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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 2002
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission file number: 1-15659
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DYNEGY INC.
(Exact name of registrant as specified in its charter)
Illinois 74-2928353
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1000 Louisiana, Suite 5800 Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
(713) 507-6400
(Registrant's telephone number, including area code)
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 [_]
Number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: Class A Common Stock, no par value
per share, 270,325,934 shares outstanding as of May 9, 2002; Class B Common
Stock, no par value per share, 96,891,014 shares outstanding as of May 9, 2002.
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DYNEGY INC.
TABLE OF CONTENTS
Page
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Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements (Unaudited and Restated):
Condensed Consolidated Balance Sheets:
March 31, 2002 and December 31, 2001........................................... 3
Condensed Consolidated Statements of Operations:
For the three months ended March 31, 2002 and 2001............................. 4
Condensed Consolidated Statements of Cash Flows:
For the three months ended March 31, 2002 and 2001............................. 5
Notes to Condensed Consolidated Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations....................................................................... 31
Item 3. Quantitative and Qualitative Disclosures About Market Risk................. 57
Part II. Other Information
Item 1. Legal Proceedings.......................................................... 58
Item 6. Exhibits and Reports on Form 8-K........................................... 58
INTRODUCTORY NOTE
Dynegy Inc. is filing this Amendment No. 1 on Form 10-Q/A ("Amendment No.
1") to reflect restatements relating to its audited consolidated financial
statements as of December 31, 2001 and its unaudited condensed consolidated
financial statements for the quarterly periods ended March 31, 2002 and 2001.
These financial statements were previously included in Dynegy's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2002, which was originally
filed with the SEC on May 15, 2002 (the "Original Filing"). These financial
statements and the other financial information included in the Original Filing
have been revised to reflect the restatement items described in the Explanatory
Note to the accompanying unaudited condensed consolidated financial statements.
Revised financial information for the periods presented reflecting these
restatements was previously included in Dynegy's Annual Report on Form 10-K for
the fiscal year ended December 31, 2001, which was most recently amended by
Amendment No. 2 thereto filed with the SEC on April 11, 2003 (the "2001 Form
10-K/A"), and Dynegy's Annual Report on Form 10-K for the fiscal year ended
December 31, 2002, which also was filed with the SEC on April 11, 2003 (the
"2002 Form 10-K"). The restated financial and other information included in
this Amendment No. 1 should be read together with the 2001 Form 10-K/A and the
2002 Form 10-K. Certain of the operating and financing cash flow data included
in this Amendment No. 1 has been revised from the comparable data included in
Note 19--Quarterly Financial Information (Unaudited) beginning on page F-76 of
the 2002 Form 10-K. This revised data, which reflects minor corrections for
errors, should be read to replace and supersede the data previously included in
the 2002 Form 10-K. In addition to the restatements described elsewhere herein,
this Amendment No. 1 also includes certain other revisions to the Original
Filing. Dynegy's periodic SEC reports, including this Amendment No. 1, remain
subject to an ongoing review by the SEC Division of Corporation Finance.
PLEASE NOTE THAT THE INFORMATION CONTAINED IN THIS AMENDMENT NO. 1,
INCLUDING THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND THE
NOTES THERETO, DOES NOT REFLECT EVENTS OCCURRING AFTER MAY 15, 2002 (THE DATE
OF THE ORIGINAL FILING). FOR A DESCRIPTION OF THESE EVENTS, PLEASE READ
DYNEGY'S EXCHANGE ACT REPORTS FILED SINCE MAY 15, 2002, INCLUDING ITS ANNUAL
REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002. SEE NOTE
12--SUBSEQUENT EVENTS FOR FURTHER DISCUSSION.
2
DYNEGY INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (RESTATED)
SEE EXPLANATORY NOTE--RESTATEMENTS
(unaudited) (in millions, except share data)
March 31, December 31,
2002 2001
--------- ------------
ASSETS
Current Assets
Cash and cash equivalents................................................................................. $ 443 $ 208
Restricted cash........................................................................................... 22 28
Accounts receivable, net of allowance for doubtful accounts of $115 million and $113 million, respectively 2,813 3,083
Accounts receivable, affiliates........................................................................... 57 36
Inventory................................................................................................. 199 256
Assets from risk-management activities.................................................................... 4,726 3,953
Prepayments and other assets.............................................................................. 1,567 1,392
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Total Current Assets................................................................................... 9,827 8,956
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Property, Plant and Equipment............................................................................. 12,019 10,135
Accumulated depreciation.................................................................................. (1,037) (934)
------- -------
Property, Plant and Equipment, Net..................................................................... 10,982 9,201
Other Assets
Investments in unconsolidated affiliates (Note 8)......................................................... 920 944
Investment in Northern Natural Gas Company (Note 3)....................................................... -- 1,501
Assets from risk-management activities.................................................................... 3,318 2,214
Goodwill.................................................................................................. 2,214 1,561
Other assets.............................................................................................. 985 791
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Total Assets........................................................................................... $28,246 $25,168
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.......................................................................................... $ 2,783 $ 2,064
Accounts payable, affiliates.............................................................................. 45 38
Accrued liabilities and other............................................................................. 1,694 2,617
Liabilities from risk-management activities............................................................... 4,461 3,361
Notes payable and current portion of long-term debt....................................................... 922 458
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Total Current Liabilities.............................................................................. 9,905 8,538
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Long-Term Debt............................................................................................ 5,187 4,500
Other Liabilities
Transitional funding trust notes.......................................................................... 495 516
Liabilities from risk-management activities............................................................... 2,894 1,871
Deferred income taxes..................................................................................... 1,606 1,568
Other long-term liabilities............................................................................... 1,086 1,070
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Total Liabilities...................................................................................... 21,173 18,063
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Minority Interest......................................................................................... 1,058 1,040
Serial Preferred Securities of a Subsidiary............................................................... 11 46
Company Obligated Preferred Securities of Subsidiary Trust................................................ 200 200
Series B Mandatorily Convertible Redeemable Preferred Securities.......................................... 965 882
Commitments and Contingencies (Note 9)
Stockholders' Equity
Class A Common Stock, no par value, 900,000,000 shares authorized at March 31, 2002 and December 31,
2001, respectively; 269,131,356 and 269,984,456 shares issued and outstanding at March 31, 2002 and
December 31, 2001, respectively.......................................................................... 2,842 2,786
Class B Common Stock, no par value, 360,000,000 shares authorized at March 31, 2002 and December 31,
2001, respectively; 96,891,014 and 86,499,914 shares issued and outstanding at March 31, 2002 and
December 31, 2001, respectively.......................................................................... 1,006 801
Additional paid-in capital................................................................................ 660 688
Subscriptions receivable.................................................................................. (15) (38)
Accumulated other comprehensive loss, net of tax.......................................................... (28) (27)
Retained earnings......................................................................................... 446 798
Treasury stock, at cost: 1,808,729 shares at March 31, 2002 and 1,766,800 shares at December 31, 2001..... (72) (71)
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Total Stockholders' Equity............................................................................. 4,839 4,937
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Total Liabilities and Stockholders' Equity............................................................. $28,246 $25,168
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See notes to condensed consolidated financial statements.
3
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (RESTATED)
SEE EXPLANATORY NOTE--RESTATEMENTS
(unaudited) (in millions, except per share data)
Three Months
Ended March 31,
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2002 2001
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Revenues................................................................ $8,426 $13,245
Cost of sales (exclusive of depreciation shown below)................... 8,075 12,743
Depreciation and amortization........................................... 137 108
General and administrative expenses..................................... 135 88
Gain on sale of assets.................................................. -- (5)
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Operating income..................................................... 79 311
Earnings (loss) from unconsolidated investments......................... (11) 32
Interest expense........................................................ (89) (66)
Other income (expense), net............................................. 22 (10)
Minority interest expense............................................... (30) (19)
Accumulated distributions associated with trust preferred securities.... (4) (6)
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Income (loss) before income taxes and change in accounting principle. (33) 242
Income tax provision (benefit).......................................... (20) 89
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Income (loss) from operations........................................... (13) 153
Cumulative effect of change in accounting principle, net (Notes 2 and 4) (234) 2
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Net Income (Loss)....................................................... $ (247) $ 155
Less: preferred stock dividends......................................... 83 --
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Net Income (Loss) applicable to common stockholders..................... $ (330) $ 155
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Net Income (Loss) Per Share:
Basic Earnings (Loss) Per Share:
Income (loss) from operations........................................ $(0.27) $ 0.47
Cumulative effect of change in accounting principle.................. (0.64) 0.01
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Basic earnings (loss) per share......................................... $(0.91) $ 0.48
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Diluted Earnings (Loss) Per Share (Note 6):
Income (loss) from operations........................................ $(0.27) $ 0.45
Cumulative effect of change in accounting principle.................. (0.64) 0.01
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Diluted earnings (loss) per share....................................... $(0.91) $ 0.46
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Basic shares outstanding................................................ 364 324
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Diluted shares outstanding.............................................. 371 338
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See notes to condensed consolidated financial statements.
4
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (RESTATED)
SEE EXPLANATORY NOTE--RESTATEMENTS
(unaudited) (in millions)
Three Months Ended
March 31,
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2002 2001
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................................................ $(247) $ 155
Items not affecting cash flows from operating activities:
Depreciation and amortization................................................. 127 104
(Earnings) losses from unconsolidated investments, net of cash distributions.. 43 (29)
Risk-management activities.................................................... 212 90
Deferred income taxes......................................................... (24) 46
Cumulative effect of change in accounting principle........................... 234 (2)
Other......................................................................... 66 12
Change in assets and liabilities resulting from operating activities:
Accounts receivable........................................................... 192 603
Inventory..................................................................... 31 293
Prepayments and other assets.................................................. 30 (24)
Accounts payable and accrued liabilities...................................... (397) (1,045)
Other, net.................................................................... (14) 71
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Net cash provided by operating activities........................................ 253 274
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CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............................................................. (395) (1,260)
Investment in unconsolidated affiliates.......................................... (3) (13)
Business acquisitions, net of cash acquired...................................... (20) (20)
Proceeds from asset sales........................................................ 6 --
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Net cash used in investing activities............................................ (412) (1,293)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from long-term borrowings........................................... 566 598
Repayments of long-term borrowings............................................... (33) --
Net cash flow from commercial paper and money market lines of credit............. (293) 577
Proceeds from sale of capital stock, options and warrants........................ 229 49
Purchase of serial preferred securities of a subsidiary.......................... (28) --
Decrease (increase) in restricted cash........................................... 6 (1)
Purchase of treasury stock....................................................... (1) --
Dividends and other distributions, net........................................... (28) (34)
Other financing, net............................................................. (9) --
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Net cash provided by financing activities........................................ 409 1,189
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Effect of exchange rate changes on cash.......................................... (15) 2
Net increase in cash and cash equivalents........................................ 235 172
Cash and cash equivalents, beginning of period................................... 208 59
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Cash and cash equivalents, end of period......................................... $ 443 $ 231
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See notes to condensed consolidated financial statements.
5
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
EXPLANATORY NOTE--RESTATEMENTS
This Amendment No. 1 on Form 10-Q/A of Dynegy Inc. ("Dynegy" or the
"Company") includes restatements relating to the Company's audited consolidated
financial statements as of December 31, 2001 and its unaudited condensed
consolidated financial statements for the three-month periods ended March 31,
2002 and 2001. On April 11, 2003, Dynegy filed its Annual Report on Form 10-K
for the fiscal year ended December 31, 2002 (the "2002 Form 10-K"), which
included restated financial statements for each of the two years in the period
ended December 31, 2001. The 2002 Form 10-K also included restated financial
information for the three-month periods ended March 31, 2002 and 2001. The
restatements relate to the following:
. the Project Alpha structured natural gas transaction,
. a balance sheet reconciliation project relating principally to the
Company's natural gas marketing business,
. corrections to the Company's previous hedge accounting for certain
contracts resulting in the Company accounting for these contracts
pursuant to the mark-to-market method under Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended ("Statement No. 133"); in addition, the
Company determined that it had incorrectly accounted for certain
derivative transactions prior to the adoption of Statement No. 133,
. the valuation used in the Company's 2000 acquisition of Extant, Inc.,
. the restatement of the Company's forward power curve methodology to
reflect forward power and market prices more closely,
. the recognition of additional assets, accrued liabilities and debt
associated with certain lease arrangements, as well as impairment,
depreciation and amortization expense for the related assets,
. a correction to the measurement date relating to the implied dividend the
Company previously recorded related to the in-the-money beneficial
conversion option in the $1.5 billion in Series B preferred stock issued
to ChevronTexaco Corporation in November 2001,
. the recognition of an other-than-temporary decline in value of a
technology investment in the third quarter of 2001 rather than the second
quarter of 2002,
. corrections to the Company's previous accounting for income taxes, and
. other adjustments that arose during the re-audit of the Company's
1999-2001 financial statements.
Specifically, the restatements are as follows:
Project Alpha. Dynegy entered into the Project Alpha structured natural gas
transaction in April 2001. As described in a Current Report on Form 8-K dated
April 25, 2002 (the "Alpha Form 8-K"), Dynegy restated the cash flow associated
with the related gas supply contract as a financing activity in its
consolidated statements of cash flows for 2001. The effect of this restatement
was to reclassify approximately $290 million of previously disclosed 2001
operating cash flow to financing cash flow. The effect of this restatement had
no impact on the previously disclosed operating cash flow for the three-month
period ended March 31, 2001. Following the disclosure in the Alpha Form 8-K and
in connection with a further review of Project Alpha, Arthur Andersen LLP
("Andersen") informed the Company that it could no longer support its tax
opinion relating to the transaction. Andersen's change in position was based in
part on its conclusion that the reclassification of cash flow from operations
to cash flow from financing lessened the factual basis for the opinion.
Dynegy's financial statement recognition of the tax benefit in 2001 was based
principally on the Company's assessment of the
6
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
relevant issues, as corroborated by Andersen's tax opinion. After the
withdrawal of Andersen's tax opinion, management concluded that sufficient
support to include the income tax benefit for financial statement presentation
purposes no longer existed, the effect of which was a reversal of approximately
$79 million of tax benefit previously recognized by the Company during the
second, third and fourth quarters of 2001. This decision had no impact on the
tax benefit previously reported for the three-month period ended March 31,
2001. Andersen further advised the Company that its audit opinion relating to
2001 should no longer be relied upon as a result of the pending restatements
relating to Project Alpha and such audit opinion has been withdrawn. Dynegy
subsequently concluded that its restated consolidated financial statements
would include the consolidation of ABG Gas Supply, LLC ("ABG"), one of the
entities formed in connection with the transaction. The consolidation of ABG,
which had no effect on reported net income for the three-month period ended
March 31, 2001, is included herein based on compilations of financial
information received from an agent of ABG's equity holders.
Balance Sheet Reconciliation Project. Dynegy originally recognized an
after-tax charge of approximately $80 million ($124 million pre-tax) in the
second quarter 2002 related to a balance sheet reconciliation project
undertaken by the Company at the beginning of 2002. The charge related
principally to the Company's natural gas marketing business and was associated
with the process of reconciling accrued to actual results. Accrual accounting
for natural gas marketing involves the estimation of gas volumes bought, sold,
transported and stored, as well as the subsequent reconciliation from estimated
to actual volumes. The Company has restated its financial statements to
allocate this $80 million charge from the second quarter 2002 back to the
periods in which the transactions giving rise to the charge originally occurred.
The table below reflects the impact on net income and diluted earnings per
share for the three months ended March 31, 2002 and 2001 related to this
restatement.
Three Months
Ended
March 31
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(in millions,
except per
share data)
Net Income (Loss)
2001............................. $ 22
2002............................. 4
Diluted Earnings (Loss) per Share
2001............................. $0.07
2002............................. 0.01
Corrected Hedge Accounting. The Company adopted Statement No. 133 effective
January 1, 2001 and reflected certain contracts as cash flow hedges upon such
adoption. Management has subsequently determined that following the initial
adoption of Statement No. 133, the documentation of compliance requirements
under the standard, particularly as it relates to documentation and the
periodic assessment of hedge effectiveness, was inadequate to support the
accounting method previously applied. In addition, the Company determined that
it had incorrectly accounted for certain derivative transactions prior to the
adoption of Statement No. 133. The resulting restatement reflects the
accounting for these contracts on a mark-to-market basis rather than on the
hedge accounting basis previously employed. The correction in the accounting
method for these contracts decreased net income for the three-month period
ended March 31, 2002 by $27 million ($0.07 per diluted share) and increased net
income for the three-month period ended March 31, 2001 by $15 million ($0.04
per diluted share). This correction had no impact on previously reported cash
flows from operations in any period.
7
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
Valuation of Extant, Inc. Purchase. On September 29, 2000, Dynegy completed
the acquisition of Extant, Inc., a privately held entity engaged in the
communications business. The transaction was accounted for as a purchase. In
2000, the Company incorrectly valued the shares of Class A common stock it
issued as consideration for the acquisition at $49.59 per share, rather than
$36.59 per share, which amount represented the average share price during the
five days surrounding the announcement of the acquisition. The $49.59 per share
originally utilized in the valuation was incorrectly based on the average
closing price of Dynegy's Class A common stock during the 30 days prior to the
closing date, which was consistent with the valuation provisions in the merger
agreement. As a result, the purchase price allocated to the assets acquired and
liabilities assumed in the purchase was overstated by $23 million in 2000. This
error resulted in an overstatement of the amortization of goodwill acquired in
the transaction during 2001 and 2000. The resulting restatement reflects an
increase in net income in the three-month period ended March 31, 2001 of
approximately $300,000 ($0.00 per diluted share). Additionally, as a result of
this error, the Company overstated by $22 million ($0.06 per diluted share) the
impairment of goodwill recorded in 2002 associated with the Company's January
1, 2002 adoption of Statement of Financial Accounting Standard No. 142,
"Goodwill and Other Intangible Assets" ("Statement No. 142").
Restated Forward Power Curve Methodology. The Company values substantially
all of its natural gas marketing, power marketing and portions of its natural
gas liquids marketing operations under a mark-to-market accounting methodology.
The estimated fair value of the marketing and trading portfolio is computed by
multiplying all existing positions in the portfolio by estimated prices,
reduced by a LIBOR-based time value of money adjustment and deduction of
reserves for credit, price and market liquidity risks. Dynegy uses a
combination of market quotes, derivatives of market quotes and proprietary
models to periodically value this portfolio as required by generally accepted
accounting principles ("GAAP"). Market quotes are used for near-term
transactions, where such quotes are generally available; derivatives of market
quotes are used for mid-term transactions, where broker quotes are only
marginally available; and proprietary models are used for long-term
transactions, where broker quotes or other objective pricing indicators
typically are not available. Beginning in the third quarter 2001, the Company
began to enter into longer-term power transactions in the United States with
respect to which no broker quotes or other market data was available;
consequently, the Company applied a proprietary model to estimate forward
prices and, in turn, the fair market value of these longer-term power
transactions.
