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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 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 (I.R.S. Employer
jurisdiction Identification No.)
of incorporation or
organization)
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, 272,427,169 shares outstanding as of August 12, 2002; Class B Common
Stock, no par value per share, 96,891,014 shares outstanding as of August 12,
2002.
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DYNEGY INC.
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets:
June 30, 2002 and December 31, 2001.................................. 3
Condensed Consolidated Statements of Operations:
For the three months ended June 30, 2002 and 2001.................... 4
Condensed Consolidated Statements of Operations:
For the six months ended June 30, 2002 and 2001...................... 5
Condensed Consolidated Statements of Cash Flows:
For the six months ended June 30, 2002 and 2001...................... 6
Notes to Condensed Consolidated Financial Statements................... 7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................ 35
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..... 76
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.............................................. 77
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............ 77
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................... 78
EXPLANATORY NOTE
This quarterly report includes financial statements which have not been
reviewed by an independent public accountant under Rule 10-01(d) of Regulation
S-X. We expect that our independent public accountant, PricewaterhouseCoopers
LLP, will complete the quarterly review required by Rule 10-01(d) of Regulation
S-X following their re-audit of our historical financial statements for the
three-year period ended December 31, 2001. This three-year re-audit will
address, among other items, the restatements to our historical financial
statements relating to the balance sheet, statement of operations and cash flow
statement impacts resulting from revisions in accounting for a structured
natural gas transaction referred to as Project Alpha and a $124 million pre-tax
charge relating principally to our natural gas marketing business, each as
further described in Note 1 to the accompanying financial statements. In this
regard, Arthur Andersen LLP, our former independent public accountant, has
advised us that its audit opinion relating to 2001 should no longer be relied
upon. As a result of the three-year re-audit, there may be other revisions to
the Company's historical financial statements in addition to those described
above, some of which may be material. Dynegy expects to file amended reports
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), for
each of the three years in the period ended December 31, 2001, as well as each
quarterly period contained therein. In addition, Dynegy expects to file amended
Exchange Act reports for the quarters ended March 31, 2002 and June 30, 2002.
These amended reports will be filed with the SEC following the completion by
PricewaterhouseCoopers LLP of the three-year re-audit and, for the quarterly
periods during 2002, their subsequent review of the interim financial
statements for these periods.
2
DYNEGY INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited) (in millions, except share data)
June 30, December 31,
2002 2001
-------- ------------
ASSETS
Current Assets
Cash and cash equivalents................................................................................. $ 378 $ 218
Accounts receivable, net of allowance for doubtful accounts of $122 million and $107 million, respectively 3,712 3,641
Accounts receivable, affiliates........................................................................... 22 80
Inventory................................................................................................. 266 391
Assets from risk-management activities.................................................................... 4,759 4,054
Prepayments and other assets.............................................................................. 555 1,370
------- -------
Total Current Assets................................................................................ 9,692 9,754
------- -------
Property, Plant and Equipment............................................................................. 12,039 9,130
Accumulated depreciation.................................................................................. (1,341) (921)
------- -------
Property, Plant and Equipment, Net.................................................................. 10,698 8,209
Other Assets
Investments in unconsolidated affiliates (Note 12)........................................................ 918 950
Investment in Northern Natural Gas Company (Note 6)....................................................... -- 1,501
Assets from risk-management activities.................................................................... 4,493 2,332
Goodwill.................................................................................................. 2,191 1,595
Other assets.............................................................................................. 997 850
------- -------
Total Assets........................................................................................ $28,989 $25,191
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.......................................................................................... $ 3,393 $ 3,522
Accounts payable, affiliates.............................................................................. 62 40
Accrued liabilities and other............................................................................. 987 1,346
Liabilities from risk-management activities............................................................... 4,520 3,562
Notes payable and current portion of long-term debt....................................................... 1,871 402
------- -------
Total Current Liabilities........................................................................... 10,833 8,872
------- -------
Long-Term Debt............................................................................................ 4,795 3,608
Other Liabilities
Transitional funding trust notes.......................................................................... 473 516
Liabilities from risk-management activities............................................................... 4,109 2,073
Deferred income taxes..................................................................................... 1,550 1,735
Other long-term liabilities............................................................................... 884 909
------- -------
Total Liabilities................................................................................... 22,644 17,713
------- -------
Minority Interest......................................................................................... 144 1,010
Serial Preferred Securities of a Subsidiary............................................................... 11 46
Company Obligated Preferred Securities of Subsidiary Trust................................................ 200 200
Series B Mandatorily Convertible Redeemable Preferred Securities.......................................... 1,519 1,503
Commitments and Contingencies (Note 13)
Stockholders' Equity
Class A Common Stock, no par value, 900,000,000 shares authorized at June 30, 2002 and December 31, 2001,
272,058,799 and 269,984,456 shares issued and outstanding at June 30, 2002 and December 31, 2001,
respectively............................................................................................. 2,871 2,837
Class B Common Stock, no par value, 360,000,000 shares authorized at June 30, 2002 and December 31, 2001,
96,891,014 and 86,499,914 shares issued and outstanding at June 30, 2002 and December 31, 2001,
respectively............................................................................................. 1,006 801
Subscriptions receivable.................................................................................. (4) (25)
Accumulated other comprehensive loss, net of tax.......................................................... (15) (35)
Retained earnings......................................................................................... 681 1,212
Treasury stock, at cost, 1,679,183 shares at June 30, 2002 and 1,766,800 shares at December 31, 2001...... (68) (71)
------- -------
Total Stockholders' Equity................................................................................ 4,471 4,719
------- -------
Total Liabilities and Stockholders' Equity.......................................................... $28,989 $25,191
======= =======
See the Explanatory Note on the Table of Contents and the notes to condensed
consolidated financial statements.
3
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited) (in millions, except per share data)
Three Months Ended
June 30,
----------------
2002 2001
------- -------
Revenues............................................................ $ 9,906 $10,812
Cost of sales....................................................... 9,604 10,375
Depreciation and amortization....................................... 141 113
Impairment and other charges (Note 5)............................... 323 --
General and administrative expenses................................. 109 126
------- -------
Operating income (loss).......................................... (271) 198
Earnings (losses) from unconsolidated investments (Notes 5 and 12).. (7) 78
Other income (Note 5)............................................... 64 26
Interest expense.................................................... (83) (68)
Other expenses (Note 5)............................................. (194) --
Minority interest expense........................................... (10) (20)
Accumulated distributions associated with trust preferred securities (4) (6)
------- -------
Income (loss) before income taxes................................... (505) 208
Income tax provision (benefit)...................................... (177) 62
------- -------
Net Income (Loss)................................................... $ (328) $ 146
======= =======
Net Income (Loss) Per Share:
Net income (loss)................................................... $ (328) $ 146
Less: preferred stock dividends..................................... 8 --
------- -------
Net income (loss) applicable to common stockholders................. $ (336) $ 146
======= =======
Basic earnings (loss) per share..................................... $ (0.92) $ 0.45
======= =======
Diluted earnings (loss) per share (Note 10)......................... $ (0.92) $ 0.43
======= =======
Basic shares outstanding............................................ 366 326
======= =======
Diluted shares outstanding.......................................... 417 339
======= =======
See the Explanatory Note on the Table of Contents and the notes to condensed
consolidated financial statements.
4
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS--(Continued)
(unaudited) (in millions, except per share data)
Six Months Ended
June 30,
----------------
2002 2001
------- -------
Revenues................................................................ $18,558 $24,980
Cost of sales........................................................... 17,748 24,066
Depreciation and amortization........................................... 258 220
Impairment and other charges (Note 5)................................... 323 --
General and administrative expenses..................................... 248 241
------- -------
Operating income (loss).............................................. (19) 453
Earnings (losses) from unconsolidated investments (Notes 5 and 12)...... (18) 110
Other income (Note 5)................................................... 100 79
Interest expense........................................................ (162) (130)
Other expenses (Note 5)................................................. (211) (53)
Minority interest expense............................................... (20) (30)
Accumulated distributions associated with trust preferred securities.... (8) (12)
------- -------
Income (loss) before income taxes and change in accounting principle.... (338) 417
Income tax provision (benefit).......................................... (126) 134
------- -------
Income (loss) from operations........................................... (212) 283
Cumulative effect of change in accounting principle, net (Notes 4 and 7) (256) 2
------- -------
Net Income (Loss)....................................................... $ (468) $ 285
======= =======
Net Income (Loss) Per Share:
Net income (loss)....................................................... $ (468) $ 285
Less: preferred stock dividends......................................... 16 --
------- -------
Net income (loss) applicable to common stockholders..................... $ (484) $ 285
======= =======
Basic earnings (loss) per share......................................... $ (1.33) $ 0.88
======= =======
Diluted earnings (loss) per share (Note 10)............................. $ (1.33) $ 0.84
======= =======
Basic shares outstanding................................................ 364 325
======= =======
Diluted shares outstanding.............................................. 416 338
======= =======
See the Explanatory Note on the Table of Contents and the notes to condensed
consolidated financial statements.
5
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Interim Periods Ended June 30, 2002 and 2001
(unaudited) (in millions)
Six Months
Ended June 30,
--------------
2002 2001
----- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................................................... $(468) $ 285
Items not affecting cash flows from operating activities:
Depreciation and amortization................................................ 258 216
Impairment and other charges................................................. 286 --
(Earnings) losses from unconsolidated investments, net of cash distributions. 65 (88)
Risk-management activities................................................... 98 244
Deferred income taxes........................................................ (134) 73
Cumulative effect of change in accounting principle.......................... 256 (2)
Gas marketing charge (Note 5)................................................ 124 --
Other........................................................................ 44 (3)
----- -------
Operating cash flows before changes in working capital.......................... 529 725
Change in working capital:
Accounts receivable.......................................................... 19 846
Inventory.................................................................... (20) 13
Prepayments and other assets................................................. (2) (170)
Accounts payable and accrued liabilities..................................... (126) (973)
Other, net................................................................... (25) (70)
----- -------
Net cash provided by operating activities....................................... 375 371
----- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............................................................ (575) (1,358)
Investments in unconsolidated affiliates........................................ (12) (37)
Business acquisitions, net of cash acquired..................................... (20) (20)
Proceeds from asset sales....................................................... 10 996
Other investing, net............................................................ -- (158)
----- -------
Net cash used in investing activities........................................... (597) (577)
----- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from long-term borrowings.......................................... 496 683
Repayments of long-term borrowings.............................................. (188) (230)
Net proceeds from short-term borrowings......................................... 245 --
Net cash flow from commercial paper and revolving lines of credit............... (233) 4
Proceeds from sale of capital stock, options and warrants....................... 236 63
Purchase of serial preferred securities of a subsidiary......................... (28) --
Purchase of treasury stock...................................................... (1) (13)
Dividends and other distributions, net.......................................... (55) (49)
Other financing, net............................................................ (55) 186
----- -------
Net cash provided by financing activities....................................... 417 644
----- -------
Effect of exchange rate changes on cash......................................... (35) (7)
Net increase in cash and cash equivalents....................................... 160 431
Cash and cash equivalents, beginning of period.................................. 218 86
----- -------
Cash and cash equivalents, end of period........................................ $ 378 $ 517
===== =======
See the Explanatory Note on the Table of Contents and the notes to condensed
consolidated financial statements.
6
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended June 30, 2002 and 2001
Note 1--Restatements
As a result of certain events, which are described below, Dynegy Inc.
("Dynegy" or the "Company") engaged PricewaterhouseCoopers LLP
("PricewaterhouseCoopers") to re-audit its 1999 through 2001 consolidated
financial statements. Following completion of these re-audits, Dynegy intends
to file amended reports under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), for each of the three years in the period ended December
31, 2001, as well as each quarterly period contained therein. In addition,
Dynegy will file amended Exchange Act reports for the quarters ended March 31,
2002 and June 30, 2002 following completion of PricewaterhouseCoopers'
subsequent review of the interim financial statements for these periods. As a
result of these re-audits and reviews, there may be revisions to the financial
statements contained in the above-referenced reports, including this quarterly
report, which are in addition to the known revisions described below, some of
which could be material. The Company expects that the re-audit of its 1999
through 2001 consolidated financial statements will take at least the remainder
of the year to complete.
Dynegy entered into a structured natural gas transaction known as Project
Alpha in April 2001. As described in a Current Report on Form 8-K dated April
25, 2002 (the "Form 8-K") Dynegy decided, after consultation with the Staff of
the SEC, to present the cash flow associated with the related gas supply
contract as a financing activity in its Consolidated Statements of Cash Flows
for 2001. Following the disclosure in the Form 8-K and in connection with a
further review of Project Alpha, Arthur Andersen ("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 $300 million in 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 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. Additionally,
as a result of further discussions with representatives of the SEC Division of
Enforcement, Dynegy will include in its restatement of its 2001 and 2002
financial statements the consolidation of ABG Gas Supply LLC, one of the
special purpose entities sponsored by Dynegy in the transaction.
The impact of Project Alpha restatement items on Dynegy's financial
statements are expected to be as follows:
. Previously reported operating cash flow for the year ended December 31,
2001 will be reduced by approximately $300 million with a corresponding
increase to financing cash flow;
. Previously reported operating cash flow for the six-month period ended
June 30, 2001 will be reduced from $371 million reported herein to
approximately $263 million, with a corresponding increase in financing
cash flow from the $644 million reported herein to approximately $752
million;
. Retained earnings at December 31, 2001 will be reduced by approximately
$79 million in relation to the balances previously reported by the
Company;
. Previously reported net income for the three-month period ended June 30,
2001 of $146 million, or $0.43 per diluted share, will be reduced to
approximately $119 million and $0.35 per diluted share, respectively;
. Previously reported net income for the six-month period ended June 30,
2001 of $285 million, or $0.84 per diluted share, will be reduced to
approximately $258 million and $0.76 per diluted share, respectively;
7
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
. Reported balance sheets for each Exchange Act reporting period in 2001
(beginning with June 30, 2001) will reflect a reclassification of
approximately $300 million from either Minority Interest or Liabilities
from Risk-Management Activities (or a combination of the two) to debt,
depending on the specific reporting period; and
. Reported balance sheets for each Exchange Act reporting period in 2002
will reflect a reclassification of approximately $300 million from
Liabilities from Risk-Management Activities to debt.
The Company's Condensed Consolidated Statements of Cash Flows for 2002 reflect
(and in all future Exchange Act filings will reflect) the cash flow associated
with the related gas supply contract as financing cash flow rather than
operating cash flow.
Andersen, Dynegy's former independent public accountant, has advised that
its audit opinion relating to 2001 should no longer be relied upon as a result
of the pending restatements relating to Project Alpha. The balance sheets,
statements of operations and cash flow statements for periods ended in 2001 and
2002 to date contained in Dynegy's Exchange Act reports have not been adjusted
to reflect the impacts of the restatements relating to Project Alpha. These
changes will be reflected in the amended Exchange Act reports once the
re-audits and reviews are completed by PricewaterhouseCoopers.
Please see Note 13 below for a description of the ongoing investigations by
the SEC and U.S. Attorney relating to Project Alpha. Note 13 also includes a
description of related shareholder litigation.
In addition to financial statement activities relating to Project Alpha,
Dynegy recognized a pre-tax charge in Other Income and Other Expenses of
approximately $124 million ($80 million after-tax) in the second quarter 2002
related principally to a balance sheet reconciliation project undertaken by the
Company at the beginning of 2002. The charge largely relates to the Company's
natural gas marketing business and is believed to have accumulated over a
number of years. As a result of the charge and the current inability of the
Company to allocate this charge to specific accounting periods, the Company
decided to extend the re-audits of its financial statements to each of the
three years in the period ended December 31, 2001, as described in the first
paragraph above. If necessary, the Company will correct prior period financial
statements based on the results of these re-audits.
Dynegy expects that one of the issues to be addressed in the re-audits is
hedge accounting under Financial Accounting Standards Board ("FASB") Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended ("Statement No. 133"). Please
see Note 7 for further discussion.
Note 2--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 SEC, except as provided in the Explanatory Note
on the Table of Contents. These interim financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2001 (the "Form 10-K"), as filed with the SEC.
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, except for the specific items described in Note 1. Interim
period results are not necessarily indicative of the results for the full year.
The preparation of the
8
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
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 3--Liquidity and Industry Conditions
During 2002, a number of events negatively impacted Dynegy as well as the
merchant energy industry in general. These events have resulted in downgrades
in the Company's credit ratings to non-investment grade by each of the major
rating agencies and a reduction in available liquidity resulting from a
combination of lower than expected cash flow from operations, reduced access to
sources of capital and increased collateralization of its trading and
commercial obligations. The credit ratings downgrades have limited and will
likely continue to limit significantly the Company's ability to refinance its
debt obligations and to access the capital markets and will likely increase the
borrowing costs incurred by the Company in connection with any refinancing
activities. The Company's financial and operating flexibility is likely to be
similarly reduced as a result of restrictive covenants and other terms that are
typically imposed on non-investment grade borrowers. The Company has
significant debt maturities over the next 12 months, which are further
described in Note 9 below. Additionally, the increased collateralization of the
Company's trading and commercial obligations has decreased capital otherwise
available to satisfy the Company's debt service, debt maturities and other
obligations.
In response to these events, on June 24, 2002 Dynegy announced a $2 billion
capital plan designed to enhance liquidity and reduce debt. Pursuant to this
capital plan, Dynegy negotiated the elimination of $301 million in credit
ratings triggers relating to its financings and completed several interim
financings. On July 28, 2002, Dynegy entered into an agreement to sell Northern
Natural Gas Company ("Northern Natural") to MidAmerican Energy Holdings Company
("MidAmerican") for $928 million in cash, subject to adjustment for working
capital changes.
The closing of the Northern Natural sale and the execution of the remaining
elements of the Company's capital plan are expected to provide sufficient
near-term liquidity for the Company. The Northern Natural sale is expected to
close in August 2002 and is subject to customary closing conditions, including
expiration of the Hart-Scott-Rodino waiting period, and the continuation of
certain transition services to Northern Natural. The remaining elements of the
capital plan are subject to a number of risks including factors beyond the
Company's control. These factors include, among others, market conditions for
asset sales, the timeliness and ability to obtain required regulatory
approvals, ongoing investigations and litigation, and the effect of commodity
prices and continued contraction in the markets in which the Company operates,
which may negatively impact its operating cash flow. The Company also must seek
to rationalize its customer and risk-management business either through the
formation of a joint venture or an alternative strategy that would reduce
Dynegy's capital commitments to this business.
As is discussed in greater detail in "Management's Discussion and Analysis
of Financial Condition and Results of Operations," the Company's liquidity will
be improved by the closing of the Northern Natural sale. Dynegy has no
significant maturities prior to November 2002 and believes that its current
liquidity will be sufficient to meet the collateral requirements of its
business through the expected closing of the Northern Natural sale. However, a
delay in the closing of the Northern Natural sale or other adverse developments
affecting the Company's liquidity could materially adversely affect Dynegy's
financial condition. If Dynegy is unable to
9
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
complete the Northern Natural sale in the near term or other elements of its
strategy prior to the second quarter 2003, it may be forced to consider other
strategic alternatives or a possible reorganization under the protection of
bankruptcy laws.
The accompanying unaudited condensed consolidated financial statements have
been prepared assuming that the Company will continue as a going concern. This
basis of accounting contemplates the recovery of the Company's assets and the
satisfaction of its liabilities in the normal course of conducting business,
which in turn is dependent upon the Company's ability to consummate the
Northern Natural sale and successfully execute its capital plan as well as the
performance of the Company's operations for the foreseeable future. Management
believes that actions presently being taken relative to the Company's capital
plan and other strategic alternatives should enable the Company to meet its
obligations in a manner consistent with this accounting treatment.
Note 4--Changes in Accounting Principles
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("Statement No. 142").
Statement No. 142 discontinues goodwill amortization over its estimated useful
life and provides that 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 six-month period ended June 30, 2002 are
as follows (in millions):
Wholesale Dynegy Transmission Dynegy
Energy Midstream & Global
Network Services Distribution Communications Total
--------- --------- ------------ -------------- ------
Balances as of January 1, 2002........... $935 $16 $ 388 $ 256 $1,595
Cumulative effect of change in accounting
principle.............................. -- -- -- (256) (256)
Goodwill acquired during the period...... -- -- 887 -- 887
Purchase price adjustments............... (7) -- (28) -- (35)
---- --- ------ ----- ------
Balances as of June 30, 2002............. $928 $16 $1,247 $ -- $2,191
==== === ====== ===== ======
The Company recognized a $256 million charge in the first quarter 2002
related to its Dynegy Global Communications ("DGC") segment in accordance with
Statement No. 142 and reflected such charge as a cumulative effect of change in
accounting principle. The fair value of that reporting segment was estimated
using the expected present value of future cash flows. The value was negatively
impacted by continued weakness in the telecommunications and broadband markets.
Goodwill acquired during the period relates to the acquisition of Northern
Natural, the previously announced sale of which is further described in Note 6
below. The purchase price adjustments relate to the United Kingdom natural gas
storage assets purchased in late 2001 and to the acquisition of Northern
Natural in early 2002.
10
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
The following table sets forth what Dynegy's net income and earnings per
share ("EPS") would have been in the three- and six-month periods ended June
30, 2001, if goodwill had not been amortized during those periods, compared to
the net loss and loss per share Dynegy recorded for the three- and six-month
periods ended June 30, 2002 (in millions, except per share data).
