SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
-- OR --
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
ENSERCH Corporation
A Texas Corporation I.R.S. Employer
Commission File Number 1-3183 Identification
No. 75-0399066
ENERGY PLAZA, 1601 BRYAN STREET, DALLAS, TEXAS 75201-3411
(214) 812-4600
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes x No
------ ------
Common Stock outstanding at November 6, 1998: 201,000 shares, par value $0.01
per share.
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TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
ENSERCH Corporation and Subsidiaries
Condensed Statements of Consolidated Income -
Three, Nine and Twelve Months Ended
September 30, 1998 and 1997 3
Condensed Statements of Consolidated Cash Flows -
Nine Months Ended September 30, 1998 and 1997 5
Condensed Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997 6
Notes to Condensed Consolidated Financial
Statements 8
Independent Accountants' Reports 12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operation 13
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 19
Part II.OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 20
Signature 21
2
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Item 1. Financial Statements
<TABLE>
<CAPTION>
ENSERCH CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
Three Months Ended September 30 Nine Months Ended September 30
---------------------------------------------- --------------------------------------
1998 1997 1998 1997
------------ ---------------------------- ----------- -----------------------------
Predecessor Predecessor
------------- ---------------
Period From Period From Period From Period From
Three Months Acquisition July 1, 1997 Nine Months Acquisition January 1, 1997
Ended Date to Through Ended Date to Through
September 30, September 30, Acquisition September 30, September 30 Acquisition
1998 1997 Date 1998 1997 Date
---- ---- ---- ---- ---- ----
Thousands of dollars
<S> <C> <C> <C> <C> <C> <C>
OPERATING REVENUES. . . . . . . . . . . . $1,089,815 $276,263 $135,492 $2,983,066 $276,263 $1,279,678
---------- -------- -------- ---------- -------- ----------
OPERATING EXPENSES
Gas and electricity purchased for resale 982,724 208,486 86,471 2,593,355 208,486 955,261
Operation and maintenance . . . . . . . 79,021 53,198 28,710 250,616 53,198 197,482
Depreciation and amortization . . . . . 19,636 12,584 4,793 58,268 12,584 33,693
Taxes other than income . . . . . . . . 12,548 8,296 3,712 51,725 8,296 46,358
---------- -------- -------- ---------- -------- ----------
Total operating expenses. . . . . . 1,093,929 282,564 123,686 2,953,964 282,564 1,232,794
---------- -------- -------- ---------- -------- ----------
OPERATING INCOME (LOSS) . . . . . . . . . (4,114) (6,301) 11,806 29,102 (6,301) 46,884
OTHER INCOME (DEDUCTIONS) - NET . . . . . 315 697 (17,939) 1,087 697 (23,845)
---------- -------- -------- ---------- -------- ----------
INCOME (LOSS) BEFORE INTEREST
AND INCOME TAXES . . . . . . . . . . (3,799) (5,604) (6,133) 30,189 (5,604) 23,039
INTEREST INCOME . . . . . . . . . . . . . 104 83 81 198 83 1,509
INTEREST CHARGES. . . . . . . . . . . . . (18,830) (12,178) (6,581) (55,868) (12,178) (44,537)
---------- ------- -------- ---------- -------- ----------
LOSS BEFORE INCOME TAXES . . . . . . . . (22,525) (17,699) (12,633) (25,481) (17,699) (19,989)
INCOME TAX BENEFIT . . . . . . . . . . . (6,124) (5,428) (256) (4,188) (5,428) (4,612)
---------- ------- -------- ---------- -------- ----------
LOSS FROM CONTINUING
OPERATIONS . . . . . . . . . . . . . . (16,401) (12,271) (12,377) (21,293) (12,271) (15,377)
INCOME (LOSS) FROM DISCONTINUED
OPERATIONS . . . . . . . . . . . . . . 3,321 (224,691)
---------- ------- -------- ---------- -------- ----------
NET LOSS. . . . . . . . . . . . . . . . . (16,401) (12,271) (9,056) (21,293) (12,271) (240,068)
PREFERRED STOCK DIVIDENDS . . . . . . . . 935 1,878 970 3,169 1,878 6,725
---------- -------- -------- ---------- -------- ----------
NET LOSS AVAILABLE FOR
COMMON STOCK . . . . . . . . . . . . . $ (17,336) $(14,149) $(10,026) $ (24,462) $(14,149) $ (246,793)
========== ======== ======== ========== ======== ==========
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
3
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<PAGE>
<TABLE>
<CAPTION>
ENSERCH CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Unaudited)
Twelve Months Ended September 30
------------------------------------------------------
1998 1997
-------------- ----------------------------------
Predecessor
---------------
Period From Period From
Twelve Months Acquisition October 1, 1996
Ended Date to Through
September 30, September 30, Acquisition
1998 1997 Date
---- ---- ----
Thousands of dollars
<S> <C> <C> <C>
OPERATING REVENUES. . . . . . . . . . . . . . . . . . . . . $3,983,809 $276,263 $1,871,229
---------- -------- ----------
OPERATING EXPENSES
Gas and electricity purchased for resale. . . . . . . . . 3,447,309 208,486 1,374,680
Operation and maintenance . . . . . . . . . . . . . . . . 339,104 53,198 291,628
Depreciation and amortization . . . . . . . . . . . . . . 75,404 12,584 47,568
Taxes other than income . . . . . . . . . . . . . . . . . 66,765 8,296 63,321
---------- -------- ----------
Total operating expenses. . . . . . . . . . . . . . . 3,928,582 282,564 1,777,197
---------- -------- ----------
OPERATING INCOME (LOSS) . . . . . . . . . . . . . . . . . . 55,227 (6,301) 94,032
OTHER INCOME (DEDUCTIONS) - NET . . . . . . . . . . . . . . 1,041 697 (30,696)
---------- -------- ----------
INCOME (LOSS) BEFORE INTEREST
AND INCOME TAXES . . . . . . . . . . . . . . . . . . . . 56,268 (5,604) 63,336
INTEREST INCOME . . . . . . . . . . . . . . . . . . . . . . 345 83 2,058
INTEREST CHARGES. . . . . . . . . . . . . . . . . . . . . . (75,445) (12,178) (64,251)
---------- -------- ----------
INCOME (LOSS) BEFORE INCOME TAXES . . . . . . . . . . . . . (18,832) (17,699) 1,143
INCOME TAX EXPENSE (BENEFIT). . . . . . . . . . . . . . . . (245) (5,428) 6,051
---------- -------- ----------
LOSS FROM CONTINUING
OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . (18,587) (12,271) (4,908)
LOSS FROM DISCONTINUED OPERATIONS . . . . . . . . . . . . . (221,817)
---------- -------- ----------
NET LOSS. . . . . . . . . . . . . . . . . . . . . . . . . . (18,587) (12,271) (226,725)
PREFERRED STOCK DIVIDENDS . . . . . . . . . . . . . . . . . 5,968 1,878 9,602
---------- -------- ----------
NET LOSS AVAILABLE FOR
COMMON STOCK . . . . . . . . . . . . . . . . . . . . . . $ (24,555) $(14,149) $ (236,327)
========== ======== ==========
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
4
<PAGE>
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<TABLE>
<CAPTION>
ENSERCH CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED
CASH FLOWS (Unaudited)
Nine Months Ended September 30
------------------------------------------------------
1998 1997
--------------------------------
Predecessor
---------------
Period From Period From
Nine Months Acquisition January 1, 1997
Ended Date to Through
September 30, September 30, Acquisition
1998 1997 Date
---- ---- ----
Thousands of Dollars
<S> <C> <C> <C>
CASH FLOWS - OPERATING ACTIVITIES
Loss from continuing operations. . . . . . . . . . . . . . . . . . . . $(21,293) $(12,271) $(15,377)
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . 57,827 12,584 33,693
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . 32,908 5,422 (8,803)
Changes in operating assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . 162,357 3,318 132,763
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,979) (19,409) 14,776
Accounts payable
Parent and affiliates . . . . . . . . . . . . . . . . . . . . . . 6,479
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (108,998) 22,413 (148,859)
Interest and taxes accrued. . . . . . . . . . . . . . . . . . . . . (2,980) (8,887) (8,627)
Other working capital . . . . . . . . . . . . . . . . . . . . . . . (32,977) 8,694 12,123
Energy marketing risk management assets and liabilities . . . . . . (26,124) (25,536) 2,924
Other - net . . . . . . . . . . . . . . . . . . . . . . . . . . . . (66,036) 4,533 9,669
--------- ------- -------
Cash (used in) provided by operating activities . . . . . . . . . (4,816) (9,139) 24,282
--------- ------- -------
CASH FLOWS - FINANCING ACTIVITIES
Issuances of securities:
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000 100,000
Preferred securities. . . . . . . . . . . . . . . . . . . . . . . . 150,000
