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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
[_] 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: 1-11156
DYNEGY INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3248415
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1000 Louisiana, Suite 5800
Houston, Texas 77002
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (713) 507-6400
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class: on which registered:
Common Stock, par value $.01 per share New York Stock Exchange
Series A Participating Preferred Stock --
6.75% Debt Securities due 2005 --
7.125% Debentures due 2018 --
7.625% Senior Notes due 2026 --
Securities registered pursuant to Section 12(g) of the Act: None
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 the filing
requirements for the past 90 days.
Yes [X] No [_]
The aggregate value of Common Stock held by non-affiliates of the registrant was
approximately $434,709,735 on March 24, 1999, (based on $15.00 per share, the
last sale price of the Common Stock as reported on the New York Stock Exchange
Composite Tape on such date). 152,599,134 shares of the registrant's Common
Stock were outstanding as of March 24, 1999.
DOCUMENTS INCORPORATED BY REFERENCE. Portions of Parts I, II and IV in the
Annual Report to Shareholders for the fiscal year ended December 31, 1998. As
to Part III (items 10, 11, 12 and 13), Notice and Proxy Statement for the 1999
Annual Meeting of Stockholders to be filed not later than 120 days after
December 31, 1998.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
DYNEGY INC.
FORM 10-K
TABLE OF CONTENTS
Page
PART I
Item 1. Business........................................... 1
Item 1A. Executive Officers................................. 13
Item 2. Properties......................................... 15
Item 3. Legal Proceedings.................................. 20
Item 4. Submission of Matters to a Vote of Security Holders 22
PART II
Item 5. Market for the Registrant's Common Equity and
Related Stockholder Matters........................ 22
Item 6. Selected Financial Data............................. 23
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................ 24
Item 8. Financial Statements and Supplementary Data......... 39
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................ 39
PART III
Item 10. Directors and Executive Officers of the Registrant. 39
Item 11. Executive Compensation............................. 39
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................ 39
Item 13. Certain Relationships and Related Transactions..... 39
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K........................................ 39
Signatures........................................................ 46
For definitions of certain terms used herein,
see "Item 1. BUSINESS -- DEFINITIONS."
PART I
Item 1. BUSINESS
THE COMPANY
General
Dynegy Inc. ("Dynegy" or the "Company") is a leading provider of energy
products and services in North America and the United Kingdom. Products marketed
by the Company's wholesale marketing operations include natural gas,
electricity, coal, natural gas liquids, crude oil, liquid petroleum gas and
related services. The Company's wholesale marketing operations are supported by
ownership or control of an extensive asset base and transportation network that
includes unregulated power generation, gas and liquids storage capacity, gas,
power and liquids transportation capacity and gas gathering, processing and
fractionation assets. The critical mass achieved through the combination of a
large scale energy marketing operation with strategically located assets which
augment the marketing efforts affords the Company the ability to offer
innovative, value-creating energy solutions to its customers.
The Company is a holding company that conducts substantially all of its
business through its subsidiaries. From inception of operations in 1984 until
1990, Natural Gas Clearinghouse ("Clearinghouse") limited its activities
primarily to natural gas marketing. Starting in 1990, Clearinghouse began
expanding its core business operations through acquisitions and strategic
alliances resulting in the formation of a mid-stream energy asset business and
establishing energy marketing operations in both Canada and the United Kingdom.
The Company initiated electric power marketing operations in February 1994 in
order to exploit opportunities created by the deregulation of the domestic
electric power industry. Effective March 1, 1995, Clearinghouse and Trident NGL
Holding, Inc. ("Holding"), a fully integrated natural gas liquids company,
merged ("Trident Combination") and the combined entity was renamed NGC
Corporation ("NGC"). On August 31, 1996, NGC completed a strategic combination
with Chevron U.S.A. Inc. and certain Chevron affiliates (collectively "Chevron")
whereby substantially all of Chevron's mid-stream assets merged with NGC
("Chevron Combination"). BG plc, Chevron and NOVA Chemicals Corp. ("NOVA") each
own approximately 26 percent of the outstanding common stock of Dynegy.
Effective July 1, 1997, NGC acquired Destec Energy, Inc. ("Destec Acquisition"),
a leading independent power producer. During 1998, the Company changed its name
to Dynegy Inc. in order to reflect its evolution from a natural gas marketing
company to an energy services company capable of meeting the growing demands and
diverse challenges of the dynamic energy market of the 21st Century.
The principal executive office of the Company is located at 1000 Louisiana,
Suite 5800, Houston, Texas 77002, and the telephone number of that office is
(713) 507-6400. Dynegy and its affiliates maintain marketing and/or regional
offices in Atlanta, Georgia; Boston, Massachusetts; Calgary, Alberta; Chicago,
Illinois; Dallas, Texas; Englewood, Colorado; London, England; Midland, Texas;
Oklahoma City, Oklahoma; Pleasanton, California; Tampa, Florida; Tulsa,
Oklahoma; and Washington D.C.
UNCERTAINTY OF FORWARD-LOOKING STATEMENTS AND INFORMATION
This Form 10-K contains various forward-looking statements, within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, and information that are based on management's beliefs as
well as assumptions made by and information currently available to management.
When used in this document, words such as "anticipate", "estimate", "project",
and "expect" reflect forward-looking statements. Although the Company believes
that the expectations reflected in such forward-looking statements are
reasonable; it can give no assurance that such expectations will prove to have
been correct. Such statements are subject to certain risks, uncertainties and
assumptions. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results may vary
materially from those anticipated, estimated, projected or expected. Among the
key risk factors that may have a direct bearing on Dynegy's results of
operations and financial condition are:
. Competitive practices in the industries in which Dynegy competes;
. Fluctuations in commodity prices for natural gas, electricity, natural gas
liquids, crude oil or coal;
. Fluctuations in energy commodity prices which could not or have not been
properly hedged or which are inconsistent with Dynegy's open position in its
energy marketing activities;
. Operational and systems risks;
. Environmental liabilities which are not covered by indemnity or insurance;
. Software, hardware or third-party failures resulting from Year 2000 issues;
1
. General economic and capital market conditions, including fluctuations in
interest rates; and
. The impact of current and future laws and governmental regulations
(particularly environmental regulations) affecting the energy industry in
general, and Dynegy's operations in particular.
DEFINITIONS
As used in this Form 10-K, the abbreviations listed below are defined as
follows:
Bbl 42 U.S. gallons, the basic unit for measuring crude oil and
natural gas condensate.
MBbls/d Volume of one thousand barrels per day.
MMBbls Volume of one million barrels.
MMcf/d Volume of one million cubic feet per day.
Bcf Volume of one billion cubic feet.
Bcf/d Volume of one billion cubic feet per day.
Btu British Thermal Unit - a measure of the amount of heat required
to raise the temperature of one pound of water one degree Fahrenheit.
Bpd Barrels per day.
NGLs Natural gas liquids.
LPG Liquid petroleum gas.
MW Megawatts.
Spot The Henry Hub cash price posting for natural gas per the "Inside FERC"
publication.
BUSINESS
The Company reports operations under two primary business segments: the
Wholesale Gas and Power and Liquids segments. A general description of the
business strategy employed by each segment is followed by a discussion of each
segment's component businesses.
WHOLESALE GAS AND POWER SEGMENT
This segment is actively engaged in value creation through marketing and
trading of natural gas, power and coal and the generation of electricity
principally under the name Dynegy Marketing and Trade. Dynegy is pursuing an
integrated wholesale energy business approach based on execution of an energy
convergence strategy. This strategy exploits the marketing, trading and
arbitrage opportunities existing in the natural gas and power markets that are
enhanced by the control and optimization of related physical assets. The
combination of a portfolio of strategic generation assets and a national gas and
power marketing franchise allow for extraction of value resulting from arbitrage
opportunities occurring across energy products, across geographic regions and
over time. The Company refers to this synergistic relationship between merchant
generation capacity and energy trading and marketing as the "Merchant Leverage
Effect" depicted below.
DYNEGY'S MERCHANT LEVERAGE EFFECT
GENERATION TRADING & MARKETING
Capacity & Energy National Market Access
Expanded Product Portfolio Market Infrastructure & Intelligence
Supply Reliability Risk Management & Arbitrage
Development Expertise Fuel and Asset Management
Operations Expertise Transmission Expertise & Position
MARKET SHARE INCREASED RETURNS
2
Dynegy views its gas and power marketing and power generation businesses as
an integrated unit. Ownership or control of merchant generation, or "Btu
Conversion" capacity, when coupled with the Company's national wholesale gas and
power marketing franchise, creates a wide range of value creation opportunities
benefiting both the Company and its customers. Dynegy's wholesale trading and
marketing franchise adds value to its generation assets by providing national
market access, market infrastructure and intelligence, risk management and
arbitrage opportunities, fuel management and procurement expertise and
transmission expertise for inputs (gas) and outputs (power). Generation capacity
adds value to the Company's wholesale trading and marketing franchise by
providing an outlet/market for gas supply, a source of reliable power supply and
an enhanced ability to structure innovative new products and services for
customers.
Concurrent with the restructuring of the U.S. wholesale electricity
markets, Dynegy is continuing its focus on building a portfolio of merchant
generation capacity in select markets across the country. Dynegy believes that
merchant generation capacity, which is designed principally to supply power to
markets during periods of peak demand, offers the greatest flexibility in
executing its strategy of an integrated gas and power marketing and power
generation business. For the foreseeable future, Dynegy will continue to expand
its ownership or commercial control over strategic generation assets/capacity in
selected markets through acquisitions, greenfield development and asset
management agreements. It is expected that approximately seventy percent of
projected capital expenditures over the next three years will be directed to the
control or ownership of generation assets designed to maximize value extraction
through execution of the Merchant Leverage Effect.
Deregulation of the retail gas and power markets is also evolving to
encourage greater competition and access to markets. Dynegy's retail gas and
electric strategy is designed to access a significant national customer base
while mitigating the large capital investment and financial risks necessitated
by other national retail marketing strategies. Rather than competing directly
with its existing wholesale customers, Dynegy has chosen to strengthen key
customer relationships by forming a number of regional retail gas alliances. The
combination of Dynegy's low cost energy supply (gas and power) with a regional
utility's large, installed customer base and local name recognition positions
each alliance to capture a significant portion of the local gas and power
market, when those markets fully open to competition. Dynegy's goal is to form
a North American network of regional retail energy alliances. Dynegy believes
that this strategy will accelerate its penetration of the retail gas and
electric markets while significantly reducing financial risk during this period
of regulatory uncertainty and restructuring. The following chart provides
geographic data on existing and targeted alliance markets.
DYNEGY'S RETAIL ALLIANCE NETWORK
[Map appears here]
Dynegy's integrated vision of the gas and power marketing and power
generation businesses in the United States is expected to be replicated
throughout Canada, the United Kingdom, Europe and Australia as those markets
open up to greater competition, subject to any unique attributes associated with
market deregulation in those areas. The Company maintains established energy
trading operations in both Canada and in the UK and is continuing to assess
local, regional and national markets, regulatory environments and other factors
in order to support and direct future economic investment.
3
Liquids Segment
This segment principally operates under the name Dynegy Mid-Stream Services
and consists of the North American mid-stream liquids operations, as well as the
global liquefied petroleum gas transportation and natural gas liquids marketing
operations located in Houston and London, and certain other businesses. The
North American mid-stream liquids operations are actively engaged in the
gathering and processing of natural gas and the transportation, fractionation
and storage of NGLs. Dynegy believes that a strategic shift in the historical
mid-stream asset business paradigm is occurring as major producers upstream and
refiners downstream have divested their ownership in these assets and
operations. Traditionally, these operations provided intermediate service and
support functions within most integrated petroleum companies. Dynegy believes
that it can achieve significant costs and operating efficiencies as well as
attractive returns on services provided to the market from the independent
ownership and operation of these assets. Dynegy believes that value creation
occurs throughout the mid-stream service businesses. As a result, Dynegy has
built a vertically integrated natural gas liquids infrastructure having the
capability of extracting profit throughout the value chain extending from inlet
natural gas volumes gathered from producing horizons throughout the US and
Canada to marketing NGLs to wholesalers and end-users throughout the world.
DYNEGY'S "LIQUIDS VALUE CHAIN"
[Graphic appears here]
The Company is a recognized industry leader in substantially all mid-stream
component businesses, ranging from natural gas processing to marketing NGLs to
end users. Dynegy is the second largest processor of natural gas in the United
States; it owns substantial fractionation capacity that exceeds three hundred
thousand barrels per day and the Company markets over four hundred fifty
thousand barrels of NGLs daily. These activities are supported by an extensive
storage and transportation system, which includes in excess of 14,000 miles of
natural gas pipelines, 2,000 miles of crude oil pipelines, 500 miles of NGL
pipelines and 60 million barrels of NGL storage capacity. To further assist its
operations, the Company has access to substantial barge, rail, trucking and
terminalling assets as well as large-hull ships having long-haul capabilities,
which enhance international trading opportunities.
Despite significant consolidation over the last four years, the domestic
mid-stream industry remains relatively fragmented and competition for additional
inlet volumes remains intense. The recent downturn in NGL prices has put
additional pressure on operating margins. Dynegy has responded to these industry
conditions by aggressively reducing costs, rationalizing assets in non-core
areas and improving its competitive position in core operating areas through
asset consolidation and alliances with industry partners. The goal of these
efforts is to mitigate the variability of earnings and cash flow caused by
fluctuations in commodity prices.
4
OVERVIEW OF SEGMENT BUSINESSES
WHOLESALE GAS AND POWER SEGMENT - NATURAL GAS
The Company's wholesale natural gas marketing activities are conducted
throughout North America and in the United Kingdom. These activities consist of
contracting to purchase specific volumes of natural gas from suppliers at
various points of receipt to be supplied over a specific period of time;
aggregating natural gas supplies and arranging for the transportation of these
gas supplies through proprietary and third-party transmission systems;
negotiating the sale of specific volumes of natural gas over a specific period
of time to local distribution companies (LDCs), utilities, power plants and
other end-users; and matching natural gas receipts and deliveries based on
volumes required by customers.
NATURAL GAS PURCHASES. The Company purchases natural gas from a variety of
suppliers under contracts with varying terms and conditions intended to ensure a
stable supply of natural gas. When purchasing natural gas, the Company considers
price, location, liquids content, if applicable, and quantities available. In
1998, the Company purchased natural gas in every major producing basin in the
United States and Canada from over 700 suppliers, ranging from major producers
to small independent companies. Pursuant to ancillary agreements entered into as
part of the Chevron Combination, Dynegy has the obligation to purchase and the
right to market substantially all of the natural gas produced or controlled by
Chevron in the United States (except Alaska). The Chevron relationship provides
the Company with a significant, stable supply of natural gas which, when
combined with gas supplies available from its network of other supply sources,
allows it to effectively manage gas supplies and reduces the risk of short-term
supply shortages during periods of peak demand.
TRANSPORTATION. The Company arranges for transportation of the natural gas
it markets from the supplier receipt point to the delivery point requested by
the purchaser. The Company generally retains title to the natural gas from the
receipt point to the delivery point and obtains transportation on unaffiliated
pipelines. The Company believes that its understanding of the United States'
pipeline network, along with the scale and geographic reach of its gas marketing
efforts, are important to the Company's success as a gas marketer. The Company
uses a variety of transportation arrangements to move its customers' volumes,
including short-term and long-term firm and interruptible agreements with
pipelines and brokered firm contracts with its customers.