Three Months Six Months
Ended Ended
June 30, June 30,
------------- -------------
2002 2001 2002 2001
------ ----- ------ -----
Reported net income (loss)........................ $ (328) $ 146 $ (468) $ 285
Add back: Goodwill amortization................... -- 12 -- 24
------ ----- ------ -----
Adjusted net income (loss)........................ $ (328) $ 158 $ (468) $ 309
Less: preferred stock dividends................... 8 -- 16 --
------ ----- ------ -----
Net income (loss) available to common stockholders $ (336) $ 158 $ (484) $ 309
====== ===== ====== =====
Basic EPS:
Reported net income (loss)........................ $(0.92) $0.45 $(1.33) $0.88
Goodwill amortization............................. -- 0.03 -- 0.07
------ ----- ------ -----
Adjusted net income (loss)........................ $(0.92) $0.48 $(1.33) $0.95
====== ===== ====== =====
Diluted EPS:
Reported net income (loss)........................ $(0.92) $0.43 $(1.33) $0.84
Goodwill amortization............................. -- 0.04 -- 0.07
------ ----- ------ -----
Adjusted net income (loss)........................ $(0.92) $0.47 $(1.33) $0.91
====== ===== ====== =====
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. FASB Statement No. 143. 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.
FASB Statement No. 145. In April 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"). The adoption of Statement No. 145 effective January 1,
2003 is not expected to impact the Company.
11
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
FASB Statement No. 146. In July 2002, the FASB issued Statement of
Financial Accounting Standards No. 146, "Accounting for Exit or Disposal
Activities" ("Statement No. 146"). Statement No. 146 addresses issues regarding
the recognition, measurement and reporting of costs that are associated with
exit and disposal activities, including restructuring activities that are
currently accounted for pursuant to the guidance that the Emerging Issues Task
Force ("EITF" or the "Task Force") has set forth in EITF Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The scope of Statement No. 146 also includes (1) costs related
to terminating a contract that is not a capital lease and (2) termination
benefits that employees who are involuntarily terminated receive under the
terms of a one-time benefit arrangement that is not an ongoing benefit
arrangement or an individual deferred compensation contract. Statement No. 146
will be effective for exit or disposal activities that are initiated after
December 31, 2002, although early adoption of the standard is allowed. If the
Company had adopted Statement No. 146 early, it would not have affected the
Company's accounting for restructuring activities which occurred in the second
quarter 2002.
EITF Issue 02-3. In June 2002, the EITF reached consensus on two of three
issues presented in EITF Issue 02-3, "Accounting for Contracts Involved in
Energy Trading and Risk Management Activities" ("EITF Issue 02-3"). First, the
Task Force concluded that all mark-to-market gains and losses on energy trading
contracts (whether realized or unrealized) should be shown net in the income
statement, irrespective of whether the contract is physically or financially
settled. In addition, the Task Force concluded that an entity should disclose
the gross transaction volumes for those energy trading contracts that are
physically settled. Beginning in the third quarter 2002, Dynegy will present
all mark-to-market gains and losses on a net basis and will expand its
volumetric disclosures to comply with the consensus. Additionally, in
accordance with the transition provisions in the consensus, comparative
financial statements will be conformed to meet the requirements mandated by the
Task Force. This change in accounting classification will have no impact on
operating income, net income, earnings per share or cash flow from operations.
The second consensus reached by the Task Force related to required
disclosures regarding energy trading operations. The Task Force agreed to
clarify the application of APB Opinion No. 22, "Disclosure of Accounting
Policies" and SOP 94-6, "Disclosure of Significant Risks and Uncertainties" to
an entity's energy trading operations by requiring that entities disclose the
applicability of EITF Issue 98-10, "Accounting for Contracts Involved in Energy
Trading and Risk Management Activities," the types of contracts that are
accounted for as energy trading contracts, a description of the methods and
significant assumptions used to estimate the fair value of various classes of
energy trading contracts and the sensitivity of its estimates to changes in the
near term. The Task Force indicated that additional disclosure regarding the
fair value of contracts, aggregated by source or method of estimating fair
value and by maturity date, would also be meaningful. The Company will assess
its disclosures with respect to these matters.
The third issue addressed by the Task Force in EITF Issue 02-3 deals with
the recognition of unrealized gains and losses at inception of an energy
trading contract (commonly referred to as dealer profit). The Task Force
reached no consensus on this issue, and the issue was assigned to a working
group for resolution by the end of 2002. It is not possible to predict how the
working group will resolve issues related to the recognition of dealer profit.
Further, it is unclear how the working group will address the accounting
transition resulting from adoption of new guidance. Three transition
alternatives exist in practice. These transition alternatives include: (a) a
retroactive restatement to eliminate dealer profit recognized in previous
periods; (b) a cumulative effect adjustment for a change in accounting
principle, which eliminates the recognition of previous periods' dealer profit
in the current period; or, (c) as a prospective change, eliminating the
recognition of dealer profit on future transactions but leaving past
transactions unaffected.
12
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Finally, it is unclear whether the scope of the working group's activities
will include a comprehensive conclusion regarding the appropriateness of the
use of models as a fundamental method for valuing transactions when market
quotations are unavailable. Should the Task Force issue definitive guidance on
any one or all of these issues, it will impact Dynegy. However, the extent of
the financial impact to Dynegy, if any, cannot be predicted with any degree of
certainty until the scope of the Task Force's conclusion is known and the
transition alternative is determined. If the Task Force prefers a retroactive
or a cumulative effect transition alternative, then Dynegy's historical
financial position and results of operations will be impacted negatively. If
the Task Force prefers a prospective transition alternative, then Dynegy's
current financial position will be unaffected and the impact to future
operations in the near term is not expected to be material (largely as a result
of a reduction in these types of transactions in the marketplace).
Note 5--Restructuring and Impairment Charges
During the second quarter 2002, the Company recognized a $499 million
pre-tax ($324 million after-tax) charge principally related to the impairment,
write-off or obsolescence of certain assets and an accrual for severance
related to a corporate restructuring. The charge primarily relates to the
impairment of the Company's investment in the telecommunications business, the
impairment of certain investments in securities of entities engaged in
technology-related ventures, a write-off of net assets related principally to
the Company's gas marketing business and a severance charge related to a plan
of restructuring of the Company's operations. The pre-tax charge, which was
substantially non-cash in nature, consisted of the following (in millions):
Impairment of telecommunications business $286
Impairment of technology investments..... 40
Gas marketing charge..................... 124
Severance charge......................... 37
Write-off of other obsolete assets....... 12
----
$499
====
During the second quarter 2002, prospects for the telecommunications sector
continued to deteriorate as evidenced by an increased number of bankruptcies in
the sector, continued devaluation of debt and equity securities and a lack of
financing sources and further pricing pressures resulting from challenges faced
by major industry participants. As a result of this deterioration, a continuing
negative outlook for the industry and Dynegy's desire to improve its own
liquidity, management began to take measures to reduce cash losses in the
business, including reducing capital spending and lowering operating and
administrative expenses. Management is aggressively pursuing alternatives for
exiting this business segment, although no formal plans are currently in place
and no assurance can be provided as to the timing or structure of any such
transaction.
Statement No. 144 requires long-lived assets to be tested for impairment
whenever events or changes in circumstances indicate that their carrying amount
may not be recoverable from future cash-flows of the segment or there is an
expectation that it is more likely than not that a long-lived asset group will
be sold or otherwise disposed of before the end of its previously estimated
useful life. Dynegy's impairment analysis at June 30, 2002, calculated in
accordance with the guidelines set forth in Statement No. 144, indicates future
cash flows from DGC's operations are insufficient to cover the carrying value
of that segment's long-lived assets. As a result, a pre-tax impairment charge
totaling $286 million ($186 million after-tax) was recorded in Impairment and
Other Charges in the accompanying Condensed Consolidated Statements of
Operations for the three- and six-month periods ended June 30, 2002.
13
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
In addition, the impairment analysis indicates that future cash flows are
insufficient to support the lessor's obligation of $367 million related to
telecommunications leases, of which Dynegy has guaranteed approximately $303
million. In accordance with EITF Issue 96-21, "Implementation Issues in
Accounting for Leasing Transactions involving Special-Purpose Entities", the
loss under the guarantees will be accrued under a straight-line method over the
remaining terms of the leases. This non-cash pre-tax charge is expected to
approximate $23 million per quarter beginning in the third quarter 2002 through
the remaining terms of the leases, unless the obligation is accelerated or
terminated as a result of a business combination, joint venture or other
similar transaction resulting from Dynegy's managed exit from its
telecommunications business.
At June 30, 2002, the valuations of certain technology investments were
assessed in light of the Company's decision to pursue a managed exit strategy
from its telecommunications business. These investments were originally entered
into in order to leverage existing commercial relationships or as a means of
expanding new relationships. Historically, the Company viewed these investments
as strategic and core to its telecommunications strategy. Accordingly, Dynegy
expected to hold these investments for the long-term and viewed trends in the
sector as cyclical. These investments include ownership in public and private
companies and investment funds focused in the technology sector. The continued
downturn in the technology sector during the second quarter 2002 combined with
the Company's change in strategy resulted in a decision to recognize an
impairment charge relative to these investments. After recognition of the
impairment, values for these investments represent expected realizable value at
June 30, 2002. The $40 million pre-tax ($26 million after-tax) charge was
recorded in Earnings of Unconsolidated Affiliates in the accompanying Condensed
Consolidated Statements of Operations for the three and six months ended June
30, 2002.
The non-cash gas marketing charge is the result of a balance sheet review
and reconciliation process started early in 2002. Management believes the
charge is largely associated with the process of reconciling accrued to actual
results principally in its natural gas marketing business and that it
accumulated over a number of years. 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 $124 million pre-tax ($80 million after-tax) charge was recorded
in Other Income and Other Expenses in the accompanying Condensed Consolidated
Statements of Operations for the three and six months ended June 30, 2002.
Please read Note 1 above for additional information regarding the previously
announced re-audit of Dynegy's 1999-2001 financial statements.
The Company recognized a pre-tax charge of approximately $37 million ($24
million after-tax) for severance benefits for approximately 325 employees who
were from various segments and included all staffing levels, including the
Company's former Chief Executive Officer and Chief Financial Officer. The
charge is included in Impairment and Other Charges in the accompanying
Condensed Consolidated Statements of Operations. No severance amounts were paid
as of June 30, 2002, thus the entire amount is included within Accrued
Liabilities and Other in the accompanying June 30, 2002 Condensed Consolidated
Balance Sheet.
The remaining pre-tax non-cash charge of $12 million ($8 million after-tax)
relates to the retirement of partially depreciated information technology
equipment and software replaced during the quarter with new system applications
and arrangements as well as miscellaneous deposits that are not expected to
provide future value. The charge was recorded in Other Expenses in the
accompanying Condensed Consolidated Statements of Operations for the three and
six months ended June 30, 2002.
During the three months ended March 31, 2002, the Company incurred an $18
million pre-tax ($13 million after-tax) charge associated with a commitment to
deliver gas assumed in the acquisition of Northern Natural. The pre-tax charge
is included in the accompanying Condensed Consolidated Statement of Operations
for the six months ended June 30, 2002.
14
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Note 6--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. 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
Dynegy's merger agreement with Enron Corp. ("Enron"), and the closing of the
option exercise occurred on January 31, 2002. Enron retained an option to
reacquire Northern Natural, which expired unexercised on July 1, 2002.
On July 28, 2002, Dynegy executed an agreement to sell Northern Natural to
MidAmerican for $928 million in cash, subject to adjustment for working capital
changes. Under the terms of this agreement, MidAmerican is expected to acquire
all of the common and preferred stock of Northern Natural and to assume all of
Northern Natural's $950 million of debt with a fair value of approximately $890
million. The transaction is expected to close in August 2002 and is subject to
customary closing conditions, including expiration of the Hart-Scott-Rodino
waiting period. No assurance can be given as to the timing of such approval or
the consummation, if at all, of the transaction. Because Dynegy paid
approximately $1.5 billion for Northern Natural, Dynegy expects to incur a
significant loss associated with the sale.
Northern Natural was 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 Dynegy's acquisition of
Northern Natural had taken place on January 1, 2001 (in millions, except per
share data).
Three Months Six Months
Ended Ended
June 30, June 30,
--------------- ----------------
2002 2001 2002 2001
------ ------- ------- -------
Pro forma revenues................................................. $9,906 $10,920 $18,616 $25,263
Pro forma income (loss) from operations before change in accounting
principle (Notes 4 and 7)........................................ (328) 163 (189) 348
Pro forma income (loss) from operations before change in accounting
principle per share (diluted).................................... (0.92) 0.48 (0.52) 1.03
Pro forma net income (loss) before preferred stock dividends....... (328) 163 (445) 350
Pro forma net income (loss) available to common shareholders....... (336) 163 (461) 350
Pro forma earnings (loss) per share (diluted)...................... (0.92) 0.48 (1.27) 1.04
Note 7--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 Form 10-K.
15
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Changes in stockholders' equity related to derivatives for the six-month
period ended June 30, 2002 were as follows, net of tax (in millions):
Balance at December 31, 2001............. $ 12
Current period changes in fair value, net (3)
Reclassifications to earnings, net....... (27)
----
Balance at June 30, 2002................. $(18)
====
Accumulated other comprehensive loss, net of tax is included in
Stockholders' Equity on the Condensed Consolidated Balance Sheets as follows
(in millions):
Statement No. 133, net............................................ $(18)
Currency translation adjustment................................... 3
Unrealized loss on available-for-sale securities, net............. --
----
Accumulated other comprehensive loss, net of tax, at June 30, 2002 $(15)
====
Other comprehensive income (loss) is as follows (in millions):
Six Months
Ended June 30,
--------------
2002 2001
----- ----
Net income (loss)................ $(468) $285
Other comprehensive income....... 20 27
----- ----
Total comprehensive income (loss) $(448) $312
===== ====
Additional disclosures required by Statement No. 133, as amended, are
provided in the following paragraphs.
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.
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 customer and risk-management 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.
Dynegy recognized a charge of less than $1 million relating to hedge
ineffectiveness during the six months ended June 30, 2002, 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.
The balance in other comprehensive income at June 30, 2002 associated with
these cash flow hedges is expected to be reclassified to future earnings,
contemporaneously with the related purchases of fuel, sales of
16
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
electricity or liquids, payments of interest and recognition of operating lease
expense, as applicable to each type of hedge. Of this amount, approximately $13
million loss, net of taxes, is estimated to be reclassed into earnings over the
12-month period ending June 30, 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 fixed-rate debt into variable-rate debt.
During the six months ended June 30, 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 investments in foreign
operations, the effective portion of changes in the fair value of the
derivative is recorded in the cumulative translation adjustment. For the six
months ended June 30, 2002, approximately $34 million of net losses related to
these contracts were included in the cumulative translation adjustment. During
the six months ended June 30, 2002, ineffectiveness from changes in fair value
of net investment hedge positions was a loss of approximately $5 million. There
were no net investment hedges for the six months ended June 30, 2001.
As part of the re-audit process (see Note 1), Dynegy expects the criteria
for and interpretation of hedge accounting under Statement No. 133 to be one of
the issues addressed. During the six-quarter period ended June 30, 2002, Dynegy
accounted for certain derivative transactions as hedges of its generation
facilities. If Dynegy's accounting treatment relating to Statement No. 133 were
to change as a result of the re-audit, the income recognized over the six
quarters may be re-allocated within the period. Cash flow for the six-quarter
period would remain unaffected by any change in the timing of income statement
recognition.
Note 8--Capital Leases
In response to the initiatives currently underway at the FASB, on June 28,
2002 the Company unilaterally undertook actions, the effect of which altered
the accounting for some of its existing lease obligations and anticipated lease
obligations relating to assets under construction. These actions included the
delivery of guarantees of lessor debt in certain existing leases of power
generation facilities. In addition, the Company notified certain lenders of its
intent to purchase power generation facilities that are currently under
construction and that were expected to be placed in synthetic leases upon
completion of their construction. As a result of these actions, approximately
$528 million of obligations due in 2005 to 2007 were brought on-balance sheet.
This non-cash action resulted in an increase to Property, Plant and Equipment
and a corresponding increase in Long-Term Debt on the Company's June 30, 2002
Condensed Consolidated Balance Sheet. These obligations were previously
reported as lease obligations in the footnotes to the Company's financial
statements and in the Commercial Financial Obligations and Contingent Financial
Commitments tables in the Form 10-K. In addition, actions taken by the Company
relating to assets under construction required the reclassification of
approximately $673 million from Prepayments and Other Assets to Property, Plant
and Equipment on the Company's June 30, 2002 Condensed Consolidated Balance
Sheet. Property under capital leases of $528 million is included in Property,
Plant and Equipment and is amortized over the useful life of the asset, which
approximates 40 years.
17
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
The following is a schedule of future minimum lease payments under capital
leases together with the present value of the net minimum lease payments as of
June 30, 2002 (in millions):
Six months ending December 31, 2002........ $ 6
Year ending December 31:
2003.................................... 13
2004.................................... 13
2005.................................... 176
2006.................................... 186
2007.................................... 185
----
Total minimum lease payments............... 579
Less: Amount representing interest......... (51)
----
Present value of net minimum lease payments $528
====
Note 9--Debt
As of August 12, 2002, the Company's debt and preferred stock maturities
through December 31, 2003, inclusive of letters of credit issued under
revolving credit facilities, were as follows: remainder of third quarter
2002--$14 million; fourth quarter 2002--$386 million (not including a $450
million secured line of credit at Northern Natural that will be assumed by
MidAmerican in the sale of Northern Natural, as further described in Note 6
above); first quarter 2003--$241 million; second quarter 2003--$1,856 million;
third quarter 2003--$233 million; and fourth quarter 2003--$1,543 million
(including $1.5 billion in Series B Mandatorily Convertible Redeemable
Preferred Stock held by ChevronTexaco Corporation). Please read "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" for a discussion of the Company's
current liquidity and capital plans.
In July 2002, the Company completed a $200 million interim financing,
bearing interest at LIBOR plus 1.38 percent. This loan matures in January 2003
and is secured by interests in Dynegy's Renaissance and Rolling Hills merchant
power generation facilities.
In June 2002, the Company completed a $250 million interim financing,
bearing interest at LIBOR plus 1.75 percent. This loan matures in June 2003 and
represents an advance on a portion of the proceeds from the expected sale of
certain of the Company's United Kingdom natural gas storage facilities.
Dynegy completed an amendment to the Catlin Associates, LLC minority
interest transaction (also referred to as "Black Thunder") in June 2002, which
permanently removed a $270 million obligation which could have been triggered
by declines in Dynegy's credit ratings. The amended agreement requires a
subsidiary of Dynegy to amortize $275 million over the remaining three years of
the transaction. The subsidiary has already paid approximately $73 million of
the amortization. Quarterly maturities are approximately $20 million through
the first quarter 2005. In addition, Dynegy agreed to grant mortgages on the
midwest generation assets covered by the transaction, post a letter of credit
to secure a contingent obligation expiring December 31, 2002 and make certain
structural changes to enhance the security of the third-party lenders involved
in the transaction. As a result of this amendment, $796 million related to
Catlin Associates, LLC was reclassified from Minority Interest to debt on
Dynegy's Condensed Consolidated Balance Sheets at June 30, 2002.
18
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Also in June 2002, West Coast Power, LLC ("West Coast Power"), a joint
venture owned equally by Dynegy and NRG Energy with generation assets in
California, repaid a non-recourse project financing with cash on hand within
the joint venture entity. This payment eliminated a $31 million obligation
triggered by declines in Dynegy's credit ratings. Concurrent with the
retirement of the project financing, West Coast Power entered into an amended
$120 million bank facility consisting of a $100 million letter of credit
facility that will be used to collateralize West Coast Power's obligations, a
$10 million term loan and a $10 million working capital facility. The facility
has resulted in the release of approximately $100 million in letters of credit
previously posted by Dynegy on behalf of West Coast Power.
Dynegy incurred upfront fees aggregating approximately $19 million in
connection with the interim financings, Black Thunder amendment and West Coast
Power transactions described above. Such amounts are capitalized and amortized
over the term of the respective financing transaction.
On May 17, 2002, Illinois Power Company ("IP"), an indirect wholly owned
Dynegy subsidiary, exercised the "term-out" provision contained in its $300
million 364-day revolving credit facility, which was scheduled to mature on May
20, 2002. In connection with this conversion, IP borrowed the remaining $60
million available under this facility. The exercise of the "term-out" provision
converted the facility to a one-year term loan that matures in May 2003. As
such, the amounts outstanding under this loan are classified as current.
Borrowings of $300 million were outstanding under this loan at June 30, 2002.
On April 29, 2002, DHI closed a $900 million unsecured revolving credit
agreement with a syndicate of commercial banks. 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. Facility fees are payable on the full amount
of the facility and are determined based on designated unsecured debt ratings.
Dynegy will incur higher interest costs and fees associated with the new
facility as compared to those incurred under the expired facility.
Specifically, assuming that all amounts were outstanding under this facility,
DHI would pay approximately $10 million in additional interest expense on the
new facility compared to what it would have paid under the expired facility.
Additionally, as compared to similar fees paid by DHI under the expired
facility, DHI expects to pay approximately $2 million in additional facility
fees during the term of the new facility and paid approximately $3 million in
additional upfront fees.
Financial covenants under the new DHI revolver 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
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
19
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
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. As such, the amounts outstanding under this facility are
classified as current. Management currently believes DHI is in compliance with
the covenants contained in this agreement.
On February 21, 2002, DHI issued $500 million of 8.75% senior notes due
2012. Interest on the notes is due on February 15 and August 15 of each year,
beginning August 15, 2002. The notes are unsecured 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.
On January 31, 2002, 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 consists of senior unsecured notes with maturities
ranging from 2005 to 2011. The remaining $450 million consists of a secured
line of credit that matures in November 2002. See Note 6 for discussion of
Dynegy's previously announced sale of Northern Natural. In the event the
Company cannot consummate the sale of Northern Natural, 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 current intention to do so. On April 26, 2002, DHI purchased $90
million of Northern Natural's senior unsecured notes due 2005 pursuant to a
tender offer. The Company is currently considering alternatives relating to the
sale of these notes.