Common stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,757
Retirements of securities:
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . (190,750) (260,361) (100,784)
Preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . (100,000)
Change in notes payable:
Commercial paper. . . . . . . . . . . . . . . . . . . . . . . . . . (204,540) 66,540
Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,168)
Parent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,498 512,300
Cash dividends paid. . . . . . . . . . . . . . . . . . . . . . . . . . (4,413) (2,909) (12,771)
Debt financing expenses. . . . . . . . . . . . . . . . . . . . . . . . (4,613)
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (7)
--------- ------- -------
Cash provided by financing activities . . . . . . . . . . . . . . 119,554 44,490 56,735
--------- ------- -------
CASH FLOWS - INVESTING ACTIVITIES
Construction expenditures. . . . . . . . . . . . . . . . . . . . . . . (107,278) (21,558) (62,074)
Other investments. . . . . . . . . . . . . . . . . . . . . . . . . . . (7,275) (7,564) 2,899
--------- ------- -------
Cash used in investing activities . . . . . . . . . . . . . . . . (114,553) (29,122) (59,175)
--------- ------- -------
CASH USED FOR DISCONTINUED OPERATIONS. . . . . . . . . . . . . . . . . . (695) (1,862) (27,414)
--------- ------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS. . . . . . . . . . . . . . . . . (510) 4,367 (5,572)
CASH AND CASH EQUIVALENTS - BEGINNING BALANCE. . . . . . . . . . . . . . 11,770 12,143 17,715
--------- ------- -------
CASH AND CASH EQUIVALENTS - ENDING BALANCE . . . . . . . . . . . . . . . $ 11,260 $ 16,510 $ 12,143
========= ======== ========
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
5
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<TABLE>
<CAPTION>
ENSERCH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
September 30,
1998 December 31,
(Unaudited) 1997
------------ ------------
Thousands of Dollars
<S> <C> <C>
PROPERTY, PLANT AND EQUIPMENT
Gas distribution and pipeline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,117,313 $1,068,708
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,151 46,400
---------- ----------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,177,464 1,115,108
Less accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67,607 24,669
---------- ----------
Net of accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . 1,109,857 1,090,439
Construction work in progress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115,291 85,635
Held for future use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 121
---------- ----------
Net property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . 1,225,269 1,176,195
---------- ----------
INVESTMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,005 37,041
---------- ----------
CURRENT ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,260 11,770
Accounts receivable (net of allowance for
uncollectible accounts: 1998 - $7,288,000;
1997 - $3,902,000). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 359,699 524,908
Energy marketing risk management assets . . . . . . . . . . . . . . . . . . . . . . . . 590,241 365,650
Inventories - at average cost:
Materials and supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,434 6,544
Gas stored underground . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121,333 114,244
Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,737 1,527
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,663 22,663
Other current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,375 7,678
---------- ----------
Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,135,742 1,054,984
---------- ----------
DEFERRED DEBITS
Goodwill (net of accumulated amortization: 1998 - $23,249,000;
1997 - $8,113,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 835,876 791,401
Energy marketing risk management assets . . . . . . . . . . . . . . . . . . . . . . . . 92,109 41,522
Unamortized regulatory assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,368 52,336
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55,040 72,631
Other deferred debits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,725 14,038
---------- ----------
Total deferred debits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,051,118 971,928
---------- ----------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,456,134 $3,240,148
========== ==========
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
6
<PAGE>
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<TABLE>
<CAPTION>
ENSERCH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
CAPITALIZATION AND LIABILITIES
September 30,
1998 December 31,
(Unaudited) 1997
--------------- ------------
Thousands of Dollars
<S> <C> <C>
CAPITALIZATION
Common stock (par value - $.01 per share):
Authorized shares - 100,000,000
Outstanding shares - 201,000 . . . . . . . . . . . . . . . . . . . . . . . . . $ 2 $ 2
Paid in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 776,031 771,207
Retained deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (32,401) (9,565)
---------- ----------
Total common stock equity. . . . . . . . . . . . . . . . . . . . . . . . . . 743,632 761,644
Preferred stock not subject to mandatory redemption . . . . . . . . . . . . . . . 75,000 175,000
ENSERCH obligated, mandatorily redeemable, preferred securities of subsidiary
trust holding solely debentures of ENSERCH . . . . . . . . . . . . . . . . . 146,477
Advances from parent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316,710 293,843
Long-term debt, less amounts due currently. . . . . . . . . . . . . . . . . . . . 550,712 646,796
---------- ----------
Total capitalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,832,531 1,877,283
---------- ----------
CURRENT LIABILITIES
Notes payable - banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,899 6,067
Long-term debt due currently. . . . . . . . . . . . . . . . . . . . . . . . . . . 151,125
Accounts payable:
Parent and affiliates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,405 4,926
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381,975 491,645
Energy marketing risk management liabilities. . . . . . . . . . . . . . . . . . . 572,941 357,044
Taxes accrued . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,190 19,010
Interest accrued. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,583 20,264
Dividends declared. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 616 1,859
Customers' deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,117 7,751
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,031 79,078
---------- ----------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . 1,251,882 987,644
---------- ----------
DEFERRED CREDITS AND OTHER NONCURRENT LIABILITIES
Accumulated deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . 10,088 10,498
Unamortized investment tax credits. . . . . . . . . . . . . . . . . . . . . . . . 3,319 3,364
Pensions and other postretirement benefits. . . . . . . . . . . . . . . . . . . . 144,307 165,514
Energy marketing risk management liabilities. . . . . . . . . . . . . . . . . . . 64,481 31,324
Other deferred credits and noncurrent liabilities . . . . . . . . . . . . . . . . 149,526 164,521
---------- ----------
Total deferred credits and other noncurrent liabilities . . . . . . . . . . 371,721 375,221
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 7)
Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,456,134 $3,240,148
========== ==========
<FN>
See Notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
7
<PAGE>
<PAGE>
ENSERCH CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.MERGERS AND DISPOSITIONS
On August 5, 1997 (Merger Date or Acquisition Date), the merger
transactions involving the former Texas Utilities Company, now known as Texas
Energy Industries, Inc., and ENSERCH Corporation (ENSERCH or the Corporation)
were completed. All of the common stock of ENSERCH was converted into common
stock of a new holding company now known as Texas Utilities Company (TUC), and
ENSERCH became a wholly-owned subsidiary of TUC. Immediately prior to
ENSERCH's merger with TUC, Enserch Exploration, Inc. (EEX) and Lone Star
Energy Plant Operations, Inc. (LSEPO), former subsidiaries of the Corporation,
were merged to form a new company (New EEX), and ENSERCH distributed to its
common shareholders its ownership interest in these businesses.
