SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
-- OR --
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
ENSERCH Corporation
A Texas Corporation I.R.S. Employer Identification
Commission File Number 1-3183 No. 75-0399066
ENERGY PLAZA, 1601 BRYAN STREET, DALLAS, TEXAS 75201-3411
(214) 812-4600
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes _ x _ No
Common Stock outstanding at August 13, 1998: 201,000 shares, par value $0.01
per share.
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
ENSERCH Corporation and Subsidiaries
Condensed Statements of Consolidated Income -
Three, Six and Twelve Months Ended June 30, 1998 and 3
1997
Condensed Statements of Consolidated Cash Flows -
Six Months Ended June 30, 1998 and 1997 4
Condensed Consolidated Balance Sheets -
June 30, 1998 and December 31, 1997 5
Notes to Condensed Consolidated Financial
Statements 7
Independent Accountants' Reports 11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operation 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 17
Part II.OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
2
<captions>
ENSERCH CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
Predecessor
---------------------------
Twelve Months Ended June 30, 1998
Predecessor Predecessor ---------------------------------
----------- ----------- Period From
Three Months Ended Six Months Ended Period From July 1, 1997 Twelve
June 30 June 30 Acquisition Through Months Ended
--------------------- ----------------------- Date Thru Acquisition June 30,
1998 1997 1998 1997 June 30, 1998 Date 1997
---------- --------- ----------- ---------- ------------- ------------- ------------
Thousands of Dollars
OPERATING REVENUES . . . . . . . . . $873,441 $348,649 $1,893,251 $1,144,186 $3,170,257 $135,492 $2,045,451
-------- -------- ---------- ---------- ---------- -------- ----------
OPERATING EXPENSES
Gas purchased for resale. . . . . . 766,983 246,625 1,610,631 868,790 2,673,071 86,471 1,494,359
Operation and maintenance . . . . . 85,508 84,481 171,595 168,772 313,281 28,710 345,272
Depreciation and amortization . . . 19,504 14,429 38,632 28,900 68,352 4,793 56,073
Taxes other than income . . . . . . 16,465 19,364 39,177 42,646 62,513 3,712 73,110
-------- -------- ---------- ---------- ---------- -------- ----------
Total operating expenses. . . . . 888,460 364,899 1,860,035 1,109,108 3,117,217 123,686 1,968,814
-------- -------- ---------- ---------- ---------- -------- ----------
OPERATING INCOME (LOSS) . . . . . . (15,019) (16,250) 33,216 35,078 53,040 11,806 76,637
MERGER EXPENSES. . . . . . . . . . . (5,070) (5,825) (19,310) (12,615)
OTHER INCOME (DEDUCTIONS) - NET. . . 934 1,224 866 1,347 1,747 1,452 (320)
INTEREST CHARGES . . . . . . . . . . (18,287) (19,022) (37,038) (37,956) (68,793) (6,581) (77,715)
-------- -------- ---------- ---------- ---------- -------- ----------
LOSS BEFORE INCOME TAXES . . . . . . (32,372) (39,118) (2,956) (7,356) (14,006) (12,633) (14,013)
INCOME TAX EXPENSE (BENEFIT) . . . . (9,996) (17,542) 1,936 (4,356) 451 (256) (4,084)
-------- -------- ---------- ---------- ---------- -------- ----------
LOSS FROM CONTINUING
OPERATIONS. . . . . . . . . . . . . (22,376) (21,576) (4,892) (3,000) (14,457) (12,377) (9,929)
INCOME (LOSS) FROM DISCONTINUED
OPERATIONS . . . . . . . . . . . . (8,511) (228,012) 3,321 (223,021)
EXTRAORDINARY LOSS ON
EXTINGUISHMENT OF DEBT. . . . . . . (2,096)
-------- -------- ---------- ---------- ---------- -------- ----------
NET LOSS . . . . . . . . . . . . . . (22,376) (30,087) (4,892) (231,012) (14,457) (9,056) (235,046)
PREFERRED STOCK DIVIDENDS. . . . . . 952 2,893 2,234 5,755 6,911 970 11,518
-------- -------- ---------- ---------- ---------- -------- ----------
NET LOSS AVAILABLE FOR
COMMON STOCK . . . . . . . . . $(23,328) $(32,980) $ (7,126) $ (236,767) $ (21,368) $(10,026) $ (246,564)
======== ======== ========== ========== ========== ======== ==========
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
3
<captions>
ENSERCH CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED
CASH FLOWS (Unaudited)
Predecessor
-----------
Six Months Ended June 30
-------------------------
1998 1997
---- ----
Thousands of Dollars
CASH FLOWS - OPERATING ACTIVITIES
Loss from continuing operations . . . . . . . . . . . . . . . . . . $ (4,892) $ (3,000)
Depreciation and amortization . . . . . . . . . . . . . . . . . . . 38,672 31,916
Deferred income taxes . . . . 31,770 (7,595)
Changes in operating assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . 240,005 166,235
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,568 19,826
Accounts payable
Parent and affiliates. . . . . . . . . . . . . . . . . . . . . . 5,108
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (162,763) (154,274)
Interest and taxes accrued. . . . . . . . . . . . . . . . . . . . (35,312) (15,440)
Other working capital . . . . . . . . . . . . . . . . . . . . . . (24,381) 1,491
Energy marketing risk management assets and liabilities . . . . . (25,393)
Other - net . . . . . . . . . . . . . . . . . . . . . . . . . . . (7,609) 5,419
--------- ---------
Cash provided by operating activities . . . . . . . . . . . . . 65,773 44,578
--------- ---------
CASH FLOWS - FINANCING ACTIVITIES
Issuances of securities:
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . 250,000 100,000
Common stock. . . . . . . . . . . . . . . . . . . . . . . . . . . 3,762
Retirements of securities:
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . (90,750) (100,784)
Preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . (100,000)
Change in notes payable:
Commercial paper. . . . . . . . . . . . . . . . . . . . . . . . . 65,500
Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,094)