NATURAL GAS SALES. The Company sells natural gas under sales agreements
that have varying terms and conditions intended to match seasonal and other
changes in demand. The Company's wholesale customer base consists primarily of
gas and electric utilities and industrial and commercial end-users and marketers
of natural gas. In 1998, sales were made to approximately 900 customers located
throughout the contiguous United States and parts of Canada. For the year ended
December 31, 1998, the Company's North American operations sold an aggregate
average of 8.2 Bcf per day of natural gas.
NATURAL GAS STORAGE. Natural gas storage capacity plays an important role
in the Company's ability to act as a full-service natural gas marketer by
allowing it to manage relatively constant gas supply volumes with uneven demand
levels. Through the use of its storage capabilities, the Company offers peak
delivery services to satisfy winter heating and summer electric-generating
demands. Storage inventories also provide performance security or "backup"
service to the Company's customers. The Company at various times leases short-
term and long-term firm and interruptible storage.
UNITED KINGDOM. Beginning in 1997, the Company began an independent energy
marketing business through a wholly owned subsidiary in the United Kingdom.
Additionally, Dynegy maintains a twenty-five percent participating preferred
stock interest in Accord Energy Limited ("Accord"), a U.K.-based energy
marketing company. During 1998, the Company's U.K. subsidiary purchased product
from 42 suppliers and marketed sales to 35 customers. For the year ended
December 31, 1998, the Company's U.K.-based operations sold an aggregate average
of 0.7 Bcf per day of natural gas.
WHOLESALE GAS AND POWER SEGMENT - POWER
Dynegy markets electricity and power products and services through Electric
Clearinghouse Inc. ("ECI"), an indirect wholly-owned subsidiary, providing a 24-
hour-a-day resource for the sale and purchase of power through access to
wholesale markets throughout North America. The Company helps generation
customers manage and optimize their fuel supplies, optimize generation assets
and capacity utilization and maximize energy conversion and tolling
opportunities. In addition, the Company provides market aggregation and sales
assistance and risk-management services and strategies. The Company will at
times contract for transmission capacity over regulated transmission lines in
order to facilitate regional movements of power. In 1998, Dynegy made sales to
approximately 180 customers and sold 121 million-megawatt hours of electricity.
5
Dynegy has interests in thirty-one power projects in operation, under
construction, in late stage development or pending acquisition having combined
gross capacity of 6,832 megawatts of electricity. The majority of these
facilities are gas-fired and are principally owned through interests in joint
ventures formed to operate the plants. In addition to ownership and operation of
generating capacity, the Company provides services to the joint ventures in
which it owns an interest in the areas of project development, engineering,
environmental affairs, operating services, management and fuel supply services.
Such management services include:
. Engineering oversight of all conceptual planning, feasibility studies,
environmental studies and plant, engineering and construction design;
. Specialized and comprehensive operating, maintenance, testing and start-up
services;
. Power and fuel management involving purchases and sales for and from the
projects;
. Contract negotiation;
. Development and maintenance of business plans and forecasts;
. Development and implementation of profit improvement opportunities;
. Monitoring regulatory, legislative, and environmental affairs; and
. Providing various accounting and financial services.
LIQUIDS SEGMENT - NATURAL GAS GATHERING AND PROCESSING
The natural gas processing industry is a major segment of the oil and gas
industry, providing the necessary service of refining raw natural gas into
marketable pipeline quality natural gas and natural gas liquids. The Company
owns interests in 42 gas processing plants, including 35 plants that it
operates, as well as associated and stand-alone natural gas gathering pipeline
systems. These assets are primarily located in the key producing areas of New
Mexico, Texas, Louisiana, Arkansas, Oklahoma, Kansas and Alberta, Canada.
During 1998, the Company processed an average of 2.3 Bcf per day of natural
gas and produced an average of 110.0 thousand barrels per day of natural gas
liquids. As part of the Chevron Combination's ancillary agreements, Dynegy
acquired the right to process substantially all of Chevron's processable natural
gas in those geographic areas where it is economically feasible for Dynegy to
provide such service.
LIQUIDS SEGMENT - FRACTIONATION
Natural gas liquids removed from the natural gas stream at gas processing
plants are generally in the form of a commingled stream of liquid hydrocarbons
(raw product). The commingled natural gas liquids are separated at fractionation
facilities into the component products of ethane, propane, normal butane,
isobutane and natural gasoline. The Company has ownership interests in three
fractionation facilities; two in Mont Belvieu, Texas and one in Lake Charles,
Louisiana. During 1998, these facilities fractionated an average of 285 thousand
gross barrels per day.
LIQUIDS SEGMENT - NGL MARKETING
The Company markets its own NGL production and also purchases NGLs from
third parties for resale. During 1998, the Company sold approximately 410
thousand barrels per day of natural gas liquids to over 900 customers.
LIQUIDS SEGMENT - TRANSPORTATION OPERATIONS
The Company's transportation assets are inter-connected with the nation's
gas liquids and natural gas pipeline systems. Through this network of pipeline
connections, terminals, rail cars, trucks, barges and storage facilities, the
Company moves natural gas liquids from producing regions in the Gulf Coast, West
and Midwest to most major domestic and international markets. The Company
operates large-scale marine terminals in Texas, Florida and Louisiana, which
offer importers a variety of methods for transporting products to the
marketplace. In addition, Dynegy has access to over 60 million barrels of
underground liquids storage providing customers with the ability to store,
trade, buy and sell specification products. Dynegy also leases large-hull ships
capable of importing/exporting liquid petroleum gas to/from markets throughout
the world.
6
LIQUIDS SEGMENT - CRUDE OIL MARKETING
The Company provides a full range of crude oil marketing services to
producers, and serves the North American refining community as a regionally
diversified supplier of crude oil. Through its participation in major trading
centers in Canada and the Mid-Continent, Rocky Mountain and Gulf Coast areas,
the Company has established itself as a dependable source of competitively
priced crude oil. During 1998, the Company sold approximately 240 thousand
barrels per day of crude oil to over 100 customers.
LIQUIDS SEGMENT - INTERNATIONAL LPG MARKETING
The Company markets and trades LPG to markets throughout the world through
use of chartered large-hull ships. Product marketed and traded by this business
is acquired from producing areas in the North Sea, West Africa, Algeria and the
Arabian Gulf as well as from the U.S. Gulf Coast region. Currently, this
business markets approximately 75,000 barrels per day of LPG.
RISK MANAGEMENT ACTIVITIES
Dynegy 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 at its gas processing and power generation
facilities.
The Company may, at times, have a bias in the market, within established
guidelines, resulting from the management of its portfolio. Additionally, Dynegy
monitors its exposure to fluctuations in interest rates and foreign currency
exchange rates and may execute swaps, forward-exchange contracts or other
financial instruments to hedge and manage these exposures.
In addition to the risk associated with price or interest rate movements,
credit risk is also inherent in the Company's risk management activities. Credit
risk relates to the risk of loss resulting from the nonperformance of
contractual obligations by a counterparty. Dynegy maintains credit policies with
regard to its counterparties, which management believes minimize its overall
credit risk.
The commercial groups of Dynegy manage, on a portfolio basis, the resulting
market risks inherent in the transactions, subject to parameters established by
the Dynegy Board of Directors. Market risks are monitored by a risk control
group that operates independently from the commercial units that create or
actively manage these risk exposures to ensure compliance with Dynegy's risk
management policies. Risk measurement is also practiced against the Dynegy
portfolios with value at risk, stress testing and scenario analysis.
As a result of recent pronouncements issued by the Financial Accounting
Standards Board and the Emerging Issues Task Force, the Company's comprehensive
method of accounting for energy-related contracts and/or derivative instruments
and hedging activities is changing effective January 1, 1999. Refer to "Item 7.
- - Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Item 8. - Financial Statements and Supplementary Data", for
further discussion and analysis of the effects of these accounting principle
changes.
COMPETITION
All phases of the businesses in which Dynegy is engaged are highly
competitive. In connection with both domestic and foreign operations, the
Company encounters strong competition from companies of all sizes, having
varying levels of financial and personnel resources.
Dynegy competes in its gas marketing business with other natural gas
merchants, producers and pipelines for sales based on its ability to aggregate
competitively priced supplies from a variety of sources and locations and to
utilize transportation efficiently through third-party pipelines. With respect
to its marketing operations, Dynegy believes that:
7
. Customers will increasingly scrutinize the financial condition of their
suppliers to assure that contract obligations will be met;
. Suppliers and transporters will demand more stringent credit terms to secure
the performance of natural gas merchants;
. The increased role of storage and other risk management tools will add to the
financial costs of doing business;
. The increasing availability of pricing information to participants in the
natural gas industry will continue to exert downward pressure on per-unit
profit margins in the industry;
. Suppliers will have to be multi-fuel marketers; and
. Large competitors will create competition from entities having significant
liquidity and other resources.
As a result, Dynegy believes its financial condition and its access to capital
markets will play an increasing role in distinguishing the Company from many of
its competitors. Operationally, Dynegy believes its ability to remain a low-cost
merchant and to effectively combine value-added services, competitively priced
supplies and price risk management services will determine the level of success
in its natural gas marketing operations.
Dynegy's power marketing business is similar to its gas marketing business
in that it provides contract services to electric utilities, markets and
supplies electricity and invests in power-related assets and joint ventures. As
a result, the competitive issues incumbent upon the Company's gas marketing
operations similarly affect the Company's power marketing business. As with its
gas marketing operations, the Company believes it has the ability to establish
itself as a low cost and dependable merchant providing competitively priced
supplies and a variety of services which will differentiate Dynegy from the
competition.
The independent power generation industry has grown rapidly over the past
twenty years. The demand for power may be met by generation capacity based on
several competing technologies, such as gas-fired or coal-fired cogeneration and
power generating facilities fueled by alternative energy sources including hydro
power, synthetic fuels, solar, wind, wood, geothermal, waste heat, solid waste
and nuclear sources. The Company's power generation business competes with other
non-utility generators, regulated utilities, unregulated subsidiaries of
regulated utilities and other energy service companies in the development and
operation of energy-producing projects. The trend towards deregulation in the
U.S. electric power industry has resulted in a highly competitive market for
acquisition or development of domestic power generating facilities. As the
nation's regulated utilities seek non-regulated investments and states move
toward retail electric competition, these trends can be expected to continue for
the foreseeable future.
The Company's natural gas liquids, crude oil marketing and gas transmission
businesses face significant competition from a variety of competitors including
major integrated oil companies, major pipeline companies and their marketing
affiliates and national and local gas gatherers, processors, brokers, marketers
and distributors of varying sizes and experience. The principal areas of
competition include obtaining gas supplies for gathering and processing
operations, obtaining supplies of raw product for fractionation, the marketing
of natural gas liquids, crude oil, residue gas, helium, condensate and sulfur,
and the transportation of natural gas, natural gas liquids and crude oil.
Competition typically arises as a result of the location and operating
efficiency of facilities, the reliability of services and price and delivery
capabilities. The Company believes it has the infrastructure, long-term
marketing abilities, financial resources and management experience to enable it
to effectively compete.
Regulation
General. The Company is subject to the laws, rules and regulations of the
jurisdictions and countries in which it conducts its operations. The regulatory
burden on the energy industry increases its cost of doing business and,
consequently, affects its profitability. Inasmuch as these rules and regulations
are frequently amended or reinterpreted, the Company is unable to predict the
future cost or impact of complying with such regulations. These rules and
regulations affect the industry as a whole; therefore, the Company does not
believe that it is affected in a significantly different manner from its
competitors.
NATURAL GAS REGULATION. The transportation and sale for resale of natural
gas is subject to regulation by the Federal Energy Regulatory Commission
("FERC") under the Natural Gas Act of 1938, as amended ("NGA") and, to a lesser
extent, the Natural Gas Policy Act of 1978, as amended ("NGPA"). Interstate
transportation and storage services by natural gas companies, including
interstate pipeline companies, and the rates charged for such services, are
regulated by the FERC. Certain of the Company's pipeline activities and
facilities are involved in interstate transportation of natural gas, crude oil
and natural gas liquids, and are subject to these or other federal regulations.
8
NATURAL GAS MARKETING. Commencing in 1985, the FERC promulgated a series
of orders and regulations adopting changes that significantly altered the
business of transporting and marketing natural gas by fostering competition. The
thrust of these regulations was to induce interstate pipeline companies to
provide nondiscriminatory transportation services to producers, distributors and
other shippers. The effect of the foregoing regulations has been the creation of
an open access market for natural gas purchases and sales and the creation of a
business environment which has fostered the evolution of various unregulated,
privately negotiated natural gas sales, purchase and transportation
arrangements. Regulations in Canada have resulted in a similar business
environment in that country. The sale for resale of natural gas in North America
has substantially completed its evolution to an unregulated, open access market.
The Company does not believe that any further regulatory matters will have a
material adverse effect on the Company's operations or competitiveness.
In the latter half of 1998, the FERC issued two proposed rulemakings in
which it laid out possible changes to the character of interstate transportation
services. Some proposed changes could benefit the Company, while others could
have a negative impact. It is too early to predict which, if any, changes will
be implemented.
In Canada, certain federal and provincial regulatory authorities require
parties to hold export or removal permits for transactions pursuant to which
natural gas is to be exported from the jurisdiction in which it is produced.
These requirements apply whether the gas is removed from one province to another
or from a province to the United States. The Company's indirectly wholly-owned
Canadian subsidiary, Dynegy Canada Inc., holds permits from the National Energy
Board, the Alberta Energy and Utilities Board ("AEUB") and the British Columbia
Ministry of Employment and Investment, Oil and Gas Section for such purposes. In
addition, Dynegy Canada Inc. holds export permits from the National Energy Board
similar to the foregoing for butane, propane and crude oil. In the United
Kingdom, regulation of the natural gas business is subject to regulation by the
Office of Gas Supply.
GAS PROCESSING. The primary function of Dynegy's gas processing plants is
the extraction of natural gas liquids and the conditioning of natural gas for
marketing, and not natural gas transportation. The FERC has traditionally
maintained that a processing plant is not a facility for transportation or sale
for resale of natural gas in interstate commerce and therefore is not subject to
jurisdiction under the NGA. Even though the FERC has made no specific
declaration as to the jurisdictional status of the Company's gas processing
operations or facilities, Dynegy believes its gas processing plants are
primarily involved in removing natural gas liquids and therefore exempt from
FERC jurisdiction. Nonetheless, certain facilities downstream of processing
plants are being considered for use in transporting gas between pipelines, which
may invoke FERC's jurisdiction. Such jurisdiction should apply to the downstream
facility as a pipeline, however, and not to the plants themselves.
In Canada, the AEUB governs the permitting, emissions and operations of gas
gathering and processing facilities. These facilities require a permit from the
AEUB to process or transport a specified volume of gas and a demonstration at
the time of application that the impact on the environment will be minimal.
Dynegy Canada Inc. holds all necessary permits required in order to own and
operate its processing and gathering facilities. Notwithstanding the
jurisdiction of the AEUB, the rates, terms and conditions of service of such
facilities are the result of privately negotiated arrangements.