TUC accounted for its acquisition of ENSERCH as a purchase, and purchase
accounting adjustments, including goodwill, have been pushed down and are
reflected in the financial statements of ENSERCH and its subsidiaries for the
period subsequent to August 5, 1997. The financial statements of ENSERCH for
the periods ended before August 5, 1997 were prepared using ENSERCH's
historical basis of accounting and are designated as "Predecessor". The
comparability of the operating results for the Predecessor and the periods
encompassing push down accounting are affected by the purchase accounting
adjustments, including the amortization of goodwill over a period of forty
years.
The fair value of the assets and liabilities of ENSERCH's rate-regulated
natural gas utility business (conducted through its Lone Star Gas Company and
Lone Star Pipeline Company divisions) is considered to be equivalent to the
historical basis of accounting and accordingly, no adjustment has been made to
the carrying value. The process of determining the fair value of assets
acquired, liabilities assumed and contingencies existing at the Merger Date
was completed in the third quarter of 1998 and resulted in an increase in
goodwill of approximately $60,000,000 over the preliminary allocation
primarily due to refinement of estimates and settlement of preacquisition
contingencies.
The Predecessor financial statements have been restated to reflect EEX
and LSEPO as a discontinued operation. The historical financial statements of
ENSERCH reflect certain reclassifications made to conform to TUC's
presentation style. On December 31, 1997, ENSERCH sold, to another subsidiary
of TUC, at net book value, the group of companies which had constituted the
Corporation's power development and international gas distribution
operations. For financial reporting purposes, the sale was deemed to have
occurred on August 5, 1997. Accordingly, operating results for periods
following the Merger Date exclude those operations. Prior periods were not
restated to reflect the sale.
2.SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation -- The condensed consolidated financial statements
of ENSERCH and its subsidiaries have been prepared on the same basis as those
in the 1997 Annual Report on Form 10-K (1997 Form 10-K) and, in the opinion of
ENSERCH, all adjustments (constituting only normal recurring accruals)
necessary for a fair presentation of the results of operation and financial
position have been included therein. Certain information and footnote
disclosures normally included in annual consolidated financial statements
prepared in accordance with generally accepted accounting principles have been
omitted pursuant to rules and regulations of the Securities and Exchange
Commission (SEC). Certain previously reported amounts have been reclassified
to conform to current classifications.
8
<PAGE>
<PAGE>
Consolidation -- The consolidated financial statements include the
accounts of the Corporation and all of its subsidiaries, including its
subsidiary business trust.
Energy Marketing Activities -- The Corporation, through its energy
marketing subsidiary, Enserch Energy Services, Inc. (EES), enters into a
variety of transactions, including forward contracts involving physical
delivery of natural gas or electrical power commodities, as well as swaps,
futures, options and other derivative contractual arrangements. As part of
these business activities, EES offers price risk management services to the
energy sector. These transactions are primarily conducted with retail end
users, established energy companies and major financial institutions. EES
uses the mark-to-market method of valuing and accounting for these activities.
Under this method, the current market value of EES' energy portfolio, net of
future servicing costs, is reflected within the Corporation's consolidated
balance sheets, with resulting unrealized gains and losses, as "Energy
Marketing Risk Management Assets" or "Energy Marketing Risk Management
Liabilities". The actual timing of cash receipts and payments may, however,
vary as contracts may be settled at intervals other than their scheduled
maturities. (See Note 6).
3.COMPREHENSIVE INCOME
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income," became effective as of the first quarter of 1998. This
statement requires companies to report and display comprehensive income and
its components (revenues, expenses, gains and losses). Comprehensive income
includes all changes in common stock equity during a period except those
resulting from investments by owners and distributions to owners. For the
Corporation, comprehensive income is the same as net income reported in the
statements of consolidated income, since there were no other items of
comprehensive income for the periods presented.
4.LINES OF CREDIT
At September 30, 1998, TUC, Texas Utilities Electric Company (a
subsidiary of TUC) (TU Electric) and ENSERCH had joint US dollar-denominated
lines of credit under revolving credit facility agreements (US Credit
Agreements) with a group of banking institutions. The US Credit Agreements
have two facilities. At September 30, 1998, Facility A provided for
short-term borrowings aggregating up to $2,921,000,000 outstanding at any one
time at variable interest rates and terminates March 1, 1999. Facility B
provides for borrowings aggregating up to $1,400,000,000 outstanding at any
one time at variable interest rates and terminates March 2, 2003. Excluding
$2,121,000,000 which is restricted to TUC's use in financing the acquisition
of a United Kingdom based entity, the combined borrowings of TUC, TU Electric
and ENSERCH under both facilities are limited to an aggregate of
$2,200,000,000 outstanding at any one time, which may be used for working
capital and other general corporate purposes, including commercial paper
backup. ENSERCH's borrowings under both facilities are limited to an
aggregate of $650,000,000 outstanding at any one time. At September 30,
1998, ENSERCH had no borrowings outstanding under these facilities.
5.CAPITALIZATION
Preferred Stock -- In January 1998, the Corporation redeemed the
$100,000,000 principal amount of its Adjustable Rate Preferred Stock, Series
E, at par value, plus accrued and unpaid dividends.