Parent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (50,524)
Cash dividends paid . . . . . . . . . . . . . . . . . . . . . . . . (3,455) (12,773)
Debt financing expenses . . . . . . . . . . . . . . . . . . . . . . (1,060)
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (7)
--------- ---------
Cash provided by financing activities . . . . . . . . . . . . . 117 55,698
--------- ---------
CASH FLOWS - INVESTING ACTIVITIES
Construction expenditures . . . . . . . . . . . . . . . . . . . . . (67,296) (50,625)
Other investments . . . . . . . . . . . . . . . . . . . . . . . . . (3,908) (26,870)
--------- ---------
Cash used in investing activities . . . . . . . . . . . . . . . (71,204) (77,495)
--------- ---------
CASH PROVIDED BY (USED FOR) DISCONTINUED OPERATIONS. . . . . . . . . 1,462 (30,867)
--------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS. . . . . . . . . . . . . . . (3,852) (8,086)
CASH AND CASH EQUIVALENTS - BEGINNING BALANCE. . . . . . . . . . . . 11,770 17,715
--------- ---------
CASH AND CASH EQUIVALENTS - ENDING BALANCE . . . . . . . . . . . . . $ 7,918 $ 9,629
========= =========
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
4
<captions>
ENSERCH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
June 30,
1998 December 31,
(Unaudited) 1997
---------- -----------
Thousands of Dollars
PROPERTY, PLANT AND EQUIPMENT
Gas distribution and pipeline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,090,647 $1,068,708
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56,002 46,400
---------- ----------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,146,649 1,115,108
Less accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53,139 24,669
---------- ----------
Net of accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,093,510 1,090,439
Construction work in progress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118,597 85,635
Held for future use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 121
---------- ----------
Net property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . 1,212,228 1,176,195
---------- ----------
INVESTMENTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,788 37,041
---------- ----------
CURRENT ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,918 11,770
Accounts receivable (net of allowance for uncollectible accounts: 1998 - $6,402,000;
1997 - $3,902,000). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309,263 524,908
Energy marketing risk management assets . . . . . . . . . . . . . . . . . . . . . . . . . 493,247 365,650
Inventories - at average cost:
Materials and supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,500 6,544
Gas stored underground . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104,720 114,244
Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,010 1,527
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,663 22,663
Other current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,761 7,678
---------- ----------
Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 959,082 1,054,984
---------- ----------
DEFERRED DEBITS
Goodwill (net of accumulated amortization: 1998 - $18,107,000; 1997 - $8,113,000) . . . . 781,407 791,401
Energy marketing risk management assets . . . . . . . . . . . . . . . . . . . . . . . . . 70,980 41,522
Unamortized regulatory assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,298 52,336
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,362 72,631
Other deferred debits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,247 14,038
---------- ----------
Total deferred debits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 970,294 971,928
---------- ----------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,182,392 $3,240,148
========== ==========
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
5
<captions>
ENSERCH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
CAPITALIZATION AND LIABILITIES
June 30,
1998 December 31,
(Unaudited) 1997
----------- -----------
Thousands of Dollars
CAPITALIZATION
Common Stock (par value - $.01 per share):
Authorized shares - 100,000,000
Outstanding shares - 201,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2 $ 2
Paid in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 770,923 771,207
Retained earnings (deficit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (16,001) (9,565)
---------- ----------
Total common stock equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 754,924 761,644
Preferred stock not subject to mandatory redemption . . . . . . . . . . . . . . . . . . 75,000 175,000
Advances from parent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 242,913 293,843
Long-term debt, less amounts due currently. . . . . . . . . . . . . . . . . . . . . . . 802,952 646,796
---------- ----------
Total capitalization. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,875,789 1,877,283
---------- ----------
CURRENT LIABILITIES
Notes payable - banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,973 6,067
Accounts payable:
Parent and affiliates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,034 4,926
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 328,240 491,645
Energy marketing risk management liabilities. . . . . . . . . . . . . . . . . . . . . . 471,754 357,044
Taxes accrued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,222 19,010
Interest accrued. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,123 20,264
Dividends declared. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 638 1,859
Customers' deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,017 7,751
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62,131 79,078
---------- ----------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 913,132 987,644