During January 2003, in connection with the re-audit of the Company's
1999-2001 financial statements and an assessment of various accounting
policies, the Company reconsidered the model-based methodology used to value
the portions of its power marketing and trading portfolio for which broker
quotes were not available. Under the Company's prior methodology, forward
curves used to calculate the value of its long-term U.S. power contracts were
derived from a proprietary model based on a required rate of return on
investments in new generation facilities. The primary disadvantage of this type
of methodology, which had been confirmed by the Company's former independent
auditors prior to the withdrawal of their audit opinion for unrelated matters,
is that, in certain circumstances, it may not reflect true market prices in
future years. After reconsidering the appropriateness of this methodology in
light of changing industry circumstances and in connection with the re-audit,
in late January 2003 the Company determined that, beginning with the third
quarter 2001, a different forward power curve methodology would more
appropriately reflect the value of its long-term power contracts.
Upon making this determination, the Company corrected the forward power
curve methodology it used to estimate the fair market value of its U.S. power
marketing and trading portfolio. This corrected methodology incorporates
forward energy prices derived from broker quotes and values from executed
transactions to estimate forward price curves for periods where broker quotes
and transaction data cannot be obtained. Further, the
8
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
Company determined that in order to adequately reflect its results, it was
appropriate to restate its prior period financial statements, beginning with
the third quarter 2001, to reflect the corrected methodology.
The change decreased reported net income for the three-month period ended
March 31, 2002 by $74 million ($0.20 per diluted share). There was no change to
reported net income for the three-month period ended March 31, 2001.
Restated Lease Accounting. The Company previously accounted for seven
generation lease arrangements and one communications lease arrangement as
operating leases. Its previous accounting treatment of these lease
arrangements, which was confirmed by the Company's former independent auditors
prior to the withdrawal of their audit opinion for unrelated matters, reflected
its belief that these arrangements satisfied the applicable GAAP requirements
so as to justify their treatment as operating leases. However, these
requirements are very technical and subject to a high degree of interpretation.
During the course of the re-audit of the Company's financial statements for
1999-2001, the Company analyzed its accounting for these arrangements and
considered a variety of factors, including interpretations of the applicable
GAAP requirements. Upon completion of this analysis and discussions with
PricewaterhouseCoopers LLP, in January 2003, the Company determined it
necessary to correct its accounting for these lease arrangements to recognize
on its balance sheet the related assets as of the inception of six of these
arrangements. Although the Company previously amended the agreements relating
to six generation lease arrangements so as to require them to be treated as
capital leases in the second quarter 2002, the restatement of the accounting
originally applied to these arrangements results in the recognition of the
related assets as of an earlier date. Consequently, the Company's previously
reported net income has been reduced, reflecting the recognition of impairment,
depreciation and amortization expenses associated with the related assets. In
addition, balance sheet amounts have been adjusted for this change as follows:
March 31, December 31,
2002 2001
--------- ------------
($ in millions)
Restricted cash.............. $ 10 $ 17
Property, plant and equipment 1,167 1,094
Accrued liabilities and other 626 445
Long-term debt............... 700 666
Please read Note 7--Debt in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2001, as most recently amended by Amendment No.
2 thereto filed with the SEC on April 11, 2003 (the "2001 Form 10-K/A"), for
further discussion.
The change decreased reported net income by $14 million ($0.04 per diluted
share) for the three-month period ended March 31, 2002. There was no change to
reported net income for the three-month period ended March 31, 2001.
Change in Implied Preferred Dividends. In November 2001, the Company issued
$1.5 billion in Series B preferred stock to ChevronTexaco. This preferred stock
is convertible by ChevronTexaco into shares of Dynegy's Class B common stock at
a conversion price of $31.64. This conversion price represents an approximate
5% discount to the Company's stock price on November 7, 2001, the date the
conversion price was negotiated. Based on the implied value of this beneficial
conversion option as of November 7, Dynegy recognized a $65 million preferred
stock dividend to be amortized over the two-year period leading up to the
9
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
mandatory redemption date for the shares. During the course of the re-audit of
the Company's financial statements for 1999-2001 the Company analyzed its
accounting for the beneficial conversion option and determined it necessary to
correct the commitment date used for valuing this beneficial conversion option
to November 13, 2001, the date ChevronTexaco funded and consummated its
preferred stock purchase and the preferred securities were issued. The
Company's stock price increased significantly between November 7 and November
13 after the announcement of the proposed Enron Corp. merger. As a result of
the increase in the intrinsic value of ChevronTexaco's beneficial conversion
option, the restated preferred stock dividend amount is calculated based on a
two-year amortization of the beneficial conversion option's implied value of
approximately $660 million--an increase of approximately $595 million over the
$65 million originally reported.
Net income available to common stockholders as originally reported for the
three-month period ended March 31, 2002 is accordingly reduced by approximately
$75 million ($0.20 per diluted share) as a result of this commitment date
change. There was no impact on net income available to common shareholders for
the three-month period ended March 31, 2001.
Valuation of Technology Investment. The Company acquired the common stock
of a technology investment in the second quarter 2000. In the second quarter
2002, after several quarters of declines in the market price of the investment,
the Company determined that the decline in value was other-than-temporary. As
such, the Company recognized a $12 million after-tax charge during the second
quarter 2002. Upon further review, the Company determined it incorrectly
delayed recognition of the charge associated with this investment, as the
decline in value through September 30, 2001 met the "other-than-temporary"
threshold. Therefore, the Company has restated the financial statements to
record the impairment in the third quarter 2001. This restatement had no impact
on reported net income or diluted earnings per share for the three-month
periods ended March 31, 2002 or 2001.
Correction for Income Taxes. During the course of the re-audit of its
1999-2001 financial statements, the Company reviewed its previous accounting
for income taxes and determined that it made errors in accounting for certain
tax matters. These errors related to book-tax basis differences that were
reflected as permanent differences as opposed to temporary differences, the
failure to record differences between the amounts recognized as income tax
provision and the amounts actually reflected in the applicable income tax
returns, adjustments related to book and tax-basis balance sheet
reconciliations and changes in estimates of tax contingencies. The Company has
restated its financial statements to correct these errors, resulting in
additional deferred tax expense. The restatement decreased reported net income
for the three-month period ended March 31, 2002 by $3 million ($0.01 per
diluted share) and for the three-month period ended March 31, 2001 by $5
million ($0.01 per diluted share).
Other Adjustments Arising During the Re-Audit. PricewaterhouseCoopers LLP
re-audited Dynegy's 1999-2001 financial statements. The re-audit was completed
in April 2003. The Company has restated its 1999-2001 financial statements to
correct various errors that were identified during the course of the re-audit,
which restatements are reflected in the 2001 Form 10-K/A and the 2002 Form
10-K. The corrections principally relate to the timing on which various
transactions were recorded in the ordinary course of business. The corrections
resulted in reductions to previously reported net income for the three months
ended March 31, 2002 and 2001 of approximately $15 million ($0.04 per diluted
share) and $16 million ($0.05 per diluted share), respectively.
10
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
A synopsis of the aggregate financial impact of these restatements on the
amounts originally reported in the Original Filing is as follows (in millions):
RESTATED SELECTED BALANCE SHEET DATA
March 31,
2002
-------------
(in millions)
Current Assets
As Reported........ $10,608
Restatement Effect. (781)
-------
As Restated........ $ 9,827
=======
Total Assets
As Reported........ $28,047
Restatement Effect. 199
-------
As Restated........ $28,246
=======
Current Liabilities
As Reported........ $ 9,946
Restatement Effect. (41)
-------
As Restated........ $ 9,905
=======
Total Liabilities
As Reported........ $20,516
Restatement Effect. 657
-------
As Restated........ $21,173
=======
Stockholders' Equity
As Reported........ $ 4,800
Restatement Effect. 39
-------
As Restated........ $ 4,839
=======
11
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
RESTATED RESULTS OF OPERATIONS
Three
Months
Ended
March 31,
-------------
(in millions,
except per
share
amounts)
2002
Net Income (Loss):
As Reported..................................... $ (140)
Restatement Effect.............................. (107)
------
As Restated..................................... $ (247)
======
Net Income (Loss) Available to Common Stockholders:
As Reported..................................... $ (148)
Restatement Effect.............................. (182)
------
As Restated..................................... $ (330)
======
Earnings (Loss) Per Diluted Share:
As Reported..................................... $(0.41)
Restatement Effect.............................. (0.50)
------
As Restated..................................... $(0.91)
======
2001
Net Income (Loss):
As Reported..................................... $ 139
Restatement Effect.............................. 16
------
As Restated..................................... $ 155
======
Net Income (Loss) Available to Common Stockholders:
As Reported..................................... $ 139
Restatement Effect.............................. 16
------
As Restated..................................... $ 155
======
Earnings (Loss) Per Diluted Share:
As Reported..................................... $ 0.41
Restatement Effect.............................. 0.05
------
As Restated..................................... $ 0.46
======
12
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
RESTATED SELECTED CASH FLOW DATA
Three
Months
Ended
March 31,
-------------
(in millions)
2002
Operating Cash Flows:
As Reported........ $ 293
Restatement Effect. (40)
-------
As Restated........ $ 253
=======
Investing Cash Flows:
As Reported........ $ (371)
Restatement Effect. (41)
-------
As Restated........ $ (412)
=======
Financing Cash Flows:
As Reported........ $ 330
Restatement Effect. 79
-------
As Restated........ $ 409
=======
2001
Operating Cash Flows:
As Reported........ $ 265
Restatement Effect. 9
-------
As Restated........ $ 274
=======
Investing Cash Flows:
As Reported........ $(1,166)
Restatement Effect. (127)
-------
As Restated........ $(1,293)
=======
Financing Cash Flows:
As Reported........ $ 1,056
Restatement Effect. 133
-------
As Restated........ $ 1,189
=======
13
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
PLEASE NOTE THAT THESE FINANCIAL STATEMENTS AND THE NOTES THERETO DO NOT
REFLECT EVENTS OCCURRING AFTER MAY 15, 2002 (THE DATE ON WHICH DYNEGY
ORIGINALLY FILED ITS FIRST QUARTER 2002 FORM 10-Q). FOR A DESCRIPTION OF THESE
EVENTS, PLEASE READ THE COMPANY'S EXCHANGE ACT REPORTS FILED SINCE MAY 15,
2002, INCLUDING ITS ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2002. SEE NOTE 12--SUBSEQUENT EVENTS FOR FURTHER DISCUSSION.
NOTE 1--ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions to interim financial
reporting as prescribed by the Securities and Exchange Commission ("SEC").
These interim financial statements and notes thereto should be read in
conjunction with the restated consolidated financial statements and notes
thereto included in the 2001 Form 10-K/A, which includes restated financial
statements for 1999-2001 reflecting the revisions described in the Explanatory
Note above.
The financial statements include all material adjustments, which, in the
opinion of management, are necessary for a fair presentation of the results for
the interim periods. Interim period results are not necessarily indicative of
the results for the full year. The preparation of the condensed consolidated
financial statements in conformity with generally accepted accounting
principles requires management to develop estimates and make assumptions that
affect reported financial position and results of operations and that impact
the nature and extent of disclosure, if any, of contingent assets and
liabilities. Actual results could differ materially from those estimates.
Certain reclassifications have been made to prior period amounts in order to
conform to current year presentation.
NOTE 2--CHANGES IN ACCOUNTING PRINCIPLES
On July 20, 2001, the Financial Accounting Standards Board ("FASB") issued
Statement No. 142. Statement No. 142 discontinues goodwill amortization over
its estimated useful life; rather, goodwill is subject to at least an annual
fair-value based impairment test. The Company adopted Statement No. 142
effective January 1, 2002. The changes in the carrying amount of goodwill for
each of Dynegy's reportable business segments for the three-month period ended
March 31, 2002 are as follows:
Wholesale Dynegy Transmission
Energy Midstream & Dynegy Global
Network Services Distribution Communications Total
--------- --------- ------------ -------------- ------
Balances as of January 1, 2002........... $930 $16 $ 381 $ 234 $1,561
Cumulative effect of change in accounting
principle.............................. -- -- -- (234) (234)
Goodwill acquired during the period...... -- -- 887 -- 887
---- --- ------ ----- ------
Balances as of March 31, 2002............ $930 $16 $1,268 $ -- $2,214
==== === ====== ===== ======
The Company has recognized a cumulative effect of change in accounting
principle of $234 million related to its Dynegy Global Communications segment
in accordance with Statement No. 142. The fair value of that reporting segment
was estimated using the expected present value of future cash flows to
determine impairment. The value was negatively impacted by continued weakness
in the telecommunications and broadband markets.
14
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
Goodwill acquired during the period relates to the acquisition of Northern
Natural Gas Company ("Northern Natural"). (See Note 3 below.)
The following table sets forth what net income and earnings per share
("EPS") would have been in the three months ended March 31, 2001 exclusive of
goodwill amortization compared to net loss and loss per share for the three
months ended March 31, 2002.
Three Months
Ended
March 31,
----------------
2002 2001
------ -----
($ in millions,
except per share
data)
Reported net income (loss)......................... $ (247) $ 155
Add back: Goodwill amortization.................... -- 12
------ -----
Adjusted net income (loss)......................... (247) 167
Less: preferred stock dividends.................... 83 --
------ -----
Net income (loss) available to common stockholders. $ (330) $ 167
====== =====
Basic EPS:
Reported net income (loss)......................... $(0.91) $0.48
Goodwill amortization.............................. -- 0.04
------ -----
Adjusted net income (loss)......................... $(0.91) $0.52
====== =====
Diluted EPS:
Reported net income (loss)......................... $(0.91) $0.46
Goodwill amortization.............................. -- 0.04
------ -----
Adjusted net income (loss)......................... $(0.91) $0.50
====== =====
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
("Statement No. 144"). Statement No. 144 addresses the accounting and reporting
for the impairment or disposal of long-lived assets and supersedes FASB
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" and APB Opinion No. 30, "Reporting the
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The Company's adoption of Statement No. 144 on January 1, 2002
did not have any impact on its financial position, results of operations or
cash flows.
Accounting Principles Not Yet Adopted. Also during 2001, the FASB issued
Statement of Financial Accounting Standards No. 143, "Accounting for Asset
Retirement Obligations" ("Statement No. 143"). Statement No. 143 requires that
the fair value of a liability for an asset retirement obligation be recognized
in the period in which it is incurred with the associated asset retirement
costs being capitalized as a part of the carrying amount of the long-lived
asset. The Company is evaluating the future financial effects of adopting
Statement No. 143 and will adopt the standard effective January 1, 2003.
15
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
On April 30, 2002, the FASB issued Statement of Financial Accounting
Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment
of FASB Statement No. 13, and Technical Corrections" ("Statement No. 145").
Statement No. 145 rescinds Statement of Financial Accounting Standards No. 4,
"Reporting Gains and Losses from Extinguishment of Debt" ("Statement No. 4"),
the amendment to Statement No. 4, and Statement of Financial Accounting
Standards No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements" ("Statement No. 64"). Through this rescission, Statement No. 145
eliminates the requirement (in both Statement No. 4 and Statement No. 64) that
gains and losses from the extinguishment of debt be aggregated and, if
material, classified as an extraordinary item, net of the related income tax
effect.
Further, Statement No. 145 amends paragraph 14(a) of Statement of Financial
Accounting No. 13, "Accounting for Leases", to eliminate an inconsistency
between the accounting for sale-leaseback transactions and certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. Statement No. 145 also makes several other technical corrections
to existing pronouncements that may change accounting practice. Statement No.
145 is effective for transactions occurring after May 15, 2002, and the Company
is evaluating the future financial effects, if any, of adopting Statement No.
145.
NOTE 3--BUSINESS COMBINATIONS AND OTHER ACQUISITIONS
In November 2001, Dynegy acquired 1,000 shares of Series A Preferred Stock
("Series A Preferred Stock") in Northern Natural for $1.5 billion. The Series A
Preferred Stock is entitled to cumulative dividends, as and if declared by the
board of directors of Northern Natural, at a rate of 6%, payable annually
beginning on January 31, 2003. Dividends of approximately $8 million are
reflected in "Other Income (Expense), net" on the Condensed Consolidated
Statement of Operations for the quarter ended March 31, 2002 for dividends
earned by Dynegy prior to the closing of the Northern Natural acquisition on
January 31, 2002. The Series A Preferred Stock is redeemable at the option of
Northern Natural under specified circumstances at a redemption price equal to
the liquidation preference plus accrued and unpaid dividends and other items.
In connection with the investment, Dynegy Holdings Inc. ("DHI"), a wholly owned
subsidiary of Dynegy, acquired an option to purchase all of the equity of
Northern Natural's indirect parent company. DHI exercised its option to acquire
the indirect parent of Northern Natural in November 2001 upon termination of
the merger agreement with Enron. The exercise price for the option was $23
million subject to adjustment based on Northern Natural's indebtedness and for
the amount of working capital at closing. Subsequent litigation relating to the
option was settled in part by the parties on January 3, 2002, and the closing
of the option exercise occurred on January 31, 2002. Enron still maintains a
damage action that DHI's exercise of the option was wrongful. (See Note 9
below.)
At January 31, 2002, Northern Natural had approximately $950 million of debt
outstanding. Approximately $500 million of this debt consisted of senior
unsecured notes with maturities ranging from 2005 to 2011. The remaining $450
million consisted of a secured line of credit due November 2002. In order to
obtain a bondholder consent required in connection with the Northern Natural
acquisition, DHI agreed to effect a tender offer for one series of $100 million
of Northern Natural's senior unsecured notes. On April 26, 2002, DHI purchased
$90 million of the notes due 2005 pursuant to such tender offer. An Enron
subsidiary has the option through June 30, 2002 to repurchase the Series A
Preferred Stock and equity in Northern Natural's parent by repayment of the
purchase price, subject to adjustments for working capital and indebtedness.
16
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
Northern Natural is consolidated with Dynegy's operations beginning February
1, 2002. The following table reflects certain unaudited pro forma information
for Dynegy for the periods presented as if the Northern Natural acquisition had
taken place on January 1, 2001 (in millions, except per share data).
Three Three
Months Months
Ended Ended
March 31, March 31,
2002 2001
--------- ---------
Pro forma revenues........................................................... $8,484 $13,420
Pro forma income from operations before change in accounting principle
(Notes 2 and 4)............................................................ 10 201
Pro forma income (loss) from operations before change in accounting principle
(per diluted share)........................................................ (0.20) 0.59
Pro forma net income (loss) before preferred stock dividends................. (224) 203
Pro forma net income (loss) available to common shareholders................. (307) 203
Pro forma earnings (loss) per share (diluted)................................ (0.84) 0.60
NOTE 4--COMMERCIAL OPERATIONS, RISK MANAGEMENT ACTIVITIES AND FINANCIAL
INSTRUMENTS
Provisions in Statement No. 133, as amended, affect the accounting and
disclosure of certain contractual arrangements and operations of the Company.
Under Statement No. 133, as amended, all derivative instruments are recognized
in the balance sheet at their fair values and changes in fair value are
recognized immediately in earnings, unless the derivatives which are not a part
of the Company's marketing activities qualify and are designated as hedges of
future cash flows, fair values, or net investments or qualify and are
designated, as normal purchases and sales. Derivatives treated as normal
purchases or sales are recorded and recognized in income using accrual
accounting.
The nature of the Company's business necessarily involves certain market and
financial risks. The Company routinely enters into financial instrument
contracts in an attempt to mitigate or eliminate these various risks. These
risks and the Company's strategy for mitigating these risks are more fully
described in Note 3 to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2001 (the "2001 Form 10-K").
