- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): DECEMBER 31, 2002
TXU US HOLDINGS COMPANY
(FOR TXU ENERGY COMPANY LLC)
(Exact Name of Registrant as Specified in its Charter)
TEXAS 1-11668 75-1837355
(State or Other (Commission (I.R.S. Employer
Jurisdiction of File Number) Identification No.)
Incorporation)
ENERGY PLAZA, 1601 BRYAN STREET, DALLAS, TEXAS 75201-3411
(Address of Principal Executive Offices, Including Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE - (214)-812-4600
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- -------------------------------------------------------------------------------------------------------------------------
PAGE
----
ITEM 5. OTHER EVENTS AND REGULATION FD DISCLOSURE..............................................................1
INTRODUCTION...........................................................................................1
BUSINESS OF TXU ENERGY.................................................................................1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS...................................................................11
TXU ENERGY FINANCIAL INFORMATION
Independent Auditors' Report..........................................................................43
Statements of Consolidated Income and Comprehensive Income
for the years ended December 31, 2002, 2001 and 2000..................................................44
Statements of Consolidated Cash Flows for the years ended
December 31, 2002, 2001 and 2000......................................................................45
Consolidated Balance Sheets - December 31, 2002 and 2001..............................................46
Statements of Consolidated Member Interests for the years ended
December 31, 2002, 2001 and 2000......................................................................47
Notes to Financial Statements.........................................................................48
Controls and Procedures...............................................................................75
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.....................................................................75
SIGNATURE........................................................................................................76
CERTIFICATION....................................................................................................77
i
ITEM 5. OTHER EVENTS AND REGULATION FD DISCLOSURE
INTRODUCTION
TXU US Holdings Company (US Holdings) is providing the following
business description, annual audited financial information and management's
discussion and analysis of financial conditions and results of operations to
meet the ongoing needs of customers, counterparties and others for financial
information concerning its unregulated energy business, TXU Energy Company LLC
(TXU Energy). TXU Energy was created as a result of the deregulation of the
electric utility industry in Texas, which became effective January 1, 2002. On
that date, the power generation and certain retail operations of US Holdings,
the portfolio management operations and the unregulated commercial and
industrial retail gas operations of TXU Gas Company and other energy related
businesses of TXU Corp. were transferred to TXU Energy. The electricity
transmission and distribution (T&D) businesses of US Holdings and TXU SESCO
Company were transferred to Oncor Electric Delivery Company (Oncor), a regulated
entity. Both TXU Energy and Oncor are wholly-owned subsidiaries of US Holdings,
which is a wholly-owned subsidiary of TXU Corp.
The relationships of the entities affected by the restructuring of US
Holdings 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, which provides, in general, that the
economic impacts of the transition of the electricity business from a regulated
to a competitive environment will be borne by TXU Energy.
BUSINESS OF TXU ENERGY
TXU Energy is an energy company that engages in power production,
wholesale energy sales, retail energy sales and related services and portfolio
management, including risk management and certain trading activities, primarily
in the state of Texas. TXU Energy is one of the largest competitive retailers of
energy in the United States (US). 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. 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 Energy Solutions
Company LP; TXU Fuel Company; and two coal mining subsidiaries.
TXU Energy's strategy is to focus on operational excellence, customer
retention and low risk growth from core operations in Texas. TXU Energy intends
to accomplish this through the operation of a single, integrated energy business
managing a portfolio of assets, capabilities and customer relationships. TXU
Energy's portfolio of assets includes 19,140 megawatts (MW) of owned or leased
power generating capacity, approximately 2,700 MW of power generating capacity
under power purchase contracts and over 2.7 million retail electric
customers.(1) Early in 2002, TXU Energy intended to enhance its significant
business portfolio in Texas through expansion into other regions in North
America. However, the slowed pace of deregulation, the weaker economy, reduced
liquidity in the power markets and reduced developmental capital spending have
resulted in TXU Energy delaying those growth objectives until competitive and
regulatory environments develop and economic factors improve. TXU Energy is
currently implementing plans to reduce operating costs.
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 the North Texas market, at competitive production costs.
As part of TXU Energy's integrated business portfolio, much of the low cost
power generation is available to supply the power demands of its retail
customers and other competitive retail electric providers (REPs).
TXU Energy's portfolio management operation is responsible for managing
the risks inherent in TXU Energy's portfolio of businesses and providing supply
structuring, pricing and risk management services in connection with TXU
Energy's unregulated retail energy activities. The portfolio management
operation also is responsible for the commodity price risk management of the
- ----------
(1) All numbers of electric customers are based on the number of meters.
1
fuel supply needs of TXU Energy's generating plants as well as the dispatch and
sale of power from those plants.
POWER PRODUCTION
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 has adequate power capacity to supply its
retail customer base from its power fleet and purchases from third parties. TXU
Energy believes that a key competitive advantage is its ability to produce
electricity at low variable costs. The power generating plants and other
important properties of TXU Energy are located primarily on land owned in fee
simple.
TXU Energy completed the acquisition of the Pedricktown, New Jersey
co-generation facility and wholesale energy production business in April 2002.
The acquisition included a 122 MW combined-cycle power production facility and
various contracts, including electric supply and gas transportation agreements.
In May 2002, TXU Energy acquired a 260 MW combined-cycle power production
facility in northwest Texas through a settlement agreement which dismissed a
lawsuit previously filed related to the plant. 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 its Handley and
Mountain Creek power generating plants (total plant capacity of 2,334 MW). The
Handley plant consists of five natural gas-fueled generating units with a total
plant capacity of 1,441 MW. The Mountain Creek plant consists of five natural
gas-fueled generating units with a total plant capacity of 893 MW. The
transaction included a power purchase and tolling agreement for TXU Energy to
purchase power during the summer months through 2006. TXU Energy from time to
time may sell additional assets to reduce its position in the Texas market, to
provide funds for other investments and to reduce debt.
TXU Energy has been active in adding renewable energy to its portfolio.
TXU Energy is one of the largest purchasers of wind-generated, renewable energy
in Texas and the US. TXU Energy currently purchases renewable energy from over
382 MW of wind projects located in West Texas. TXU Energy expects to continue to
add additional renewable supplies as commercial opportunities become available.
CAPACITY AUCTION -- To encourage competition in the Electric
Reliability Council of Texas (ERCOT) region, each power generation company (PGC)
with 400 MW or more of installed generating capacity that is unbundled from an
integrated electric utility in Texas is required to sell at auction entitlements
to 15% of the output of its installed generating capacity. The obligation of an
affiliated PGC to sell capacity entitlements at auction continues until the
earlier of January 1, 2007 or the date on which 40% of the electricity consumed
by residential and small commercial customers initially transferred to the PGC's
affiliated REP on January 1, 2002 is supplied by competing REPs. This capacity
auction allows market participants to purchase power either through purchases in
the wholesale power markets or through mandated capacity auctions. A REP cannot
purchase entitlements sold by its affiliated PGC in mandated capacity auctions.
The first auction in Texas was held in September 2001. There was significant
interest in the entitlements being auctioned, and the auction of two-year,
one-year and monthly entitlements required to be sold was successful. The second
and third auctions were held in March and July of 2002, respectively. TXU Energy
sold the monthly entitlements required at each of these auctions. 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
will re-offer these unsold entitlements in subsequent auctions to be held
through 2003.
POWER FLEET
NUCLEAR PRODUCTION ASSETS -- TXU Energy owns and operates two
nuclear-fueled electricity generating units at the Comanche Peak plant, each of
which is designed for a capacity of 1,150 MW.
TXU Energy has on hand, or has contracted for, services it expects to
need for its nuclear units through the years INDICATED: conversion (2003),
enrichment (2005), and fabrication (2011). TXU Energy is currently evaluating
2
bids for the purchase of uranium for 2003, which is readily available on the
open market. 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 non-bypassable 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.
LIGNITE/COAL 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 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 77% of the fuel used at TXU Energy's lignite plants in 2002 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 (PRB) in Wyoming. The
coal is purchased from multiple suppliers under contracts of various lengths and
is transported from the PRB to TXU Energy's generating plants by railcar.
Approximately 23% of the fuel used at TXU Energy's lignite plants in 2002 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 PRODUCTION ASSETS -- TXU Energy has eighteen gas/oil fueled
plants (including Pedricktown, New Jersey) with a capacity of 11,003 MW. Gas/oil
requirements for 2002 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, 2003, TXU
Energy had fuel oil storage capacity sufficient to accommodate approximately 5.5
million barrels of oil and had approximately 0.9 million barrels of oil in
inventory. A significant portion of the gas/oil generating plants have the
ability to switch between gas and fuel oil.
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 to serve US Holdings' generating plants. In keeping with the
deregulation principles, this network now offers transportation and storage
service to TXU Energy as well as third parties at a competitive price.
TXU Energy also owns and operates two underground gas storage
facilities with a usable capacity of 14.0 billion cubic feet (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.
PRODUCTS AND SERVICES
On January 1, 2002, all of US Holdings' over 2.7 million retail
electric service customers in Texas who did not choose a different REP
automatically became customers of TXU Energy. TXU Energy's historical service
territory is located in the north-central, eastern and western parts of Texas,
with an estimated population in excess of 7 million, about one-third of the
population of Texas. TXU Energy provides electric service in that service
territory to customers in 92 counties and 370 incorporated municipalities,
including Dallas, Fort Worth, Arlington, Irving, Plano, Waco, Mesquite, Rowlett,
3
Grand Prairie, Wichita Falls, Odessa, Midland, Carrollton, Tyler, Richardson and
Killeen. The 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 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.
TXU Energy's wholesale power sales are conducted through its portfolio
management activities that are designed to integrate a portfolio of assets,
capabilities and customer relationships. See Portfolio Management below. In
February 2002, TXU Energy was awarded 1,000 MW of load in the New Jersey
Statewide Basic Generation Service Electricity Supply Auction, establishing
itself in the Pennsylvania-New Jersey-Maryland market. However, plans for
further expansion outside of Texas have been delayed until competitive and
regulatory environments develop and economic factors improve.
TXU Energy's natural gas operation in Texas includes pipelines, storage
facilities, well-head production contracts, transportation agreements, storage
leases, retail and wholesale customers and supply to gas fired generation
plants. Service is primarily provided to TXU Energy's generation operations.
Third party service, which is expected to increase in coming years, comprised
approximately 15% of revenue for the pipeline system in 2002. TXU Energy's
portfolio management operation integrates various techniques and resources to
maximize the value and manage the risks inherent in this natural gas operation.
The main goal of portfolio management, in this regard, is to reduce costs and
improve gross margin associated with the assets through storage, transportation
and exchange and production contracts. Portfolio management must take into
account market pricing, operational constraints and existing obligations in
order to determine the best blend of resources.
PORTFOLIO MANAGEMENT
The portfolio management operation integrates, manages and creates
value from TXU Energy's extensive portfolio of retail and production assets,
capabilities and customer relationships. Specifically, portfolio management
ensures supply availability and manages associated operating costs, provides
competitively priced power, and maximizes the value of physical assets, capital
and technological infrastructure to monitor, evaluate and anticipate gas and
electric commodity market trends relating to fundamental supply, market demand
and Texas deregulation. TXU Energy uses these capabilities to optimize the cash
flows and earnings of its deregulated Texas portfolio. TXU Energy also offers
similar portfolio management services to non-affiliated third parties.
TXU Energy enters into both financial contracts as well as contracts
that provide for physical delivery related to the purchase and sale of
electricity and gas primarily in the wholesale markets in Texas and to a limited
extent in selected regions elsewhere in North America. Competitive markets
demand that a number of services be offered, including term contracts with
interruptible and firm deliveries, risk management, aggregation of supply,
nominations, scheduling of deliveries for both gas transportation capacity and
gas storage, as well as power generating facilities. In the course of providing
these comprehensive portfolio management services to its customer base, TXU
Energy engages in energy price risk management activities. 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 TXU
Energy's portfolio management activities.
TXU Energy manages its exposure to price risk from existing contractual
commitments as well as other energy related assets and liabilities within
established transactional policies and limits. TXU Energy ensures 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 the portfolio management 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
4
designed to protect earnings, cash flows and credit ratings. For information
regarding TXU Energy's risk management policies, please read MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -
"Financial Condition, Liquidity and Capital Resources - Quantitative and
Qualitative Disclosures about Market Risk - Risk Oversight."
COMPETITION
TEXAS -- Deregulation of the electric utility industry in Texas,
effective January 1, 2002, allows retail consumers of independent operating
utilities in the ERCOT region to choose a REP, which purchases its power from
competing power producers. All customer switching is conducted through ERCOT,
which acts as a clearinghouse and enforcement agent. Texas is one of the fastest
growing states in the nation with a diverse and resilient economy and, as a
result, has attracted several 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.
According to the latest data provided by the Public Utility Commission
of Texas (Commission) (September 2002), customers at over 400,000 locations
across ERCOT had elected to switch providers within their historical service
territory. This number represents approximately 7% of all customers in ERCOT
areas open to customer choice. Since December 2000, the Commission has certified
a total of 54 REPs and while some have dropped out, competition has remained
strong.
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 cost 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
initial customer base and to add customers.
Because Texas began restructuring its wholesale electricity business in
1995, new generation was encouraged to enter the state. As a result, there have
been approximately 60 new power plants added in the state since that time,
providing the state with ample power resources. Capacity margins for ERCOT,
based upon existing capacity and planned capacity with interconnection
agreements, are expected to be 24% in 2003 and remain at or above 20% for the
next several years. New gas-fired capacity is generally more efficient to
operate than existing gas/oil-fired capacity due to technological advances.
However, base-load nuclear, lignite and coal plants have lower variable
production costs than even new gas-fired plants at current annual average market
gas prices. 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.
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 2.8% per
year;
5
o it is a sizeable market with over 57 gigawatts (GW) of peak
demand and 33 GW of average demand; and
o there is no mandatory power pool structure.
OUTSIDE TEXAS -- Deregulation, although proceeding well in Texas, has
not had similar success in other parts of the US. Federal legislation such as
the Public Utility Regulatory Policy Act of 1978 (PURPA) and the Energy Policy
Act, as well as initiatives in various states, were enacted to encourage
wholesale competition among electric utility and non-utility power producers.
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 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 deregulation. New entry by retailers
as well as by merchant generators in states other than Texas has been slowed.
The continued uncertainty regarding regional transmission organizations (Federal
Energy Regulatory Commission's (FERC's) Order 2000) and more recently FERC's
Notice of Proposed Rulemaking regarding Standard Market Design have delayed the
opening of new retail markets and decreased the economic viability for merchant
generation.
NATURE OF COMPETITION -- The level of competition in the energy
industry is affected by a number of variables, including price, reliability of
service, the cost of energy alternatives, new technologies and governmental
regulations.
TXU Energy competes with other energy providers based on the ability to
aggregate supplies at competitive prices from different sources and locations
and to efficiently utilize transportation from third-party pipelines and
transmission from electric utilities. These operations also compete against
other energy marketers on the basis of their relative skills, financial position
and credit. Competition means energy customers, wholesale energy suppliers and
transporters may seek financial guarantees and other assurances that their
energy contracts will be satisfied. As pricing information becomes increasingly
available in the energy business and when deregulation in the electricity
markets begins to revive, the power generation and portfolio management
operations of TXU Energy may experience greater competition.
CUSTOMERS
There are no individually significant unaffiliated customers upon which
TXU Energy's business or results of operations are highly dependent.
REGULATION AND RATES
GENERAL
TXU Corp. is a holding company as defined in the Public Utility Holding
Company Act of 1935. However, TXU Corp. and all of its subsidiary companies are
exempt from the provisions of such Act, 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 subject to various federal, state and local regulations.
TXU Energy is an exempt wholesale generator under the Federal Power Act
and is subject to the jurisdiction of the Nuclear Regulatory Commission (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.
6
RESTRUCTURING LEGISLATION
Legislation passed during the 1999 session of the Texas Legislature
restructured the electric utility industry in Texas and provided for a
transition to increased competition in the generation and retail sale of
electricity (1999 Restructuring Legislation). By January 1, 2002, each electric
utility was required to separate (unbundle) its business activities into a PGC,
a REP, and a T&D utility or separate T&D utilities. Unbundled T&D utilities
within ERCOT, such as Oncor, remain regulated by the Commission.
Beginning January 1, 2002, REPs affiliated with T&D utilities began
charging residential and small commercial customers located in their historical
service territory rates that are 6% less than the rates that were in effect on
January 1, 1999, as adjusted for fuel factor changes ("price-to-beat rate"). TXU
Energy, as a REP affiliated with a T&D utility, may not charge prices to such
customers that are different from the price-to-beat rate until the earlier of
January 1, 2005 or the date on which 40% of the electricity consumed by
customers in those respective customer classes is supplied by competing REPs.
Thereafter, TXU Energy may offer rates different from the price-to-beat rate,
but it must also continue to make the price-to-beat rate, adjusted for fuel
factor changes, available for residential and small commercial customers until
January 1, 2007. REPs must be certified by the Commission. TXU Energy has
received appropriate REP certifications from the Commission.
Also, beginning January 1, 2002, PGCs that are affiliated with T&D
utilities may charge unregulated prices in connection with ERCOT wholesale power
transactions. Estimated costs associated with PGC nuclear power plant
decommissioning obligations continue to be recovered as a nonbypassable T&D
charge over the life of the plant. Each affiliated PGC owning 400 MW or more of
installed generating capacity must offer each year at auction entitlements to at
least 15% of such capacity. The obligation of an affiliated PGC to sell capacity
entitlements at auction continues until the earlier of January 1, 2007 or the
date on which 40% of the electricity consumed by residential and small
commercial customers of the PGC's affiliated REP is supplied by competing REPs.
PGCs must be registered with the Commission. TXU Energy has filed appropriate
PGC registrations with the Commission.
The 1999 Restructuring Legislation also provided for the recovery of
generation-related regulatory assets (regulatory assets) and generation-related
and purchased power-related costs that are in excess of market value (stranded
costs). It provided means for electric utilities to mitigate stranded costs
during the rate freeze period that preceded unbundling. Unmitigated stranded
costs would be finally determined in a 2004 "true-up" proceeding relying
principally upon market-based asset valuations. Regulatory assets and
unmitigated stranded costs can be recovered through the issuance of transition
(securitization) bonds or imposition of a competition transition charge.
Further, a REP would also be required to reconcile and credit to its
affiliated T&D utility (and the T&D utility to credit T&D customers), as a
so-called retail clawback, any positive difference between the price-to-beat
rate, reduced by the nonbypassible delivery charge, and the prevailing market
price of electricity during the same time period to the extent the price-to-beat
rate exceeded the market price of electricity. This reconciliation is not
required for the applicable customer class if 40% of the electricity consumed by
customers in that class is supplied by competing REPs before January 1, 2004. If
a retail clawback reconciliation is required, the 1999 Restructuring Legislation
provided that the amount credited cannot exceed an amount equal to the number of
residential or small commercial customers served by a T&D utility that are
buying electricity from the affiliated REP at the price-to-beat rate on January
1, 2004, minus the number of new customers obtained outside the historical
service territory, multiplied by $150. (The calculation of this credit was
altered for TXU Energy in connection with the Settlement Plan discussed below.)
REGULATORY SETTLEMENT PLAN
On December 31, 2001, US Holdings filed a settlement plan (Settlement
Plan) with the Commission. It resolved all major pending issues related to US
Holdings' transition to competition pursuant to the Restructuring Legislation.
The settlement (Settlement) provided for in 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 was approved by
the Commission in June 2002. In August 2002, the Commission issued a financing
order, pursuant to the Settlement Plan, authorizing the issuance of
securitization bonds relating to recovery of regulatory assets. The Commission's
order approving the Settlement Plan and the financing order were appealed by
7
certain nonsettling parties to the Travis County, Texas District Court in August
2002. In January 2003, US Holdings concluded a settlement of these appeals and
they were dismissed. Thus, the Settlement became final.
The major elements of the Settlement are:
EXCESS MITIGATION CREDIT AND APPEALS RELATED TO T&D RATES -- Beginning
in 2002, Oncor began implementing an excess stranded cost mitigation credit in
the amount of $350 million, plus interest, applied over a two-year period as a
reduction to T&D rates charged to REPs. In June 2001, the Commission had issued
an interim order that addressed Oncor's charges for T&D service when retail
competition would begin. Among other things, that interim order, and subsequent
final order issued in October 2001, required Oncor to reduce rates over the
period from 2002-2008. The Commission's decision was appealed by US Holdings and
other parties to the Travis County, Texas District Court. Finalization of the
Settlement means US Holdings' appeal has been dismissed. Also, in July 2001, the
staff of the Commission had notified US Holdings and the Commission that it
disagreed with US Holdings' computation of the level of earnings in excess of
the regulatory earnings cap for calendar year 2000. In August, 2001, the
Commission issued an order adopting the staff position. US Holdings appealed
this matter to the Travis County, Texas District Court, which affirmed the
Commission's order and US Holdings then appealed that decision to the Third
District Court of Appeals in Austin, Texas. This appeal has now been dismissed.
REGULATORY ASSET SECURITIZATION -- In October 1999, US Holdings filed
an application with the Commission for a financing order to permit the issuance
by a special purpose entity of $1.65 billion of securitization bonds. In May
2000, the Commission signed an order rejecting such request and authorized only
$363 million of such bonds. US Holdings filed an appeal with the Travis County,
Texas District Court and in September 2000, the Court issued a judgment that
reversed part of the Commission's order and affirmed other aspects of the
Commission's order. US Holdings and various other parties appealed this judgment
directly to the Supreme Court of Texas; and in June 2001, it issued a ruling and
in October 2001 remanded the case to the Commission, which consolidated it into
the Settlement Plan proceeding. In accordance with the Settlement, Oncor
received a financing order authorizing it to issue securitization bonds in the
aggregate principal amount of $1.3 billion to recover regulatory assets and
other qualified costs. The Settlement provides that there can be an initial
issuance of securitization bonds in the amount of up to $500 million, followed
by a second issuance of the remainder after 2003. The Settlement resolves all
issues related to regulatory assets and liabilities.
RETAIL CLAWBACK -- If, as currently expected, TXU Energy retains more
than 60% of its historical residential and small commercial customers after the
first two years of competition, the amount of the retail clawback credit will be
equal to the number of residential and small commercial customers retained by
TXU Energy in its historical service territory on January 1, 2004, less the
number of new customers TXU Energy has added outside of its historical service
territory as of January 1, 2004, multiplied by $90. This determination will be
made separately for the residential and small commercial classes. The credit, if
any, will be applied to T&D rates charged by Oncor to REPs, including TXU Energy
over a two-year period beginning January 1, 2004. Under the settlement
agreement, TXU Energy will make a compliance filing with the Commission
reflecting customer count as of January 2004. In the fourth quarter of 2002, TXU
Energy recorded a $185 million ($120 million after-tax) charge for the retail
clawback, which represents the current best estimate of the amount to be funded
to Oncor over the two-year period.
STRANDED COST RESOLUTION -- TXU Energy's stranded costs, not including
regulatory assets, are fixed at zero. Accordingly, it will not have to conduct
the stranded cost true-up in 2004 provided for in the 1999 Restructuring
Legislation. In addition, the Settlement resulted in a resolution of the
regulatory disallowance of amounts related to US Holdings' repurchase of
minority owner interests in the Comanche Peak nuclear generating station. The
Commission's final order in connection with US Holdings' January 1990 rate
increase request had been ultimately reviewed by the Supreme Court of Texas, and
an aggregate of $909 million of disallowances with respect to US Holdings'
reacquisitions of minority owners' interests in Comanche Peak, which had
previously been recorded as a charge to earnings, was remanded to the District
Court and then to the Commission for reconsideration. As a result of the
Settlement, US Holdings will move to dismiss this remand. The settlement also
precludes recovery by US Holdings of certain environmental improvement costs.
8
FUEL COST RECOVERY -- The Settlement also provides that 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.