Gathering. The NGA exempts gas-gathering facilities from the jurisdiction
of the FERC. Interstate transmission facilities, on the other hand, remain
subject to FERC jurisdiction. The FERC has historically distinguished between
these two types of facilities on a fact-specific basis. Dynegy believes its
gathering facilities and operations meet the current tests used by the FERC to
determine a nonjurisdictional gathering facility status. Some of the recent
cases applying these tests in a manner favorable to the determination of
Dynegy's nonjurisdictional status are still subject to rehearing and appeal. In
addition, the FERC's articulation and application of the tests used to
distinguish between jurisdictional pipelines and nonjurisdictional gathering
facilities have varied over time. While the Company believes current definitions
create nonjurisdictional status for Dynegy's gathering facilities, no assurance
can be given that such facilities will remain classified as gas gathering
facilities and the possibility exists that the rates, terms, and conditions of
the services rendered by those facilities, and the construction and operation of
the facilities will be subject to regulation by the FERC or by the various
states in the absence of FERC regulation.
OTHER REGULATORY ISSUES. The Company's gas purchases and sales are
generally not regulated by the FERC or other regulatory authorities; however, as
a gas merchant, the Company depends on the gas transportation and storage
services offered by various pipeline companies to enable the sale and delivery
of its gas supplies. Additionally, certain other pipeline activities and
facilities of the Company are involved in interstate and intrastate
transportation and storage services and are subject to various federal and state
regulations which generally regulate rates, terms and conditions of service.
9
ELECTRICITY MARKETING REGULATION. The Federal Power Act ("FPA") and rules
promulgated by the FERC regulate the transmission of electric power in
interstate commerce and sales for resale of that power. As a result, portions of
ECI's operations are under the jurisdiction of the FPA and FERC. In April 1996,
the FERC adopted rules ("Order 888") to expand transmission service and access
and provide alternative methods of pricing for transmission services. Order 888
is intended to open the FERC-jurisdictional interstate transmission grid in the
continental United States to all qualified persons that seek transmission
services to wheel wholesale power. Utilities are required to provide
transmission customers non-discriminatory open access to their transmission
grids with rates, terms, and conditions comparable to that which the utility
imposes on itself. Order 888 was upheld by the FERC in March 1997 and is
subject to appeal. Second generation implementation issues arising out of Order
888 abound. These include issues relating to power pool structures and
transmission pricing. These too will likely find their way to the courts, and
their outcome cannot be predicted.
POWER GENERATION REGULATION. Historically in the United States, regulated
and government-owned utilities have been the only significant producers of
electric power for sale to third parties. Pursuant to the enactment of the
federal Public Utility Regulatory Policies Act of 1978 ("PURPA"), companies
other than utilities were encouraged to enter the electric power business by
reducing regulatory constraints. In addition, PURPA and its implementing
regulations created unique opportunities for the development of cogeneration
facilities by requiring utilities to purchase electric power generated in
cogeneration plants meeting certain requirements (referred to as "Qualifying
Facilities"). As a result of PURPA, a significant market for electric power
produced by independent power producers developed in the United States. The
exemptions from extensive federal and state regulation afforded by PURPA to
Qualifying Facilities are important to Dynegy and its competitors. Many of the
projects that Dynegy currently owns meet the requirements under PURPA to be
Qualifying Facilities and are maintained on that basis.
In 1992, Congress enacted the Energy Policy Act of 1992 ("Energy Act"),
which amended the FPA and the Public Utility Holding Company Act of 1935
("PUHCA") to create new exemptions from PUHCA for independent power producers
selling electric energy at wholesale, to increase electricity transmission
access for independent power producers and to reduce the burdens of complying
with PUHCA's restrictions on corporate structures for owning or operating
generating or transmission facilities in the United States or abroad. The Energy
Act has enhanced the development of independent power projects and has further
accelerated the changes in the electric utility industry that were initiated by
PURPA.
Changes in PURPA, PUHCA and other related federal statutes may occur in the
next several years. The nature and impact of such changes on the Company's
projects, operations and contracts is unknown at this time. Dynegy actively
monitors these developments to determine such impacts as well as to evaluate new
business opportunities created by restructuring of the electric power industry.
Depending on the outcome of these legislative matters, changes in legislation
could have an adverse effect on current contract terms.
The enactment in 1978 of PURPA and the adoption of regulations thereunder
by the FERC and individual states provide incentives for the development of
small power production facilities and cogeneration facilities meeting certain
criteria. In order to be a Qualifying Facility, a cogeneration facility must (i)
produce not only electricity but also a certain quantity of thermal energy (such
as steam) which is used for a qualified purpose other than power generation,
(ii) meet certain energy operating and efficiency standards when oil or natural
gas is used as a fuel source and (iii) not be controlled or more than 50 percent
owned by an electric utility or electric utility holding company, or any
combination thereof. PURPA provides two primary benefits to Qualifying
Facilities owned and operated by non-utility generators. First, Qualifying
Facilities under PURPA are exempt from certain provisions of PUHCA, the FPA and,
except under certain limited circumstances, state laws respecting rate and
financial regulation. Second, PURPA requires that electric utilities purchase
electricity generated by Qualifying Facilities at a price equal to the
purchasing utility's full "avoided cost" and that the utility sell back-up power
to the Qualifying Facility on a non-discriminatory basis. The FERC regulations
also permit Qualifying Facilities and utilities to negotiate agreements for
utility purchases of power at rates other than the purchasing utility's avoided
cost. If Congress amends PURPA, the statutory requirement that an electric
utility purchase electricity from a Qualifying Facility at full avoided costs
could be eliminated. Although current legislative proposals specify the honoring
of existing contracts, repeal of the statutory purchase requirements of PURPA
going forward could increase pressure to renegotiate existing contracts. Any
changes that result in lower contract prices could have an adverse effect on the
Company's operations and financial position.
The Congress passed the Energy Act to promote further competition in the
development of new wholesale power generation sources. Through amendments to
PUHCA, the Energy Act encourages the development of independent power projects
that are certified by the FERC as exempt wholesale generators ("EWGs"). The
owners or operators of qualifying EWGs are exempt from the provisions of PUHCA.
The Energy Act also provides the FERC with extensive new authority to order
electric utilities to provide other electric utilities, Qualifying Facilities
and independent power projects with access to their transmission systems.
However, the Energy Act does preclude the FERC from ordering transmission
services to retail customers and prohibits
10
"sham" wholesale energy transactions which appear to provide wholesale service,
but actually are providing service to retail customers.
The FPA grants the FERC exclusive ratemaking jurisdiction over wholesale
sales of electricity in interstate commerce. The FPA provides the FERC with
ongoing as well as initial jurisdiction, enabling the FERC to revoke or modify
previously approved rates. Such rates may be based on a cost-of-service approach
or on rates that are determined through competitive bidding or negotiation on a
market basis. Although Qualifying Facilities under PURPA are exempt from
ratemaking and certain other provisions of the FPA, independent power projects
and certain power marketing activities are subject to the FPA and to the FERC's
ratemaking jurisdiction. Utilities are not obligated to purchase power from
projects subject to regulation by the FERC under the FPA because they do not
meet the requirements of PURPA. However, because such projects would not be
bound by PURPA's thermal energy use requirement, they may have greater latitude
in site selection and facility size. All of the projects currently owned or
operated by Dynegy as Qualifying Facilities under PURPA are exempt from the FPA.
Dynegy's EWGs, El Segundo, Long Beach, Commonwealth Atlantic and Hartwell, are
subject to the FPA and the jurisdiction of the FERC. With approval from FERC,
such entities, with certain exceptions, are exempted from being required to sell
at cost-based rates and can make all sales at market-based rates set through
negotiations. Independent power projects in which the Company has an interest
and that are not Qualifying Facilities have been granted market based rate
authority and comply with the FPA requirements governing approval of wholesale
rates and subsequent transfers of ownership interests in such projects.
Development of projects in international markets typically creates exposure
and obligations to the national, provincial and local laws of each host country,
worldwide environmental standards and requirements imposed by multi-lateral
lending institutions. The principal regulatory consideration for international
projects is PUHCA, since it is broadly applicable to the ownership and operation
of power facilities (including generation and transmission facilities) both
inside and outside of the United States. For international projects, the
principal basis for exemption from PUHCA is by obtaining EWG status from the
FERC. EWG status is very beneficial for international projects because EWGs are
generally allowed to make retail sales in international markets. Another way to
obtain an exemption from PUHCA for foreign ownership and operation activities is
by filing a foreign utility company determination ("FUCO") with the Securities
and Exchange Commission. However, FUCO filings are less frequently used,
because unlike EWGs, no formal regulatory order is issued confirming the status
of a FUCO. The development of international power generation and transmission
projects also may entail other multi-national regulatory considerations arising
under United States law, including export/import controls, trade laws and other
similar legislation. Dynegy attempts to identify and manage those issues early
in the development process to ensure compliance with such laws and regulations.
STATE REGULATORY REFORMS. Legislation currently under review in various
states affecting gas and power marketing and power generation businesses is most
likely to impact Dynegy in the near term. However, other state regulatory
reforms impacting the Company's processing and gathering operations and other
businesses are proceeding. While the ultimate impact of such legislation on the
Company's businesses cannot be predicted with certainty, the Company does not
believe that the outcome of these matters will have a material adverse effect on
the Company's operations or competitiveness.
ENVIRONMENTAL AND OTHER MATTERS
Dynegy's operations are subject to extensive federal, state and local
statutes, rules and regulations governing the discharge of materials into the
environment or otherwise relating to environmental protection. Development of
projects in international markets creates exposure and obligations to the
national, provincial and local laws of each host country, including
environmental standards and requirements imposed by these governments.
Compliance with these statutes, rules and regulations requires capital and
operating expenditures including those related to monitoring, pollution control
equipment, emission fees and permitting at various operating facilities and
remediation obligations. Failure to comply with these statutes, rules and
regulations may result in the assessment of civil and even criminal penalties.
The Company's environmental expenditures have not been prohibitive in the past,
but are anticipated to increase in the future with the trend toward stricter
standards, greater regulation, more extensive permitting requirements and an
increase in the number and types of assets operated by the Company subject to
environmental regulation. No assurance can be given that future compliance with
these environmental statutes, rules and regulations will not have a material
adverse effect on the Company's operations or its financial condition.
The vast majority of federal environmental remediation provisions are
contained in the Superfund laws -- the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA") and the Superfund Amendments and
Reauthorization Act ("SARA") and in the corrective action provisions of the
Federal Resource Conservation and Recovery Act ("RCRA"). Typically, the U.S.
Environmental Protection Agency ("EPA") acts pursuant to Superfund legislation
to
11
remediate facilities that are abandoned or inactive or whose owners are
insolvent; however, the legislation may be applied to sites still in operation.
Superfund law imposes liability, regardless of fault or the legality of the
original conduct, on certain classes of persons that contributed to the release
of a "hazardous substance" into the environment. These persons include the
current or previous owner and operator of a facility and companies that
disposed, or arranged for the disposal, of the hazardous substance found at a
facility. CERCLA also authorizes the EPA and, in certain instances, private
parties to take actions in response to threats to public health or the
environment and to seek recovery for the costs of cleaning up the hazardous
substances that have been released and for damages to natural resources from
such responsible party. Further, it is not uncommon for neighboring landowners
and other third parties to file claims for personal injury and property damage
allegedly caused by the hazardous substances released into the environment. RCRA
provisions apply to facilities that have been used to manage or are currently
managing hazardous waste and which are either still in operation or have
recently been closed. As amended, RCRA requires facilities to remedy any
releases of hazardous wastes or hazardous waste constituents at waste treatment,
storage or disposal facilities.
In connection with discrete asset acquisitions and sales, Dynegy may obtain
or be required to provide indemnification against certain environmental
liabilities. These indemnities are typically limited in scope and time period.
To minimize its exposure for such liabilities, environmental audits of the
assets Dynegy wishes to acquire are made, either by Dynegy personnel, outside
environmental consultants, or a combination of the two. The Company has not
heretofore incurred any material environmental liabilities arising from its
acquisition or divestiture activities. The incurrence of a material
environmental liability, and/or the failure of an indemnitor to meet its
indemnification obligations with respect thereto, could have a material adverse
effect on Dynegy's operations and financial condition.
To the Company's knowledge, it is in substantial compliance with, and is
expected to continue to comply in all material respects with, applicable
environmental statutes, regulations, orders and rules. Further, to the best of
the Company's knowledge, there are no existing, pending or threatened actions,
suits, investigations, inquiries, proceedings or clean-up obligations by any
governmental authority or third party relating to any violations of any
environmental laws with respect to the Company's assets or pertaining to any
indemnification obligations with respect to properties previously owned or
operated by the Company which would have a material adverse effect on the
Company's operations and financial condition. Dynegy's aggregate expenditures
for compliance with laws and regulations related to the discharge of materials
into the environment or otherwise related to the protection of the environment
approximated $9 million in 1998. Total environmental expenditures for both
capital and operating maintenance and administrative costs are not expected to
exceed $14 million in 1999.
In addition to environmental regulatory issues, the design, construction,
operation and maintenance of the Company's pipeline facilities are subject to
the safety regulations established by the Secretary of the Department of
Transportation pursuant to the Natural Gas Pipeline Safety Act ("NGPSA"), or by
state regulations meeting the requirements of the NGPSA, or to similar statutes,
rules and regulations in Canada. The Company believes it is currently in
substantial compliance, and expects to continue to comply in all material
respects, with these rules and regulations.
The Company's operations are subject to the requirements of the Federal
Occupational Safety and Health Act ("OSHA") and other comparable federal, state
and provincial statutes. The OSHA hazard communication standard, the EPA
community right-to-know regulations under Title III of SARA and similar state
statutes require that information be organized and maintained about hazardous
materials used or produced in its operations. Certain of this information must
be provided to employees, state and local government authorities and citizens.
The Company believes it is currently in substantial compliance, and expects to
continue to comply in all material respects, with these rules and regulations.
OPERATIONAL RISKS AND INSURANCE
Dynegy is subject to all risks inherent in the various businesses in which
it operates. These risks include, but are not limited to, explosions, fires and
product spillage, which could result in damage to or destruction of operating
assets and other property, or could result in personal injury, loss of life or
pollution of the environment, as well as curtailment or suspension of operations
at the affected facility. Dynegy maintains general public liability, property
and business interruption insurance in amounts that it considers to be adequate
for such risks. Such insurance is subject to deductibles that the Company
considers reasonable and not excessive. The occurrence of a significant event
not fully insured or indemnified against, and/or the failure of a party to meet
its indemnification obligations, could materially and adversely affect Dynegy's
operations and financial condition. Moreover, no assurance can be given that
Dynegy will be able to maintain insurance in the future at rates it considers
reasonable.
12
The Company has designated two of its subsidiaries to assist in the
management of certain liabilities principally relating to environmental,
litigation and credit reserves. Together with the involvement of third parties
whose primary consideration will be based on the realization of savings by the
Company, the subsidiaries will attempt to find new ways to handle these costs in
a more efficient manner.
EMPLOYEES
The Company employs approximately 1,220 employees at its administrative
offices and approximately 1,214 employees at its operating facilities.
Approximately 137 employees at Company-operated facilities are subject to
collective bargaining agreements with one of the following unions: the Oil,
Chemical and Atomic Workers International Union, the Metal Trades Council or the
Communications, Energy and Paperworkers Union. Management considers relations
with both union and non-union employees to be satisfactory.
ITEM 1A. EXECUTIVE OFFICERS
Set forth below are the names and positions of the current executive
officers of the Company, together with their ages, position(s) and years of
service with the Company.