---------- ----------
DEFERRED CREDITS AND OTHER NONCURRENT LIABILITIES
Accumulated deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,088 10,498
Unamortized investment tax credits. . . . . . . . . . . . . . . . . . . . . . . . . . . 3,334 3,364
Pensions and other postretirement benefits. . . . . . . . . . . . . . . . . . . . . . . 165,780 165,514
Energy marketing risk management liabilities. . . . . . . . . . . . . . . . . . . . . . 48,276 31,324
Other deferred credits and noncurrent liabilities . . . . . . . . . . . . . . . . . . . 165,993 164,521
---------- ----------
Total deferred credits and other noncurrent liabilities. . . . . . . . . . . . . . . 393,471 375,221
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 8)
---------- ----------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,182,392 $3,240,148
========== ==========
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
6
ENSERCH CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.MERGERS AND DISPOSITIONS
On August 5, 1997 (Merger Date or Acquisition Date), the merger
transactions between Texas Utilities Company (TUC) and ENSERCH Corporation
(ENSERCH or the Corporation) were completed. All of the common stock of
ENSERCH was converted into common stock of TUC, and ENSERCH became a
wholly-owned subsidiary of TUC. Immediately prior to ENSERCH's merger with
TUC, Enserch Exploration, Inc. (EEX) and Lone Star Energy Plant Operations,
Inc. (LSEPO), former subsidiaries of the Corporation, were merged to form a
new company (New EEX), and ENSERCH distributed to its common shareholders its
ownership interest in these businesses.
TUC accounted for its acquisition of ENSERCH as a purchase, and purchase
accounting adjustments, including goodwill, have been pushed down and are
reflected in the financial statements of ENSERCH and its subsidiaries for the
period subsequent to August 5, 1997. The financial statements of ENSERCH for
the periods ended before August 5, 1997 were prepared using ENSERCH's
historical basis of accounting and are designated as "Predecessor". The
comparability of the operating results for the Predecessor and the periods
encompassing push down accounting are affected by the purchase accounting
adjustments, including the amortization of goodwill over a period of forty
years.
The Predecessor financial statements have been restated to reflect EEX
and LSEPO as a discontinued operation. The historical financial statements of
ENSERCH reflect certain reclassifications made to conform to TUC's
presentation style. On December 31, 1997, ENSERCH sold, to another subsidiary
of TUC, at net book value, the group of companies which had constituted the
Corporation's power development and international gas distribution
operations. For financial reporting purposes, the sale was deemed to have
occurred on August 5, 1997. Accordingly, operating results for periods
following the Merger Date exclude those operations. Prior periods were not
restated to reflect the sale.
The fair value of the assets and liabilities of ENSERCH's rate-regulated
natural gas utility business (conducted through its Lone Star Gas Company and
Lone Star Pipeline Company divisions) is considered to be equivalent to the
historical basis of accounting and accordingly, no adjustment has been made to
the carrying value. The excess of the consideration paid by TUC over the
estimated fair value of the assets and liabilities of ENSERCH at the merger
date was approximately $800 million and is reflected as goodwill in the
ENSERCH balance sheet as of December 31, 1997. The process of determining the
fair value of assets and liabilities at the Merger Date is continuing, and the
final result awaits the resolution of income tax and other contingencies and
finalization of certain estimates.
7
2.SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation -- The condensed consolidated financial statements
of ENSERCH and its subsidiaries have been prepared on the same basis as those
in the 1997 Annual Report on Form 10-K (1997 Form 10-K) and, in the opinion of
ENSERCH, all adjustments (constituting only normal recurring accruals)
necessary to a fair presentation of the results of operation and financial
position have been included therein. Certain information and footnote
disclosures normally included in annual consolidated financial statements
prepared in accordance with generally accepted accounting principles have been
omitted pursuant to rules and regulations of the Securities and Exchange
Commission.
Certain previously reported amounts have been reclassified to
conform to current classifications.
Energy Marketing Activities -- The Corporation, through its energy
marketing subsidiary, Enserch Energy Services, Inc. (EES), enters into a
variety of transactions, including forward contracts involving physical
delivery of natural gas or electrical power commodities, as well as swaps,
futures, options and other derivative contractual arrangements. As part of
these business activities, EES offers price risk management services to the
energy sector. These transactions are primarily conducted with retail end
users, established energy companies and major financial institutions. EES
uses the mark-to-market method of valuing and accounting for these
activities. Under this method, the current market value of EES' energy
portfolio, net of future servicing costs is reflected within the Corporation's
consolidated balance sheets, with resulting unrealized gains and losses, as
"Energy Marketing Risk Management Assets" or "Energy Marketing Risk Management
Liabilities". The actual timing of cash receipts and payments may however
vary as contracts may be settled at intervals other than their scheduled
maturities. (See Note 6).