ENSERCH Obligated, Mandatorily Redeemable, Preferred Securities of
Subsidiary Trust Holding Solely Debentures of ENSERCH -- In July 1998, a
statutory business trust, ENSERCH Capital I, established as a financing
subsidiary of ENSERCH for the purpose of issuing common and preferred trust
securities, issued $150,000,000 of floating rate capital securities. The
proceeds were used by ENSERCH for general
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corporate purposes, including the
acquisition or redemption of outstanding securities of ENSERCH. Distributions
on these capital securities are payable quarterly based on an annual floating
rate determined quarterly with reference to a three-month LIBOR plus a
margin. The only assets held by the trust are $154,600,000 principal amount
of Floating Rate Junior Subordinated Debentures Series A (Series A Debentures)
of ENSERCH. The interest on the Series A Debentures is payable at a rate
equal to that of the preferred trust securities. The interest rate for the
period from July 2, 1998 to September 30, 1998 was 7.06875% and for the period
from October 1, 1998 to December 31, 1998 is 6.6625%. The Series A
Debentures will mature on July 1, 2028 and ENSERCH has the right to redeem the
Series A Debentures and the capital securities in whole or in part on or after
July 1, 2003.
On October 1, 1998, an interest rate swap was entered into which
effectively fixes the rate on $100,000,000 notional amount of the ENSERCH
floating rate capital securities at 6.629% to July 1, 2003.
Long-Term Debt -- In January 1998, the Corporation issued $125,000,000 of
6.25% Series A Notes due January 1, 2003 (Series A Notes) and $125,000,000 of
Remarketed Reset Notes due January 1, 2008 (Reset Notes). Net proceeds from
these borrowings were used to refinance or redeem like amounts of higher rate
debt and preferred stock. In July 1998, the interest rate on the Reset Notes
was reset to a fixed rate of 6.564% payable until July 1, 2005.
In March 1998, ENSERCH redeemed the outstanding balance of its 6.375%
Convertible Subordinated Debentures. Holders of $3,005,000 principal amount
of the debentures elected to convert such debentures into 77,963 shares of TUC
common stock, and the remaining $87,745,000 principal amount was redeemed at
par for cash.
In July 1998, ENSERCH redeemed at par its $100,000,000 principal amount
8.875% Senior Notes due 2001.
6.DERIVATIVE INSTRUMENTS
The Corporation enters into derivative instruments, including
options, swaps, futures and other contractual commitments to manage market
risks related to changes in interest rates and commodity prices. The
Corporation's participation in derivative transactions, except for its energy
marketing activities conducted by EES, has been designated for hedging
purposes, and those derivative instruments are not held or issued for trading
purposes.
Energy Marketing Activities -- EES' energy portfolio is comprised of
forward commitments, futures, swaps, options and other derivative instruments
related to natural gas and electricity marketing activities. The notional
amounts and terms of the portfolio as of September 30, 1998 included financial
instruments that provide for fixed price receipts of 2,599 trillion British
thermal units equivalent (TBtue) and fixed price payments of 2,689 TBtue, with
a maximum term of eight years. Additionally, sales and purchase commitments
totaling 1,245 TBtue, with terms extending up to nine years, are included in
the portfolio as of September 30, 1998.
Notional amounts reflect the volume of transactions but do not represent
the amounts exchanged by the parties to the financial instruments.
Accordingly, the notional amounts represented above do not necessarily measure
EES' exposure to market or credit risks. Additionally, the maximum term in
years are not indicative of likely future cash flows as these positions may be
offset in the markets at any time in response to EES' risk management needs.
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7.COMMITMENTS AND CONTINGENCIES
Guarantees -- The Corporation and/or its subsidiaries are the guarantors
on various commitments and obligations of others aggregating approximately
$32,520,000 at September 30, 1998. The Corporation is exposed to loss in the
event of nonperformance by other parties. However, the Corporation does not
anticipate nonperformance by the counterparties.
Legal Proceedings -- On August 3, 1998, the Gracy Fund, L.P. filed suit
in the United States District Court for the Northern District of Texas against
New EEX, formerly EEX, TUC, David W. Biegler, Gary J. Junco, Erle Nye, Thomas
Hamilton and J. Phillip McCormick. The plaintiff seeks to represent a class
comprised of all purchasers of the common stock of ENSERCH or EEX between
January 26, 1996 and August 4, 1997, including former shareholders of ENSERCH
who received shares of EEX and TUC pursuant to the merger agreement between
ENSERCH and TUC dated April 13, 1996, all EEX shareholders solicited pursuant
to a proxy statement/prospectus issued by EEX dated October 2, 1996 and all
ENSERCH shareholders solicited by a joint proxy statement/prospectus issued by
ENSERCH and TUC dated September 23, 1996. The individual defendants are
current or former officers and/or directors of TUC or EEX. The plaintiffs
allege that the defendants participated in a fraudulent scheme and course of
business by disseminating materially false and misleading statements regarding
EEX's and ENSERCH's business which caused the plaintiffs and other members of
the class to purchase EEX and ENSERCH stock at artificially inflated prices.
In such connection, the plaintiffs allege that the defendants violated various
provisions of the Securities Act of 1933 and the Securities Exchange Act of
1934 (Exchange Act). No amount of damages is specified. It has been agreed
by the parties to this suit that the Thorne suit described below will be
consolidated with this suit. TUC is evaluating these claims and is unable at
this time to predict the outcome of this proceeding, but it intends to
vigorously defend this suit.
Also on August 3, 1998, Stan C. Thorne filed suit in the United States
District Court for the Southern District of Texas against EEX, ENSERCH,
DeGolyer & MacNaughton (D&M), David W. Biegler, Gary J. Junco, Fredrick S.
Addy and B. K. Irani. The plaintiff seeks to represent a class comprised of
all purchasers of the common stock of EEX during the period of August 3, 1995
through August 5, 1997. The individual defendants are current or former
officers and/or directors of EEX and Mr. Biegler has been an officer and
director of ENSERCH. D&M served as independent petroleum consultants to EEX.
The plaintiff alleges that the defendants engaged in a course of conduct
designed to mislead the plaintiff and the investing public in order to
maintain the price of EEX common stock at artificially high levels through
false and misleading representations concerning the gas reserves of EEX in
violation of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5
thereunder. The plaintiff also alleges that the defendants were negligent in
making such misrepresentations and that they constituted common law fraud
against the defendants. No amount of damages is specified in this action.
This suit has been transferred to the Northern District of Texas and the
parties have agreed to consolidate it with the Gracy Fund suit described
above. TUC is also evaluating these claims and is unable at this time to
predict the outcome of this proceeding, but it also intends to vigorously
defend this suit.