Served with the
Name Age * Position(s) Company Since
C. L. Watson 49 Chairman of the Board, Chief Executive Officer, 1985
and a Director of the Company
Stephen W. Bergstrom 41 President and Chief Operating Officer of 1986
Dynegy Marketing and Trade, and a Director
of the Company
John U. Clarke 46 Senior Vice President, Chief Financial Officer 1997
of the Company, and an Advisory Director of
the Company
Dan W. Ryser 49 Executive Vice President of Dynegy Marketing 1993
and Trade
Stephen A. Furbacher 51 President and Chief Operating Officer of 1996
Dynegy Mid-Stream Services
Kenneth E. Randolph 42 Senior Vice President, General Counsel and 1984
Secretary of the Company
* As of April 1, 1999.
The executive officers named above will serve in such capacities until the
next annual meeting of the Company's Board of Directors, or until their
respective successors have been duly elected and have been qualified, or until
their earlier death, resignation, disqualification or removal from office.
C. L. Watson is the Chairman and Chief Executive Officer of Dynegy Inc. He
joined the company as President in 1985 and became Chairman and Chief Executive
Officer of NGC Corporation, Dynegy's predecessor, in 1989. Prior to his
employment with Clearinghouse, he served as Director of Gas Sales for the
Western United States for Conoco Inc. Mr. Watson serves on the board of
directors of Baker Hughes Incorporated.
Stephen W. Bergstrom, President and Chief Operating Officer of Dynegy
Marketing and Trade and Senior Vice President of Dynegy Inc., is responsible for
natural gas and power marketing, generation and international functions. He is
also a member of Dynegy's board of directors. After joining Natural Gas
Clearinghouse, the predecessor of Dynegy, in 1986 as Vice President of Gas
Supply, Mr. Bergstrom was promoted to Senior Vice President of Gas Marketing and
Supply in 1987. In 1990, he was named Executive Vice President of Natural Gas
Clearinghouse. Prior to joining the Company, Mr. Bergstrom
13
was Vice President of Gas Supply for Enron Gas Marketing. Mr. Bergstrom began
his professional career with Transco Energy Company of Houston.
John U. Clarke joined the Company in April 1997 as Senior Vice President
and Chief Financial Officer and serves as the Company's principal financial
officer. Mr. Clarke is also an Advisory Director of the Company. Prior to
joining Dynegy, Mr. Clarke was a managing director and co-head of a specialty
energy practice group with Simmons & Company International, an investment-
banking firm for approximately one year. He previously had served as President
of Concept Capital Group, Inc., a financial advisory firm formed by Mr. Clarke
in May, 1995. Mr. Clarke was Executive Vice President and Chief Financial and
Administrative Officer with Cabot Oil & Gas Corporation from August 1993 to
February 1995, and worked for Transco Energy Company, from April 1981 to May
1993, last serving as Senior Vice President and Chief Financial Officer. Mr.
Clarke began his career with Tenneco Inc. in January 1978.
Dan W. Ryser serves as Senior Vice President of Dynegy Inc. and executive
Vice President of Dynegy Marketing and Trade. Mr. Ryser manages the Company's
power generation business. Since joining Dynegy in 1993, Mr. Ryser has served
the Company in several capacities, including managing ECI's electricity
marketing operations. Prior to joining the Company in 1993, Mr. Ryser held
various positions at Enron Corp. including President of Enron Gas Processing
Company, President of Transwestern Pipeline Company, Executive Vice President of
Enron Gas Marketing and President of Houston Pipe Line Company.
Stephen A. Furbacher serves as President and Chief Operating Officer of
Dynegy Mid-Stream Services. In this capacity, Mr. Furbacher is responsible for
the operations of Dynegy's North American mid-stream liquids operations, as well
as the global liquefied petroleum gas transportation and natural gas liquids
marketing operations. The North American mid-stream liquids operations are
actively engaged in the gathering and processing of natural gas and the
transportation, fractionation and storage of NGLs. Prior to joining the Company
in September 1996, Mr. Furbacher served as President of Warren Petroleum
Company, a division of Chevron U.S.A. Inc.
Kenneth E. Randolph serves as Senior Vice President, General Counsel and
Secretary of the Company. He has served as Senior Vice President and General
Counsel of Dynegy (or its predecessor, Clearinghouse) since July 1987. In
addition, he served as a member of the Clearinghouse Management Committee from
May 1989 through February 1994 and managed Clearinghouse's marketing operations
in the Western and Northwestern United States from July 1984 through July 1987.
Prior to his employment with the Company, Mr. Randolph was associated with the
Washington, D.C. office of Akin, Gump, Strauss, Hauer & Feld, L.L.P.
14
ITEM 2. PROPERTIES
Over the last 5 years, Dynegy has built a national network of strategic
assets that support and enhance its wholesale gas, liquids and power marketing
franchise. The following provides a geographic view of the depth and breadth of
Dynegy's domestic strategic asset network.
DYNEGY'S STRATEGIC ASSET NETWORK
[Map appears here]
Current year operational activity conducted in these areas is discussed
under "Item 1. BUSINESS -- General." Following is a description of such
properties owned by the Company at December 31, 1998.
POWER GENERATION FACILITIES
Dynegy has interests in thirty-one power projects in operation, under
construction, in late stage development or pending acquisition. The majority of
these projects are cogeneration facilities operated by Dynegy. The portfolio
includes one heat recovery plant and one coal gasification facility. A
cogeneration plant utilizes power production technology that results in the
sequential generation of two or more useful forms of energy (e.g., electricity
and steam) from a single fuel source (e.g., natural gas). The Company's
generation assets include projects that are deemed Qualifying Facilities, EWGs
and "Merchant Plants". A Qualifying Facility is operated under laws outlined in
PURPA, by the FERC and by certain state legislatures, as previously discussed
herein, and typically sells the power it generates to a single power purchaser.
A Merchant Plant operates independently from designated power purchasers and as
a result will generate and sell power to the market when market economics
dictate that electricity prices exceed the cost of production. Merchant Plants
provide flexibility to the Company in executing its Energy Convergence strategy.
The combined gross capacity of facilities in operation is approximately 4,409
megawatts of electricity and over 3.4 million pounds per hour of steam sold to
third parties. The following table provides pertinent information concerning
power projects owned by the Company:
15
SUMMARY OF DYNEGY'S POWER GENERATION FACILITIES
===========================================================================================================================
POWER GENERATION PERCENT GROSS PRIMARY
PROJECT OWNED CAPACITY LOCATION FUEL PRIMARY POWER PURCHASER
- ----------------- -------- -------- -------- -------- -----------------------
(MW)
OPERATING
CoGen Power 100 5 Port Arthur, TX Waste heat Great Lakes Carbon Corporation
CoGen Lyondell Lessee (100%) 610 Channelview, TX Gas-fired Lyondell Chemical Company
Oyster Creek 50 424 Freeport, TX Gas-fired The Dow Chemical Company
Corona 40 47 Corona, CA Gas-fired SOCAL Edison Company
Kern Front 50 48 Kern County, CA Gas-fired Pacific Gas & Electric Company
High Sierra 50 48 Kern County, CA Gas-fired Pacific Gas & Electric Company
Double "C" 50 48 Kern County, CA Gas-fired Pacific Gas & Electric Company
San Joaquin 100 48 Stockton, CA Gas-fired Pacific Gas & Electric Company
Chalk Cliff 100 46 Kern County, CA Gas fired Pacific Gas & Electric Company
Badger Creek 50 46 Kern County, CA Gas-fired Pacific Gas & Electric Company
McKittrick 50 46 McKittrick, CA Gas-fired Pacific Gas & Electric Company
Live Oak 50 47 Kern County, CA Gas-fired Pacific Gas & Electric Company
Crockett 8 240 Crockett, CA Gas-fired Pacific Gas & Electric Company
Bear Mountain 100 46 Bakersfield, CA Gas-fired Pacific Gas & Electric Company
El Segundo 50 1,020 El Segundo, CA Gas-fired Merchant Facility
Long Beach 50 530 Long Beach, CA Gas-fired Merchant Facility
Black Mountain 50 85 Las Vegas, NV Gas-fired Nevada Power Company
Commonwealth Atlantic 50 340 Chesapeake, VI Gas-fired Virginia Electric & Power Company
Hartwell Energy 50 300 Hart County, GA Gas-fired Ogelthorpe Power Corporation
Michigan Power 50 123 Ludlington, MI Gas-fired Consumers Energy Company
Wabash Lessee (100%) 262 W. Terre Haute, IN Gasification PSI Energy, Inc.
-----
TOTAL 4,409
DEVELOPMENT PROJECTS (1)
Rockingham 100 800 Rockingham County, NC Gas-fired Duke Energy (3 years)
Rocky Road (2) 100 250 Chicago, IL. Gas-fired Merchant Facility
Encina Acquisition 50 1,218 San Diego County, CA. Gas-fired Merchant Facility
CoGen Lyondell Expansion 100 155 Channelview, TX. Gas-fired Merchant Facility
-----
Total 2,423
-----
TOTAL CAPACITY 6,832
============================================================================================================================
(1) The Encina Acquisition includes the Encina generating facility and
seventeen combustion turbines in the San Diego, Ca. Area. The transaction
is expected to close in the first half of 1999.
(2) This project is currently owned 100 percent by Dynegy but the Company
expects to divest itself of 50 percent of its ownership interest during
1999.
GATHERING SYSTEMS AND PROCESSING FACILITIES
Dynegy's natural gas processing services are provided at two types of gas
processing plants, referred to as field and straddle plants. Field plants
aggregate volumes from multiple producing wells into quantities that can be
economically processed to extract natural gas liquids and to remove water vapor,
solids and other contaminants. Straddle plants are situated on mainline natural
gas pipelines and allow operators to extract natural gas liquids from a natural
gas stream when the market value of natural gas liquids separated from the
natural gas stream is higher than the market value of the same unprocessed
natural gas. The following table provides certain information, including
operational data for the year ended December 31, 1998, concerning the gas
processing plants and gathering systems in which Dynegy owns an interest.
16
SUMMARY OF DYNEGY'S GAS PROCESSING FACILITIES
===================================================================================================================================
LOCATION TOTAL PLANT
-------------------------------- -----------------------------
PRACTICAL 1998 INLET NGL
GAS PROCESSING FACILITIES % OWNED COUNTY/PARISH STATE CAPACITY (2) THROUGHPUT PRODUCTION
- -----------------------------------------------------------------------------------------------------------------------------------
(MMCF/D) (1) (BPD) (1)
OPERATED FIELD PLANTS:
Binger (3) 100.00 Caddo OK 10 7.2 900.1
Bridger Lake (7) 100.00 Summit UT 25 10.5 434.0
Canadian Complex (3) 100.00 Hemphill TX 25 20.5 2,000.0
Chico Complex (3) 100.00 Wise TX 100 79.7 11,798.4
East Texas (3) 100.00 Gregg TX 34 20.1 3,379.8
Eustace (3) 100.00 Henderson TX 70 32.2 2,002.6
Fashing 58.24 Atascosa TX 38 14.3 286.8
Gladys 100.00 Alberta Can. 15 4.7 60.0
Leedey (3) 100.00 Roger Mills OK 50 31.5 2,891.2
Lefors Complex (3) 100.00 Wheeler TX 13 12.5 2,906.4
Madill (3) 100.00 Marshall OK 25 9.0 636.1
Mazeppa 100.00 Alberta Can. 82 37.6 475.0
Moores Orchard (3) 100.00 Fort Bend TX 7 3.4 71.7
Monahans (3) 100.00 Ward TX 31 24.5 1,378.1
New Hope 100.00 Franklin TX 30 16.4 993.2
Niject 16.00 Caddo OK 3.2 0.3 34.9
Ringwood (3) 100.00 Major OK 75 33.1 2,286.1
Rodman (3) 100.00 Garfield OK 65 52.7 5,086.7
Sand Hills Complex (3) 100.00 Crane TX 200 152.8 14,605.5
Sherman (3) 100.00 Grayson TX 33 20.6 853.0
Sligo 100.00 Bossier LA 40 35.4 593.8
Texarkana (3) 100.00 Miller AR 22 11.5 393.6
West Seminole (3) 40.14 Gaines TX 5 12.9 504.9
Versado Gas Processors Joint 63.00 Various TX / NM 376 161.8 19,088.0
Venture (8)
OPERATED STRADDLE PLANTS:
Barracuda 100.00 Cameron LA 190 169.4 3,442.0
Cheney 100.00 Kingman KS 85 62.9 3,603.6
Lowry (3) 100.00 Cameron LA 265 67.6 1,647.8
Stingray 100.00 Cameron LA 300 292.5 2,229.4
Yscloskey (5) 21.00 St. Bernard LA 473 372.8 6,351.0
NON-OPERATED FIELD PLANTS:
Diamond M (3) 3.98 Scurry TX 1 0.7 117.9
Spivey (4) (5) 3.87 Harper KS 3 0.8 43.2
Dover Hennessey (3) 18.29 Kingfisher OK 14 5.0 525.6
Indian Basin (3) 14.29 Eddy NM 30 27.1 1,519.1
Maysville (3) 44.00 Garvin OK 59 38.1 5,245.8
Snyder (3) (6) 3.25 Scurry TX 2 1.8 73.9
NON-OPERATED STRADDLE PLANTS:
Bluewater 16.72 Acadia LA 122 42.8 952.1
Calumet (5) 21.91 St. Mary's LA 300 223.4 4,696.1
Iowa 9.92 Jefferson LA 50 31.2 647.5
Davis
Patterson 1.09 St. Mary's LA 3 0.7 26.4
Sea Robin 18.70 Vermillion LA 187 17.6 803.6
Terrebone 0.83 Terrebone LA 10 4.0 74.8
Toca 8.86 St. Bernard LA 93 114.2 4,361.8
==============================================================================================================================
(1) Capacity, throughput and gross production are net to the Company's
ownership interest.
(2) Capacity data is at practical recovery rates, net to Dynegy's interest.
(3) Dynegy owns the indicated percentage of an associated gas gathering system.
(4) Dynegy owns 2.19 percent of the associated gas gathering system.
(5) Dynegy ownership is adjustable and subject to periodic (usually annual)
redetermination.
(6) Dynegy owns the indicated percentage of the Snyder gas gathering system and
3.98 percent of the Diamond M gas gathering system that also supplies the
Snyder plant.
(7) This facility consists of a 100 percent interest in a processing plant and
an NGL pipeline, a 100 percent interest in a crude oil pipeline and a 33.33
percent interest in reserves connected and dedicated to the plant.
(8) Versado Gas Processors includes the Saunders, Monument and the Eunice
Complex facilities. Ownership in the Saunders, Monument and Eunice
facilities changed from 100 percent to 63 percent during 1998 as a result
of formation of a joint venture with Texaco. Statistical information
includes the aggregate inlet gas throughput and NGL production volumes
accruing to Dynegy's interest during the year.
17
FRACTIONATION FACILITIES
The following table provides certain information concerning stand alone
fractionation facilities in which Dynegy owns an interest.