The Company recorded the impact of the adoption of Statement No. 133, as
amended, as a cumulative effect adjustment in the Company's consolidated
results on January 1, 2001. The amounts recorded, which are immaterial to net
income and the Company's financial position, are as follows (in millions):
Other
Net Comprehensive
Income Income
------ -------------
Adjustment to fair value of derivatives $ 3 $105
Income tax effects..................... (1) (44)
--- ----
Total............................... $ 2 $ 61
=== ====
17
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
Changes in stockholders' equity related to derivatives for the three-month
period ended March 31, 2002 were as follows, net of tax (in millions):
Balance at December 31, 2001.............. $ 8
Current period decrease in fair value, net (1)
Reclassifications to earnings, net........ (9)
---
Balance at March 31, 2002.............. $(2)
===
Accumulated Other Comprehensive Loss, Net of Tax, is included in
Stockholders' Equity on the Condensed Consolidated Balance Sheet as follows (in
millions):
Statement No. 133, net................................................. $ (2)
Currency translation adjustment........................................ (25)
Unrealized loss on available-for-sale securities, net.................. (1)
----
Accumulated other comprehensive loss, net of tax, at March 31, 2002. $(28)
====
Other comprehensive income (loss) is as follows (in millions):
March 31, March 31,
2002 2001
--------- ---------
Net income (loss).................... $(247) $155
Other comprehensive income........... (1) 43
----- ----
Total comprehensive income (loss). $(248) $198
===== ====
Additional disclosures required by Statement No. 133, as amended, are
provided in the following paragraphs.
The Company enters into various financial derivative instruments which
qualify as cash flow hedges. For derivatives treated as hedges of future cash
flows, the effective portion of changes in fair value is recorded in other
comprehensive income until the related hedged items impact earnings. Any
ineffective portion of a hedge is reported in earnings immediately. Instruments
related to the Company's energy convergence and midstream liquids businesses
are entered into for purposes of hedging forward fuel requirements for certain
power generation facilities, locking in future margin in the domestic midstream
liquids business and hedging price risk in the global liquids business.
Interest rate swaps are used to convert the floating interest-rate component of
certain obligations to fixed rates.
The Company determined that its documentation and assessment of hedge
effectiveness related to certain contracts entered into to hedge fuel
requirements and power sales commitments was incomplete. As a result, the
accounting for these contracts has been restated herein. Otherwise, during the
three months ended March 31, 2002 and 2001, there was no material
ineffectiveness from changes in fair value of hedge positions, and no amounts
were excluded from the assessment of hedge effectiveness related to the hedge
of future cash flows. Additionally, no amounts were reclassified to earnings in
connection with forecasted transactions that were no longer considered probable
of occurring.
18
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
The balance in other comprehensive income at March 31, 2002 is expected to
be reclassified to future earnings, contemporaneously with the related
purchases of fuel, sales of electricity or liquids, payments of interest and
recognition of operating lease expense, as applicable to each type of hedge. Of
this amount, approximately $2 million in losses, net of taxes, is estimated to
be reclassed into earnings over the 12-month period ending March 31, 2003.
Actual amounts ultimately reclassed to earnings over the next 12 months could
vary materially from this estimated amount as a result of changes in market
conditions.
The Company also enters into derivative instruments which qualify as
fair-value hedges. For derivatives treated as fair value hedges, changes in the
fair value of the derivative and changes in the fair value of the related asset
or liability are recorded in current period earnings. The Company uses interest
rate-swaps to convert a portion of its non-prepayable fixed-rate debt into
variable-rate debt. During the three months ended March 31, 2002 and 2001,
there was no ineffectiveness from changes in fair value of hedge positions, and
no amounts were excluded from the assessment of hedge effectiveness.
Additionally, no amounts were recognized in relation to firm commitments that
no longer qualified as fair-value hedge items.
The Company has investments in foreign subsidiaries, and the net assets of
these subsidiaries are exposed to currency exchange-rate volatility. The
Company uses derivative financial instruments, including foreign exchange
forward contracts and cross currency interest rate swaps, to hedge this
exposure. For derivatives treated as hedges of net investment in foreign
operations, the effective portion of changes in the fair value of the
derivative is recorded in the cumulative translation adjustment. For the three
months ended March 31, 2002, approximately $15 million of net gains related to
these contracts were included in the cumulative translation adjustment. There
was no net impact on the cumulative translation adjustment in the first quarter
2001.
NOTE 5--DEBT
DHI closed a $900 million unsecured revolving credit agreement with a
syndicate of commercial banks on April 29, 2002. This facility, which matures
on April 28, 2003, replaced an expiring $1.2 billion revolving credit
agreement. The new facility provides funding for working capital, capital
expenditures and general corporate purposes. Generally, borrowings under the
credit agreement bear interest at a Eurodollar rate plus a margin that is
determined based on designated unsecured debt ratings. The increase in this
margin over the margins under the expired facility is expected to result in an
increase in the fees paid by DHI compared to the fees paid under the expiring
facility. Specifically, DHI expects to pay approximately $1.4 million in
additional borrowing fees during the term of the new facility and paid
approximately $3.2 million in additional upfront fees in connection with the
closing of the new facility. Financial covenants include a
debt-to-capitalization test (which takes into account certain lease and similar
commitments of DHI and its subsidiaries) and a newly added 3.5 times earnings
before interest, taxes and depreciation and amortization ("EBITDA")-to-interest
test. The permissible threshold for the debt-to-capitalization test was lowered
in the new facility from 65% to 60%. Other newly added covenants in the new
facility include subordination of certain intercompany debt owed to Dynegy and
its subsidiaries (other than DHI and its subsidiaries), restrictions on liens
and limitations prohibiting subsidiary debt at Dynegy Marketing & Trade, Dynegy
Power Marketing, Inc. and Dynegy Midstream Services, Limited Partnership.
Default provisions include cross payment default of Dynegy, DHI or any
principal subsidiary with respect to debt or other similar obligations that
exceed $100 million, cross acceleration of Dynegy, DHI or any principal
subsidiary under any instrument covering debt or similar obligations that
exceed $100 million and bankruptcy or receivership of Dynegy, DHI or any
principal subsidiary. The new facility does not contain any defaults relating
to material adverse changes in the condition of Dynegy or DHI after the closing
date or to changes in Dynegy's or DHI's credit ratings. The new facility also
does not contain a "term-out" provision that
19
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
would permit Dynegy to extend the maturity for borrowings under the facility
beyond the facility's April 28, 2003 maturity date.
On February 21, 2002, DHI issued $500 million of 8.75% senior notes due
2012. DHI will pay interest on the notes on February 15 and August 15 of each
year, beginning August 15, 2002. The notes are unsecured and unsubordinated
debt securities and are not subject to a sinking fund. DHI may redeem the notes
prior to maturity, in whole or in part, at a redemption price equal to the
greater of the principal amount of the notes and the make-whole price specified
in the indenture relating to the notes.
The Company acquired debt with a face value of approximately $950 million
(and a fair value of approximately $890 million) through the acquisition of
Northern Natural. Approximately $500 million of the Northern Natural debt
consisted of senior unsecured notes with maturities ranging from 2005 to 2011.
The remaining $450 million consisted of a secured line of credit due November
2002. On April 26, 2002, DHI purchased $90 million of Northern Natural's senior
unsecured notes due 2005 pursuant to a tender offer. (See Note 3 above.)
During the three-month period ended March 31, 2002, the Company repaid
commercial paper and revolving credit facilities for DHI and Illinois Power
Company ("IP"), a wholly owned subsidiary of Dynegy, of approximately $293
million.
On April 10, 2001, ABG Gas Supply entered into a credit agreement with a
consortium of lenders in order to provide financing associated with Project
Alpha. Advances under the agreement allowed ABG Gas Supply to purchase NYMEX
natural gas contracts with the underlying physical gas supply to be sold to
Dynegy Marketing and Trade under an existing natural gas purchases and sales
agreement. The credit agreement requires ABG Gas Supply to repay the advances
in monthly installments commencing February 2002 through December 2004 from
funds received from Dynegy Marketing and Trade under the natural gas purchases
and sales agreement. The advances bear interest at a Eurodollar rate plus a
margin as defined in the agreement. Advances of $307 million were outstanding
under this agreement at March 31, 2002.
NOTE 6--EARNINGS PER SHARE
Basic earnings (loss) per share represents the amount of earnings (loss) for
the period available to each share of common stock outstanding during the
period. Diluted earnings (loss) per share represents the amount of earnings
(loss) for the period available to each share of common stock outstanding
during the period plus each share that would have been outstanding assuming the
issuance of common shares for all dilutive potential common shares outstanding
during the period. Outstanding options contribute to the differences between
basic and diluted shares outstanding in all periods. The diluted shares in the
2002 period do not include the effect of the assumed conversion of the Series B
Mandatorily Convertible Redeemable Preferred Securities held by ChevronTexaco
as it would be anti-dilutive.
When an entity has a net loss from continuing operations, Statement of
Financial Accounting Standards No. 128, "Earnings per Share," prohibits the
inclusion of dilutive potential common shares in the computation of diluted
per-share amounts. Accordingly, the Company has utilized the basic shares
outstanding amount to calculate both basic and diluted loss per share for the
quarter ended March 31, 2002.
20
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
NOTE 7--CAPITAL STOCK
Chevron U.S.A. Inc., a ChevronTexaco subsidiary, purchased approximately
10.4 million shares of Class B common stock in the three-month period ended
March 31, 2002 pursuant to its preemptive right under its shareholder agreement
with Dynegy. Proceeds from this sale totaled approximately $205 million and
were invested in cash to enhance short-term liquidity.
NOTE 8--INVESTMENTS IN UNCONSOLIDATED AFFILIATES
Investments in affiliates that are not controlled by the Company but where
the Company has significant influence over operations are accounted for by the
equity method. The Company's share of net income from these affiliates is
reflected in the Condensed Consolidated Statements of Operations as Earnings
(Loss) from Unconsolidated Investments. The Company's principal equity method
investments consist of entities that operate generation assets and natural gas
liquids assets. These equity investments totaled $844 million and $830 million
at March 31, 2002 and December 31, 2001, respectively. The Company entered into
these ventures principally for the purpose of sharing risk and leveraging
existing commercial relationships. These ventures maintain independent capital
structures and have financed their operations on a non-recourse basis to the
Company. The Company holds investments in three joint ventures in which Chevron
U.S.A. or its affiliates are investors. For additional information about these
investments, please read Note 16 to the 2001 Form 10-K.
Generation Assets. Investments primarily include ownership interests in
eight joint ventures that own fossil fuel electric generation facilities in
diverse geographic regions. The Company's ownership is generally 50 percent in
the majority of these ventures. The Company's aggregate net investment of $698
million at March 31, 2002 represents approximately 2,400 MW of net generating
capacity. Dynegy's most significant investment in generating capacity is its
interest in West Coast Power, LLC ("West Coast Power"), a 50 percent owned
venture with NRG Energy Inc. ("NRG") representing approximately 1,400 MW of net
generating capacity in California. The net investment in West Coast Power
totaled approximately $325 million at March 31, 2002. West Coast Power provided
equity earnings of approximately $15 million and $12 million in the quarterly
periods ending March 31, 2002 and 2001, respectively.
Midstream Investments. Investments primarily include ownership interests in
three ventures that operate natural gas liquids ("NGL") processing, extraction,
fractionation and storage facilities in the Gulf Coast region as well as an
interstate NGL pipeline. The Company's ownership interest in these ventures
ranges from 23 percent to 39 percent. At March 31, 2002, the Company's
aggregate net investment in these midstream businesses totaled approximately
$146 million.
Summarized aggregate financial information for these investments and
Dynegy's equity share thereof was (in millions):
Three Months Ended March 31,
--------------------------
2002 2001
------------ -------------
Equity Equity
Total Share Total Share
----- ------ ------ ------
Revenues........ $826 $289 $1,481 $568
---- ---- ------ ----
Operating margin $230 $ 68 $ 176 $ 65
---- ---- ------ ----
Net income...... $114 $ 34 $ 91 $ 32
---- ---- ------ ----
21
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
Other Investments. In addition to these equity investments, the Company
holds interests in companies for which it does not have significant influence
over the operations. These investments are accounted for by the cost method.
Such investments totaled $63 million and $91 million at March 31, 2002 and
December 31, 2001, respectively. The change is primarily attributed to the
impairment of an investment in the Dynegy Global Communications segment
resulting from unfavorable market conditions.
The Company also owns securities that have a readily determinable fair
market value and are considered available-for-sale. The market value of these
investments at March 31, 2002 and December 31, 2001 was estimated to be $13
million and $23 million, respectively. The change is primarily attributed to
the impairment of an available-for-sale investment in the Dynegy Global
Communications segment resulting from unfavorable market conditions.
NOTE 9--COMMITMENTS AND CONTINGENCIES
PLEASE NOTE THAT THE INFORMATION CONTAINED IN THIS NOTE 9, WHICH WAS
PRESENTED IN THE COMPANY'S FIRST QUARTER 2002 FORM 10-Q ORIGINALLY FILED WITH
THE SEC ON MAY 15, 2002 IN ORDER TO REFLECT MATERIAL CHANGES IN OR UPDATES TO
THE COMPANY'S MATERIAL LEGAL PROCEEDINGS SINCE THE ORIGINAL FILING OF ITS 2001
FORM 10-K, DOES NOT REFLECT EVENTS OCCURRING AFTER MAY 15, 2002. FOR A
DESCRIPTION OF THESE EVENTS, INCLUDING MATERIAL CHANGES IN, OR UPDATES TO, THE
COMPANY'S MATERIAL LEGAL PROCEEDINGS, PLEASE READ ITS EXCHANGE ACT REPORTS
FILED SINCE MAY 15, 2002, INCLUDING ITS ANNUAL REPORT ON FORM 10-K FOR THE
FISCAL YEAR ENDED DECEMBER 31, 2002. SEE NOTE 12--SUBSEQUENT EVENTS FOR FURTHER
DISCUSSION.
Please see Note 11, "Commitments and Contingencies," to the 2001 Form 10-K
for a description of the Company's material legal proceedings. Set forth below
is a description of any material developments that have occurred with respect
to such proceedings since the Company's original filing of the 2001 Form 10-K
and a description of any new matters that have arisen during the quarter.
We record reserves for estimated losses from contingencies when information
available indicates that a loss is probable and the amount of the loss is
reasonably estimable in accordance with SFAS No. 5 "Accounting for
Contingencies." For environmental matters, we record liabilities when
environmental assessment indicates that remedial efforts are probable and the
costs can be reasonably estimated. Please read Note 2--Accounting Policies of
the 2001 Form 10-K for further discussion.
With respect to several of the items listed below, Dynegy has determined
that a loss is not probable or that any such loss, to the extent probable, is
not reasonably estimable. Notwithstanding the foregoing, Dynegy's management
has assessed the matters described below based on currently available
information and made an informed judgment concerning the potential outcome of
such matters, giving due consideration to the nature of the claim, the amount
and nature of damages sought and the possibility of success. Management's
judgment may, as a result of facts arising prior to resolution of these matters
or other factors, prove inaccurate and investors should be aware that such
judgment is made subject to the known uncertainty of litigation.
22
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
Baldwin Station Litigation. As previously described in the 2001 Form 10-K,
IP and Dynegy Midwest Generation, Inc. (collectively, the Defendants) are the
subject of a Notice of Violation ("NOV") from the Environmental Protection
Agency (the "EPA") and a complaint filed by the EPA and the Department of
Justice alleging violations of the Clean Air Act (the "Act") and, the
regulations promulgated under the Act. Similar notices and complaints have been
filed against a number of other utilities. Both the NOV and the complaint
allege that certain equipment repairs, replacements and maintenance activities
at the Defendants' three Baldwin Station generating units constituted "major
modifications" under the Prevention of Significant Deterioration and/or the New
Source Performance Standards regulations. When activities that meet the
definition of "major modifications" occur and they are not otherwise exempt,
the Act and related regulations generally require that generating facilities
meet more stringent emissions standards, which may entail the installation of
potentially costly pollution control equipment. The Defendants filed an answer
denying all claims and asserting various specific defenses and a trial date of
February 11, 2003 has been set.
None of the Defendants' other facilities are covered in the complaint and
NOV, but the EPA has officially requested information concerning activities at
the Defendants' Vermilion, Wood River, and Hennepin Plants as well as Dynegy
Northeast Generation's Danskammer Plant. It is possible that the EPA will
eventually commence enforcement actions based on activities at those plants as
well. The EPA has also recently requested information concerning activities at
Dynegy Northeast Generation's Roseton Plant. The EPA has the authority to seek
penalties for the alleged violations in question at the rate of up to $27,500
per day for each violation. The EPA may also seek to require installation of
the "best available control technology" (or the equivalent) at the Baldwin
Station, and possibly at the Vermillion, Wood River, Hennepin, Danskammer, and
Roseton Plants if the EPA initiates and successfully prosecutes enforcement
actions against those plants.
California Market Litigation. As previously described in the 2001 Form
10-K, six class action lawsuits have been filed against various Dynegy entities
based on the events occurring in the California power market. The complaints
allege violations of California's Business and Professions Code, Unfair Trade
Practices Act and various other statutes. The plaintiffs allege that the
defendants, including the owners of in-state generation and various power
marketers, conspired to manipulate the California wholesale power market to the
detriment of California consumers. Included among the acts forming the basis of
the plaintiffs' claims are the alleged improper sharing of generation outage
data, improper withholding of generation capacity and the manipulation of power
market bid practices. The plaintiffs seek unspecified treble damages.
All six lawsuits were consolidated before Judge Sammartino, Superior Court
Judge for the County of San Diego. Judge Sammartino recently entered a pretrial
conference order that establishes a trial date of March 1, 2004. In addition,
on April 17, 2002, Dynegy and the other defendants in these actions filed
challenges to the master plaintiffs' complaint moving to, among other things,
have the actions dismissed in their entirety on grounds of federal preemption
and to stay the proceedings in deference to the FERC's primary jurisdiction
over wholesale electricity transactions. Briefing on these motions is scheduled
to be completed on June 7, 2002 and the defendants' pleading challenges should
be heard and decided by Judge Sammartino thereafter.
On March 11, 2002, the California Attorney General filed, on behalf of the
People of the State of California, complaints in San Francisco Superior Court
against several energy generators, including subsidiaries of West Coast Power
and indirectly by Dynegy. The complaints allege that since June 1998, these
generators sold power in the open market that should have been held in
emergency reserve for the State. In the aggregate, the complaints seek more
than $150 million in penalties, restitution and return of profits from the
generators.
23
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
On April 23, 2002, T&E Pastorino and Pastorino & Son Nursery filed a class
action complaint in the Superior Court of the State of California for the
County of San Mateo. Named as defendants are various generators and marketers,
including Dynegy and certain affiliates. The complaint alleges unfair, unlawful
and deceptive practices in violation of the California Unfair Business
Practices Act and seeks to enjoin illegal conduct, restitution and unspecified
damages. While some of the allegations in this lawsuit are similar to the
allegations in the other six lawsuits, this lawsuit includes additional
allegations based on events occurring subsequent to the filing of the other six
lawsuits. These additional allegations include allegations similar to those
made by the California Attorney General in the March 11, 2002 suit described
above as well as allegations that contracts between these generators and the
California Department of Water Resources (the "DWR") constitute unfair business
practices resulting from market manipulation.