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INDEPENDENT ACCOUNTANTS' REPORT
ENSERCH Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of
ENSERCH Corporation and subsidiaries (the "Corporation") as of September 30,
1998, and the related condensed statements of consolidated income for the
three-month, nine-month and twelve-month periods ended September 30, 1998,
and the period from the acquisition date (August 5, 1997) through September
30, 1997 (Successor Company Operations) and the condensed statements of
consolidated income for the periods from July 1, 1997, January 1, 1997 and
October 1, 1996 through the acquisition date (Predecessor Company Operations)
and the condensed statements of consolidated cash flows for the nine-month
period ended September 30, 1998 and the period from the acquisition date to
September 30, 1997 (Successor Company), and the period from January 1, 1997
through the acquisition date (Predecessor Company). These financial
statements are the responsibility of the Corporation's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical review
procedures to financial data and making inquiries of persons responsible for
financial and accounting matters. It is substantially less in scope than an
audit in accordance with generally accepted auditing standards, the objective
of which is the expression of an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to such condensed consolidated financial statements for them to
be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of the Corporation as of December
31, 1997, and the related consolidated statements of income, cash flows and
common stock equity for the year then ended (not presented herein); and in our
report dated February 24, 1998, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth
in the accompanying condensed consolidated balance sheet as of December 31,
1997, is fairly stated in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
Dallas, Texas
November 12, 1998
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
FORWARD-LOOKING STATEMENTS
This report and other presentations made by ENSERCH Corporation (ENSERCH
or the Corporation) and its subsidiaries contain forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. Although ENSERCH believes that in making any such statement its
expectations are based on reasonable assumptions, any such statement involves
uncertainties and is qualified in its entirety by reference to factors
contained in the Forward-Looking Statements section of Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operation in
ENSERCH's Annual Report on Form 10-K for the year 1997 (1997 Form 10-K), among
others, that could cause the actual results of ENSERCH to differ materially
from those projected in such forward-looking statement.
Any forward-looking statement speaks only as of the date on which such
statement is made, and ENSERCH undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time, and it is not possible for
ENSERCH to predict all of such factors, nor can it assess the impact of each
such factor or the extent to which any factor, or combination of factors, may
cause results to differ materially from those contained in any forward-looking
statement.
FINANCIAL CONDITION
Merger With TUC and Disposition
On August 5, 1997 (Merger Date or Acquisition Date), the merger
transactions involving the former Texas Utilities Company, now known as Texas
Energy Industries, Inc., and ENSERCH were completed. All of the common stock
of ENSERCH was converted into common stock of a new holding company now known
as Texas Utilities Company (TUC), and ENSERCH became a wholly-owned subsidiary
of TUC. Immediately prior to ENSERCH's merger with TUC, Enserch Exploration,
Inc. (EEX) and Lone Star Energy Plant Operations, Inc. (LSEPO), former
subsidiaries of the Corporation, were merged to form a new company (New EEX),
and ENSERCH distributed to its common shareholders its ownership interest in
these businesses.
TUC accounted for its acquisition of ENSERCH as a purchase, and purchase
accounting adjustments, including goodwill, have been pushed down and are
reflected in the financial statements of ENSERCH and its subsidiaries for the
period subsequent to August 5, 1997. The financial statements of ENSERCH for
the periods ended before August 5, 1997 were prepared using ENSERCH's
historical basis of accounting and are designated as "Predecessor". The
comparability of the operating results for the Predecessor and the periods
encompassing push down accounting are affected by the purchase accounting
adjustments, including the amortization of goodwill over a period of forty
years.
The fair value of the assets and liabilities of ENSERCH's rate-regulated
natural gas utility business (conducted through its Lone Star Gas Company and
Lone Star Pipeline Company divisions) is considered to be equivalent to the
historical basis of accounting and accordingly, no adjustment has been made to
the carrying value. The process of determining the fair value of assets
acquired, liabilities assumed and contingencies existing at the Merger Date
was completed in the third quarter of 1998 and resulted in an increase in
goodwill of approximately $60 million over the preliminary allocation
primarily due to refinement of estimates and settlement of preacquisition
contingencies.
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The Predecessor financial statements have been restated to reflect EEX
and LSEPO as a discontinued operation. The historical financial statements of
ENSERCH reflect certain reclassifications made to conform to TUC's
presentation style. On December 31, 1997, ENSERCH sold, to another subsidiary
of TUC, at net book value, the group of companies which had constituted the
Corporation's power development and international gas distribution
operations. For financial reporting purposes, the sale was deemed to have
occurred on August 5, 1997. Accordingly, operating results for periods
following the Merger Date exclude those operations. Prior periods were not
restated to reflect the sale.
For purposes of the discussion of operating results provided herein, the
financial information of the Predecessor for the 1997 periods prior to the
merger date have been combined with the post-merger financial information.
The continuing business operations of ENSERCH were not significantly changed
as a result of the merger, and post-merger and pre-merger operating results,
except as noted, are comparable.
Liquidity and Capital Resources
For information concerning liquidity and capital resources, see Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operation in ENSERCH's 1997 Form 10-K. Results for the three- and nine-month
periods presented herein are not necessarily indicative of expectations for a
full year's operations because of seasonal and other factors, including
variations in maintenance and other operating expense patterns. No significant
changes or events which might affect the financial condition of the
Corporation have occurred subsequent to year-end other than as disclosed in
other reports of ENSERCH or included herein.
Continuing operations used cash of $4.8 million for operating activities
in the nine months of 1998 compared with cash provided of $15 million in the
same period of 1997. Discontinued operations used cash of $.7 million in
the 1998 nine months and $29.3 million in the 1997 period.
Investing activities required $115 million in the nine months of 1998
versus $88 million in 1997. Capital spending in the nine months of 1998 was
$24 million higher than the nine months of the prior year. Other investing
activities used cash of $7.3 million in 1998 and $4.7 million in 1997.
The capitalization ratios of the Corporation as of September 30, 1998
consisted of approximately 47.3% long-term debt (including amounts due
parent), 4.1% preferred stock, 8.0% preferred securities and 40.6% common
stock equity.
In January 1998, ENSERCH issued $125 million of 6.25% Series A Notes due
2003 and $125 million of Remarketed Reset Notes due 2008 (Reset Notes). Net
proceeds from these borrowings were used to refinance or redeem like amounts
of higher rate debt and preferred stock. In July 1998, the interest rate on
the Reset Notes was reset to a fixed rate of 6.564% payable until July 1,
2005. In January 1998, the $100 million principal amount of Series E
Adjustable Rate Preferred Stock was redeemed at 100% of its liquidation price
plus accrued and unpaid dividends. In March 1998, holders of $3.0 million
principal amount of 6.375% Convertible Subordinated Debentures converted such
debentures into 77,963 shares of TUC common stock, and the remaining $87.7
million principal amount was redeemed at par for cash. In July 1998, ENSERCH
redeemed at par its $100 million principal amount of 8.875% Senior Notes due
2001.
In July 1998, a statutory business trust, ENSERCH Capital I, established
as a financing subsidiary of ENSERCH for the purpose of issuing common and
preferred trust securities, issued $150 million of floating rate capital
securities. The proceeds were used by ENSERCH for general corporate purposes,
including the acquisition or redemption of outstanding securities of ENSERCH.
Distributions on these capital securities are payable quarterly based on an
annual floating rate determined quarterly with reference to a three-month
LIBOR plus a margin. The only assets held by the trust are $154.6 million
principal amount of Floating Rate Junior Subordinated Debentures Series A
(Series A Debentures) of ENSERCH. The interest on the Series A Debentures is
payable at a rate equal to that of the preferred trust securities. The
interest rate for the period from July 2, 1998 to September 30, 1998 was
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7.06875% and for the period from October 1, 1998 to December 31, 1998 is
6.6625%. The Series A Debentures will mature on July 1, 2028 and ENSERCH has
the right to redeem the Series A Debentures and the capital securities in
whole or in part on or after July 1, 2003.