SUMMARY OF DYNEGY'S FRACTIONATION FACILITIES (1)
PERCENT 1998
FRACTIONATION FACILITIES OWNED GROSS CAPACITY (2) NET CAPACITY (2) INLET THROUGHPUT
------------------------ ------- ------------------ ---------------- ----------------
(MBbls/d) (MBBLS/D) (MBBLS/D)
Lake Charles, La. (3) 100.00 55 55 28
Cedar Bayou Fractionators (Mont Belvieu, Tx.) (4) 88.00 205 180 158
Gulf Coast Fractionators (Mont Belvieu, Tx.) 38.75 110 42 99
=======================================================================================================================
(1) Table does not include fractionation operations at VESCO or at other gas
processing facilities.
(2) Gross capacity data is at practical recovery rates and net capacity is at
practical rates multiplied by Dynegy's interest.
(3) The Lake Charles, La. Fractionator extracts ethane and propane only.
(4) Effective January 1, 1998, Dynegy's interest in this facility was reduced
to 88 percent as a result of a formation of a joint venture with Amoco.
STORAGE AND TERMINAL FACILITIES
The following table provides information concerning terminal and storage
facilities owned by the Company:
SUMMARY OF DYNEGY'S STORAGE AND TERMINAL FACILITIES
LOCATION
----------------------------------------
STORAGE AND TERMINAL
FACILITIES % OWNED COUNTY/PARISH STATE DESCRIPTION
--------------------------------------------------------------------------------------------------------------------
Hackberry Storage 100.00 Cameron LA NGL storage facility
Mont Belvieu Storage 100.00 Chambers TX NGL storage facility
Hattiesburg Storage 100.00 Washington MS NGL storage facility
Mont Belvieu Terminal 100.00 Chambers TX Product terminal facility
Galena Park Terminal 100.00 Harris TX LPG import/export terminal
Calvert City Terminal 100.00 Marshall KY Product transport terminal
Greenville Terminal 100.00 Washington MS Propane terminal
Hattiesburg Terminal 50.00 Forrest MS Propane terminal
Pt. Everglades Terminal 100.00 Broward FL Marine propane terminal
Tampa Terminal 100.00 Hillsborough FL Marine propane terminal
Tyler Terminal 100.00 Smith TX Product terminal
Mont Belvieu Transport 100.00 Chambers TX Offices and repair shop
Abilene Transport 100.00 Taylor TX Raw LPG transport terminal
Bridgeport Transport 100.00 Jack TX Raw LPG transport terminal
Gladewater Transport 65.00 Gregg TX Raw LPG transport terminal
Grand Lake Tank Farm 100.00 Cameron LA Condensate storage
====================================================================================================================
18
NATURAL GAS, LIQUIDS AND CRUDE OIL PIPELINES
Dynegy owns interests in various interstate and intrastate pipelines and
gathering systems as follows:
SUMMARY OF DYNEGY'S PIPELINE ASSETS
PIPELINE SYSTEMS % OWNED 1998 THROUGHPUT (1) STATES DESCRIPTION
--------------------------------------------------------------------------------------------------------------------
Crude Oil Pipeline System 100.00 24.1 TX/OK Crude oil pipelines
Kansas Gas Supply 100.00 61.5 KS/OK Intrastate natural gas pipeline
Dynegy NGL Pipeline 100.00 27.1 TX/LA Interstate liquids pipeline
Bridger Lake/Phantex 100.00 0.4 UT/WY Interstate liquids pipeline
Pipeline
Pelican Pipeline 100.00 42.0 LA Gas gathering pipeline
Vermillion Pipeline 100.00 11.4 Gulf of Mexico Gas gathering pipeline
Western Gas Gathering 100.00 2.9 KS Gas gathering pipeline
Pawnee Rock 100.00 11.7 KS Gas gathering pipeline
Seahawk 100.00 41.2 LA Intrastate natural gas pipeline
Dynegy Midstream Pipeline, 100.00 34.1 OK Intrastate natural gas pipeline
Inc.
Dynegy Intrastate Gas 100.00 6.2 TX Intrastate natural gas pipeline
Supply
Lake Boudreaux 100.00 1.0 LA Gas gathering pipeline
Grand Lake Liquids System 100.00 1.3 LA Intrastate liquids pipeline
====================================================================================================================
(1) 1998 throughput is based on thousands of barrels per day for the liquids and
crude lines and million cubic feet per day for the gas gathering and
transportation lines.
OTHER PROPERTY INVESTMENTS
Dynegy owns a 49 percent interest in a partnership that owns and operates
the West Texas LPG Pipeline, an interstate LPG pipeline. The interest was
acquired in the Chevron Combination.
In 1996, the Company and Chevron formed Venice Gas Processing Company, a
Texas limited partnership ("Venice"). Venice was formed for the purpose of
owning and operating the Venice Complex, located in Plaquemines Parish,
Louisiana. The complex includes 271 miles of gathering pipeline that extends
into the Gulf of Mexico having capacity of 810 MMcf/d, a one lean oil gas
processing plant, a 35,000 barrel per day fractionator, a 300 MMcf/d cryogenic
gas processing unit, 12 million barrels of NGL storage capacity, a marine
terminal and acreage. In 1997, Venice reorganized as a limited liability
company changing its name to VESCO. In September 1997, the VESCO members agreed
to expand ownership in VESCO to include an affiliate of Shell Midstream
Enterprises, a subsidiary of Shell Oil Company ("Shell"), effective September 1,
1997, in exchange for Shell's commitment of certain offshore reserves to VESCO.
In 1998, ownership in the LLC was again expanded to include Koch, in exchange
for their contribution of the cryogenic processing unit. At December 31, 1998,
Dynegy's interest in VESCO approximated 23 percent. Dynegy operates the facility
and has commercial responsibility for product distribution and sales.
During 1997, the Company contributed the Waskom gas processing facility to
the Waskom Gas Processing Company ("Waskom"), a Texas limited partnership.
Dynegy owns a 33 percent interest in Waskom, operates the facility and has
commercial responsibility for product distribution and sales.
TITLE TO PROPERTIES
The Company believes it has satisfactory title to its properties in
accordance with standards generally accepted in the energy industry, subject to
such exceptions which, in the opinion of the Company, would not have a material
adverse effect on the use or value of said properties.
The operating agreements for certain of the Company's natural gas
processing plants and fractionation facilities grant a preferential purchase
right to the plant owners in the event that any owner desires to sell its
interest. Such agreements may also require the consent of a certain percentage
of owners before rights under such agreements can be transferred. The Company is
subject, as a plant owner under such agreements, to all such restrictions on
transfer of its interest. In a few instances, the Company has granted rights of
first refusal with respect to any future sale of certain assets.
19
Certain of the Company's power generation assets are subject to rights of first
refusal or consent requirements with the Company's partners or power purchasers
which restrict the transfer of interests in the facilities.
Substantially all of Dynegy's gathering and transmission lines are
constructed on rights-of-way granted by the apparent record owners of such
property. In some instances, land over which rights-of-way have been obtained
may be subject to prior liens that have not been subordinated to the right-of-
way grants. Permits have been obtained from public authorities to cross over or
under, or to lay facilities in or along, water courses, county roads, municipal
streets and state highways, and in some instances, such permits are revocable at
the election of the grantor. Permits have also been obtained from railroad
companies to cross over or under lands or rights-of-way, many of which are also
revocable at the grantor's election. Some such permits require annual or other
periodic payments. In a few minor cases, property was purchased in fee.
INDUSTRY SEGMENTS
Segment financial information is included in Note 15 of Dynegy's
consolidated financial statements contained elsewhere herein.
Item 3. LEGAL PROCEEDINGS
On April 17, 1997, Pacific Gas and Electric Company ("PG&E") filed a
lawsuit in the Superior Court of the State of California, City and County of San
Francisco, against Destec, Destec Holdings, Inc. and Destec Operating Company
(wholly-owned subsidiaries of the Company now known respectively as Dynegy Power
Corp., Dynegy Power Holdings, Inc. and Dynegy Operating Company) as well as
against San Joaquin CoGen Limited ("San Joaquin" or the "Partnership") and its
general partners (collectively the "Dynegy Defendants"). Dynegy Power Corp. and
its affiliates now own all of the partnership interests in the Partnership as a
result of the purchase of the interests of the two outside partners in the
Partnership. In the lawsuit, PG&E asserts claims and alleges unspecified damages
for fraud, negligent misrepresentation, unfair business practices, breach of
contract and breach of the implied covenant of good faith and fair dealing.
PG&E alleges that due to the insufficient use of steam by San Joaquin's steam
host, the Partnership did not qualify as a cogenerator pursuant to the
California Public Utilities Code ("CPUC") Section 218.5, and thus was not
entitled under CPUC Section 454.4 to the discount the Partnership received under
gas transportation agreements entered into between PG&E and San Joaquin in 1989,
1991, 1993 and 1995. All of PG&E's claims in this suit arise out of the
Partnership's alleged failure to comply with CPUC Section 218.5. The defendants
filed a response to the suit on May 15, 1997. On October 20, 1997, PG&E named
Libbey-Owens-Ford ("LOF"), the Partnership's steam host, as an additional
defendant in the action. On February 23, 1998, PG&E served its Second Amended
Complaint on all defendants. On March 30, 1998, the defendants filed their
response to PG&E's Second Amended Complaint, denying PG&E's allegations and
alleging certain counterclaims against PG&E. By Order dated July 20, 1998, the
court dismissed certain of defendants' counterclaims against PG&E, and abated
certain others, pending resolution by the CPUC. The trial date is currently June
15, 1999. The Partnership has previously advised the FERC of PG&E's claims, and
stated that it would submit any appropriate filings upon completion of its
investigation. If the facility was found not to have satisfied the California
cogeneration facility standards, there is a strong likelihood that it would also
fail to satisfy the more stringent federal standards. In accordance with the
terms of a Protective Order entered into by the parties at the commencement of
the litigation, PG&E has notified San Joaquin that it may make a FERC filing
seeking damages from San Joaquin and decertification of its status as a
qualifying facility under the federal standards. Under FERC precedent, if the
San Joaquin facility were found not to have been a qualifying facility, San
Joaquin could be required to refund to PG&E payments it received pursuant to the
Power Purchase Agreement in excess of PG&E's short-term energy costs during the
period of non-compliance, plus interest. In the event the court or FERC were to
determine that San Joaquin is liable to PG&E under the Gas Transportation
Agreement or Power Purchase Agreement due to LOF's failure to use sufficient
quantities of steam, San Joaquin will seek to recover such amounts from LOF
under the terms of the Steam Purchase Agreement between San Joaquin and LOF. The
parties have been actively engaged in settlement discussions, which resulted in
the execution of a Termination and Settlement Agreement between PG&E and the
Dynegy Defendants on March 9, 1999 (the "Settlement Agreement"). The Settlement
Agreement provides for, upon the receipt of CPUC approval, a dismissal with
prejudice of PG&E's claims against the Dynegy Defendants, a release by PG&E of
all claims relative to FERC matters and a termination of the San Joaquin power
purchase agreement as of December 31, 1999, whereupon the San Joaquin facility
will continue to operate as a merchant plant. The Dynegy Defendants will seek to
recover from LOF any losses resulting from the settlement with PG&E. However, if
the settlement is not ultimately concluded, the Dynegy Defendants will seek to
recover from LOF any losses or amounts for which it may be found liable.
Further, the Company's subsidiaries intend to continue to vigorously defend this
action. In the opinion of management, the ultimate resolution of this lawsuit
will not have a material adverse effect on the Company's financial position or
results of operations.
20
On March 24, 1995, Southern California Gas Company ("SOCAL") filed a
lawsuit in the Superior Court of the State of California for the County of Los
Angeles, against Destec, Destec Holdings and Destec Gas Services, Inc. (now
known respectively as Dynegy Power Corp., Dynegy Holdings, Inc. and Dynegy Gas
Services, Inc.), wholly-owned direct and indirect subsidiaries of the Company
(collectively, the "Defendants"), as well as against Chalk Cliff Limited and
McKittrick Limited (collectively, the "Partnerships"). The Company owns an
indirect 50 percent limited partnership interest in McKittrick Limited, and
Chalk Cliff Limited is now wholly owned by subsidiaries of the Company through
the purchase of the interests of Dominion Energy, Inc. All general partners of
the Partnerships are also named defendants. The lawsuit alleged breach of
contract against the Partnerships and their respective general partners, and
interference and conspiracy to interfere with contracts against the Defendants.
The breach of contract claims arose out of the "transport-or-pay" provisions of
the gas transportation service agreements between the Partnerships and SOCAL.
SOCAL sought damages from the Partnerships for past damages and anticipatory
breach damages in an amount equal to approximately $31,000,000. On October 24,
1997, the Court granted SOCAL's Motion for Summary Judgment relating to the
breach of contract causes of action against the Partnerships and their
respective general partners, and requested that SOCAL submit a proposed order
consistent with that ruling for the Court's signature. On November 21, 1997, the
Partnerships filed for voluntary Chapter 11 bankruptcy protection in the Eastern
District of California. Normal business operations by the Partnerships continued
throughout the course of these reorganization proceedings. On January 12, 1998,
the Court entered a Final Order that (a) severed out the Partnerships due to
their Chapter 11 bankruptcy filings, (b) included a finding of contract
liability against the Defendants, (c) dismissed the tortious interference claims
against the Defendants, and (d) assessed damages in an aggregate amount of
approximately $31,000,000. On the same day, the Defendants filed their Notice of
Appeal, and posted a security bond with the Second Appellate District in Los
Angeles based on the lack of allegations made or proven by SOCAL which support
holding those entities liable in contract. On March 11, 1998, the Partnerships
and their respective general partners filed Notices of Appeal with respect to
certain findings of fact in the Court's January 12, 1998 Final Order that were
adverse to those defendants. On or about April 15, 1998, the Court entered a
final judgment against the Partnerships themselves in recognition of the lifting
of the automatic stay against those entities by the Bankruptcy Court. The
Partnerships filed their appeal of that final judgment on June 4, 1998. On
October 21, 1998, the Bankruptcy Court dismissed the voluntary bankruptcy
filings of the Partnerships and their respective lenders thereafter notified
each of the Partnerships of the occurrences of an Event of Default under the
Partnerships' respective credit agreements due to the existence of the SOCAL
judgment against them, and have instituted foreclosure proceedings as to the
projects. Additionally, receivers were named by the lenders and approved by the
Court for each of the projects. In early December 1998, the defendants filed
their opening appellate briefs in the appeal of the Court's final judgment. On
February 23, 1999, the Court granted a motion by SOCAL to amend the Court's
final judgment to include a finding that Dynegy Power Corp. is the alter ego of
the Partnerships and their respective general partners. Dynegy Power Corp. will
appeal the Court's ruling, and will vigorously defend SOCAL's claims.
The PG&E and SOCAL litigations represent pre-acquisition contingencies
acquired by the Company in the Destec Acquisition. In a related matter, Chalk
Cliff and San Joaquin have each guaranteed the obligations of the other
partnership, represented by the project financing loans used to construct the
power generation facilities owned by the respective Partnerships. In the
opinion of management, the election by the lender of its option under the terms
of such arrangements would not have a material adverse effect on the Company's
financial position or results of operations.