PROVIDER OF LAST RESORT -- Through calendar year 2002, TXU Energy was
the provider of last resort (POLR) for residential and small non-residential
customers in those areas of ERCOT where customer choice was available outside
its incumbent service areas, and was the POLR for large non-residential
customers in its incumbent service area. TXU Energy's POLR contract expired on
December 31, 2002. However, in August 2002, the Commission adopted new rules
that significantly changed POLR service. Under the new POLR rules, instead of
being transferred to the POLR, non-paying residential and small non-residential
customers served by affiliated REPs are subject to disconnection. Non-paying
residential and small non-residential customers served by non-affiliated REPs
are transferred to the affiliated REP. Non-paying large non-residential
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 must decide
whether all REPs should be permitted to disconnect all non-paying customers. The
new POLR rules are expected to result in reduced bad debt expense beginning in
2003.
FORWARD-LOOKING STATEMENTS
This report and other presentations made by US Holdings with respect to
TXU Energy contain forward-looking statements within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended. Although US Holdings
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 any such forward-looking statement:
o prevailing governmental policies and regulatory actions,
including those of the FERC, the Commission and the NRC, with
respect to:
o industry, market and rate structure;
o purchased power and recovery of investments;
o operations of nuclear generating facilities;
o acquisitions and disposal of assets and facilities;
o operation and construction of facilities;
o decommissioning costs;
o present or prospective wholesale and retail competition;
o changes in tax laws and policies; and
o changes in and compliance with environmental and safety laws
and policies;
o continued implementation of the 1999 Restructuring Legislation;
o legal and administrative proceedings and settlements;
o general industry trends;
o power costs and availability;
o weather conditions and other natural phenomena, and acts of
sabotage, wars or terrorist activities;
o unanticipated population growth or decline, and changes in market
demand and demographic patterns;
o changes in business strategy, development plans or vendor
relationships;
9
o competition for retail and wholesale customers;
o access to adequate transmission facilities to meet changing
demands;
o pricing and transportation of crude oil, natural gas and other
commodities;
o unanticipated changes in interest rates, commodity prices, rates
of inflation or foreign exchange rates;
o unanticipated changes in operating expenses, liquidity needs and
capital expenditures;
o commercial bank market and capital market conditions;
o competition for new energy development and other business
opportunities;
o inability of various counterparties to meet their obligations
with respect to TXU Energy's financial instruments;
o changes in technology used by and services offered by TXU Energy;
o significant changes in TXU Energy's relationship with its
employees, including the availability of qualified personnel, and
the potential adverse effects if labor disputes or grievances
were to occur;
o significant changes in critical accounting policies material to
TXU Energy; and
o actions of rating agencies.
Any forward-looking statement speaks only as of the date on which such
statement is made, and US Holdings undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time, and it is not possible for US
Holdings to predict all of such factors, nor can it assess the impact of each
such factor or the extent to which any factor, or combination of factors, may
cause the actual results of TXU Energy to differ materially from those projected
in any forward-looking statement.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
TXU Energy Company LLC (TXU Energy) is a Delaware limited liability
company that began operations on January 1, 2002. TXU Energy is a wholly-owned
subsidiary of TXU US Holdings Company (US Holdings), formerly TXU Electric
Company, which is a wholly-owned subsidiary of TXU Corp. TXU Energy was created
as a result of the restructuring of the electric utility industry in Texas,
which took effect on January 1, 2002. As of that date, US Holdings transferred
to TXU Energy its power generation assets and retail customers. In addition, as
of January 1, 2002, TXU Energy acquired the following businesses from within the
TXU Corp. system: the retail electric provider (REP) of TXU SESCO Company; the
wholesale portfolio management and the unregulated commercial and industrial
(C&I) retail gas operations of TXU Gas Company (TXU Gas); and the energy
management services businesses and other affiliates of TXU Corp., including the
fuel procurement and coal mining businesses that service the power generation
operations. On January 1, 2002, US Holdings also transferred its transmission
and distribution (T&D) operations to Oncor Electric Delivery Company (Oncor).
TXU Energy engages in power production, wholesale energy sales, retail
energy sales and related services and portfolio management, including risk
management and certain trading activities, principally in the competitive Texas
market. TXU Energy is managed as a single, integrated energy business;
consequently, there are no separate reportable business segments.
In connection with the restructuring of certain of TXU Corp.'s
businesses effective January 1, 2002, the wholesale portfolio management and the
unregulated C&I retail gas operations of TXU Gas were acquired by TXU Energy.
Included in the balance sheet of TXU Gas at December 31, 2001 was $773 million
of goodwill, net of amortization, arising from TXU Corp.'s 1997 acquisition of
ENSERCH Corporation. As a result of TXU Energy's acquisition of the businesses
from TXU Gas, that were originally part of ENSERCH Corporation, and the adoption
of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets", $468 million of goodwill, net of $56 million of
accumulated amortization, has been allocated to these businesses and reflected
in the December 31, 2002 balance sheet of TXU Energy.
The financial information for 2001 and 2000 for TXU Energy 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 T&D operations. Allocation
of revenues reflected consideration of return on invested capital, which
continues to be regulated for the T&D 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 common expenses,
assets and liabilities between US Holdings' generation and T&D operations.
Interest and other financing costs were determined based upon debt allocated.
Allocations reflected in the financial information for 2001 and 2000 did not
necessarily result in amounts reported in individual line items that are
comparable to actual results in 2002. Had the unbundled operations of US
Holdings actually existed 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.
CRITICAL ACCOUNTING POLICIES
TXU Energy's significant accounting policies are detailed in Note 2 to
Financial Statements. TXU Energy follows accounting principles generally
accepted in the United States of America (US GAAP). 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.
11
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 market risks related to
changes in commodity prices, including costs of fuel for generation of power, as
well as changes in interest rates. These financial instruments are accounted for
in accordance with SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" and, prior to October 26, 2002, Emerging Issues Task Force
(EITF) Issue No. 98-10, "Accounting for Contracts Involved in Energy Trading and
Risk Management Activities". The majority of financial instruments entered into
by TXU Energy are derivatives as defined in SFAS No. 133.
SFAS No. 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 No. 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.
Any hedge ineffectiveness is recorded in earnings. Amounts are reclassified from
other comprehensive income to earnings as the underlying transactions occur and
realized gains and losses are recognized in earnings. As of December 31, 2002,
TXU Energy had no fair value hedges.
TXU Energy documents designated commodity and debt-related 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 No.
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.
Pursuant to SFAS No. 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.
Financial instruments entered into in connection with indebtedness to
manage interest rate risk are generally accounted for as cash flow hedges in
accordance with SFAS No. 133.
EITF Issue No. 98-10 required mark-to-market accounting for
energy-related contracts, whether or not derivatives under SFAS No. 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 Issue No. 98-10 and were therefore marked to market. On
October 25, 2002, the EITF rescinded EITF Issue No. 98-10. Pursuant to this
rescission, only contracts that are derivatives under SFAS No. 133 will be
subject to mark-to-market accounting.
In June 2002, in connection with the EITF's consensus on Issue No.
02-03, 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. If the C&I contracts that TXU Energy enters into do not meet
the revised guidance, then income from such contracts will be recognized on a
settlement basis.
The majority of financial instruments entered into by TXU Energy for
the purpose of managing risk or optimizing margins in meeting the energy demands
of customers are derivatives and will continue to be subject to SFAS No. 133.
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.
12
For those periods where quoted market prices are not available, forward
price curves are developed based on the available information or through the use
of industry accepted modeling techniques and practices based on market
fundamentals (e.g., supply/demand, replacement cost, etc.). As a matter of
policy, however, TXU Energy generally does not recognize any income or loss from
the illiquid periods.
REVENUE RECOGNITION -- TXU Energy generally records revenue for retail
and wholesale energy sales under the accrual method, with the exception of
certain large C&I contracts that are derivatives as defined in SFAS No. 133 and
have therefore been marked-to-market. 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
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.
As a result of the opening of the Texas market to competition and
related changes in systems and processes within the Electric Reliability Council
of Texas (ERCOT), adjustments are recorded for accounts receivable from or
payable to ERCOT related to system balancing and are recorded net in revenues.
Such balances reflect estimates of volumetric data and are subject to adjustment
as data is reconciled and final settlements are received. Net accounts
receivable from ERCOT totaled approximately $40 million at December 31, 2002,
covering periods that date back to 2001.
Revenues reflect unrealized gains and losses related to large C&I
retail contracts, including unrealized gains recorded upon inception of these
contracts, as discussed below under "Commodity Contracts and Mark-to-Market
Activities." Results of wholesale portfolio management activities, which
represent realized and unrealized gains and losses from transacting in
energy-related contracts, are also 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.
The historical financial statements for periods prior to 2002 included
adjustments made to revenues of TXU Energy 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 rate amounts are
applied prospectively.
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 current 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 effects of the provider of last resort
(POLR) rules (as discussed below under "Regulation and Rates"), billing delays
due to new procedures within ERCOT and changes in systems and processes, and
customer churn due to competitor actions has added some level of complexity to
the estimation process. In 2002, TXU Energy recorded bad debt expense of $158
million.
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. As discussed in Note 9 to Financial Statements,
a retail clawback liability arises if TXU Energy retains more than 60% of US
13
Holdings' former residential and small business customers after the first two
years of competition. The amount of the liability is based on the number of such
customers as of January 1, 2004 less the number of new customers from outside
the historical service territory multiplied by $90. In 2002, TXU Energy recorded
a retail clawback accrual of $185 million ($120 million after-tax) reported in
the "Cost of energy sold and delivery fees" caption of the statement of income.
Over a two-year period beginning January 1, 2004, the liability would be paid to
Oncor, which in turn would pass the credit to REPs, including TXU Energy,
through reduced electricity delivery rates. The accrual reflects assumptions and
estimates regarding the number of customers expected in and out of territory.
The accrual is subject to further adjustment as the actual measurement date
approaches.
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 No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets". 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 current wholesale electricity market conditions and
reduced planned developmental capital spending. Fair value was determined based
on current appraisals of property and equipment. The charge is reported in the
"Other deductions" caption of the statement of income. As the writedown is based
on current estimates, the remaining carrying value of the projects of $113
million is subject to further adjustment should estimates of recoverable value
change.
GOODWILL AND INTANGIBLE ASSETS -- TXU Energy evaluates goodwill for
impairment at least annually in accordance with SFAS No. 142. TXU Energy has
performed impairment tests, and no goodwill impairment charges were recorded.
TXU Energy primarily uses discounted cash flow analyses to test for
goodwill impairment. 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.
DEPRECIATION -- The depreciable lives of power generation plants are
based on management's estimates/determinations of the plants' economically
useful lives. To the extent that the actual lives differ from these estimates,
there would be an impact on the amount of depreciation charged to the financial
statements.
DEFINED BENEFIT PENSION PLANS AND OTHER POSTRETIREMENT BENEFIT PLANS--
TXU Energy is a participating employer in the TXU Retirement Plan (Retirement
Plan), a defined benefit pension plan sponsored by TXU Corp. TXU Energy also
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
from TXU Corp. Reported costs of providing non-contributory defined pension
benefits and other postretirement benefits (see Note 7 to Financial Statements)
are dependent upon numerous factors, assumptions and estimates.
For example, these costs are impacted by actual employee demographics
(including age, compensation levels, and employment periods), the level of
contributions made to the plan, and earnings on plan assets. The Retirement
Plan's assets are primarily made up of equity and fixed income investments.
Changes made to the provisions of the plan may also impact current and future
pension costs. Fluctuations in actual equity market returns as well as changes
in general interest rates may result in increased or decreased pension costs in
future periods. Pension 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 and
pension costs.
14
In accordance with SFAS 87, "Employers' Accounting for Pensions,"
changes in pension obligations associated with these factors may not be
immediately recognized as pension costs on the income statement, but generally
are recognized in future years over the remaining average service period of plan
participants. As such, significant portions of pension costs recorded in any
period may not reflect the actual level of cash benefits provided to plan
participants.
As of December 31, 2002, key assumptions of the Retirement Plan and
other postretirement benefit plans were revised, including decreasing the
expected return on plan assets from 9% to 8.5% and decreasing the assumed
discount rate from 7.5% to 6.75%. In selecting assumed discount rates, TXU Corp.
considered fixed income security yield rates for AA rated portfolios as reported
by Moody's. In selecting an assumed rate of return on plan assets, TXU Corp.
considered past performance and economic forecasts for the types of investments
held by the plan. The market value of the Retirement Plan assets has been
affected by sharp declines in equity markets since the first quarter of 2000.
Plan asset values have declined $151 million and $49 million in 2002 and 2001,
respectively. The projected benefit obligation has increased by $165 million as
a result of the change in the discount rate. Further, based on the current
assumptions and available information, in 2003 funding requirements for TXU
Energy are expected to increase approximately $3 million and pension expense is
expected to increase, as a result of the changed assumptions above and other
actions, a total of approximately $17 million over 2002 amounts. Pension cost
and cash funding requirements could increase in future years.
As a result of the Retirement Plan asset return experience, at December
31, 2002, TXU Energy was required to recognize its portion of an additional
minimum liability as prescribed by SFAS 87, "Employers' Accounting for
Pensions," and SFAS 132, "Employers' Disclosures about Pensions and
Postretirement Benefits." The liability, which amounted to $60 million ($39
million after-tax) for TXU Energy, was recorded as a reduction to member
interests through a charge to Other Comprehensive Income, and did not affect net
income for 2002. The charge to Other Comprehensive Income will be reversed in
future periods to the extent fair value of trust assets exceeds the accumulated
benefit obligation.
The amounts provided above for funding requirements, pension expense
and minimum liability adjustment mentioned above, represent allocations of the
TXU Corp. Retirement Plan to TXU Energy.
15
OPERATING DATA
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
OPERATING STATISTICS:
Retail electric sales volumes (Gigawatt hours)......................... 90,581 99,151 100,493
Wholesale electric sales volumes (Gigawatt hours)...................... 29,578 6,409 6,154
Retail customers (end of period & in thousands)
Electric (based on number of meters).............................. 2,737 2,728 2,672
Gas ............................................................ 2 3 4
-------- --------- --------
Total customers............................................... 2,739 2,731 2,676
======== ========= ========
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
OPERATING REVENUES (MILLIONS OF DOLLARS):
Retail electric:
Residential......................................................... $ 3,108 $ 3,255 $ 3,263
Commercial and industrial........................................... 3,415 3,837 4,025
--------- --------- ---------
Total........................................................... 6,523 7,092 7,288
Wholesale electric....................................................... 845 96 168
Wholesale portfolio management activities................................ 211 258 44
Other revenues........................................................... 159 46 254
Mitigation............................................................... - (34) (305)
--------- ---------- ----------
Total operating revenues........................................ $ 7,738 $ 7,458 $ 7,449
======== ======== ========
Weather (average for service territory)(**)
Percent of normal:
Cooling degree days............................................. 99.9% 100.5% 119.1%
Heating degree days............................................. 101.6% 97.5% 94.6%
<FN>
- ------------------------------------
(**) Weather data is obtained from Meteorlogix, a private company that collects
weather data from reporting stations of the National Oceanic and
Atmospheric Administration (a federal agency under the US Department of
Commerce).
</FN>
The results of operations and the related management's discussion of
those results for all periods presented have been restated to reflect the change
in format of the statements of consolidated income, the inclusion of delivery
fees in 2001 and 2000 and the impact of 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", as discussed below.
(See Note 2 to Financial Statements for description of new line items.)
CHANGES IN ACCOUNTING STANDARDS -- In June 2002, the EITF reached a
consensus on certain aspects of Issue No. 02-3 regarding the presentation of
trading activities in the statement of income. The new rules were effective for
TXU Energy on July 1, 2002, and required that all trading contracts (as defined
by EITF Issue No. 98-10), whether or not physically settled, be recorded net
upon settlement, rather than gross as a sale and cost of sale. TXU Energy has
historically recorded financial contracts net, but has recorded those contracts
that provide for physical delivery gross upon settlement. Prior period amounts
have been reclassified to conform to this new reporting requirement.
Transactions affected by the new reporting requirements represent contracts that
provided for physical delivery but were settled financially without delivery, as
well as contracts physically settled but classified as trading activities. With
16
the rescission of EITF Issue No. 98-10 (see discussion below), the EITF modified
Issue No. 02-3 to apply to contracts that are derivatives and entered into for
trading purposes effective January 1, 2003. The new reporting requirements have
no impact on TXU Energy's gross margin, net income or cash provided by operating
activities.
Effective January 1, 2002, TXU Energy incurs electricity delivery fees
charged by Oncor and other T&D utilities, which TXU Energy includes in billings
to its large C&I customers. For residential and small business customers, the
price-to-beat rates include a delivery component, but such billed amounts are
not necessarily equivalent to delivery fees incurred by TXU Energy. Prior
revenues as previously reported represented only the revenues associated with
generation activity, as such revenues were derived by unbundling the revenues of
US Holdings into a generation component and a delivery component. The delivery
component revenues have been included in TXU Energy's revenues and cost of
energy sold for the year ended December 31, 2001 and 2000. TXU Energy's gross
margin for those years is not affected by the inclusion of these electricity
delivery fees.
The table below summarizes the impact on TXU Energy's operating
revenues and cost of energy sold for prior years of the new reporting rules
under EITF Issue No. 02-3 and the inclusion of delivery fees.
YEAR ENDED DECEMBER 31,
-----------------------
2001 2000
---- ----
Operating revenues as previously reported................... $ 10,867 $ 10,858
Electricity delivery fees................................... 1,750 1,909
Cost of energy sold and delivery fees netted with revenues.. (5,159) (5,318)
---------- ----------
Operating revenues after reclassification................... $ 7,458 $ 7,449
========= =========
Cost of energy sold and delivery fees as previously reported $ 8,211 $ 8,510
Electricity delivery fees................................... 1,750 1,909
Cost of energy sold and delivery fees netted with revenues.. (5,159) (5,318)
---------- ----------
Cost of energy sold and delivery fees after reclassification $ 4,802 $ 5,101
========= =========
On October 25, 2002, the EITF rescinded EITF Issue No. 98-10, which
required mark-to-market accounting for all trading activities. Pursuant to this
rescission, only contracts that are derivatives under SFAS No. 133 will be
subject to mark-to-market accounting. Contracts that may not be derivatives
under SFAS No. 133, but were marked-to-market under EITF Issue No. 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 approximately $100 million ($65 million after-tax) is expected to be
reported as a cumulative effect of an accounting change in the first quarter of
2003. The expected cumulative effect adjustment represents the net gains
previously recognized for these contracts under mark-to-market accounting.
See Note 2 to Financial Statements for further discussion of other
changes in accounting standards.
2002 COMPARED TO 2001
TXU Energy's operating revenues increased $280 million, or 4%, to $7.7
billion in 2002. Wholesale electric revenues increased $749 million to $845
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 C&I markets. Year-end residential
electric 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 Oncor in 2001, but are
included in TXU Energy revenues in 2002.
17
GROSS MARGIN
YEAR ENDED DECEMBER 31,
-----------------------
% OF % OF
2002 REVENUE 2001 REVENUE
---- ------- ---- -------
Operating revenues..................................... $ 7,738 100% $ 7,458 100%
Cost and expenses:
Cost of energy sold and delivery fees............. 4,803 62% 4,802 64%
Operating costs................................... 747 10% 708 10%
Depreciation and amortization related to generation
assets........................................ 396 5% 391 5%
------- ------ ------- -------
Gross margin........................................... $ 1,792 23% $ 1,557 21%
======= ====== ======= =======
Gross margin increased $235 million, or 15%, to $1.8 billion in 2002.
The increase was driven by lower average costs of electricity and delivery fees
and significant growth in wholesale electric sales in the newly deregulated
ERCOT market, partially offset by the effect of lower retail electric volumes.
Gross margin in 2002 was negatively affected by the accrual of $185 million for
retail clawback (see discussion above under "Accounting for Contingencies"),
which is reported in cost of energy sold and delivery fees. Results of wholesale
portfolio management activities were down $47 million from the prior year,
primarily due to hedge ineffectiveness. Mark-to-market accounting for wholesale
and retail commodity contracts reduced revenues and gross margin by $72 million
in 2002 (as compared to accounting on a settlement basis), and increased results
in 2001 by $314 million. Operating costs rose $39 million, or 6%, to $747
million primarily reflecting repair and maintenance costs associated with an
unplanned outage at the nuclear-powered generation plant.
The following table analyzes TXU Energy's gross margin between its
realized and unrealized components:
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001
---- ----
Gross margin................................................ $ 1,792 $ 1,557
Noncash items:
Unrealized mark-to-market (gain) loss.................... 72 (314)
Retail clawback accrual.................................. 185 -
Depreciation and amortization related to generation assets 396 391
Cash flow hedge ineffectiveness.......................... 41 (4)
Other noncash items included in cost of energy sold...... (31) 86
Mitigation............................................... - 34
Over-recovered fuel costs................................ - 568
--------- ---------
Gross margin on a cash basis......................... $ 2,455 $ 2,318
========= =========
The increase in total depreciation and amortization, other than
goodwill (including amounts shown in the gross margin table above), of $41
million, or 10%, to $438 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 selling, general and administrative (SG&A) expenses of
$477 million, or 131%, to $842 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 portfolio management 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 that are
expected to continue in 2003. Such actions resulted in $31 million in severance
charges in 2002, which contributed to the increase in SG&A expense. In addition,
new POLR rules established by the Public Utility Commission of Texas
(Commission) (see Note 9 to Financial Statements) are expected to result in
reduced bad debt expense. With the anticipated lower staffing and related
administrative expenses and improvement in bad debt experience, SG&A expenses
are expected to decline in 2003.
18
Franchise and revenue-based taxes rose $106 million to $121 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 $30 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 $204 million to $254 million, reflecting
a $237 million writedown in 2002 of two generation plant construction projects
(see discussion above under "Impairment of Long-Lived Assets"). Amounts in 2001
included a $22 million regulatory asset writeoff 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 declined $7 million, or 3%, to $216
million. Of the change, $53 million was due to lower average debt levels, which
was partially offset by $38 million due to higher rates and an $8 million
increase in capitalized interest.
The effective tax rate decreased to 25.0% in 2002 from 29.7% 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.
(See Note 6 to Financial Statements.)
Income before extraordinary loss decreased $390 million, or 59%, to
$270 million in 2002. The decline was driven by an increase in SG&A expenses,
the impairment charge reported in other deductions and higher franchise and
revenue-based taxes, partially offset by the improved gross margin (net of the
effect of the retail clawback accrual). Net pension and postretirement benefit
cost reduced net income by $21 million in 2002 and $13 million in 2001.
TXU Energy recorded an extraordinary loss in 2001 of $153 million (net
of income tax benefit of $114 million). The extraordinary loss consisted of $97
million (net of $52 million income tax benefit) of charges related to the
acquisition of debt under the debt restructuring and refinancing plan pursuant
to the requirements of the 1999 Restructuring Legislation and $56 million (net
of $62 million income tax benefit) of net charges related to the settlement plan
with the Commission to resolve all major open items related to the transition to
deregulation. (See Note 9 to Financial Statements.)
2001 COMPARED TO 2000
TXU Energy's operating revenues of $7.5 billion for 2001 were
essentially even with the prior year. This performance reflected lower retail
electricity revenues of approximately $200 million, or 3%, largely offset by
increased wholesale portfolio management activities, due in large part to the
anticipated opening of the Texas market to competition, as well as increased
wholesale activity in markets outside of Texas. Lower retail electricity
revenues reflected both volume declines and lower fuel revenues, due to lower
fuel (primarily natural gas) costs in generation operations, partially offset by
a lower adjustment for earnings in excess of the regulatory earnings cap
(mitigation). Retail electricity volumes declined 1% due to milder, more normal
weather, partially offset by the effect of 2% growth in number of customers.