On May 13, 2002, two California law firms filed suit in California State
Court against more than 20 energy generators, including those owned directly by
West Coast Power and indirectly by Dynegy. Although Dynegy has not yet been
served with this suit, the Company understands from press reports relating to
the suit that it principally alleges the defendant generators, in connection
with their execution of long-term power supply contracts with the DWR, took
advantage of a manipulated market to overcharge for electricity. The suit,
which was filed on behalf of California taxpayers, seeks to halt enforcement of
the existing DWR contracts to the extent that the contracted prices are found
to be unfair. The suit further seeks damages in the amount of the alleged
excess prices under the contracts.
Dynegy believes that it has meritorious defenses to these claims and intends
to defend vigorously against them. Dynegy is unable to estimate the range of
possible loss that could be incurred with respect to these lawsuits. However,
an adverse result in any of these proceedings could have a material adverse
effect on its financial condition and results of operations.
As previously described in the 2001 Form 10-K, on February 13, 2002, the
FERC initiated an investigation of possible manipulation of natural gas and
power prices in the western United States during the period from January 2001
through the present. On May 8, 2002, in response to three memoranda discovered
by the FERC allegedly containing evidence of market manipulation by Enron in
California, the FERC issued data requests to all sellers in the California
Independent System Operator (the "ISO") and the California Power Exchange (the
"PX") markets during 2000 and 2001 seeking information with respect to whether
those sellers engaged in trading strategies described in the three Enron
memoranda. Responses to the data requests are due on May 22, 2002. The
California State Senate has issued similar data requests.
Based on its investigation to date, Dynegy believes that its trading
practices are consistent with applicable law and tariffs and will continue to
cooperate fully with the FERC's investigation. However, the Company is
continuing to assess these allegations and cannot predict with certainty how
such allegations will ultimately be resolved.
In addition, as previously described in the 2001 Form 10-K, on February 25,
2002 the California Public Utilities Commission and the California Electricity
Oversight Board filed complaints with the FERC asking that it void or reform
power supply contracts between the DWR and, among others, West Coast Power. The
complaints allege that prices under the contracts exceed just and reasonable
prices permitted under the Federal Power Act. The FERC recently set these
complaints for evidentiary hearing. The hearing, which will be deferred until
completion of settlement talks currently scheduled to begin on May 16, 2002,
will be limited to the question whether the California real-time market
adversely affected the long-term bilateral markets to the extent that
24
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
modifications to the DWR power contracts are required. While the Company
believes the terms of its contracts are just and reasonable and do not reflect
alleged market manipulation, it cannot predict the outcome of this matter.
On March 20, 2002, the California Attorney General filed, on behalf of the
People of the State of California, a complaint with the FERC against numerous
power marketers and energy generators, including those owned directly by West
Coast Power and indirectly by Dynegy. The complaint alleges that during
2000-2001, these marketers and generators failed to file with sufficient
specificity the required quarterly reports under the Federal Power Act relating
to sales to the ISO, the PX and the California Energy Resources Scheduling
Division of the DWR, thereby making unlawful the market-based rates charged by
these entities. The complaint seeks retroactive refunds to the extent such
rates are found by the FERC to exceed just and reasonable levels. The Company
believes it has meritorious defenses and will vigorously defend against these
claims.
Enron Litigation. As previously described, Dynegy and DHI were sued on
December 2, 2001 by Enron and Enron Transportation Services Co. in the United
States Bankruptcy Court for the Southern District of New York, Adversary
Proceeding No. 01-03626 (AJG). Enron claimed that Dynegy materially breached
the Merger Agreement dated November 9, 2001 between Enron and Dynegy and
related entities by wrongfully terminating that Agreement on November 28, 2001.
Enron also claims that DHI wrongfully exercised its option to take ownership of
Northern Natural under an Option Agreement dated November 9, 2001. Enron seeks
damages in excess of $10 billion and declaratory relief against Dynegy for
breach of the Merger Agreement. Enron also seeks unspecified damages against
Dynegy and DHI for breach of the Option Agreement. Dynegy filed an answer on
February 4, 2002, denying all material allegations. On April 12, 2002, the
Bankruptcy Court granted Dynegy's motion to transfer venue in the proceeding to
the United States District Court for the Southern District of Texas (Houston
Division). Discovery in this proceeding has not yet commenced.
In the 2001 Form 10-K, Dynegy also described a suit filed against Dynegy and
DHI by Ann C. Pearl and Joel Getzler in the United States District Court for
the Southern District of New York, Cause No. 01 CV 11652. Plaintiffs filed the
lawsuit as a purported class action on behalf of all persons or entities that
owned common stock of Enron Corp. as of November 28, 2001. A similar suit was
filed by Bernard D. Shapiro and Peter Strub in the 129th Judicial District
Court for Harris County, Texas, Cause No. 2002-00080. Plaintiffs in each case
allege that they are intended third party beneficiaries of the Merger Agreement
dated November 9, 2001 among Enron and Dynegy and related entities. Plaintiffs
claim that Dynegy materially breached the Merger Agreement by, inter alia,
wrongfully terminating that agreement. Plaintiffs also claim that Dynegy
breached the implied covenant of good faith and fair dealing. Plaintiffs seek
unspecified damages and other relief.
Before any ruling on Dynegy's motion to transfer venue in the Pearl/Getzler
case, and before any further proceedings in either of these actions, Enron
moved before the Bankruptcy Court for any order staying all further prosecution
of both the Pearl/Getzler case and the Shapiro/Strub case pursuant to the
automatic stay provision contained in the Bankruptcy Code. On April 12, 2002,
Enron's stay motion was granted. Thereafter, the Shapiro/Strub matter was
withdrawn without prejudice, but the Pearl/Getzler plaintiffs filed an appeal
from the Bankruptcy Court's stay order, which appeal is pending.
Dynegy believes that it has meritorious defenses against these claims and
intends to vigorously defend against them. Dynegy is unable to estimate the
range of possible loss that could be incurred with respect to these lawsuits.
However, an adverse result in any of these proceedings could have a material
adverse effect on its financial position and results of operations.
25
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
SEC Investigations. Dynegy has been advised by the Staff of the SEC that it
intends to seek a formal order of investigation in connection with the
previously announced inquiry into the facts and circumstances surrounding
Project Alpha. Having commenced an investigation, the SEC can be expected to
examine whether there are any additional transactions with similar financial
statement effects as Project Alpha as well as any other transactions or
business activities which receive media attention, including the CMS Energy
trades described below. The Company has assured the Staff that it intends to
cooperate fully with this investigation.
CMS Transactions. On November 15, 2001, Dynegy executed two sets of
simultaneous buy and sale trades with CMS Energy Corp. In the first set of
trades, Dynegy purchased 15 million megawatts of power from CMS Energy for
delivery in December 2001 at $25.50 per megawatt hour; concurrently, CMS Energy
purchased from Dynegy the same amount of power at the same price per megawatt
hour. In the second set of trades, Dynegy purchased 5 million megawatts of
power per month from CMS Energy for delivery in January-December 2002 at $34.00
per megawatt hour; concurrently, CMS Energy purchased from Dynegy the same
amount of power at the same price per megawatt hour.
The information gathered to date indicates that the trades were consummated
outside the view of other trading parties and, accordingly, could not have
impacted market prices. In addition, the volumes, revenues and costs of sales
associated with the trades were excluded from the Company's December 31, 2001
year-end operating statistics as reflected in the 2001 Form 10-K and are
excluded from the operating statistics for the three months ended March 31,
2002. The Company had previously disclosed its first quarter 2002 results of
operations in an earnings release dated April 30, 2002. In that release, 2002
first quarter revenues and 2002 first quarter costs of sales each contained
$236 million related to these trades. These amounts netted to zero in the
operating margin line, resulting in no net income effect from the trades in
that press release. For the purposes of reporting herein, the revenues and
costs of sales for accrued portions of the CMS Energy trades have been excluded
from the Company's December 31, 2001 and March 31, 2002 Revenues or Costs of
Sales in the Consolidated Statements of Operations. The volumes related to
these CMS Energy trades were excluded from the Operating Statistics for the WEN
segment in the 2001 Forms 10-K and 10-K/A and the 2002 Forms 10-Q and 10-Q/A.
Based on the Company's preliminary investigation, although certain
simultaneous buy and sell trades have been consummated, Dynegy believes that it
has not performed any simultaneous buy and sell trades with counterparties for
the purpose of artificially increasing its trading volumes or revenues. The
Staff of the U.S. Commodity Futures Trading Commission ("CFTC") has requested
that Dynegy voluntarily provide information to the Division of Enforcement of
the CFTC relating to, among other things, trading activities on Dynegydirect,
the Company's on-line trading platform, including all trades or trading
activities between Dynegy and CMS Energy in November 2001. The Staff of the
CFTC also has requested that Dynegy voluntarily provide information relating to
the Company's trading activities in the California power market. The Company
expects that Project Alpha, the CMS Energy trades and other previously
consummated transactions may be reviewed by other governmental and regulatory
agencies with competent jurisdiction. Dynegy intends to cooperate fully with
any and all such reviews.
NOTE 10--REGULATORY ISSUES
The Company is subject to regulation by various federal, state, local and
foreign agencies, including extensive rules and regulations governing
transportation, transmission and sale of energy commodities as well as the
discharge of materials into the environment or otherwise relating to
environmental protection. Compliance
26
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
with these regulations requires general and administrative, capital and
operating expenditures including those related to monitoring, pollution control
equipment, emission fees and permitting at various operating facilities and
remediation obligations. In addition, the U.S. Congress has before it a number
of bills that could impact regulations or impose new regulations applicable to
Dynegy and its subsidiaries. The Company cannot predict the outcome of these
bills or other regulatory developments or the effects that they might have on
its business. For a more detailed description of regulatory issues affecting
the Company's business, please refer to "Item 1. Business--Regulation" in the
2001 Form 10-K.
NOTE 11--SEGMENT INFORMATION
Dynegy's operations are divided into four reportable segments: Wholesale
Energy Network (WEN), Dynegy Midstream Services (DMS), Transmission and
Distribution (T&D) and Dynegy Global Communications (DGC). WEN is engaged in a
broad array of businesses, including physical supply, of and risk-management
activities around, wholesale natural gas, power, coal and other similar
products. This segment is focused on optimizing the Company's and its
customers' global portfolio of energy assets and contracts, as well as direct
commercial and industrial sales and retail marketing alliances. DMS consists of
the Company's North American midstream processing and marketing businesses and
worldwide natural gas liquids marketing and transportation operations. Dynegy's
T&D segment includes the operations of IP and Northern Natural. IP is an
energy-delivery company engaged in the transmission, distribution and sale of
electricity and natural gas to customers across a 15,000-square-mile area of
Illinois. Northern Natural's 16,600 miles of pipeline extend from the Permian
Basin in Texas to the Upper Midwest, providing extensive access to major
utilities and industrial customers. Northern Natural's storage capacity is 59
billion cubic feet (Bcf) and its market area capacity is approximately 4.3 Bcf
per day. DGC is engaged in the telecommunications business through its global
long-haul fiber optic and metropolitan network located in key cities in the
United States and Europe.
27
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
Dynegy accounts for intercompany transactions at prevailing market rates.
Unaudited operating segment information for the three months ended March 31,
2002 and 2001 is presented below. See the Explanatory Note for a discussion of
the restatements made to the financial information included herein.
DYNEGY'S SEGMENT DATA FOR THE QUARTER ENDED MARCH 31, 2002
($ in millions)
WEN DMS T&D DGC Eliminations Total
------- ------ ------ ----- ------------ -------
Unaffiliated revenues:
Domestic.............................. $ 4,637 $ 650 $ 483 $ $2 $ -- $ 5,772
Canadian.............................. 705 231 -- -- -- 936
European and other.................... 1,520 196 -- 2 -- 1,718
------- ------ ------ ----- ----- -------
6,862 1,077 483 4 -- 8,426
Intersegment revenues:
Domestic.............................. 139 33 8 -- (180) --
------- ------ ------ ----- ----- -------
Total revenues.................... 7,001 1,110 491 4 (180) 8,426
------- ------ ------ ----- ----- -------
Depreciation and amortization............ (46) (19) (46) (26) -- (137)
Operating income (loss).................. 4 39 96 (60) -- 79
Earnings (losses) from unconsolidated
investments............................ 30 4 -- (45) -- (11)
Other income (expense)................... (22) 1 4 5 -- (12)
Interest expense......................... (33) (10) (38) (8) -- (89)
Income tax provision (benefit)........... (32) 12 27 (27) -- (20)
Income (loss) from operations............ 11 22 35 (81) -- (13)
Cumulative effect of change in accounting
principle.............................. -- -- -- (234) -- (234)
Net income (loss)........................ $ 11 $ 22 $ 35 $(315) $ -- $ (247)
Identifiable assets:
Domestic.............................. $15,338 $2,061 $6,428 $ 486 $ -- $24,313
Canadian.............................. 640 120 -- -- -- 760
European and other.................... 2,895 -- -- 278 -- 3,173
Investments in unconsolidated affiliates. 761 149 10 -- -- 920
Capital expenditures and investments in
unconsolidated affiliates.............. (271) (31) (29) (67) -- (398)
28
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
DYNEGY'S SEGMENT DATA FOR THE QUARTER ENDED MARCH 31, 2001
($ in millions)
WEN DMS T&D DGC Eliminations Total
------- ------ ------ ---- ------------ -------
Unaffiliated revenues:
Domestic.............................. $ 7,763 $1,512 $ 526 $ 2 $ -- $ 9,803
Canadian.............................. 1,907 340 -- -- -- 2,247
European and other.................... 1,005 189 -- 1 -- 1,195
------- ------ ------ ---- ----- -------
10,675 2,041 526 3 -- 13,245
------- ------ ------ ---- ----- -------
Intersegment revenues:
Domestic.............................. 36 105 6 -- (147) --
------- ------ ------ ---- ----- -------
Total revenues.................... 10,711 2,146 532 3 (147) 13,245
------- ------ ------ ---- ----- -------
Depreciation and amortization............ (44) (20) (40) (4) -- (108)
Operating income (loss).................. 198 57 76 (20) -- 311
Earnings from unconsolidated investments. 31 1 -- -- -- 32
Other income (expense)................... (35) (5) (1) 6 -- (35)
Interest expense......................... (21) (14) (29) (2) -- (66)
Income tax provision (benefit)........... 63 12 21 (7) -- 89
Income (loss) from operations............ 110 27 25 (9) -- 153
Cumulative effect of change in accounting
principle.............................. 2 -- -- -- -- 2
Net income (loss)........................ $ 112 $ 27 $ 25 $ (9) $ -- $ 155
Identifiable assets:
Domestic.............................. $15,050 $1,922 $3,554 $478 $ -- $21,004
Canadian.............................. 731 230 -- -- -- 961
European and other.................... 859 -- -- 155 -- 1,014
Investment in unconsolidated affiliates.. 663 170 -- -- -- 833
Capital expenditures and investments in
unconsolidated affiliates.............. (1,141) (33) (27) (72) -- (1,273)
NOTE 12--SUBSEQUENT EVENTS
Credit Ratings. The credit ratings of Dynegy and its subsidiaries were
placed under review for possible downgrade by Moody's, Standard & Poor's and
Fitch on April 25, May 8 and April 26, 2002, respectively, due to uncertainties
regarding the sustainability of cash flow, the Enron litigation (see Note 9),
Dynegy's ability to access the capital markets, the cash flow treatment of
Project Alpha (see Explanatory Note), allegations of market manipulation in
California, the effect of these items on counterparty confidence and other
matters. In addition, as a result of the Enron bankruptcy, the credit rating
agencies have refocused their attention on the credit characteristics and
credit protection measures of industry participants, and in some cases appear
to have tightened the standards for a given rating level.
On March 14, 2002, Moody's affirmed Dynegy's and select subsidiaries'
ratings with a qualification of negative outlook. Subsequently, on April 25,
2002, Moody's placed Dynegy and select subsidiaries under review for possible
downgrade following the Company's announced reclassification of $300 million in
cash flow from
29
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
For the Interim Periods Ended March 31, 2002 and 2001
operations from 2001 to cash flow from financing in connection with Project
Alpha. On April 24, 2002, Standard & Poor's lowered its credit ratings for
Dynegy and its subsidiaries following a business risk evaluation of the
Company's various operating segments, its overall financial profile, capital
adequacy and liquidity position. In addition, on May 8, 2002, Standard & Poor's
placed Dynegy and it subsidiaries on CreditWatch with negative implications. On
April 30, 2002, Fitch lowered its credit ratings and reiterated its negative
watch status for Dynegy and its subsidiaries due to concerns regarding the
Company's financial flexibility and its ability to operate its business
recognizing a difficult business and capital environment and maintained its
status of review for possible downgrade. For a discussion of the Company's
current credit ratings, please read "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources-- Credit Rating Discussion."
THE COMPANY HAS EXPERIENCED A NUMBER OF MATERIAL DEVELOPMENTS SINCE THE
ORIGINAL FILING OF ITS MARCH 31, 2002 FORM 10-Q ON MAY 15, 2002. FOR FURTHER
DISCUSSION OF SUCH EVENTS, PLEASE READ THE COMPANY'S EXCHANGE ACT REPORTS FILED
SINCE SUCH DATE, INCLUDING ITS ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR
ENDED DECEMBER 31, 2002, WHICH DISCUSSION IS INCORPORATED HEREIN BY THIS
REFERENCE.
30
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 2002 and 2001
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
unaudited condensed consolidated financial statements of Dynegy Inc. ("Dynegy"
or the "Company") and the notes thereto included elsewhere herein and with the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2001, as filed with the SEC. As discussed in the Introductory Note to this Form
10-Q/A, the financial information contained in this report has been revised to
reflect the restatement items described in the Explanatory Note to the
accompanying unaudited Condensed Consolidated Financial Statements. Dynegy has
also amended its 2001 Form 10-K, most recently with Amendment No. 2 thereto
filed with the SEC on April 11, 2003. The restatements to the Company's 2001
financial statements and related information are further described therein, and
this Form 10-Q/A should be read together with such Amendment No. 2.
PLEASE NOTE THAT THE INFORMATION CONTAINED IN THIS FORM 10-Q/A, INCLUDING
THE FINANCIAL STATEMENTS AND THE NOTES THERETO, DOES NOT REFLECT EVENTS
OCCURRING AFTER MAY 15, 2002 (THE DATE ON WHICH DYNEGY ORIGINALLY FILED ITS
MARCH 31, 2002 FORM 10-Q). FOR A DESCRIPTION OF THESE EVENTS, PLEASE READ THE
COMPANY'S EXCHANGE ACT REPORTS FILED SINCE MAY 15, 2002, INCLUDING ITS ANNUAL
REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002. SEE NOTE
12--SUBSEQUENT EVENTS FOR FURTHER DISCUSSION.
Dynegy is one of the world's leading energy merchants. Through its global
energy delivery network and marketing, logistics and risk-management
capabilities, the Company provides innovative solutions to customers in North
America, the United Kingdom and Continental Europe. Dynegy's operations are
reported in four segments: Wholesale Energy Network ("WEN"), Dynegy Midstream
Services ("DMS"), Transmission and Distribution ("T&D") and Dynegy Global
Communications ("DGC").