During the six-month period ended June 30, 2002, the Company repaid
commercial paper borrowings and revolving credit facilities for DHI and IP of
approximately $293 million in the aggregate and borrowed approximately $60
million under IP's revolving credit facility. Additionally, during the six
months ended June 30, 2002, Dynegy and DHI issued an aggregate of $433 million
of letters of credit under their revolving credit facilities. During the period
from June 30, 2002 through August 12, 2002, Dynegy paid at maturity $200
million in senior notes of DHI and $96 million in IP mortgage bonds, borrowed
an aggregate of $137 million and issued an aggregate of $251 million of letters
of credit under the Dynegy and DHI revolving credit facilities.
Note 10--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. In-the-money outstanding options contribute to the
differences between basic and diluted shares outstanding in all periods.
Additionally, the diluted shares in the 2002 periods include the effect of the
assumed conversion to Class A common stock of the Series B Mandatorily
Convertible Redeemable Preferred Securities held by ChevronTexaco.
When an entity has a net loss from continuing operations, Statement of
Financial Accounting Standards No. 128, "Earnings per Share," prohibits the
inclusion of 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 three and six
months ended June 30, 2002.
20
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Note 11--Capital Stock
Chevron U.S.A. Inc., a ChevronTexaco subsidiary, purchased approximately
10.4 million shares of Class B common stock in January 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.
Dynegy's Board of Directors has elected not to pay a dividend on Dynegy's
Class A or Class B common stock for the third quarter 2002. Payments of
dividends for subsequent periods will be at the discretion of the Board of
Directors.
Note 12--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
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 $854 million and $843 million
at June 30, 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.
Generation Assets. These investments primarily include ownership interests
in eight joint ventures that own fossil fuel electric generation facilities in
diverse geographic regions as well as a limited number of international
ventures. The Company's ownership is generally 50 percent in the majority of
these ventures. The Company's aggregate net investment of $720 million at June
30, 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, representing approximately 1,400 MW of net generating capacity in
California. The net investment in West Coast Power totaled approximately $348
million at June 30, 2002. West Coast Power provided equity earnings of
approximately $37 million and $70 million in the six months ended June 30, 2002
and 2001, respectively.
Midstream Investments. These 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 June 30, 2002, the
Company's aggregate net investment in these midstream businesses totaled
approximately $134 million.
Summarized aggregate financial information for these generation and
midstream investments and Dynegy's equity share thereof was ($ in millions):
Six Months Ended June 30,
---------------------------
2002 2001
------------- -------------
Equity Equity
Total Share Total Share
------ ------ ------ ------
Revenues........ $1,851 $703 $2,455 $936
====== ==== ====== ====
Operating margin $ 397 $135 $ 388 $152
====== ==== ====== ====
Net income...... $ 210 $ 66 $ 253 $ 94
====== ==== ====== ====
21
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Other Investments. In addition to these equity investments, the Company
holds interests in non-public companies for which it does not have significant
influence over operations. These investments are generally accounted for by the
cost method. Such investments totaled $52 million and $84 million at June 30,
2002 and December 31, 2001, respectively. The change is primarily attributed to
the impairment of technology investments resulting from unfavorable market
conditions.
The Company also owns equity securities that have a readily determinable
fair market value and are considered available-for-sale. The market value of
these investments at June 30, 2002 and December 31, 2001 was determined to be
$12 million and $23 million, respectively. The change is primarily attributed
to the decline in value of available-for-sale technology investments resulting
from unfavorable market conditions. The Company wrote off the unrealized losses
related to such decline in the second quarter 2002. The Company is currently in
the process of selling these investments.
Note 13--Commitments and Contingencies
Please see Note 11, "Commitments and Contingencies," in the Form 10-K and
Note 10, "Commitments and Contingencies," in the Company's Form 10-Q for the
quarter ended March 31, 2002 (the "Form 10-Q") 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 filing of the Form 10-Q for the first quarter 2002 and a
description of any new matters that have arisen during the quarter.
Baldwin Station Litigation. IP and Dynegy Midwest Generation, Inc.
(collectively, the "Defendants") are currently 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.
The Company believes that it has meritorious defenses to the EPA allegations
and will vigorously defend against these claims. The Company has undertaken
activities to significantly reduce emissions at the Baldwin Station since the
complaint was filed in 1999. In 2000, the Baldwin Station was converted from
high to low sulfur coal. This conversion resulted in sulfur dioxide emission
reductions of over 90% from 1999 levels. Furthermore, selective catalytic
reduction equipment has been installed at two of the three units at Baldwin
Station resulting in significant emission reductions of nitrogen oxides.
However, the EPA may seek to require the installation of the "best available
control technology" (or the equivalent) at the Baldwin Station. Independent
experts hired by Dynegy estimate capital expenditures of up to $380 million if
the installation of best available control technology is required. The EPA also
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 Company has filed a
motion for summary judgment based on the five-year statute of limitations,
which could affect the EPA's ability to collect penalties.
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
22
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
well as Dynegy Northeast Generation's Danskammer and Roseton Plants. It is
possible that the EPA will eventually commence enforcement actions based on
activities at those plants as well.
On June 13, 2002, the EPA announced its intention to implement several
reforms to its regulations governing new source review. These reforms, if made,
would clarify the routine maintenance, repair and replacement exclusion,
provide more certainty in evaluating permit requirements and increase
operational flexibility for affected facilities.
California Market Litigation. 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. Subsequent to the consolidation two
defendants filed cross complaints against a number of corporations and
governmental agencies that sold power in California's wholesale energy markets.
Four cross defendants removed the six cases to the United States District Court
for the Southern District of California (San Diego). Following removal, certain
cross defendants filed motions to dismiss the cross complaints, which motions
are currently pending. The original plaintiffs in the six consolidated
complaints have filed motions to remand the consolidated cases back to state
court, which motions are currently pending. The defendants in the six
consolidated cases have filed motions to dismiss the complaints based on the
filed rate doctrine and preemption defense, which motions are currently
pending. Federal Judge Whaley has decided that the Court will hear the motion
to remand and the cross defendants' motion to dismiss on September 19, 2002. If
the Court decides that it has jurisdiction over the claims, the defendants'
motion to dismiss will be heard as soon as possible after September 19th.
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 owners of power generation facilities, including subsidiaries
of West Coast Power. 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. These lawsuits were subsequently removed to the United States
District Court for the Northern District of California. The California Attorney
General filed motions to remand the cases back to state court. By Order issued
on August 6, 2002, Judge Walker denied the motions to remand, thus keeping the
cases in federal court. The Company intends to vigorously defend against these
claims.
In addition to the six consolidated lawsuits discussed above, eight new
putative class actions were filed on behalf of business and residential
electricity consumers, including consumers residing in the State of Washington.
The lawsuits were filed in various state courts in Northern California, and in
respect to the lawsuit on behalf of consumers in the State of Washington, in
the United States District Court for the Northern District of California. Named
as defendants are various generators and marketers, including Dynegy and
certain affiliates. The complaints allege unfair, unlawful and deceptive
practices in violation of the California Unfair Business Practices Act and seek
to enjoin illegal conduct, restitution and unspecified damages. While some of
the
23
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
allegations in these lawsuits are similar to the allegations in the other six
lawsuits, these lawsuits include 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 lawsuit 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. The lawsuits filed in state court have been
removed to federal courts in the Northern and Eastern Districts of California.
Certain defendants have filed a petition with the Judicial Panel For
Multidistrict Litigation seeking to consolidate the new cases with the six
cases consolidated in the United States District Court for the Southern
District of California. The Company intends to vigorously defend against these
claims.
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. This suit 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 agreed prices are found to be unfair. The suit further seeks
damages in the amount of the alleged excess prices under the contracts. The
Company intends to 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 claims 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 claimed that DHI wrongfully exercised its option to take ownership of
Northern Natural under an Option Agreement dated November 9, 2001. Enron sought
damages in excess of $10 billion and declaratory relief against Dynegy for
breach of the Merger Agreement. Enron also sought 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).
Dynegy also previously 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 who 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 between 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
an award of damages and other relief. Enron moved for an order of the
Bankruptcy Court in the Southern District of New York, directing that the Pearl
and Shapiro plaintiffs be enjoined from prosecuting their actions and
immediately dismiss those actions. The Bankruptcy Court held that the claims
asserted by the Pearl and Shapiro plaintiffs were the exclusive property of the
Enron bankruptcy estate, and that the plaintiffs lacked standing to sue as
third party beneficiaries of the Merger Agreement. Accordingly, by an order
entered on April 19, 2002, the Bankruptcy Court granted Enron's motion,
enjoined the prosecution of both actions, and directed that they be dismissed.
The Pearl and Shapiro plaintiffs thereafter complied with that order, but filed
an appeal to the United States District Court for the Southern District of New
York, which remains pending.
24
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Dynegy believes the allegations in Enron's claim against Dynegy and the
Pearl and Shapiro matters arising out of the terminated merger are without
merit and will vigorously defend against these claims. An adverse result in any
of these proceedings, however, could have a material adverse effect on the
Company's financial position or results of operations.
As previously described, as a result of Enron's bankruptcy filing, Dynegy
recognized in its fourth quarter 2001 financial results a pre-tax charge
related to the Company's net exposure for commercial transactions with Enron.
As of June 30, 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 $94 million and was calculated by setting off
approximately $220 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
as well as the valuation of the commercial transactions covered by the
agreement remain subject to negotiation between the parties and, if any
disputes cannot be resolved by the parties, to arbitration as called for by the
terms of the agreement. If the setoff rights were modified, 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.
Shareholder Litigation. Since April 2002, a number of class action lawsuits
have been filed on behalf of purchasers of publicly traded securities of Dynegy
generally during the period between April 2001 and April 2002. These lawsuits
principally assert that Dynegy and certain of its executive officers violated
the federal securities laws in connection with Dynegy's accounting treatment
and disclosure of Project Alpha. These lawsuits have been consolidated in the
United States District Court for the Southern District of Texas. Under the
Private Securities Litigation Reform Act of 1995, the court in which the cases
have been consolidated will appoint a lead plaintiff, and the lead plaintiff
will, in turn, select class counsel. Following that process, a consolidated
complaint will be filed which may differ materially from the complaints
presently on file. Dynegy intends to vigorously defend against these lawsuits.
It is not possible to predict with certainty whether Dynegy will incur any
liability or to estimate the damages, if any, that might be incurred in
connection with such lawsuits, but an adverse outcome could have a material
adverse effect on the Company's financial condition or results of operations.
In addition, three derivative lawsuits have been filed in which the Company
is a nominal defendant. Two of these three lawsuits relate to Project Alpha and
the third relates to severance for the Company's former Chief Executive
Officer. All three lawsuits seek recovery on behalf of the Company from various
present and former officers and directors. These actions have only recently
been filed and the Company is currently analyzing them. The Company does not
expect to incur any material liability with respect to these derivative claims.
Farnsworth Litigation. On August 2, 2002, Bradley Farnsworth filed a
lawsuit against Dynegy in Texas state district court claiming that he was
demoted and ultimately fired from the position of Controller for refusing to
participate in alleged accounting irregularities. Specifically, Mr. Farnsworth
alleges that certain present and former executive officers of the Company
requested that he shave forward price curves for natural gas in order to
improve the Company's results of operations for the third quarter 2000. Mr.
Farnsworth, who seeks actual and exemplary damages and other compensation, also
alleges that he is entitled to termination payments under his employment
agreement. Dynegy intends to vigorously defend against these claims. The
Company does not believe that any liability it might incur as a result of this
litigation would have a material adverse effect on its financial condition or
results of operations.
Roundtrip 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 5 million megawatts of power
25
90
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
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 for delivery during the same period. In the second
set of trades, Dynegy purchased 20 million megawatts of power from CMS Energy
for delivery in the period 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 for delivery during the same period. Dynegy and
CMS have terminated the 2002 trades.
During the second quarter 2002, the Company undertook a comprehensive review
of these CMS Energy trades and its trading operations generally. The Company's
review confirmed that the CMS Energy trades were consummated outside the view
of other trading parties and could not have impacted market prices. The results
of the CMS Energy trades were not included in the Company's December 31, 2001
Consolidated Statement of Operations, and the volumes from these trades were
not included in the operating statistics for the Wholesale Energy Network
("WEN") segment in the Form 10-K, nor were such results or volumes included in
the Company's first quarter Form 10-Q. In an April 30, 2002 press 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. The Company eliminated these amounts from Revenues and
Costs of Sales in its Form 10-Q for the first quarter and in this report.
Based on the Company's review of its trading operations to date, Dynegy
believes that it has not executed any simultaneous buy and sell trades with
counterparties for the purpose of artificially increasing its trading volumes
or revenues.
SEC Investigation. The SEC has commenced an investigation into the facts
and circumstances surrounding Project Alpha and the roundtrip trades described
above. The Company has produced documents and witnesses for interviews in
connection with this investigation. The Company has assured the SEC that it
intends to cooperate fully with this investigation. Dynegy has been informed by
the Staff of the SEC that they believe that, among other things, Dynegy's
disclosures and reports relating to both Project Alpha and the CMS Energy
trades violate various antifraud and other provisions of the federal securities
laws. The Company cannot predict the ultimate outcome of this matter.
CFTC Investigation. The U.S. Commodity Futures Trading Commission ("CFTC")
has commenced an investigation relating to, among other things, trading
activities on Dynegydirect, the Company's on-line trading platform, and any
roundtrip gas or power trades since January 2000, including all trades or
trading activities between Dynegy and CMS Energy in November 2001. The
investigation also relates to the Company's trading activities in the
California power market. The Company has produced documents in connection with
this investigation. The Company has assured the Staff of the CFTC that it
intends to cooperate fully with this investigation. The Company cannot predict
the ultimate outcome of this matter.
FERC and Related Regulatory Investigations. 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 (authored by
individuals employed by or previously employed by Enron) discovered by the FERC
allegedly containing evidence of market manipulation by Enron in California,
the FERC issued requests for information 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.
26
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Dynegy responded to these requests on May 22, 2002, and updated its
responses on July 30, 2002 at the conclusion of its due diligence. A California
State Senate committee subsequently issued similar requests, and Dynegy's
responses were consistent with those submitted to the FERC. 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 these investigations. The California State Senate committee has not issued
its preliminary findings on its investigation, and Dynegy cannot predict with
certainty how such allegations will ultimately be resolved.
On August 13, 2002, the FERC issued a notice requesting comments on a
proposal made by the FERC staff to change the method for determining natural
gas prices for purposes of computing the market mitigation clearing price that
it intends to utilize in calculating refunds for sales of power in California
power markets during the period from October 2, 2000 to June 19, 2001. As
drafted, the proposal would likely reduce gas prices used in the computation,
thus reducing the market mitigation clearing price for power and potentially
increasing calculated refunds, subject to a provision that would generally
provide full recoverability of fuel costs by the generators. The FERC has
provided parties to the refund proceeding with 30 days to provide comments and
it may or may not adopt the staff's recommendation. Dynegy is evaluating the
staff's recommendation and is unable to assess at this time the impact, if any,
that this proposal may have on any refunds which the FERC may order from Dynegy
or West Coast Power pursuant to the FERC's investigation of the California
power market for the period from October 2, 2000 to June 19, 2001.
On May 21, 2002, the FERC issued requests for information to all sellers of
wholesale electricity and/or ancillary services in the Western Systems
Coordinating Council ("WSCC") seeking information with respect to whether those
sellers engaged in "wash," "round trip" or "sale/buyback" transactions in the
WSCC during the years 2000-2001. Dynegy responded on May 31, 2002. On May 22,
2002, the FERC issued requests for information to all sellers of natural gas in
the WSCC or Texas seeking information with respect to whether those sellers
engaged in "wash," "round trip" or "sale/buyback" transactions in the WSCC or
Texas during the years 2000-2001. Dynegy responded on June 5, 2002. On August
12, 2002, Dynegy updated its May 31 and June 5 responses at the conclusion of
its due diligence. Requests for similar information with respect to electric
power trading activities in the Electric Reliability Council of Texas were
received from the Texas Public Utility Commission on June 12, 2002. Dynegy
responded to these requests on July 2, 2002.
Based on the investigation conducted in order to make these filings, Dynegy
believes that it has not executed any simultaneous buy and sell trades with
counterparties for the purpose of artificially increasing its trading volumes
or revenues in these markets.
In addition, 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. A rehearing order issued on July 23, 2002 affirmed
the underlying findings and conclusions related to West Coast Power's contract
with the DWR. 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, however, is being
held in abeyance pending completion of settlement talks. While West Coast Power
continues in good faith negotiations with the State of California on reforming
the terms of its DWR contract, settlement ultimately may not be possible. If a
hearing on the contracts entered into by West Coast Power or others is
necessary, the first phase of the hearing will be limited to the question of
whether the California real-time market adversely affected the long-term
bilateral markets. 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.
27
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
U.S. Attorney Investigation. In May 2002, Dynegy received a subpoena from
the U.S. Attorney's office in Houston requesting documents relating to Project
Alpha, roundtrip trades with CMS Energy and the Black Thunder transaction. The
Company is cooperating fully with the U.S. Attorney's office in its
investigation of these matters. The Company cannot predict the ultimate outcome
of this matter.
Telstra Litigation. On January 25, 2002, Telstra Corporation, Ltd. and
Telstra Wholesale Inc. filed suit in Delaware Chancery Court against
DynegyConnect, L.P. ("DynegyConnect"), a limited partnership in which Dynegy
holds a combined 80% interest, as well as certain other Dynegy affiliates.
DynegyConnect is a vehicle through which the Company participates in the U.S.
telecommunications business. The plaintiffs brought this action in connection
with Telstra Wholesale's attempted exercise of a put right under the
DynegyConnect partnership agreement. The plaintiffs allege breach of contract
and bad faith, among other things, and seek approximately $50 million plus
interest in damages together with fees and other litigation expenses. Dynegy
intends to vigorously defend against these claims.
Note 14--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 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 Form 10-K.
Note 15--Related Party Transactions
ChevronTexaco Commercial Arrangements. 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 increased 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, the 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 a new security agreement designed to improve Dynegy's liquidity
position by reducing its reliance upon the financial markets for surety bonds
and letters of credit and to significantly reduce ChevronTexaco's open credit
exposure. The new security agreement involved the 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.
In July 2002, Dynegy and ChevronTexaco executed a 90-day amendment to their
security agreement. This amendment was designed to address the reduction in
activity in Dynegy's gas marketing business and the
28
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
corresponding reduction in Dynegy's gas marketing receivables relative to the
required coverage ratio contained in the security agreement. The amendment,
which was executed in conjunction with a six-month netting agreement between
the parties that has since been made permanent, reduced the required coverage
ratio contained in the security agreement.
In August 2002, in partial satisfaction of certain of its obligations to
ChevronTexaco under these agreements, Dynegy transferred to ChevronTexaco its
39.2% ownership interest in West Texas LPG Pipeline Limited Partnership
("WTLPS"), which is the owner of West Texas LPG Pipeline. ChevronTexaco was
already the owner of the largest interest in WTLPS and the operator of the
pipeline. The interest transferred to ChevronTexaco was valued at approximately
$45 million.
Also in August 2002, Dynegy and ChevronTexaco executed an agreement pursuant
to which the parties amended their gas purchase agreement, security agreement,
netting agreement and certain related agreements. Under this new agreement,
Dynegy agreed to accelerate payment to the month of delivery for a portion of
the natural gas it purchases from ChevronTexaco, with the amount of the
accelerated payment generally being equal to 75 percent of the value of the
prior month's gas deliveries, after reduction pursuant to the netting agreement
described above. This payment arrangement will be effective upon the closing of
the sale of Northern Natural described in Note 6 above. The initial payment
amount, upon consummation of the Northern Natural sale, will be $187.5 million.
The amount of the payment could change materially as a result of changes in
commodity prices. If the Northern Natural sale does not close on or prior to
August 30, 2002, then a special report concerning the security agreement
coverage ratios would be due by September 4, 2002. Dynegy's right to withdraw
sums from the designated account in which the proceeds from the gas receivables
covered by the security agreement in favor of ChevronTexaco are deposited would
be suspended pending receipt of that report, and that report demonstrating
compliance with the required coverage ratios. Management believes that absent
the agreed payment with proceeds from the Northern Natural sale, this special
report likely would require Dynegy to pay additional amounts in order to be in
compliance with the coverage ratios under the security agreement. The new
agreement also suspends ChevronTexaco's right to request special reports
concerning the security agreement coverage ratios as long as those payments are
made, and makes permanent the netting agreement and reduction in the coverage
ratios referred to above.
The obligation to make payments as described above will be suspended if
Dynegy or a successor to its gas and natural gas liquids customer and
risk-management business carries at least two of the following three credit
ratings: at least BBB+ by Standard & Poor's, at least Baa1 by Moody's and at
least BBB+ by Fitch.
Dan Dienstbier Contract for Services. Dynegy entered into a services
agreement with Daniel L. Dienstbier effective as of May 28, 2002, the date on
which Mr. Dienstbier assumed the position of interim Chief Executive Officer.
Mr. Dienstbier agreed to serve as Dynegy's interim Chief Executive Officer
until either Dynegy or Mr. Dienstbier terminate the arrangement on 30 days'
written notice. Pursuant to the terms of the agreement, Dynegy agreed to pay
Mr. Dienstbier $1 million per year, to be paid ratably once per month, in the
form of cash or Dynegy Class A common stock as the parties shall agree. Upon
termination of the agreement, Mr. Dienstbier is eligible to receive a bonus
payment and a Class A common stock grant, in each case at Dynegy's discretion.
The agreement contains customary indemnification, confidentiality and
non-compete provisions relating to Mr. Dienstbier's provision of services.
