncor. For
the years ended December 31, 2003 and 2002, these fees totaled
$1.5 billion in each year.
o In accordance with the Business Separation Agreement, TXU Energy
records interest expense payable to Oncor with respect to Oncor's
generation-related regulatory assets that are subject to
securitization. The interest expense reimburses Oncor for the
interest expense Oncor incurs on that portion of its debt
associated with the generation-related regulatory assets. For the
years ended December 31, 2003 and 2002, this interest expense
totaled $43 million and $28 million, respectively.
o Under the terms of the settlement plan, Oncor issued an initial
$500 million of securitization bonds in 2003 and is expected to
issue $790 million in the first half of 2004. The incremental
income taxes Oncor will pay on the increased delivery fees to be
charged to Oncor's customers related to the bonds will be
reimbursed by TXU Energy. Therefore, TXU Energy's financial
statements reflect a $437 million non-interest bearing payable to
Oncor ($13 million of which is due currently) that will be
extinguished as Oncor pays the related income taxes.
o TXU Energy had a note payable to Oncor, in the original amount of
$350 million, related to the excess mitigation credit established
in accordance with the Settlement Plan. Oncor implemented the
credit as a reduction to delivery fees charged to all REPs,
including TXU Energy, for a two-year period beginning January 1,
2002. For the years ended December 31, 2003 and 2002, the
principal payments made on the note payable totaled $170 million
and $180 million, respectively, and the interest expense totaled
$6 million and $21 million, respectively.
o Average daily short-term advances from affiliates during 2003 and
2002 were $343 million and $417 million, respectively, and
interest expense incurred on the advances was $8 million and $10
million, respectively. The weighted average interest rate for 2003
and 2002 was 2.8% and 2.7%, respectively.
o TXU Business Services Company, a subsidiary of TXU Corp., charges
TXU Energy for financial, accounting, information technology,
environmental, procurement and personnel services and other
administrative services at cost. For 2003 and 2002, these costs
totaled $223 million and $286 million, respectively, and are
included in selling, general and administrative expenses.
A-64
o TXU Energy receives payments from TXU Gas, a subsidiary of TXU
Corp., under a service agreement that began in 2002 covering
customer billing and customer support services provided for TXU
Gas. These revenues totaled $29 million and $28 million in 2003
and 2002, respectively and are included in other revenues.
Accounts Receivable -- At December 31, 2003 and 2002, accounts receivable
of $943 million and $1.3 billion, respectively, are stated net of uncollectible
accounts of $51 million and $71 million, respectively. During 2003, bad debt
expense was $114 million, account writeoffs were $121 million and other activity
decreased the allowance for uncollectible accounts by $13 million. During 2002,
bad debt expense was $155 million, account write-offs were $101 million and
other activity decreased the allowance for uncollectible accounts by $6 million.
Allowances related to receivables sold are reported in current liabilities and
totaled $39 million and $19 million at December 31, 2003 and 2002, respectively.
See Note 7 regarding sale of receivables.
Accounts receivable included $388 million and $489 million of unbilled
revenues at December 31, 2003 and 2002, respectively.
Commodity Contract Assets At December 31, 2003 and 2002, current and
noncurrent commodity contract assets totaling $1.1 billion and $1.8 billion,
respectively, are stated net of applicable credit (collection) and performance
reserves totaling $18 million and $43 million, respectively. Performance
reserves are provided for direct, incremental costs to settle the contracts.
Inventories by Major Category --
December 31,
-----------------------
2003 2002
---- ----
Materials and supplies...................................................... $ 226 $ 224
Fuel stock.................................................................. 78 70
Gas stored underground...................................................... 83 57
-------- --------
Total inventories...................................................... $ 387 $ 351
======== ========
Inventories reflect a $22 million reduction in 2003 as a result of the
rescission of EITF 98-10 as discussed in Note 2.
Property, Plant and Equipment --
December 31,
----------------------
2003 2002
---- ----
Electricity generation...................................................... $ 15,900 $ 15,675
Other....................................................................... 739 460
-------- --------
Total.................................................................. 16,639 16,135
Less accumulated depreciation............................................... 6,645 6,178
-------- --------
Net of accumulated depreciation........................................ 9,994 9,957
Construction work in progress............................................... 256 286
Nuclear fuel (net of accumulated amortization: 2003-- $934; 2002-- $847).. 131 137
-------- --------
Net property, plant and equipment...................................... $ 10,381 $ 10,380
======== ========
A-65
Supplemental Cash Flow Information --
Year Ended December 31,
------------------------------
2003 2002 2001
---- ---- ----
Cash payments:
Interest (net of amounts capitalized).............. $ 262 $ 204 $ 240
Income taxes....................................... $ 92 $ 157 $ 366
Non-cash investing and financing activities:
Non-cash advances.................................. $ - $ - $ 89
Conversion of capital (from) to advances........... $ - $ (15) $ 28
Non-cash capital contribution related to issuance
of exchangeable subordinated notes............ $ - $ 266 $ -
Quarterly Information (unaudited) -- The results of operations by quarter
are summarized below and reflect the discontinuance of the strategic retail
service business operations.