3.COMPREHENSIVE INCOME
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income," became effective as of the first quarter of 1998. This
statement requires companies to report and display comprehensive income and
its components (revenues, expenses, gains and losses). Comprehensive income
includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners. For the Corporation,
comprehensive income is the same as net income reported in the consolidated
statement of income. There are no other items of comprehensive income for the
periods presented.
4.LINES OF CREDIT
At June 30, 1998, TUC, Texas Utilities Electric Company (a subsidiary of
TUC) (TU Electric) and ENSERCH had joint lines of credit under revolving
credit facility agreements (Credit Agreements) with a group of banking
institutions. The Credit Agreements have two facilities. Facility A provides
for short-term borrowings aggregating up to $3,600,000,000 outstanding at any
one time at variable interest rates and terminates March 1, 1999. Facility B
provides for borrowings aggregating up to $1,400,000,000 outstanding at any
one time at variable interest rates and terminates March 2, 2003. Excluding
$2,800,000,000 which is restricted to TUC's use in financing the acquisition
of a foreign-based entity, the combined borrowings of TUC, TU Electric and
ENSERCH under both facilities are limited to an aggregate of $2,200,000,000
outstanding at any one time, which may be used for working capital and other
general corporate purposes, including commercial paper backup. ENSERCH's
borrowings under both facilities are limited to an aggregate of up to
8
$650,000,000 outstanding at any one time. At June 30, 1998, ENSERCH had
no borrowings outstanding under these facilities.
5.CAPITALIZATION
Long-Term Debt -- In January 1998, the Corporation issued $125,000,000 of
6.25% Series A Notes due January 1, 2003 (Series A Notes) and $125,000,000 of
Remarketed Reset Notes due January 1, 2008 (Reset Notes). Net proceeds from
these borrowings were used to refinance or redeem like amounts of higher rate
debt and preferred stock. On July 1, 1998, the interest rate on the Reset
Notes was reset to a fixed rate of 6.564% to July 1, 2005.
In March 1998, ENSERCH redeemed the outstanding balance of its 6.375%
Convertible Subordinated Debentures. Holders of $3,005,000 principal amount
of the debentures elected to convert such debentures into 77,963 shares of TUC
common stock, and the remaining $87,745,000 principal amount was redeemed at
par for cash.
On July 6, 1998, ENSERCH redeemed at par its $100,000,000 principal
amount 8.875% Senior Notes.
ENSERCH Obligated, Mandatorily Redeemable, Preferred Securities of
Subsidiary Trust Holding Solely Debentures of ENSERCH -- In July 1998, a
statutory business trust, ENSERCH Capital I, was established as a financing
subsidiary of ENSERCH for the purpose of issuing common and preferred trust
securities, with a liquidation preference of $1,000 per unit, and holding
Junior Subordinated Debentures issued by ENSERCH. ENSERCH Capital I issued
$150,000,000 of floating rate capital securities. Distributions on these
capital securities are payable quarterly based on an annual floating rate
determined quarterly with reference to a three-month LIBOR plus a margin of
1.35%. The debentures held by the trust are its only assets. The trust
assets are $154,600,000 principal amount of Floating Rate Junior Subordinated
Debentures Series A (Series A Debentures). ENSERCH Capital I will use interest
payments received on the Series A Debentures to make cash distributions on the
capital securities it has issued. The interest rate on the Series A
Debentures will be set quarterly, based on three-month LIBOR plus 1.35%. The
initial rate for the period from July 2, 1998 to September 30, 1998 is
7.06875%. The proceeds were used by ENSERCH for general corporate purposes,
including the acquisition or redemption of outstanding securities of ENSERCH.
The Series A Debentures will mature on July 1, 2028 and ENSERCH has the right
to redeem the debentures in whole or in part on or after July 1, 2003.
Preferred Stock -- In January 1998, the Corporation redeemed all of the
outstanding shares of its Adjustable Rate Preferred Stock, Series E, at par
value of $1,000 per share, $100,000,000 principal amount, plus accrued and
unpaid dividends of $14.777 per share.
ENSERCH may issue additional debt and equity securities as needed,
including the possible future sale of up to $100,000,000 aggregate principal
amount of securities currently registered with the SEC for offering pursuant
to Rule 415 under the Securities Act of 1933.
9
6.DERIVATIVE INSTRUMENTS
Energy Marketing Activities -- EES' energy portfolio is comprised of
forward commitments, futures, swaps, options and other derivative
instruments. The notional amounts and terms of the portfolio as of June 30,
1998 included financial instruments that provide for fixed price receipts of
2,265 trillion British thermal units equivalent (Tbtue) and fixed price
payments of 2,314 Tbtue, with a maximum term of seven years. Additionally,
sales and purchase commitments totaling 1,140 Tbtue, with terms extending up
to five years are included in the portfolio as of June 30, 1998.
Notional amounts reflect the volume of transactions but do not represent
the amounts exchanged by the parties to the financial instruments.Accordingly,
the notional amounts represented above do not necessarily measure EES'
exposure to market or credit risks. Additionally, the maximum term in years
are not indicative of likely future cash flows as these positions may be
offset in the markets at any time in response to EES' risk management needs.