19
GROSS MARGIN
YEAR ENDED DECEMBER 31,
-----------------------
% OF % OF
2001 REVENUE 2000 REVENUE
---- ------- ---- -------
Operating revenues..................................... $ 7,458 100% $ 7,449 100%
Cost and expenses:
Cost of energy sold and delivery fees............. 4,802 64% 5,101 69%
Operating costs................................... 708 10% 673 9%
Depreciation and amortization related to generation
assets........................................ 391 5% 390 5%
--------- --------- --------- ---------
Gross margin........................................... $ 1,557 21% $ 1,285 17%
========= ========= ========= =========
Gross margin increased $272 million, or 21%, to $1.6 billion in 2001.
The improved results reflected growth in wholesale portfolio management
activities, arising primarily in anticipation of the opening of the Texas market
to competition, partially offset by an increase in operating costs.
Mark-to-market accounting for commodity contracts increased revenues and gross
margin by $314 million in 2001 (as compared to accounting on a settlement
basis.) This amount reflects $88 million in origination gains recorded upon
execution of retail contracts with large C&I customers. Such contracts are
derivatives and are marked-to-market in accordance with SFAS No. 133. Operating
costs increased $35 million, or 5%, to $708 million in 2001 primarily reflecting
higher generation plant maintenance costs.
The increase in depreciation and amortization, other than goodwill
(including amounts shown in the gross margin table above), of $6 million, or 2%,
to $397 million was primarily due to investments in computer systems and
expansion of office facilities.
The increase in SG&A expense of $117 million, or 47%, to $365 million
reflected higher spending for staffing and computer systems to support expanded
retail sales and portfolio management operations, largely in anticipation of
deregulation of the Texas electricity market, as well as increased bad debt
expense. The increase in bad debts was primarily due to the rise in fuel costs
and related revenue in late 2000 and early 2001.
Other income decreased by $29 million to $3 million, reflecting a $28
million gain on the sale of land in 2000.
Other deductions increased $44 million to $50 million, reflecting a $22
million write-off of regulatory assets pursuant to a regulatory order and $18
million in various asset writedowns, both in 2001.
Interest income increased $32 million to $38 million primarily due to
interest income on under-recovered fuel costs under regulation.
Interest expense and other charges declined $34 million, or 13%, to
$223 million due primarily to lower interest rates and a $9 million increase in
capitalized interest.
The effective tax rate increased to 29.7% in 2001 from 27.5% in 2000,
primarily due to higher state income taxes.
Income before extraordinary loss increased $84 million, or 15%, to $660
million in 2002. The increase was driven by the higher gross margin, partially
offset by higher SG&A expenses.
TXU Energy recorded an extraordinary loss in 2001 of $153 million (net
of income tax benefit of $114 million), as described above in the comparison of
results for 2002 versus 2001.
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, 2002 and 2001. The net change in
these assets and liabilities, excluding "other activity" as described below,
20
represents the net unrealized gains/(losses) recognized under mark-to-market
accounting. In 2002, mark-to-market accounting reduced pre-tax earnings by $72
million (as compared to accounting on a settlement basis), and increased pre-tax
earnings by $314 million in 2001.
2002 2001
---- ----
Balance of net commodity contract assets/(liabilities) at beginning of year... $ 371 $ 27
Settlements of positions included in the opening balance(1) .................. (230) (54)
Unrealized mark-to-market valuations of positions held at end of period(2)... 158 368
Changes in fair value attributable to changes in valuation techniques........ - -
Other activity(3)............................................................ 17 30
-------- --------
Balance of net commodity contract assets/(liabilities) at end of year........ $ 316 $ 371
======== ========
<FN>
- ------------------------------------
(1) Represents unrealized mark-to-market valuations of these positions
recognized in earnings as of the beginning of the year.
(2) Includes unrealized gains recognized upon origination of retail electric
contracts in accordance with SFAS No. 133 as discussed below, and $14
million on nonderivative wholesale contracts entered into prior to July 1,
2002.
(3) Represents net options paid and a commodity contract transferred from TXU
Gas in the current period. Also includes $71 million of unsettled
liabilities to Enron reclassified to other current liabilities in 2002.
These activities have no effect on unrealized mark-to-market valuations.
</FN>
ORIGINATION GAINS -- With the opening of the Texas electricity market
to competition, retail electric contracts are no longer subject to rate
regulation and are negotiated between the various REPs and the customer. This
has resulted in an especially competitive environment for power contracts with
large C&I customers. The contracts are derivatives as defined in SFAS No. 133
and, therefore, have been marked-to-market upon execution. Origination gains of
$40 million and $88 million were recorded in 2002 and 2001, respectively. The
decline reflected fewer contracts executed in 2002. The average term of a C&I
contract is approximately 18 months.
The C&I contracts are typically standard contracts that provide for the
delivery of power at fixed prices up to the expected load. Within the ERCOT
system, a competitive, liquid wholesale market exists. Given TXU Energy's
inherent asset position of baseload generation coupled with the ability to
transact competitively in the wholesale market, a "dealer profit" is recognized.
TXU Energy is able to validate the forward price curve of the commodity given
the short term nature of the retail contracts and the existence of a wholesale
market in ERCOT. (See Note 2 to Financial Statements -- Financial Instruments
and Mark-to-Market Accounting.)
MATURITY TABLE -- Of the net commodity contract asset balance above at
December 31, 2002, the amount representing unrealized mark-to-market net gains
that have been recognized in current and prior years' earnings is $336 million.
The offsetting net liabilities of $20 million included in the December 31, 2002
balance consists of net option premiums received. The following table presents
the unrealized mark-to-market balance at December 31, 2002 scheduled by
contractual settlement dates of the underlying positions (in millions).
MATURITY DATES OF UNREALIZED NET MARK-TO-MARKET BALANCES AT DECEMBER 31, 2002
-----------------------------------------------------------------------------
MATURITY MATURITY IN
LESS THAN MATURITY OF MATURITY OF EXCESS OF
SOURCE OF FAIR VALUE 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS TOTAL
-------------------- ------ --------- --------- ------- -----
Prices actively quoted....... $ (4) $ - $ - $ - $ (4)
Prices provided by other
external sources........... 125 87 25 6 243
Prices based on models....... 62 25 4 6 97
-------- -------- -------- -------- --------
Total........................ 183 112 29 12 336
Less estimated cumulative
effect of an accounting change
change-(EITF Issue No. 98-10
rescission) 56 25 9 10 100
-------- -------- -------- -------- --------
Adjusted total............... $ 127 $ 87 $ 20 $ 2 $ 236
======== ======== ======== ======== ========
% - before EITF 98-10
rescission................ 54% 33% 9% 4% 100%
% - after EITF 98-10
rescission................ 54% 37% 8% 1% 100%
21
As the above table indicates, approximately 91% of the remaining
unrealized mark-to-market valuations at December 31, 2002, as adjusted for the
estimated cumulative effect of the accounting change to be recorded in the first
quarter of 2003 for EITF Issue No. 98-10, 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 2005. The "prices provided by
other external sources" category represents forward commodity positions at
locations for which over-the-counter (OTC) broker quotes are available. OTC
quotes for power and natural gas generally extend through 2005 and 2012,
respectively. This category also includes values of large commercial/industrial
retail sales contracts. 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 by TXU Energy 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.
PORTFOLIO MANAGEMENT - The use of commodity contracts to manage risks,
generally referred to as trading activities, is one of several responsibilities
of the "portfolio management" operations of TXU Energy. Portfolio management
refers to risk management and value creation activities undertaken to balance
the demand for energy by customers with the supply of energy in an economically
efficient and effective manner. These activities include:
o Managing the utilization of generation assets through "make or
buy" decisions.
o Forecasting volume demands and scheduling supply resources.
o Entering into short and long-term contracts to balance energy
supply and demand.
o Arranging physical sales of energy to wholesale customers.
o Buying and selling energy-related contracts to minimize the cost
of fuel used to generate electricity and to maximize the margin
earned on wholesale and retail sales of energy. These activities
are sometimes broadly characterized as "trading". However,
speculative trading, whereby energy-related financial instruments
are bought and sold outside of the supply/demand balancing
process with the objective of generating profits on anticipated
price changes, represents a small fraction of TXU Energy's
portfolio management activities.
In this Management's Discussion and Analysis of Financial Condition and
Results of Operations, analyses of revenue and gross margin performance refer to
results of wholesale portfolio management activities. Such results represent net
realized and unrealized gains and losses from transacting in energy-related
contracts as described in the last point above, which are reported as a
component of revenues.
COMPREHENSIVE INCOME
A minimum pension liability loss adjustment of $60 million ($39 million
after-tax) was recorded in other comprehensive income in 2002. The minimum
pension liability represents the difference between the excess of the
accumulated benefit obligation over the plans' assets and the liability
reflected in the balance sheet. Further, based on the current assumptions and
available information, funding requirements in 2003 related to the pension plans
are expected to increase for TXU Energy by $3 million, and pension expense is
expected to increase approximately $17 million over the 2002 amounts. The
recording of the liability did not affect TXU Energy's financial covenants in
any of its credit agreements.
TXU Energy has historically used, and will 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 other comprehensive income are expected to be used in the future to offset
the impact of rate or price changes on related payments. Amounts in other
comprehensive income include (i) the value of cash flow hedges, 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.
22
During 2002 and 2001, changes in the fair value of derivatives
effective as cash flow hedges reflected losses of $197 million ($128 million
after-tax) and gains of $25 million ($16 million after-tax), respectively.
Losses in 2002 were evenly divided between decreases of $98 million ($63 million
after-tax) in the fair value of interest rate hedges because of lower interest
rates and decreases of $99 million ($65 million after-tax) in the fair value of
commodity hedges. Gains in 2001 were related to increases in the fair value of
commodity hedges.
During 2002, $21 million ($14 million after-tax) in other comprehensive
income gains was recognized in earnings, primarily reflecting commodity hedges.
See also Note 12 to Financial Statements.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
TXU Energy expects to satisfy its liquidity needs from existing cash
balances, cash flows from operations, advances from affiliates, renewal of
existing credit facilities, successful remarketing of mandatorily tendered
securities, issuance of additional securities and dispositions of non-strategic
assets.
CASH FLOWS -- Cash flows provided by operating activities for the year
ended December 31, 2002 were $1.0 billion compared to $1.2 billion and $670
million for the years ended December 31, 2001 and 2000, respectively. The
decrease in cash flows provided by operating activities in 2002 of $142 million,
or 12%, reflected a number of factors. The principal driver of the decline was
lower cash earnings (net income adjusted for the significant noncash items
identified in the statement of cash flows). The net working capital (accounts
receivable, accounts payable and inventories) increase of approximately $380
million in 2002 was comparable to 2001. However, this performance reflected
higher unbilled accounts receivable of approximately $200 million related to the
opening of the Texas market to competition, which reflects the effects of a new
ERCOT protocol that allows five days to clear meter-read data through ERCOT, as
well as other changes in billing processes. The higher accounts receivable was
largely offset by increased accounts payable, reflecting more purchases of power
(as opposed to power generated by TXU Energy) and timing of payments. The
operating cash flow performance in 2002 was favorably impacted by higher
balances due Oncor of approximately $200 million, reflecting the start-up of
billing REPs for electric delivery fees, but this change was largely offset by
the effect of a return of margin deposits of $227 million in 2001 (in exchange
for letters of credit).
The increase in cash flows in 2001 from 2000 of $506 million was driven
by the effect of under-recovered fuel costs, reflecting high gas prices in 2000
that reduced cash flows in 2000 as the gas costs were incurred, but increased
cash flows in 2001 as the costs were recovered from customers.
Cash flows used in financing activities were $407 million, $765 million
and $252 million during 2002, 2001 and 2000, respectively. Net issuances,
retirements and repurchases of debt securities in 2002 resulted in net cash
outflows of $872 million. Advances from affiliates increased $1.2 billion,
reflecting the drawdown of credit facilities in the fourth quarter of 2002 by US
Holdings, primarily to repay TXU Energy's commercial paper borrowings, and notes
payable to banks increased $282 million in 2002. Cash distributions to US
Holdings in 2002 were $777 million.
Cash flows used in investing activities were $44 million, $406 million
and $404 million for the years ended December 31, 2002, 2001 and 2000,
respectively. Proceeds in 2002 from the sale of the Handley and Mountain Creek
power plants in the Dallas-Ft. Worth area were $443 million. Acquisitions in
2002 included $36 million for a cogeneration and wholesale production business
in New Jersey. Capital expenditures declined to $274 million in 2002 from $330
million, reflecting the spending in 2001 for computer system development and
office facilities in connection with the opening of the Texas market to
competition. Nuclear fuel spending of $52 million reflected refuelings at the
Comanche Peak nuclear generating plant. Other investing activities in 2002
included terminations of out-of-the-money cash flow hedges, primarily reflecting
declines in interest rates.
23
Depreciation and amortization expense reported in the statement of cash
flows exceeds the amount reported in the statement of income by $64 million.
This difference primarily represents the amortization of nuclear fuel, which is
reported as cost of energy sold in the statement of income, consistent with
industry practice.
GENERATION PLANT ACQUISITIONS AND DISPOSITIONS -- In May 2002, TXU
Energy acquired a 260 megawatt 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 its Handley and
Mountain Creek generating plants in the Dallas-Fort Worth area with total plant
capacity of 2,334 megawatts for $443 million in cash, including an above-market
price tolling agreement with a fair value of $190 million. The tolling agreement
provides for TXU Energy to purchase power during the summer months through 2006.
A pretax gain on the sale of $146 million, net of the effects of the
above-market 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.
FUTURE CAPITAL REQUIREMENTS -- Capital expenditures are estimated at
$328 million for 2003, substantially all of which is for maintenance and organic
growth of existing operations, and are expected to be funded by cash flows from
operations.
EXCHANGEABLE DEBT -- In November 2002, TXU Energy issued $750 million
of exchangeable subordinated notes. The notes will mature in November 2012, bear
interest at the annual rate of 9% and permit the deferral of interest payments.
TXU Corp. has granted the holders the right to exchange the notes for TXU Corp.
common stock. The notes currently may be exchanged, subject to certain
restrictions, at any time for up to approximately 57 million shares of TXU Corp.
common stock at an exercise 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 principal amount of notes to be exchanged by
the exercise price. The exercise price and the number of shares to be issued are
subject to anti-dilution adjustments. The proceeds from the issuance of the
notes were used for the repayment of two standby credit facilities that expired
in November 2002. TXU Energy has recognized a capital contribution from TXU
Corp. and a corresponding discount on the notes of $266 million, for the value
of the exchange right as TXU Corp. granted an irrevocable right to exchange the
notes for shares of TXU Corp. common stock. This discount amount is being
amortized to interest expense over the term of the debt. At the time of any
exchange of the notes for common stock, the unamortized discount will be
proportionately written off as a charge to earnings. (See Note 5 to Financial
Statements.)
The exchangeable notes are subordinated in bankruptcy to all other TXU
Energy obligations. TXU Energy has the right until May 2003 to require the
holders of the notes to exchange their interest in the notes for a preferred
equity interest in TXU Energy with economic and other terms substantially
identical to the notes.
CAPITALIZATION -- The ratio of TXU Energy's long-term debt (less
amounts due currently) to long-term debt (less amounts due currently) plus
member interests at December 31, 2002 was 35.8%. Long-term debt includes TXU
Energy's $750 million exchangeable subordinated notes (net of unamortized
discount balance of $264 million). Member interests include $266 million of
original non-cash capital contribution related to the issuance of such notes.
US DEBT RESTRUCTURING -- During the fourth quarter of 2001, US Holdings
restructured its debt in connection with its plan for compliance with the 1999
Restructuring Legislation. As a result of the debt restructuring and
refinancings, TXU Energy recorded an extraordinary charge of $97 million
after-tax. (See Notes 9 and 11 to Financial Statements).
24
LONG-TERM DEBT -- During the year ended December 31, 2002, TXU Energy
issued, redeemed, reacquired or made scheduled principal payments on long-term
debt as follows:
Issuances Retirements
--------- -----------
Exchangeable subordinated notes.................. $ 750 $ -
Pollution control revenue bonds.................. 61 61
Floating rate debentures......................... - 1,500
Other long-term debt............................. - 122
-------- --------
Total.......................................... $ 811 $ 1,683
======== ========
See Note 5 to Financial Statements for further detail of debt issuance
and retirements.
In April 2002, US Holdings, TXU Energy and Oncor entered into the joint
$1.0 billion 364-day revolving credit facility with a group of banks that
terminates in April 2003, but borrowings outstanding at that time can be
extended for one year. This facility is used for working capital and general
corporate purposes. Up to $1.0 billion of letters of credit may be issued under
the facility. In October 2002, TXU Energy borrowed approximately $282 million
and US Holdings borrowed approximately $596 million in cash against this credit
facility, the total of which represented the remaining availability after $122
million was used to support outstanding letters of credit. As of December 31,
2002, the facility was fully drawn and TXU Energy's portion of the outstanding
borrowings, approximately $282 million, is reflected in Notes Payable - Banks on
the balance sheet
US Holdings has a $1.4 billion five-year revolving credit facility that
terminates in February 2005. In October 2002, US Holdings borrowed $939 million
in cash against the remaining availability of this facility. A portion of the
proceeds of this borrowing were used to make advances to affiliates, including
TXU Energy.
Funds borrowed under the 364-day revolving credit facility by TXU
Energy, short-term advances from affiliates and other available cash, were used
by TXU Energy to repay outstanding commercial paper upon maturity. Excess cash
of approximately $600 million at December 31, 2002, has been invested in liquid
short-term marketable securities earning current market rates. These funds will
be used to repay debt as it matures and meet other working capital requirements
until such time as the commercial paper market becomes more accessible to TXU
Energy.
TXU Energy is also provided short-term financing by TXU Corp. and its
affiliated companies. TXU Energy had short-term advances from affiliates of $1.3
billion and $250 million outstanding as of December 31, 2002 and December 31,
2001, respectively. The weighted average interest rate on short-term borrowings
at December 31, 2002 was 2.328%.
SALE OF RECEIVABLES -- Certain subsidiaries of TXU Corp. sell customer
accounts receivable to TXU Receivables Company, a wholly-owned bankruptcy remote
subsidiary of TXU Corp., which sells undivided interests in accounts receivable
it purchases to financial institutions. As of December 31, 2002, the facility
includes TXU Energy (through certain subsidiaries), Oncor and TXU Gas as
qualified originators of accounts receivable under the program. TXU Receivables
Company may sell up to an aggregate of $600 million in undivided interests in
the receivables purchased from the originators under the program. As of December
31, 2002, TXU Energy had sold $1,091 million face amount of receivables to TXU
Receivables Company under the program in exchange for cash of $352 million and
$711 million in subordinated notes, with $28 million of losses on sales for the
year ended December 31, 2002 that principally represent the interest costs on
the underlying financing. These losses approximated 5% of the cash proceeds from
the sale of undivided interests in accounts receivable on an annualized basis.
Funding under the program decreased from $547 million at September 30, 2002, to
$352 million at December 31, 2002, primarily due to billing and collection
delays arising from new systems and processes in TXU Energy and ERCOT for
clearing customer switching and billing data, as well as seasonality of the
business.
Upon termination, cash flows to the originators would be delayed as
collections of sold receivables were used by TXU Receivables Company to
repurchase the undivided interests of the financial institutions instead of
purchasing new receivables. The level of cash flows would normalize in
approximately 16 to 31 days. TXU Business Services, a subsidiary of TXU Corp.,
services the purchased receivables and is paid a market based servicing fee by
TXU Receivables Company. The subordinated notes receivable from TXU Receivables
Company represent TXU Energy's retained interests in the transferred receivables
and are recorded at book value, net of allowances for bad debts, which
25
approximates fair value due to the short-term nature of the subordinated notes,
and are included in accounts receivable in the consolidated balance sheet.
In October 2002, the program was amended to extend the program to July
2003, to provide for reserve requirement adjustments as the quality of the
portfolio changes and to provide for adjustments to reduce receivables in the
program by the related amounts of customer deposits held by originators. In
February 2003, the program was further amended to allow receivables 31-90 days
past due into the program. (See also discussion below under Contingencies
Related to the Receivables Program.)
CREDIT RATINGS OF TXU CORP., US HOLDINGS AND TXU ENERGY
The current credit ratings for TXU Corp., US Holdings and TXU Energy
are presented below:
TXU Corp. US Holdings TXU Energy
--------- ----------- ----------
(Senior (Senior (Senior
Unsecured) Unsecured) Unsecured)
S&P ................. BBB- BBB- BBB
Moody's................ Ba1 Baa3 Baa2
Fitch ................. BBB- BBB- BBB
Moody's currently maintains a negative outlook for TXU Corp. and a
stable outlook for US Holdings and TXU Energy. Fitch currently maintains a
stable outlook for TXU Corp., US Holdings and TXU Energy. S&P currently
maintains a negative outlook for TXU Corp., US Holdings and TXU Energy.
These ratings are investment grade, except for Moody's rating of TXU
Corp.'s senior unsecured debts, which is one notch below investment grade.
A rating reflects only the view of a rating agency and it is not a
recommendation to buy, sell or hold securities. Any rating can be revised upward
or downward at any time by a rating agency if such rating agency decides that
circumstances warrant such a change.
FINANCIAL COVENANTS, CREDIT RATING PROVISIONS AND CROSS DEFAULT
PROVISIONS -- The terms of certain financing arrangements of US Holdings, TXU
Energy and Oncor contain financial covenants that require maintenance of
specified fixed charge coverage ratios, shareholders' equity to total
capitalization ratios and leverage ratios and/or contain minimum net worth
covenants. TXU Energy's exchangeable subordinated notes 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, 2002, US
Holdings, TXU Energy and Oncor were in compliance with all such applicable
covenants.
Certain financing and other arrangements of TXU Corp. and its US
subsidiaries contain provisions that are specifically affected by changes in
credit ratings and also include cross default provisions. The material
provisions are described below:
Credit Rating Provisions
------------------------
TXU Energy has provided a guarantee of the obligations under TXU
Corp.'s lease (approximately $140 million at December 31, 2002) 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 be required 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.
26
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 $150 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 any
specified rating agency. The amount TXU Energy would post under these
transactions depends in part, on the value of the contract at that time. Based
on current market conditions, the maximum TXU Energy would post for these
transactions is $246 million. Of this amount $190 million relates to an
arrangement that would require TXU Energy to be downgraded to below investment
grade by all three rating agencies before collateral would be required to be
posted.
TXU Energy is also the obligor on leases, which total $167 million.
Under the terms of those leases, if TXU Energy's credit rating was 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 which 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 was downgraded below investment grade by any specified
rating agency, TXU Energy could be required to post collateral of approximately
$31 million.
Under the accounts receivable program, all originators (currently TXU
Energy through certain subsidiaries, Oncor and TXU Gas), are required to
maintain a `BBB-' (S&P) and a `Baa3' (Moody's) rating (or supply a parent
guarantee with a similar rating). A downgrade below the required ratings for an
originator would prevent that originator from selling its accounts receivable
under the program. If all originators are downgraded so that there are no
eligible originators, the facility would terminate. Upon termination, cash flows
to the originators would be delayed as collections of sold receivables were used
to repurchase the undivided interests of the financial institutions instead of
purchasing new receivables. The level of cash flows would normalize in
approximately 16 to 31 days.
Other agreements of US Holdings and TXU Energy, including 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
US Holdings or TXU Energy.
Cross Default Provisions
------------------------
Certain financing arrangements of TXU Corp. and its subsidiaries
contain provisions that would result in an event of default under these
arrangements if there is 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.
Most agreements have a cure period of up to 30 days from the occurrence of the
specified event during which the company is allowed to rectify or correct the
situation before it becomes an event of default.