Short-Term Executive Stock Purchase Loan Program. In July 2001, Dynegy
established the Dynegy Inc. Short-Term Executive Stock Purchase Loan Program
pursuant to which eligible employees were loaned funds to acquire Class A
common stock through market purchases. Dynegy terminated this program as it
relates to new
29
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
loans effective as of June 30, 2002. The notes bear interest at the greater of
five percent or the applicable federal rate as of the loan date, are full
recourse to the participants and mature on December 31, 2004. At June 30, 2002,
there were approximately $12 million in loans outstanding under this program to
a total of 30 participants.
December 2001 Equity Purchases. In December 2001, certain executive
officers purchased Class A common stock from Dynegy in a private placement
pursuant to Section 4(2) of the Securities Act of 1933. These executives
received loans from Dynegy to purchase the common stock at a price of $19.75
per share. The purchase price equaled the net proceeds per share to Dynegy from
a concurrent public offering (after a $1.00 per share underwriting discount).
The notes bear interest at 3.25%, are full recourse to the purchasing officers
and mature on September 15, 2002. At June 30, 2002, there were approximately
$3.5 million in loans outstanding with respect to these purchases to a total of
five Dynegy executive officers.
Note 16--Segment Information
Dynegy's operations are divided into four reportable segments: 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 gas
processing and liquids 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. As reflected in
Note 6, the Company is expecting to close the sale of Northern Natural in
August 2002. 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. Management is aggressively pursuing alternatives
for exiting this business segment and has impaired substantially all of the
historical cost of the fiber optic network at June 30, 2002. Dynegy accounts
for intercompany transactions at prevailing market rates. Unaudited operating
segment information for the three- and six-month periods ended June 30, 2002
and 2001 is presented below.
30
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Dynegy's Segment Data for the Quarter Ended June 30, 2002
($ in millions)
WEN DMS T&D DGC Eliminations Total
------- ------ ------ ----- ------------ -------
Unaffiliated revenues:
Domestic............................. $ 6,194 $ 778 $ 411 $ 4 $ -- $ 7,387
Canadian............................. 725 361 -- -- -- 1,086
European and other................... 1,431 -- -- 2 -- 1,433
------- ------ ------ ----- ----- -------
8,350 1,139 411 6 -- 9,906
Intersegment revenues:
Domestic............................. 175 41 13 -- (229) --
------- ------ ------ ----- ----- -------
Total revenues................... 8,525 1,180 424 6 (229) 9,906
------- ------ ------ ----- ----- -------
Depreciation and amortization........... (54) (24) (56) (7) -- (141)
Impairment and other charges............ (26) (3) (7) (287) -- (323)
Operating income (loss)................. (17) 11 57 (322) -- (271)
Interest expense........................ (27) (13) (42) (1) -- (83)
Other income (expense).................. (130) (13) 2 (3) -- (144)
Earnings (losses) from unconsolidated
investments........................... (6) 4 (2) (3) -- (7)
Income tax provision (benefit).......... (65) (3) 6 (115) -- (177)
Net income (loss)....................... $ (115) $ (8) $ 9 $(214) $ -- $ (328)
Identifiable assets:
Domestic............................. $16,831 $1,971 $6,380 $ 110 $ -- $25,292
Canadian............................. 611 139 -- -- -- 750
European and other................... 2,894 -- -- 53 -- 2,947
Investments in unconsolidated affiliates 774 144 -- -- -- 918
Capital expenditures and investments in
unconsolidated affiliates............. (331) (22) (43) (13) -- (409)
See the Explanatory Note on the Table of Contents.
31
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Dynegy's Segment Data for the Quarter Ended June 30, 2001
($ in millions)
WEN DMS T&D DGC Eliminations Total
------- ------ ------ ---- ------------ -------
Unaffiliated revenues:
Domestic............................. $ 7,666 $ 580 $ 328 $ 2 $ -- $ 8,576
Canadian............................. 1,188 327 -- -- -- 1,515
European and other................... 719 -- -- 2 -- 721
------- ------ ------ ---- ----- -------
9,573 907 328 4 -- 10,812
Intersegment revenues:
Domestic............................. 264 68 8 -- (340) --
------- ------ ------ ---- ----- -------
Total revenues................... 9,837 975 336 4 (340) 10,812
------- ------ ------ ---- ----- -------
Depreciation and amortization........... (44) (20) (43) (6) -- (113)
Operating income (loss)................. 164 32 41 (39) -- 198
Interest expense........................ (22) (14) (31) (1) -- (68)
Other income (expense).................. 13 (6) (1) (6) -- --
Earnings from unconsolidated investments 59 5 -- 14 -- 78
Income tax provision (benefit).......... 64 7 3 (12) -- 62
Net income (loss)....................... $ 150 $ 10 $ 6 $(20) $ -- $ 146
Identifiable assets:
Domestic............................. $15,056 $1,898 $3,679 $334 $ -- $20,967
Canadian............................. 714 227 -- -- -- 941
European and other................... 715 -- -- 201 -- 916
Investment in unconsolidated affiliates. 728 161 -- 25 -- 914
Capital expenditures and investments in
unconsolidated affiliates............. (159) (25) (38) (27) -- (249)
See the Explanatory Note on the Table of Contents.
32
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Dynegy's Segment Data for the Six Months Ended June 30, 2002
($ in millions)
WEN DMS T&D DGC Eliminations Total
------- ------ ------ ----- ------------ -------
Unaffiliated revenues:
Domestic.............................. $11,007 $1,674 $ 894 $ 6 $ -- $13,581
Canadian.............................. 1,430 592 -- -- -- 2,022
European and other.................... 2,951 -- -- 4 -- 2,955
------- ------ ------ ----- ----- -------
15,388 2,266 894 10 -- 18,558
Intersegment revenues:
Domestic.............................. 314 74 21 -- (409) --
------- ------ ------ ----- ----- -------
Total revenues.................... 15,702 2,340 915 10 (409) 18,558
------- ------ ------ ----- ----- -------
Depreciation and amortization............ (100) (43) (103) (12) -- (258)
Impairment and other charges............. (26) (3) (7) (287) -- (323)
Operating income (loss).................. 156 42 151 (368) -- (19)
Interest expense......................... (56) (23) (80) (3) -- (162)
Other income (expense)................... (124) (11) 6 (10) -- (139)
Earnings (losses) from unconsolidated
investments............................ 24 8 (2) (48) -- (18)
Income tax provision (benefit)........... (18) 7 30 (145) -- (126)
Income (loss) from operations............ 18 9 45 (284) -- (212)
Cumulative effect of change in accounting
principle.............................. -- -- -- (256) -- (256)
Net income (loss)........................ $ 18 $ 9 $ 45 $(540) $ -- $ (468)
Identifiable assets:
Domestic.............................. $16,831 $1,971 $6,380 $ 110 $ -- $25,292
Canadian.............................. 611 139 -- -- -- 750
European and other.................... 2,894 -- -- 53 -- 2,947
Investments in unconsolidated affiliates. 772 146 -- -- -- 918
Capital expenditures and investments in
unconsolidated affiliates.............. (421) (53) (72) (41) -- (587)
See the Explanatory Note on the Table of Contents.
33
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended June 30, 2002 and 2001
Dynegy's Segment Data for the Six Months Ended June 30, 2001
($ in millions)
WEN DMS T&D DGC Eliminations Total
------- ------ ------ ---- ------------ -------
Unaffiliated revenues:
Domestic.............................. $15,710 $2,720 $ 860 $ 4 $ -- $19,294
Canadian.............................. 3,275 681 -- -- -- 3,956
European and other.................... 1,726 -- -- 4 -- 1,730
------- ------ ------ ---- ----- -------
20,711 3,401 860 8 -- 24,980
Intersegment revenues:
Domestic.............................. 300 159 14 -- (473) --
------- ------ ------ ---- ----- -------
Total revenues.................... 21,011 3,560 874 8 (473) 24,980
------- ------ ------ ---- ----- -------
Depreciation and amortization............ (87) (40) (83) (10) -- (220)
Operating income (loss).................. 339 84 92 (62) -- 453
Interest expense......................... (40) (27) (60) (3) -- (130)
Other income (expense)................... (24) (11) 19 -- -- (16)
Earnings from unconsolidated investments. 90 6 -- 14 -- 110
Income tax provision (benefit)........... 115 19 20 (20) -- 134
Income (loss) from operations............ 250 33 31 (31) -- 283
Cumulative effect of change in accounting
principle.............................. 2 -- -- -- -- 2
Net income (loss)........................ $ 252 $ 33 $ 31 $(31) $ -- $ 285
Identifiable assets:
Domestic.............................. $15,056 $1,898 $3,679 $334 $ -- $20,967
Canadian.............................. 714 227 -- -- -- 941
European and other.................... 715 -- -- 201 -- 916
Investments in unconsolidated affiliates. 728 161 -- 25 -- 914
Capital expenditures and investments in
unconsolidated affiliates.............. (1,243) (58) (65) (29) -- (1,395)
See the Explanatory Note on the Table of Contents.
34
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 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") included elsewhere herein and with the Company's Annual
Report on Form 10-K for the year ended December 31, 2001 (the "Form 10-K"), as
filed with the SEC. As discussed in the Explanatory Note on the Table of
Contents, Dynegy intends to file amended reports under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), for each of the three years in
the period ended December 31, 2001, as well as each quarterly period contained
therein. In addition, Dynegy intends to file amended Exchange Act reports for
the quarters ended March 31, 2002 and June 30, 2002. Dynegy expects to file
these amended reports with the SEC following completion of
PricewaterhouseCoopers LLP's previously announced re-audit of Dynegy's
1999-2001 financial statements and, for the quarterly periods during 2002,
PricewaterhouseCoopers' subsequent review of the interim financial statements
for those periods. As a result of the three-year re-audit, there may be
revisions to the Company's historical financial statements in addition to those
described in the Explanatory Note on the Table of Contents and in Note 1 to the
accompanying financial statements, some of which could be material.
Dynegy is a global energy merchant. Through its owned and contractually
controlled network of physical assets and its marketing, logistics and
risk-management capabilities, the Company provides services 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 the merchant energy industry, Dynegy has faced a
number of challenges since the end of 2001. These challenges include, among
others, the effects of contraction in the trading markets and downgrades in the
Company's credit ratings on its ability to conduct its customer and
risk-management business, a weak commodity price environment for natural gas
and power, the impact of various legal proceedings and investigations involving
Project Alpha, roundtrip trades and the Company's failed merger with Enron,
increased collateralization requirements for the Company's commercial
obligations resulting from downgrades in its credit ratings and the effect of
these and other issues on public confidence in Dynegy's long-term business
strategy and its ability to generate sustainable cash flows.
Since the Company filed its first quarter 2002 Form 10-Q on May 15, 2002,
Dynegy has announced a number of significant developments. On May 24, 2002,
Dynegy announced that it received a subpoena from the U.S. Attorney's office in
Houston requesting documents relating to the Company's transactions, including
Project Alpha and the roundtrip trades with CMS Energy. On May 28, 2002, Dynegy
announced that Charles L. Watson had resigned as its Chairman of the Board and
Chief Executive Officer and that two of its Board members, Glenn F. Tilton and
Daniel L. Dienstbier, respectively, had been appointed to fill those positions
on an interim basis. On June 19, 2002, Dynegy announced that Robert D. Doty,
Jr. had resigned as its Chief Financial Officer and that Louis J. Dorey had
been appointed to fill that position. Also on June 19/th/, Dynegy announced a
workforce reduction that affected approximately 325 employees.
On June 24, 2002, Dynegy announced a $2 billion capital plan designed to
enhance liquidity and reduce debt. Dynegy also announced that
PricewaterhouseCoopers would re-audit Dynegy's 2001 financial statements as
part of the previously announced 2001 restatement process. Dynegy further
announced that its second quarter results were expected to include certain
non-recurring pre-tax charges of up to $450 million related to the
telecommunications business, severance expenses, consulting fees and other
charges. On July 15, 2002, Dynegy
35
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
announced that it would adjust upward its previously disclosed estimated second
quarter pre-tax charge from $450 million to $500 million as the result of an
increase in an expected non-cash charge in the Company's natural gas marketing
business. Dynegy also announced that it had requested PricewaterhouseCoopers to
expand its re-audit to include the Company's 1999 and 2000 financial
statements. On July 23, 2002, Dynegy announced that it was lowering its earlier
fiscal year 2002 guidance for cash flow from operations to a range of $600
million to $700 million from its previous estimate of up to $1 billion. The
Company attributed the reduction to a downturn in its customer and
risk-management activities, partially the result of industry conditions, and
lower-than-expected prices for power, natural gas and natural gas liquids. The
Company also indicated that the previously announced $325 million mortgage bond
offering by Illinois Power Company, its indirect wholly owned subsidiary
("IP"), had been terminated because of credit rating downgrades.
These and other issues facing the Company have resulted in a precipitous
decline in the Company's stock price and downgrades to the Company's credit
ratings by all three major credit rating agencies to below investment grade.
The Company's trading and commercial counterparties have also required
additional postings of collateral or ceased conducting business with the
Company. These actions, together with the general contraction in the trading
markets, contributed to lower than anticipated operating results and cash flows
during the second quarter 2002 and have materially adversely affected the
Company's business and operating capabilities. Dynegy remains committed to
addressing these issues. However, the Company's future financial condition will
depend upon its ability to successfully execute its $2 billion capital plan.
Important factors impacting Dynegy's ability to execute this plan and to
otherwise continue its operations and achieve its business strategy include the
following:
. Dynegy's ability to address its significant financial obligations given
its non-investment grade status and lack of borrowing capacity;
. Dynegy's ability to rationalize its customer and risk-management
business, either through the formation of a joint venture or the
execution of an alternative strategy;
. Dynegy's ability to generate sustainable cash flows from its assets and
businesses;
. ongoing investigations and litigation relating to Project Alpha, Black
Thunder, the California power markets and roundtrip transactions;
. confidence in Dynegy's financial reporting in light of the previously
announced restatements and the ongoing re-audit of its 1999-2001
financial statements; and
. Dynegy's ability to eliminate or further reduce net cash outflows
associated with its telecommunications business.
Please read "Liquidity and Capital Resources" for additional details with
respect to these factors and "Uncertainty of Forward-Looking Statements and
Information" for additional factors that could impact future operating results.
36
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
LIQUIDITY AND CAPITAL RESOURCES
Capital Plan
On June 24, 2002, Dynegy announced a $2 billion capital plan designed to
enhance liquidity and reduce debt. These measures are in addition to the equity
sales and capital expenditure reductions totaling approximately $1.25 billion
previously achieved through its December 2001 capital plan. The new plan
proposed removing $301 million in obligations triggered by declines in Dynegy's
credit ratings, a $100 million reduction in capital expenditures, a sale or
joint venture of a portion of Dynegy's ownership interest in Northern Natural
and in its United Kingdom natural gas storage facilities, a proposed initial
public offering of Dynegy Energy Partners L.P., a proposed $300-$400 million
mortgage bond offering by IP, workforce reductions and certain other measures.
As part of the capital plan, on June 27, 2002, Dynegy completed an amendment
to the Catlin Associates, LLC minority interest transaction (also referred to
as "Black Thunder"), which permanently removed a $270 million obligation which
could have been triggered by declines in Dynegy's credit ratings. The amended
agreement requires a subsidiary of Dynegy to amortize $275 million over the
remaining three years of the transaction. The subsidiary has already paid
approximately $73 million of the amortization. Quarterly maturities are
approximately $20 million through the first quarter 2005. In addition, Dynegy
agreed to grant mortgages on the midwest power generation assets covered by the
transaction, post a letter of credit to secure a contingent obligation expiring
on December 31, 2002 and make certain structural changes to enhance the
security of the third-party lenders involved in the transaction. As a result of
this amendment, $796 million related to Catlin Associates, LLC was reclassified
from Minority Interest to debt on Dynegy's Condensed Consolidated Balance
Sheets at June 30, 2002.
On June 28, 2002, Dynegy completed a $250 million interim financing, which
bears interest at LIBOR plus 1.75 percent. This loan matures in June 2003 and
represents an advance on a portion of the proceeds from the expected sale of
certain of the Company's United Kingdom natural gas storage facilities. Dynegy
also completed a restructuring of the financing arrangements for West Coast
Power, LLC ("West Coast Power"), a joint venture owned equally by Dynegy and
NRG Energy, that resulted in the release of approximately $100 million in
letters of credit that Dynegy had posted on behalf of West Coast Power. In
connection with this restructuring, West Coast Power repaid bank borrowings
that resulted in the permanent elimination of a $31 million net obligation
which could have been triggered by declines in Dynegy's credit ratings.
On July 15, 2002, Dynegy completed a $200 million interim financing, bearing
interest at LIBOR plus 1.38 percent. This loan matures in January 2003 and is
secured by interests in Dynegy's Renaissance and Rolling Hills merchant power
generation facilities.
Dynegy incurred upfront fees aggregating approximately $19 million in
connection with the interim financings, Black Thunder amendment and West Coast
Power transaction described above.
In addition, on July 28, 2002 Dynegy entered into an agreement to sell
Northern Natural Gas Company ("Northern Natural") to MidAmerican Energy
Holdings Company ("MidAmerican") for $928 million in cash, subject to
adjustment for working capital changes. Under the terms of this agreement,
MidAmerican is expected to acquire all of the common and preferred stock of
Northern Natural and to assume $950 million in outstanding Northern Natural
debt. The transaction is expected to close in August 2002 and is subject to
customary closing conditions, including expiration of the Hart-Scott-Rodino
waiting period, and the continuation of certain
37
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
transition services to Northern Natural. The sale will eliminate approximately
$800 million of Northern Natural debt on Dynegy's consolidated balance sheet.
Following is a list of items that remain to be completed under Dynegy's
original $2 billion capital plan:
. Closing of the pending sale of Northern Natural;
. Sale or joint venture transaction of Dynegy's natural gas storage and gas
processing facilities in the United Kingdom;
. Sale of additional assets totaling $200 million;
. Issuance of $300-$400 million of IP mortgage bonds to repay or refinance
existing obligations;
. Initial public offering of Dynegy Energy Partners L.P., a newly formed
master limited partnership expected to own and operate a portion of the
Company's downstream natural gas liquids business; and
. Consideration of an equity-like offering based on market conditions and
the results of capital-enhancing transactions.
The closing of the Northern Natural sale and the execution of the remaining
elements of the Company's capital plan is expected to provide sufficient
near-term liquidity for the Company. The remaining elements of the capital plan
are subject to a number of risks including factors beyond the Company's
control. These factors include, among others, market conditions for asset
sales, the timeliness and ability to obtain required regulatory approvals,
ongoing investigations and litigation, and the effect of commodity prices and
continued contraction in the markets in which the Company operates, which may
negatively impact its operating cash flow. Current conditions have caused the
termination of a previously announced $325 million mortgage bond offering by IP
and delayed the proposed initial public offering of Dynegy Energy Partners L.P.
These conditions will also impact any potential capital-raising activities of
Dynegy in the near future. In addition, Dynegy has previously announced its
intention to rationalize its customer and risk-management business through a
joint venture or another strategic alternative. Dynegy cannot guarantee that
any of these planned transactions will be successfully completed or that if
completed they will occur on terms that the Company currently anticipates.
Available Credit Capacity, Liquidity and Debt Maturities
Dynegy is currently satisfying its capital requirements primarily with cash
from operations, cash on hand and limited borrowings available under its
revolving credit facilities. Dynegy currently does not have access to the
commercial paper market and has only limited access to the capital markets due
to its non-investment grade credit ratings, the ongoing re-audit of the
Company's historical financial statements and other factors. Given these facts,
Dynegy expects to continue to rely primarily on cash from operations, cash on
hand and proceeds from its capital plan initiatives to fund its near-term
obligations.
38
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
The following table summarizes Dynegy's credit capacity and liquidity
position at June 30, 2002:
Dynegy
Dynegy Holdings Illinois Northern
Total Inc. Inc. Power Natural
------- ------ -------- -------- --------
($ in millions)
Total Credit Capacity........ $ 2,640 $ 300 $1,590 $ 300 $ 450
Outstanding Loans............ (1,390) -- (640) (300) (450)
Outstanding Letters of Credit (810) (240) (570) -- --
------- ----- ------ ----- -----
Unused Borrowing Capacity.... $ 440 $ 60 $ 380 $ -- $ --
Cash......................... 378 26 322 30 --
Highly Liquid Inventory(1)... 214 -- 214 -- --
------- ----- ------ ----- -----
Total Available Liquidity.... $ 1,032 $ 86 $ 916 $ 30 $ --
======= ===== ====== ===== =====
- --------
(1) Consists principally of natural gas inventories that the Company believes
could be monetized within 60 days based on current spot market prices.
During July and August 2002, Dynegy repaid approximately $296 million in
debt maturities and posted substantial additional collateral to support its
business resulting in a reduction in total liquidity from June 30, 2002. The
Company's total available liquidity as of August 12, 2002 was approximately
$593 million, including approximately $330 million in cash, $52 million in
available borrowing capacity and $211 million in highly liquid inventory.
Completion of the Northern Natural sale should enable Dynegy to have sufficient
time and financial resources to rationalize its customer and risk-management
business through a joint venture or another strategic alternative, thereby
reducing its capital requirements and enhancing its liquidity position.