Like many companies in our industry, Dynegy has faced a number of challenges
since the end of 2001. Events surrounding the collapse of Enron Corp. ("Enron")
have contributed to an unprecedented business environment fueled by skepticism
among regulators and investors alike. Dynegy's management understands the
demands of these new market realities and is responding within the framework of
our customer-focused, asset-backed business model. As we describe below,
current conditions have required us to take steps to strengthen our balance
sheet and address credit concerns. While much of this discussion focuses on the
impact of these developments on our wholesale marketing and risk-management
business, this business is generally responsible for only 30% of the Company's
operating income on an annual basis. As we have previously disclosed,
approximately 70% of the Company's annual operating income is derived from
owned physical assets. This asset base is not expected to be significantly
negatively impacted by these recent developments and continues to provide the
foundation for Dynegy's energy merchant business.
This Form 10-Q describes a number of recent developments affecting the
Company. On April 25, 2002, the Company preliminarily released its first
quarter 2002 earnings and announced that it would reclassify $300 million in
cash flow from operations to cash flow from financing in 2001 related to
Project Alpha. Also on April 25th, Moody's placed Dynegy's credit ratings under
review for possible downgrade citing concerns over the Company's ability to
generate sustainable recurring operating cash flow. The Company has
subsequently been named in several purported class action lawsuits alleging
violations of the federal securities laws and announced the SEC's intention to
expand its review of Project Alpha into a formal investigation. More recently,
31
on May 8, 2002, Standard & Poor's placed Dynegy's credit ratings on credit
watch with negative implications due to concerns regarding the SEC's
investigation and renewed allegations of price manipulation in California power
markets as well as the effect of these actions on counterparty confidence.
Management remains committed to responding to these recent developments.
With the exception of additional collateral requirements resulting from recent
events, the Company's business results have not been significantly adversely
affected to date. However, we are not operating in a normal business
environment and our results of operations for the remainder of 2002 and beyond
will be significantly affected by our ability to restore confidence with
customers and investors. Among the most significant factors that Dynegy must
address are the following:
. confidence in the Company's long-term business strategy as an energy
merchant company built around a physical asset base and in its execution
of this strategy, including the cash flow it generates;
. questions about the capital structure and liquidity position of the
Company, including the overall amount of leverage relative to its asset
base;
. ongoing investigations and litigation relating to Project Alpha, the
California power markets, the CMS trades and the Enron merger; and
. the Company's ability to eliminate losses associated with its
communications business by year-end.
Our success in addressing these issues will in turn affect the views of
credit rating agencies, the capital markets and trade counterparties about our
Company. Each of these factors is described in greater detail below. Please
also read "Uncertainty of Forward-Looking Statements and Information" below for
additional factors that could impact future operating results.
The following discussion also provides important information about the
effect of recent events on our liquidity and capital resources. The Company's
wholesale marketing and risk-management business has required additional
capital in response to a general tightening of trade credit after Enron's
bankruptcy and in response to recent events impacting Dynegy specifically. We
are working diligently to address the concerns discussed above and to take the
measures necessary to defend our investment grade credit ratings. However, as
the Company has previously disclosed, management believes that Dynegy has
sufficient liquidity and capital resources to continue to meet its obligations
and to operate its business even in the event of the loss of our investment
grade credit rating by one or more rating agencies. The Company intends to
manage its wholesale marketing business in a manner consistent with its
liquidity position. For further discussion, see "Liquidity and Capital
Resources" below.
LIQUIDITY AND CAPITAL RESOURCES
In December 2001, Dynegy announced a $1.25 billion capital restructuring
program to respond to concerns of credit rating agencies and trade
counterparties regarding balance sheet strength in the merchant energy sector.
In accordance with the plan, Dynegy raised $744 million in net proceeds by
selling approximately 39.1 million shares of common stock, including 10.4
million shares purchased by ChevronTexaco and 1.2 million shares purchased by
senior management. Net proceeds from the sale of these shares were used to
reduce indebtedness under DHI's revolving credit facility by approximately $540
million and the remainder of the proceeds were held as cash. In addition to
these equity sales, the Company reduced its original 2002 capital-spending
program by over $500 million to approximately $1.2 billion. This reduction in
capital spending related to funds originally budgeted for capital expenditure
opportunities that were anticipated to arise during the year. The Company's
primary capital expenditure focus will be the acquisition and/or construction
of energy assets that will enable the Company to expand its energy network.
Expenditures will include maintenance capital at existing facilities of
approximately $430 million. The Company also anticipates limiting future
capital expenditures associated with its communications network.
32
The Company believes it prudent to increase liquidity and strengthen its
balance sheet and, as a result, continues to assess additional alternatives,
including possible joint ventures or sales of assets and businesses. These
steps are designed to continue the Company's capital restructuring program.
Such steps are also being taken to reduce leverage and to establish revised
targets for debt to capitalization and coverage ratios.
Dynegy also continues to pursue a potential initial public offering by a
newly created master limited partnership which would own a portion of the
Company's downstream NGL business. The registration statement relating to this
offering has not yet been declared effective by the SEC and Dynegy cannot
guarantee its eventual effectiveness or that once effective, Dynegy Energy
Partners' initial public offering will be successfully completed. Further, the
issues facing Dynegy as described elsewhere in this Form 10-Q could affect
Dynegy Energy Partners' ability to successfully market and consummate its
initial public offering.
Dynegy's balance sheet at March 31, 2002 also reflects the increased
leverage associated with our acquisition of Northern Natural Gas Company
("Northern Natural") from Enron at January 31, 2002. This increased leverage
results partially from Northern Natural's $950 million of indebtedness and
partially from the $1.5 billion of Series B Mandatorily Convertible Redeemable
Preferred Stock ("Series B Preferred Stock") sold to ChevronTexaco in November
2001, the proceeds of which were used to purchase preferred stock in Northern
Natural. The Company is continuing to assess alternatives regarding the Series
B Preferred Stock, its capital structure and other alternatives relating to
Northern Natural in the event Enron does not exercise its repurchase option.
This option expires at the end of June. See "--Other Matters--Enron/Northern
Natural."
DHI Revolving Credit Agreement
DHI closed a $900 million unsecured revolving credit agreement with a
syndicate of commercial banks on April 29, 2002. This facility, which matures
on April 28, 2003, replaced an expiring $1.2 billion revolving credit
agreement. The new facility provides funding for working capital, capital
expenditures and general corporate purposes. Generally, borrowings under the
credit agreement bear interest at a Eurodollar rate plus a margin that is
determined based on designated unsecured debt ratings. The increase in this
margin over the margins under the expired facility is expected to result in an
increase in the fees paid by DHI compared to the fees paid under the expiring
facility. Specifically, DHI expects to pay approximately $1.4 million in
additional borrowing fees during the term of the new facility and paid
approximately $3.2 million in additional upfront fees in connection with the
closing of the new facility.
Financial covenants in the revolving credit agreement include a
debt-to-capitalization test (which takes into account certain lease and similar
commitments of DHI and its subsidiaries) and a newly added 3.5 times earnings
before interest, taxes and depreciation and amortization ("EBITDA")-to-interest
test. The permissible threshold for the debt-to-capitalization test was lowered
in the new facility from 65% to 60%. Other newly added covenants in the new
facility include subordination of certain intercompany debt owed to Dynegy and
its subsidiaries (other than DHI and its subsidiaries), restrictions on liens
and limitations prohibiting subsidiary debt at Dynegy Marketing & Trade, Dynegy
Power Marketing, Inc. and Dynegy Midstream Services, Limited Partnership.
Default provisions include cross payment default of Dynegy, DHI or any
principal subsidiary with respect to debt or other similar obligations that
exceed $100 million, cross acceleration of Dynegy, DHI or any principal
subsidiary under any instrument covering debt or similar obligations that
exceed $100 million and bankruptcy or receivership of Dynegy, DHI or any
principal subsidiary. The new facility does not contain any defaults relating
to material adverse changes in the condition of Dynegy or DHI after the closing
date or to changes in Dynegy's or DHI's credit ratings. The new facility also
does not contain a "term-out" provision that would permit Dynegy to extend the
maturity for borrowings under the facility beyond the facility's April 28, 2003
maturity date.
33
Available Credit Capacity and Debt Maturities
The following table describes our available credit capacity at quarter end:
AVAILABLE CREDIT CAPACITY AS OF MARCH 31, 2002
Dynegy
Dynegy Holdings Illinois Northern
Total Inc. Inc. Power Natural
------ ------ -------- -------- --------
($ in millions)
Outstanding Loans and Letters of Credit $1,425 $ -- $ 735 $240 $450
Unused Borrowing Capacity.............. 1,265 300 905 60 --
------ ---- ------ ---- ----
Total Credit Capacity.................. $2,690 $300 $1,640 $300 $450
====== ==== ====== ==== ====
Under current market conditions, Dynegy does not have access to the
commercial paper markets and has relied on bank credit facilities, operating
cash flow, public equity and debt issuances and cash on hand for its short-term
liquidity requirements. Sales of common stock in December 2001 and January 2002
generated aggregate net proceeds of approximately $744 million which were used
to pay down approximately $540 million of indebtedness under DHI's revolving
credit facility; the remainder was invested in cash. In February 2002, DHI
issued $500 million of 8.75% senior notes due 2012 and used the net proceeds to
pay down approximately $250 million of indebtedness under DHI's revolving
credit facility; the remainder was held in cash.
Illinois Power Company ("IP") has a $300 million 364-day revolving credit
facility that matures on May 20, 2002. IP is seeking to replace the maturing IP
facility with a new facility of at least $200 million. The Company can provide
no assurance that IP will be able to refinance this revolving credit facility
on terms comparable to its existing facility. The existing IP revolver includes
a "term-out" provision which would permit IP to convert outstanding borrowings
under the current revolver to a one-year term loan in the event a new facility
cannot be placed.
In addition to the $900 million DHI facility described above and the IP
facility, Dynegy Inc. has a $300 million revolving credit facility which
matures in November 2002. DHI also has a $400 million revolving credit facility
that matures in May 2003. Northern Natural has a $450 million 364-day revolving
credit facility that matures in November 2002.
In addition to these bank credit facilities, Dynegy has $351 million of debt
maturities through the third quarter of 2002, including $200 million of DHI
senior notes due July 2002, $96 million of IP mortgage bonds also due in July
2002 and $34 million of payments associated with ABG Gas Supply. Dynegy also
has $42 million of debt other than bank credit facilities maturing in the
fourth quarter of 2002. See Note 5 to the accompanying financial statements.
As of May 14, 2002, the Company had committed credit lines of approximately
$2.4 billion, reflecting the new DHI revolving credit facility of $900 million
that replaced a $1.2 billion facility that matured in May 2002. At May 14,
2002, the Company had borrowings of approximately $1.1 billion and outstanding
letters of credit of approximately $669 million under these credit facilities
(of which approximately $337 million have been posted since April 25, 2002),
leaving approximately $631 million of unused borrowing capacity. In addition,
at May 14 the Company had cash of approximately $360 million and in excess of
$300 million of other highly liquid assets which is principally natural gas and
crude inventories.
Credit Rating Discussion
Credit ratings impact the Company's ability to obtain short- and long-term
financing, the cost of such financing and the execution of its commercial
strategies. In determining the Company's credit ratings, the rating agencies
consider a number of factors. Quantitative factors that are given significant
weight include, among other things, EBITDA; operating cash flow; total debt
outstanding; off balance sheet obligations and other
34
commitments; fixed charges such as interest expense, rent or lease payments;
payments to preferred stockholders; liquidity needs and availability; and
various ratios calculated from these factors. Qualitative factors include,
among other things, predictability of cash flows, business strategy, industry
position and contingencies. Although these factors are among those considered
by the rating agencies, each agency may calculate and weigh each factor
differently.
The credit ratings of Dynegy and its subsidiaries were placed under review
for possible downgrade by Moody's and Standard & Poor's on April 25 and May 8,
respectively, due to uncertainties regarding the sustainability of cash flow,
the Enron litigation (see Note 9 to the accompanying financial statements),
Dynegy's ability to access the capital markets, the cash flow treatment of
Project Alpha (see the Introductory Note to the accompanying financial
statements), allegations of market manipulation in California, the effect of
these items on counterparty confidence and other matters. On April 30, 2002,
Fitch clarified its position with respect to a possible downgrade to include
similar concerns. In addition, as a result of the Enron bankruptcy, the credit
rating agencies have refocused their attention on the credit characteristics
and credit protection measures of industry participants, and in some cases
appear to have tightened the standards for a given rating level.
On April 24, 2002, Standard & Poor's lowered its credit ratings for Dynegy
and its subsidiaries following a business risk evaluation of the Company's
various operating segments, its overall financial profile, capital adequacy and
liquidity position. On April 30, 2002, Fitch lowered its credit ratings for
Dynegy and its subsidiaries due to concerns regarding the Company's financial
flexibility and its ability to operate its business recognizing a difficult
business and capital environment. The updated ratings are reflected in the
table below.
As of May 9, 2002, Dynegy's senior unsecured debt ratings, as assessed by
the three major credit rating agencies, were as follows:
Standard
Rated Enterprises & Poor's Moody's Fitch
----------------- -------- ------- -----
Senior Unsecured Debt Rating:
Dynegy Holdings Inc.(1)......... BBB Baa3 BBB
Dynegy Inc.(2).................. BBB- Ba1 BBB-
Illinois Power(3)............... BBB- Baa3 BBB
Illinova Corporation(4)......... BBB- Ba1 BBB-
Northern Natural(5)............. CC B3 CC
Commercial Paper/Short-Term Rating:
Dynegy Holdings Inc............. A-3 P-3 F3
Dynegy Inc...................... A-3 NP F3
Illinois Power.................. A-3 P-3 F2
--------
(1) Dynegy Holdings Inc. is the primary debt financing entity for the
enterprise. This entity is a subsidiary of Dynegy Inc. and is a holding
company that includes substantially all of the operations of the WEN and
DMS business segments and Northern Natural, which is reported in the T&D
segment.
(2) Dynegy Inc. is the parent holding company. This entity generally provides
financing to the enterprise through issuance of capital stock.
(3) This entity includes the Company's regulated transmission and distribution
business in Illinois.
(4) Illinova Corporation is the holding company for Illinois Power and is no
longer used to raise capital.
(5) Ratings have not changed since Dynegy's acquisition of Northern Natural and
reflect Enron's repurchase option.
A downgrade in Dynegy's credit ratings to below investment grade would cause
a reduction in the amount of trade credit expected to be extended by Dynegy's
counterparties until these ratings could be restored. The
35
Company also anticipates that counterparties would increase their collateral
demands relating to its wholesale marketing and risk-management business.
Downgrades in Dynegy's credit ratings to below investment grade also would
trigger the financing covenants described below under "Financing Trigger
Events." Such a downgrade also could increase the risk that the Company would
be unable to refinance debt obligations as they mature and could increase the
borrowing costs incurred by the Company in connection with any such
refinancings. The Company's financial flexibility would likewise be reduced as
a result of restrictive covenants and other terms that are typically imposed on
non-investment grade borrowers.
Management is in discussions with representatives of Moody's, Standard &
Poor's and Fitch. These discussions focus on the Company's business strategy,
2002 forecast, business operations and the amount and sustainability of cash
flows. Dynegy cannot predict with any certainty the actions, if any, that may
be taken by the rating agencies subsequent to these meetings.
Financing Trigger Events
Dynegy's debt instruments and other financial obligations include routine
provisions, which, if not met, could require early payment, additional
collateral support or similar actions. For Dynegy, these trigger events include
leverage ratios, insolvency events, defaults on scheduled principal or interest
payments, acceleration of other financial obligations and change of control
provisions. Dynegy does not have any trigger events tied to specified credit
ratings or stock price in its debt instruments and has not executed any
transactions that require it to issue equity based on credit rating or other
trigger events.
The Company has two non-commercial agreements that have trigger events tied
to credit ratings. At March 31, 2002, the amount of cash collateral that the
Company would have to post in the event of a ratings trigger under these two
agreements was $300 million. The Company's investment in Catlin Associates,
LLC, described below, accounts for $270 million of the $300 million in possible
cash collateralization and would be triggered only if the senior unsecured debt
ratings for DHI were downgraded below investment grade by both Moody's and
Standard & Poor's. The remaining $30 million relates to the Company's guarantee
of certain contingent environmental obligations of West Coast Power, a 50
percent owned equity investment. This obligation would be triggered by a
downgrade in DHI's credit rating to below investment grade by either Moody's or
Standard & Poor's. Dynegy's credit ratings are under review by Moody's,
Standard & Poor's and Fitch. Please see "--Credit Rating Discussion."
In June 2000, Dynegy and Black Thunder Investors LLC ("Investor") invested
in Catlin Associates, LLC ("Catlin"), an entity that is consolidated by Dynegy,
with the Investor's ownership in Catlin reflected as Minority Interest in the
Condensed Consolidated Balance Sheets. Dynegy invested $100 million in Catlin
and the Investor invested $850 million. As a result of its investment, the
Investor received a preferred interest in Catlin, which holds indirect economic
interests in Dynegy's midwest generation assets. As of March 31, 2002, these
assets had a net book value of approximately $3.0 billion. If DHI's senior
unsecured debt is downgraded below investment grade by both Standard & Poor's
and Moody's, Dynegy would be required to post cash collateral in an aggregate
amount of $270 million and, within 30 days, obtain an investment grade rating
for the interest held by the Investor by either Standard & Poor's or Moody's or
obtain a waiver from the Investor.
If Dynegy were unable to obtain the required rating for the interest held by
the Investor or waiver, Dynegy would have the option of purchasing or
refinancing the Investor's interest in Catlin. If Dynegy were to elect not to
exercise this option, it could ultimately result in an election by the Investor
to cause the liquidation of the underlying generation assets in an amount
sufficient to redeem the Investor's interest. Given the strategic importance of
these generation assets, it is likely that Dynegy would seek to refinance or
purchase the Investor's interest under such circumstances. For additional
information regarding Catlin, please read "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources--Contingent Financial Commitments as of December 31, 2001" in the
2001 Form 10-K.
36
Trade Credit and Liquidity
Following the Enron bankruptcy, there has been a general industry-wide
contraction in trade credit in the wholesale energy markets. Open or unsecured
credit lines generally have been reduced, and counterparties are more stringent
in requiring credit support in the form of cash in advance, letters of credit
or guarantees as a condition to transacting business above open credit limits.
In addition, parties engaged in the wholesale marketing business, including
Dynegy, are moving towards the implementation of standardized agreements that
allow for the netting of positive and negative exposures associated with a
single counterparty. Dynegy believes that the trend toward such master netting
agreements is a positive market development and has executed or is in the
process of negotiating such agreements with a number of its trading partners.
Most commercial agreements typically include "adequate assurance" provisions or
specific ratings triggers. These clauses typically give counterparties the
right to suspend or terminate credit if the Company's credit ratings fall below
investment grade.
Dynegy's wholesale marketing and risk-management business has historically
relied upon DHI's senior unsecured debt investment grade credit rating to
satisfy the credit support requirements of many counterparties. Prior to April
25, 2002, Dynegy had approximately $350 million in letters of credit posted in
connection with its commercial operations. Since the April 25, 2002 action by
Moody's placing Dynegy's credit ratings under review for possible downgrade,
Dynegy has been able to transact its wholesale marketing and risk-management
business by posting an additional approximately $360 million in letters of
credit to collateralize its net exposure to various counterparties. Total
outstanding letters of credit as of May 14, 2002 approximate $710 million.