7.REGULATION AND RATES
Lone Star Gas Rates -- In August 1996, the Railroad Commission of Texas
(RRC) ordered a general inquiry into the rates and services of Lone Star Gas,
most notably a review of historic gas cost and gas acquisition practices since
the last rate setting. The inquiry docket was separated into different phases,
all of which are now resolved. Two of the phases, conversion to the National
Association of Regulatory Utility Commissioners account numbering system and
unbundling, have been dismissed by the RRC, and one other phase, rate case
expense, has been concluded. In the phase dealing with historic gas cost and
gas acquisition practices, the RRC issued a final order on June 2, 1998
approving a stipulated settlement of the docket. Lone Star Gas agreed to
credit residential and commercial customers $18 million to be spread over the
next two heating seasons (November through March). The earnings of Lone Star
Gas are not affected by the settlement due to previously established reserves.
Lone Star Gas and the intervenors both agreed to withdraw their appeals of
the city gate rate case. The final order approving the stipulation found that
all gas costs flowed through Lone Star Gas' monthly gas cost adjustment clause
prior to October 31, 1997 were just, reasonable, and necessary.
8.COMMITMENTS AND CONTINGENCIES
Guarantees -- The Corporation and/or its subsidiaries are the guarantor
on various commitments and obligations of others aggregating approximately
$33,300,000 at June 30, 1998. The Corporation is exposed to loss in the event
of nonperformance by other parties. However, the Corporation does not
anticipate nonperformance by the counterparties.
10
INDEPENDENT ACCOUNTANTS' REPORT
ENSERCH Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of
ENSERCH Corporation and subsidiaries (the Corporation) as of June 30, 1998,
and the related condensed statements of consolidated income for the
three-month and six-month periods ended June 30, 1998 and the period from the
acquisition date (August 5, 1997) through June 30, 1998 (Successor Company
Operations), the condensed statements of consolidated income for the
three-month, six-month and twelve-month periods ended June 30, 1997 and the
period from July 1, 1997 through the acquisition date (Predecessor Company
Operations) and the consolidated cash flows for the six-month periods ended
June 30, 1998 and 1997. These financial statements are the responsibility of
the Corporation's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical review
procedures to financial data and making inquiries of persons responsible for
financial and accounting matters. It is substantially less in scope than an
audit in accordance with generally accepted auditing standards, the objective
of which is the expression of an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to such condensed consolidated financial statements for them to
be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of the Corporation as of December 31,
1997, and the related consolidated statements of income, cash flows and
common stock equity for the year then ended (not presented herein); and in our
report dated February 24, 1998, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth
in the accompanying condensed consolidated balance sheet as of December 31,
1997, is fairly stated in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Dallas, Texas
August 13, 1998
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
FORWARD-LOOKING STATEMENTS
This report and other presentations made by ENSERCH Corporation (ENSERCH
or the Corporation) and its subsidiaries contain forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. Although ENSERCH 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 factors
contained in the Forward-looking Statements section of Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operation in
ENSERCH's 1997 Annual Report on Form 10-K for the year 1997 (1997 Form 10-K),
among others, that could cause the actual results of ENSERCH to differ
materially from those projected in such forward-looking statement.
Any forward-looking statement speaks only as of the date on which such
statement is made, and ENSERCH 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
ENSERCH 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 results to differ materially from those contained in any forward-looking
statement.
FINANCIAL CONDITION
Merger With TUC and Disposition
On August 5, 1997 (Merger Date or Acquisition Date), the merger
transactions between Texas Utilities Company (TUC) and ENSERCH Corporation
(ENSERCH or the Corporation) were completed. All of the common stock of
ENSERCH was converted into common stock of TUC, and ENSERCH became a
wholly-owned subsidiary of TUC. Immediately prior to ENSERCH's merger with
TUC, Enserch Exploration, Inc. (EEX) and Lone Star Energy Plant Operations,
Inc. (LSEPO), former subsidiaries of the Corporation, were merged to form a
new company (New EEX), and ENSERCH distributed to its common shareholders its
ownership interest in these businesses.
TUC accounted for its acquisition of ENSERCH as a purchase, and purchase
accounting adjustments, including goodwill, have been pushed down and are
reflected in the financial statements of ENSERCH and its subsidiaries for the
period subsequent to August 5, 1997. The financial statements of ENSERCH for
the periods ended before August 5, 1997, were prepared using ENSERCH's
historical basis of accounting and are designated as "Predecessor". The
comparability of the operating results for the Predecessor and the periods
encompassing push down accounting are affected by the purchase accounting
adjustments including the amortization of goodwill over a period of forty
years.
The Predecessor financial statements have been restated to reflect EEX
and LSEPO as a discontinued operation. The historical financial statements of
ENSERCH reflect certain reclassifications made to conform to TUC's
presentation style. On December 31, 1997, ENSERCH sold, to another subsidiary
of TUC, at net book value, the group of companies which had constituted the
Corporation's power development and international gas distribution operations.