Dynegy's current liquidity levels and its dependence on the sale of Northern
Natural and other elements of its capital plan for financing expose the Company
to substantial risk. In the event that the Northern Natural sale is not
completed or is significantly delayed or if other adverse developments impact
cash liquidity, Dynegy may not be able to meet its near-term obligations. Over
the longer term, particularly in the second quarter 2003 when Dynegy expects to
have approximately $1.9 billion in debt maturities and in the fourth quarter
2003 when Dynegy has a redemption obligation with respect to $1.5 billion in
preferred stock issued to ChevronTexaco, Dynegy's ability to meet its
obligations will require the successful execution of remaining elements of the
capital plan and the rationalization of its customer and risk-management
business. Dynegy faces execution risk with respect to its capital plan and
other strategies both in the near and longer term. If Dynegy is unable to
complete the Northern Natural sale in the near term or other elements of its
strategy prior to the second quarter 2003, it may be forced to consider other
strategic alternatives or a possible reorganization under the protection of
bankruptcy laws.
As of August 12, 2002, the Company's debt and preferred stock maturities
through December 31, 2003, inclusive of letters of credit issued under
revolving credit facilities, were as follows: remainder of third quarter
2002--$14 million; fourth quarter 2002--$386 million (not including a $450
million secured line of credit at Northern Natural that will be assumed by
MidAmerican in the sale of Northern Natural as further described above); first
quarter 2003--$241 million; second quarter 2003--$1,856 million; third quarter
2003--$233 million; and fourth quarter 2003--$1,543 million (including $1.5
billion in Series B Mandatorily Convertible Redeemable Preferred Stock held by
ChevronTexaco).
39
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Trade Credit and Other Collateral Obligations
During the second quarter 2002, Dynegy continued to experience increased
demands to provide collateral in both its trading and other commercial
operations. Counterparties have increased their collateral demands and, in some
cases, have refused to transact little more than spot gas trades with Dynegy.
Most commercial agreements typically include "adequate assurance" provisions or
specific ratings triggers. Specific ratings triggers give counterparties the
right to suspend or terminate credit if the Company's credit ratings fall below
investment grade; "adequate assurance" provisions permit a counterparty to
request adequate assurance (which is generally not specified in the agreement)
of continued performance. Parties engaged in the customer and risk-management
business, including Dynegy, are attempting to implement standardized agreements
that allow for the netting of positive and negative exposures associated with a
single counterparty. Dynegy has executed or is in the process of negotiating
such agreements with a number of its trading partners.
Dynegy's counterparties have historically relied upon DHI's investment grade
credit rating to satisfy their credit support requirements. Prior to April 25,
2002, Dynegy had approximately $350 million in letters of credit posted in
connection with its commercial operations. Since that date, Dynegy has posted
approximately $910 million in additional cash and letters of credit to
collateralize its commercial obligations. Outstanding letters of credit and
cash collateral totaled approximately $1.26 billion as of August 12, 2002.
As further described in Note 15 to the accompanying financial statements,
following the closing of the Northern Natural sale, Dynegy has agreed to
accelerate payment to the month of delivery for a portion of the natural gas
sold to Dynegy by ChevronTexaco under the parties' gas purchase agreement, with
the amount of the accelerated payment generally being equal to 75 percent of
the value of the prior month's gas deliveries, after reduction pursuant to the
parties' netting agreement. Upon consummation of the Northern Natural sale, the
initial payment amount will be $187.5 million. The amount of the payment could
change materially as a result of changes in commodity prices.
As a result of downgrades to Dynegy's credit ratings, the Company received a
request from Sithe/Independence Funding to provide adequate assurance for its
obligations under a long-term tolling agreement, and three other related
contracts, with the Sithe/Independence Power Project. The Company's annual
payments under these arrangements approximate $66 million and the contracts
extend through 2014. The Company has offered to post an additional amount of
collateral as adequate assurance under the contracts. The Company has yet to
reach agreement with Sithe/Independence Funding regarding a mutually acceptable
amount of collateral. Sithe/Independence Funding has sent the Company a notice
of default in this regard and the two parties are continuing to negotiate with
regard to these issues.
Dynegy intends to continue to manage its customer and risk-management
business in a manner consistent with its liquidity position. In response to the
decreasing liquidity in the trading markets and the actions of counterparties
either requiring additional collateral or refusing to trade with the Company,
Dynegy has reduced the level of its customer and risk-management business
activities. The impact of this reduction in activities has adversely impacted
earnings and cash flow. Accordingly, Dynegy is assessing alternative strategies
for its customer and risk-management business. These alternatives include,
among others, an independently rated joint venture comprising this business and
potentially other complimentary assets or businesses. Dynegy's ability to
execute a joint venture or other alternative transaction with respect to its
customer and risk-management business will significantly affect its liquidity
position and future results of operations. For example, if Dynegy were to
contribute its customer and risk-management business to a joint venture with an
investment grade credit rating and independently established trade credit,
Dynegy's capital commitments with respect to that business would be
significantly reduced. Similarly, a reduction in the size of this business
would reduce Dynegy's capital commitments. However, the amount of this
reduction will depend upon the Company's ability to execute such a transaction
and the structure of any such transaction.
40
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
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, including counterparty confidence and the Company's ability to
conduct its customer and risk-management business. In determining the Company's
credit ratings, the rating agencies consider a number of factors. Quantitative
factors that management believes are given significant weight include, among
other things, EBITDA; operating cash flow; total debt outstanding; off balance
sheet obligations and other 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, regulatory investigations and other
contingencies. Although these factors are among those considered by the rating
agencies, each agency may calculate and weigh each factor differently.
Since the Company filed its first quarter 2002 Form 10-Q on May 15, 2002,
all three major credit rating agencies have downgraded Dynegy's credit ratings.
On June 24, 2002, following the announcement of Dynegy's new capital plan,
Fitch, Inc. lowered its credit ratings for, and maintained its Ratings Watch
Negative status on, Dynegy and its subsidiaries. The senior unsecured debt of
Dynegy and Dynegy Holdings was downgraded to "BB+," which is below investment
grade. Fitch subsequently downgraded the senior unsecured debt ratings of
Dynegy and Dynegy Holdings to "BB-" and then to "B," which is five notches
below investment grade. Fitch stated that these ratings actions were based on a
continued weakening in Dynegy's credit profile and concerns over Dynegy's
ability to generate sustainable cash flows and to execute its $2 billion
capital plan.
On June 25, 2002, Standard & Poor's Rating Services lowered its ratings on
Dynegy and its subsidiaries and stated that these ratings would remain on
CreditWatch with negative implications. Standard & Poor's lowered its long-term
corporate credit ratings of Dynegy and its subsidiaries to "BBB-," its lowest
investment grade credit rating. Standard & Poor's subsequently lowered its
long-term corporate credit ratings of Dynegy and its subsidiaries to "BB" and
then to "B+," which is four notches below investment grade. Standard & Poor's
stated that these ratings actions reflected pronounced erosion in Dynegy's core
merchant energy business, including the unwillingness of counterparties to
transact in little more than spot gas trades with Dynegy, and Dynegy's failure
to provide sustainable cash flow necessary for investment grade status.
On June 28, 2002, Moody's Investors Service lowered its ratings on Dynegy
and its subsidiaries and stated that the ratings outlook remained negative. The
senior unsecured debt of Dynegy Holdings was downgraded from "Baa3" to "Ba1,"
which is below investment grade. Moody's subsequently lowered its senior
unsecured debt ratings on Dynegy to "B3," which is six notches below investment
grade, and DHI to "B1," which is four notches below investment grade. Moody's
stated that these ratings actions were based on continuing concerns over
Dynegy's liquidity and operating cash flow, increased amounts of secured debt
and the expectation that future renewals of existing bank debt will likely be
done on a secured basis, effectively subordinating DHI's senior unsecured
lenders.
41
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
As of August 12, 2002, Dynegy's credit ratings, as assessed by the three
major credit rating agencies, were as follows:
Rated Enterprises Standard & Poor's Moody's Fitch
----------------- ----------------- ------- -----
Senior Unsecured Debt Rating:
Dynegy Inc.(1)............ B- B3 B
Dynegy Holdings Inc.(2)... B- B1 B
Illinois Power(3)......... * Ba3 B
Illinova Corporation(4)... B- B1 B
Northern Natural.......... B+ B3 B
Senior Secured Debt Rating:
Illinois Power............ B+ Ba2 BB-
- --------
* Not rated.
(1) Dynegy Inc. is the parent holding company. This entity generally provides
financing to the enterprise through issuance of capital stock.
(2) 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.
(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.
The recent downgrades in Dynegy's credit ratings have caused further
reductions in the amount of trade credit extended by Dynegy's counterparties.
Counterparties have generally increased their collateral demands relating to
Dynegy's trading and commercial obligations. Counterparties in Dynegy's
customer and risk-management business have refused to trade or are unwilling to
transact little more than spot gas trades with the Company. See "Trade Credit
and Other Collateral Obligations" discussion above. Additionally, Dynegy's
non-investment grade status has limited and will likely continue to limit
significantly its ability to refinance its debt obligations and to access the
capital markets and will likely increase the borrowing costs incurred by the
Company in connection with any refinancing activities. The Company's financial
flexibility is likely to be reduced as a result of, among other things,
restrictive covenants and other terms typically imposed on non-investment grade
borrowers.
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 currently 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.
Capital Leases
In response to the initiatives currently underway at the FASB, on June 28,
2002 the Company unilaterally undertook actions, the effect of which altered
the accounting for some of its existing lease obligations and anticipated lease
obligations relating to assets under construction. These actions included the
delivery of
42
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
guarantees of lessor debt in certain existing leases of power generation
facilities. In addition, the Company notified certain lenders of its intent to
purchase power generation facilities that are currently under construction and
that were expected to be placed in synthetic leases upon completion of their
construction. As a result of these actions, approximately $528 million of
obligations due in 2005 to 2007 were brought on-balance sheet. This non-cash
action resulted in an increase to Property, Plant and Equipment and a
corresponding increase in Long-Term Debt on the Company's June 30, 2002
Condensed Consolidated Balance Sheet. These obligations were previously
reported as lease obligations in the footnotes to the Company's financial
statements and in the Commercial Financial Obligations and Contingent Financial
Commitments tables in the Form 10-K. In addition, actions taken by the Company
relating to assets under construction required the reclassification of
approximately $673 million from Prepayments and Other Assets to Property, Plant
and Equipment on the Company's June 30, 2002 Condensed Consolidated Balance
Sheet. Property under capital leases of $528 million is included in Property,
Plant and Equipment and is amortized over the useful life of the asset, which
approximates 40 years.
OTHER MATTERS
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. Substantially all of Dynegy's direct
sales made in California represent bilateral sales made to creditworthy
counterparties. Through its interest in West Coast Power, Dynegy has credit
exposure for past transactions to certain state agencies ("ISO" and "PX"),
which primarily relied on receipts from California utilities to pay their
bills. West Coast Power currently sells directly to the California Department
of Water Resources ("DWR") pursuant to other bilateral agreements.
As described in Note 13 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 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, however, is
being held in abeyance pending completion of settlement talks. While West Coast
Power continues in good faith negotiations with the State of California on
reforming the terms of its DWR contract, settlement ultimately may not be
possible. If a hearing on the contracts entered into by West Coast Power or
others is necessary, the first phase of the hearing will be limited to the
question of whether the California real-time market adversely affected the
long-term bilateral markets. Please read Note 11, "Commitments and
Contingencies," to the Form 10-K and Note 13 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 June 30, 2002, Dynegy's portion of the receivables
owed to West Coast Power by the ISO and PX approximated $208 million.
Management is continually assessing Dynegy's exposure, as well
43
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
as its exposure through West Coast Power, relative to its California
receivables and establishes and maintains reserves as necessary.
Dividend Policy
In further support of the Company's $2 billion capital plan, Dynegy's Board
of Directors has elected not to pay a dividend on Dynegy's Class A or Class B
common stock for the third quarter 2002. Payments of dividends for subsequent
periods will be at the discretion of the Board of Directors, but Dynegy does
not foresee reinstating the dividend in the near term. During the six-month
periods ended June 30, 2002 and 2001, the Company paid approximately $55
million and $49 million in cash dividends, respectively, on common stock.
New Power Plants
In the second quarter 2002, Dynegy started commercial operation at three new
merchant power plants in Kentucky and Michigan. The combined generating
capacity of the facilities is 1,510 MW. These three peaking facilities will
sell the power generated through the East Central Area Reliability Council and
other regions of the country.
Recent Accounting Pronouncements
See Note 4 to the accompanying financial statements for a discussion of
recently issued accounting pronouncements that could affect the Company.
Additionally, the following further describes proposed rules that are likely to
affect the Company if they are issued.
EITF Issue 02-3. In June 2002, the EITF reached consensus on two of three
issues presented in EITF Issue 02-3 "Accounting for Contracts Involved in
Energy Trading and Risk Management Activities." First, the Task Force concluded
that all mark-to-market gains and losses on energy trading contracts (whether
realized or unrealized) should be shown net in the income statement,
irrespective of whether the contract is physically or financially settled. In
addition, the Task Force concluded that an entity should disclose the gross
transaction volumes for those energy trading contracts that are physically
settled. Beginning in the third quarter of 2002, Dynegy will present all
mark-to-market gains and losses on a net basis and will expand its volumetric
disclosures to comply with the consensus. Additionally, in accordance with the
transition provisions in the consensus, comparative financial statements will
be conformed to meet the requirements mandated by the Task Force. It is
estimated that this accounting change will reduce Dynegy's reported revenues
and cost of sales by as much as 85 percent in any given period. The change
in accounting classification will have no impact on operating income, net
income, earnings per share or cash flow from operations.
The second consensus reached by the Task Force related to required
disclosures regarding energy trading operations. The Task Force agreed to
clarify the application of APB Opinion No. 22, "Disclosure of Accounting
Policies" and SOP 94-6, "Disclosure of Significant Risks and Uncertainties" to
an entity's energy trading operations by requiring that entities disclose the
applicability of EITF Issue 98-10, "Accounting for Contracts Involved in Energy
Trading and Risk Management Activities," the types of contracts that are
accounted for as energy trading contracts, a description of the methods and
significant assumptions used to estimate the fair value of various classes of
energy trading contracts and the sensitivity of its estimates to changes in the
near term. The Task Force indicated that additional disclosure regarding the
fair value of contracts, aggregated by source or method of estimating fair
value and by maturity date, would also be meaningful. The Company will assess
its disclosures with respect to these matters.
44
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
The third issue addressed by the Task Force in EITF Issue 02-3 deals with
the recognition of unrealized gains and losses at inception (commonly referred
to as dealer profit) of an energy trading contract. The Task Force reached no
consensus on this issue and the issue was assigned to a working group for
resolution by no later than the end of the calendar year. Inherent in these
discussions is the fundamental conclusion of whether and when an enterprise
should use valuation models for the purpose of valuing energy contracts that
are transacted in regions or in periods which lack significant trading activity
(i.e., market liquidity).
Consistent with SFAS No. 107, SFAS No. 125, and SFAS No. 133, EITF Issue No.
98-10 footnote 2, stated that quoted market prices in active markets are the
best evidence of fair value and shall be used as the basis for measuring
transactions, if available. The footnote further states that if a quoted market
price is unavailable, the estimate of fair value shall be based on the best
information available in the circumstances. The estimate of fair value shall
consider prices for similar energy contracts and the results of valuation
techniques to the extent available. Those techniques shall incorporate
assumptions that market participants would use in their estimates of values,
future revenues, future expenses, interest rates, default risk, prepayment
risk, and volatility. The guidance goes on to explain that examples of
valuation techniques include the present value of expected future cash flows
using discount rates commensurate with the risks involved, option-pricing
models, matrix pricing, option-adjusted spread models, and fundamental analysis.
In EITF Issue No. 00-17, the Task Force reiterated its consensus that energy
contracts, including energy-related contracts, that are within the scope of
EITF Issue No. 98-10 should be reported at fair value on a stand-alone, or
individual contract, basis. In Issue No. 00-17, the Task Force declined to
specify whether any specific measurement techniques for estimating fair value
of individual contracts should be considered unacceptable or to proscribe any
specific valuation methodologies. Rather, the Task Force reiterated that the
estimate of fair value should be based on the best information available in the
circumstances. The Task Force stated in Issue No. 00-17 that:
. The price at which an energy contract is exchanged normally is its
initial fair value;
. Current market transactions also may provide evidence for recognition of
dealer profit;
. When available, current market transactions provide the basis for
estimating subsequent changes in fair value;
. Valuation models, including option pricing models, should be used only
when market transactions are not available to evidence fair values; and
. When valuation models are used, the best information available would
consider, but is not limited to, recent spot prices and forward prices,
and for option pricing models, the volatility implied by recent
transactions, when available, or the historical volatility of the
commodities and/or services underlying the contract.
As stated previously, a working group of the Task Force was assigned the
task of definitively resolving this issue by the end of the calendar year.
However, upon issuing the EITF minutes of the June 19 - 20 EITF meeting (which
meeting included a discussion of Issue No. 02-3), the FASB staff stated that it
will continue to hold the view that EITF 98-10 and 00-17 do not allow for
recognition of dealer profit (i.e., unrealized gain or loss at inception of a
transaction) unless evidenced by quoted market prices or other current market
transactions for energy trading contracts with similar terms and counterparties.
Dynegy has consistently employed modeling valuation techniques consistent
with those described in Issues 98-10 and 00-17 as a means of adhering to the
fair value accounting model prescribed by authoritative literature
45
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
for certain parts of its business operations. The businesses affected, the
models employed and the assumptions underlying these models are disclosed in
Dynegy's annual report on Form 10-K for the year ended December 31, 2001.
Management is uncertain as to how the working group will resolve issues
related to recognition of dealer profit. Further, it is unclear how the working
group will address dealer profit and the accounting transition resulting from
adoption of new guidance. Three transition alternatives exist in practice.
These transition alternatives include: (a) a retroactive restatement to
eliminate dealer profit recognized in previous periods; (b) a cumulative effect
adjustment for a change in accounting principle, which eliminates the
recognition of previous periods' dealer profit in the current period; or, (c)
as a prospective change, eliminating the recognition of dealer profit on future
transactions but leaving past transactions unaffected. Finally, it is unclear
whether the scope of the working group's activities will include a
comprehensive conclusion regarding the appropriateness of the use of models as
a fundamental method for valuing transactions when market quotations are
unavailable. Should the Task Force issue definitive guidance on any one or all
of these issues, it will impact Dynegy. However, the extent of the financial
impact to Dynegy, if any, cannot be predicted with any degree of certainty
until the scope of the Task Force's conclusion is known and the transition
alternative is mandated. If the Task Force prefers a retroactive or a
cumulative effect transition alternative, then Dynegy's historical financial
position and results of operations will be impacted negatively. If the Task
Force prefers a prospective transition alternative, then Dynegy's current
financial position will be unaffected and the impact to future operations in
the near term is not expected to be material (largely as a result of a
reduction in these types of transactions in the marketplace). As an order of
magnitude, approximately $419 million of assets valued using models are
included in Dynegy's net risk management assets at June 30, 2002.
EITF Issue 01-08. The EITF is deliberating the issue of when an
energy-related contract under EITF Issue No. 98-10, "Accounting for Contracts
Involved in Energy Trading and Risk Management Activities," is a lease. This
issue impacts the accounting for tolling arrangements that are considered
energy-related contracts. A working group has been formed to assess the
implications of this issue and their work is continuing. The working group
agreed that the evaluation of whether an arrangement conveys the right to use
property, plant, or equipment should be based on the substance of an
arrangement and that the property that is the subject of a lease must be
specified (explicitly or implicitly) either at inception of the arrangement or
at the beginning of the lease term. The working group generally agreed that
when property, plant, or equipment is explicitly identified and the benefits of
the property, plant, or equipment are conveyed based on the passage of time,
the arrangement is likely a lease. The difficulty in determining whether an
arrangement is a lease arises when the property, plant, or equipment is not
explicitly identified and/or the benefits of property, plant, or equipment are
conveyed based on the output of the property, plant, or equipment. Management
is uncertain as to how the working group will conclude on this issue but will
continue to assess the potential impact to the Company as more definitive
guidance from the working group is made public.
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 financial statements included in the 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 financial statements included in
the Form 10-K. Accounting methodology and application of accounting
methodologies are more fully described in the Form 10-K.
46
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
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.
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
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 currently
reflected gross in revenues and cost of sales. Upon adoption of EITF 02-3,
effective for the third quarter 2002, realized and settled amounts will be
reflected net in the income statement.
Dynegy estimates the fair value of its marketing portfolio using a
liquidation value approach assuming normal liquidity. The estimated fair value
of the portfolio is computed by multiplying all existing positions in the
portfolio by estimated mid-market prices, reduced by a LIBOR-based time value
of money adjustment and deduction of reserves for credit, price and market
risks.
47
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Dynegy's forward power price curves are derived by modeling a combined cycle
gas facility as a "spark spread" in the calculation of required cost of capital
returns. This assumption is based on the premise that a portfolio manager would
be indifferent to holding these two assets and is reflective of how Dynegy
manages its own portfolio of physical and financial positions. Dynegy's
modeling methodology has been consistently applied during the quarters ended
June 30, 2002 and March 31, 2002 and the three years in the period ended
December 31, 2001.
Market Information Generating Facility
Information
Natural Gas Location
Prices Inflation Rates
Natural Gas Location Capital and Operational
Market Volatility Costs
Natural Gas Volatility
Forecast Economic Growth Rates
Power Volatility Factors Impact of Temperature and
Altitude
Monthly On and Off Peak Local Taxes and
Curve Shapes Environmental Restriction
Regional Correlation
Assessments Industry Cost of Capital
Supply/Demand Balance
Dynegy's cost-based pricing models depend on extensive, region specific
studies regarding the cost of new generation, as well as detailed proprietary
competitive intelligence on new generation additions, retirements and estimates
of regional power demand growth. Dynegy believes its pricing models are based
on reasonable and sound assumptions. Risks associated with these assumptions
include actual versus estimated regional supply/demand balance, the accuracy of
cost and cost of capital estimates and assumptions regarding the preferred
future technologies and regulatory factors that could impact the continued
formation of competitive markets. As with pricing curves derived from quoted
market prices, the application of forecasted pricing curves to contractual
commitments may result in realized cash returns on these commitments that vary
significantly, either positively or negatively, from the estimated values.