In the opinion of TXU Energy, all other adjustments (consisting of normal
recurring accruals) necessary for a fair statement of such amounts have been
made. Quarterly results are not necessarily indicative of expectations for a
full year's operations because of seasonal and other factors.
Quarter Ended
---------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
2003:
Operating revenues .............................................. $ 1,791 $ 2,017 $ 2,442 $ 1,745
Income from continuing operations before
cumulative effect of changes in accounting principles......... $ 34 $ 154 $ 249 $ 56
Income (loss) from discontinued operations, net of tax effect.... $ 1 $ - $ - $ (15)
Cumulative effect of changes in accounting principles, net of tax
effect........................................................... $ (58) $ - $ - $ -
Net income (loss)................................................ $ (23) $ 154 $ 249 $ 41
2002:
Operating revenues .............................................. $ 1,790 $ 2,007 $ 2,411 $ 1,483
Income (loss) from continuing operations......................... $ 190 $ 198 $ 242 $ (311)
Loss from discontinued operations, net of tax effect............. $ (3) $ (15) $ (15) $ (16)
Net income (loss) ............................................... $ 187 $ 183 $ 227 $ (327)
Included in fourth quarter 2003 income from discontinued operations were
impairment and other exit charges totaling $10.3 million ($6.7 million
after-tax). Included in fourth quarter 2002 results of continuing operations
were $185 million ($120 million after-tax) accrual for regulatory-related retail
clawback and a $237 million ($154 million after-tax) writedown of an investment
in generation plant construction projects.
Reconciliation of Previously Reported Quarterly Information - The
following table presents the changes to previously reported quarterly amounts to
reflect discontinued operations (see Note 3). Net income was not affected by
these changes.
Quarter Ended
--------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
-------- ------- -------- -------
Increase (Decrease) From Previously Reported
2003:
Operating revenues - from discontinued operations................ $ (15) $ (28) $ (11) $ -
Loss from continuing operations before cumulative effect of
changes in accounting principles............................... (1) - - -
2002:
Operating revenues - from discontinued operations................ $ (9) $ (12) $ (9) $ (17)
Income from continuing operations................................ 3 15 15 16
A-66
TXU Energy Company LLC Exhibits to 2003 Form 10-K
APPENDIX B
Previously Filed*
With File As
Exhibits Number Exhibit
-------- ----- -------
(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession.
2(a) 1-12833 2 -- Master Separation Agreement by and among Oncor, TXU
Form 8-K Generation Holdings Company LLC, TXU Merger Energy Trading
(filed January 16, Company LP, TXU SESCO Company, TXU SESCO Energy Services
2002) Company, TXU Energy Retail Company LP and TXU US Holdings,
dated as of December 14, 2001.
3(i) Articles of Incorporation.
3(a) 333-108876 3(a) Certificate of Formation of TXU Energy Company LLC dated
Form S-4 (filed November 5, 2001.
September 17, 2003
3(ii) By-laws.
3(b) 333-108876 3(b) -- Second Amended and Restated Limited Liability Company
Form S-4 (filed Agreement of TXU Energy Company LLC dated as of July 1, 2003.
September 17, 2003)
(4) Instruments Defining the Rights of Security Holders, Including Indentures.**
4(a) 333-108876 4(a) -- Indenture (For Unsecured Debt Securities), dated as of March
Form S-4 (filed 1, 2003, from TXU Energy Company LLC to The Bank of New
September 17, 2003) York, as trustee (TXU Energy Indenture)
4(b) 333-108876 4(c) -- Form of TXU Energy Company LLC 6.125% Exchange Senior Notes
Form S-4 (filed due 2008.
September 17, 2003)
4(c) 333-108876 4(d) -- Form of TXU Energy Company LLC 7.000% Exchange Senior Notes
Form S-4 (filed due 2013.
September 17, 2003)
4(d) 1-12833 10(a) -- Exchange Agreement, dated as of November 22, 2002, among TXU
Form 8-K (filed Corp., TXU Energy and UXT Holdings LLC and UXT Intermediary
November 26, 2002) LLC.
4(e) 1-12833 10(c) -- Registration Rights Agreement, dated as of November 22,
Form 8-K (filed 2002, among TXU Corp. and UXT Holdings LLC and UXT
November 26, 2002) Intermediary LLC.
4(f) 1-12833 4(uu) -- Amendment No. 1 to Registration Rights Agreement, dated as
Form 10-K (2002) of December 19, 2002, among TXU Corp. and UXT Holdings LLC
(filed March 12, and UXT Intermediary LLC.