On October 1, 1998, an interest rate swap was entered into which
effectively fixes the rate on $100 million notional amount of the ENSERCH
floating rate capital securities at 6.629% to July 1, 2003.
ENSERCH may issued additional debt and equity securities as needed,
including the possible future sale of up to $100 million aggregate principal
amount of securities currently registered with the SEC for offering pursuant
to Rule 415 under the Securities Act of 1933.
At September 30, 1998, TUC, Texas Utilities Electric Company (a
subsidiary of TUC) (TU Electric) and ENSERCH had joint US dollar-denominated
lines of credit under revolving credit facility agreements (US Credit
Agreements) with a group of banking institutions. The US Credit
Agreements have two facilities. At September 30, 1998, Facility A provided
for short-term borrowings aggregating up to $2,921 million outstanding at any
one time at variable interest rates and terminates March 1, 1999. Facility B
provides for borrowings aggregating up to $1,400 million outstanding at any
one time at variable interest rates and terminates March 2, 2003. Excluding
$2,121 million which is restricted to TUC's use in financing the acquisition
of a United Kingdom based entity, the combined borrowings of TUC, TU Electric
and ENSERCH under both facilities are limited to an aggregate of $2,200
million outstanding at any one time, which may be used for working capital and
other general corporate purposes, including commercial paper backup.
ENSERCH's borrowings under both facilities are limited to an aggregate of
$650 million outstanding at any one time. At September 30, 1998, ENSERCH had
no borrowings outstanding under these facilities.
Sales of Accounts Receivable -- ENSERCH has facilities with financial
institutions whereby it is entitled to sell and such financial institutions
may purchase, on an ongoing basis, undivided interests in customer accounts
receivables representing up to an aggregate of $100 million. Additional
receivables are continually sold to replace those collected. At September 30,
1998, ENSERCH companies had sold $100 million of accounts receivable under
such agreements.
Risk Management -- The Corporation's operations involve managing market
risks related to changes in interest rates and commodity price exposures.
Derivative instruments including swaps and forward contracts are used to
reduce and manage a portion of those risks. With the exception of the energy
marketing activities of a subsidiary, Enserch Energy Services, Inc. (EES) the
Corporation's participation in derivative transactions are designed for
hedging purposes; and derivative instruments are not held or issued for
trading purposes. Credit risk relates to the risk of loss that the
Corporation would incur as a result of nonperformance by counterparties to
their respective derivative instruments. The Corporation believes the risk of
nonperformance by counterparties is minimal.
As part of its energy marketing business activities, EES enters into a
variety of transactions, including forward contracts involving physical
delivery of natural gas or electrical power commodities, as well as swaps,
futures, options and other derivative contractual arrangements. These
activities involve price commitments into the future and, therefore, give rise
to market risk. EES uses the mark-to-market method of valuing and accounting
for these activities.
EES' energy portfolio is comprised of forward commitments, futures,
swaps, options and other derivative instruments. The notional amounts and
terms of the portfolio as of September 30, 1998 included financial instruments
that provide for fixed price receipts of 2,599 trillion British thermal units
equivalent (TBtue) and fixed price payments of 2,689 TBtue, with a maximum
term of eight years. Additionally, sales and purchase commitments totaling
1,245 TBtue, with terms extending up to nine years, are included in the
portfolio as of September 30, 1998.
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Regulation and Rates
Under a settlement of the Railroad Commission of Texas (RRC) rate inquiry
approved in June 1998, Lone Star Gas agreed to credit residential and
commercial customers $18 million to be spread over the next two heating
seasons (November through March). Earnings are not affected by the settlement
due to previously established reserves.
RESULTS OF OPERATION
For the three-, nine- and twelve-month periods ended September 30, 1998,
ENSERCH had losses from continuing operations of $16.4 million, $21.3 million
and $18.6 million, respectively, compared with losses of $24.6 million, $27.6
million and $17.2 million, respectively, for the Corporation and Predecessor,
as applicable, for the same periods of 1997.
The amortization of goodwill arising from the acquisition by Texas
Utilities was $5.1 million for the three months, $15.1 million for the
nine months and $20.1 million for the twelve months ended September 30, 1998.
Income for the 1997 nine and twelve month period was reduced by an $8.6
million pretax, $5.6 million after-tax, provision for a credit Lone Star
Pipeline Company made voluntarily to its customers.
Consolidated revenues for the three, nine and twelve months ended
September 30, 1998 increased 165%, 92% and 86% compared with the same periods
for 1997. The higher revenues reflect a significant increase in energy
marketing revenues in all periods from both gas and electricity marketing
activities.
Energy marketing revenues for the three, nine and twelve months ended
September 30, 1998 were $946 million, $2.3 billion and $3.0 billion compared
with $243 million, $784 million and $1.1 billion for the same periods last
year. Energy marketing revenues increased substantially as the trading
volumes of natural gas increased from earlier periods and as sales of
electricity contracts began in 1998. Gas distribution revenues for the three,
nine and twelve months ended September 30, 1998 were down 20.4%, 21.9% and
14.4%, respectively, from the same periods last year due to decreases in sales
volumes of 12.5%, 11.1% and 5.8%, respectively, reflecting the effects of
warmer weather, and lower flow-through of gas costs. Pipeline transportation
revenues for the three-, nine- and twelve-months periods decreased from the
prior year by 17.4%, 3.2% and 1.0%, respectively, on lower margins as
transportation volumes were higher for all comparable periods.
Gas and electricity purchased for resale increased 233%, 123% and 118% in
the three-, nine- and twelve-month 1998 periods, respectively, over the same
periods of 1997, reflecting the increase in energy marketing activity.
Other income-net for the three-, nine- and twelve-month periods ending
September 30, 1997 included merger related expenses incurred through the
acquisition date of $19.3 million, $25.1 million and $29.4 million,
respectively.
The loss from discontinued operations of $225 million for the nine months
and $222 million for the twelve months ended September 30, 1997, included the
effect of a $236 million after-tax write-down of the carrying value of EEX's
oil and gas properties due to the US cost center ceiling limitation at March
31, 1997, and a $9.7 million ($14.9 million pre-tax) provision for estimated
costs and expenses to wind-up engineering and construction operations.
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COMPREHENSIVE INCOME
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income," became effective as of the first quarter of 1998. This
statement requires companies to report and display comprehensive income and
its components (revenues, expenses, gains and losses). Comprehensive income
includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners. For the Corporation,
comprehensive income is the same as net income reported in the statements of
consolidated income, since there are no other items of comprehensive income
for the periods presented.
CHANGES IN ACCOUNTING STANDARDS
SFAS 131, "Disclosures About Segments of an Enterprise and Related
Information," will become effective in 1998. This statement establishes
standards for defining and reporting business segments. The Corporation is
currently determining its reportable segments, if any. SFAS 132, "Employer's
Disclosures about Pensions and Other Postretirement Benefits" revises existing
rules for employers' disclosures about pensions and other postretirement
benefit plans. It does not change the measurement or recognition of those
plans. This standard will become effective in 1998 for year end disclosures.