Dynegy's enterprise-wide risk department, led by Dynegy's Chief Risk
Officer, independently verifies the outputs from the Company's proprietary
pricing models. This department routinely applies a mathematical model approach
to independently assess forward price curves. This methodology derives forward
energy prices from assumptions about the random factors driving energy prices
and other key variables such as the long-term price and mean reversion rate.
This method is consistent with market observable forward prices and
volatilities. The method models the evolution of the entire forward curve
conditioned on the initial forward curve. Material differences, if any, between
the forward curves developed from Dynegy's proprietary systems and the
mathematical model are reviewed, assessed and, if deemed necessary by the Chief
Risk Officer and Controller, adjusted in determining the reported fair value of
the marketing portfolio.
48
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
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 June 30, 2002 and December 31, 2001:
Net Risk-Management Asset and Liability Disclosures
Total 2002(3) 2003 2004 2005 2006 Thereafter
----- ------- ---- ---- ---- ---- ----------
($ in millions)
Mark-to-Market Value of Risk-Management Assets and
Liabilities(1):
June 30, 2002(2)............................... $639 $ 3 $93 $38 $ (1) $58 $448
December 31, 2001.............................. 678 460 33 20 (18) 29 154
---- ----- --- --- ---- --- ----
Increase (Decrease)............................... $(39) $(457) $60 $18 $ 17 $29 $294
==== ===== === === ==== === ====
- --------
(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, which
are included in other comprehensive income (a component of Stockholders'
Equity). The net risk-management assets of $623 million on the Condensed
Consolidated Balance Sheet include the $639 million herein as well as
emission allowance credits, other comprehensive income balances and other
non-trading amounts.
(2) Excluding the impact of Project Alpha, net risk-management assets and
liabilities would have been as follows: Total--$958 million, 2002--$48
million, 2003--$182 million, 2004--$123 million, 2005--$80 million,
2006--$77 million and Thereafter--$448 million. See Note 1 to the
accompanying financial statements.
(3) Amounts represent July 1 to December 31, 2002 values in the June 30, 2002
row and January 1 to December 31, 2002 values in the December 31, 2001 row.
The increases (decreases) in the Net Risk Management Asset and Liabilities
were impacted by the following:
. A net deferral of the anticipated timing of cash inflows totaling $95
million from the 2002 through 2004 time periods to beyond 2006 related to
long-term natural gas storage transactions. The change in the timing of
cash inflows on these transactions results from the decision to extend
the term of the contract through 2007;
. The realization of approximately $338 million of cash related to
contracts settled during the first and second quarters of 2002;
. The execution in the first quarter of 2002 of a large power origination
transaction, which increased anticipated cash inflows beyond 2006 by $114
million; and
. The impact of the recognition of other net mark-to-market gains, change
in reserves, changes in interest rates and changes in foreign exchange
rates and their related impact on the discounted value of the portfolio
and related annual cash flow amounts.
49
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Net Risk-Management Asset and Liability Disclosures
Six Months Six Months
Ended Ended
June 30, December 31, Total
2002 2002 2002 2003 2004 2005 2006 Thereafter
---------- ------------ ----- ---- ---- ---- ---- ----------
($ in millions)
Cash Flow of Risk-Management
Assets and Liabilities(1):
June 30, 2002(2)......... $338 $26 $ 364 $115 $51 $ 5 $75 $1,079
December 31, 2001........ 496 55 40 (2) 53 330
----- ---- --- --- --- ------
Increase (Decrease)......... $(132) $ 60 $11 $ 7 $22 $ 749
===== ==== === === === ======
- --------
(1) The cash flow value reflects realized cash flows for the remaining periods
for the six months ended June 30, 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, which are included in other
comprehensive income (a component of Stockholders' Equity) as well as
emission allowance credits and other non-trading amounts.
(2) Excluding the impact of Project Alpha, the cash flows would have been as
follows: six months ended December 31, 2002--$71 million; 2003--$206
million; 2004--$142 million; 2005--$97 million; 2006--$105 million; and
Thereafter--$1,079 million. See Note 1 to the accompanying financial
statements.
50
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
The following table provides a reconciliation of the risk-management data on
the balance sheet, statement of operations and statement of cash flows ($ in
millions):
As of and for
the Six
Months
Ended
June 30, 2002
-------------
Balance Sheet Risk-Management Accounts
Fair value of portfolio at January 1, 2002.......................................... $ 751
Risk-management gains recognized through the income statement in the period, net(1). 208
Cash received related to contracts settled in the period, net....................... (338)
Changes in fair value as a result of a change in valuation technique(2)............. --
Non-cash adjustments and other...................................................... 2
-----
Fair value of portfolio June 30, 2002............................................... $ 623
=====
Income Statement Reconciliation
Risk-management gains recognized through the income statement in the period, net.... $ 208
Physical business recognized through the income statement in the period, net........ (30)
Non-cash adjustments and other...................................................... (2)
-----
Net recognized operating margin(3).................................................. $ 176
=====
Cash Flow Statement
Cash received related to risk-management contracts settled in the period, net....... $ 338
Estimated cash paid related to physical business settled in the period, net......... (30)
Timing and other, net(4)............................................................ (34)
-----
Cash received (paid) during the period.............................................. $ 274
=====
Risk Management cash flow adjustment for the six-month period ended June 30, 2002(5) $ 98
=====
- --------
(1) This amount includes approximately $140 million which represents
management's estimate of the initial value of new contracts entered into in
the six months ended June 30, 2002.
(2) Dynegy's modeling methodology has been consistently applied period over
period.
(3) This amount consists primarily of the customer and risk-management portion
of WEN's operating income before the deduction of Depreciation and
Amortization, Impairment and Other Charges and General and Administrative
Expenses.
(4) Primarily represents cash paid for emission credits and physical inventory
utilized in customer and risk-management business.
(5) This amount is calculated as "Cash received (paid) during the period" less
"Net recognized operating margin."
51
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
The following table provides an assessment of net contract values by year
based on the Company's valuation methodology described above. Approximately 35
percent of Dynegy's net risk-management asset value at June 30, 2002 was
determined by market quotations or validation against industry posted prices.
This is a significant reduction from the December 31, 2001 amount of 83 percent
and March 31, 2002 amount of 55 percent. The percentage reduction resulted from
a significant realization of cash during the six-month period, a significant
power origination transaction during the first quarter, the impact of reduced
industry liquidity on the portfolio and a transfer of $105 million of cash
flows from Other External Sources to Prices Based on Models. At June 30, 2002,
the Company was unable to validate the pricing of certain transactions against
external sources, as the merchant energy industry is currently experiencing
reduced energy trading and wholesale origination activity associated with low
market liquidity. The Company will continue to assess the liquidity of the
market as a prolonged downturn in transaction volumes in the industry as a
whole or within specific regions could result in further reduction in the
availability of market quotations.
Net Fair Value of Marketing Portfolio
Total 2002(1) 2003 2004 2005 2006 Thereafter
----- ------- ---- ---- ---- ---- ----------
($ in millions)
Market Quotations(2)........................ $110 $ 3 $51 $(1) $(85) $(20) $162
Other External Sources(3)................... 110 -- 42 39 25 (1) 5
- ---- --- --- --- ---- ---- ----
Market Quotations and Other External Sources 220 3 93 38 (60) (21) 167
Prices Based on Models(4)................... 419 -- -- -- 59 79 281
- --------
(1) Amount represents July 1 to December 31, 2002 values.
(2) Prices obtained from actively traded, liquid markets for commodities other
than natural gas positions. All natural gas positions for all periods are
contained in this line based on available market quotations.
(3) Mid-term prices validated against industry posted prices.
(4) See discussion of the Company's use of long-term models in the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" section in the Form 10-K.
The Company is evaluating the possibility of presenting the Net Fair Value
of the Marketing Portfolio in two categories, "Market Quotations and Other
External Sources" and "Prices Based on Models" beginning in the third quarter
2002.
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 and foreign exchange 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.
52
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
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 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. The Company has also
disclosed an average VaR for the quarters ended June 30, 2002 and December 31,
2001 in order to provide context around the one-day amounts.
The following table sets forth the aggregate daily VaR of Dynegy's marketing
portfolio:
Daily and Average VaR for Marketing Portfolio
June 30, December 31,
2002 2001
-------- ------------
($ in millions)
One Day VaR--95% Confidence Level............................ $16 $18
=== ===
One Day VaR--99% Confidence Level............................ $23 $26
=== ===
Average VaR for the Year-to-Date Period--95% Confidence Level $19 $12
=== ===
The increase in Average VAR from December 31, 2001 is due primarily to the
long-term power origination transactions executed in the first quarter 2002 and
to increased volatility in the second quarter 2002 due to volatility of power
prices in the summer months as compared to the entire year of 2001.
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.
53
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Dynegy's industry has historically operated 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. Recent events in the merchant energy
industry have affected historical credit activities in the industry. Please
read "Trade Credit and Other Collateral Obligations" above.
The following table displays the value of Dynegy's marketing portfolio,
inclusive of hedging activities, at June 30, 2002 (in millions):
Investment Grade Credit Quality.......... $ 657
Below Investment Grade Quality or Unrated 174
-----
Value of portfolio before reserves....... 831
Credit and market reserves............... (192)
-----
639
Other(1)................................. (16)
-----
Net risk-management assets(2)............ $ 623
=====
- --------
(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.
The following table sets forth the daily and average VaR associated with the
interest rate component of the marketing portfolio. 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 June 30, 2002 and December
31, 2001 and are reflected in the table below.
Daily and Average VaR on Interest Component of Marketing Portfolio
June 30, December 31,
2002 2001
-------- ------------
($ in millions)
One Day VaR--95% Confidence Level............................ $0.2 $1.6
==== ====
Average VaR for the Year-to-Date Period--95% Confidence Level $0.5 $1.6
==== ====
54
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
The decrease in One Day VaR is due to the timing of removing positions with
Enron from the Company's portfolio at the end of December 2001 and not changing
the hedge positions until early January 2002. The decrease in Average VaR is
due to the impact of the Company's hedging program since the entire six months
of 2002 were under this program that was initiated in November 2001.
In addition to the marketing portfolio, the Company is exposed to
fluctuating interest rates as it relates to other variable rate financial
obligations. Based on sensitivity analysis as of June 30, 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 June 30,
2003 would (decrease) increase income before taxes by approximately $20
million. Hedging instruments executed to mitigate such interest rate exposure
are included in the sensitivity analysis.
Foreign Currency Exchange Rate Risk. Foreign currency risk arises from the
Company's investments in affiliates and subsidiaries owned and operated in
foreign countries. Such risk is also a result of risk management transactions
with customers in countries outside the U.S. Management continually monitors
its exposure to fluctuations in foreign currency exchange rates. When possible,
contracts are denominated in or indexed to the U.S. dollar, or such risk may be
hedged through debt denominated in the foreign currency or through financial
contracts. At June 30, 2002, the Company's primary foreign currency exchange
rate exposures were the United Kingdom Pound, Canadian Dollar, European Euro
and Norwegian Kroner.
The following table sets forth the daily and average foreign currency
exchange VaR. Hedging instruments executed to mitigate such foreign currency
exchange exposure are included in the VaR as of June 30, 2002 and December 31,
2001 reflected in the table below.
Daily and Average Foreign Currency Exchange VaR
June 30, December 31,
2002 2001
-------- ------------
($ in millions)
One Day VaR--95% Confidence Level............................ $0.7 $0.6
= ==== ====
Average VaR for the Year-to-Date Period--95% Confidence Level $0.4 $1.1
= ==== ====
55
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
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 at June 30, 2002 and
December 31, 2001, respectively:
Absolute Notional Contract Amounts
June 30, December 31,
2002 2001
-------- ------------
Natural Gas (Trillion Cubic Feet).......................................... 17.087 11.936
Electricity (Million Megawatt Hours)....................................... 149.830 77.997
Natural Gas Liquids (Million Barrels)...................................... 2.920 5.655
Crude Oil (Million Barrels)................................................ 37.250 --
Weather Derivatives (In thousands of $/Degree Day)......................... $ 224 $ 190
Coal (Millions of Tons).................................................... 9.8 18.5
Variable Rate Financial Obligation Interest Rate Swaps (In Millions of U.S.
Dollars)................................................................. $ 2,000 $ --
Weighted Average Fixed Interest Rate Paid (Percent)........................ 2.755 --
Fair Value Hedge Interest Rate Swaps (In Millions of U.S. Dollars)......... $ 626 $ 206
Fixed Interest Rate Received on Swaps (Percent)............................ 5.619 5.284
Interest Rate Risk-Management Contract (In Millions of U.S. Dollars)....... $ 626 $ 206
Fixed Interest Rate Paid (Percent)......................................... 5.643 5.310
U.K. Pound Sterling (In Millions of U.S. Dollars).......................... $ 764 $ 906
Average U.K. Pound Sterling Contract Rate (In U.S. Dollars)................ $ 1.430 $ 1.423
Euro (In Millions of U.S. Dollars)......................................... $ 27 $ 18
Average Euro Contract Rate (In U.S. Dollars)............................... $ 0.930 $ 0.886
Canadian Dollar (In Billions of U.S. Dollars).............................. $ 1.141 $ 1,395
Average Canadian Dollar Contract Rate (In U.S. Dollars).................... $ 0.640 $ 0.644
RESULTS OF OPERATIONS
Provided below are a narrative and tabular presentation of certain operating
and financial data and statistics for the Company's businesses for the three-
and six-month periods ended June 30, 2002 and 2001. For segment reporting
purposes, all general and administrative expenses incurred by Dynegy on behalf
of its subsidiaries are charged to the applicable subsidiary as incurred.
Dynegy allocates indirect general and administrative expenses to its
subsidiaries using a two-step formula that considers both payroll expense and
the net book value of property, plant and equipment. Interest expense incurred
by Dynegy on behalf of its subsidiaries is allocated based on the subsidiaries'
debt to equity relationship. Other income (expense) items incurred by Dynegy on
behalf of its subsidiaries are allocated equally among sub-components of the
four segments.
56
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
The reconciliation from reported net income (loss) and EPS to recurring net
income (loss) and EPS, adjusted for the impact of non-recurring special
charges, is as follows:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- ---------------------------
2002 2001 2002 2001
------------- ------------ ------------- ------------
Income Income
(Loss) EPS Income EPS (Loss) EPS Income EPS
------ ------ ------ ----- ------ ------ ------ -----
Net Income (Loss) and EPS, as
reported(1)............................. $(328) $(0.92) $146 $0.43 $(468) $(1.33) $285 $0.84
Impairment of communications
assets(2)............................... 212 0.58 -- -- 256 0.70 -- --
Severance(3)............................. 24 0.07 -- -- 24 0.07 -- --
Natural gas marketing charge(4).......... 80 0.22 80 0.22
Loss on gas delivery commitment(5)....... -- -- -- -- 13 0.04 -- --
Cumulative effect of change in accounting
principle(6)............................ -- -- -- -- 256 0.70 (2) --
Other(7)................................. 8 0.02 -- -- 8 0.02 -- --
Special dividend(8)...................... -- 0.02 -- -- -- 0.04 -- --
FAS 128 EPS calculation difference(9).... -- -- -- -- -- (0.05) -- --
----- ------ ---- ----- ----- ------ ---- -----
Recurring Net Income (Loss) and
EPS..................................... $ (4) $(0.01) $146 $0.43 $ 169 $ 0.41 $283 $0.84
===== ====== ==== ===== ===== ====== ==== =====
- --------
(1) Dynegy will restate its June 30, 2001 Condensed Consolidated Financial
Statements to increase the income tax provision for the three- and
six-month periods ended June 30, 2001 by approximately $27 million relating
to the elimination of the tax benefit associated with Project Alpha. This
will reduce net income and recurring net income by $27 million in the
three- and six-month periods ended June 30, 2001 and will reduce the
corresponding earnings per share amounts for those periods. See the related
disclosure in Note 1 to the accompanying Condensed Consolidated Financial
Statements.
(2) The Company recognized an after-tax charge of $212 million ($326 million
pre-tax) and $256 million ($390 million pre-tax) associated with the
write-down of certain communications assets and technology investments for
the three- and six-month periods ended June 30, 2002, respectively. The
pre-tax charge is included in Cost of Sales, Impairment and Other Charges,
Earnings (Losses) of Unconsolidated Affiliates and Other Expenses in the
accompanying Condensed Consolidated Statements of Operations.
(3) The Company recognized an after-tax charge of approximately $24 million
($37 million pre-tax) for severance benefits for approximately 325
employees, including the Company's former Chief Executive Officer and Chief
Financial Officer. The charge is included in Impairment and Other Charges
in the accompanying Condensed Consolidated Statements of Operations.
(4) Dynegy recognized an after-tax charge of $80 million ($124 million pre-tax)
related principally to its natural gas marketing business. As a result of
this charge and the current inability of the Company to allocate this
charge to specific accounting periods, the Company has decided to undergo
re-audits of its financial statements for each of the three years in the
period ended December 31, 2001. If necessary, the Company will restate
prior period financial statements based on its continuing review process to
determine the periods affected. Dynegy has engaged PricewaterhouseCoopers
to re-audit its 1999-2001 consolidated financial statements. The Company
expects that this re-audit will take at least the remainder of the year to
complete. Following the completion of this re-audit, the Company expects
that PricewaterhouseCoopers will perform its required quarterly reviews of
the financial statements for each of the quarterly periods in 2002.
(5) The Company incurred a $13 million ($18 million pre-tax) charge in the
first quarter 2002 associated with a commitment to deliver gas assumed in
the acquisition of Northern Natural. The pre-tax charge is included in
Revenues in the accompanying Condensed Consolidated Statements of
Operations.
57
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
(6) Effective January 1, 2002, the Company adopted Statement No. 142, realizing
an after-tax cumulative effect loss of approximately $256 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.
(7) The amount represents $4 million after-tax ($6 million pre-tax) of fees
related to a voluntary action that the Company took that altered the
accounting for certain lease obligations. Additionally, the Company had $4
million after-tax ($6 million pre-tax) of write-offs related to information
technology equipment. These amounts are included in Other Income and Other
Expenses in the accompanying Condensed Consolidated Statements of
Operations.
(8) The special dividend in 2002 relates to the conversion price embedded in
the Series B Preferred Stock held by Chevron U.S.A. Inc, a subsidiary of
ChevronTexaco.
(9) When an entity has a net loss from continuing operations, Statement of
Financial Accounting Standards No. 128, "Earnings per Share," prohibits the
inclusion of 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 three and six months ended June 30, 2002. However, when calculating
recurring diluted earnings per share, there is not a net loss from
continuing operations, thus the diluted shares outstanding amount is used
rather than the basic shares outstanding amount. In reconciling reported
diluted loss per share and recurring diluted earnings per share, there is a
reconciling difference due to different denominators being used (basic
shares outstanding for reported diluted loss per share and diluted shares
outstanding for recurring diluted earnings per share).
Three-Month Periods Ended June 30, 2002 and 2001
For the quarter ended June 30, 2002, Dynegy recorded a net loss of $328
million or $0.92 per diluted share, compared with second quarter 2001 net
income of $146 million or $0.43 per diluted share. Recurring net loss,
excluding non-recurring after-tax charges of $324 million, was $4 million or
$0.01 per diluted share for the quarter ended June 30, 2002, compared with
second quarter 2001 recurring net income of $146 million or $0.43 per diluted
share. The second quarter 2002 recurring net income excludes non-recurring
after-tax charges of $212 million related to the impairment of certain
telecommunications assets and technology investments, $80 million related to
the Company's natural gas marketing business and $32 million primarily for
severance and related exit costs and other write-offs. On a recurring basis,
the $150 million decrease in net income is due primarily to reduced energy
trading and customer origination and lower sales prices received by the
Company's generation and natural gas liquids businesses. Second quarter 2002
results benefited from inclusion of the BG Storage Limited ("BGSL") natural gas
storage assets in the United Kingdom, which were acquired in the fourth quarter
2001.
As described in Note 4 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 June 30,
2001, had goodwill not been amortized during that period, would have been $158
million or $0.47 per diluted share.
Operating income decreased $469 million quarter-to-quarter due primarily to
less price volatility for gas marketing in certain areas of the country, lower
sales prices received by the Company's generation and natural gas liquids
businesses, a $323 million pre-tax impairment charge related to severance and
impairment of communications segment assets and increased depreciation and
amortization expense. 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.
58
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Impacting Dynegy's consolidated results was the Company's earnings (losses)
from investments in unconsolidated affiliates, which was a loss of
approximately $7 million in 2002 compared to earnings of $78 million in 2001.
Variances period-to-period in these results primarily reflect the impact of the
impairment of $40 million of certain technology investments resulting from
unfavorable market conditions, a $36 million decrease in earnings related to
West Coast Power and an approximate $10 million charge recognized in the second
quarter 2002 related to a 2001 earnings restatement at NICOR Energy.
Interest expense totaled $83 million for the three-month period ended June
30, 2002, compared to $68 million for the equivalent 2001 period. The variance
is primarily attributable to higher average principal balances in the 2002
period compared to the 2001 period, partially offset by lower average interest
rates on borrowings.
Other income and expenses, net (including minority interest expense and
accumulated distributions associated with trust preferred securities) totaled
$144 million in expense in the quarter ended June 30, 2002. Combined other
income and other expenses totaled zero in 2001. Variances period-to-period in
these results primarily reflect the impact of the natural gas marketing charge
described above. Additional items impacting the variance include increased
litigation expense during 2002, losses associated with the retirement of
existing IT systems during the second quarter 2002 as a result of implementing
new systems and gains recognized in 2001 from asset sales.