In the event of a further downgrade by one or more credit rating agencies,
management estimates it would require an additional $350 million to
collateralize existing commercial arrangements. This $350 million of additional
collateral, together with the approximately $360 million in collateral posted
since April 25, represents the approximate $700 million of additional
collateral previously described by management as the necessary liquidity to
support the commercial business in the event of a downgrade. The financing
triggers described above represent an additional $300 million of commitments,
$270 million of which would be triggered only in the event of a downgrade by
both agencies. At May 14, Dynegy had unused borrowing capacity of approximately
$631 million, cash of approximately $360 million and in excess of $300 million
of other highly liquid assets, principally natural gas and crude inventories.
Dynegy's current liquidity position can be summarized as follows (in
millions):
Capacity
Bank capacity...................... $ 631
Cash............................... 360
Highly Liquid Inventory............ 300
------
$1,291
Requirements in Double Downgrade Event
Additional Collateral.............. $ 350
Financing Triggers................. 300
------
$ 650
------
Available Liquidity Remaining......... $ 641
------
Dynegy intends to manage its wholesale marketing and risk-management
business in a manner consistent with its liquidity position. In the event of a
downgrade, Dynegy believes it can reduce the level of short-term wholesale
marketing and risk-management business activities with little impact on
earnings and cash flow. However, in the event of a downgrade, longer term
wholesale marketing and risk-management business activities could be affected
and could have an impact on earnings in the future.
Other factors which will impact liquidity in the near term are cash flow
from operations, capital spending, the approximately $300 million in debt
maturities in July 2002 and the Company's ability to execute additional
37
capital enhancing transactions such as asset or business sales, joint ventures
or financings. Based on current credit capacity and assumptions management
believes to be reasonable, we believe that Dynegy has sufficient liquidity and
capital resources to meet its obligations even in a downgrade scenario.
Long-Term Supply Commitments
During the first quarter of 2002, the Company executed long-term supply
contracts, including tolling arrangements. This long-term supply was acquired
at a cost below that which would be incurred to build and maintain power
generation facilities to provide such supply. The supply commitment increased
the Company's firm capacity payments by $624 million on a discounted basis, for
total capacity payments of $2.1 billion on a discounted basis at March 31,
2002. The additional future payment obligations associated with firm capacity
contracts executed in the first quarter 2002 are expected to occur ratably
beginning in year 2005 and beyond. These amounts include supply contracts that
are reflected on the Condensed Consolidated Balance Sheets in Risk Management
Assets or Risk Management Liabilities and those that are accounted for on an
accrual basis, each as determined by the applicable contractual terms and in
accordance with generally accepted accounting principles.
OTHER MATTERS
Enron/Northern Natural. On November 9, 2001, Dynegy entered into a merger
agreement with Enron. The closing of the merger was conditioned upon the
accuracy of representation and warranties, approval of the shareholders of both
Dynegy and Enron, the receipt of applicable regulatory approvals, the absence
of material adverse changes and other customary conditions.
On November 13, 2001, in connection with the merger agreement, ChevronTexaco
purchased 150,000 shares of Dynegy's Series B Preferred Stock for $1.5 billion.
Dynegy used the $1.5 billion of proceeds from this issuance to purchase 1,000
shares of Series A Preferred Stock in Northern Natural. The Series A Preferred
Stock has a 6% cumulative dividend which accrues from the issue date but is not
payable until January 31, 2003. In connection with the preferred stock
investment in Northern Natural, Dynegy paid $1 million to acquire an option to
purchase all of the equity of Northern Natural's indirect parent company. The
exercise price for the option was $23 million, subject to adjustment based on
Northern Natural's indebtedness and working capital.
On November 28, 2001, Dynegy exercised its right to terminate the merger
agreement with Enron. The above-mentioned agreements were impacted as follows:
. Dynegy exercised its option to purchase the indirect parent company of
Northern Natural. The closing of the transaction occurred on January 31,
2002. An Enron subsidiary has the option to reacquire Northern Natural
through June 30, 2002 for $1.5 billion plus accrued but unpaid dividends
on the Series A Preferred Stock and the option exercise price, subject to
adjustment based on Northern Natural's indebtedness and working capital.
. At January 31, 2002, Northern Natural had approximately $950 million of
debt outstanding. The significant terms of the Northern Natural debt are
as follows ($ in millions):
Senior Notes, 6.875% due May 2005.................................. $100
Senior Notes, 6.75% due September 2008............................. 150
Senior Notes, 7.00% due June 2011.................................. 250
Borrowing under Revolving Credit Agreement, 4.66% due November 2002 450
----
Total debt.................................................. $950
====
38
In order to obtain a bondholder consent required in connection with the
Northern Natural acquisition, DHI agreed to effect a tender offer for $100
million of senior unsecured notes of Northern Natural due in 2005. On April 26,
2002, DHI purchased $90 million of the notes pursuant to such tender offer.
. Management believes, based on an internal analysis of Northern Natural's
credit capacity, including a review of other regulated pipelines, that
Northern Natural will be able to refinance the $450 million secured line
of credit, and it is Northern Natural's management's intention to do so.
. Each share of Dynegy's Series B Preferred Stock became convertible, at
the option of ChevronTexaco, for a period of two years, into shares of
Dynegy Class B common stock at the conversion price of $31.64. This
conversion price represents a 5% discount to the Company's stock price on
November 7, 2001, the date the conversion price was negotiated. As a
result of this event, ChevronTexaco acquired a beneficial conversion
option, which will be accreted by Dynegy over the two-year option
conversion term as an implied dividend. Based on the implied value of the
beneficial conversion option as of November 7, the Company originally
recognized a special preferred stock dividend of approximately $65
million. The Company was recognizing this dividend over the two-year
period from the issuance date of the preferred stock to the mandatory
redemption date. For purposes of calculating the value of the beneficial
conversion option, the Company originally used November 7, 2001 as the
commitment date. The Company has since determined that it should have
used November 13, the date ChevronTexaco funded its preferred stock
purchase and the preferred securities were issued, as the commitment
date. The Company's stock price increased significantly between these two
dates after the announcement of the proposed Enron Corp. merger resulting
in an implied value of $660 million rather than the previously disclosed
$65 million. The restated preferred stock dividend amount is calculated
based on a two-year amortization of the beneficial conversion option's
implied value of approximately $660 million. Unless ChevronTexaco
exercises its conversion right, Dynegy is required to redeem the Series B
Preferred Stock for $1.5 billion two years from the date of issuance. The
Series B Preferred Stock is not entitled to a dividend.
On December 2, 2001, Enron filed for federal bankruptcy protection in the
United States Bankruptcy Court, Southern District of New York. Enron also filed
an adversary proceeding in the bankruptcy court against Dynegy and DHI seeking
damages of $10 billion for wrongful termination of the merger agreement and the
wrongful exercise of its option to take ownership of Northern Natural. Please
refer to Note 9 to the accompanying financial statements for further discussion
of this dispute.
As previously described in the 2001 Form 10-K, as a result of Enron's
bankruptcy filing, Dynegy recognized in its fourth quarter 2001 financial
statements a pre-tax charge related to the Company's net exposure for
commercial transactions with Enron. As of March 31, 2002, the Company's net
exposure to Enron, inclusive of certain liquidated damages and other amounts
relating to the termination of the transactions, was approximately $84 million
and was calculated by setting off approximately $230 million owed from various
Dynegy entities to various Enron entities against approximately $314 million
owed from various Enron entities to various Dynegy entities. The master netting
agreement between Dynegy and Enron and the valuation of the commercial
transactions covered by the agreement, which valuation is based principally on
the parties' assessment of market prices for such period, remain subject to
dispute by Enron with respect to which there have been negotiations between the
parties. These negotiations have focused on the scope of the transactions
covered by the master netting agreement and the parties' valuations of those
transactions. If any disputes cannot be resolved by the parties, the agreement
calls for arbitration. If the setoff rights were modified or disallowed, either
by agreement or otherwise, the amount available for Dynegy entities to set off
against sums that might be due Enron entities could be reduced materially.
California Market/West Coast Power. Dynegy and NRG Energy each own 50
percent of West Coast Power, a joint venture owning power generation plants in
southern California. Dynegy's net interest in West Coast Power represents
approximately 1,400 MW of generating capacity. Dynegy also participates in the
California markets independently, as a wholesale marketer of gas and power.
Through its interest in West Coast
39
Power, Dynegy has credit exposure for past transactions to state agencies
("ISO" and "PX"), which primarily relied on receipts from California utilities
to pay their bills. West Coast Power also sells directly to the California
Department of Water Resources ("DWR") pursuant to other bilateral agreements.
As described in Note 9 to the accompanying financial statements, on February
25, 2002, the California Public Utilities Commission and the California
Electricity Oversight Board filed complaints with the FERC asking that it void
or reform power supply contracts between CDWR and, among others, West Coast
Power. The complaints allege that prices under the contracts exceed just and
reasonable prices permitted under the Federal Power Act. The FERC recently set
these complaints for evidentiary hearing. The hearing, which will be deferred
until after settlement talks currently scheduled to begin on May 16, 2002, will
be limited to the question whether the California market adversely affected the
long-term bilateral markets to the extent that modifications to the DWR power
contracts are required. While the Company believes the terms of its contracts
are just and reasonable and do not reflect alleged market manipulation, it
cannot predict how the FERC will respond to these complaints. The Company is
vigorously defending against these complaints. Please read Note 11,
"Commitments and Contingencies," to the 2001 Form 10-K and Note 9 to the
accompanying financial statements for additional discussion of the Company's
activities in the California power market.
As a result of West Coast Power's previously announced long-term sales
arrangement with the DWR, ongoing management of credit risk associated with
direct sales to customers in California and other factors, management believes
that Dynegy's primary exposure relates to the realization of its share of West
Coast Power's receivables from the ISO and PX and potential refunds or offsets
associated with related transactions. Transactions with the aforementioned
counterparties, other than the ISO and PX, are current under the terms of each
individual arrangement. At March 31, 2002, Dynegy's portion of the receivables
owed to West Coast Power by the ISO and PX approximated $206 million.
Management is continually assessing Dynegy's exposure, as well as its exposure
through West Coast Power, relative to its California receivables and
establishes reserves for contingent liabilities where the amount of potential
loss is determined to be probable and estimable. During the three months ended
March 31, 2002 and 2001, Dynegy's share of reserves taken by West Coast Power
aggregated $0.2 million and $85.5 million, respectively. Dynegy's share of the
total reserve at March 31, 2002 and December 31, 2001 was $152.0 million and
$151.8 million, respectively.
ChevronTexaco Commercial Relationship. In March 2002, Dynegy and
ChevronTexaco executed agreements to expand their commercial relationships to
include substantially all of the natural gas and domestic mixed NGLs and NGL
products produced or controlled by the former Texaco. The expanded term
agreements extend through August 2006. This expanded relationship increases the
volume of natural gas Dynegy purchases from ChevronTexaco from approximately
1.7 Bcf/d to approximately 2.9 Bcf/d. Dynegy also provides supply and service
for in excess of 1.6 Bcf/d of natural gas for the combined ChevronTexaco
facilities and third-party term markets. In addition, DMS' expanded contract
with ChevronTexaco includes substantially all of the U.S. NGL production of the
former Texaco. Concurrent with the expanded commercial agreements, the two
companies executed new security provisions that Dynegy believes are mutually
beneficial. The new security agreement improves Dynegy's liquidity position by
reducing its reliance upon the financial markets for surety bonds and letters
of credit, while ChevronTexaco's open credit exposure is significantly reduced.
Additionally, it is scaleable to include the increased volumes in any pricing
environment and provides cost savings to Dynegy. Such provisions involve
replacement of historic credit support arrangements with a perfected security
interest in a portion of Dynegy's domestic natural gas receivables. Dynegy has
the option to revert back to historic credit support arrangements, which
included the issuance of surety bonds and/or letters of credit.
Recent Accounting Pronouncements. Several recently issued accounting
pronouncements have been adopted or will be adopted within the next year by the
Company. See Note 2 to the accompanying financial statements for a discussion
of Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("Statement No. 142"), Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" ("Statement
No. 143"), Statement of Financial Accounting Standards No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" ("Statement No. 144") and
Statement of
40
Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections"
("Statement No. 145").
In addition, we have interests in joint ventures, equity investors and
financing arrangements that existing accounting guidance precludes us from
consolidating. In the wake of the Enron bankruptcy, accounting standard
setters, including the SEC and FASB, are evaluating the existing accounting and
disclosure rules and requirements. One area that has received a high level of
scrutiny is the accounting rules related to consolidations, specifically those
that address special purpose entities. Standard setting bodies and regulators
are evaluating the consolidation rules to determine whether the existing
accounting framework should change. There is a risk that existing standards
will change, particularly in light of the events of 2001, and that these
changes could result in the consolidation in the Company's financial statements
of entities that it does not consolidate.
Commitments and Contingencies. See Note 9 to the accompanying financial
statements for a discussion of the Company's Commitments and Contingencies.
Dividend Policy. Dynegy intends to pay a quarterly dividend of $0.075 per
share of common stock, subject to declaration by the Board of Directors of the
Company and the availability of funds legally available therefor. During the
three-month periods ended March 31, 2002 and 2001, the Company paid
approximately $28 million and $25 million in cash dividends, respectively, on
common stock.
Concentration of Credit Risk. As a result of recent volatility in both the
commodity and equity markets, Dynegy has reassessed its industry credit
concentration as well as specific counterparty credit risks. Based on this
reassessment, Dynegy continues to believe that credit risk imposed by industry
concentration is largely offset by the diversification and creditworthiness of
its customer base. The Company believes that its corporate credit policies are
aligned with business risks in support of minimizing enterprise credit risk.
ACCOUNTING METHODOLOGY
The Company has identified three critical accounting policies that require a
significant amount of judgment and are considered to be the most important to
the portrayal of Dynegy's financial position and results of operations. These
policies include the accounting for long-lived assets, the evaluation of
counterparty credit and other similar risks and revenue recognition. See Note 3
to the 2001 Form 10-K for a discussion of the process surrounding the
evaluation of counterparty credit and other similar risks. For disclosure on
the Company's accounting for long-lived assets and revenue recognition, refer
to Note 2 to the 2001 Form 10-K. Accounting methodology and application of
accounting methodologies is more fully described in the 2001 Form 10-K.
ENTERPRISE RISK MANAGEMENT, VALUATION AND MONITORING
Market Risk. The Company is exposed to commodity price variability related
to its natural gas, NGLs, crude oil, electricity and coal businesses. In
addition, fuel requirements at its power generation, gas processing and
fractionation facilities represent additional commodity price risks to the
Company. In order to manage these commodity price risks, Dynegy routinely
utilizes certain types of fixed-price forward purchase and sales contracts,
futures and option contracts traded on the New York Mercantile Exchange and
swaps and options traded in the over-the-counter financial markets to:
. Manage and hedge its fixed-price purchase and sales commitments;
. Provide fixed-price commitments as a service to its customers and
suppliers;
. Reduce its exposure to the volatility of cash market prices;
. Protect its investment in storage inventories; and
. Hedge fuel requirements.
41
The potential for changes in the market value of Dynegy's commodity,
interest rate and currency portfolios is referred to as "market risk." A
description of each market risk category is set forth below:
. Commodity price risks result from exposures to changes in spot rates,
forward prices and volatilities in commodities, such as electricity,
natural gas, coal, NGLs, crude oil and other similar products;
. Interest rate risks primarily result from exposures to changes in the
level, slope and curvature of the yield curve and the volatility of
interest rates; and
. Currency rate risks result from exposures to changes in spot rates,
forward rates and volatilities in currency rates.
Dynegy seeks to manage these market risks through diversification,
controlling position sizes and executing hedging strategies. The ability to
manage an exposure may, however, be limited by adverse changes in market
liquidity or other factors.
Valuation Criteria and Management Estimates. As more fully described in the
2001 Form 10-K, Dynegy utilizes a fair value accounting model for certain
aspects of its operations as required by generally accepted accounting
principles. The net gains or losses resulting from the revaluation of these
contracts during the period are recognized currently in the Company's results
of operations. For financial reporting purposes, assets and liabilities
associated with these transactions are reflected on the Company's balance sheet
as risk management assets and liabilities, classified as short- or long-term
pursuant to each contract's individual tenor. Net unrealized gains and losses
from these contracts are classified as revenue in the accompanying statement of
operations. Transactions that have been realized and settled are reflected
gross in revenues and cost of sales.
As more fully described in the Explanatory Note to the accompanying
unaudited Condensed Consolidated Financial Statements, the Company corrected
the forward power curve methodology it used to estimate the fair market value
of its U.S. power marketing and trading portfolio. Further, the Company
restated its financial statements, beginning with the third quarter 2001, to
reflect the revised methodology.
Risk-Management Asset and Liability Disclosures. The following tables
depict the mark-to-market value and cash flow components of the Company's net
risk-management assets and liabilities at March 31, 2002:
MARK-TO-MARKET VALUE OF NET RISK-MANAGEMENT ASSET
Total 2002(2) 2003 2004 2005 2006 Thereafter
----- ------- ---- ---- ---- ---- ----------
($ in millions)
Mark-to-Market Value of Risk-Management Assets
and Liabilities............................. $620 $72 $223 $137 $34 $23 $131
--------
(1) The table reflects the fair value of Dynegy's risk-management asset
position after deduction of time value, credit, price and other reserves
necessary to determine fair value. These amounts exclude the fair value
associated with certain derivative instruments designated as hedges. The
net risk-management assets of $689 million on the Condensed Consolidated
Balance Sheets include the $620 million herein as well as emission
allowance credits, other comprehensive income balances and other
non-trading amounts.
(2) Amounts represent April 1 to December 31, 2002 values.
42
CASH FLOW COMPONENTS OF NET RISK-MANAGEMENT ASSET
Three-months Nine-months
Ended Ended
March 31, December 31,
2002 2002 2003 2004 2005 2006 Thereafter
------------ ------------ ---- ---- ---- ---- ----------
($ in millions)
Cash Flow of Risk-Management Assets
and Liabilities.................. $270 $179 $236 $158 $51 $39 $339
--------
(1) The cash flow value reflects realized cash flows for the first quarter 2002
and anticipated undiscounted cash inflows and outflows by contract based on
tenor of individual contract position and have not been adjusted for
counterparty credit or other reserves. These amounts exclude the cash flows
associated with certain derivative instruments designated as hedges as well
as other non-trading amounts.
Changes in the March 31, 2002 net risk management assets and liabilities and
the associated cash flows from December 31, 2001 were primarily driven by the
following factors:
. Cash realization of existing contracts during the first quarter of 2002;
. Extension of the timing of hedged storage withdrawals from 2002 to 2003
and beyond as a result of market opportunities;
. Incremental natural gas and power transactions, which in some instances,
result in negative cash flows in 2002 and positive cash flows in future
periods; and
The following table provides an assessment of the factors impacting the
change in net value of the risk-management asset and liability accounts during
the quarter ended March 31, 2002 ($ in millions).
Fair value of portfolio at January 1, 2002............................... $ 935
Gains (losses) recognized through the income statement in the period, net 130
Cash received related to contracts settled during the period, net........ (375)
Changes in fair value as a result of a change in valuation technique(1).. --
Other changes in fair value, net......................................... (1)
-----
Fair value of portfolio at March 31, 2002(2)............................. $ 689
=====
--------
(1) Dynegy's modeling methodology has been consistently applied period over
period.