On August 3, 1998, Modesto Irrigation District ("MID") filed a lawsuit
against PG&E and Destec in federal court for the Northern District of
California, San Francisco division. The lawsuit alleges violation of federal
and state antitrust laws and breach of contract against Destec. The allegations
are related to a power sale and purchase arrangement in the city of Pittsburg,
CA. MID seeks actual damages from PG&E and Destec in amounts not less than $25
million. MID also seeks a trebling of any portion of damages related to its
antitrust claims. By order dated February 2, 1999, the federal District Court
dismissed MID's state and federal antitrust claims against PG&E and Destec;
however, the Court granted MID leave of thirty days to amend its complaint to
state an antitrust cause of action. On March 3, 1999, MID filed an amended
complaint recasting its federal and state antitrust claims against PG&E and
Destec and restating its breach of contract claim against Destec. Dynegy
believes the allegations made by MID are meritless and will continue to
vigorously defend MID's claims. In the opinion of management, the amount of
ultimate liability with respect to these actions will not have a material
adverse effect on the financial position or results of operations of the
Company.
The Company assumed liability for various claims and litigation in
connection with the Chevron Combination, the Trident Combination, the Destec
Acquisition and in connection with the acquisition of certain gas processing and
gathering facilities from Mesa Operating Limited Partnership. The Company
believes, based on its review of these matters and consultation with outside
legal counsel, that the ultimate resolution of such items will not have a
material adverse effect on the Company's financial position or results of
operations. Further, the Company is subject to various legal proceedings and
claims, which arise in the normal course of business. In the opinion of
management, the amount of ultimate liability with
21
respect to these actions will not have a material adverse effect on the
financial position or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's $0.01 par value common stock ("Common Stock") is listed and
traded on the New York Stock Exchange under the ticker symbol "DYN". The number
of stockholders of record of the Common Stock as of March 24, 1999, was 290.
The following table sets forth the high and low closing prices for
transactions involving the Company's Common Stock for each calendar quarter, as
reported on the New York Stock Exchange Composite Tape and related dividends
paid per common share during such periods.
Summary of Dynegy's Common Stock Price and Dividend Payments
High Low Dividend
------------------------------------------
1998:
Fourth Quarter $15.250 $10.250 $0.0125
Third Quarter 14.063 9.563 0.0125
Second Quarter 15.375 12.500 0.0125
First Quarter 17.250 14.625 0.0125
1997:
Fourth Quarter $19.875 $16.000 $0.0125
Third Quarter 17.750 14.875 0.0125
Second Quarter 19.625 15.500 0.0125
First Quarter 24.000 15.375 0.0125
=========================================================================
The holders of the Common Stock are entitled to receive dividends if, when
and as declared by the Board of Directors of the Company out of funds legally
available therefor. Consistent with the Board of Directors' intent to establish
a policy of declaring quarterly cash dividends, a cash dividend of $0.0125 per
share was declared and paid in each quarter during 1998 and 1997. The holders of
the Series A Preferred Stock are entitled to receive dividends or distributions
equal per share in amount and kind to any dividend or distribution payable on
shares of the Company's common stock, when and as the same are declared by the
Company's Board of Directors. Accordingly, the Company also paid quarterly cash
dividends on its Series A Participating Preferred Stock of $0.0125 per share, or
$0.05 per share on an annual basis.
22
ITEM 6. SELECTED FINANCIAL DATA
The selected financial information presented below was derived from, and is
qualified by reference to, the Consolidated Financial Statements of the Company,
including the Notes thereto, contained elsewhere herein. The selected financial
information should be read in conjunction with the Consolidated Financial
Statements and related Notes and Management's Discussion and Analysis of
Financial Condition and Results of Operations.
DYNEGY'S SELECTED FINANCIAL DATA
Year Ended December 31,
--------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------------------------------------------
($ in thousands, except per share data)
STATEMENT OF OPERATIONS DATA (1) :
Revenues $14,257,997 $13,378,380 $7,260,202 $3,665,946 $3,237,843
Operating margin 428,687 385,294 369,500 194,660 99,126
General and administrative expenses 185,708 149,344 100,032 68,057 47,817
Depreciation and amortization expense 113,202 104,391 71,676 44,913 8,378
Asset impairment, abandonment
Severance and other charges 9,644 275,000 --- --- ---
Net income (loss) (3) $ 108,353 $ (102,485) $ 113,322 $ 92,705 $ 42,101
Earnings (loss) per share (4) $0.66 $(0.68) $0.83 $0.82 n/a
Pro forma earnings per share (4) n/a n/a n/a $0.40 $0.28
Shares outstanding 164,605 150,653 136,099 113,176 97,804
CASH FLOW DATA:
Cash flows from operating activities $ 250,780 $ 278,589 $ (30,954) $ 90,648 $ 17,170
Cash flows from investment activities (295,082) (510,735) (111,140) (310,623) (38,376)
Cash flows from financing activities 49,622 204,984 176,037 221,022 18,959
OTHER FINANCIAL DATA:
EBITDA (5) $ 363,517 $ 291,899 $ 289,023 $ 142,538 $ 57,716
Dividends or distributions to partners, net 7,988 7,925 6,740 9,253 14,041
Capital expenditures, acquisitions
And investments (6) 478,464 1,034,026 859,047 979,603 47,014
=================================================================================================================================
December 31,
--------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------------------------------------------
($ in thousands)
BALANCE SHEET DATA (2) :
Current assets $ 2,117,241 $ 2,018,780 $1,936,721 $ 762,939 $ 445,782
Current liabilities 2,026,323 1,753,094 1,548,987 705,674 404,144
Property and equipment, net 1,932,107 1,521,576 1,691,379 948,511 114,062
Total assets 5,264,237 4,516,903 4,186,810 1,875,252 645,471
Long-term debt 1,046,890 1,002,054 988,597 522,764 33,000
Total equity 1,128,063 1,019,125 1,116,733 552,380 152,213
=================================================================================================================================
(1) The Destec Acquisition was accounted for as an acquisition of a business in
accordance with the purchase method of accounting and the results of
operations attributed to the acquired business are included in the
Company's financial statements and operating statistics effective July 1,
1997. The Chevron Combination was accounted for as an acquisition of
assets under the purchase method of accounting and the results of
operations attributed to the acquired assets are included in the Company's
financial statements and operating statistics effective September 1, 1996.
The Trident Combination was accounted for as an acquisition of a business
in accordance with the purchase method of accounting and the results of
operations attributed to the acquired business are included in the
Company's financial statements and operating statistics effective March 1,
1995.
(2) The Destec Acquisition and the Chevron and Trident Combinations were each
accounted for under the purchase method of accounting. Accordingly, the
purchase price was allocated to the assets acquired and liabilities assumed
based on their estimated fair values as of the effective dates of each
transaction. The effective dates of the Destec Acquisition, Chevron
Combination and Trident Combination were June 30, 1997, September 1, 1996
and March 1, 1995, respectively.
(3) Net income (loss) does not include a provision for federal income taxes,
other than minimal amounts on the taxable income of Clearinghouse's
corporate subsidiaries, for the year ended December 31, 1994.
(4) Earnings (loss) per share are computed in accordance with provisions of
Statement of Financial Accounting Standard No. 128, "Earnings Per Share",
for each of the years ended December 31, 1998, 1997, 1996 and 1995,
respectively. Pro forma earnings per share for each of the years ended
December 31,
23
1995 and 1994, respectively, are based on reported net income for the
period adjusted for the incremental statutory federal and state income
taxes that would have been provided had Clearinghouse been a taxpaying
entity prior to the Trident Combination. The pro forma earnings per share
computation for the year ended December 31, 1995, eliminates the effect of
a one-time $45.7 million income tax benefit associated with the Trident
Combination. The weighted average shares outstanding for the year ended
December 31, 1995, is based on the weighted average number of common shares
outstanding plus the common stock equivalents that would arise from the
exercise of outstanding options or warrants, when dilutive. Pro forma
weighted average shares outstanding of 97.8 million shares for the year
ended December 31, 1994, gives effect to the terms of the Trident
Combination and the common stock equivalent shares outstanding as of the
effective date of the Trident Combination assuming a common stock market
price of $12 in all periods.
(5) Earnings before interest, taxes, depreciation and amortization ("EBITDA")
is presented as a measure of the Company's ability to service its debt and
to make capital expenditures. It is not a measure of operating results and
is not presented in the Consolidated Financial Statements. The 1997 amount
includes the non-cash portion of items associated with the $275 million
impairment and abandonment charge.
(6) Includes all value assigned the assets acquired in various business and
asset acquisitions. The 1997 amount is before reduction for value received
upon sale of Destec's foreign and non-strategic assets of approximately
$735 million.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
COMPANY PROFILE
Dynegy is a leading provider of energy products and services in North
American and the United Kingdom. Products marketed by the Company's wholesale
operations include natural gas, electricity, coal, natural gas liquids, crude
oil, liquid petroleum gas and related services. The Company's wholesale
marketing operations are supported by ownership or control of an extensive asset
base and transportation network that includes unregulated power generation, gas
and liquids storage capacity, gas, power and liquids transportation capacity and
gas gathering, processing and fractionation assets. The critical mass achieved
through the combination of a large scale energy marketing operation with
strategically located assets which augment the marketing efforts affords the
Company the ability to offer innovative, value-creating energy solutions to its
customers.
From inception of operations in 1984 until 1990, Clearinghouse limited its
activities primarily to natural gas marketing. Starting in 1990, Clearinghouse
began expanding its core business operations through acquisitions and strategic
alliances resulting in the formation of a mid-stream energy asset business and
establishing energy marketing operations in both Canada and the United Kingdom.
The Company initiated electric power marketing operations in February 1994 in
order to exploit opportunities created by the deregulation of the domestic
electric power industry. Effective March 1, 1995, Clearinghouse and Holding, a
fully integrated natural gas liquids company, merged and the combined entity was
renamed NGC. On August 31, 1996, NGC completed a strategic combination with
Chevron whereby substantially all of Chevron's mid-stream assets were merged
with NGC. Effective July 1, 1997, NGC acquired Destec, a leading independent
power producer. During 1998, the Company changed its name to Dynegy Inc. in
order to reflect its evolution from a natural gas marketing company to an energy
services company capable of meeting the growing demands and diverse challenges
of the dynamic energy market of the 21st Century.
BUSINESS SEGMENTS
Dynegy's operations are divided into two segments: the Wholesale Gas and
Power and Liquids segments. The Wholesale Gas and Power segment is actively
engaged in value creation through marketing and trading of natural gas, power
and coal and the generation of electricity principally under the name Dynegy
Marketing and Trade. The Liquids segment consists of the North American mid-
stream liquids operations, as well as the international liquefied petroleum gas
transportation and natural gas liquids marketing operations located in Houston
and London, and certain other businesses. The North American mid-stream liquids
operations are actively engaged in the gathering and processing of natural gas
and the transportation, fractionation and storage of NGLs. The Liquids segment
operates principally under the name Dynegy Mid-Stream Services.
24
RECENT DEVELOPMENTS
During 1998, Dynegy successfully executed key operating and business
strategies that management believes provide impetus for financial growth in 1999
and beyond. Key accomplishments during the period, which are more fully
described elsewhere herein, included:
. Expansion of ownership or control of power generating assets and
infrastructure;
. Formation of additional regional retail energy marketing alliances in the
United States;
. Formation of asset management and marketing alliances with electric utilities,
municipalities and others;
. Enhancement of unit margins through selective disposition of marginally
profitable sales volumes;
. Continued rationalization of the Company's natural gas liquids businesses
through formation of joint ventures, asset consolidations, discrete asset
dispositions and strategic cost efficiency and reduction measures;
. Implementation of "just-in-time" controlled inventory management techniques;
. Sales of non-strategic assets and operations;
. Implementation of technology infrastructure improvements intended to provide
the Company with state-of-the-art business and financial software
applications; and
. Continued restructuring of the Company's long-term debt portfolio.
WHOLESALE GAS AND POWER SEGMENT -
Dynegy expects to continue expanding its ownership or commercial control of
strategic assets and generating capacity in selected major market areas through
acquisitions, greenfield development and asset management agreements in order to
leverage its marketing and trading capabilities. Execution of this strategy
began with the acquisition of Destec in 1997 and has continued during 1998 and
into 1999.
During 1998, the Company and a partner, NRG Energy, Inc. ("NRG"), a wholly-
owned subsidiary of Northern States Power Company, acquired two California-based
gas-fired merchant plants known as Long Beach and El Segundo. These generation
facilities have a combined gross capacity of over 1,500 megawatts, providing the
Company with significant commercial flexibility in the recently deregulated
California electricity market. Dynegy and NRG each own a 50 percent interest in
these facilities. Late in 1998, the Company and NRG announced the acquisition of
the Encina power plant and certain other assets representing over 1,200
megawatts of additional generation capacity located in the San Diego, California
area. The transaction is expected to close during the first half of 1999 and
Dynegy will own a 50 percent interest in the special purpose entities that are
acquiring the assets. Dynegy will provide fuel procurement, power marketing and
asset management services for these ventures, while NRG will be responsible for
operation of the facilities. In addition, during the year, Dynegy increased its
ownership interest in certain other California based Qualifying Facilities.
The Company is in the process of constructing two projects in the U.S., one
in North Carolina and one near Chicago, Illinois. The North Carolina project is
an 800 megawatt dual fuel fired facility that is expected to be operational by
mid-year 2000 and is currently wholly owned by the Company. The Illinois
facility is a 250 megawatt gas-fired merchant plant designed to assist in
reducing power system congestion induced by peak electricity demands in the
Midwest. The Illinois facility is expected to be operational in the summer of
1999. Dynegy currently owns 100 percent of this venture, but intends to divest
50 percent of its ownership interest in the venture in 1999. The Company has
also announced its intent to expand the capacity of its Lyondell power
generation facility by 155 megawatts in order to increase its capability of
meeting peak demands in the Texas power markets. The expansion is anticipated
to be operational in June 2000.
Execution of the Company's retail marketing strategy expanded during 1998
with the addition of two new retail marketing alliances, one in the Southeast
and one in the Northern Plains. These alliances expand Dynegy's retail presence
to a significant part of the Eastern U.S. and in Canada. The Company is
continuing to pursue additional alliance partners in order to achieve its goal
of forming a North American network of regional retail energy marketers.
During 1998, Dynegy consummated several agreements to manage the wholesale
power, natural gas supply, transportation and storage needs for numerous
municipalities, utilities and other similar entities. These arrangements
typically represent full-service energy supply and asset management agreements
requiring Dynegy to assure all energy requirements, as dictated by the specific
agreement, as well as requiring Dynegy to manage firm transportation capacity
and firm storage capacity. In addition, Dynegy and Florida Power Corporation, a
Florida Progress Corporation company located in St. Petersburg, Florida, agreed
to form a power marketing alliance that will operate in the U.S. wholesale
electric and natural gas markets. The alliance created a commercial relationship
between a power marketer and a utility focused on developing
25
wholesale energy markets in Florida and other regions. These examples represent
execution of Dynegy's goal to achieve commercial control over physical assets in
order to optimize returns, to both Dynegy and our customers.
During 1998, the Company eliminated from its wholesale marketing customer
base identified non-strategic or marginally profitable contracts and
arrangements. As a result, the Company's growth in and market share of U.S. gas
marketing volumes decreased during the period. However, this strategy resulted
in higher average per unit margins achieved by the Company during 1998.
Management will continue to stress the quality of its customer base and service
offering over sales volumes in order to maximize profitability.