The Company reported an income tax benefit of $177 million for the quarter
ended June 30, 2002, compared to an income tax provision of $62 million for the
2001 period. The effective tax rates approximated 35 percent and 30 percent in
2002 and 2001, respectively. The difference in the 2001 period from the
effective tax rates and the statutory tax rate of 35 percent 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.
Six-Month Periods Ended June 30, 2002 and 2001
For the six months ended June 30, 2002, Dynegy recorded a net loss of $468
million or $1.33 per diluted share, compared with net income of $285 million or
$0.84 per diluted share in the same 2001 period. Recurring net income,
excluding non-recurring after tax charges of $637 million, was $169 million or
$0.41 per diluted share for the six months ended June 30, 2002, compared with
recurring net income of $283 million or $0.84 per diluted share in the same
2001 period. The six-month period ended June 30, 2002 recurring net income
excludes non-recurring charges related to impairment of communications assets
and technology investments, severance, a charge related principally to natural
gas marketing, a loss on a gas delivery commitment and a cumulative effect of a
change in accounting principle related to goodwill. On a recurring basis, the
$114 million decrease in net income is due primarily to the aforementioned
reduced energy trading and origination, decline in price volatility and lower
sales prices received by the Company's generation and natural gas liquids
businesses in the second quarter, partially offset by increased origination in
the first quarter. In addition, the 2002 period results benefited from the
inclusion of Northern Natural, which the Company acquired effective February 1,
2002, and the BGSL natural gas storage assets. The recurring net income for the
six-month period ended June 30, 2001 excludes the $2 million cumulative effect
of change in accounting principle recorded in connection with the Company's
adoption of Statement No. 133.
As described in Note 4 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 six months ended June 30,
2001, had goodwill not been amortized during the period, would have been $309
million or $0.91 per diluted share.
59
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Operating income decreased $472 million period over period primarily due to
less price volatility for gas marketing in certain areas of the country, lower
sales prices received by the generation business, a $323 million pre-tax
impairment charge related to severance and impairment of communications segment
assets and increased depreciation and amortization expense. 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 (losses)
from investments in unconsolidated affiliates, which was approximately $18
million of losses and $110 million of earnings in the 2002 and 2001 periods,
respectively. Variances period-to-period in these results primarily reflect the
impact of the impairment of $85 million of certain technology investments
resulting from unfavorable market conditions, a $33 million decrease in
earnings related to West Coast Power and an approximate $10 million charge
recognized in the second quarter 2002 related to a 2001 earnings restatement at
NICOR Energy.
Interest expense totaled $162 million for the six-month period ended June
30, 2002, compared to $130 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, partially offset by lower average interest rates
on borrowings.
Other income and expenses, net (including minority interest expense and
accumulated distributions associated with trust preferred securities) totaled
$139 million in expense in the six-month period ended June 30, 2002 compared
with $16 million in expense in the same 2001 period. Variances period-to-period
in these results primarily reflect the impact of the natural gas marketing
charge described above. Additional items impacting the variance include
increased litigation expense during 2002, losses associated with the retirement
of existing IT systems during the second quarter of 2002 as a result of
implementing new systems and gains recognized in 2001 from asset sales and
insurance refunds.
The Company reported an income tax benefit of $126 million for the six-month
period ended June 30, 2002, compared to an income tax provision of $134 million
for the 2001 period. The effective tax rates approximated 37 percent and 32
percent in 2002 and 2001, respectively. The difference from the effective tax
rates and the statutory tax rate of 35 percent results principally from
permanent differences arising from the amortization of certain intangibles,
book-tax basis differences and the effect of certain foreign equity investments
and state income taxes.
60
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
The following table provides recurring financial contribution by contract
type and segment. Financial contribution is defined as Revenues less Cost of
Sales plus Earnings (Losses) from Unconsolidated Investments. Management
believes this disclosure provides insight into the dependability and
sustainability of earnings and cash flows by business segment. However,
financial contribution is a non-GAAP measure and should not be considered as an
alternative to net income as an indicator of our operating performance or as an
alternative to cash flows as a better measure of liquidity. Additionally, other
companies may calculate similarly titled measures in a different manner so as
to make these measures difficult to compare. A reconciliation to recurring and
reported operating income has been provided for further clarification of how
this non-GAAP measure compares to a GAAP measure.
For the Three Months Ended June 30, 2002
------------------------------------
WEN DMS T&D DGC Consolidated
---- ---- ---- ----- ------------
($ in millions)
Regulated............................................. $ -- $ -- $141 $ -- $ 141
Contract.............................................. 133 53 -- -- 186
Other Asset Businesses................................ 16 -- -- (13) 3
Trading and Other..................................... 2 3 -- 1 6
---- ---- ---- ----- -----
Total Recurring Financial Contribution................ 151 56 141 (12) 336
Less Earnings/Add Loss from Unconsolidated Investments (27) (6) 1 -- (32)
Less Depreciation and Amortization.................... (54) (24) (56) (7) (141)
Less General and Administrative Expenses.............. (61) (12) (22) (16) (111)
---- ---- ---- ----- -----
Total Recurring Operating Income (Loss)............... 9 14 64 (35) 52
Non-Recurring Items Impacting Operating Income (Loss). (26) (3) (7) (287) (323)
---- ---- ---- ----- -----
Total Operating Income (Loss)......................... $(17) $ 11 $ 57 $(322) $(271)
==== ==== ==== ===== =====
For the Six Months Ended June 30, 2002
--------------------------------------
WEN DMS T&D DGC Consolidated
----- ---- ----- ----- ------------
($ in millions)
Regulated............................................. $ -- $ -- $ 325 $ -- $ 325
Contract.............................................. 258 103 -- -- 361
Other Asset Businesses................................ 45 -- -- (34) 11
Trading and Other(1).................................. 178 20 -- 6 204
----- ---- ----- ----- -----
Total Recurring Financial Contribution................ 481 123 325 (28) 901
Less Earnings/Add Loss from Unconsolidated Investments (57) (10) 1 -- (66)
Depreciation and Amortization......................... (100) (43) (103) (12) (258)
General and Administrative Expenses................... (142) (25) (47) (34) (248)
----- ---- ----- ----- -----
Total Recurring Operating Income (Loss)............... 182 45 176 (74) 329
Non-Recurring Items Impacting Operating Income (Loss). (26) (3) (25) (294) (348)
----- ---- ----- ----- -----
Total Operating Income (Loss)......................... $ 156 $ 42 $ 151 $(368) $ (19)
===== ==== ===== ===== =====
- --------
(1) WEN's Trading and Other for the six months ended June 30, 2002 included
$114 million related to a large power origination transaction executed in
the first quarter 2002.
61
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Segment Disclosures
WHOLESALE ENERGY NETWORK
Three Months Six Months Ended
Ended June 30, June 30,
--------------------- --------------------
2002 2001 2002 2001
------ ------- ------ -------
($ in millions, except operating statistics)
Operating Income:
Customer and Risk-Management Activities................. $ (67) $ 96 $ 40 $ 193
Asset Businesses........................................ 50 68 116 146
------ ------- ------ -------
Total Operating Income........................... (17) 164 156 339
------ ------- ------ -------
Earnings (Losses) from Unconsolidated Investments.......... (6) 59 24 90
Other Items................................................ (130) 13 (124) (24)
------ ------- ------ -------
Earnings (Loss) Before Interest and Taxes........ (153) 236 56 405
Interest Expense........................................... (27) (22) (56) (40)
------ ------- ------ -------
Pre-tax Earnings (Loss).......................... (180) 214 -- 365
Income Tax Provision (Benefit)............................. (65) 64 (18) 115
------ ------- ------ -------
Income (Loss) From Operations.................... (115) 150 18 250
Cumulative Effect of Change in Accounting Principle........ -- -- -- 2
------ ------- ------ -------
Net Income (Loss)................................ $ (115) $ 150 $ 18 $ 252
====== ======= ====== =======
Recurring Net Income(1).......................... $ 11 $ 150 $ 144 $ 250
====== ======= ====== =======
Operating Statistics:
Natural Gas Marketing (Bcf/d)--
Domestic Marketing Volumes.......................... 8.5 8.2 9.1 8.3
Canadian Marketing Volumes.......................... 2.7 2.7 3.0 2.5
European Marketing Volumes.......................... 2.2 0.7 2.2 0.7
------ ------- ------ -------
Total Marketing Volumes.......................... 13.4 11.6 14.3 11.5
====== ======= ====== =======
Million Megawatt Hours Generated--Gross................. 10.0 9.9 19.5 20.2
Million Megawatt Hours Generated--Net................... 9.1 7.9 17.6 16.9
North American Physical Million Megawatt Hours Sold..... 82.0 70.1 232.0 122.1
European Physical Million Megawatt Hours Sold........... 36.2 -- 96.2 --
------ ------- ------ -------
Total Physical Million Megawatt Hours Sold.......... 118.2 70.1 328.2 122.1
====== ======= ====== =======
Coal Marketing Volumes (Millions of Tons)............... 9.0 9.3 17.3 18.5
Average Natural Gas Price--Henry Hub ($/MMbtu).......... $ 3.38 $ 4.65 $ 2.86 $ 5.85
Average On-Peak Market Power Prices
Cinergy............................................. $26.89 $ 39.71 $24.43 $ 41.01
TVA................................................. 28.06 51.71 25.11 47.25
PJM................................................. 35.84 44.09 30.54 44.19
New York--Zone G.................................... 46.52 57.97 39.48 58.57
Platts SP 15........................................ 32.14 188.92 30.49 206.58
- --------
(1) The recurring net income consists of segment reported net income adjusted
for identified non-recurring items more fully described above.
See the Explanatory Note on the Table of Contents.
62
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Three-Month Periods Ended June 30, 2002 and 2001
WEN reported recurring segment net income of $11 million for the three-month
period ended June 30, 2002, compared with recurring segment net income of $150
million in the 2001 quarter. The segment's customer and risk-management
business incurred an operating loss of $67 million during the second quarter
2002. The results reflect reduced energy trading and customer origination due
to an overall decline in market liquidity because of increasing credit concerns
in the merchant energy sector, counterparty concerns over Dynegy's lower credit
ratings, a reduction in the spread between natural gas and power prices and an
allocated charge of $19 million associated with severance and related costs.
The segment's asset businesses recorded operating income of $50 million in the
second quarter 2002. The results reflect lower generation earnings due to an
overall decrease in commodity prices compared to the second quarter 2001 and an
allocated charge of $7 million associated with severance and related costs. The
lower earnings from generation were partially offset by margins associated with
the BGSL natural gas storage and processing facilities in the United Kingdom
not included in 2001 results. The loss from unconsolidated subsidiaries in the
second quarter 2002 resulted primarily from charges related to a 2001 earnings
restatement at NICOR Energy, a joint venture in which Dynegy maintains an
equity investment, and impairment of certain technology equity investments.
Additionally, there was a $36 million decline in earnings from the equity
investment in West Coast Power due to a decrease in power prices and an overall
decline in demand. The $130 million loss in Other Items results primarily from
a non-recurring charge in the natural gas marketing business. Management
believes the charge is largely associated with the process of reconciling
accrued to actual results in its natural gas marketing business and that it
accumulated over a number of years. Interest expense was higher in the second
quarter 2002 due to higher average borrowings, partially offset by lower
average interest rates.
Total physical MW hours sold in the second quarter 2002 increased to 118.2
million MW hours as compared to 70.1 million MW hours in the second quarter
2001 due primarily to increased physical MW hours sold in Europe. Total natural
gas volumes sold in the second quarter 2002 increased to 13.4 billion cubic
feet per day as compared to 11.6 billion cubic feet per day during last year's
second quarter due primarily to increases in gas volumes sold in Europe.
Six-Month Periods Ended June 30, 2002 and 2001
WEN reported recurring segment net income of $144 million for the six-month
period ended June 30, 2002, compared with recurring net income of $250 million
in the same 2001 period. In addition to the items described above for the
second quarter comparisons, Dynegy's customer and risk-management business'
operating income for the six-month period included increased customer
origination during the first quarter 2002 in both the wholesale and commercial
and industrial businesses. The increased origination resulted from the absence
of Enron in the market, new contracts for the acquisition of long-term power
supply at competitive prices and incremental natural gas storage contracts.
Earnings from the long-term power origination contracts were significant to the
results for the first quarter 2002, accounting for approximately 20 percent of
the Company's consolidated financial contribution in that quarter. Offsetting
the increased origination were unfavorable variances in marketing activities
due to a continual decline in price volatility throughout the first quarter
2002 as well as reduced margins associated with power generation as a result of
lower market prices.
Total physical MW hours sold in the six-month period ended June 30, 2002
increased to 328.2 million MW hours compared to 122.1 million MW hours in the
same period in 2001 due primarily to increased physical MW hours sold in Europe
and greater customer origination in the first quarter of 2002. Total natural
gas volumes sold in the six months ended June 30, 2002 increased to 14.3
billion cubic feet per day as compared to 11.5 billion cubic feet per day
during the same period last year due to the inclusion of incremental
ChevronTexaco volumes associated with former Texaco equity production and
increases in gas volumes sold in Europe.
63
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Outlook for Remainder of 2002
The weak commodity price environment for natural gas and power has continued
into the third quarter 2002. In addition, the above-described reduction in
market liquidity has become more pronounced, as has the inability of the
customer and risk-management business to hedge its positions. These and other
factors, including counterparty concerns relating to Dynegy's non-investment
grade credit ratings and Dynegy's ability to rationalize its customer and
risk-management business through a joint venture or another strategic
alternative, can be expected to negatively impact this segment's results of
operations for the third quarter 2002 and beyond.
DYNEGY MIDSTREAM SERVICES
Three Months Six Months Ended
Ended June 30, June 30,
--------------------- --------------------
2002 2001 2002 2001
------ ------ ------ ------
($ in millions, except operating statistics)
Operating Income:
Upstream......................................... $ 6 $ 21 $ 11 $ 56
Downstream....................................... 5 11 31 28
------ ------ ------ ------
Total Operating Income.................... 11 32 42 84
Earning from Unconsolidated Investments............. 4 5 8 6
Other Items......................................... (13) (6) (11) (11)
------ ------ ------ ------
Earnings Before Interest and Taxes........ 2 31 39 79
Interest Expense.................................... (13) (14) (23) (27)
------ ------ ------ ------
Pre-tax Earnings (Loss)................... (11) 17 16 52
Income Tax Provision (Benefit)...................... (3) 7 7 19
------ ------ ------ ------
Net Income (Loss)......................... $ (8) $ 10 $ 9 $ 33
====== ====== ====== ======
Recurring Net Income (Loss)(1)............ $ (4) $ 10 $ 13 $ 33
====== ====== ====== ======
Operating Statistics:
Natural Gas Processing Volumes (MBbls/d):
Field Plants................................. 52.7 56.0 54.3 55.8
Straddle Plants.............................. 37.9 27.9 37.1 25.2
------ ------ ------ ------
Total Natural Gas Processing Volumes......... 90.6 83.9 91.4 81.0
====== ====== ====== ======
Fractionation Volumes (MBbls/d)..................... 241.6 250.6 223.2 224.9
Natural Gas Liquids Sold (MBbls/d)............... 468.8 493.8 538.7 567.9
Average Commodity Prices:
Natural Gas--Henry Hub ($/MMbtu)............. $ 3.38 $ 4.65 $ 2.86 $ 5.85
Crude Oil--Cushing ($/Bbl)................... 25.32 27.90 22.95 28.46
Natural Gas Liquids ($/Gal).................. 0.39 0.49 0.36 0.55
Fractionation Spread ($/MMBtu)............... 1.02 0.92 1.16 0.45
- --------
(1) The recurring net income (loss) consists of segment reported net income
adjusted for identified non-recurring items more fully described above.
See the Explanatory Note on the Table of Contents.
64
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Three-Month Periods Ended June 30, 2002 and 2001
DMS reported recurring net loss of $4 million in the second quarter 2002
compared with recurring net income of $10 million in the second quarter 2001.
The segment's recurring results of operations were impacted by lower natural
gas and NGL prices, the residual volume effect of low rig counts in the second
half of 2001 and a temporary shutdown of a major third-party natural gas
pipeline in North Texas, which resulted in a decline in volumes processed. In
addition, as a result of slow economic recovery, high industry-wide inventory
levels, reduced NGL liquidity and Dynegy specific credit limitations, the
segment experienced a decline in domestic and foreign marketing volumes and
margins.
Aggregate domestic NGL processing volumes totaled 90.6 thousand gross
barrels per day in the second quarter 2002 compared to 83.9 thousand gross
barrels per day during the same period in 2001. A small percentage of this
volume increase resulted from the inclusion of incremental ChevronTexaco
volumes associated with former Texaco equity production. The majority of the
volume growth is related to the Louisiana straddle plants and is the direct
result of an increasing need to process Gulf of Mexico natural gas production
to meet third party pipeline dew point specification limits. This pipeline
specification-driven need for processing has moved fractionation spread risk to
the producer by shifting processing contract terms to a fee based arrangement
when keep-whole processing is not economical. This trend is expected to
continue as the volume of gas produced in the deep-water Gulf of Mexico
increases.
The average fractionation spread was $1.02 for the three months ended June
30, 2002, compared to $0.92 for the comparable 2001 period. Despite the
year-over-year increase in this spread, traditional keep-whole processing is
still not economical at this level. Historically, the Louisiana straddle plants
would not have operated in this pricing environment.
Gas processing volumes for the field plants were slightly lower for second
quarter 2002 as compared to prior period volumes as the result of low drilling
rig counts during the latter half of 2001 and second quarter 2002. DMS'
business is dependent on producer drilling activity in the producing regions
that its gathering systems serve. At current natural gas price levels,
producers are actively drilling new wells and DMS' new connect gas volumes for
processing are currently growing enough to more than offset natural decline in
production. The producers supplying DMS' facilities are primarily independent
producers who, as a group, react quickly to changes in gas prices. As natural
gas prices decline significantly from current levels, these producers have
historically reduced their drilling investment. If this occurs going forward,
DMS could experience difficulty in acquiring enough volumes to offset natural
declines. Conversely, as gas prices strengthen from current levels, producers
have historically invested more heavily in drilling and development.
Six-Month Periods Ended June 30, 2002 and 2001
DMS reported recurring net income of $13 million in the six months ended
June 30, 2002 compared with recurring net income of $33 million in the six
months ended June 30, 2001. In addition to the items described above for the
second quarter comparisons, warmer winter temperatures influenced recurring
results of operations period-to-period.
Aggregate domestic NGL processing volumes totaled 91.4 thousand gross
barrels per day in the six months ended June 30, 2002 compared to 81.0 thousand
gross barrels per day during the same period in 2001. A small percentage of
this volume resulted from the inclusion of incremental ChevronTexaco volumes
associated with former Texaco equity production. The majority of the volume
growth related to the Company's Louisiana
65
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
straddle plants and is the direct result of an increasing need to process Gulf
of Mexico natural gas production to meet third party pipeline dew point
specification limits. This pipeline specification-driven need for processing
has moved fractionation spread risk to the producer by shifting processing
contract terms to a fee based arrangement when keep-whole processing is not
economical. This trend is expected to continue as the volume of gas produced in
the deep-water Gulf of Mexico increases.
The average fractionation spread was $1.16 for the six months ended June 30,
2002, compared to $0.45 for the comparable 2001 period. Despite the
year-over-year increase in this spread, traditional keep-whole processing is
still not economical at this level. Historically, the Louisiana straddle plants
would not have operated in this pricing environment.
Outlook for Remainder of 2002
The weak fractionation spread environment has continued into the third
quarter 2002. The correlation of prices for propane relative to prices for oil
is lower than historical levels, yielding lower than expected revenues for DMS
in the current pricing environment. As described above, drilling activity,
which is substantially dependent upon the commodity pricing environment,
significantly impacts DMS' results of operations.
In addition, counterparty credit concerns and the resulting industry-wide
contraction in trade credit have limited DMS' ability to purchase incremental
volumes of natural gas liquids at historical levels. DMS cannot predict with
any degree of certainty the effect that this contraction in credit will have on
its results of operations in the future.
66
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
TRANSMISSION AND DISTRIBUTION
Three Months Six Months Ended
Ended June 30, June 30,
-------------- --------------
2002 2001 2002 2001
------ ------ ------ ------
($ in millions)
Northern Natural........................ $ 10 $ -- $ 66 $ --
Illinois Power.......................... 47 41 85 92
------ ------ ------ ------
Operating Income..................... 57 41 151 92
Losses from Unconsolidated Investments.. (2) -- (2) --
Other Items............................. 2 (1) 6 19
------ ------ ------ ------
Earnings Before Interest and Taxes... 57 40 155 111
Interest Expense........................ (42) (31) (80) (60)
------ ------ ------ ------
Pre-tax Earnings..................... 15 9 75 51
Income Tax Provision.................... 6 3 30 20
------ ------ ------ ------
Net Income(1)........................ $ 9 $ 6 $ 45 $ 31
====== ====== ====== ======
Recurring Net Income(1)(2)........... $ 15 $ 6 $ 64 $ 31
====== ====== ====== ======
Illinois Power:
Electric Sales in kWh (Millions)
Residential.......................... 1,206 1,097 2,510 2,479
Commercial........................... 1,081 1,060 2,103 2,114
Commercial distribution.............. -- 11 1 34
Industrial........................... 1,676 1,674 3,052 3,109
Industrial distribution.............. 593 674 1,300 1,260
Other................................ 92 90 185 190
------ ------ ------ ------
Total Electric Sales............. 4,648 4,606 9,151 9,186
====== ====== ====== ======
Gas Sales in Therms (Millions)
Residential.......................... 43 32 196 205
Commercial........................... 17 13 79 87
Industrial........................... 19 19 37 45
Transportation of Customer-Owned Gas. 61 64 133 136
------ ------ ------ ------
Total Gas Delivered.............. 140 128 445 473
====== ====== ====== ======
Heating Degree Days.................. 498 293 2,995 3,057
Northern Natural:
Heating Degree Days.................. 976 N/A 4,465 N/A
Throughput (Bcf/d)................... 3.2 N/A 12.8 N/A
- --------
(1) Northern Natural was acquired effective February 1, 2002 and had a net loss
of $4 million and net income of $23 million for the three and six months
ended June 30, 2002, while recurring net loss was $1 million and recurring
net income was $39 million for the three and six months ended June 30, 2002.