For financial reporting purposes, the sale was deemed to have occurred on
August 5, 1997. Accordingly, operating results for periods following the
Merger Date exclude those operations. Prior periods were not restated to
reflect the sale.
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Liquidity and Capital Resources
For information concerning liquidity and capital resources, see Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operation in ENSERCH's 1997 Form 10-K. Results for the three- and six-month
periods presented herein are not necessarily indicative of expectations for a
full year's operations because of seasonal and other factors, including
variations in maintenance and other operating expense patterns. No significant
changes or events which might affect the financial condition of the
Corporation have occurred subsequent to year-end other than as disclosed in
other reports of ENSERCH or included herein.
Continuing operations provided cash of $66 million for operating
activities in the first six months of 1998 compared with $45 million in the
same period of 1997. Discontinued operations provided cash of $1.5 million
in the 1998 six months and used cash of $31 million in the 1997 period.
Investing activities required $71 million in the first six months of 1998
versus $77 million in 1997. Capital spending in the first six months of 1998
was $17 million higher than the first six months of the prior year. Other
investing activities used cash of $3.9 million in 1998 and $27 million in
1997.
The capitalization ratios of the Corporation as of June 30, 1998
consisted of approximately 55.8% long-term debt (including amounts due
parent), 4.0% preferred stock and 40.2% common stock equity.
In January 1998, ENSERCH issued $125 million of 6.25% Series A Notes due
2003 and $125 million of Remarketed Reset Notes due 2008. Net proceeds from
these borrowings were used to refinance or redeem like amounts of higher rate
debt and preferred stock. On July 1, 1998, the interest rate on the Reset
Notes was reset to a fixed rate of 6.564% to July 1, 2005. In January,
the $100 million principal amount of Series E Adjustable Rate Preferred Stock
was redeemed at 100% of its liquidation price plus accrued and unpaid
dividends. In March 1998, the Corporation redeemed the outstanding balance of
its 6.375% Convertible Subordinated Debentures. Holders of the debentures
elected to convert $3.0 million principal amount of such debentures into
77,963 shares of TUC common stock, and the remaining $87.7 million principal
amount was redeemed at par for cash. On July 6, 1998, ENSERCH redeemed at par
its $100 million principal amount of 8.875% Senior Notes due 2001.
In July 1998, a statutory business trust, ENSERCH Capital I, was
established as a financing subsidiary of ENSERCH for the purpose of issuing
common and preferred trust securities with a liquidation preference of $1,000
per unit, and holding Junior Subordinated Debentures, issued by ENSERCH.
ENSERCH Capital I issued $150 million of floating rate capital securities.
Distributions on these capital securities are payable quarterly based on an
annual floating rate determined quarterly with reference to a three-month
LIBOR plus a margin of 1.35%. The debentures held by the trust are its only
assets. The trust assets are $154.6 million principal amount of Floating Rate
Junior Subordinated Debentures Series A (Series A Debentures). ENSERCH
Capital I will use interest payments received on the Series A Debentures to
make cash distributions on the capital securities it has issued. The interest
rate on the Series A Debentures will be set quarterly, based on three-month
LIBOR plus 1.35%. The initial rate for the period from July 2, 1998 to
September 30, 1998 is 7.06875%. The proceeds were used by ENSERCH for general
corporate purposes, including the acquisition or redemption of outstanding
securities of ENSERCH. The Series A Debentures will mature on July 1, 2028
and ENSERCH has the right to redeem the debentures in whole or in part on or
after July 1, 2003.
ENSERCH may issue additional debt and equity securities as needed,
including the possible future sale of up to $100 million aggregate principal
amount of securities currently registered with the Securities and Exchange
Commission (SEC) for offering pursuant to Rule 415 under the Securities Act of
1933.
13
At June 30, 1998, TUC, Texas Utilities Electric Company, subsidiary of
TUC (TU Electric), and ENSERCH had joint lines of credit under revolving
credit facility agreements (Credit Agreements) with a group of banking
institutions. The Credit Agreements have two facilities. Facility A provides
for short-term borrowings aggregating up to $3.6 billion outstanding at any
one time at variable interest rates and terminates March 1, 1999. Facility B
provides for borrowings aggregating up to $1.4 billion outstanding at any one
time at variable interest rates and terminates March 2, 2003. Excluding $2.8
billion of Facility A which is restricted to use by TUC in financing the
acquisition of The Energy Group PLC, the combined borrowings of TUC, TU
Electric and ENSERCH under both facilities are limited to an aggregate of $2.2
billion outstanding at any one time which may used for working capital and
other general corporate purposes, including commercial paper backup.
ENSERCH's borrowings under both facilities are limited to an aggregate of up
to $650 million outstanding at any one time. At June 30, 1998, ENSERCH had no
borrowings outstanding under these facilities.