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
$1.0 billion joint US Holdings/TXU Energy/Oncor 364-Day revolving credit
facility, the $1.4 billion US Holdings five-year revolving credit facility and
the $103 million TXU Mining Company LP senior notes (which have a $1 million
threshold). Under the joint US Holdings/TXU Energy/Oncor $1.0 billion 364-Day
revolving 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 and US Holdings, 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 to be accelerated under such facility as to
Oncor and US Holdings, but not as to TXU Energy. Further, under this credit
facility, a default by US Holdings would cause the maturity of outstanding
balances under such facility to be accelerated as to US Holdings, but not as to
Oncor or TXU Energy.
The accounts receivable program, described above, contains a cross
default provision with a threshold of $50 million applicable to each of the
originators under the program. TXU Receivables Company, a wholly-owned
27
bankruptcy remote subsidiary of TXU Corp. which sells undivided interests in
accounts receivable it purchases to financial institutions, and TXU Business
Services Company, a subsidiary of TXU Corp. which services the purchased
receivables, each have a cross default threshold of $50 thousand. If either an
originator, TXU Business Services Company or TXU Receivables Company defaults on
indebtedness of the applicable threshold, the facility could terminate.
TXU Energy, as the lessee, has certain mining and equipment leasing
arrangements aggregating $226 million that would terminate upon the default on
any other obligations of TXU Energy owed to the lessor. In the event of a
default by TXU Mining Company LP, a subsidiary of TXU Energy, on indebtedness in
excess of $1 million, a cross default would result under the $31 million TXU
Mining Company LP leveraged lease and the lease would 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.
US Holdings, TXU Energy and Oncor have other arrangements, including
interest rate and currency swap agreements and leases with cross default
provisions, the triggering of which would not result in a significant effect on
liquidity.
LONG-TERM CONTRACTUAL OBLIGATIONS AND COMMITMENTS -- The following
table summarizes the contractual cash obligations of TXU Energy for each of the
periods presented (see Note 10 to Financial Statements for additional
disclosures regarding terms of these obligations.)
PAYMENT DUE
-------------------------------------------------------------------
CONTRACTUAL CASH OBLIGATIONS 2003 2004 2005 2006 2007 THEREAFTER
- ------------------------------------ ---- ---- ---- ---- ---- ----------
Long - term debt.................. $ 72 $ - $ 30 $ - $ - $ 2,603
Capital lease obligations ........ 1 1 2 2 2 6
Operating leases ................. 65 65 69 65 69 513
Capacity payments-electricity
contracts ...................... 315 163 146 117 17 -
Coal contracts ................... 94 78 23 18 - -
Pipeline transportation and storage
reservation fees................ 14 6 6 6 4 6
------- ------- ------- ------- ------- -------
Total contractual cash obligations $ 561 $ 313 $ 276 $ 208 $ 92 $ 3,128
======= ======= ======= ======= ======= =======
TXU Energy is the lessee under various operating leases that under
their terms obligate the lessees to guaranty the residual values of the leased
facilities. At December 31, 2002, the aggregate maximum amount of residual
values guaranteed by TXU Energy is approximately $299 million with an estimated
residual recovery of approximately $222 million. The average life of the lease
portfolio is approximately nine years.
TXU Energy Solutions, a subsidiary of TXU Energy, has guaranteed that
certain customers will realize specified annual savings resulting from energy
management services provided by TXU Energy Solutions. In aggregate, the average
annual savings has exceeded the annual savings guaranteed. The maximum potential
annual payout is approximately $4.3 million and a maximum total potential payout
of approximately $18.6 million. The average remaining tenor of the portfolio is
approximately 5 years.
TXU Energy has entered into various agreements that require letters of
credit for financial assurance purposes. Approximately $522.6 million of letters
of credit are outstanding to support existing floating rate pollution control
revenue bond financings on existing debt of approximately $433 million. The
letters of credit are available to fund the payment of such debt obligations.
These letters of credit have expiration dates in 2003; however, TXU Energy
intends to provide from either existing or new facilities for the extension,
renewal or substitution of these letters of credit to the extent required for
such floating rate debt or their remarketing as fixed rate debt.
TXU Energy has provided for the posting of letters of credit in the
amount of $183.4 million to support portfolio management margining requirements
of subsidiaries in the normal course of business. As of December 31, 2002,
28
approximately 82% of the obligations supported by these letters of credit mature
within 1 year and substantially all of the remainder mature in the second year.
US Holdings has entered into contracts with public agencies to purchase
cooling water for use in the generation of electric energy and has agreed, in
effect, to guarantee the principal, $16 million at December 31, 2002, and
interest on bonds issued by the agencies to finance the reservoirs from which
the water is supplied. The bonds mature at various dates through 2011 and have
interest rates ranging from 5.5% to 7% per annum. US Holdings is required to
make periodic payments equal to such principal and interest, including amounts
assumed by a third party and reimbursed to US Holdings, of $4 million for 2003,
$7 million for 2004 and $1 million for 2005 and 2006. In addition, US Holdings
is obligated to pay certain variable costs of operating and maintaining the
reservoirs. US Holdings has assigned to a municipality all contract rights and
obligations of US Holdings in connection with $19 million remaining principal
amount of bonds at December 31, 2002, issued for similar purposes which had
previously been guaranteed by US Holdings. US Holdings is, however, contingently
liable in the unlikely event of a default by the municipality. TXU Energy is
entitled to the benefits of these contracts and has agreed to indemnify US
Holdings for obligations under these contracts.
CONTINGENCIES RELATED TO 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:
o the credit rating for the long-term senior debt securities of
both any originator and its parent guarantor, if any, declines
below BBB- by S&P or Baa3 by Moody's; or
o 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 exceeds stated thresholds.
The delinquency and dilution ratios exceeded the relevant thresholds at
various times during 2002 and in January 2003, but waivers were granted. These
ratios were affected by issues related to the transition to deregulation.
Certain billing and collection delays arose due to implementation of new systems
and processes within TXU Energy and ERCOT for clearing customer switching and
billing data. The resolution of these issues as well as the implementation of
new POLR rules by the Commission (see Note 9 to Financial Statements) are
expected to bring the ratios in consistent compliance with the program.
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 or 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, including cash flow hedges 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 operations manage 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.
29
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.
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. Through its portfolio management operations, TXU Energy actively
manages its portfolio of owned generation, fuel supply and retail load to
mitigate the impacts of these risks on its results of operations.
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.
VaR METHODOLOGY -- A VaR methodology is used to measure the amount of
current and prospective risk that exists within a portfolio under a variety of
market conditions. The VaR process 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 maximum potential loss in value, due to price risk, 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 probability 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.
2002 2001 (a)
---- --------
(MILLIONS OF DOLLARS)
YEAR- END VaR........................................ $ 23.2 $ 38.7
AVERAGE VaR.......................................... $ 38.0 -
<FN>
(a) Comparable information on an average VaR basis is not available for the
full year of 2001 because during part of 2001, VaR was calculated using
different assumptions than in 2002 and an average VaR for 2001 would
therefore not be comparable.
</FN>
PORTFOLIO VaR -- Represents the estimated maximum potential loss in
market value, due to price risk, of the entire energy portfolio, including owned
assets and all contractual positions (the portfolio assets). Assumptions in
determining this VaR include using a 95% confidence level and a five-day holding
period and includes both mark-to-market and accrual positions expiring over the
next ten years.
30
2002 2001 (a)
---- --------
(MILLIONS OF DOLLARS)
YEAR-END PORTFOLIO VaR............................... $ 143.5 -
<FN>
(a) Prior to deregulation in Texas, which became effective January 1, 2002, the
portfolio assets included in the Portfolio VaR were regulated assets and
not subject to market risk. As a result, there is no Portfolio VaR at
year-end 2001 and no average Portfolio VaR for either 2001 or 2002.
</FN>
OTHER RISK MEASURES -- The metrics appearing below provide information
regarding the effect of energy price risk on earnings and cash flow.
EARNINGS AT RISK (EaR) -- EaR measures the estimated maximum short-fall
in fiscal year projected margin (revenues less cost of energy sold), due to
price risk. EaR metrics include the portfolio assets 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. As of December 31, 2002, the EaR for TXU Energy was $27.7 million.
As this measure is stated on the last business day of 2002, it represents the
EaR measure for fiscal year 2003.
CASH FLOW AT RISK (CFaR) -- CFaR measures the estimated maximum
short-fall of projected cash flow over the next six months, due to price risk.
CFaR metrics include all portfolio positions that impact cash flow during the
next six months. Assumptions include using a 99% confidence level over a 125 day
holding period under normal market conditions. As of December 31, 2002, the
CFaR, based on a contract settlement period of six months, was $177.5 million.
INTEREST RATE RISK
The table below provides information concerning TXU Energy's financial
instruments as of December 31, 2002 and 2001 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 and fair value hedges on long-term debt are excluded from the table.
See Note 5 to Financial Statements for a discussion of changes in debt
obligations.
EXPECTED MATURITY DATE
-------------------------------------------------
(MILLION OF DOLLARS, EXCEPT PERCENTAGES)
2002 2001
THERE- 2002 FAIR 2001 FAIR
2003 2004 2005 2006 2007 AFTER TOTAL VALUE TOTAL VALUE
---- ---- ---- ---- ---- ----- ----- ----- ----- -----
Long-term debt
(including current
maturities)
Fixed rate (a) $ 72 $ - $ 30 $ - $ - $2,170 $2,272 $2,230 $1,646 $1,651
Average interest rate 7.00% - 6.88% - - 6.46% 6.48% - - -
Variable rate - - - - - $ 433 $ 433 $ 432 $1,932 $1,932
Average interest rate - - - - - 1.46% 1.46% - - -
<FN>
(a) Reflects the maturity date and not the remarketing date for certain debt
which is subject to mandatory tender for remarketing prior to maturity. See
Note 5 to Financial Statements for details concerning long-term debt
subject to mandatory tender for remarketing.
</FN>
CREDIT RISK -- Credit risk relates to the risk of loss that TXU Energy
may incur as a result of 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 ratings, 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
31
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
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.
CONCENTRATION OF CREDIT RISK
TXU Energy's gross exposure to credit risk represents trade accounts
receivable, commodity contract assets and derivative assets (See Note 13 to
Financial Statements).
A large share of gross assets subject to credit risk represent accounts
receivable from the retail sale of electricity and gas to residential and small
commercial customers. The risk of material loss from non-performance from these
customers is unlikely based upon historical experience. Reserves 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. The restructuring of the electric industry in Texas
effective January 1, 2002 increases the risk profile of TXU Energy in relation
to these customers; however, TXU Energy has the ability to take actions to
mitigate such customer risk, particularly with the change in the POLR rules (see
Note 9 to Financial Statements).
Most of the remaining trade accounts receivable are with large C&I
customers. TXU Energy's wholesale commodity contract counterparties include
major energy companies, financial institutions, gas and electric utilities,
independent power producers, oil and gas producers and energy trading companies.
The following table presents the distribution of credit exposure as of
December 31, 2002 for commodity contract assets, derivative assets and trade
accounts receivable from large C&I customers, by investment and noninvestment
grade, credit quality and maturity.
EXPOSURE BY MATURITY
--------------------
EXPOSURE
BEFORE GREATER
CREDIT CREDIT NET LESS THAN 2-5 THAN 5
COLLATERAL COLLATERAL EXPOSURE 2 YEARS YEARS YEARS TOTAL
---------- ---------- -------- ------- ----- ----- -----
Investment grade $ 821 $ (4) $ 817 $ 763 $ 50 $ 4 $ 817
Noninvestment grade 518 (151) 367 346 21 - 367
--- ---- --- --- -- --- ---
Totals $ 1,339 $ (155) $ 1,184 $ 1,109 $ 71 $ 4 $ 1,184
========== ========== ========== ========== ======= ======= =======
Investment grade 61% 3% 69% - - - -
Noninvestment grade 39% 97% 31% - - - -
The exposure to credit risk from these customers and counterparties,
excluding credit collateral, as of December 31, 2002, is $1.3 billion net of
standardized master netting contracts and agreements which 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 $1.2
billion. Of this amount, approximately 69% 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 exposure to credit risk 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 $1.2 billion at December 31, 2002. Additionally,
approximately 93% of the credit exposure, net of collateral held, has a maturity
32
date of less than two years. 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.
REGULATION AND RATES
RESTRUCTURING LEGISLATION -- See Note 9 to Financial Statements for a
description of the significant provisions of the legislation passed by the Texas
Legislature regarding the restructuring of the Texas electricity market to
provide for a transition to competition. The opening of the Texas market to
competition was effective January 1, 2002.
Under Commission rules, 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 4% from the level used to set the previous price-to-beat fuel factor rate.
On August 23, 2002, the Commission approved TXU Energy's request to increase the
fuel factor component of its price-to-beat rates. The fuel factor increase went
into effect for the billing cycle that began on August 26, 2002. As a result,
average monthly residential bills rose approximately 5%.
On January 24, 2003, TXU Energy filed a request with the Commission to
increase the fuel factor component of its price-to-beat rates based upon
significant increases in the market price of natural gas. If approved, this
request would increase the average monthly residential bill by approximately
12%. The Commission has 45 days to act on the request.
Through calendar year 2002, TXU Energy was the POLR for residential and
small non-residential customers in those areas of ERCOT where customer choice
was available outside its incumbent service areas, and was the POLR for large
non-residential customers in its incumbent service area. TXU Energy's POLR
contract expired on December 31, 2002. However, in August 2002, the Commission
adopted new rules that significantly changed POLR service. Under the new POLR
rules, instead of being transferred to the POLR, residential and small
non-residential customers served by affiliated REPs are subject to
disconnection. Non-paying residential and small non-residential customers served
by non-affiliated REPs are transferred to the affiliated REP. Non-paying large
non-residential 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 must decide whether all REPs should be permitted to disconnect all
non-paying customers. The new POLR rules are expected to result in reduced bad
debt expense beginning in 2003.
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 POLR, but was designated POLR
through lottery for small business and residential customers in certain West
Texas service areas and for small business customers in the Houston service
area.
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.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
The following risk factors are being presented in consideration of
industry practice with respect to disclosure of such information in filings
under the Securities Exchange Act of 1934, as amended.
Some important factors, in addition to others specifically addressed in
this MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS, that could have a material impact on TXU Energy's operations and
financial results, and could cause TXU Energy's actual results or outcomes to
33
differ materially from those discussed in the forward-looking statements
contained herein, include:
The competitive electric market in Texas is new. TXU Energy, the
Commission, ERCOT and other market participants have limited operating history
under the market framework created by the 1999 Restructuring Legislation. ERCOT
is the independent system operator that is responsible for maintaining reliable
operations of the bulk electric power supply system in the ERCOT region. Its
responsibilities include ensuring that information relating to a customer's
choice of REP is conveyed in a timely manner to anyone needing the information.
Some operational difficulties were encountered in the pilot program conducted in
2001 and are currently being experienced. Problems in the flow of information
between ERCOT, the T&D utilities and the REPs have resulted in delays in
switching customers from one REP to another and delays in billings to and
payments from customers. While the flow of information is improving, operational
problems in the new system and processes are still being worked out. If these
issues are not effectively addressed in a timely manner, TXU Energy's financial
results could be adversely affected.
Existing laws and regulations governing the market structure in Texas,
including the provisions of the 1999 Restructuring Legislation, could be
reconsidered, revised or reinterpreted, or new laws or regulations could be
adopted. Any changes to such laws or regulations could have a detrimental effect
on TXU Energy's business.
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 is subject to changes in laws or regulations, including the
Federal Power Act, as amended, the Public Utility Regulatory Policies Act of
1978, as amended, and the Public Utility Holding Company Act of 1935, as
amended, changing governmental policies and regulatory actions, including those
of the Commission, the NRC and the FERC, with respect to matters including, but
not limited to, implementation of the Settlement Plan, operation of nuclear
power facilities, operation and construction of other power generation
facilities, decommissioning costs, and present or prospective wholesale and
retail competition. Changes in regulations or imposition of additional
regulation may have an adverse impact on TXU Energy's results of operations.
TXU Energy is subject to the effects of new, or changes in, income tax
rates or policies and increases in taxes related to property, plant and
equipment and gross receipts and other taxes. Further, TXU Energy is subject to
audit and reversal of its tax positions by the Internal Revenue Service and
state taxing authorities.
TXU Energy is not guaranteed any rate of return on its capital
investments through mandated rates. TXU Energy markets and trades power,
including from its own power production facilities, as part of its wholesale
energy sales business and portfolio management operation. TXU Energy's expenses,
revenues and 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 markets 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. These factors could have a material adverse
impact on TXU Energy's revenues and results of operations.
Volatility in market prices for fuel and electricity may result from:
34
o severe or unexpected weather conditions,
o seasonality,
o changes in electricity usage,
o the current diminished liquidity in the wholesale power markets
as well as any future illiquidity in these 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 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 plant 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 plant 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 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
cannot cover the entire exposure of its assets or its positions to market price
volatility, and the coverage will vary over time. To the extent TXU Energy has
unhedged positions, fluctuating commodity prices can impact TXU Energy's results
of operations and financial position, either favorably or unfavorably. For
additional information regarding the accounting treatment for TXU Energy's
hedging and portfolio management activities, see Notes 2 and 12 to Financial
Statements. For additional information regarding the types of contracts and
activities of TXU Energy's wholesale energy sales business and portfolio
management operation, see the discussion above under - "Financial Condition,
Liquidity and Capital Resources - Qualitative and Quantitative Disclosures about
Market Risk."
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 work as planned and cannot
eliminate all the risks associated with these activities. As a result of these
and other factors, TXU Energy cannot predict with precision the impact that its
risk management decisions may have on its businesses, results of operations or
financial position. For information regarding TXU Energy's risk management
policies, see the discussion above under - "Financial Condition, Liquidity and
35
Capital Resources - Quantitative and Qualitative Disclosures about Market Risk -
Risk Oversight."
In connection with TXU Energy's portfolio management activities, TXU
Energy has guaranteed or indemnified the performance of a portion of the
obligations of its portfolio management subsidiaries. Some of these guarantees
and indemnities are for fixed amounts, others have a fixed maximum amount and
others do not specify a maximum amount. The obligations underlying these
guarantees and indemnities are recorded on TXU Energy's consolidated balance
sheet as both current and non-current commodity contract liabilities. These
obligations make up a significant portion of these line items. TXU Energy might
not be able to satisfy all of these guarantees and indemnification obligations
if they were to come due at the same time.
TXU Energy's portfolio management activities are exposed to the risk
that counterparties which 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 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. For information regarding TXU Energy's credit risk, see the
discussion above under - "Quantitative and Qualitative Disclosure About Market
Risk - Credit Risk" and Note 13 to Financial Statements.
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 long-term ratings, particularly below investment grade,
TXU Energy's borrowing costs would increase and its potential pool of investors
and funding sources would likely decrease, all of which would diminish its
financial results.
Most of TXU Energy's large customers, suppliers and counterparties
require sufficient creditworthiness in order to enter into transactions. If TXU
Energy's ratings were to decline to below investment grade, TXU Energy's costs
to operate its power and gas businesses would increase because counterparties
may require TXU Energy to post collateral in the form of cash-related
instruments. These increased costs would likely adversely affect TXU Energy's
financial results. If counterparties decline to do business with TXU Energy, its
business activities may suffer.
In addition, as discussed elsewhere in this Current Report on Form 8-K,
the terms of certain financing and other arrangements of US Holdings and TXU
Energy 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 equipment and pipelines, 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. Older generating equipment, even if
maintained in accordance with good engineering practices, may require
significant capital expenditures to keep it operating at peak efficiency. This
equipment is also likely to require periodic upgrading and improvement. The
increased starting and stopping of plant operations due to the volatility of the
competitive market is likely to increase maintenance requirements for certain of
TXU Energy's plants. Increased maintenance and capital expenditures, as well as
any unexpected failure to produce power, including failure caused by breakdown
or forced outage, could materially adversely affect TXU Energy's results of
operations and financial condition. Also, the cost of repairing damage to TXU
Energy's facilities due to storms, natural disasters, wars, terrorist acts and
other catastrophic events, in excess of reserves established for such repairs,
would adversely impact TXU Energy's revenues, operating and capital expenses and
results of operations. Further, TXU Energy's ability to successfully and timely
36
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 any or
all 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.
The ownership and operation of nuclear facilities, including TXU
Energy's ownership and operation of Comanche Peak, 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.
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 that
require a substantial increase in capital expenditures or that
result in increased operating or decommissioning costs could
materially adversely affect TXU Energy's results of operations
and financial condition.
o Nuclear Accident Risk - Although the safety record of Comanche
Peak and nuclear reactors generally has been very good, accidents
and other unforeseen problems have occurred both in the United
States 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.
In connection with the unbundling of US Holdings, Oncor acquired
regulatory assets (including regulatory assets related to US Holdings' power
production business) that are expected to be recovered through rates. In
addition, TXU Energy agreed to hold Oncor harmless for generation-related
liabilities. TXU Energy is also obligated to hold Oncor harmless from the
ongoing tax and other expenses resulting from securitization of
generation-related regulatory assets and from any refunding of excess mitigation
credits related to TXU Energy's power production assets. As of December 31,
2002, these matters were largely settled and TXU Energy had recorded $607
million of amounts due to Oncor for these purposes. Other unanticipated payments
by TXU Energy to Oncor to satisfy the obligation to hold Oncor harmless may have
a material adverse impact on TXU Energy's results of operations and financial
condition.
TXU Energy will be required to make payments (retail clawback) to Oncor
beginning in early 2004 unless the Commission determines that, on or prior to
January 1, 2004, 40% or more of the amount of electric power that was consumed
in 2000 by residential or small commercial customers, as applicable, within the
historical service territories of US Holdings and TXU SESCO is committed to be
served by REPs other than TXU Energy. Under the Settlement, if the 40% test is
not met and a payment is required, the amount of these payments would be $90
multiplied by the number of residential or small commercial customers, as the
case may be, that TXU Energy serves on January 1, 2004 in the historical service
territories of US Holdings and TXU SESCO, as the case may be, less the number of
new retail electric customers TXU Energy serves in other areas of Texas. As of
December 31, 2002, TXU Energy had approximately 2.7 million residential and
37
small commercial customers in the historical service territories of US Holdings
and TXU SESCO. Based on assumptions and estimates regarding the number of
customers expected in and out of territory, TXU Energy recorded an accrual for
retail clawback in 2002 of $185 million ($120 million after-tax). This accrual
is subject to adjustment as the actual measurement date approaches.
TXU Energy's power production business is subject to extensive
environmental regulation by federal, state and local 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. If any of these events occur, TXU
Energy's results of operations and financial condition could be materially
adversely affected.
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 it may be uneconomical for TXU Energy to install the
necessary equipment, which may cause TXU Energy to shut down those power
production units.
In addition, TXU Energy may be responsible for any on-site liabilities
associated with the environmental condition of its power production facilities
and natural gas assets 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. The
incurrence of a material liability, or the failure of the other party to meet
its indemnification obligations to TXU Energy, could have a material adverse
effect on TXU Energy's results of operations and financial condition.
On January 1, 2002, most retail customers in Texas of investor-owned
utilities, and those of any municipal utility and electric cooperative that
opted to participate in the competitive marketplace, became able to choose their
REP. On January 1, 2002, TXU Energy began to provide retail electric services to
all customers of US Holdings who did not take action to select another REP.
TXU Energy will not be permitted to offer electricity to residential
and small commercial customers in US Holdings' 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 each respective class of customers in that area is committed
to be served by REPs other than TXU Energy. Because TXU Energy will not be able
to compete for residential and small commercial customers on the basis of price
in the historical service territory of US Holdings, 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.
Other REPs will be allowed to offer electricity to TXU Energy's
residential and small commercial 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 non-bypassable charges and the
price that REP pays for power. The higher the amount of headroom for competitive
REPs, the more incentive those REPs should have to provide retail electric
services in a given market.