(2) The 2002 recurring net income consists of segment reported net income
adjusted for identified non-recurring items more fully described above.
See Explanatory Note to the Table of Contents.
67
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Three-Month Periods Ended June 30, 2002 and 2001
The T&D segment reported recurring net income of $15 million in the second
quarter 2002 compared to $6 million in the second quarter 2001. The operating
results of Northern Natural are not included in prior year results. Northern
Natural's recurring net loss was $2 million in the second quarter 2002.
Illinois Power experienced favorable results from operations period-to-period
that were influenced by increased electricity usage from commercial and
residential customers due to favorable weather conditions, a reduction in
operating expenses due to savings realized from a 2001 restructuring, the
resolution of a contingent liability for a bulk power billing dispute and a
favorable litigation settlement. These results were partially offset by a
mandated five percent residential rate reduction effective May 1, 2002, the
election of some commercial and industrial customers to pay for power at
market-based prices, rather than under bundled tariffs, and a decrease in
industrial customer demand due to a weakened economy in Illinois Power's
principal market areas.
Six Month Periods Ended June 30, 2002 and 2001
The T&D segment reported recurring net income of $64 million in the six
months ended June 30, 2002 compared to $31 million in the same 2001 period. The
recurring net income for the six months ended June 30, 2002 excludes a $13
million after-tax ($18 million pre-tax) charge associated with a gas delivery
commitment that was assumed with the acquisition of Northern Natural. The T&D
segment reflects five months of operating results from Northern Natural, which
explains the increase in operating results. Northern Natural was acquired
February 1, 2002 and, therefore was not included in prior year results.
Northern Natural's recurring net income was $39 million in the six months ended
June 30, 2002. Illinois Power experienced slightly unfavorable results
period-to-period. In addition to the items described above for the second
quarter comparisons, the recurring results were influenced by decreased demand
from commercial and residential customers due to unfavorable weather conditions
experienced during the first quarter 2002 and a favorable insurance settlement
which occurred in 2001.
Outlook for Remainder of 2002
The T&D Segment's results of operations for the third quarter 2002 and
beyond will exclude the operating results of Northern Natural upon consummation
of the sale of Northern Natural as described in Note 6 to the accompanying
financial statements. Future results of operations for IP may be affected,
either positively or negatively, by general economic and capital market
conditions, including overall economic growth, the demand for power and natural
gas in IP's service area and interest rates. In addition, changes in Dynegy's
financial condition may impact IP's capitalization as well as its ability to
access the capital markets.
68
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
DYNEGY GLOBAL COMMUNICATIONS
Six Months
Three Months Ended
Ended June 30, June 30,
------------- -----------
2002 2001 2002 2001
----- ---- ----- ----
($ in millions)
Operating Loss..................................... $(322) $(39) $(368) $(62)
Earnings (Losses) from Unconsolidated Investments.. (3) 14 (48) 14
Other Items........................................ (3) (6) (10) --
----- ---- ----- ----
Loss Before Interest and Taxes..................... (328) (31) (426) (48)
Interest Expense................................... (1) (1) (3) (3)
----- ---- ----- ----
Pre-tax Loss....................................... (329) (32) (429) (51)
Income Tax Benefit................................. (115) (12) (145) (20)
----- ---- ----- ----
Net Loss from Operations........................... (214) (20) (284) (31)
Cumulative Effect of Change in Accounting Principle -- -- (256) --
----- ---- ----- ----
Net Loss........................................... $(214) $(20) $(540) $(31)
===== ==== ===== ====
Recurring Net Loss (1)............................. $ (26) $(20) $ (52) $(31)
===== ==== ===== ====
- --------
(1) The 2002 recurring net loss consists of segment reported net income
adjusted for identified non-recurring items more fully described above.
See Explanatory Note to the Table of Contents.
Three-Month Periods Ended June 30, 2002 and 2001
During the quarter, the telecommunications sector continued to deteriorate
at a rapid pace, as evidenced by an increased number of bankruptcies of both
long-haul and metro loop providers, continued devaluation of equity securities
and lack of financing sources in the sector, and further pricing pressures
resulting from challenges faced by major industry players. As a result of the
significant deterioration in the sector, negative outlook on the industry and
Dynegy's focus on significantly improving its liquidity (see Liquidity and
Capital Resources section), management is aggressively taking measures to
reduce cash losses in the business by eliminating capital spending and reducing
operating and administrative expenses. Management also continues to pursue
partnership and joint venture opportunities which are consistent with the
Company's strategy of reducing its operating losses in this business.
Statement No. 144 requires long-lived assets to be tested for impairment
whenever events or changes in circumstances indicate that its carrying amount
may not be recoverable from future cash flows of the long-lived asset group or
it becomes more likely than not that a long-lived asset group will be sold or
otherwise disposed of before the end of its previously estimated useful life.
Dynegy's impairment analysis at June 30, 2002, under Statement No. 144,
indicates future cash flows from DGC's operations are insufficient to cover the
carrying value of segment long-lived assets. As a result, a pre-tax impairment
charge totaling $286 million ($186 million after-tax) was recorded in
Impairment and Other Charges in the Condensed Consolidated Statement of
Operations for the three and six months ended June 30, 2002.
69
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
In addition, the impairment analysis also indicated that future cash flows
are insufficient to support the lessor's obligation of $367 million relating to
telecommunications leases, of which Dynegy has guaranteed approximately $303
million. In accordance with EITF Issue 96-21, "Implementation Issues in
Accounting for Leasing Transactions involving Special-Purpose Entities", the
loss under the guarantees will be accrued under a straight-line method over the
remaining term of the lease. This non-cash charge is expected to be
approximately $23 million (pre-tax) a quarter through the remaining term of the
leases, unless the obligation is accelerated or terminated as a result of a
business combination, joint venture or other similar transaction resulting from
Dynegy's managed exit from the telecommunications segment. When the lease term
expires in the second quarter 2005 or the obligation is accelerated or
terminated, the Company may be required to pay cash of up to the $303 million.
DGC's recurring results reflect a $26 million quarterly loss in the
three-month period ended June 30, 2002 resulting from continued operating
losses caused by the fact that the costs associated with operating a lit
network have exceeded revenues. This compares to a $20 million quarterly loss
in the three-month period ended June 30, 2001. The increased loss was primarily
caused by a decrease in Earnings from Unconsolidated Investments. At June 30,
2002, the valuations of certain technology investments were assessed in light
of the Company's decision to pursue a managed exit strategy from the
telecommunications business. These investments were originally entered into in
order to leverage existing commercial relationships or as a means of expanding
new relationships. Historically, the Company viewed these investments as
strategic and core to its telecommunications strategy. As a result,
management's expectation was that Dynegy would hold these investments for the
long-term and that trends in the sector were cyclical. The Company viewed the
downturn in valuation as temporary.
Management is aggressively pursuing alternatives for exiting this business
segment, although no formal plans are currently in place and no assurance can
be provided as to the timing or structure of any such transaction. Continued
losses through 2002 will negatively impact the Company's cash flows and
earnings. In addition, if Dynegy were unable to eliminate these losses and
decided to shut down or dispose of its telecommunications business, Dynegy
could incur approximately $367 million in lease obligations relating to its
telecommunications network. As of June 30, 2002, Dynegy also had approximately
$244 million, or approximately $152 million on a discounted basis, in long-term
operating commitments relating to its telecommunications business.
Six-Month Periods Ended June 30, 2002 and 2001
DGC's recurring results reflect a $52 million quarterly loss in the
six-month period ended June 30, 2002 resulting from continued operating losses
caused by the fact that the costs associated with operating lit network have
exceeded revenues and vendor equipment problems which delayed anticipated
revenues. This compares to a $31 million loss in the six-month period ended
June 30, 2001. The 2002 recurring net loss excludes the cumulative effect of
change in accounting principle (see Note 4 to the accompanying financial
statements) and impairment of communications assets, principally underutilized
equipment and certain investments. The increased loss includes the difference
in equity earnings described above related to the 2001 second quarter and
additional net operating losses in 2002.
70
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Cash Flow Disclosures
The following table is a condensed version of the operating section of the
Condensed Consolidated Statements of Cash Flows (in millions):
For the Six Months Ended June 30, 2002
-----------------------------------------------
Corporate
&
WEN DMS T&D DGC Eliminations Consolidated
----- --- ---- ----- ------------ ------------
Net Income (Loss)............................. $ 18 $ 9 $ 45 $(540) $ -- $(468)
Net Non-Cash Items Included in Net Income..... 345 44 157 468 (17) 997
----- --- ---- ----- ---- -----
Operating Cash Flows Before Changes in Working
Capital..................................... 363 53 202 (72) (17) 529
Changes in Working Capital.................... (198) 8 10 -- 26 (154)
----- --- ---- ----- ---- -----
Net Cash Provided by (Used in) Operating
Activities.................................. $ 165 $61 $212 $ (72) $ 9 $ 375
===== === ==== ===== ==== =====
For the Six Months Ended June 30, 2001(1)
------------------------------------------------
Corporate
&
WEN DMS T&D DGC Eliminations Consolidated
----- ---- ---- ---- ------------ ------------
Net Income (Loss)............................. $ 252 $ 33 $ 31 $(31) $ -- $ 285
Net Non-Cash Items Included in Net Income..... 290 50 95 (11) 16 440
----- ---- ---- ---- ---- -----
Operating Cash Flows Before Changes in Working
Capital..................................... 542 83 126 (42) 16 725
Changes in Working Capital.................... (319) 64 (58) (27) (14) (354)
----- ---- ---- ---- ---- -----
Net Cash Provided by (Used in) Operating
Activities.................................. $ 223 $147 $ 68 $(69) $ 2 $ 371
===== ==== ==== ==== ==== =====
- --------
(1) Dynegy intends to restate the 2001 operating cash flow amounts from $371
million to approximately $263 million related to Project Alpha. This
reduction to operating cash flow will impact the risk management line on
the statement of cash flow for the six months ended June 30, 2001 by
changing the current $244 million add-back to an approximately $136 million
add-back. (See Note 1 to the accompanying financial statements.)
Operating Cash Flow. Cash flow from operating activities totaled $375
million for the six-month period ended June 30, 2002 compared to $371 million
reported in the same 2001 period. Non-cash add-backs were greater in the 2002
period, primarily due to the following non-recurring charges, which are further
described in Note 5 to the accompanying financial statements:
. The $256 million impairment of goodwill for DGC related to the adoption
of Statement No. 142 as previously disclosed in the first quarter 2002
and $286 million of additional pre-tax impairment charges for DGC during
the second quarter 2002;
. Reconciliation of estimated accrued to actual charges in the natural gas
marketing business following a balance sheet review, which produced a
$124 million pre-tax charge in the WEN segment;
. Pre-tax write-offs within Earnings (Losses) from Unconsolidated
Investments of $85 million representing technology investment impairments
based on the Company's change in business strategy
71
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
and continued downturn in the technology sector. Of the total write-offs,
$33 million related to WEN and $48 million related to DGC, with the
remaining amounts allocated to DMS and T&D.
Other changes in non-cash items include the following:
. Depreciation and amortization expense increased by $42 million primarily
due to the addition of Northern Natural in January 2002 and the United
Kingdom natural gas storage facilities in November 2001;
. A reduction in Earnings (Losses) from Unconsolidated Investments of
approximately $30 million related to West Coast Power;
. Deferred income taxes are a $134 million benefit position for the six
months ended June 30, 2002, compared to an expense of $73 million in the
same 2001 period, producing a $207 million decreased add-back; and
. Risk Management activity produced a $98 million add-back, compared to an
add-back of $136 million in the 2001 period (after taking into account
the Project Alpha adjustment the Company intends to make). The add-backs
represent cash realized for settled contracts in excess of gains
recognized.
Changes in working capital had a negative impact on cash flow from
operations for the six-month period ended June 30, 2002 primarily due to the
following:
. Timing of customer receivable and vendor payable trade accounts,
primarily for WEN's natural gas and power accruals as well as IP's power
receivables for seasonal trends beginning in the summer months;
. Parts, supplies and natural gas inventory builds for the power generation
business in anticipation of plants becoming commercial and increased
summer generation demand;
. Fuel oil and coal inventory builds to replenish supply for the Northeast
generation plants in anticipation of seasonal summer generation demand;
. Amortization of liabilities associated with previous acquisitions; and
. Increased natural gas futures positions or contracts at June 30, 2002
versus December 31, 2001, representing cash remitted to brokers held on
account for the WEN segment.
Capital Expenditures and Investing Activities. Cash used for investing
activities during the six-month period ended June 30, 2002 totaled $597
million. Capital spending and investments in unconsolidated investments totaled
$587 million and relate primarily to generation asset additions and
improvements, environmental compliance and first quarter investments in
technology infrastructure. Cash spent for the acquisition of Northern Natural
totaled $20 million, net of cash acquired. These cash outflows were offset by
$10 million in proceeds from asset sales.
Financing Activities. Cash provided by financing activities during the
six-month period ended June 30, 2002 totaled $417 million. The Company received
$205 million in cash proceeds relative to ChevronTexaco's preemptive right
purchase of approximately 10.4 million shares of Class B common stock in
January 2002. Additional capital stock proceeds include $21 million in cash
from members of senior management associated with the December 2001 private
equity placement. Dividends declared and paid to holders of Class A and Class B
common stock totaled $40 million and $15 million, respectively, for the
six-month period ended June 30, 2002.
In March 2002, Illinova Corporation, a wholly owned subsidiary of Dynegy and
the parent company of IP, paid $28 million in cash for shares of IP's preferred
stock through the consummation of a tender offer.
72
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
Long-term debt proceeds, net of issuance costs, for the six-months ended
June 30, 2002 consisted of $496 million from the issuance of 8.75 percent
senior notes due February 2012. Repayments of long-term debt totaled $188
million for the six-months ended June 30, 2002 and consisted of $44 million in
payments of IP Transitional Funding Notes, $90 million relating to the April
2002 purchase of Northern Natural's senior unsecured notes due 2005, and $54
million in June 2002 principal payments related to the restructuring of Black
Thunder from Minority Interest to Long-Term Debt. Net proceeds from short-term
financing consisted of $245 million cash advance for the anticipated sale of
certain United Kingdom gas storage assets. Additionally, during the six months
ended June 30, 2002, Dynegy repaid $293 million in commercial paper and
borrowings under revolving credit lines for DHI and IP in the aggregate and
borrowed $60 million under IP's term loan.
Finally, other financing cash payments totaled $55 million for the
six-months ended June 30, 2002. These payments primarily consisted of $13
million in interest associated with the Black Thunder transaction prior to the
June 2002 restructuring and $39 million associated with Project Alpha. (See
Note 1 to the accompanying financial statements for more information on Project
Alpha.) Additionally, Dynegy intends to restate the statement of cash flows for
the six months ended June 30, 2001 to increase cash from financing activities
from $644 million to approximately $752 million.
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, including the application of
forecasted pricing curves to contractual commitments that may result in
realized cash returns on these commitments which may vary significantly,
either positively or negatively, from estimated values;
. Expectations regarding capital expenditures, dividends and other payments;
. The pending sale of Northern Natural, including the anticipated closing
date and the financial impact of the sale on Dynegy's balance sheet and
liquidity position;
. 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;
. The Company's ability to execute additional capital-raising 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 primarily relating to Project Alpha, roundtrip trades
and Black Thunder;
73
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
. The Company's ability to rationalize its customer and risk-management
business, either through the formation of a joint venture or the
execution of an alternative strategy;
. The expected commencement date for commercial operations for new power
plants; and
. The Company's strategic plans relating to the DGC segment, including the
Company's ability to eliminate or further reduce net cash outflows
associated with this segment.
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 consummation of the Northern Natural sale;
. 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 its ability to
improve its 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;
. 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 Dynegy's 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;
. 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 factor's
affecting Dynegy's financing activities, including the effect of Dynegy's
publicly announced re-audit of its 1999-2001 financial statements and the
other issues described in this Form 10-Q;
. Dynegy's ability to successfully execute its $2 billion capital plan and
to otherwise satisfy its obligations as they become due;
. The direct or indirect effects on Dynegy's business of downgrades in
credit ratings (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 current
counterparties, refusal by our
74
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the Interim Periods Ended June 30, 2002 and 2001
current or potential counterparties to enter into transactions with us
and our inability to obtain credit or capital in amounts or on terms
favorable to us; and
. 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 FERC, CFTC and other
similar investigations primarily surrounding Project Alpha and roundtrip
trades;
. 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.
75
DYNEGY INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For the Interim Periods Ended June 30, 2002 and 2001
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.
76
DYNEGY INC.
PART II. OTHER INFORMATION
ITEM 1--LEGAL PROCEEDINGS
See Note 13 to the accompanying financial statements for discussion of
material recent developments in the Company's material legal proceedings.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 2002 annual meeting of the shareholders of the Company was held on May
17, 2002. The purpose of the annual meeting was to consider and vote upon the
following proposals:
1. to elect eleven Class A common stock directors and three Class B common
stock directors to serve until the 2003 annual meeting of shareholders;
2. to consider and act upon a proposal to approve the Dynegy Inc. 2002
Long Term Incentive Plan; and
3. to ratify the selection of PricewaterhouseCoopers LLP as independent
auditors of the Company for the fiscal year ended December 31, 2002.
The Company's Board of Directors is comprised of fourteen members. At the
annual meeting, each of the following individuals was re-elected to serve as a
director of the Company: C.L. Watson; Stephen W. Bergstrom; Charles E. Bayless;
Michael D. Capellas; Daniel L. Dienstbier; Patricia M. Eckert; Jerry L.
Johnson; H. John Riley, Jr.; Sheli Z. Rosenberg; Joe J. Stewart; J. Otis
Winters; Darald W. Callahan; Glenn F. Tilton; and John S. Watson. The votes
cast for each nominee and the votes withheld were as follows:
CLASS A DIRECTORS
For Withheld
----------- ---------
1. C.L. Watson......... 227,129,756 6,767,969
2. Stephen W. Bergstrom 227,938,470 5,406,783
3. Charles E. Bayless.. 226,979,906 6,398,851
4. Michael D. Capellas. 227,933,542 5,418,793
5. Daniel L. Dienstbier 227,941,706 5,388,900
6. Patricia M. Eckert.. 227,923,503 5,428,083
7. Jerry L. Johnson.... 226,567,550 6,643,704
8. H. John Riley, Jr... 226,623,666 6,702,674
9. Sheli Z. Rosenberg.. 227,899,769 5,446,158
10. Joe J. Stewart...... 226,613,075 6,709,880
11. J. Otis Winters..... 226,597,406 6,728,997
CLASS B DIRECTORS
For Withheld
----------- ---------
1. Darald W. Callahan.. 96,891,014 0
2. Glenn F. Tilton..... 96,891,014 0
3. John S. Watson...... 96,891,014 0
The following votes were cast with respect to the proposal to approve the
Dynegy Inc. 2002 Long Term Incentive Plan. There were no broker non-votes.
For Against Abstain
----------- ---------- ---------
298,932,107 29,112,925 2,063,927
77
The following votes were cast with respect to the ratification of the
selection of PricewaterhouseCoopers LLP as independent auditors of the Company
for the fiscal year ended December 31, 2002. There were no broker non-votes.
For Against Abstain
----------- --------- ---------
321,459,217 7,216,161 1,433,581
ITEM 6--EXHIBITS AND REPORTS ON FORM 8-K
(a) The following instruments and documents are included as exhibits to
this Form 10-Q:
10.1 Purchase and Sale Agreement dated July 28, 2002 among Dynegy Inc., NNGC Holding Company,
Inc. and MidAmerican Energy Holdings Company (incorporated by reference to Exhibit 99.2 to
the Company's Current Report on Form 8-K dated July 29, 2002).
10.2 Agreement dated as of July 31, 2002 among Chevron U.S.A. Inc., Dynegy Marketing and Trade,
Dynegy Holdings Inc., Dynegy Inc. and the other parties thereto.
10.3 Contract for Services between Daniel L. Dienstbier and Dynegy Inc. effective as of May 28, 2002.
(b) Reports on Form 8-K of Dynegy Inc. for the second quarter 2002.
1. During the quarter ended June 30, 2002, the Company filed a Current Report
on Form 8-K dated April 25, 2002. Items 5, 7 and 9 were reported and
no financial statements were filed.
2. During the quarter ended June 30, 2002, the Company filed a Current Report
on Form 8-K dated April 29, 2002. Items 5 and 7 were reported and no
financial statements were filed.
3. During the quarter ended June 30, 2002, the Company filed a Current Report
on Form 8-K dated May 8, 2002. Items 5 and 7 were reported and no
financial statements were filed.
4. During the quarter ended June 30, 2002, the Company filed a Current Report
on Form 8-K dated May 28, 2002. Items 5 and 7 were reported and no
financial statements were filed.
5. During the quarter ended June 30, 2002, the Company filed a Current Report
on Form 8-K dated June 19, 2002. Items 5 and 7 were reported and no
financial statements were filed.
78
DYNEGY INC.
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.
/S/ MICHAEL R. MOTT
BY:____________________________________
Date: August 14, 2002
Michael R. Mott
Senior Vice President and Controller
(Duly Authorized Officer and
Principal Accounting Officer)
79