Regulation and Rates
Lone Star Gas Rates -- In August 1996, the Railroad Commission of Texas
(RRC) ordered a general inquiry into the rates and services of Lone Star Gas,
most notably a review of historic gas cost and gas acquisition practices since
the last rate setting. The inquiry docket was separated into different phases,
all of which are now resolved. Two of the phases, conversion to the National
Association of Regulatory Utility Commissioners account numbering system and
unbundling, have been dismissed by the RRC, and one other phase, rate case
expense, has been concluded. In the phase dealing with historic gas cost and
gas acquisition practices, the RRC issued a final order on June 2, 1998
approving a stipulated settlement of the docket. Lone Star Gas agreed to
credit residential and commercial customers $18 million to be spread over the
next two heating seasons (November through March). The earnings of Lone Star
Gas are not affected by the Settlement due to previously established reserves.
Lone Star Gas and the intervenors both agreed to withdraw their appeals of the
city gate rate case. The final order approving the stipulation found that all
gas costs flowed through Lone Star Gas' monthly gas cost adjustment clause
prior to October 31, 1997 were just, reasonable, and necessary.
RESULTS OF OPERATION
For the three-, six- and twelve-month periods ended June 30, 1998,
ENSERCH had losses from continuing operations of $22 million, $4.9 million and
$27 million, respectively compared with losses of $22 million, $3.0 million
and $9.9 million, respectively, for the Corporation and Predecessor, as
applicable, for the same period of 1997. The amortization of goodwill
arising from the acquisition by Texas Utilities was $5.0 million for the three
months, $10.0 million the first six months and $18.1 million for the twelve
months ended June 30, 1998. Income for the 1997 six and twelve month period
was reduced by an $8.6 million pretax, $5.6 million after-tax, provision for a
credit Lone Star Pipeline Company made voluntarily to its customers.
Consolidated revenues for the three, six and twelve months ended June 30,
1998 increased 151%, 65% and 62% compared with the same periods for 1997. The
higher revenues reflect a significant increase in energy marketing revenues in
the second quarter. Gas purchased for resale increased 211%, 85% and 85% in
the three-, six- and twelve-month 1998 periods, respectively, over the same
periods of 1997, reflecting the increase in energy marketing activity.
14
Operating income for the twelve months ended June 30, 1998 was $64.8
million compared to $76.6 million for the 1997 period.
Consolidated operating income the for the six months was $33.2 million
in 1998 compared with $35.1 million in 1997. There was an operating loss from
natural gas gathering and processing operations of $1.9 million for the six
months of 1998 compared with operating income of $6.4 million for the same
period of 1997. Fluctuations in natural gas liquids (NGL) demand, price
volatility for NGL products and natural-gas feedstock costs are the major
factors that influence financial results in the NGL processing business. Lone
Star Pipeline operating income increased $4.0 million in the 1998 six month
period from the 1997 first six months, partially attributable to lower
operating and maintenance expenses. The results in 1997 were after a
voluntary refund of $8.6 million made to residential and commercial
customers. For the first six months, Lone Star Gas operating income decreased
$10.5 million in 1998 from 1997 primarily due to higher operating and
maintenance expenses. Energy marketing activities reported an improvement in
operating results of some $16.2 million compared with the 1997 first six
months, the result of improved gas margins. Power development and
international gas operations, transferred to another TUC affiliate effective
with the Merger, detracted $7.0 million from operating income in the first six
months of 1997. Results for the first six months of 1998 were reduced $10.0
million by the amortization of goodwill recorded in connection with the Merger
with TUC.
In the second quarter of 1998, the Corporation had an operating loss of
$15.0 million compared with a loss of $16.3 million in 1997. There was an
operating loss from natural gas gathering and processing operations of $.7
million for the second quarter of 1998 compared with operating income of $2.4
million for the same period of 1997. Lone Star Pipeline operating income
increased $.5 million in the 1998 second quarter from the 1997 second
quarter, which was partially attributable to lower operating and maintenance
expenses. For the second quarter, Lone Star Gas had an operating loss of
$12.2 million in 1998 compared with a loss of $9.2 million in 1997 primarily
due to higher operating and maintenance expenses. Energy marketing
activities reported an improvement in operating results of some $6.1 million
compared with the 1997 second quarter, the result of improved gas margins.
Amortization of goodwill reduced 1998 second quarter results by $5.0 million.
The loss from discontinued operations of $228.0 million for the six
months ended June 30, 1997, included the effect of a $236 million after-tax
write-down of the carrying value of EEX's oil and gas properties due to the US
cost center ceiling limitation at March 31, 1997, and a $9.7 million ($14.9
million pre-tax) provision for estimated costs and expenses to wind-up
engineering and construction operations.
COMPREHENSIVE INCOME
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income," became effective as of the first quarter of 1998. This
statement requires companies to report and display comprehensive income and
its components (revenues, expenses, gains and losses). Comprehensive income
includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners. For the Corporation,
comprehensive income is the same as net income reported in the statements of
consolidated income, since there are no other items of comprehensive income
for the periods presented.
CHANGES IN ACCOUNTING STANDARDS
SFAS 131, "Disclosures About Segments of an Enterprise and Related
Information," will become effective in 1998. This statement establishes
standards for defining and reporting business segments. The Corporation is
currently determining its reportable segments. The adoption of SFAS 131 will
not affect the Corporation's consolidated financial position, results of
operations or cash flows.