In addition, TXU Energy provides commodity and value-added energy
management services to the large C&I customers formerly served by US Holdings
who did not take action to select another REP beginning on January 1, 2002. TXU
Energy or any other REP can offer to provide services to these customers at any
negotiated price. TXU Energy believes that this market will be very competitive;
consequently, a significant number of these customers may choose to be served by
another REP, and any of these customers that select TXU Energy to be its
provider may subsequently decide to switch to another provider.
38
An affiliated REP 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. 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 is 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.
The results of TXU Energy's retail electric operations in US Holdings'
historical service territory will be 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 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 other Texas retail electric
market. Headroom may be a positive or negative number. If the amount of headroom
in its price-to-beat rate is a negative number, TXU Energy will be selling power
to its price-to-beat rate customers in the historical service territory of US
Holdings at prices below its costs of purchasing and delivering power to those
customers. If the amount of positive headroom for competitive REPs in its
price-to-beat rate is large, TXU Energy may lose customers to competitive REPs.
In April 2002, pursuant to Commission rules, TXU Energy filed a request
with the Commission to increase the fuel factor component of its price to beat.
On August 23, 2002, the Commission acted on this request, increasing TXU
Energy's price-to-beat rates for residential and small commercial customers by
slightly less than 5%. On January 24, 2003, TXU Energy again filed a request
with the Commission to increase the fuel factor component of its price-to-beat
rates based upon significant increases in the market price of natural gas. If
approved, this request would increase the average monthly residential bill by
approximately 12%. The Commission has 45 days from receipt of the request to act
on it. However, if TXU Energy's price- to-beat rate results in negative headroom
in the future, or if future adjustments to its price-to-beat rate are inadequate
to cover future increases in its costs to purchase power to serve its
price-to-beat rate customers, TXU Energy's business, results of operations and
financial condition could be materially adversely affected.
In most retail electric markets outside the historical service
territory of US Holdings, TXU Energy's principal competitor may be the local
incumbent utility company or its retail affiliate. The incumbent utilities 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 in both local and national markets, 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 T&D facilities owned and operated by Oncor and
other utilities to deliver the electricity it sells from its power production
facilities to its customers, as well as other REPs, who in turn deliver
electricity to their customers. If transmission capacity is inadequate, TXU
Energy's ability to sell and deliver electricity may be hindered, it may have to
forego 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 service other customers, resulting in lower gross margins. 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.
Additionally, in Texas, TXU Energy is dependent on the local T&D
utilities for the reading of its customers' energy meters. TXU Energy is
required to rely on the local utility or, in some cases, the independent
transmission system operator, to provide TXU Energy with its customers'
information regarding energy usage, and it is limited in its ability to confirm
the accuracy of the information. Inaccurate information provided to TXU Energy
by the local T&D utilities or independent transmission system operators could
have a material adverse impact on its business and results of operations.
39
In connection with any future entry into retail electric markets
outside of Texas, TXU Energy may be required under the regulatory structure of
the relevant market to rely on utilities with which it may be competing to
perform billing and collection services, the services and functions described in
the prior paragraph or other services and functions. In addition, TXU Energy may
be required to enter into agreements with local incumbent utilities for use of
the local distribution systems and for the creation and operation of functional
interfaces necessary for TXU Energy to serve its customers. Any delay in these
negotiations or TXU Energy's inability to enter into reasonable agreements could
delay or negatively impact its ability to serve customers in those markets.
TXU Energy offers its customers a bundle of services that include, at a
minimum, the electric commodity itself plus transmission, distribution and
related services. To the extent that 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, differ from TXU
Energy's underlying cost to obtain the commodities or services, its results of
operations would be adversely affected. TXU Energy will encounter similar risks
in selling bundled services that include non-energy-related services, such as
telecommunications, facilities management, and the like. In some cases, TXU
Energy has little, if any, prior experience in selling these non-energy-related
services.
The 1999 Restructuring Legislation required the Commission to determine
procedures and criteria for designating REPs to serve as the provider of last
resort (POLR) in areas of the state in which retail competition is in effect.
Through calendar year 2002, TXU Energy was the POLR for residential and small
non-residential customers in those areas of ERCOT where customer choice was
available outside its incumbent service areas, and was the POLR for large
non-residential customers in its incumbent service area. TXU Energy's POLR
contract expired on December 31, 2002. However, in August 2002, the Commission
adopted new rules that significantly changed POLR service. Under the new POLR
rules, instead of being transferred to the POLR, non-paying residential and
small non-residential customers served by affiliated REPs are subject to
disconnection. Non-paying residential and small non-residential customers served
by non-affiliated REPs are transferred to the affiliated REP. Non-paying large
non-residential 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 must decide whether all REPs should be permitted to disconnect all
non-paying customers. The new POLR rules are expected to result in reduced bad
debts expense beginning in 2003.
Through a competitive bid process, the Commission selected a POLR
provider to serve for a two-year term beginning January 1, 2003, for several
areas within the State. In areas for which no bids were submitted, the
Commission selected the POLR by lottery. TXU Energy did not bid to be the POLR
in any area, but was designated POLR through lottery for small business and
residential customers in certain West Texas service areas and for small business
customers in the Houston service area. Under the new rules, as an affiliated
REP, TXU Energy may have to temporarily provide electric service to some
customers that are unable to pay their electric bills. If the number of such
customers is significant and TXU Energy is delayed in terminating electric
service to those customers, its results of operations may be materially
adversely affected. TXU Energy cannot be sure whether the structure of POLR
service and obligations will change further, how it will change or what effect,
if any, any further changes would have on the financial condition, results of
operations or cash flows of TXU Energy.
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 work as planned. Delays
in the perfection of these systems and processes and any related increase in
costs could have a material adverse impact on TXU Energy's business and results
of operations.
Research and development activities are ongoing to improve existing and
alternative technologies to produce electricity, including gas turbines, fuel
cells, microturbines and photovoltaic (solar) cells. It is possible that
advances in these or other alternative technologies will reduce the costs of
electricity production from these technologies to a level that will enable these
technologies to compete effectively with electricity production from traditional
power plants like TXU Energy's. While demand for electric energy services is
generally increasing throughout the United States, 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
40
has facilities will likely increase the competitiveness of the wholesale power
market in those regions, which could have a material adverse effect on its
businesses, results of operations and financial condition. In addition, the
market value of TXU Energy's power production assets may be significantly
reduced. In addition, electricity demand could be reduced by increased
conservation efforts and advances in technology, which could likewise
significantly reduce the value of TXU Energy's power production assets. Changes
in technology could also alter the channels through which retail electric
customers buy electricity.
TXU Energy is subject to employee workforce factors, including loss or
retirement of key executives, availability of qualified personnel, collective
bargaining agreements with union employees or work stoppage.
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 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.
Because TXU Energy is a holding company, its obligations to its
creditors are structurally subordinated to all existing and future liabilities
and any future preferred stock 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 stock. 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. As of December 31, 2002, TXU Energy's
consolidated subsidiaries had $120 million of outstanding debt.
Subject to restrictions contained in TXU Energy's financing
arrangements, TXU Energy's subsidiaries may incur additional indebtedness and
other liabilities.
TXU Energy relies on access to financial markets as a significant
source of liquidity for capital requirements not satisfied by 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 continued inability to access commercial paper markets;
o a deterioration of TXU Energy's credit or a reduction in TXU
Energy's credit ratings or the credit ratings of TXU Corp. or TXU
Corp.'s other subsidiaries;
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 continued 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
business that restrict TXU Energy's ability to access its
liquidity facilities.
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
likely increase its capital costs. Further, concerns on the part of
counterparties regarding TXU Energy's liquidity and credit could limit its
portfolio management activities.
41
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. Any such new accounting standards could negatively impact reported
financial results.
TXU Corp. is subject to costs and other effects of legal and
administrative proceedings, settlements, investigations and claims. Since
October 2002, at least twenty-five lawsuits have been filed in federal and state
courts in Texas against TXU Corp. and various of its officers, directors and
underwriters. If any of these suits results in a substantial monetary judgment
against TXU Corp. or such officers and directors, or is settled on unfavorable
terms, TXU Corp.'s financial results could be adversely affected.
In addition, TXU Corp. is unable to predict whether its decision to
exit all of its operations in Europe might result in lawsuits by the creditors
of or others associated with TXU Europe. If any such lawsuit were filed and
resulted in a substantial monetary judgment against TXU Corp. or were settled on
unfavorable terms, TXU Corp.'s financial results could be adversely affected.
Since TXU Corp. is a holding company, any substantial costs relating to
these matters would likely be funded in whole or in part using cash generated by
its subsidiaries, including TXU Energy. The reallocation of TXU Energy's capital
to fund such costs could have an adverse impact on TXU Energy's business and
financial condition.
TXU Energy is an indirect, wholly-owned subsidiary of TXU Corp. and a
direct, wholly-owned subsidiary of US Holdings. TXU Corp. and US Holdings are
not obligated to provide any loans, further equity contributions or other
funding to TXU Energy or any of its subsidiaries. TXU Energy must compete with
all of TXU Corp.'s and US Holdings' other subsidiaries for capital and other
resources.
As a member of this corporate group, TXU Energy operates within
policies, including dividend and affiliate lending policies, established by TXU
Corp. These policies may influence the operations and cash reserves of TXU
Energy in a manner that is unfavorable to creditors of TXU Energy.
A lack of necessary capital and cash reserves could adversely impact
TXU Energy's growth plans, its ability to raise additional debt and the
evaluation of its creditworthiness by counterparties and rating agencies.
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. The risks and uncertainties associated
with these additional issues could impair TXU Energy's businesses in the future.
Reference is made to the discussion under Liquidity and Capital Resources.
42
INDEPENDENT AUDITORS' REPORT
TXU ENERGY COMPANY LLC:
We have audited the accompanying consolidated balance sheets of TXU Energy
Company LLC (TXU Energy) and subsidiaries as of December 31, 2002 and 2001, and
the related statements of consolidated income, comprehensive income, cash flows
and member interests for each of the three years in the period ended December
31, 2002. 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, 2002 and 2001, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 2 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
February 14, 2003
43
TXU ENERGY COMPANY LLC
STATEMENTS OF CONSOLIDATED INCOME
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
MILLIONS OF DOLLARS
Operating revenues............................................ $ 7,738 $ 7,458 $ 7,449
--------- --------- ---------
Costs and expenses:
Cost of energy sold and delivery fees...................... 4,803 4,802 5,101
Operating costs............................................ 747 708 673
Depreciation and amortization.............................. 438 397 391
Selling, general and administrative expenses............... 842 365 248
Franchise and revenue-based taxes.......................... 121 15 16
Other income............................................... (33) (3) (32)
Other deductions........................................... 254 50 6
Interest income............................................ (10) (38) (6)
Interest expense and other charges......................... 216 223 257
--------- --------- ---------
Total costs and expenses............................... 7,378 6,519 6,654
Income before income taxes and extraordinary loss............. 360 939 795
Income tax expense............................................ 90 279 219
--------- --------- ---------
Income before extraordinary loss.............................. 270 660 576
Extraordinary loss, net of income tax......................... - (153) -
--------- --------- ---------
Net income.................................................... $ 270 $ 507 $ 576
========= ========= =========
STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
MILLIONS OF DOLLARS
Net income.................................................. $ 270 $ 507 $ 576
Other comprehensive income (loss)--
Net change during period, net of tax effects:
Minimum pension liability adjustments (net of tax
benefit of $21)........................................ (39) - -
Cash flow hedges:
Net change in fair value of derivatives
(net of tax benefit of $69 and expense of $9) (128) 16 -
Amounts realized in earnings during the period (net
of tax benefit of $8)................................ (14) - -
--------- --------- ---------
Total.................................................. (181) 16 -
--------- --------- ---------
Comprehensive income........................................ $ 89 $ 523 $ 576
========= ========= =========
See Notes to Financial Statements.
44
TXU ENERGY COMPANY LLC
STATEMENTS OF CONSOLIDATED CASH FLOWS
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
MILLIONS OF DOLLARS
Cash flows-- operating activities
Net income.............................................................. $ 270 $ 507 $576
Adjustments to reconcile net income to cash provided by operating activities:
Extraordinary loss, net of tax effect.............................. - 153 -
Depreciation and amortization .................................. 502 508 514
Deferred income taxes and investment tax credits-- net ............ (90) (155) 164
Gains from sale of assets.......................................... (30) - (30)
Reduction of revenues for earnings in excess of regulatory earnings cap - 34 305
Unrealized mark-to-market commodity contract valuation losses/(gains) 72 (314) 19
Asset impairment................................................... 253 - -
Retail clawback accrual............................................ 185 - -
Over/(under) recovered fuel costs.................................. - 568 (813)
Changes in operating assets and liabilities:
Affiliate accounts receivable/payable-- net.................. 216 9 37
Accounts receivable - trade................................... (450) 240 (799)
Inventories................................................... (42) (4) 11
Accounts payable - trade...................................... 111 (630) 852
Margin deposits .............................................. - 227 (225)
Commodity contract assets and liabilities-- net............... (11) (31) 25
Other assets....................................................... (53) (32) (2)
Other liabilities............................................. 101 92 36
------ ------- -------
Cash provided by operating activities..................... 1,034 1,172 670
----- ----- ------
Cash flows-- financing activities
Issuances of long-term debt............................................. 811 2,788 65
Retirements/repurchases of securities:
Subsidiary senior notes............................................ - - (100)
Debt allocated from US Holdings.................................... (1,683) (2,420) (415)
Distribution paid to parent............................................. (777) - -
Repurchase of member interests.......................................... - (404) (553)
Net change in advances from affiliates.................................. 1,169 (568) 766
Decrease in note payable to Oncor related to
a regulatory liability .............................................. (180) - -
Increase (decrease) in notes payable to banks........................... 282 - (9)
Debt premium, discount, financing, reacquisition expenses and other..... (29) (161) (6)
------- ------- --------
Cash used in financing activities....................... (407) (765) (252)
------ ------- ------
Cash flows-- investing activities
Capital expenditures................................................... (274) (330) (264)
Acquisition of a business.............................................. (36) - -
Nuclear fuel........................................................... (52) (39) (87)
Proceeds from sale of assets........................................... 443 - 5
Other.................................................................. (125) (37) (58)
-------- -------- --------
Cash used in investing activities........................ (44) (406) (404)
-------- -------- --------
Net change in cash and cash equivalents...................................... 583 1 14
Cash and cash equivalents-- beginning balance................................ 20 19 5
------- ------- --------
Cash and cash equivalents-- ending balance................................... $ 603 $ 20 $ 19
====== ======= =======
See Notes to Financial Statements.
45
TXU ENERGY COMPANY LLC
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
------------
2002 2001
---- ----
MILLIONS OF DOLLARS
Current assets:
Cash and cash equivalents........................................................... $ 603 $ 20
Accounts receivable - trade......................................................... 1,331 808
Inventories......................................................................... 298 259
Commodity contract assets........................................................... 1,298 848
Other current assets................................................................ 180 120
---------- ----------
Total current assets............................................................. 3,710 2,055
Goodwill .......................................................................... 533 65
Investments........................................................................... 462 692
Property, plant and equipment-- net................................................... 10,127 10,354
Commodity contract assets............................................................. 476 389
Cash flow hedges and other derivative assets......................................... 14 31
Other noncurrent assets............................................................... 108 71
---------- -----------
Total assets..................................................................... $15,430 $13,657
======= =======
LIABILITIES AND MEMBER INTERESTS
Current liabilities:
Notes payable - banks............................................................... $ 282 $ -
Long-term debt due currently........................................................ 73 123
Advances from affiliates............................................................ 1,329 250
Due to Oncor Electric Delivery Company.............................................. 170 170
Accounts payable:
Affiliates....................................................................... 248 25
Trade............................................................................ 754 612
Commodity contract liabilities...................................................... 1,138 630
Taxes accrued....................................................................... 164 155
Other current liabilities........................................................... 555 224
--------- ---------
Total current liabilities........................................................ 4,713 2,189
Accumulated deferred income taxes...................................................... 1,931 2,125
Investment tax credits................................................................. 376 397
Commodity contract liabilities......................................................... 320 236
Cash flow hedges and other derivative liabilities...................................... 150 2
Other noncurrent liabilities and deferred credits...................................... 852 425
Due to Oncor Electric Delivery Company................................................. 437 617
Long-term debt, less amounts due currently............................................. 2,378 3,454
Commitments and contingencies (Note 10)
Member interests (Note 13)............................................................. 4,273 4,212
--------- ---------
Total liabilities and member interests........................................... $15,430 $13,657
======== =======
See Notes to Financial Statements.
46
TXU ENERGY COMPANY LLC
STATEMENTS OF CONSOLIDATED MEMBER INTERESTS
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
MILLIONS OF DOLLARS
Member interests:
Capital accounts:
Balance at beginning of year............................... $4,196 $4,121 $4,098
Net income............................................. 270 507 576
Reduction in member interest - amount of repurchases of common
stock of US Holdings allocated to TXU Energy...... - (404) (553)
Distribution paid to parent............................ (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..................................... 4,438 4,196 4,121
------- ------- -------
Accumulated other comprehensive income, net of tax effects:
Minimum Pension Liability Adjustment:
Balance at beginning of year .............................. - - -
Change during the year................................. (39) - -
--------- -------- --------
Balance at end of year..................................... (39) - -
--------- -------- --------
Cash flow hedges (SFAS No. 133):
Balance at beginning of year............................... 16 - -
Change during the year................................. (142) 16 -
-------- --------- --------
Balance at end of year..................................... (126) 16 -
-------- --------- --------
Total member interests.................. $4,273 $4,212 $4,121
====== ====== ======
See Notes to Financial Statements.
47
TXU ENERGY COMPANY LLC
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS
TXU Energy Company LLC (TXU Energy) was formed as a Delaware limited
liability company in the fourth quarter of 2001. TXU Energy was created as a
result of the deregulation of the electric utility industry in Texas, which
became effective January 1, 2002. TXU Energy is a wholly-owned subsidiary of TXU
US Holdings Company (US Holdings), formerly TXU Electric Company, which is a
wholly-owned subsidiary of TXU Corp. TXU Energy's operations have been conducted
principally through the following subsidiaries since January 1, 2002: TXU
Generation Holdings Company LLC; TXU Portfolio Management Company LP; TXU Energy
Retail Company LP; TXU Energy Solutions Company LP; TXU Fuel Company; and two
coal mining subsidiaries.
TXU Energy is an energy company that engages in power production
(generation), wholesale energy sales, retail energy sales and related services,
as well as portfolio management, including risk management and certain trading
activities. TXU Energy is managed as a single, integrated energy business;
consequently, there are no separate reportable business segments.
BUSINESS RESTRUCTURING -- Legislation was passed during the 1999
session of the Texas Legislature that restructured the electric utility industry
in Texas (1999 Restructuring Legislation). As a result, TXU Corp. restructured
certain of its United States (US) businesses as of January 1, 2002. In order to
satisfy its obligations to unbundle its business pursuant to the 1999
Restructuring Legislation and consistent with its business separation plan as
approved by the Public Utility Commission of Texas (Commission), as of January
1, 2002, US Holdings transferred:
o its T&D assets to Oncor Electric Delivery Company (Oncor), which
is a utility regulated by the Commission and a wholly-owned
subsidiary of US Holdings,
o its unregulated electricity (power) generation assets to
subsidiaries of TXU Energy, which is the new competitive
business, and
o its retail customers to an unregulated subsidiary retail electric
provider (REP) of TXU Energy.
In addition, as of January 1, 2002, US Holdings acquired the following
businesses from within the TXU Corp. system and transferred them to TXU Energy:
the REP of TXU SESCO Company; the wholesale portfolio management and the
unregulated commercial and industrial retail gas operations of TXU Gas Company
(TXU Gas); and the energy management services businesses and other affiliates of
TXU Corp., including the fuel procurement and coal mining businesses that
service the generation operations.
The relationships of the entities affected by the restructuring 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 (Business Separation Agreement).
A settlement of outstanding issues and other proceedings related to
implementation of the 1999 Restructuring Legislation received final approval in
February 2003. (See Note 9 for further discussion.)
BUSINESS CHANGES
ACQUISITIONS -- In April 2002, TXU Energy acquired a cogeneration and
wholesale energy production business in New Jersey for $36 million in cash. The
acquisition, which was accounted for as a purchase business combination,
included a 122 megawatt (MW) combined-cycle power production facility and
various contracts, including electric supply and gas transportation agreements.
48
The results of operations of the acquired business are reflected in the
financial statements from its acquisition date.
GENERATION PLANT ACQUISITIONS AND DISPOSITIONS -- In May 2002, TXU
Energy acquired a 260 megawatt 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 its Handley and
Mountain Creek generating plants in the Dallas-Fort Worth area with total plant
capacity of 2,334 MW for $443 million in cash, including an above-market price
tolling agreement with a fair value of $190 million. The tolling agreement
provides for TXU Energy to purchase power during the summer months through 2006.
A pretax gain on the sale of $146 million, net of the effects of the
above-market 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.
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION -- The businesses that were combined to form TXU
Energy were operated by subsidiaries of TXU Corp. under common ownership and
control prior to January 1, 2002. The financial information for power generation
and certain retail operations included in the 2001 and 2000 combined financial
statements was derived from the historical financial statements of US Holdings.
The financial information for the wholesale portfolio management activities and
the unregulated commercial and industrial retail gas business included in the
2001 and 2000 combined financial statements was derived from the historical
financial statements of TXU Gas. The financial information for the fuel and coal
mining subsidiaries and the energy services businesses included in the 2001 and
2000 combined financial statements was derived from the separate historical
financial statements of those entities. The financial information for the REP of
TXU SESCO Company was derived from the historical financial statements of TXU
SESCO Company.
Reasonable allocation methodologies were used to unbundle the financial
statements of US Holdings for 2001 and 2000 between its power generation and T&D
operations. Allocation of revenues reflected consideration of return on invested
capital, which continues to be regulated for the T&D operations. US Holdings
maintained expense accounts for each of its component operations. Costs of
energy and expenses related to operation 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 common expenses, assets and liabilities between US Holdings' power
generation and T&D operations. Interest and other financing costs were
determined based upon debt allocated. Allocations reflected in the financial
information for 2001 and 2000 did not necessarily result in amounts reported in
individual line items that are comparable to actual results in 2002.
The financial statements for the period beginning January 1, 2002,
present TXU Energy's actual consolidated operating results. Had TXU Energy
actually existed as a separate entity prior to January 1, 2002, its results of
operation and financial position could have differed materially from those
included in the financial statements for such periods prior to January 1, 2002.
Effective January 1, 2002, in connection with the transfer of US Holdings'
retail customers to an unregulated subsidiary REP of TXU Energy, certain assets
and liabilities related to the retail function, which was previously integrated
with Oncor's regulated operations, were transferred from Oncor to TXU Energy.
The consolidated financial statements of TXU Energy have been prepared
in accordance with accounting principles generally accepted in the US (US GAAP)
and, except for reclassifications made in accordance with Emerging Issues Task
Force (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" and the adoption of Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets", and
inclusion of delivery fees, discussed below, on the same basis as the audited
financial statements included in the US Holdings Current Report on Form 8-K
filed April 17, 2002 for TXU Energy. 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
49
included therein. All intercompany items and transactions have been eliminated
in consolidation. All dollar amounts in the financial statements and notes to
financial statements are stated in millions of US dollars unless otherwise
indicated.
TXU Energy has adopted a new income statement format. Certain
previously reported amounts have been reclassified to conform to current
classifications. The following summarizes the components of the new line items:
Cost of energy sold and delivery fees -- Includes costs of nuclear,
coal and gas fuel used by generation plants, energy purchased for resale and
delivery fees paid to electricity delivery businesses.
Operating costs -- Includes all labor and overhead costs incurred to
perform activities related to electricity generation.
Selling, general and administrative expenses -- Includes all labor and
related overhead costs of support services such as finance, accounting,
portfolio management (trading), customer billing, customer service, collections,
marketing, information technology, legal, regulatory, environmental and
corporate facilities.