LIQUIDS SEGMENT -
During 1998, the Liquids segment continued execution of the restructuring
and rationalization of its operations that were begun in 1997. Despite
uncooperative market conditions, the segment's businesses were able to achieve
efficiency improvements and cost reductions that enhance its competitive
position in the marketplace. These businesses increased their focus on
extracting fee income throughout the value chain, unbundling services and
leveraging off the Company's commercial skills and relationships. In addition,
the segment businesses focused efforts on re-negotiating or restructuring
marginally profitable contractual arrangements in order to position these
businesses for profitable growth. Finally, the segment continued to invest in
strategically located mid-stream assets in order to advance existing commercial
advantages or to leverage off identified economies of scale. The intent of these
initiatives is to mitigate the variability commodity prices have on the
operating results of the segment, as well as to position the segment's
businesses to take full advantage of improvements in market conditions when
they occur.
During the period, the Company completed the plant consolidations that were
identified and accrued for in 1997. Additionally, the Company sold three non-
strategic gas processing facilities and formed a joint venture with Texaco that
combined the natural gas processing operations of both companies in Southeast
New Mexico and West Texas. The result of these activities was increased
operating efficiencies and economies of scale that are intended to increase
profitability through higher utilization, lower costs and improved performance.
Also, during the year, Dynegy Canada Inc. acquired the Mazeppa and Gladys gas
processing plants and associated gathering lines located in Alberta, Canada. The
acquisition of these mid-stream assets represents the re-establishment of a
Canadian asset base that will complement existing Canadian gas marketing and
trading operations.
The Company expanded its commercial capability in the Gulf Coast region
through completion of construction of a 55,000 barrel per day fractionation
facility near Lake Charles, Louisiana. The fractionator is capable of separating
natural gas liquids into ethane, propane and a butane and natural gasoline mix.
The facility is fed primarily from offshore production in the Gulf of Mexico and
its products are primarily shipped through pipeline to customers in the
petrochemical and refining industries in Lake Charles or to Mont Belvieu, Texas,
for further refinement. Additionally, the commercial capability of the VESCO
investment was enhanced by the contribution of a 300 MMcf/d cryogenic gas
processing unit.
In 1998, management of the Company's investment in NGL inventories was
enhanced through implementation of a "just-in-time" controlled inventory
process. The economic result of the improved management of NGL inventories
reduced carrying costs and assisted in insulating the Company from commodity
price risk resulting from the precipitous drop in NGL prices throughout most of
the year.
During the period, Dynegy sold the Ozark Gas Transmission System ("Ozark")
to an affiliate of Oklahoma City-based Enogex Inc. for $55 million, realizing an
after-tax gain of $17.1 million.
TECHNOLOGY INFRASTRUCTURE ENHANCEMENTS -
Dynegy has launched a technology infrastructure improvement initiative
aimed at optimizing major business and financial processes at the Company. Using
state-of-the-art technology and software applications, the project team is
focused on process enhancements extending throughout the organization, linking
initial price and market discovery with risk control, production, aggregation,
distribution, cash settlement, accounting and financial statement recognition.
DEBT PORTFOLIO RESTRUCTURING -
During 1998, the Company retired certain high-coupon debt and renegotiated
or refinanced other debt agreements with the intent of improving the financial
flexibility of its debt portfolio, thereby reducing the overall cost of its
indebtedness
26
and positioning the Company to manage its liquidity needs for the foreseeable
future. Further discussion of the renegotiated or refinanced indebtedness is
contained in the Liquidity and Capital Resources section of Item 7 of this Form
10-K and in the footnotes to the financial statements. The following is a
description of the more significant retirements of indebtedness occurring during
1998, which impacted the restructuring of the Company's overall debt portfolio
during the period.
In February 1998, the Company delivered Notices of Redemption to the
holders of its $65 million principal amount of 14% Senior Subordinated Notes and
$105 million principal amount of 10.25% Subordinated Notes. On March 31, 1998
and April 15, 1998, the Company retired the Senior Subordinated Notes and the
Subordinated Notes, respectively, pursuant to the redemption provisions
contained in the respective indentures. Dynegy funded the aggregate redemption
value of approximately $180 million through a public debt issuance.
As part of the Chevron Combination, Dynegy assumed approximately $155.4
million payable to Chevron upon demand on or after August 31, 1998 (the "Chevron
Note"). On August 31, 1998, the Chevron Note was retired, pursuant to the terms
of the agreement, with funds provided through the sale of commercial paper.
IMPACT OF PRICE FLUCTUATIONS
Dynegy's operating results are impacted by commodity price, interest rate and
foreign exchange rate fluctuations. The Company routinely enters into financial
instrument contracts to hedge purchase and sale commitments, fuel requirements
and inventories in its natural gas, natural gas liquids, crude oil, electricity
and coal businesses in order to minimize the risk of market fluctuations. As a
result of marketplace liquidity and other factors, the Company may, at times, be
unable to fully hedge its portfolio for certain market risks. Dynegy also
monitors its exposure to fluctuations in interest rates and foreign currency
exchange rates and may execute swaps, forward-exchange contracts or other
financial instruments to manage these exposures.
Operating margins in the Wholesale Gas and Power segment are separated into
three integrated component businesses: wholesale gas marketing, wholesale power
marketing and power generation. Operating margins earned by wholesale gas and
power marketing, exclusive of risk-management activities, are relatively
insensitive to commodity price fluctuations since most of the purchase and sales
contracts do not contain fixed-price provisions. Generally, prices contained in
these contracts are tied to a current spot or index price and, therefore, adjust
directionally with changes in overall market conditions. However, market price
fluctuations for natural gas and electricity can have a significant impact on
the operating margin derived from risk-management activities in these
businesses. Dynegy generally attempts to balance its fixed-price physical and
financial purchase and sales commitments in terms of contract volumes, and the
timing of performance and delivery obligations. However, the Company may, at
times, have a bias in the market, within established guidelines, resulting from
management of its portfolio. To the extent a net open position exists,
fluctuating commodity market prices can impact Dynegy's financial position or
results of operations, either favorably or unfavorably. Further, differences in
the comprehensive methods of accounting for North American fixed-price natural
gas transactions, which are accounted for under the mark-to-market method, and
natural gas marketing transactions in the U.K. and power marketing transactions,
which are both accounted for under accrual accounting, create differences in the
timing of the recognition of such commodity price movements. The net open
positions are actively managed, and the impact of changing prices on the
Company's financial condition at a point in time is not necessarily indicative
of the impact of price movements throughout the year. Fuel costs, principally
natural gas, represent the primary variable cost impacting margins at the
Company's power generating facilities. Historically, operating margins have been
relatively insensitive to commodity price fluctuations since most of this
business's purchase and sales contracts contain variable power sales contract
features tied to a current spot or index natural gas price, allowing revenues to
adjust directionally with changes in natural gas prices. However, as the
Company's investment in merchant generation capacity expands, changes in, and
the relationship between natural gas and electricity prices may impact the
financial performance and cash flow related to its portfolio of merchant power
generation assets.
At December 31, 1998, a $0.25 increase in the price of natural gas would
have increased operating margin of the Wholesale Gas and Power segment by
approximately $2.2 million, and a $0.25 decrease in the price of natural gas
would have decreased operating margin by approximately $1.9 million. The impact
of the $0.25 price movements referred to above are before application of market
reserves, which would likely reduce the after-tax earnings impact of these price
movements.
Operating margins associated with the Liquids segment's natural gas
gathering, processing and fractionation activities are very sensitive to changes
in natural gas liquids prices and the availability of inlet volumes. The impact
from changes in natural gas liquids prices results principally from the nature
of contractual terms under which natural gas is
27
processed and products are sold. In addition, certain of the Liquids Businesses'
processing plant assets are impacted by changes in, and the relationship
between, natural gas and natural gas liquids prices which, in turn influences
the volumes of gas processed. Commodity price fluctuations may also affect the
operating margins derived from the Company's natural gas liquid and crude oil
marketing businesses. Based upon current levels of natural gas processing
activities and industry fundamentals, the estimated impact on annual operating
margins of each one-cent movement in the annual average price of natural gas
liquids approximates $8 to $10 million. The availability of inlet volumes
directly affects the utilization and profitability of the segment's businesses
throughout the Liquids Value Chain. The acquisition of inlet volumes is highly
competitive and the availability of such volumes to industry-wide participants
is also impacted by price variability. Unilateral decisions made by producers to
shut-in production or otherwise curtail workovers, reduce well maintenance
activities and/or delay or cancel drilling activities, as a result of depressed
commodity prices or other factors, negatively affects production available to
the entire mid-stream industry. Because such decisions are based upon the
pricing environment at any particular time, management cannot predict with
precision the impact that such decisions may have on its business.
SEASONALITY
Dynegy's revenue and operating margin are subject to fluctuations during
the year, primarily due to the impact certain seasonal factors have on sales
volumes and the prices of natural gas, electricity and natural gas liquids.
Natural gas sales volumes and operating margin are typically higher in the
winter months than in the summer months, reflecting increased demand due to
greater heating requirements and, typically, higher natural gas prices.
Conversely, power marketing operations are typically impacted by higher demand
and commodity price volatility during the summer cooling season. Consistent with
power marketing, the Company's electricity generating facilities generally
experience peak demand during the summer cooling season, particularly for
merchant plant generating facilities. The Liquids Businesses are also subject
to seasonal factors; however, such factors typically have a greater impact on
sales prices than on sales volumes. Natural gas liquids prices typically
increase during the winter season due to greater heating requirements. The
Company's wholesale propane business is seasonally weighted in terms of volume
and price, consistent with the trend in the Company's natural gas operations, as
a result of greater demand for crop-drying and space-heating requirements in the
fall and winter months.
EFFECT OF INFLATION
Although Dynegy's operations are affected by general economic trends,
management does not believe inflation has had a material effect on the Company's
results of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business strategy has historically focused on acquisitions or
construction of core operating facilities in order to capture significant
synergies existing among these types of assets and Dynegy's natural gas, power
and natural gas liquids marketing businesses. For the foreseeable future, the
Company's primary focus will be the acquisition and/or construction of power
generating assets that will enable the Company to fully realize the Merchant
Leverage Effect of commercialization of these generating assets. The Company's
energy convergence strategies are focused on marketing, trading and arbitrage
opportunities involving natural gas and power, centered around the control and
optimization of Btu conversion capacity within the wholesale gas and power
businesses.
Dynegy has historically relied upon operating cash flow and borrowings from
a combination of commercial paper issuances, money market lines of credit,
corporate credit agreements and various public debt issuances for its liquidity
and capital resource requirements. The following briefly describes the terms of
these arrangements.
COMMERCIAL PAPER AND MONEY MARKET LINES OF CREDIT
The Company uses commercial paper proceeds and borrowings under uncommitted
money market lines of credit for general corporate purposes, including short-
term working capital requirements. The Company maintains a commercial paper
program for amounts up to $800 million, as supported by its corporate credit
agreements. At December 31, 1998, approximately $519 million of commercial paper
was outstanding and $20 million was outstanding under existing money market
lines of credit.
CORPORATE CREDIT AGREEMENTS
Dynegy's corporate credit agreements are comprised of a $400 million, five-
year revolving credit agreement maturing in May 2003, and a $400 million, 364-
day revolving credit agreement maturing in May 1999. Both agreements
28
provide funding for working capital, letters of credit and other general
corporate expenditures. The Company maintains an additional $240 million, 364-
day revolving credit agreement having a current maturity date of December 17,
1999. This facility also provides funding for general corporate purposes. At
December 31, 1998, letters of credit and borrowings under the corporate credit
agreements aggregated $27 million and, after consideration of the outstanding
commercial paper, aggregate unused borrowing capacity under the corporate credit
agreements approximated $495 million.
CANADIAN CREDIT FACILITY
In November 1998, an indirect wholly-owned Canadian subsidiary of the
Company entered into a $60 million, two-year revolving credit facility maturing
in November 2000. Borrowings under this agreement may be used for general
corporate purposes. At December 31, 1998, $40 million was outstanding under this
agreement.
PUBLIC DEBT
The Company has three separate public debt issues aggregating $500 million,
which mature in 2005, 2018 and 2026, respectively. Net proceeds derived from
these issues were used to reduce outstanding borrowings under credit
arrangements existing at the date of each respective issuance.
DEVELOPMENT PROJECT FINANCING
The consolidated long-term debt balance includes three notes aggregating
$103.1 million having recourse only to the assets of three power generation
projects. Each of the three notes represents a fifteen-year term loan obligation
payable in semi-annual installments of principal plus accrued interest.
GUARANTEED PREFERRED BENEFICIAL INTERESTS IN SUBORDINATED DEFERRABLE INTEREST
DEBENTURES
NGC Corporation Capital Trust I ("Trust"), a wholly owned subsidiary of
Dynegy, issued in a private transaction $200 million aggregate liquidation
amount of 8.316% Subordinated Capital Income Securities (referred to herein as
"Securities") representing preferred undivided beneficial interests in the
assets of the Trust. The Trust invested the proceeds from the issuance of the
Trust Securities in an equivalent amount of 8.316% Subordinated Debentures
("Subordinated Debentures") of the Company. The sole assets of the Trust are the
Subordinated Debentures. Following the issuance of the Securities, the Trust
completed an exchange offer through which all of the outstanding Securities were
exchanged by the holders thereof for registered securities having substantially
the same rights and obligations.
OTHER MATTERS
STOCKHOLDER DIVESTITURE. In August 1998, the Company announced that NOVA had
given notice of its intent to divest its 25.4 percent stake in Dynegy,
representing approximately 38.8 million common shares. Chevron and BG each also
currently own 25.4 percent of the outstanding common shares of Dynegy and
maintain certain preferential rights to purchase the common shares to be
divested by NOVA pursuant to the shareholder's agreement between BG, Chevron and
NOVA dated May 22, 1996. The uncertainty surrounding the change in ownership has
temporarily reduced the Company's financial flexibility by limiting its access
to certain capital market sectors. As a result, the Company's ability to finance
the full execution of its business strategy, as discussed elsewhere herein, may
be diminished if resolution of NOVA's divestiture is prolonged or is concluded
in a manner which negatively impacts Dynegy's stock price. Dynegy's management
and Board of Directors are actively pursuing alternatives to resolve this issue
in a timely manner. Management believes that the ultimate resolution of this
issue will not have a material adverse impact on its operations or financial
condition.
STOCK OPTIONS. Employee stock option grants made from 1994 to 1998 will
become exercisable during 1999 and 2000, respectively, resulting in the
potential exercise of approximately 9.6 million options during that two-year
period, at exercise prices ranging from $2.03 to $21.63. Other options currently
granted under the Company's option plans will fully vest periodically and become
exercisable through the year 2003 at prices ranging from $2.03 to $21.63. Grants
made under the Company's option plans may be canceled under certain
circumstances as provided in the plans. While the Company cannot predict the
timing or the number of shares which may be issued upon the exercise of option
grants by individual employees, the Company is pursuing a variety of
alternatives to help assure an orderly distribution of shares which may become
available to the market.