2003)
4(g) 1-12833 4(b) -- Amendment No. 2 to Registration Rights Agreement, dated as
Form 10-Q (Quarter of July 1, 2003, among TXU Corp. and the entities listed on
Ended June 30, 2003) Schedule A thereto (including UXT Holdings LLC and UXT
(filed August 13, Intermediary LLC).
2003)
B-1
(10) Material Contracts.
Credit Agreements.
10(a) 1-12833 10(e) -- $450,000,000 Revolving Credit Agreement, dated as of April
Form 8-K/A (filed 22, 2003, among Oncor, TXU Energy and certain banks listed
May 1, 2003) therein, and JPMorgan Chase Bank, as Administrative Agent.
10(b) 1-12833 10(e) -- Amendment No. 1, dated August 29, 2003, to the $450,000,000
Form 10-Q (Quarter Revolving Credit Agreement, dated as of April 22, 2003,
ended September 30, among TXU Energy, Oncor, certain banks listed therein and JP
2003) (filed Morgan Chase Banks as Administrative Agent and Fronting Bank.
November 12, 2003)
Other Material Contracts.
10(c)(1) -- Installment Payment and Bond Amortization Agreement between
the Brazos River Authority and TXU Energy dated October 1,
2003.
10(c)(2) -- Schedule A, identifying Installment Payment and Bond
Amortization Agreements not filed herewith and substantially
identical to Exhibit 10(c)(1).
10(d)(1) -- Trust Indenture between the Brazos River Authority and TXU
Energy dated October 1, 2003.
10(d)(2) -- Schedule B, identifying Trust Indentures not filed herewith
and substantially identical to Exhibit 10(d)(1).
10(e) 333-100240 10(c) -- Generation Interconnection Agreement, dated December 14,
Form S-4 2001, between Oncor and TXU Generation Company LP.
(filed October 2,
2002)
10(f) 333-100240 10(d) -- Generation Interconnection Agreement, dated December 14,
Form S-4 2001, between Oncor and TXU Generation Company LP, for
(filed October 2, itself and as Agent for TXU Big Brown Company LP, TXU
2002) Mountain Creek Company LP, TXU Handley Company LP, TXU
Tradinghouse Company LP and TXU DeCordova Company LP
(Interconnection Agreement).
10(g) 333-100240 10(e) -- Amendment No. 1 to Interconnection Agreement, dated May 31,
Form S-4 2002.
(filed October 2,
2002)
10(h) 1-12833 10(qq) -- Lease Agreement dated as of February 14, 2002 between State
Form 10-K (2003) Street Bank and Trust Company of Connecticut, National
(filed March 12, Association, as owner trustee of ZSF/Dallas Tower Trust, a
2004) Delaware grantor trust, as Lessor and TXU Properties
Company, a Texas corporation, as Lessee (Energy Plaza Property).
10(i) 1-12833 10(rr) -- Guaranty Agreement dated February 14, 2002 by TXU Corp. in
Form 10-K (2003) favor of State Street Bank and Trust Company of Connecticut,
(filed March 12, National Association, as owner trustee of ZSF/Dallas Tower
2004) Trust, a Delaware grantor trust, as Lessor.
10(j) 1-12833 10(ss) -- Additional Guaranty Agreement dated November 19, 2002 by TXU
Form 10-K (2003) Energy Company LLC in favor of State Street Bank and Trust
(filed March 12, Company of Connecticut, National Association, as owner
2004) trustee of ZSF/Dallas Tower Trust, a Delaware grantor trust,
as Lessor.
B-2
(12) Statement Regarding Computation of Ratios.
12 -- Computation of Ratio of Earnings to Fixed Charges, and Ratio
of Earnings to Combined Fixed Charges and Preference
Dividends.
(21) Subsidiaries of the Registrant.
21 -- Subsidiaries of TXU Energy Company LLC.
(23) Consents of Experts and Counsel.
23 -- Consent of Deloitte & Touche LLP, Independent Auditors for
TXU Energy Company LLC.
(31) Rule 13a - 14(a)/15d - 14(a) Certifications.
31(a) -- Certification of C. John Wilder, principal executive officer
of TXU Energy Company LLC, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31(b) -- Certification of Paul O'Malley, principal financial officer
of TXU Energy Company LLC, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
(32) Section 1350 Certifications.
32(a) -- Certification of C. John Wilder, principal executive officer
of TXU Energy Company LLC, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32(b) -- Certification of Paul O'Malley, principal financial officer
of TXU Energy Company LLC, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
- ----------------
* Incorporated herein by reference.
** Certain instruments defining the rights of holders of long-term debt of
the registrant's subsidiaries included in the financial statements
filed herewith have been omitted because the total amount of securities
authorized thereunder does not exceed 10 percent of the total assets of
the registrant and its subsidiaries on a consolidated basis. Registrant
hereby agrees, upon request of the Securities and Exchange Commission,
to furnish a copy of any such omitted instrument.
B-3