Franchise and revenue-based taxes -- Includes state and local gross
receipts tax and franchise taxes.
PRESENTATION OF REVENUES -- In June 2002, the EITF reached a consensus
on certain aspects of Issue No. 02-3 regarding the presentation of trading
activities in the statement of income. The new rules were effective for TXU
Energy on July 1, 2002, and required that all trading contracts (as defined by
EITF Issue 98-10, "Accounting for Contracts Involved in Energy Trading and Risk
Management Activities"), whether or not physically settled, be recorded net upon
settlement, rather than gross as a sale and cost of sale. TXU Energy has
historically recorded financial contracts net, but has recorded those contracts
that provide for physical delivery gross upon settlement. Prior period amounts
have been reclassified to conform to this new reporting requirement.
Transactions affected by the new reporting requirements represent contracts that
provided for physical delivery but were settled financially without delivery, as
well as contracts physically settled but classified as trading activities. With
the rescission of EITF Issue No. 98-10 (see discussion below under Financial
Instruments and Mark-to-Market Accounting), the EITF modified Issue No. 02-3 to
apply to contracts that are derivatives and entered into for trading purposes
effective January 1, 2003. The new reporting requirements have no impact on TXU
Energy's gross margin, net income or cash provided by operating activities.
(Also see Changes in Accounting Standards below.)
Effective January 1, 2002, TXU Energy incurs electricity delivery fees
charged by Oncor and other T&D utilities, which TXU Energy includes in billings
to its large commercial and industrial (C&I) customers. For residential and
small business customers, the price-to-beat rates include a delivery component,
but such billed amounts are not necessarily equivalent to delivery fees incurred
by TXU Energy. Prior revenues as previously reported represented only the
revenues associated with generation activity, as such revenues were derived by
unbundling the revenues of US Holdings into a generation component and a
delivery component. The delivery component revenues have been included in TXU
Energy's revenues and cost of energy sold for the year ended December 31, 2001
and 2000. TXU Energy's gross margin for those years is not affected by the
inclusion of these electricity delivery fees.
The table below summarizes the impact on TXU Energy's operating
revenues and cost of energy sold for prior years of the new reporting rules
under EITF Issue No. 02-3 and the inclusion of delivery fees.
YEAR ENDED DECEMBER 31,
-----------------------
2001 2000
---- ----
Operating revenues as previously reported................... $ 10,867 $ 10,858
Electricity delivery fees................................... 1,750 1,909
Cost of energy sold and delivery fees netted with revenues.. (5,159) (5,318)
---------- ----------
Operating revenues after reclassification................... $ 7,458 $ 7,449
========= =========
Cost of energy sold and delivery fees as previously reported $ 8,211 $ 8,510
Electricity delivery fees................................... 1,750 1,909
Cost of energy sold and delivery fees netted with revenues.. (5,159) (5,318)
---------- ----------
Cost of energy sold and delivery fees after reclassification $ 4,802 $ 5,101
========= =========
50
USE OF ESTIMATES -- 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 to previous estimates during the
current year.
INVESTMENTS --Deposits in an external trust fund for nuclear
decommissioning are carried at fair value in the balance sheet in investments
with the changes in fair value recorded as a liability, to reflect the statutory
nature of the trust. Investments in non-utility properties are primarily assets
to be developed and are carried at cost, subject to periodic impairment
valuation. 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 stock or
partnership interest, are accounted for under the equity method. (See Note 3 -
Investments.)
GOODWILL AND INTANGIBLE ASSETS -- Goodwill represents the excess of the
purchase price paid over the estimated fair value of the assets acquired and
liabilities assumed for each company acquired and was amortized over a range of
20 to 40 years.
In connection with the restructuring of certain of TXU Corp.'s
businesses effective January 1, 2002, the wholesale portfolio management and the
unregulated C&I retail gas operations of TXU Gas were acquired by TXU Energy.
Included in the balance sheet of TXU Gas at December 31, 2001 was $773 million
of goodwill, net of amortization, arising from TXU Corp.'s 1997 acquisition of
ENSERCH Corporation. As a result of TXU Energy's acquisition of the businesses
from TXU Gas, which were originally part of ENSERCH Corporation, and the
adoption of SFAS No. 142, $468 million of goodwill, net of $56 million of
accumulated amortization, has been allocated to these businesses and reflected
in the December 31, 2002 balance sheet of TXU Energy.
SFAS No. 142 became effective for TXU Energy on January 1, 2002. SFAS
No. 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.
In addition, SFAS No. 142 required completion of a transitional
goodwill impairment test within six months from the date of adoption. It
established a new method of testing goodwill for impairment on an annual basis,
or on an interim basis if an event occurs or circumstances change that would
reduce the fair value of a reporting unit below its carrying value. TXU Energy
completed the transitional impairment test in the second quarter of 2002, the
results of which indicated no impairment of goodwill at that time. In 2002, no
impairment resulted from the additional evaluation performed as of October 1,
which has been selected as the annual impairment test date.
SFAS No. 142 also requires additional disclosures regarding intangible
assets (other than goodwill) that are amortized or not amortized:
AS DECEMBER 31, 2002 AS OF DECEMBER 31, 2001
-------------------- -----------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION NET AMOUNT AMORTIZATION NET
------ ------------ --- ------ ------------ ---
Amortized intangible assets
Capitalized software $ 220 $ 78 $ 142 $ 100 $ 35 $ 65
Land easements 12 9 3 12 9 3
Mineral rights and other 31 20 11 31 19 12
-------- -------- --------- -------- ----- ---------
Total $ 263 $ 107 $ 156 $ 143 $ 63 $ 80
======== ======== ========= ======= ===== =========
Amortized intangible asset balances are classified as property, plant
and equipment in the balance sheet. TXU Energy has no intangible assets (other
than goodwill) that are not amortized.
51
Aggregate TXU Energy amortization expense for intangible assets,
excluding goodwill, for the years ended December 31, 2002, 2001 and 2000 was $44
million, $4 million and $1 million, respectively; estimated amounts for the next
five years are as follows:
AMORTIZATION
YEAR EXPENSE
- ---- -------
2003............................................... $ 32
2004............................................... 27
2005............................................... 27
2006............................................... 24
2007............................................... 18
At December 31, 2002 and 2001, goodwill is stated net of accumulated
amortization of $60 million and $4 million, respectively.
PROPERTY, PLANT AND EQUIPMENT -- Generation utility plant is stated at
original cost. 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.
VALUATION 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 market value. Fair value is determined
primarily by available market valuations or, if applicable, discounted cash
flows. (See Changes in Accounting Standards below.)
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 depressed wholesale electricity market conditions and
reduced planned developmental capital spending. Fair value was determined based
on current appraisals of property and equipment. The charge is reported in the
"Other deductions" caption of the statement of income. As the writedown is based
on current estimates, the remaining carrying value of the projects of $113
million is subject to further adjustment should estimates of recoverable value
change.
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 market risks related to
changes in commodity prices, including costs of fuel for generation of power, as
well as changes in interest rates. These financial instruments are accounted for
in accordance with SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities" and, prior to October 26, 2002, EITF Issue No. 98-10. The
majority of financial instruments entered into by TXU Energy are derivatives as
defined in SFAS No. 133.
SFAS No. 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 No. 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.
Any hedge ineffectiveness is recorded in earnings. Amounts are reclassified from
other comprehensive income to earnings as the underlying transactions occur and
realized gains and losses are recognized in earnings. As of December 31, 2002,
TXU Energy had no fair value hedges.
TXU Energy documents designated commodity and debt-related 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 No.
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.
52
Pursuant to SFAS No. 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.
Financial instruments entered into in connection with indebtedness to
manage interest rate risk are generally accounted for as cash flow hedges in
accordance with SFAS No. 133.
EITF Issue No. 98-10 required mark-to-market accounting for
energy-related contracts, whether or not derivatives under SFAS No. 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 Issue No. 98-10 and were therefore marked to market.
On October 25, 2002, the EITF rescinded EITF Issue No. 98-10, which
required mark-to-market accounting for all trading activities. Pursuant to this
rescission, only contracts that are derivatives under SFAS No. 133 will be
subject to mark-to-market accounting. Contracts that may not be derivatives
under SFAS No. 133, but were marked-to-market under EITF Issue No. 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 approximately $100 million ($65 million after-tax) is expected to be
reported as a cumulative effect of an accounting change in the first quarter of
2003. The expected cumulative effect adjustment represents the net gains
previously recognized for these contracts under mark-to-market accounting.
In June 2002, in connection with the EITF's consensus on Issue No.
02-03, 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. If the C&I contracts that TXU Energy enters into do not meet
the revised guidance, then income from such contracts will be recognized on a
settlement basis.
The majority of financial instruments entered into for the purpose of
managing risk or optimizing margins in meeting the energy demands of customers
are derivatives and will continue to be subject to SFAS No. 133.
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.
For those periods where quoted market prices are not available, forward
price curves are developed based on the available information or through the use
of industry accepted modeling techniques and practices based on market
fundamentals (e.g., supply/demand, replacement cost, etc.). As a matter of
policy, however, TXU Energy generally does not recognize any income or loss from
the illiquid periods.
REVENUE RECOGNITION -- TXU Energy generally records revenues for retail
and wholesale energy sales under the accrual method, with the exception of
certain large C&I contracts that are derivatives as defined in SFAS No. 133 and
have therefore been marked to market. Retail electric and gas revenues are
recognized when the commodity is provided to the customer 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.
53
As a result of the opening of the Texas market to competition and
related changes in systems and processes within ERCOT, adjustments are recorded
for accounts receivable from or payable to ERCOT related to system balancing and
are recorded net in revenues. Such balances reflect estimates of volumetric data
and are subject to adjustment as data is reconciled and final settlements are
received.
Revenues reflect unrealized gains and losses related to large C&I
customer contracts, including unrealized gains recorded upon inception of these
contracts. Results of wholesale portfolio management activities, which represent
realized and unrealized gains and losses from transacting in energy-related
contracts, are also reported as a component of revenues. Also see discussion of
Financial Instruments and Mark-To-Market Accounting above.
The historical financial statements for periods prior to 2002 included
adjustments made to revenues of TXU Energy 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 rate amounts are
applied prospectively.
DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT -- Depreciation of TXU
Energy's property, plant and equipment is generally calculated on a
straight-line basis over the estimated service lives of the properties.
Depreciation also includes an amount for decommissioning costs for the Comanche
Peak nuclear powered electric generating plant, which is being accrued over the
lives of the units. Depreciation as a percentage of average depreciable property
for TXU Energy approximated 2.6% for 2002, 2.7% for 2001 and 2.6% for 2000.
TXU Energy capitalizes computer software costs in accordance with
American Institute of Certified Public Accountants (AICPA) Statement of Position
98-1. "Accounting for the Cost of Computer Software Developed or Obtained for
Internal Use". These costs are being amortized over periods ranging from three
to ten years.
MAJOR MAINTENANCE -- Major maintenance outage costs related to nuclear
fuel reloads are charged to expense as incurred.
AMORTIZATION OF NUCLEAR FUEL -- The amortization of nuclear fuel in the
reactors (net of regulatory disallowances) is calculated on the
units-of-production method and is included in cost of energy sold.
FRANCHISE AND REVENUE-BASED TAXES -- Franchise and revenue-based taxes
such as gross receipts taxes are generally not a "pass through" item such as
sales and excise taxes. Gross receipts taxes are assessed to TXU Energy 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 Energy is included in the consolidated federal
income tax return of TXU Corp. and its subsidiary companies. TXU Energy uses the
separate return method to compute its income tax provision. Because of the
alternative minimum tax (AMT), differences may arise between the consolidated
federal income tax liability of TXU Corp. and the aggregated separate tax
liability of the group members. In instances where this occurs, the difference
is allocated pro-rata to those companies that generated AMT on a separate
company basis. 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.
GAINS/LOSSES ON EXTINGUISHMENTS OF DEBT-- Gains and losses on
reacquired debt are recognized in the Statement of Income as incurred in
accordance with SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt." (See Changes in Accounting Standards below.)
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.
54
CHANGES IN ACCOUNTING STANDARDS -- On October 25, 2002, the EITF
rescinded EITF Issue No. 98-10, which required mark-to-market accounting for all
trading activities. (See Financial Instruments and Mark-To-Market Accounting
above.)
SFAS No. 143, "Accounting for Asset Retirement Obligations", became
effective on January 1, 2003. SFAS No. 143 requires entities to record the fair
value of a legal liability for an asset retirement obligation in the period in
which it is incurred. When a new liability is recorded beginning in 2003, the
entity will capitalize the net present value of the liability by increasing the
carrying amount of the related long-lived asset. The liability is accreted each
period, and the capitalized cost is depreciated over the useful life of the
related asset. Legal liabilities identified by TXU Energy relate primarily to
nuclear decommissioning and reclamation of lands mined for lignite.
Prior to January 2003, TXU Energy recorded liabilities for nuclear
decommissioning and for land reclamation in accumulated depreciation. Upon
adoption of SFAS No. 143, TXU Energy will reclassify $271 million previously
recorded in accumulated depreciation and record the related liability. TXU
Energy has not previously recorded costs of any other asset retirement
obligations that require recognition upon adoption.
With respect to nuclear decommissioning costs, TXU Energy believes that
the adoption of SFAS No. 143 results primarily in timing differences in the
recognition of legal asset retirement costs that TXU Energy is currently
recovering, as Oncor recovers decommissioning fees from REPs on behalf of TXU
Energy, and will be deferring such differences through the regulatory process as
described in Note 9. The impact of adopting SFAS No. 143 is not expected to be
significant to TXU Energy's earnings and financial condition.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", became effective on January 1, 2002. SFAS No. 144 establishes a single
accounting model, based on the framework established in SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of", for long-lived assets to be disposed of by sale, resolves
significant implementation issues related to SFAS No. 121 and establishes new
rules for reporting of discontinued operations.
SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," was issued in
April 2002 and became effective on January 1, 2003. One of the provisions of
this statement is the rescission of SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt." Any gain or loss on the early extinguishment of debt
that was classified as an extraordinary item in prior periods in accordance with
SFAS No. 4 will be reclassified if it does not meet the criteria of an
extraordinary item as defined by Accounting Principles Board Opinion 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."
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," was issued in June 2002 and became effective on January 1, 2003.
SFAS No. 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.
Financial Accounting Standards Board Interpretation (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 FASB Interpretation No. 34", was
issued in November 2002 and became effective for disclosures made in December
31, 2002 financial statements. The interpretation requires expanded disclosures
of guarantees (see Note 10 to Financial Statements-Guarantees). In addition, the
interpretation requires recording the fair value of guarantees upon issuance or
modification after January 1, 2003.
FIN No. 46, "Consolidation of Variable Interest Entities" was issued in
January 2003. FIN No. 46 provides guidance related to identifying variable
interest entities and determining whether such entities should be consolidated.
This guidance will be effective for the quarter ending September 30, 2003.
For accounting standards not yet adopted, TXU Energy is evaluating the
potential impact on its financial position and results of operations.
55
3. INVESTMENTS
The following information is a summary of the investment balance as of
December 31, 2002 and 2001 (in millions):
DECEMBER 31,
------------
2002 2001
---- ----
Equity method investments in entities...................................... $ 3 $ 7
Nuclear decommissioning trust.............................................. 266 276
Nonutility property........................................................ 141 345
Assets related to certain employee benefit plans........................... 28 21
Notes receivable from unconsolidated entities.............................. 6 22
Miscellaneous other........................................................ 18 21
------ ------
Total investments.......................................................... $ 462 $ 692
====== ======
NUCLEAR DECOMMISSIONING TRUST -- Deposits in an external trust fund for
nuclear decommissioning costs are carried at fair value ($266 million and $276
million at December 31, 2002 and 2001, respectively) with the changes in fair
value recorded as a liability, reflecting the statutory nature of the trust (see
Note 10 - Nuclear decommissioning). Decommissioning costs are being recovered
from Oncor's customers as a non-bypassable T&D charge over the life of the plant
and deposited in the external trust fund. Realized earnings on funds deposited
in the external trust fund are recognized in the reserve. As of December 31,
2002 and 2001, the value of deposits in the external trust fund, including
related unrealized gains, for decommissioning of Comanche Peak were as follows:
DECEMBER 31, 2002
--------------------------------------------------------
NET UNREALIZED
COST GAINS/LOSSES FAIR MARKET VALUE
Debt securities... $ 128 $ 9 $137
Equity securities. 111 18 129
----- ------ ----
$ 239 $ 27 $266
===== ====== ====
DECEMBER 31, 2001
--------------------------------------------------------
NET UNREALIZED
COST GAINS/LOSSES FAIR MARKET VALUE
Debt securities... $ 120 $ 5 $125
Equity securities. 99 52 151
----- ------ ----
$ 219 $ 57 $276
===== ====== ====
Debt securities held at December 31, 2002 mature as follows: $48
million in one to five years, $28 million in five to ten years and $61 million
after ten years.
NONUTILITY PROPERTY --primarily represents the fair value of land and
equipment related to two lignite-fueled generation plant construction projects
in Texas with a carrying value of $113 million at December 31, 2002. (See Note 2
- - Impairment of Long-Lived Assets.)
4. FINANCING ARRANGEMENTS
In April 2002, US Holdings, TXU Energy and Oncor entered into a joint
$1.0 billion 364-day revolving credit facility with a group of banks that
terminates in April 2003, but borrowings outstanding at that time can be
extended for one year. This facility is used for working capital and general
corporate purposes. Up to $1.0 billion of letters of credit may be issued under
the facility. In October 2002, TXU Energy borrowed approximately $282 million
and US Holdings borrowed approximately $596 million in cash against this credit
facility, the total of which represented the remaining availability after $122
million was used to support outstanding letters of credit. As of December 31,
2002, the facility was fully drawn and TXU Energy's portion of the outstanding
borrowings, approximately $282 million, is reflected in Notes Payable - Banks on
the balance sheet.
56
US Holdings has a $1.4 billion five-year revolving credit facility that
terminates in February 2005. In October 2002, US Holdings borrowed approximately
$939 million in cash against the remaining availability of this facility. A
portion of the proceeds of this borrowing were used to make advances to
affiliates including TXU Energy.
Funds borrowed under the 364-day revolving credit facility, short-term
advances from affiliates and other available cash were used by TXU Energy to
repay outstanding commercial paper upon maturity. Excess cash of approximately
$600 million at December 31, 2002, has been invested in liquid short-term
marketable securities earning current market rates. These funds will be used to
repay debt as it matures and meet other working capital requirements until such
time as the commercial paper market becomes more accessible to TXU Energy.
TXU Energy is also provided short-term financing by TXU Corp. and its
affiliated companies. TXU Energy had short-term advances from affiliates of $1.3
billion and $250 million outstanding as of December 31, 2002 and December 31,
2001, respectively. The weighted average interest rate on short-term borrowings
at December 31, 2002 was 2.328%.
Cross Default Provisions
------------------------
Certain financing arrangements of US Holdings, TXU Energy and Oncor
contain provisions that would result in an event of default under these
arrangements if there is 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.
Most agreements have a cure period of up to 30 days from the occurrence of the
specified event during which the company is allowed to rectify or correct the
situation before it becomes an event of default.
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
$1.0 billion joint US Holdings/TXU Energy/Oncor 364-day revolving credit
facility, the $1.4 billion US Holdings five-year revolving credit facility and
the $103 million TXU Mining Company LP senior notes (which have a $1 million
threshold). Under the joint US Holdings/TXU Energy/Oncor $1.0 billion 364-day
revolving 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 and US Holdings, 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 to be accelerated under the facility as to
Oncor and US Holdings, but not as to TXU Energy. Further, under this credit
facility, a default by US Holdings would cause the maturity of outstanding
balances under the facility to be accelerated as to US Holdings, but not as to
Oncor or TXU Energy.
SALE OF RECEIVABLES -- Certain subsidiaries of TXU Corp. sell customer
accounts receivable to TXU Receivables Company, a wholly-owned bankruptcy remote
subsidiary of TXU Corp., which sells undivided interests in accounts receivable
it purchases to financial institutions. As of December 31, 2002, TXU Energy
(through certain subsidiaries), Oncor and TXU Gas are qualified originators of
accounts receivable under the program. TXU Receivables Company may sell up to an
aggregate of $600 million in undivided interests in the receivables purchased
from the originators under the program. As of December 31, 2002, TXU Energy had
sold $1,091 million face amount of receivables to TXU Receivables Company under
the program in exchange for cash of $352 million and $711 million in
subordinated notes, with $28 million of losses on sales for the year ended
December 31, 2002 that principally represent the interest costs on the
underlying financing. These losses approximated 5% of the cash proceeds from the
sale of undivided interests in accounts receivable on an annualized basis.
Funding under the program decreased from $547 million at September 30, 2002 to
$352 million at December 31, 2002, primarily due to billing and collection
delays arising from new systems and processes in TXU Energy and ERCOT for
clearing customers switching and billing data, as well as seasonality of the
business.
Upon termination, cash flows to the originators would be delayed as
collections of sold receivables were used by TXU Receivables Company to
repurchase the undivided interests of the financial institutions instead of
purchasing new receivables. The level of cash flows would normalize in
approximately 16 to 31 days. TXU Business Services, a subsidiary of TXU Corp.,
services the purchased receivables and is paid a market based servicing fee by
TXU Receivables Company. The subordinated notes receivable from TXU Receivables
Company represent TXU Energy's retained interests in the transferred receivables
and are recorded at book value, net of allowances for bad debts, which
57
approximates fair value due to the short-term nature of the subordinated notes,
and are included in accounts receivable in the consolidated balance sheet.
In October 2002, the program was amended to extend the program to July
2003, to provide for reserve requirement adjustments as the quality of the
portfolio changes and to provide for adjustments to reduce receivables in the
program by the related amounts of customer deposits held by originators. In
February 2003, the program was further amended to allow receivables 31-90 days
past due into the program.
CONTINGENCIES RELATED TO 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) the credit rating for the long-term senior debt
securities of both any originator and its parent
guarantor, if any, declines below BBB- by S&P's or
Baa3 by Moody's; or
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
exceeds stated thresholds.
Under the receivables sale program, all originators (currently TXU
Energy, through certain subsidiaries, Oncor and TXU Gas), are required to
maintain a `BBB-' (S&P) and a `Baa3' (Moody's) rating or better (or supply a
parent guarantee with a similar rating). A downgrade below the required ratings
for an originator would prevent that originator from selling its accounts
receivables under the program. If all originators are downgraded so that there
are no eligible originators, the facility would terminate.
The delinquency and dilution ratios exceeded the relevant thresholds at
various times during 2002 and in January 2003, but waivers were granted. These
ratios were affected by issues related to the transition to deregulation.
Certain billing and collection delays arose due to implementation of new systems
and processes within TXU Energy and ERCOT for clearing customer switching and
billing data. The resolution of these issues as well as the implementation of
new POLR rules by the Commission (see Note 9 to Financial Statements) are
expected to bring the ratios in consistent compliance with the program.
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 Company, a subsidiary
of TXU Corp. which services the purchased receivables, each have a cross default
threshold of $50 thousand. If either an originator, TXU Business Services
Company or TXU Receivables Company defaults on indebtedness of the applicable
threshold, the facility could terminate.