15
YEAR 2000
Year 2000 issues of ENSERCH are being addressed with those of its parent
company, TUC. The following disclosure regarding Year 2000 issues of TUC's
US companies is included in TUC's Form 10-Q for June 30, 1998:
Many existing computer programs use only two digits to identify a year in the
date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or produce erroneous data by or at the Year
2000. The Year 2000 issues affect virtually all companies and organizations.
The Company began its Year 2000 initiative in 1996 by addressing
mainframe-based application systems. In early 1997, an infrastructure project
to address information technology (IT) related equipment and system software
was begun. In late 1997, a corporate-wide project to address Year 2000 issues
related to embedded systems such as process controls for energy production and
delivery and client-developed applications was begun. Most of the ENSERCH
mainframe applications, infrastructure, embedded systems and client-developed
applications that will not be migrated to existing or planned Company systems
have been incorporated into these projects. These projects extend beyond the
Company's organization in an effort to also work with key vendors, service
suppliers and others so that the Company can appropriately prepare for the
Year 2000.
The remediation and replacement work on the majority of IT application systems
and infrastructure are targeted to be completed by the end of 1998. For the
corporate-wide effort on embedded systems, a majority of the assessment work
has been completed and, a number of tests on operational equipment have been
performed. The testing of this equipment will continue throughout 1998.
Although much of the work on the corporate-wide Year 2000 project is expected
to be completed by the end of 1998, the project will extend into 1999.
Based on additional assessment work performed during the first half of 1998,
cost estimates have been updated. The current estimate for the Year 2000
effort is $28 to $31 million including $10 to 12 million for IT Corporate
Applications, $3 to 4 million for IT Infrastructure and $15 million for
Corporate-wide Embedded Systems. These costs are being expensed as incurred
over the five-year period (1996-2000).
LEGAL PROCEEDINGS
On August 3, 1998, Stan C. Thorne filed suit in the United States
District Court for the Southern District of Texas against EEX Corporation,
formerly Enserch Exploration, Inc. (EEX), ENSERCH,
DeGolyer & MacNaughton (D&M), David W. Biegler, Gary J. Junco, Fredrick S.
Addy and B. K. Irani. The plaintiff seeks to represent a class comprised of
all purchasers of the common stock of EEX during the period of August 3, 1995
through August 5, 1997. The individual defendants are current or former
officers and/or directors of EEX and Mr. Biegler has been an officer and
director of ENSERCH. D&M served as independent petroleum consultants to
EEX. The plaintiff alleges that the defendants engaged in a course of conduct
designed to mislead the plaintiff and the investing public in order to
maintain the price of EEX common stock at artificially high levels through
false and misleading representations concerning the gas reserves of EEX in
violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10b-5 thereunder. The plaintiff also alleges that the defendants
were negligent in making such misrepresentations and that they constituted
common law fraud against the defendants. No amount of damages is specified in
this action. The Company is also evaluating these claims and is unable at
this time to predict the outcome of this proceeding, but it also intends to
vigorously defend this suit.
16
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required hereunder for the Corporation is not
significantly different from the information set forth in Item 7A.
Quantitative and Qualitative Disclosures About Market Risk included in the
1997 Form 10-K and is therefore not presented herein.
17
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On August 3, 1998, Stan C. Thorne filed suit in the United States
District Court for the Southern District of Texas against EEX Corporation,
formerly Enserch Exploration, Inc. (EEX), ENSERCH,
DeGolyer & MacNaughton (D&M), David W. Biegler, Gary J. Junco, Fredrick S.
Addy and B. K. Irani. The plaintiff seeks to represent a class comprised of
all purchasers of the common stock of EEX during the period of August 3, 1995
through August 5, 1997. The individual defendants are current or former
officers and/or directors of EEX and Mr. Biegler has been an officer and
director of ENSERCH. D&M served as independent petroleum consultants to
EEX. The plaintiff alleges that the defendants engaged in a course of conduct
designed to mislead the plaintiff and the investing public in order to
maintain the price of EEX common stock at artificially high levels through
false and misleading representations concerning the gas reserves of EEX in
violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10b-5 thereunder. The plaintiff also alleges that the defendants
were negligent in making such misrepresentations and that they constituted
common law fraud against the defendants. No amount of damages is specified in
this action. The Company is also evaluating these claims and is unable at
this time to predict the outcome of this proceeding, but it also intends to
vigorously defend this suit.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)Exhibits files as part of Part II are:
15 - Letter of Deloitte & Touche LLP as to unaudited interim
financial statements.
27 - Financial Data Schedule
(b)Reports on Form 8-K filed since March 31, 1998:
Date of Report Items Reported
-------------- --------------
June 4, 1998 Item 5. Other Events
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ENSERCH Corporation
By /s/ J. W. Pinkerton
------------------------------
J. W. Pinkerton
Vice President and Controller,
Principal Accounting Officer
Date: August 13, 1998
19