The adoption of SFAS 131 and 132 will not affect the Corporation's
consolidated financial position, results of operations or cash flows.
SFAS 133, "Accounting for Derivative Instruments and Hedging Activities,"
is effective for fiscal years beginning after June 15, 1999. This standard
requires that all derivatives be recognized as either assets or liabilities in
the balance sheet at their fair values and that accounting for the changes in
their fair values is dependent upon the intended use of the derivative and its
resulting designation. The new standard will supersede or amend existing
standards which deal with hedge accounting and derivatives. The Corporation
has not yet determined the effect adopting this standard will have on its
financial statements.
YEAR 2000
Year 2000 (Y2K) issues of ENSERCH are being addressed with those of its
parent company, TUC (the Company). The following disclosure regarding Y2K
issues of TUC's US energy business is included in TUC's Form 10-Q for the
period ended September 30, 1998:
Many existing computer programs use only the last two digits to identify a
year in the date field. Thus, they would not recognize a year that begins
with 20 instead of 19. If not corrected, many computer applications could
fail or produce erroneous data on or about the year 2000.
The Company began its efforts to address Year 2000 (Y2K) issues in 1996 by
focusing on its US information technology mainframe-based application systems
(IT Corporate Applications). In early 1997, an infrastructure project to
address the Company's information technology related equipment, operating
systems and desktop software was begun (IT Infrastructure). In late 1997, a
project was begun to address Y2K issues throughout the Company related to
embedded systems, such as process controls for energy production and delivery,
and business unit owned applications (Non-IT Equipment and Applications).
Applications and equipment in each of these three major initiatives have been
inventoried and categorized based on their criticality to the Company's
business operations. Assessments of the potential impact due to Y2K issues
are being performed. This process involves the solicitation of vendor
feedback, comparing information with other energy companies, and in many cases
internal verification by testing. The majority of assessment work has
occurred and the rest is scheduled to be completed by the end of 1998. The
remediation and replacement work on the majority of IT Corporate Applications
and IT Infrastructure is scheduled to be completed by the end of 1998. A
majority of the assessment work on embedded systems has been completed.
Remediation work is scheduled to be completed by September of 1999. A number
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of tests on operational equipment has been performed. The Company will
continue to test this equipment throughout the remainder of 1998 and into the
spring of 1999.
The IT Corporate Applications assessment, testing and remediation activities
are fully active. Twenty-seven percent of applications have been tested and
certified as Y2K compliant. Sixty percent of applications are scheduled to be
certified by the end of 1998. The remaining applications are scheduled to be
certified by March 31, 1999. The Company has established a certification
protocol to be followed for remediation of software applications. That
protocol includes testing procedures to be followed before remediated
applications are returned to production.
The IT Infrastructure project involves assessing the compliance of standard
computer hardware, network systems including gateways, hubs and routers,
telecommunications equipment, operating systems and IT standard software
products. Equipment is being individually tested using software products and
applicable test procedures. Network system tests are scheduled to be
performed prior to the end of 1998. Most of the IT Infrastructure is
scheduled to be Y2K ready by the end of 1998. Certain vendor supplied program
products will not have Y2K ready versions available until the first quarter of
1999. These product upgrades will be tested and implemented as soon as they
are available.
Non-IT Equipment and Applications involve the hardware and software products
that reside in individual business units. These products include the embedded
systems that are used in the production, energy delivery, and other processes
of the Company. Inventories have been conducted to identify these embedded
systems in the individual business units. Initial assessments are essentially
complete. More detailed assessments involving equipment and software
validation testing are scheduled throughout the spring of 1999. Remediation
activities are underway. Although much of the work is expected to be
completed by the end of 1998, equipment outage schedules necessitate that some
remediation activities will not be completed until September 1999.
The Company is analyzing the potential impact on its operations relating to
third parties. Over 2000 suppliers and service providers have been contacted
to determine the status of their Y2K efforts. Approximately sixty percent of
these vendors have responded. They are being prioritized and the programs and
status of the most significant among them will be analyzed in detail.
Companies that are considered to be critical are telecommunications and gas
suppliers. This analysis is expected to be completed by the end of 1998.
The costs associated with the Company's Y2K effort for its US energy
businesses are currently estimated to be approximately $36 million. These
costs reflect new, incremental costs and the reallocation of resources in
pre-existing maintenance budgets. The costs related to the three major
initiatives are estimated to be as follows: IT Corporate Applications - $14.1
million, IT Infrastructure - $7.2 million and Non IT-Equipment and
Applications - $14.2 million. These costs are being expensed as incurred over
the period 1996 to 2000, and it is estimated that a total of $13.6 million has
already been expended. There can be no assurance that these estimated costs
will not increase as the Company's Y2K program continues.
Strategic initiatives were begun in two areas prior to beginning work on the
Y2K issue, and the costs for these initiatives are not included in the
estimate above. The Company's energy management system for the Company's
transmission grid and the Company's principal financial and accounting systems
are being replaced. Each of these projects will eliminate potential Y2K
deficiencies; however, that was not a significant consideration at the time
replacement decisions were made.
With respect to internal risks, the Company's current assessment of the most
reasonable likely worst case scenario is that impacts on either service or
financial performance will not be materially adverse. The Company believes,
based on the results of testing that has already occurred on a large portion
of operating equipment, that if any disruption to service occurs, it will be
isolated and of short-term duration. The
18
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Company continues to collaborate
with other major energy suppliers through the joint Electric Power Research
Institute's embedded systems project.
The North American Electric Reliability Council (NERC) has conducted an
initial assessment of the electric infrastructure, in which the Company
participated. The NERC status report, issued in September 1998, indicates
that the impact of Y2K on electrical systems may be less than first
anticipated and that, with continued work and coordinated contingency
planning, operating risks can be effectively mitigated. NERC will perform
scenario analyses of potential risks to the electric infrastructure. Until
this work is complete, the Company cannot assess a worst case scenario
relating to external forces.
As the Company's Y2K program proceeds, the Company will continue to assess its
internal and external risks, not all of which are within its control; and it
will consider the most reasonably likely worst case scenario. There can be no
assurance that all material Y2K risks within the Company's control will have
been adequately identified and corrected before the end of 1999. In addition,
the Company can make no assurances regarding the Y2K readiness of systems and
parties outside its control, nor can it currently assess the effect of any
non-readiness by such systems or parties.
The Company utilizes detailed emergency response and disaster recovery plans
to ensure high reliability of service to customers. These plans are currently
available and are utilized routinely for abnormal service conditions. These
plans are being reviewed to incorporate required actions specific to the Y2K
issue. The resulting contingency plan will address both Company activities
and actions necessary to mitigate the impact of third party disruptions.
These contingency plans will be coordinated with those of the regional
independent system operator and NERC. This contingency planning is scheduled
to be completed by June 1999.