58
5. LONG-TERM DEBT
DECEMBER 31,
------------
2002 2001
---- ----
TXU Energy Company
- ------------------
Pollution Control Revenue Bonds:
Brazos River Authority:
1.390% Floating Taxable Series 1993 due June 1, 2023(a)......................... $ 44 $ 69
4.900% Fixed Series 1994A due May 1, 2029(b).................................... 39 39
5.400% Fixed Series 1994B due May 1, 2029(b).................................... 39 39
5.400% Fixed Series 1995A due April 1, 2030(b).................................. 50 50
5.050% Fixed Series 1995B due June 1, 2030(b)................................... 118 118
4.800% Fixed Series 1999A due April 1, 2033(b).................................. 111 111
1.150% Floating Series 1999B due September 1, 2034(a)........................... 16 16
1.450% Floating Series 1999C due March 1, 2032(a)............................... 50 50
4.950% Fixed Series 2001A due October 1, 2030(b)................................ 121 121
4.750% Fixed Series 2001B due May 1, 2029(b).................................... 19 19
5.750% Fixed Series 2001C due May 1, 2036(b).................................... 274 274
4.250% Fixed Series 2001D due May 1, 2033(b).................................... 271 271
1.940% Floating Taxable Series 2001E due December 31, 2036...................... - 36
1.700% Floating Taxable Series 2001F due December 31, 2036(a)................... 39 39
1.700% Floating Taxable Series 2001G due December 31, 2036(a)................... 72 72
1.470% Floating Taxable Series 2001H due December 31, 2036(a)................... 31 31
1.420% Floating Taxable Series 2001I due December 31, 2036(a)................... 63 63
1.650% Floating Series 2002A due May 1, 2037(c)................................. 61 -
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(b).................................... 91 91
5.750% Fixed Series 2001B due May 1, 2030(b).................................... 107 107
4.000% Fixed Series 2001C due May 1, 2028(b).................................... 70 70
1.700% Floating Taxable Series 2001D due December 31, 2036(a)................... 12 12
1.470% Floating Taxable Series 2001E due December 31, 2036(c)................... 45 45
Trinity River Authority of Texas:
4.900% Fixed Series 2000A due May 1, 2028(b).................................... 14 14
5.000% Fixed Series 2001A due May 1, 2027(b).................................... 37 37
Other:
7.000% Fixed Senior Notes - TXU Mining Company LP due May 1, 2003............... 72 125
3.410% Floating Rate Debentures due May 20, 2003................................ - 1,500
6.875% Fixed Senior Notes - TXU Mining Company LP due August 1, 2005............ 30 100
9.000% Fixed Exchangeable Subordinated Notes due November 22, 2012.............. 750 -
Capital Leases.................................................................. 10 -
Other........................................................................... 8 8
Unamortized premium and discount and fair value adjustments..................... (264) (1)
---- --
Total TXU Energy ........................................................... $ 2,451 $ 3,577
======== =======
<FN>
(a) Interest rate in effect at December 31, 2002. These series are in a
flexible or weekly rate mode and are each supported by an irrevocable
letter of credit. Series in the flexible mode will be remarketed for
periods of less than 270 days.
(b) These series are in the multiannual mode. These bonds are subject to
mandatory tender prior to maturity on the mandatory remarketing date.
On such date, a new interest rate and interest rate period will be
reset for the bonds.
(c) Interest rate in effect at December 31, 2002.
</FN>
In November 2002, TXU Energy issued $750 million of exchangeable
subordinated notes. The notes will mature in November 2012, bear interest at the
annual rate of 9% and permit the deferral of interest payments. TXU Corp. has
granted the holders the right to exchange the notes for TXU Corp. common stock.
The notes currently may be exchanged, subject to certain restrictions, at any
time for up to approximately 57 million shares of TXU Corp. common stock at an
exercise 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 principal amount of notes to be exchanged by the exercise price.
The exercise price and the number of shares to be issued are subject to
anti-dilution adjustments. The proceeds from the issuance of the notes were used
for the repayment of two standby credit facilities that expired in November
2002. TXU Energy has recognized a capital contribution from TXU Corp. and a
corresponding discount on the notes of $266 million, for the value of the
exchange right as TXU Corp. granted an irrevocable right to exchange the notes
for shares of TXU Corp. common stock. This discount amount is being amortized to
59
interest expense over the term of the debt. (The unamortized balance was $264
million as of December 31, 2002.) As a result, the effective interest rate on
the notes is 16.2%. At the time of any exchange of the notes for common stock,
the unamortized discount will be proportionately written off as a charge to
earnings.
The exchangeable notes are subordinated in bankruptcy to all other TXU
Energy obligations. TXU Energy has the right until May 2003 (180 days after
issuance) to require the holder of the notes to exchange its interest in the
notes for a preferred equity interest in TXU Energy with economic and other
terms substantially identical to the notes.
In July 2002, TXU Energy redeemed at par the remaining $635 million
principal amount of its floating rate debentures due May 20, 2003. TXU Energy
funded the redemption through the issuance of commercial paper, advances from
affiliates and cash from operations.
In May 2002, Oncor issued $1.2 billion aggregate principal amount of
senior secured notes in a private placement with registration rights. Proceeds
from the issuance were used by Oncor to repay long-term advances from US
Holdings. US Holdings used the repayments from Oncor to repay advances from TXU
Energy and TXU Corp. TXU Energy used the repayments to redeem $865 million
principal amount of floating rate debentures due May 20, 2003.
Also in May 2002, the Brazos River Authority issued $61 million
principal amount of weekly reset floating rate pollution control revenue
refunding bonds for TXU Energy to refund a similar principal amount of pollution
control revenue bonds.
In February 2002, TXU Mining Company LP redeemed $70 million of its
6.875% senior notes due 2005 and $53 million of its 7.0% senior notes due 2003.
MATURITIES -- Maturity requirements for the years 2003 through 2007
under long-term debt outstanding at December 31, 2002, were as follows:
YEAR
----
2003........................................................ $ 72
2004........................................................ -
2005........................................................ 30
2006........................................................ -
2007........................................................ -
Thereafter.................................................. 2,603
Capital lease............................................... 10
Unamortized discount........................................ (264)
-------
$2,451
6. INCOME TAXES
The components of income tax expense are as follows:
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
Current:
US Federal............................................... $176 $400 $ 49
State.................................................... 3 39 5
Non-US................................................... 1 (5) 1
-------- ------- -------
Total............................................... 180 434 55
------ ----- ------
Deferred:
US Federal............................................... (74) (134) 201
State.................................................... 4 (3) (20)
Non-US................................................... - (1) -
-------- -------- ------
Total............................................... (70) (138) 181
------- ----- -----
Investment tax credits...................................... (20) (17) (17)
------- ------ ------
Total............................................... $ 90 $279 $219
====== ===== ====
60
Reconciliation of income taxes computed at the US federal statutory
rate to provision for income taxes:
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
Income before income taxes and extraordinary loss............. $360 $939 $795
==== ==== ====
Income taxes at the US federal statutory rate of 35%.......... $126 $329 $278
Depletion allowance..................................... (25) (25) (24)
Amortization of investment tax credits.................. (20) (17) (17)
Redirected depreciation................................. - (18) -
State income taxes, net of federal tax benefit.......... 5 24 (10)
Other................................................... 4 (14) (8)
------- ------ -------
Income tax expense............................................ $ 90 $279 $219
===== ==== ====
Effective tax rate........................................... 25% 30% 28%
The components of TXU Energy's deferred tax assets and liabilities are
as follows:
DECEMBER 31,
----------------------------------------------------------------------------
2002 2001
------------------------------------- -------------------------------------
TOTAL CURRENT NONCURRENT TOTAL CURRENT NONCURRENT
----- ------- ---------- ----- ------- ----------
DEFERRED TAX ASSETS
Unamortized investment tax credits..... $ 132 $ - $ 132 $ 138 $ - $ 138
Bad debt reserve....................... 30 30 - 11 11 -
Impairment of assets................... 133 - 133 135 - 135
Regulatory disallowance................ 80 - 80 93 - 93
Retail clawback........................ 65 - 65 - - -
Alternative minimum tax................ 307 - 307 267 - 267
Employee benefits..................... 109 - 109 70 - 70
Deferred benefit of state income taxes 11 10 1 26 24 2
Other.................................. 164 28 136 89 44 45
------- ------- ------- ------- ------- -------
Total deferred federal income tax asset 1,031 68 963 829 79 750
Deferred state income taxes............ - - - 7 - 7
------- ------- ------- ------- ------- -------
Total deferred tax assets........... 1,031 68 963 836 79 757
------- ------- ------- ------- ------- -------
DEFERRED TAX LIABILITIES
Depreciation differences and capitalized
Construction costs................... 2,756 - 2,756 2,788 - 2,788
Software development costs............. 90 - 90 79 - 79
Deferred charges for state income taxes - - - - - -
Other.................................. 46 - 46 10 - 10
------- ------- ------- ------- ------- -------
Total deferred federal income tax liability 2,892 - 2,892 2,877 - 2,877
------- ------- ------- ------- ------- -------
Deferred state income tax ............. 2 - 2 5 - 5
------- ------- ------- ------- ------- -------
Total deferred tax liability........ 2,894 - 2,894 2,882 - 2,882
------- ------- ------- ------- ------- -------
NET DEFERRED TAX LIABILITY (ASSET ) ...... $ 1,863 $ (68) $ 1,931 $ 2,046 $ (79) $ 2,125
======= ======= ======= ======= ======= =======
61
DECEMBER 31,
----------------------------------------------------------------------------
2002 2001
------------------------------------- -------------------------------------
NET NET NET NET NET NET
CURRENT CURRENT NONCURRENT CURRENT CURRENT NONCURRENT
ASSET LIABILITY LIABILITY ASSET LIABILITY LIABILITY
----- --------- --------- ----- --------- ---------
SUMMARY OF DEFERRED INCOME TAXES
US Federal............................. $ 68 $ - $ 1,929 $ 79 $ - $ 2,127
State.................................. - - 2 - - (2)
-------- ------ ---------- --------- --------- ----------
Total................................ $ 68 $ - $ 1,931 $ 79 $ - $ 2,125
======= ====== ========== ======= ========= ==========
At December 31, 2002, TXU Energy had approximately $307 million of
alternative minimum tax credit carryforwards available to offset future tax
payments.
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 1997. In
management's opinion, an adequate provision has been made for any future taxes
that may be owed as a result of any examinations.
7. 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 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.
The allocated net periodic pension cost (benefit) applicable to TXU
Energy was $3 million for 2002, $(5) million for 2001 and $(7) million for 2000.
Estimated accrued pension cost applicable to TXU Energy as of December 31, 2002
and 2001 was $84 million and $27 million, respectively. Contributions were $9
million, $1 million and $1 million in 2002, 2001 and 2000, respectively. The
amounts provided represent allocations of the TXU Corp. Retirement Plan to TXU
Energy.
In addition, TXU Energy's 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 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, a specified amount of compensation ranging from 1%
to 20%. Employees who earn more than such threshold may contribute from 1% to
16% of their compensation. Employer matching contributions are also made in an
amount equal to 100% of employee contributions up to 6% of compensation for
employees who participate under the cash balance formula of the Retirement Plan,
and 75% of employee contributions up to 6% of compensation for employees who
participate under the traditional defined benefit formula of the Retirement
Plan. Employer matching contributions are invested in TXU Corp. common stock.
62
Contributions to the Thrift Plan by TXU Corp. aggregated $19 million for 2002,
$16 million for 2001 and $15 million in 2000.
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 $26 million for 2002, $25
million for 2001 and $23 million for 2000. Contributions paid by TXU Energy to
fund postretirement benefits other than pensions were $11 million, $19 million
and $15 million in 2002, 2001 and 2000, respectively.
The liabilities for accrued pension cost and accrued postretirement
benefits cost were based on estimates of retired employees by company. The
estimated liabilities for accrued pension cost and accrued postretirement
benefits cost recorded above may be subject to revision based on final actuarial
determinations, resulting in an increase or decrease in advances to or from
affiliates.
8. 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, 2002 DECEMBER 31, 2001
----------------- -----------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------ ----- ------ -----
ON BALANCE SHEET ASSETS (LIABILITIES):
Long-term debt (including current maturities) *................ $(2,441) $(2,662) $(3,577) $(3,584)
OFF BALANCE SHEET ASSETS (LIABILITIES):
Financial guarantees........................................... - (81) - -
* Excludes capital leases.
With the implementation of SFAS No. 133, on January 1, 2001, financial
instruments that are derivatives are now recorded on the balance sheet at fair
value.
The carrying value of securities held in external trusts for nuclear
decommissioning are based on quoted market prices. (See Note 3.) The remaining
investments are not considered to be financial instruments and are recorded at
cost.
The fair values of long-term debt 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 carrying amounts for financial assets and liabilities classified as
current approximate fair value due to the short maturity of such instruments.
The fair value of the guarantees 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 guaranty.
9. RATES AND REGULATIONS
RESTRUCTURING LEGISLATION -- The 1999 Restructuring Legislation
restructured the electric utility industry in Texas and provided for a
transition to increased competition in the generation and retail sale of
electricity. By January 1, 2002, each electric utility was required to separate
(unbundle) its business activities into a power generation company (PGC), a REP,
and a transmission and distribution (T&D) utility or separate T&D utilities.
Unbundled T&D utilities within ERCOT, such as Oncor, remain regulated by the
Commission.
63
Beginning January 1, 2002, REPs affiliated with T&D utilities began
charging residential and small commercial customers located in their historical
service territory rates that are 6% less than the rates that were in effect on
January 1, 1999, as adjusted for fuel factor changes ("price-to-beat rate"). TXU
Energy, as a REP affiliated with a T&D utility, may not charge prices to such
customers that are different from the price-to-beat rate until the earlier of
January 1, 2005 or the date on which 40% of the electricity consumed by
customers in those respective customer classes is supplied by competing REPs.
Thereafter, TXU Energy may offer rates different from the price-to-beat rate,
but it must also continue to make the price-to-beat rate, adjusted for fuel
factor changes, available for residential and small commercial customers until
January 1, 2007. REPs must be certified by the Commission. TXU Energy has
received appropriate REP certifications from the Commission.
Also, beginning January 1, 2002, PGCs that are affiliated with T&D
utilities may charge unregulated prices in connection with ERCOT wholesale power
transactions. Estimated costs associated with PGC nuclear power plant
decommissioning obligations continue to be recovered as a nonbypassable T&D
charge over the life of the plant. Each affiliated PGC owning 400 MW or more of
installed generating capacity must offer each year at auction entitlements to at
least 15% of such capacity. The obligation of an affiliated PGC to sell capacity
entitlements at auction continues until the earlier of January 1, 2007 or the
date on which 40% of the electricity consumed by residential and small
commercial customers of the PGC's affiliated REP is supplied by competing REPs.
PGCs must be registered with the Commission. TXU Energy has filed appropriate
PGC registrations with the Commission.
The 1999 Restructuring Legislation also provided for the recovery of
generation-related regulatory assets (regulatory assets) and generation-related
and purchased power-related costs that are in excess of market value (stranded
costs). It provided means for electric utilities to mitigate stranded costs
during the rate freeze period that preceded unbundling. Unmitigated stranded
costs would be finally determined in a 2004 "true-up" proceeding relying
principally upon market-based asset valuations. Regulatory assets and
unmitigated stranded costs can be recovered through the issuance of transition
(securitization) bonds or imposition of a competition transition charge.
Further, a REP would also be required to reconcile and credit to its
affiliated T&D utility (and the T&D utility to credit T&D customers), as a
so-called retail clawback, any positive difference between the price-to-beat
rate, reduced by the nonbypassible delivery charge, and the prevailing market
price of electricity during the same time period to the extent the price-to-beat
rate exceeded the market price of electricity. This reconciliation is not
required for the applicable customer class if 40% of the electricity consumed by
customers in that class is supplied by competing REPs before January 1, 2004. If
a retail clawback reconciliation is required, the 1999 Restructuring Legislation
provided that the amount credited cannot exceed an amount equal to the number of
residential or small commercial customers served by a T&D utility that are
buying electricity from the affiliated REP at the price-to-beat rate on January
1, 2004, minus the number of new customers obtained outside the historical
service territory, multiplied by $150. (The calculation of this credit was
altered for TXU Energy in connection with the Settlement Plan discussed below.)
REGULATORY SETTLEMENT PLAN -- On December 31, 2001, US Holdings filed a
settlement plan (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 (Settlement) provided for in 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 was approved by the Commission in June 2002. In August 2002, the
Commission issued a financing order, pursuant to the Settlement Plan,
authorizing the issuance of securitization bonds relating to recovery of
regulatory assets. The Commission's order approving the Settlement Plan and the
financing order were appealed by certain nonsettling parties to the Travis
County, Texas District Court in August 2002. In January 2003, US Holdings
concluded a settlement of these appeals and they were dismissed. Thus, the
Settlement became final.
The major elements of the Settlement are:
Excess Mitigation Credit and Appeals Related to T&D Rates -- Beginning
in 2002, Oncor began implementing an excess stranded cost mitigation credit in
the amount of $350 million, plus interest, applied over a two-year period as a
reduction to T&D rates charged to REPs. In June 2001, the Commission had issued
an interim order that addressed Oncor's charges for T&D service when retail
competition would begin. Among other things, that interim order, and subsequent
64
final order issued in October 2001, required Oncor to reduce rates over the
period from 2002-2008. The Commission's decision was appealed by US Holdings and
other parties to the Travis County, Texas District Court. Finalization of the
Settlement means US Holdings' appeal has been dismissed. Also, in July 2001, the
staff of the Commission had notified US Holdings and the Commission that it
disagreed with US Holdings' computation of the level of earnings in excess of
the regulatory earnings cap for calendar year 2000. In August, 2001, the
Commission issued an order adopting the staff position. US Holdings appealed
this matter to the Travis County, Texas District Court, which affirmed the
Commission's order and US Holdings then appealed that decision to the Third
District Court of Appeals in Austin, Texas. This appeal has now been dismissed.
Regulatory Asset Securitization -- In October 1999, US Holdings filed
an application with the Commission for a financing order to permit the issuance
by a special purpose entity of $1.65 billion of securitization bonds. In May
2000, the Commission signed an order rejecting such request and authorized only
$363 million of such bonds. US Holdings filed an appeal with the Travis County,
Texas District Court and in September 2000, the Court issued a judgment that
reversed part of the Commission's order and affirmed other aspects of the
Commission's order. US Holdings and various other parties appealed this judgment
directly to the Supreme Court of Texas; and in June 2001, it issued a ruling and
in October 2001 remanded the case to the Commission, which consolidated it into
the Settlement Plan proceeding. In accordance with the Settlement, Oncor
received a financing order authorizing it to issue securitization bonds in the
aggregate principal amount of $1.3 billion to recover regulatory assets and
other qualified costs. The Settlement provides that there can be an initial
issuance of securitization bonds in the amount of up to $500 million, followed
by a second issuance of the remainder after 2003. The Settlement resolves all
issues related to regulatory assets and liabilities.
Retail Clawback -- If, as currently expected, TXU Energy retains more
than 60% of its historical residential and small commercial customers after the
first two years of competition, the amount of the retail clawback credit will be
equal to the number of residential and small commercial customers retained by
TXU Energy in its historical service territory on January 1, 2004, less the
number of new customers TXU Energy has added outside of its historical service
territory as of January 1, 2004, multiplied by $90. This determination will be
made separately for the residential and small commercial classes. The credit, if
any, will be applied to T&D rates charged by Oncor to REPs, including TXU
Energy, over a two-year period beginning January 1, 2004. Under the settlement
agreement, TXU Energy will make a compliance filing with the Commission
reflecting customer count as of January 2004. In the fourth quarter of 2002, TXU
Energy recorded a $185 million ($120 million after-tax) charge for the retail
clawback, which represents the current best estimate of the amount to be funded
to Oncor over the two-year period.
Stranded Cost Resolution -- TXU Energy's stranded costs, not including
regulatory assets, are fixed at zero. Accordingly, it will not have to conduct
the stranded cost true-up in 2004 provided for in the 1999 Restructuring
Legislation. In addition, the Settlement resulted in a resolution of the
regulatory disallowance of amounts related to US Holdings' repurchase of
minority owner interests in the Comanche Peak nuclear generating station. The
Commission's final order in connection with US Holdings' January 1990 rate
increase request had been ultimately reviewed by the Supreme Court of Texas, and
an aggregate of $909 million of disallowances with respect to US Holdings'
reacquisitions of minority owners' interests in Comanche Peak, which had
previously been recorded as a charge to earnings, was remanded to the District
Court and then to the Commission for reconsideration. As a result of the
Settlement, US Holdings will move to dismiss this remand. The settlement also
precludes recovery by US Holdings of certain environmental improvement costs.
Fuel Cost Recovery -- The Settlement also provides that 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.
Provider of Last Resort -- Through calendar year 2002, TXU Energy was
the POLR for residential and small non-residential customers in those areas of
ERCOT where customer choice was available outside its incumbent service areas,
and was the POLR for large non-residential customers in its incumbent service
area. TXU Energy's POLR contract expired on December 31, 2002. However, in
August 2002, the Commission adopted new rules that significantly changed POLR
service. Under the new POLR rules, instead of being transferred to the POLR,
non-paying residential and small non-residential customers served by affiliated
REPs are subject to disconnection. Non-paying residential and small
non-residential customers served by non-affiliated REPs are transferred to the
65
affiliated REP. Non-paying large non-residential 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 must decide whether all REPs should be permitted to
disconnect all non-paying customers. The new POLR rules are expected to result
in reduced bad debt expense beginning in 2003.
10. COMMITMENTS AND CONTINGENCIES
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 generating units. 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 -- TXU Energy has entered into contracts to
purchase power through the year 2007 with certain wind power contracts for a
longer period. These contracts, except for wind contracts, provide for capacity
payments subject to performance standards and energy payments based on the
actual power taken under the contracts. Capacity payments paid under these
contracts for the years ended December 31, 2002, 2001 and 2000 were $296
million, $189 million and $186 million, respectively.
Assuming operating standards are achieved, future capacity payments
under existing agreements are estimated as follows:
2003....................................................... $315
2004....................................................... 163
2005....................................................... 146
2006....................................................... 117
2007....................................................... 17
Thereafter................................................. -
----
Total capacity payments.............................. $758
====
GAS CONTRACTS -- TXU Energy buys gas under various types of long-term
and short-term contracts and arranges for gas storage and transportation under
various contracts in order to assure reliable supply to, and to help meet the
expected needs of, its generation plants and its wholesale and retail customers.
Many of these gas purchase contracts require minimum purchases ("take-or-pay")
of gas under which the buyer agrees to pay for a minimum quantity of gas in a
year. At December 31, 2002, TXU Energy had minimal commitments under long-term
gas purchase contracts. TXU Energy has commitments for pipeline transportation
and storage reservation fees as shown in the table below:
2003....................................................... $ 14
2004....................................................... 6
2005....................................................... 6
2006....................................................... 6
2007....................................................... 4
Thereafter................................................. 6
-------
Total pipeline transportation and storage reservation
fees................................................. $ 42
=======
On the basis of TXU Energy's current expectations of demand from its
electricity and gas customers as compared with its capacity payments or
take-or-pay obligations under such purchase contracts, management does not
consider it likely that any material payments will become due from TXU Energy
for electricity or gas not taken.
66
COAL CONTRACTS -- TXU Energy has coal purchase agreements and coal
transportation agreements. Commitments under these contracts are as follows:
2003..................................................... $94
2004..................................................... 78
2005..................................................... 23
2006..................................................... 18
2007..................................................... -
Thereafter............................................... -
----
Total ................................................ $213
====
LEASES -- TXU Energy has entered into operating leases covering various
facilities and properties including generating plants, combustion turbines,
transportation, 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 for 2002, 2001 and 2000
were $134 million, $117 million and $91 million, respectively.
Future minimum lease payments under capital leases, together with the
present value of such minimum lease payments, and future minimum lease
commitments under operating leases that have initial or remaining noncancellable
lease terms in excess of one year as of December 31, 2002, were as follows:
CAPITAL OPERATING
YEAR LEASES LEASES
---- ------ ------
2003............................................................ $ 1 $ 65
2004............................................................ 1 65
2005............................................................ 2 69
2006............................................................ 2 65
2007............................................................ 2 69
Thereafter...................................................... 6 513
------ ------
Total future minimum lease payments........................ 14 $ 846
======
Less amounts representing interest.............................. 4
------
Present value of future minimum lease payments.................. 10
Less current portion............................................ 1
------
Long-term capital lease obligation.............................. $ 9
======
GUARANTEES -- TXU Energy and its subsidiaries have 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.