(2) The net risk management asset of $689 million is the aggregate of the
following line items on the Condensed Consolidated Balance Sheet: Current
Assets--Assets from Risk-Management Activities, Other Assets--Assets from
Risk-Management Activities, Current Liabilities--Liabilities from
Risk-Management Activities and Other Liabilities--Liabilities from
Risk-Management Activities.
43
The following table provides an assessment of net contract values by year
based on the Company's valuation methodology described above.
NET FAIR VALUE OF MARKETING PORTFOLIO
Total 2002(1) 2003 2004 2005 2006 Beyond
----- ------- ---- ---- ---- ---- ------
($ in millions)
Market Quotations(2)..... $371 $72 $147 $ 84 $ (6) $ (1) $ 75
Other External Sources(3) 291 -- 82 66 78 65 --
Prices Based on Models(4) (42) -- (6) (13) (38) (41) 56
---- --- ---- ---- ---- ---- ----
$620 $72 $223 $137 $ 34 $ 23 $131
==== === ==== ==== ==== ==== ====
--------
(1) Amounts represent April 1 to December 31, 2002 values.
(2) Prices obtained from actively traded, liquid markets.
(3) Mid-term prices validated against industry posted prices.
(4) See "Critical Accounting Policies" in the 2001 Form 10-K/A for a discussion
of Dynegy's use of long-term models.
Value at Risk ("VaR"). In addition to applying business judgment, senior
management uses a number of quantitative tools to manage the Company's exposure
to market risk. These tools include:
. Risk limits based on a summary measure of market risk exposure, referred
to as VaR; and
. Stress and scenario analyses performed daily that measure the potential
effects of various market events, including substantial swings in
volatility factors, absolute commodity price changes and the impact of
interest rate movements.
The modeling of the risk characteristics of Dynegy's marketing portfolio
involves a number of assumptions and approximations. Dynegy estimates VaR using
a JP Morgan RiskMetrics(TM) approach assuming a one-day holding period. Inputs
for the VaR calculation are prices, positions, instrument valuations and the
variance-covariance matrix. While management believes that these assumptions
and approximations are reasonable, there is no uniform industry methodology for
estimating VaR, and different assumptions and/or approximations could produce
materially different VaR estimates.
Dynegy uses historical data to estimate the Company's VaR and, to better
reflect current asset and liability volatilities, these historical data are
weighted to give greater importance to more recent observations. Given its
reliance on historical data, VaR is effective in estimating risk exposures in
markets in which there are not sudden fundamental changes or shifts in market
conditions. An inherent limitation of VaR is that past changes in market risk
factors, even when weighted toward more recent observations, may not produce
accurate predictions of future market risk. VaR should be evaluated in light of
this and the methodology's other limitations.
VaR represents the potential loss in value of Dynegy's enterprise-wide
marketing portfolio due to adverse market movements over a defined time horizon
within a specified confidence level. For the VaR numbers reported below, a
one-day time horizon and a 95% confidence level were used. This means that
there is a one in 20 statistical chance that the daily portfolio value will
fall below the expected maximum potential reduction in portfolio value at least
as large as the reported VaR. Thus, a change in portfolio value greater than
the expected change in portfolio value on a single trading day would be
anticipated to occur, on average, about once a month. Gains or losses on a
single day can exceed reported VaR by significant amounts. Gains or losses can
also accumulate over a longer time horizon such as a number of consecutive
trading days.
In addition, Dynegy has provided its VaR using a one-day time horizon and a
99% confidence level. The purpose of this disclosure is to provide an
indication of earnings volatility using a higher confidence level. Under
44
this presentation, there is one in one hundred statistical chance that the
daily portfolio value will fall below the expected maximum potential reduction
in portfolio value at least as large as the reported VaR. Average VaR is not
available for the three-month period ended March 31, 2002 and the year ended
December 31, 2001 due to the restatement of historical results. While VaR can
be calculated at a single point in time, it is not feasible to recalculate the
historical results necessary to calculate an average.
The following table sets forth the aggregate daily VaR of Dynegy's marketing
portfolio (in millions):
DAILY VaR FOR MARKETING PORTFOLIO
March 31, December 31,
2002 2001
--------- ------------
One Day VaR--95% Confidence Level $22 $17
One Day VaR--99% Confidence Level $31 $24
The increase in VaR from December 31, 2001 is due primarily to increases in
volatility.
Credit Risk. Credit risk represents the loss that the Company would incur
if a counterparty fails to perform under its contractual obligations. To reduce
the Company's credit exposure, the Company seeks to enter into netting
agreements with counterparties that permit Dynegy to offset receivables and
payables with such counterparties. Dynegy attempts to further reduce credit
risk with certain counterparties by entering into agreements that enable the
Company to obtain collateral or to terminate or reset the terms of transactions
after specified time periods or upon the occurrence of credit-related events.
The Company may, at times, use credit derivatives or other structures and
techniques to provide for third-party guarantees of the Company's
counterparties' obligations.
Dynegy's industry typically operates under negotiated credit lines for
physical delivery contracts. Dynegy's Credit Department, based on guidelines
set by Dynegy's Credit Policy Committee, establishes Dynegy's counterparty
credit limits. For collateralized transactions, the Company also evaluates
potential exposure over a shorter collection period and gives effect to the
value of collateral received. The Company further seeks to measure credit
exposure through the use of scenario analyses and other quantitative tools.
Dynegy's credit management systems monitor current and potential credit
exposure to individual counterparties and on an aggregate basis to
counterparties and their affiliates.
The following table displays the value of Dynegy's marketing portfolio,
inclusive of hedging activities, at March 31, 2002:
Below
Investment
Investment Grade Credit
Grade Credit Quality Or
Quality Unrated Total
------------ ------------ -----
($ in millions)
Utilities and power generators..... $ 675 $ 9 $ 684
Financial institutions............. 38 (3) 35
Oil and gas producers.............. (235) 90 (145)
Commercial and industrial companies 296 42 338
Other.............................. 21 (1) 20
----- ---- -----
Value of portfolio before reserves. $ 795 $137 932
Credit and market reserves......... (312)
-----
620
Other(1)........................... 69
-----
Net risk-management assets(2)...... $ 689
=====
45
--------
(1) Amount represents emission allowance credits, other comprehensive income
balances and other non-trading amounts.
(2) Represents amounts included in "Current Assets--Assets from Risk Management
Activities", "Other Assets--Assets from Risk-Management Activities",
"Current Liabilities--Liabilities from Risk-Management Activities", and
"Other Liabilities--Liabilities from Risk-Management Activities" on the
Condensed Consolidated Balance Sheet.
Interest Rate Risk. Interest rate risk results from variable rate financial
obligations and from providing risk-management services to customers, since
changing interest rates impact the discounted value of future cash flows used
to value risk-management assets and liabilities. Management continually
monitors its exposure to fluctuations in interest rates and may execute swaps
or other financial instruments to hedge and mitigate this exposure.
Marketing portfolio. The following table sets forth the daily VaR
associated with the interest rate component of the marketing portfolio. Average
VaR is not available for the three-month period ended March 31, 2002 and the
year ended December 31, 2001 due to the restatement of historical results.
While VaR can be calculated at a single point in time, it is not feasible to
recalculate the historical results necessary to calculate an average. Dynegy
seeks to manage its interest rate exposure through application of various
hedging strategies. Hedging instruments executed to mitigate such interest rate
exposure in the marketing portfolio are included in the VaR as of March 31,
2002 and December 31, 2001 reflected in the table below.
DAILY VaR ON INTEREST COMPONENT OF MARKETING PORTFOLIO
March 31, December 31,
2002 2001
--------- ------------
($ in millions)
One Day VaR--95% Confidence Level $3.3 $0.1
Variable Rate Financial Obligations. Based on sensitivity analysis as of
March 31, 2002, it is estimated that a one percentage point interest rate
movement in the average market interest rates (either higher or (lower)) over
the twelve months ended March 31, 2003 would decrease (increase) income before
taxes by approximately $17 million. Hedging instruments executed to mitigate
such interest rate exposure are included in the sensitivity analysis.
Foreign Currency Exchange Rate Risk. Foreign currency risk arises from the
Company's investments in affiliates and subsidiaries owned and operated in
foreign countries. Such risk is also a result of risk management transactions
with customers in countries outside the U.S. Management continually monitors
its exposure to fluctuations in foreign currency exchange rates. When possible,
contracts are denominated in or indexed to the U.S. dollar, or such risk may be
hedged through debt denominated in the foreign currency or through financial
contracts. At March 31, 2002, the Company's primary foreign currency exchange
rate exposures were the United Kingdom Pound, Canadian Dollar, European Euro
and Norwegian Kroner.
46
The following table sets forth the daily and average foreign currency
exchange VaR. Hedging instruments executed to mitigate such foreign currency
exposure are included in the VaR as of March 31, 2002 and December 31, 2001
reflected in the table below.
DAILY AND AVERAGE FOREIGN CURRENCY EXCHANGE VaR
March 31, December 31,
2002 2001
--------- ------------
($ in millions)
One Day VaR--95% Confidence Level............................ $0.1 $0.6
---- ----
Average VaR for the Year-to-Date Period--95% Confidence Level $0.5 $1.1
---- ----
Derivative Contracts
The absolute notional financial contract amounts associated with the
Company's commodity risk-management, interest rate and foreign currency
exchange contracts were as follows:
ABSOLUTE NOTIONAL CONTRACT AMOUNTS
March 31, December 31,
2002 2001`
--------- ------------
Natural Gas (Trillion Cubic Feet).................................................. 16.441 12.044
Electricity (Million Megawatt Hours)............................................... 104.6572 79.931
Natural Gas Liquids (Million Barrels).............................................. 14.125 5.655
Weather Derivatives (in thousands of $/Degree Day)................................. 148 190
Coal (Millions of Tons)............................................................ 4.0 18.5
Variable Rate Financial Obligation Interest Rate Swaps (in millions of U.S. dollars $ 2,000 $ --
Weighted Average Fixed Interest Rate Paid (Percent)................................ 2.754 --
Fair Value Hedge Interest Rate Swaps (in millions of U.S. Dollars)................. $ 331 $ 206
Fixed Interest Rate Received on Swaps (Percent)................................. 5.298 5.284
Cash Flow Hedge Interest Rate Swaps (in millions of U.S. dollars).................. $ -- $ 100
Fixed Interest Rate Paid on Swaps (Percent)..................................... -- 4.397
Interest Rate Risk-Management Contract............................................. $ 655 $ 503
Fixed Interest Rate Paid (Percent).............................................. 6.018 6.150
Interest Rate Risk-Management Contract............................................. -- $ 100
Fixed Interest Rate Received (Percent).......................................... -- 4.370
U.K. Pound Sterling Net Investment Hedges (in millions of U.S. Dollars)............ $ 941 $ 906
Average U.K. Pound Sterling Contract Rate (in U.S. Dollars)..................... $ 1.4133 $1.4233
Euro Dollars (in millions of U.S. Dollars)......................................... $ 29 $ 18
Average Euro Dollar Contract Rate (in U.S. Dollars)................................ $ 0.8629 $0.8863
Canadian Dollar (in millions of U.S. Dollars)...................................... $ 1,326 $ 1,395
Average Canadian Dollar Contract Rate (in U.S. Dollars)............................ $ 0.6389 $0.6435
47
RESULTS OF OPERATIONS
The following table reflects certain operating and financial data for the
Company's business segments for the three-month periods ended March 31, 2002
and 2001. This financial data has been revised to reflect the restatement items
described in the Explanatory Note to the accompanying unaudited Condensed
Consolidated Financial Statements. Please read this Explanatory Note for
further discussion of these restatement items.
Three-Month Periods Ended March 31, 2002 and 2001
For the quarter ended March 31, 2002, Dynegy recorded a net loss of $247
million or $0.91 per diluted share, compared with first quarter 2001 net income
of $155 million or $0.46 per diluted share. First quarter 2002 net loss
includes charges related to goodwill and other asset impairment in the DGC
segment and a charge associated with a volumetric commitment to deliver gas
assumed with the acquisition of Northern Natural. First quarter 2002 results
benefited from the January 31, 2002 acquisition of Northern Natural and the
fourth quarter 2001 acquisition of the BG Storage Limited ("BGSL") natural gas
storage assets in the United Kingdom.
As described in Note 2 to the accompanying financial statements, the Company
adopted Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" ("Statement No. 142"), effective January 1, 2002. The
Company's net income and earnings per share for the three months ended
March 31, 2001, exclusive of goodwill, would have been $167 million or $0.50
per diluted share.
Net income (loss) and EPS include the following charges:
Three Months Ended March 31,
--------------------------------
2002 2001
---------------- --------------
Charge EPS Charge EPS
------ ----- ------ ----
($ in millions, except per share
amounts)
Impairment of communications assets(1)................ (44) (0.11) -- --
Loss on gas delivery commitment(2).................... (13) (0.03) -- --
Cumulative effect of change in accounting principle(3) (234) (0.64) 2 0.01
Special dividend(4)................................... -- (0.23) -- --
--------
(1) The Company recognized an after-tax charge of $44 million ($64 million
pre-tax) associated with certain communications assets, investments in
unconsolidated affiliates and equipment. The pre-tax charge is included in
Cost of Sales, Earnings (Losses) of Unconsolidated Affiliates and Other
Expenses in the accompanying Condensed Consolidated Statements of
Operations.
(2) The Company incurred a $13 million after-tax ($18 million pre-tax) charge
associated with a commitment to deliver gas assumed in the acquisition of
Northern Natural. The pre-tax charge is included in "Operating Revenues."
(3) Effective January 1, 2002, the Company adopted Statement No. 142, realizing
an after-tax cumulative effect loss of approximately $234 million.
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended, realizing an after-tax cumulative effect
gain of approximately $2 million.
(4) The special dividend in 2002 relates to the conversion price embedded in
the Series B Preferred Stock held by ChevronTexaco Corporation.
Operating income decreased $232 million quarter-to-quarter due to reduced
revenues which were not completely offset by reduced cost of sales, increased
general and administrative expense and increased depreciation and amortization
expense. The most significant revenue decrease was in the WEN segment,
primarily due to lower power prices. Increased general and administration
expense is reflective of the infrastructure required to support a larger and
more diverse operation. Included in the first quarter 2002 general
48
and administrative expense is approximately $2 million of costs associated with
implementing the operating and support system for the DGC segment. Increased
depreciation and amortization expense is associated with the expansion of
Dynegy's depreciable asset base, primarily due to the acquisitions of Northern
Natural and the BGSL natural gas storage assets.
Impacting Dynegy's consolidated results was the Company's earnings (loss)
from investment in unconsolidated affiliates, which was approximately $(11)
million and $32 million in the 2002 and 2001 periods, respectively. Variances
period-to-period in these results primarily reflect the impact of the
impairment of $45 million of certain DGC segment investments resulting from
unfavorable market conditions.
Interest expense totaled $89 million for the three-month period ended March
31, 2002, compared to $66 million for the equivalent 2001 period. The variance
is primarily attributed to higher average principal balances in the 2002 period
compared to the 2001 period, in addition to slight increases in average
interest rates on borrowings.
Other income and expenses, net (including minority interest expense and
accumulated distributions associated with trust preferred securities) totaled
$12 million in expense in the quarter ended March 31, 2002 compared with $35
million in expense in the 2001 period. Variances period-to-period in these
results primarily reflect the impact of more favorable foreign exchange
results, increased interest income and the recognition of a dividend on the
Series A Preferred Stock in Northern Natural in January 2002, partially offset
by an increase in minority interest expense.
The Company reported an income tax benefit of $20 million for the quarter
ended March 31, 2002, compared to an income tax provision of $89 million for
the 2001 period. The effective rates approximated 61 percent and 37 percent in
2002 and 2001, respectively. The tax benefit in the 2002 period resulted from
the combination of book income and losses in jurisdictions with varying tax
rates and the realization of permanent differences. The difference from the
effective rates and the statutory rate of 35 percent in the 2001 period results
principally from permanent differences arising from the amortization of certain
intangibles, book-tax basis differences and the effect of certain foreign
equity investments and state income taxes.
49
Segment Disclosures
WHOLESALE ENERGY NETWORK
Three Months
Ended March 31,
---------------
2002 2001
------ -------
($ in millions,
except operating
statistics)
Operating Income:
Customer and Risk-Management Activities.......... $ (62) $ 124
Asset Businesses................................. 66 74
------ -------
Total Operating Income.................... 4 198
Earnings from Unconsolidated Investments............ 30 31
Other Items......................................... (22) (35)
------ -------
Earnings Before Interest and Taxes........ 12 194
Interest Expense.................................... (33) (21)
------ -------
Pre-tax Earnings (Loss)................... (21) 173
Income Tax Provision (Benefit)...................... (32) 63
------ -------
Income From Operations.................... 11 110
Cumulative Effect of Change in Accounting Principle. -- 2
------ -------
Net Income................................ $ 11 $ 112
====== =======
OPERATING STATISTICS:
Natural Gas Marketing (Bcf/d)--
Domestic Marketing Volumes..................... 9.7 8.4
Canadian Marketing Volumes..................... 3.3 2.3
European Marketing Volumes..................... 2.2 0.7
------ -------
Total Marketing Volumes...................... 15.2 11.4
====== =======
Million Megawatt Hours Generated-- Gross............ 9.5 10.3
Million Megawatt Hours Generated-- Net.............. 8.5 8.9
North American Physical Million Megawatt Hours Sold. 150.0 52.0
European Physical Million Megawatt Hours Sold....... 60.0 --
------ -------
Total Physical Million Megawatt Hours Sold....... 210.0 52.0
====== =======
Coal Marketing Volumes (Millions of Tons)........ 8.3 4.6
Average Natural Gas Price--Henry Hub ($/Mmbtu)... $ 2.34 $ 7.05
Average On-Peak Market Power Prices
Cinergy...................................... $21.90 $ 42.31
TVA.......................................... 22.10 42.79
PJM.......................................... 25.14 44.29
Platts SP 15................................. 28.68 224.24
50
Three-Month Periods Ended March 31, 2002 and 2001
WEN reported segment net income of $11 million for the three-month period
ended March 31, 2002, compared with net income of $112 million in the 2001
quarter. The first quarter 2001 net income includes the $2 million cumulative
effect of a change in accounting principle described in Note 4 to the Condensed
Consolidated Financial Statements. Dynegy's results of operations
period-to-period were influenced by the following:
. Reduced margins associated with generation as a result of lower megawatt
hours generated reflecting lower market prices and milder weather
conditions primarily in the West. The decline is partially offset as a
result of price risk management activities that mitigated the impact of
decreased market prices as compared to the comparable prior year period;
. Continued weakness in commodity prices during the first quarter of 2002,
and an overall decrease in commodity prices compared to the first quarter
of 2001;
. Milder weather conditions experienced during the first quarter of 2002
compared to the first quarter of 2001;
. Improved Canadian and European margins due to increased volumes as a
result of market share gains from the prior year. There were increased
power volumes in Canada due to opening of the markets to competition and
Enron's absence from the market. Natural gas volumes in Europe increased
due to trading activity around the BGSL natural gas storage assets in the
United Kingdom;
. Incremental ChevronTexaco natural gas volumes associated with former
Texaco's equity production;
. Favorable variances in other income and expense related to foreign
exchange gain and loss and increased interest income;
. Decreased minority interest expense;
. Increased general and administration expenses reflecting increased
capital and overhead costs required to support a larger, more diverse
base of operations;
. Increased interest expense due to higher average borrowings; and
. Increased depreciation due principally to the depreciation of the natural
gas storage assets in the United Kingdom.