LEGAL PROCEEDINGS
See Note 7 to Condensed Consolidated Financial Statements for a
description of legal proceedings.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required hereunder for the Corporation is not
significantly different from the information set forth in Item 7A.
Quantitative and Qualitative Disclosures About Market Risk included in the
1997 Form 10-K and is therefore not presented herein.
19
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<PAGE>
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On August 3, 1998, the Gracy Fund, L.P. filed suit in the United States
District Court for the Northern District of Texas against New EEX, formerly
EEX, TUC, David W. Biegler, Gary J. Junco, Erle Nye, Thomas Hamilton and J.
Phillip McCormick. The plaintiff seeks to represent a class comprised of all
purchasers of the common stock of ENSERCH or EEX between January 26, 1996 and
August 4, 1997, including former shareholders of ENSERCH who received shares
of EEX and TUC pursuant to the merger agreement between ENSERCH and TUC dated
April 13, 1996, all EEX shareholders solicited pursuant to a proxy
statement/prospectus issued by EEX dated October 2, 1996 and all ENSERCH
shareholders solicited by a joint proxy statement/prospectus issued by ENSERCH
and TUC dated September 23, 1996. The individual defendants are current or
former officers and/or directors of TUC or EEX. The plaintiffs allege that
the defendants participated in a fraudulent scheme and course of business by
disseminating materially false and misleading statements regarding EEX's and
ENSERCH's business which caused the plaintiffs and other members of the class
to purchase EEX and ENSERCH stock at artificially inflated prices. In such
connection, the plaintiffs allege that the defendants violated various
provisions of the Securities Act of 1933 and the Securities Exchange Act of
1934 (Exchange Act). No amount of damages is specified. It has been agreed
by the parties to this suit that the Thorne suit described below will be
consolidated with this suit. TUC is evaluating these claims and is unable at
this time to predict the outcome of this proceeding, but it intends to
vigorously defend this suit.
Also on August 3, 1998, Stan C. Thorne filed suit in the United States
District Court for the Southern District of Texas against EEX, ENSERCH,
DeGolyer & MacNaughton (D&M), David W. Biegler, Gary J. Junco, Fredrick S.
Addy and B. K. Irani. The plaintiff seeks to represent a class comprised of
all purchasers of the common stock of EEX during the period of August 3, 1995
through August 5, 1997. The individual defendants are current or former
officers and/or directors of EEX and Mr. Biegler has been an officer and
director of ENSERCH. D&M served as independent petroleum consultants to EEX.
The plaintiff alleges that the defendants engaged in a course of conduct
designed to mislead the plaintiff and the investing public in order to
maintain the price of EEX common stock at artificially high levels through
false and misleading representations concerning the gas reserves of EEX in
violation of Sections 10(b) and 20(a) of the Exchange Act of 1934 and Rule
10b-5 thereunder. The plaintiff also alleges that the defendants were
negligent in making such misrepresentations and that they constituted common
law fraud against the defendants. No amount of damages is specified in this
action. This suit has been transferred to the Northern District of Texas and
the parties have agreed to consolidate it with the Gracy Fund suit described
above. TUC is evaluating these claims and is unable at this time to predict
the outcome of this proceeding, but it intends to vigorously defend this suit.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)Exhibits files as part of Part II are:
15 - Letter of Deloitte & Touche LLP as to unaudited interim
financial statements.
27 - Financial Data Schedule
(b)Reports on Form 8-K filed since June 30, 1998:
Date of Report Items Reported
July 2, 1998 Item 7. Financial Statements and Exhibits
20
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<PAGE>
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 thereunto duly authorized.
ENSERCH Corporation
By /s/ J. W. Pinkerton
-------------------------
J. W. Pinkerton
Vice President and Controller,
Principal Accounting Officer
Date: November 13, 1998
<TABLE> <S> <C>
<ARTICLE> UT
<CIK> 0000033015
<NAME> ENSERCH CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<BOOK-VALUE> PER-BOOK
<TOTAL-NET-UTILITY-PLANT> 1,225,269
<OTHER-PROPERTY-AND-INVEST> 44,005
<TOTAL-CURRENT-ASSETS> 1,135,742
<TOTAL-DEFERRED-CHARGES> 1,051,118
<OTHER-ASSETS> 0
<TOTAL-ASSETS> 3,456,134
<COMMON> 2
<CAPITAL-SURPLUS-PAID-IN> 776,031
<RETAINED-EARNINGS> (32,401)
<TOTAL-COMMON-STOCKHOLDERS-EQ> 743,632
146,477
75,000
<LONG-TERM-DEBT-NET> 867,422
<SHORT-TERM-NOTES> 1,899
<LONG-TERM-NOTES-PAYABLE> 0
<COMMERCIAL-PAPER-OBLIGATIONS> 0
<LONG-TERM-DEBT-CURRENT-PORT> 151,125
0
<CAPITAL-LEASE-OBLIGATIONS> 0
<LEASES-CURRENT> 0
<OTHER-ITEMS-CAPITAL-AND-LIAB> 1,470,579
<TOT-CAPITALIZATION-AND-LIAB> 3,456,134
<GROSS-OPERATING-REVENUE> 2,983,066
<INCOME-TAX-EXPENSE> (4,188)
<OTHER-OPERATING-EXPENSES> 2,953,964
<TOTAL-OPERATING-EXPENSES> 2,953,964
<OPERATING-INCOME-LOSS> 29,102
<OTHER-INCOME-NET> 1,087
<INCOME-BEFORE-INTEREST-EXPEN> 30,189
<TOTAL-INTEREST-EXPENSE> 55,868
<NET-INCOME> (21,293)
3,169
<EARNINGS-AVAILABLE-FOR-COMM> (24,462)
<COMMON-STOCK-DIVIDENDS> 4,413
<TOTAL-INTEREST-ON-BONDS> 0
<CASH-FLOW-OPERATIONS> (4,816)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
EXHIBIT 15
ENSERCH Corporation:
We have made a review, in accordance with standards established by the
American Institute of Certified Public Accountants, of the unaudited condensed
consolidated interim financial information of ENSERCH Corporation and
subsidiaries (the "Corporation") for the three-month and six-month periods
ended September 30, 1998 and the period from the acquisition (August 5, 1997)
through September 30, 1998 (Successor Company Operations), and three-month,
nine-month and twelve-month periods ended September 30, 1997 and the
period from July 1, 1997 through the acquisition date (Predecessor Company
Operations) as indicated in our report dated November 12, 1998; because we did
not perform an audit, we expressed no opinion on that information.
We are aware that our report referred to above, which is included in the
Corporation's Quarterly Report on Form 10-Q for the quarter ended September
30, 1998, is incorporated by reference in Registration Statement Nos.
333-43811 and 333-43811-01 on Form S-3, of ENSERCH Corporation.
We are also aware that the aforementioned report, pursuant to Rule 436(c)
under the Securities Act of 1933, is not considered a part of the Registration
Statement prepared or certified by an accountant or a report prepared or
certified by an accountant within the meaning of sections 7 and 11 of that
Act.
DELOITTE & TOUCHE LLP
Dallas, Texas
November 12,1998