TXU Energy is the lessee under various operating leases that under the
terms obligate the lessees to guaranty the residual values of the leased
facilities. At December 31, 2002, the aggregate maximum amount of residual
values guaranteed by TXU Energy is approximately $299 million with an estimated
residual recovery of approximately $222 million. The average life of the lease
portfolio is approximately nine years.
TXU Energy has provided a guarantee of the payment of TXU Corp.'s
obligations under its headquarters building lease (approximately $140 million at
December 31, 2002). The term of the lease ends in 2022 unless renewed or
otherwise terminated. The maximum total potential payout is $297 million over
the lease term.
TXU Energy Solutions, a subsidiary of TXU Energy, has guaranteed that
certain customers will realize specified annual savings resulting from energy
management services provided by TXU Energy Solutions. In aggregate, the average
annual savings has exceeded the annual savings guaranteed. The maximum potential
annual payout is approximately $4.3 million, and the maximum total potential
payout is approximately $18.6 million. The average remaining life of the
portfolio is approximately 5 years.
67
TXU Energy has entered into various agreements that require letters of
credit for financial assurance purposes. Approximately $522.6 million of letters
of credit are outstanding to support existing floating rate pollution control
revenue bond financings on existing debt of approximately $433 million. The
letters of credit are available to fund the payment of such debt obligations.
These letters of credit have expiration dates in 2003; however, TXU Energy
intends to provide from either existing or new facilities for the extension,
renewal or substitution of these letters of credit to the extent required for
such floating rate debt or their remarketing as fixed rate debt.
TXU Energy has provided for the posting of letters of credit in the
amount of $183.4 million to support portfolio management margin requirements of
subsidiaries in the normal course of business. As of December 31, 2002,
approximately 82% of the obligations supported by these letters of credit mature
within 1 year, and substantially all of the remainder mature in the second year.
US Holdings has entered into contracts with public agencies to purchase
cooling water for use in the generation of electric energy and has agreed, in
effect, to guarantee the principal, $16 million at December 31, 2002, and
interest on bonds issued by the agencies to finance the reservoirs from which
the water is supplied. The bonds mature at various dates through 2011 and have
interest rates ranging from 5.5% to 7% per annum. US Holdings is required to
make periodic payments equal to such principal and interest, including amounts
assumed by a third party and reimbursed to US Holdings, of $4 million for 2003,
$7 million for 2004 and $1 million for 2005 and 2006. In addition, US Holdings
is obligated to pay certain variable costs of operating and maintaining the
reservoirs. US Holdings has assigned to a municipality all contract rights and
obligations of US Holdings in connection with $19 million remaining principal
amount of bonds at December 31, 2002, issued for similar purposes which had
previously been guaranteed by US Holdings. US Holdings is, however, contingently
liable in the unlikely event of a default by the municipality. TXU Energy is
entitled to the benefits of these contracts and has agreed to indemnify US
Holdings for obligations under these contracts.
NUCLEAR INSURANCE -- With regard to liability coverage, the
Price-Anderson Act (the 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 currently at $9.6
billion 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 the modification, if any,
are not presently known and therefore TXU Energy is unable, at this time, to
determine any impact it may have on nuclear liability coverage. As required, TXU
Energy 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 Energy has $300 million of liability coverage
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 United States is
subject to an assessment of up to $88 million, subject to increases for
inflation every five years, in the event of a nuclear incident at any nuclear
plant in the United States. 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,
Nuclear Regulatory Commission (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 Energy maintains nuclear
decontamination and property damage insurance for Comanche Peak in the amount of
$3.5 billion, above which TXU Energy 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 $737 million from Lloyds of London,
other insurance markets and foreign nuclear insurance pools. TXU Energy is
subject to a maximum annual assessment from NEIL of $26.6 million.
68
TXU Energy 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 Energy is subject to a maximum annual assessment of $8.7 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 one year beginning with the first loss from
terrorism, NEIL would make available one industry aggregate limit of $3.24
billion and any amounts it recovers from reinsurance, government indemnity or
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 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 re-insurance with respect
to acts of terrorism in the US for losses caused by or on behalf of foreign
parties. In such circumstances, the NEIL and ANI terrorism aggregates would not
apply.
NUCLEAR DECOMMISSIONING -- TXU Energy has established a reserve,
charged to depreciation expense and included in accumulated depreciation, for
the decommissioning of Comanche Peak. Decommissioning costs are being recovered
from Oncor customers over the life of the plant and deposited in external trust
funds (included in investments - see Note 3.) Based on a site-specific study
completed during 1997 using the prompt dismantlement method and 1997 dollars,
decommissioning costs for Comanche Peak Unit 1 and for Unit 2 and common
facilities were estimated to be $271 million and $404 million, respectively.
This estimate is subject to change in the future.
Under current regulatory licenses, decommissioning activities are
projected to begin in 2030 for Comanche Peak Unit 1 and 2033 for Unit 2 and
common facilities. Through December 31, 2001, decommissioning costs were
recovered based upon a 1992 site-specific study through rates placed in effect
under US Holdings' January 1993 rate increase request. Effective January 1,
2002, decommissioning costs are being recovered through a non-bypassable charge
billed by Oncor and remitted to TXU Energy based upon a 1997 site-specific
study, adjusted for trust fund assets, through rates. TXU Energy accrued $14
million of decommissioning costs in 2002 and $18 million in each of the years
ended December 31, 2001 and 2000.
Because the accounting for nuclear decommissioning recognizes that
costs are recovered through rates or a non-bypassable charge to customers,
fluctuations in equity prices or interest rates of trust fund assets do not
affect results of operations, cash flows or financial position. In accordance
with SFAS No. 143, beginning in 2003 TXU Energy will record the fair value of
the liability for retirement obligations and related accretion expense rather
than including the reserve in accumulated depreciation.
GENERAL -- In addition to the above, TXU Energy is involved in various
other legal and administrative proceedings 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.
11. EXTRAORDINARY LOSS
LOSS ON REACQUISITION OF DEBT -- As a result of US Holdings' debt
restructuring and refinancings in the fourth quarter of 2001, TXU Energy
recorded an extraordinary loss of $97 million (after taxes of $52 million) for
the early acquisition of debt.
LOSS ON SETTLEMENT -- As a result of the Settlement Plan submitted to
the Commission for approval of outstanding unbundling issues (see Note 9), TXU
Energy recorded an extraordinary loss of $56 million (after taxes of $62
million) in the fourth quarter of 2001 to reflect the effect of settlement items
that are no longer probable of recovery. The settlement related items include
unrecovered fuel cost, all remaining generation-related regulatory assets and
69
regulatory liabilities that are not subject to recovery through the issuance of
securitization bonds, and the excess cost over market of certain purchased power
contracts.
12. DERIVATIVE FINANCIAL INSTRUMENTS
During 2002, certain of TXU Energy's cash flow hedges related to
anticipated sales from baseload generation became less effective due to changes
in ERCOT market rules and conditions. TXU Energy experienced net hedge
ineffectiveness of $41 million ($27 million after-tax) in 2002, which has been
recognized as a loss in revenues related to these contracts. In 2001,
ineffectiveness of $4 million ($3 million after-tax) was recognized as a gain in
revenues.
The maximum length of time TXU Energy is hedging its exposure to the
variability of future cash flows for forecasted transactions, excluding the
payment of variable interest on existing indebtedness, is two years. During
2002, TXU Energy entered into cash flow hedges related to future forecasted
interest payments. These hedges were terminated in October 2002, and $94 million
($61 million after-tax) was recorded as a charge to other comprehensive income.
These losses are being amortized to earnings over a period of up to twenty
years.
As of December 31, 2002, TXU Energy expects that $79 million ($51
million after-tax) in 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 gain 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 other comprehensive income
(loss):
OTHER COMPREHENSIVE INCOME (LOSS)
YEAR ENDED DECEMBER 31, 2002
TREASURY COMMODITY TOTAL
-------- --------- -----
Dedesignated hedges (amounts fixed)..................... $ (62) (24) (86)
Hedges subject to market price fluctuations............. - (40) (40)
-------- --------- --------
Total............................................... $ (62) (64) (126)
======== ========= ========
13. SUPPLEMENTARY FINANCIAL INFORMATION
Operations of TXU Energy in 2002 are unregulated since the Texas
electricity market is now open to competition. However, retail pricing to
residential and small business customers in TXU Energy's historical service
territory continues to be subject to certain regulations as discussed in Note 9.
Prior years were subject to regulation.
OTHER INCOME AND DEDUCTIONS --
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
Other income
Gain on sale of property, plant and equipment...... $ 30 $ 1 $ 30
Other.............................................. 3 2 2
-------- --------- ---------
Total other income............................. $ 33 $ 3 $ 32
======= ======== ========
Other deductions
Loss on sale of properties............................. $ 2 $ 8 $ -
Equity in losses of unconsolidated entities............ 3 4 -
Asset impairment....................................... 237 - -
Regulatory asset write-off............................. - 22 -
Other.................................................. 12 16 6
-------- --------- ---------
Total other deductions......................... $ 254 $ 50 $ 6
======= ======== ========
CREDIT RISK -- Credit risk relates to the risk of loss that TXU Energy
may incur as a result of 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 ratings, and other quantitative and qualitative
70
credit criteria and specific 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
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.
CONCENTRATION OF CREDIT RISK -- TXU Energy's gross exposure to credit
risk as of December 31, 2002 was $3.1 billion, representing trade accounts
receivable, commodity contract assets and derivative assets.
A large share of gross assets subject to credit risk are accounts
receivable from the retail sale of electricity and gas to residential and small
commercial customers. The risk of material loss from non-performance from these
customers is unlikely based upon historical experience. Reserves 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. The restructuring of the electric industry in Texas
effective January 1, 2002 increased the risk profile of TXU Energy in relation
to these customers; however, TXU Energy has the ability to take actions to
mitigate such customer risk, particularly with the change in the POLR rules (see
Note 9).
Most of the remaining trade accounts receivable are with large
commercial and industrial customers. TXU Energy's wholesale commodity contract
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
(including large commercial and industrial retail customers), excluding credit
collateral, as of December 31, 2002, is $1.3 billion net of standardized master
netting contracts and agreements which provide the right of offset of positive
and negative credit exposures with individual counterparties. When considering
collateral held (cash, letters of credit and other security interests), the net
credit exposure is $1.2 billion.
TXU Energy had no exposure to any one customer or counterparty greater
than 10% of the net exposure of $1.2 billion at December 31, 2002. Additionally,
approximately 93% of the credit exposure, net of collateral held, has a maturity
date of less than 2 years. 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.
AFFILIATE TRANSACTIONS -- The following represent the significant
affiliate transactions of TXU Energy:
o Reference should be made to Note 9 regarding the regulatory
settlement plan and the Business Separation Agreement between TXU
Energy and Oncor. 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 year ended December 31, 2002, this interest
expense totaled $28 million.
o Under the terms of the settlement plan, Oncor expects to issue
securitization bonds of $1.3 billion. 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 payable to Oncor that will be extinguished as
Oncor pays the related income taxes.
71
o In addition, TXU Energy has a note payable to Oncor related to
the excess mitigation credit established in accordance with the
settlement plan. Oncor has implemented the $350 million credit,
plus interest, as a reduction of its fees charged to REPs,
including TXU Energy, for a two-year period. The principal and
interest payments on the note payable to Oncor were used to
reimburse Oncor for the credit relating to the delivery fees
billed to REPs. For the year ended December 31, 2002, the
principal payments made on the note payable totaled $180 million
and the interest expense totaled $21 million.
o Average daily short-term advances from affiliates during 2002
were $417 million, and interest expense incurred on the advances
was $18 million. The weighted average interest rate for 2002 was
2.3%.
o TXU Energy incurs electricity delivery fees charged by Oncor. For
the year ended December 31, 2002, these fees totaled $1.5
billion.
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 2002, 2001 and 2000, these
costs totaled $286 million, $238 million and $133 million,
respectively, and are included in selling, general and
administrative expenses.
o TXU Energy receives payments from TXU Gas, a subsidiary of TXU
Corp., under a service agreement beginning in 2002 covering
customer billing and customer support services provided for TXU
Gas. These revenues totaled $28 million in 2002 and are included
in other revenues.
ACCOUNTS RECEIVABLE -- At December 31, 2002 and 2001, accounts
receivable are stated net of uncollectible accounts of $71 million and $24
million, respectively. During 2002, bad debt expense was $158 million, account
writeoffs were $102 million and other activity decreased the allowance for
uncollectible accounts by $9 million.
Accounts receivable included $489 million and $288 million of unbilled
revenues at December 31, 2002 and 2001, respectively.
COMMODITY CONTRACT ASSETS-- At December 31, 2002 and 2001, current and
noncurrent commodity contract assets are stated net of applicable credit and
performance reserves (described in Note 2 - Financial Instruments and
Mark-to-Market Accounting) of $43 million and $25 million, respectively.
INVENTORIES BY MAJOR CATEGORY --
DECEMBER 31,
------------
2002 2001
---- ----
Materials and supplies...................................................... $ 171 $ 148
Fuel stock.................................................................. 70 62
Gas stored underground...................................................... 57 49
-------- --------
Total inventories...................................................... $ 298 $ 259
======== ========
Inventories are carried at average costs, except for gas inventories
managed as part of the portfolio management activities, which are carried at
spot rates through December 31, 2002. Inventories recorded at spot rates at
December 31, 2002 and 2001 were $54 million and $18 million, respectively. As
part of the rescission of EITF Issue No. 98, such inventories will be adjusted
to average costs as part of the cumulative adjustment to be recorded in the
first quarter of 2003.
72
PROPERTY, PLANT AND EQUIPMENT --
DECEMBER 31,
-----------------------
2002 2001
------------ ---------
Electric production......................................................... $ 15,675 $ 15,791
Other....................................................................... 483 242
-------- --------
Total.................................................................. 16,158 16,033
Less accumulated depreciation............................................... 6,454 6,186
-------- --------
Net of accumulated depreciation........................................ 9,704 9,847
Construction work in progress............................................... 286 361
Nuclear fuel (net of accumulated amortization: 2002-- $847; 2001-- $787)... 137 146
-------- --------
Net property, plant and equipment...................................... $ 10,127 $ 10,354
======== ========
MEMBER INTERESTS -- In the first quarter of 2002, goodwill of $468
million, net of accumulated amortization, was transferred from TXU Gas to TXU
Energy, which was accounted for as a non-cash capital contribution. In addition,
$15 million of advances from affiliates were converted to capital during 2002.
On March 6, 2002, TXU Energy approved a cash distribution of $200
million, which was paid to US Holdings on April 1, 2002. On May 6, 2002, TXU
Energy approved cash distributions of $177 million and $200 million, which were
paid to US Holdings on May 17, 2002 and July 1, 2002, respectively. On August 7,
2002, TXU Energy approved a cash distribution of $200 million, which was paid to
US Holdings on October 1, 2002. On November 15, 2002, TXU Energy approved a cash
distribution of $200 million which was paid to US Holdings on January 2, 2003.
With the issuance in November 2002 of $750 million of exchangeable
subordinated notes (see Note 5), TXU Energy recognized a capital contribution
from TXU Corp. and a corresponding discount on the notes of $266 million,
recorded as a credit to additional paid-in capital. This amount is being
amortized to interest expense over the term of the debt. At the time of any
exchange of notes for common stock, the unamortized discount will be
proportionately written off as a charge to earnings.
SUPPLEMENTAL CASH FLOW INFORMATION --
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
Cash payments:
Interest (net of amounts capitalized).............. $ 204 $ 240 $ 266
Income taxes....................................... $ 157 $ 366 $ 24
Non-cash investing and financing activities:
Non-cash advances.................................. $ - $ 89 $ (61)
Conversion of capital (from) to advances........... $ (15) $ 28 $ -
Receipt of note receivable from sale of asset...... $ - $ - $ 23
Non-cash capital contribution related to issuance
of exchangeable subordinated notes............ $ 266 $ - $ -
73
QUARTERLY INFORMATION (UNAUDITED) -- The results of operations by
quarter are summarized below. Revenues have been reclassified to reflect the
implementation of EITF Issue No. 02-3 to report certain trading activities on a
net basis, as well as to reflect the inclusion of delivery fees in revenues.
(See Note 2 for a discussion of both changes.) Gross margin and net income were
not affected by these changes as the offset was in cost of energy sold and
delivery fees. 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
-------- ------- -------- -------
2002:
Operating revenues .............................................. $ 1,799 $ 2,019 $ 2,420 $ 1,500
Income (loss) before income taxes and extraordinary loss ........ $ 276 $ 267 $ 329 $ (512)
Net income (loss) ............................................... $ 187 $ 183 $ 227 $ (327)
2001:
Operating revenues .............................................. $ 1,884 $ 1,928 $ 2,154 $ 1,492
Income before income taxes and extraordinary loss ............... $ 174 $ 275 $ 376 $ 114
Net income (loss) ............................................... $ 125 $ 187 $ 275 $ (80)
RECONCILIATION OF PREVIOUSLY REPORTED QUARTERLY INFORMATION --
Quarterly amounts previously reported for 2001 and the first two quarters of
2002 have been reclassified to report certain trading activities on a net basis
(see Note 2.) Quarterly revenue amounts previously reported for 2001 also
reflect the inclusion of delivery fees (see Note 2.) Gross margin and net income
were not affected by these changes.
QUARTER ENDED
-------------------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
-------- ------- -------- -------
Increase (Decrease) From Previously Reported
2002:
Operating revenues as previously reported........................ $ 3,502 $ 3,543 $ - $ -
Cost of energy sold and delivery fees netted with revenues....... (1,703) (1,524) - -
-------- -------- ------- -------
Operating revenues after reclassification........................ $ 1,799 $ 2,019 - -
======= ======= ======= =======
2001:
Operating revenues as previously reported........................ $ 3,644 $ 2,529 $ 2,728 $ 1,966
Electricity delivery fees........................................ 473 438 407 432
Cost of energy sold and delivery fees netted with revenues....... (2,233) (1,039) (981) (906)
------- -------- -------- --------
Operating revenues after reclassification........................ $ 1,884 $ 1,928 $ 2,154 $ 1,492
======= ======= ======= =======
INTEREST EXPENSE AND RELATED CHARGES --
YEAR ENDED DECEMBER 31,
----------------------------------
2002 2001 2000
---- ---- ----
Interest ........................................................ $ 214 $ 230 $ 253
Amortization of debt expense..................................... 8 7 9
Capitalized interest............................................. (6) (14) (5)
---------- ---------- ---------
Total interest expense and other related charges ................ $ 216 $ 223 $ 257
======== ======== =======
74
CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of US Holdings' and 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 within 90 days of the filing of this annual report. Based
on the evaluation performed, US Holdings' and TXU Energy's management, including
the principal executive officer and principal financial officer, concluded that
the disclosure controls and procedures were effective. There were no significant
changes in TXU Energy's internal controls or in other factors that could
significantly affect internal controls subsequent to their evaluation.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(c) Exhibits
12 Calculation of ratio of earnings to fixed charges
99(a) Chief Executive Officer Certification
99(b) Chief Financial Officer Certification
75
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
TXU US HOLDINGS COMPANY
By /s/ Biggs C. Porter
------------------------------------
Biggs C. Porter
Vice President,
Principal Accounting Officer
Date: February 24, 2003
76
TXU US HOLDINGS COMPANY
CERTIFICATION OF CEO
I, Erle Nye, Chairman of the Board and Chief Executive of TXU US Holdings
Company (the "Company"), certify that:
1. I have reviewed this current report on Form 8-K of the Company related to
TXU Energy Company LLC's ("TXU Energy") annual information (annual report);
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
TXU Energy as of, and for, the period presented in this annual report;
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for TXU Energy and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to TXU Energy, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of TXU Energy's disclosure controls and
procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officer and I have disclosed, based on our
most recent evaluation, to TXU Energy's auditors and the board of directors
(or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect TXU Energy's ability to record,
process, summarize and report financial data and have identified for
TXU Energy's auditors any material weaknesses in internal controls;
and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in TXU Energy's internal
controls; and
6. The Company's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 24, 2003 /s/ Erle Nye
-----------------------------------------
Signature: Erle Nye
Title: Chairman of the Board and Chief Executive
77
TXU US HOLDINGS COMPANY
CERTIFICATION OF PFO
I, Michael J. McNally, Principal Financial Officer of TXU US Holdings
Company (the "Company"), certify that:
1. I have reviewed this current report on Form 8-K of the Company related to
TXU Energy Company LLC's ("TXU Energy") annual information (annual report);
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
TXU Energy as of, and for, the period presented in this annual report;
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for TXU Energy and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to TXU Energy, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of TXU Energy's disclosure controls and
procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officer and I have disclosed, based on our
most recent evaluation, to TXU Energy's auditors and board of directors (or
persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect TXU Energy's ability to record,
process, summarize and report financial data and have identified for
TXU Energy's auditors any material weaknesses in internal controls;
and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in TXU Energy's internal
controls; and
6. The Company's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: February 24, 2003 /s/ Michael J. McNally
-------------------------------------------
Signature: Michael J. McNally
Title: Principal Financial Officer
78
EXHIBIT 12
TXU ENERGY COMPANY LLC
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
YEAR ENDED DECEMBER 31,
-----------------------------------------
2002 2001 2000
---- ---- ----
MILLIONS OF DOLLARS, EXCEPT RATIOS
EARNINGS:
Net income before extraordinary items........................... $ 270 $ 660 $ 576
Add: Total federal income taxes................................. 90 279 219
Fixed charges (see detail below)........................... 268 279 301
----- ----- ------
Total earnings.......................................... $ 628 $1,218 $1,096
===== ====== ======
FIXED CHARGES:
Interest expense, excluding capitalized interest................ $ 222 $ 237 $ 262
Rentals representative of the interest factor................... 46 42 39
----- ----- ------
Fixed charges deducted from earnings....................... $ 268 $ 279 $ 301
===== ===== ======
RATIO OF EARNINGS TO FIXED CHARGES................................... 2.34 4.37 3.64
==== ==== ====
79
EXHIBIT 99(A)
TXU US HOLDINGS COMPANY
CERTIFICATE PURSUANT TO SECTION 906
OF SARBANES - OXLEY ACT OF 2002
-------------------------------
The undersigned, Erle Nye, Chairman of the Board and Chief Executive of
TXU US HOLDINGS COMPANY (the "Company"), DOES HEREBY CERTIFY that:
1. The Company's Current Report on Form 8-K related to TXU Energy
Company LLC filed on or about February 24, 2003 ("the Report")
fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934, as amended; and
2. Information contained in the Report fairly presents, in all
material respects, the financial condition and results of
operations of TXU Energy Company LLC.
IN WITNESS WHEREOF, the undersigned has caused this instrument to be
executed this 24th of February 2003.
/s/ Erle Nye
-------------------------------
Name: Erle Nye
Title: Chairman of the Board
and Chief Executive
80
EXHIBIT 99(B)
TXU US HOLDINGS COMPANY
CERTIFICATE PURSUANT TO SECTION 906
OF SARBANES - OXLEY ACT OF 2002
The undersigned, Michael J. McNally, Principal Financial Officer of TXU
US HOLDINGS COMPANY (the "Company"), DOES HEREBY CERTIFY that:
1. The Company's Current Report on Form 8-K related to TXU Energy
Company LLC filed on or about February 24, 2003 (the "Report")
fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934, as amended; and
2. Information contained in the Report fairly presents, in all
material respects, the financial condition and results of
operations of TXU Energy Company LLC.
IN WITNESS WHEREOF, the undersigned has caused this instrument to be
executed this 24th day of February 2003.
/s/ Michael J. McNally
--------------------------------------
Name: Michael J. McNally
Title: Principal Financial Officer
81