Total physical MW hours sold in the first quarter of 2002 increased to 210.0
million MW hours compared to 52.0 million MW hours in the first quarter of
2001. Total natural gas volumes sold in North America in the first quarter of
2002 totaled 13.0 billion cubic feet per day compared to 10.7 billion cubic
feet per day during last year's first quarter. The increased volumes in both
power and gas were a result of improved market liquidity, greater sales volumes
and greater market origination. These increases were offset by decreased
generation volumes, primarily in the West, as a result of milder weather
conditions.
51
DYNEGY MIDSTREAM SERVICES
Three Months
Ended March 31,
--------------
2002 2001
------ ------
($ in millions,
except operating
statistics)
Operating Income:
Upstream........................................... $ 13 $ 41
Downstream......................................... 26 16
------ ------
Total Operating Income...................... 39 57
Earnings from Unconsolidated Investments.............. 4 1
Other Items........................................... 1 (5)
------ ------
Earnings Before Interest and Taxes.......... 44 53
Interest Expense...................................... (10) (14)
------ ------
Pre-tax Earnings............................ 34 39
Income Tax Provision.................................. 12 12
------ ------
Net Income.................................. $ 22 $ 27
====== ======
OPERATING STATISTICS:
Natural Gas Processing Volumes (MBbls/d):
Field Plants................................... 55.9 55.6
Straddle Plants................................ 36.2 22.5
------ ------
Total Natural Gas Processing Volumes........ 92.1 78.1
------ ------
Fractionation Volumes (MBbls/d).................... 204.6 199.1
Natural Gas Liquids Sold (MBbls/d)................. 609.5 640.7
Average Commodity Prices:
Crude Oil--Cushing ($/Bbl).................. $20.55 $29.01
Natural Gas Liquids ( $/Gal)................ 0.32 0.61
Fractionation Spread ($/MMBtu).............. 1.30 (0.03)
Three-Month Periods Ended March 31, 2002 and 2001
DMS reported net income of $22 million in the first quarter of 2002 compared
with net income of $27 million in the first quarter of 2001. The following
influenced results of operations period-to-period:
. Lower natural gas and NGL prices resulting in a decline in processing
plant margins; partially offset by,
. Higher price realization resulting from marketing activities; and
. Favorable operating expense variances.
Aggregate domestic NGL processing volumes totaled 92.1 thousand gross
barrels per day in the first quarter of 2002 compared to 78.1 thousand gross
barrels per day during the same period in 2001. This increase was primarily due
to increased straddle volumes resulting from higher fractionation spreads
compared to the first quarter of 2001. The average fractionation spread was
$1.30 for the three months ended March 31, 2002, compared to negative $0.03 for
the comparable 2001 period. NGL marketing volumes were lower period-over-period
reflecting the impact of seasonal winter weather during the first quarter of
2001.
52
TRANSMISSION AND DISTRIBUTION
Three Months
Ended March 31,
--------------
2002 2001
------ ------
($ in millions)
Operating Income................................ $ 96 $ 76
Other Items..................................... 4 (1)
------ ------
Earnings Before Interest and Taxes.............. 100 75
Interest Expense................................ (38) (29)
------ ------
Pre-tax Earnings................................ 62 46
Income Tax Provision............................ 27 21
------ ------
Net Income...................................... $ 35 $ 25
====== ======
OPERATING STATISTICS:
Illinois Power:
Electric Sales in kWh (Millions)--
Residential.............................. 1,304 1,382
Commercial............................... 1,023 1,077
Industrial............................... 2,083 2,021
Other.................................... 93 100
------ ------
Total Electric Sales.................. 4,503 4,580
====== ======
Gas Sales in Therms (Millions)--
Residential.............................. 153 173
Commercial............................... 62 74
Industrial............................... 18 25
Transportation of Customer-Owned Gas..... 72 73
------ ------
Total Gas Delivered................... 305 345
====== ======
Heating Degree Days............................. 2,498 2,764
Northern Natural:
Heating Degree Days.......................... 3,489 N/A
Throughput (Bcf/d)........................... 3.3 N/A
Three-Month Periods Ended March 31, 2002 and 2001
The T&D segment reported net income of $35 million in the first quarter of
2002 compared to $25 million in the first quarter of 2001. The 2002 net income
includes an $18 million pre-tax ($13 million after tax) charge associated with
a gas delivery commitment that was assumed with the acquisition of Northern
Natural. The T&D segment reflects two months of operating results from Northern
Natural. The increase related to Northern Natural's results is partially offset
by a decrease in IP's results associated with decreased residential and
commercial volumes due to lower weather driven demand and a downturn in
economic conditions.
53
DYNEGY GLOBAL COMMUNICATIONS
Three Months
Ended March
31,
--------------
2002 2001
----- ----
($ in millions)
Operating Income (Loss)................................................. $ (60) $(20)
Losses from Investments in Unconsolidated Affiliates.................... (45) --
Other Items............................................................. 5 6
----- ----
Loss Before Interest and Taxes.......................................... (100) (14)
Interest Expense........................................................ (8) (2)
----- ----
Pre-tax Loss............................................................ (108) (16)
Income Tax Benefit...................................................... (27) (7)
----- ----
Net Loss from Operations................................................ (81) (9)
Cumulative Effect of Change in Accounting Principle Accounting Principle (234) --
----- ----
Net Loss................................................................ $(315) $ (9)
----- ----
Three-Month Periods Ended March 31, 2002 and 2001
DGC's segment results reflect a $315 million quarterly loss in the
three-month period ended March 31, 2002 resulting from start-up costs
associated with expansion of the Company's global communications business and
vendor equipment problems which delayed anticipated revenues. This compares to
a $9 million quarterly loss in the three-month period ended March 31, 2001. The
2002 net loss includes the $234 million cumulative effect of change in
accounting principle (see Note 2 to the accompanying condensed consolidated
financial statements) and impairment of communications assets, principally
underutilized equipment and certain investments.
Dynegy is assessing alternatives with respect to its telecommunications
business and has publicly expressed its intention to eliminate the losses
associated with this segment by the end of 2002. Continued losses through 2002
would negatively impact the Company's cash flows and earnings and could require
Dynegy to record additional impairment charges related to its
telecommunications assets, of which there is approximately $625 million
recorded in Property, Plant and Equipment on the Condensed Consolidated Balance
Sheets. As of March 31, 2002, Dynegy also had approximately $270 million, or
approximately $195 million on a discounted basis, in long-term operating
commitments relating to its telecommunications business.
Cash Flow Disclosures
The following table is a condensed version of the operating section of the
Condensed Consolidated Statements of Cash Flows:
Quarter Ended
March 31,
--------------
2002 2001
----- -----
($ in millions)
Operating Cash Flows:
Net Income (Loss)..................................... $(247) $ 155
Net Non-Cash Items Included in Net Income............. 658 221
----- -----
Operating Cash Flow Before Changes in Working Capital. 411 376
Changes in Working Capital............................ (158) (102)
----- -----
Net Cash Provided by Operating Activities............. $ 253 $ 274
----- -----
54
Operating Cash Flow. Cash flow from operating activities totaled $253
million for the three-month period ended March 31, 2002, compared to $274
million reported in the same 2001 period. The decrease in operating cash flow
is reflective of the net loss and an unfavorable change in working capital,
partially offset by higher non-cash add-backs such as charges related to the
cumulative effect of a change in accounting principle, depreciation and
amortization and earnings and losses from unconsolidated affiliates. The
cumulative effect of a change in accounting principle is a non-cash charge as a
result of adopting Statement No. 142 related to the impairment of goodwill for
the DGC segment. The depreciation and amortization is higher due to a larger
asset base. Changes in working capital had a negative impact on operating cash
flow during the first quarter of 2002 due primarily to the timing of cash
inflows and outflows related to trade accounts as follows:
. Payments during the quarter for operational and overhead costs accrued at
December 31, 2001;
. Increases in receivables associated with the sale of emission allowances
at the end of the winter season and the sale of NGL liquids inventories,
as well as an increase in receivables for IP resulting from cooler
weather late in the quarter; and
. The accrual of the dividend on the Series A Preferred Stock in Northern
Natural in January 2002; offset by
. The non-cash expense associated with the recognition of the gas delivery
obligation assumed in the acquisition of Northern Natural.
Capital Expenditures and Investing Activities. Funds used in investing
activities in the first quarter of 2002 totaled $412 million. Capital
expenditures of $398 million relate primarily to the construction and
improvement of power generation assets and investments associated with
technology infrastructure. The business acquisition cash outflows of $20
million relate to the acquisition of Northern Natural, net of cash acquired.
Capital expenditures of $1.3 billion in the three-month period ended March
31, 2001 relate to the acquisition of the Central Hudson power generation
facilities in the Northeast and to the construction of power generation assets,
betterments of existing facilities related to the T&D segment and investments
associated with technology infrastructure. Business acquisitions for the
three-month period ended March 31, 2001 included acquisition costs related to
the acquisition of iaxis, Limited.
Financing Activities. Net cash provided by financing activities was $409
million during the first quarter of 2002. Dynegy received $205 million in cash
proceeds relative to ChevronTexaco's January 2002 purchase of approximately
10.4 million shares of Class B common stock. Capital stock proceeds also
include $21 million of cash inflow associated with cash received from senior
management associated with a December 2001 private placement of equity. In
March 2002, dividends of $21 million were paid to the holders of Class A common
stock and $7 million was paid to the holder of Class B common stock. In March
2002, Illinova Corporation, a wholly owned subsidiary of Dynegy and the parent
company of IP, consummated a tender offer pursuant to which it paid $28 million
in cash for shares of IP's preferred stock. Net proceeds of long-term debt from
the February 2002 issuance of 8.75 percent senior notes due February 2012 were
$496 million, and payments of IP's transitional funding notes totaled $22
million during the quarter. Also during the first quarter of 2002, proceeds
from lease arrangements of approximately $34 million were used in the
construction of generation facilities and the U.S. fiber optic network.
Finally, proceeds related to borrowings entered into by ABG Gas Supply totaled
$36 million and repayments totaled $11 million. Additionally, Dynegy repaid
commercial paper and borrowings under revolving credit lines for DHI and IP of
$293 million.
55
UNCERTAINTY OF FORWARD-LOOKING STATEMENTS AND INFORMATION
This Quarterly Report on Form 10-Q includes statements reflecting
assumptions, expectations, projections, intentions or beliefs about future
events that are intended as "forward-looking statements" under the Private
Securities Litigation Reform Act of 1995. You can identify these statements by
the fact that they do not relate strictly to historical or current facts. They
use words such as "anticipate," "estimate," "project," "forecast," "may,"
"will," "should," "expect" and other words of similar meaning. In particular,
these include, but are not limited to, statements relating to the following:
. Projected operating or financial results;
. Expectations regarding capital expenditures, dividends and other payments;
. Pending or recent acquisitions such as the acquisitions of Northern
Natural and BG Storage Limited, including the anticipated closing date,
expected cost savings or synergies and the accretive or dilutive impact
of an acquisition on earnings;
. Expectations regarding transaction volume and liquidity in wholesale
energy markets in North America and Europe;
. The Company's beliefs and assumptions relating to trade credit in the
wholesale energy market and its liquidity position, including its ability
to meet its obligations in the event of a downgrade in its credit ratings;
. The Company's ability to execute additional capital enhancing
transactions such as asset sales, joint ventures or financings to enhance
its liquidity position;
. Beliefs or assumptions about the outlook for deregulation of retail and
wholesale energy markets in North America and Europe and anticipated
business developments in such markets;
. The Company's ability to effectively compete for market share with
industry participants;
. Beliefs about the outcome of legal and administrative proceedings,
including matters involving Enron, the California power market,
shareholder class action lawsuits and environmental matters as well as
the investigations surrounding Project Alpha and CMS Energy trades,
respectively;
. The expected commencement date for commercial operations for new power
plants; and
. Anticipated developments with respect to demand for broadband services
and related applications and the Company's strategic plans in connection
therewith, including the Company's ability to effectively execute DGC's
business plan, meet forecasted revenues and manage functionality and
operating costs of its network.
Any or all of Dynegy's forward-looking statements may turn out to be wrong.
They can be affected by inaccurate assumptions or by known or unknown risks and
uncertainties, including the following:
. The timing and extent of changes in commodity prices for energy,
particularly natural gas, electricity and NGLs, or communications
products or services;
. The timing and extent of deregulation of energy markets in North America
and Europe and the rules and regulations adopted on a transitional basis
in such markets;
. The condition of the capital markets generally, which will be affected by
interest rates, foreign currency fluctuations and general economic
conditions, and Dynegy's financial condition, including DHI's ability to
maintain its investment grade credit ratings;
. Developments in the California power markets, including, but not limited
to, governmental intervention, deterioration in the financial condition
of our counterparties, default on receivables due and adverse results in
current or future litigation;
56
. The effectiveness of Dynegy's risk-management policies and procedures and
the ability of Dynegy's counterparties to satisfy their financial
commitments;
. The liquidity and competitiveness of wholesale trading markets for energy
commodities, including the impact of electronic or online trading in
these markets;
. The direct or indirect effects on our business resulting from the
financial difficulties of Enron, or other competitors of Dynegy,
including, but not limited to, their effects on liquidity in the trading
and power industry, and its effects on the capital markets views of the
energy or trading industry and our ability to access the capital markets
on the same favorable terms as in the past;
. Operational factors affecting the start up or ongoing commercial
operations of Dynegy's power generation or midstream natural gas
facilities, including catastrophic weather related damage, unscheduled
outages or repairs, unanticipated changes in fuel costs or availability
of fuel emission credits, the unavailability of gas transportation, the
unavailability of electric transmission service or workforce issues;
. The cost of borrowing, availability of trade credit and other factors
affecting Dynegy's financing activities including issues described in
this Form 10-Q;
. The direct or indirect effects on our business of a lowering of our
credit rating (or actions we may take in response to changing credit
ratings criteria), including, increased collateral requirements to
execute our business plan, demands for increased collateral by our
counterparties, refusal by our counterparties to enter into transactions
with us and our inability to obtain credit or capital in amounts or on
terms favorable to us;
. Uncertainties regarding the development of, and competition within, the
market for broadband services in North America and Europe, including
risks relating to technologies and standards, regulation, capital costs,
the timing and amount of customer demand for high bandwidth applications
and the effect of global market conditions in the telecommunications
business on customers and equipment service providers;
. Cost and other effects of legal and administrative proceedings,
settlements, investigations and claims, including legal proceedings
related to the terminated merger with Enron, the California power market,
shareholder claims and environmental liabilities that may not be covered
by indemnity or insurance, as well as the SEC and CFTC investigation
surrounding Project Alpha and simultaneous buy and sell trades,
respectively;
. Other North American or European regulatory or legislative developments
that affect the demand for energy generally, increase the environmental
compliance cost for Dynegy's power generation or midstream gas facilities
or impose liabilities on the owners of such facilities; and
. General political conditions, including any extended period of war or
conflict involving North America or Europe.
Many of these factors will be important in determining Dynegy's actual
future results. Consequently, no forward-looking statement can be guaranteed.
Dynegy's actual future results may vary materially from those expressed or
implied in any forward-looking statements.
All of Dynegy's forward-looking statements, whether written or oral, are
expressly qualified by these cautionary statements and any other cautionary
statements that may accompany such forward-looking statements. In addition,
Dynegy disclaims any obligation to update any forward-looking statements to
reflect events or circumstances after the date of this report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Quantitative and Qualitative Disclosures About Market Risk are set forth
in "Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations" herein.
57
DYNEGY INC.
PART II. OTHER INFORMATION
ITEM 1--LEGAL PROCEEDINGS
See Note 9 to the accompanying financial statements for discussion of
material recent developments in the Company's material legal proceedings.
ITEM 6--EXHIBITS AND REPORTS ON FORM 8-K
(a) The following instruments and documents are included as exhibits to
this Form 10-Q/A:
*10.1 Natural Gas Purchase and Sale Agreement among Chevron U.S.A. Inc., Texaco
Exploration and Production Inc., Texaco Natural Gas Inc. and Dynegy Marketing and
Trade, effective as of March 1, 2002.
**10.2 Security Agreement among Chevron U.S.A. Inc., Texaco Exploration and Production Inc.,
Texaco Natural Gas Inc. and Dynegy Marketing and Trade, effective as March 1, 2002.
+99.1 Certification Pursuant to 18 United States Code Section 1350, As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
+99.2 Certification Pursuant to 18 United States Code Section 1350, As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
-----
* Exhibit omits certain information that the Company has filed separately
with the SEC in connection with a confidential request pursuant to Rule
24b-2 promulgated under the Securities Exchange Act of 1934, as amended.
** Previously filed.
+ Pursuant to Securities and Exchange Commission Release No. 33-8212, this
certification will be treated as "accompanying" this Amendment No. 1 and
not "filed" as part of such report for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended, or the Exchange Act, or
otherwise subject to the liability of Section 18 of the Exchange Act and
this certification will not be deemed to be incorporated by reference
into any filing under the Securities Act of 1933, as amended, or the
Exchange Act.
(b) Reports on Form 8-K of Dynegy Inc. for the first quarter of 2002.
1. During the quarter ended March 31, 2002, the Company filed a Current Report
on Form 8-K dated January 3, 2002. Items 5 and 7 were reported and no
financial statements were filed.
2. During the quarter ended March 31, 2002, the Company filed a Current Report
on Form 8-K dated January 31, 2002. Items 5, 7 and 9 were reported and no
financial statements were filed.
3. During the quarter ended March 31, 2002, the Company filed a Current Report
on Form 8-K dated March 15, 2002. Items 4 and 7 were reported and no
financial statements were filed.
58
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNEGY INC.
Date: May 14, 2003 By: /s/ NICK J. CARUSO
----------------------------------
Nick J. Caruso
Executive Vice President and Chief
Financial Officer
59
SECTION 302 CERTIFICATION
I, Bruce A. Williamson, certify that:
1. I have reviewed this Amendment No. 1 to Quarterly Report on Form 10-Q/A of
Dynegy Inc. (this "Amendment No. 1");
2. Based on my knowledge, this Amendment No. 1 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 Amendment No. 1; and
3. Based on my knowledge, the financial statements, and other financial
information included in this Amendment No. 1, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this Amendment No. 1.
Date: May 14, 2003
By: /s/ BRUCE A. WILLIAMSON
-----------------------------
Bruce A. Williamson
Chief Executive Officer
60
SECTION 302 CERTIFICATION
I, Nick J. Caruso, certify that:
1. I have reviewed this Amendment No. 1 to Quarterly Report on Form 10-Q/A of
Dynegy Inc. (this "Amendment No. 1");
2. Based on my knowledge, this Amendment No. 1 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 Amendment No. 1; and
3. Based on my knowledge, the financial statements, and other financial
information included in this Amendment No. 1, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this Amendment No. 1.
Date: May 14, 2003
By: /s/ NICK J. CARUSO
-----------------------------
Nick J. Caruso
Chief Financial Officer
61