29
ACQUISITION AND CONSTRUCTION PROJECTS. Included in the 1999 budget is
approximately $440 million committed to construction projects in progress,
identified asset acquisitions, maintenance capital projects, environmental
projects, technology infrastructure and software enhancements, contributions to
equity investments and certain discretionary capital investment funds. The
capital budget is subject to revision as unforeseen opportunities or
circumstances arise. Funds committed in 1999 to announced acquisitions and
significant construction projects and other capital investments are as follows:
COMMITTED FUNDING FOR 1999 ACQUISITION AND CONSTRUCTION PROJECTS
ESTIMATED
PROJECTED FUNDING
PROJECT IN-SERVICE DATE COMMITMENT
- -------------------------------------------------------------------------------
($ in
thousands)
Encina Acquisition Mid-Year 1999 $178,000
Rockingham Power Generation Plant Mid-Year 2000 60,000
Lyondell Expansion Mid-Year 2000 8,700
Maintenance Capital Various 73,000
Information Technology Infrastructure and Various 55,000
Software
===============================================================================
COMMITMENTS. In conducting its operations, the Company routinely enters
into agreements that commit future cash flow to the lease and or acquisition of
assets used in its businesses. These commitments are typically associated with
capital projects, reservation charges for storage and transportation capacity,
office and equipment leases and other similar items. The terms of these
agreements vary based on the nature and intent of each transaction. The
following describes the more significant commitments outstanding at December 31,
1998.
A subsidiary of the Company has entered into various binding agreements
committing the Company to expend approximately $14 million for the acquisition
of combustion turbine generators. Currently, other non-binding agreements are
executed which could ultimately commit the Company to expend approximately $500
million in total over the next three years for the acquisition of turbine
generators and related equipment. This equipment will be used in the
construction of electricity generating capacity in selected sites throughout the
U.S. A significant portion of the current commitment relates to agreements that
include cancellation provisions providing for termination at Dynegy's option
during the construction phase in exchange for variable penalty payments.
In 1997, Dynegy received cash from a gas purchaser as an advance payment
for future natural gas deliveries over a ten-year period ("Advance Agreement").
As a condition of the Advance Agreement, Dynegy entered into a natural gas swap
with a third party under which Dynegy became a fixed-price payor on identical
volumes to those to be delivered under the Advance Agreement at prices based on
then current market rates. The cash payment was classified as an advance on the
balance sheet and is ratably reduced as gas is delivered to the purchaser under
the terms of the Advance Agreement. In addition, the purchaser pays a monthly
fee to Dynegy associated with delivered volumes. The Advance Agreement contains
certain non-performance penalties that impact both parties and as a condition
precedent, Dynegy purchased a surety bond in support of its obligations under
the Advance Agreement.
For a two-year period beginning January 1, 1998, the Company contracted for
1.3 billion cubic feet per day of firm transportation capacity to California on
the El Paso Natural Gas pipeline system. Pursuant to this arrangement, Dynegy is
obligated to pay a minimum of $38 million of reservation charges during 1999.
A wholly-owned subsidiary of the Company leases certain power generating
assets under agreements that are classified as operating leases. These
agreements had aggregate future minimum lease payments of approximately $410
million at December 31, 1998.
DIVIDEND REQUIREMENTS. Holders of the Company's Common Stock are entitled
to receive dividends if, when and as declared by the Board of Directors of the
Company out of funds legally available therefor. Currently, aggregate cash
dividends of $0.05 per share on the outstanding Common Stock are expected to be
declared by the Board of Directors and paid by the Company during 1999.
Accordingly, the Company also anticipates payment of dividends during 1999 on
the outstanding shares of its Series A Participating Preferred Stock of $0.05
per share on an annual basis.
30
Stock Repurchase Plan. The Company has a stock repurchase program, approved
by the Board of Directors, that allows it to repurchase, from time to time, up
to 1.6 million shares of common stock in open market transactions. The timing
and number of shares ultimately repurchased will depend upon market conditions
and consideration of alternative investments. Pursuant to this program, the
Company has acquired 1,200,700 shares at a total cost of $17.4 million, or
$14.50 per share on a weighted average cost basis, through December 31, 1998.
QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURES. The Company is
exposed to certain market risks inherent in the Company's financial instruments,
which arise from transactions entered into in the normal course of business. The
Company routinely enters into financial instrument contracts to hedge purchase
and sale commitments, fuel requirements and inventories in its natural gas,
natural gas liquids, crude oil, electricity and coal businesses in order to
minimize the risk of market fluctuations. Dynegy also monitors its exposure to
fluctuations in interest rates and foreign currency exchange rates and may
execute swaps, forward-exchange contracts or other financial instruments to
hedge and manage these exposures. The absolute notional contract amounts
associated with commodity risk-management, interest rate and forward exchange
contracts, respectively, were as follows:
ABSOLUTE NOTIONAL CONTRACT AMOUNTS
DECEMBER 31,
---------------------------------------------
1998 1997 1996
---------------------------------------------
Natural Gas (Trillion Cubic Feet) 4.179 2.558 1.535
Electricity (Million Megawatt Hours) 1.835 2.244 ---
Natural Gas Liquids (Million Barrels) 6.397 4.355 3.270
Crude Oil (Million Barrels) 18.800 14.920 2.034
Interest Rate Swaps (in thousands of US Dollars) $ 69,332 $180,000 $ ---
Fixed Interest Rate Paid on Swaps 8.067 6.603 ---
U.K. Pound Sterling (in thousands of US Dollars) $ 69,254 $ 74,638 $ ---
Average U.K. Pound Sterling Contract Rate (in $ 1.6143 $ 1.5948 $ ---
US Dollars)
Canadian Dollar (in thousands of US Dollars) $268,307 $ 37,041 $ ---
Average Canadian Dollar Contract Rate (in US $ 0.6710 $ 0.7240 $ ---
Dollars)
=============================================================================================
Cash-flow requirements for these commodity risk-management, interest rate
and foreign exchange contracts were estimated based upon market prices in effect
at December 31, 1998. Cash-flow requirements were as follows:
CASH FLOW REQUIREMENTS FOR RISK MANAGEMENT CONTRACTS
1999 2000 2001 2002 2003 BEYOND
----------------------------------------------------------------------------------------------
($ IN THOUSANDS)
Future estimated net
inflows (outflows) based
on year end market
prices/rates $38,104 $(9,574) $(3,475) $(2,473) $ 180 $1,073
======= ======= ======= ======= ===== ===========
Accounting Pronouncements. As a result of recent pronouncements issued by
the Financial Accounting Standards Board and the Emerging Issues Task Force, the
Company's comprehensive method of accounting for energy-related contracts and/or
derivative instruments and hedging transactions is changing. Previously, only
North American fixed-price natural gas transactions were recorded at fair value,
net of future servicing costs and reserves as estimated by the Company. The
Company does not anticipate that its current mark-to-market accounting for
fixed-price natural gas contracts will be significantly affected by the adoption
of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("Statement No. 133") or by the Emerging Issues Task
Force's conclusions in EITF 98-10, "Accounting for Energy Trading and Risk
Management Activities" ("EITF 98-10"). However, provisions in Statement No. 133
and in EITF 98-10 will affect the accounting for other trading and marketing
operations that are currently accounted for under the accrual method. Further,
provisions in Statement No. 133 will affect the accounting for and disclosure of
other contractual arrangements and operations of the Company. The Company is
required to adopt the provisions of EITF 98-10 effective January 1, 1999. The
cumulative effect of the change in accounting resulting from adoption of the
provisions of EITF 98-10 is immaterial. The transition rules under Statement No.
133 provide for early adoption as of the beginning of any fiscal
31
quarter subsequent to June 15, 1998. Dynegy intends to adopt the provisions of
Statement No. 133 within the timeframe and in accordance with the requirements
provided by that statement.
Management believes that the adoption of the provisions of these standards
may affect the variability of future periodic results reported by Dynegy, as
well as its competitors, as market conditions and resulting valuations change
from time to time. Such earnings variability, if any, will likely result
principally from valuation issues arising from imbalances between supply and
demand created by illiquidity in certain commodity markets resulting from, among
other things, a lack of mature trading and price discovery mechanisms,
transmission and/or transportation constraints resulting from regulation or
other issues in certain markets and the need for a representative number of
market participants maintaining the financial liquidity and other resources
necessary to compete effectively. Management will monitor exposure to these and
other market and business risks and will adjust valuation factors accordingly as
indicated by changing circumstances.
Year 2000 Issues. The Company is continuing its analysis of the "Year
2000" issue, which arises from the use by certain computer hardware and software
applications of two digits rather than four to define an applicable year. Such
hardware and software may be incapable of appropriately recognizing the year
2000, the result of which could be system failures or miscalculations leading to
disruptions in the Company's activities and operations. If the Company and/or
its significant customers or suppliers fail to timely make necessary
modifications and conversions, the Year 2000 issue could have a material adverse
effect on Company operations and its financial position. The Company believes
that its competitors face similar risks.
Dynegy has established a corporate-wide project team to identify and
rectify non-compliant hardware and software within its infrastructure. The
Company has completed its inventory of corporate-wide imbedded systems issues as
well as its inventory of corporate hardware and software applications. The
Company is substantially complete with its inventorying of hardware and software
infrastructure at remote locations. A final risk assessment, testing and
remediation activity is ongoing and will be substantially underway on all of the
Company's core systems and business applications at both corporate and field
locations by the end of the first quarter 1999. It is expected that all core
systems and business applications will be Year 2000 ready by September 1999. In
addition, the Company is focusing assessment efforts to determine that major
customers and suppliers are also Year 2000 ready. The project team is also
formulating contingency plans to address alternatives for the Company should
Year 2000 issues disrupt operations. As part of the plan, the Company is
developing contingency plans that address essential aspects of the Year 2000
problem. The contingencies identified include:
. Satisfactory remediation of all core systems and business applications is
not executed by December 31, 1999;
. System modifications and conversions instituted by significant customers or
suppliers fail to satisfactorily remediate Year 2000 issues by December 31,
1999; and
. Year 2000 issues remain unidentified by Dynegy, its industry partners or
ancillary service providers, which disrupt operations of the Company.
Dynegy's contingency plans are being designed to minimize any disruptions or
other adverse effects resulting from Year 2000 incompatibilities regarding core
systems and business applications and to facilitate the early identification and
remediation of system problems that manifest themselves after December 31, 1999.
In addition to software and hardware issues directly affecting commercial
operations of the Company, the contingency plan addresses, for example, loss of
electricity, telecommunications, building access, security and other factors.
Nevertheless, there can be no absolute assurance that there will not be a
material adverse effect on the Company if its efforts are delayed or are
ineffective, if material issues remain unidentified or if third party entities
do not convert or replace hardware and software applications in a timely manner
and in a way that is compatible with the Company's hardware and software
infrastructure.
The Securities and Exchange Commission requires that public companies
forecast the most reasonable likely worst-case Year 2000 scenario. In doing so,
the Company assumed that its Year 2000 plan is ineffective. In reviewing a
worst-case scenario, the Company contemplated issues that, although considered
highly unlikely, must be contemplated in such a review. Issues contemplated in
this review included total failure of financial and operational systems, total
loss of supplies from third parties, total loss of transportation, storage and
similar operational capabilities and widespread extended loss of utilities,
building access and other similar items. Under this scenario, the Company would
face substantial claims by third parties and loss of revenue and cash flow
resulting from, among other things, service interruptions, the inability to meet
contractual obligations and the inability to invoice or pay third parties timely
and accurately. Further, such a disruption could affect the operational
integrity of certain commercial assets, the result of which could have
operational, safety and environmental implications. The Company is not able to
quantify the financial effect of the worst case scenario described
32
above and will continue to actively monitor business conditions with the aim of
assessing and quantifying material adverse effects, if any, that result or may
result from the Year 2000 issue.
Results of the review conducted to date indicate that the Company is
unlikely to be burdened by a material event resulting from the Company's
untimely resolution of Year 2000 issues. The potential costs and uncertainties
associated with this review are dependent upon a number of factors, including
legacy software and hardware configurations, planned information technology
infrastructure enhancements and the availability of trained personnel. Aggregate
current cost estimates for the entire Year 2000 project are projected to range
between $8 and $10.5 million. Approximately $2 million of this amount was
expended during 1998 related to this project. These cost estimates include costs
for identification and remediation of Year 2000 issues. Such cost estimates are
based on current available information and are subject to revision, either
upward or downward, as the project matures and additional information becomes
available.
ENVIRONMENTAL MATTERS. Dynegy's operations are subject to extensive
federal, state, provincial and local statutes, rules and regulations governing
the discharge of materials into the environment or otherwise relating to
environmental protection. Compliance with these statutes, rules and regulations
requires capital and operating expenditures including those related to
monitoring and permitting at various operating facilities and the cost of
remediation obligations. The Company's environmental expenditures have not been
prohibitive in the past, but are anticipated to increase in the future with the
trend toward stricter standards, greater regulation, more extensive permitting
requirements and an increase in the number of assets operated by the Company
subject to environmental regulation.
Dynegy's aggregate expenditures for compliance with laws and regulations
related to the discharge of materials into the environment or otherwise related
to the protection of the environment approximated $9 million in 1998. Total
environmental expenditures for both capital and operating maintenance and
administrative costs are not expected to exceed $14 million in 1999.
CONCLUSION
The Company continues to believe that it will be able to meet all
foreseeable cash requirements, including working capital, capital expenditures
and debt service, from operating cash flow, supplemented by borrowings under its
various credit facilities, if required.
33
RESULTS OF OPERATIONS
The following table reflects certain operating and financial data for the
Company's business segments for the years ended December 31, 1998, 1997 and
1996, respectively.
DYNEGY'S OPERATING AND FINANCIAL DATA
Years Ended December 31,
------------------------------------------
1998 1997 1996
------------------------------------------
($ in thousands)
FINANCIAL CONTRIBUTION (1) (2):
WHOLESALE GAS AND POWER -
Natural Gas Marketing $115,895 $ 99,375 $100,243
UK Gas Marketing 14,164 3,917 ---
Electric Power Marketing 42,816 4,526 3,379
Power Generation 63,400 18,987 ---
-------- -------- --------
Total Wholesale Gas and Power Operating Margin 236,275 126,805 103,622
-------- -------- --------
Gas Marketing Investments 18,353 22,943 20,090
Electric Power Marketing Investments 509 518 606
Power Generation Investments 56,380 12,780 ---
-------- -------- --------
Total Wholesale Gas and Power Equity Earnings 75,242 36,241 20,696
-------- -------- --------
TOTAL WHOLESALE GAS AND POWER FINANCIAL CONTRIBUTION 311,517 163,046 124,318
-------- -------- --------
LIQUIDS -
Natural Gas Processing - Field Plants 73,478 159,710 124,054
Natural Gas Processing - Straddle Plants 7,786 30,097 42,198
Fractionation (7) 28,379 25,813 20,223
Natural Gas Liquids Marketing 53,641 22,639 48,355
Crude Oil Marketing 9,138 500 11,583
Natural Gas Gathering and Transmission 10,208 16,757 18,140
International LPG Sales 9,782 2,973 1,325
-------- -------- --------
Total Liquids Operating Margin 192,412 258,489 265,878
-------- -------- --------
Natural Gas Processing Investments 5,643 9,004 2,429
Fractionation Investments 3,741 6,624 3,360
Gathering and Transmission Investments 6,412 7,090 1,590
-------- -------- --------
Total Liquids Equity Earnings 15,796 22,718 7,379
-------- -------- --------
TOTAL LIQUIDS FINANCIAL CONTRIBUTION 208,208 281,207 273,257
-------- -------- --------
TOTAL FINANCIAL CONTRIBUTION $519,725 $444,253 $397,575
======== ======== ========
CONSOLIDATED OPERATING MARGIN $428,687 $385,294 $369,500
CONSOLIDATED EQUITY EARNINGS 91,038 58,959 28,075
-------- -------- --------
TOTAL FINANCIAL CONTRIBUTION $519,725 $444,253 $397,575
======== ======== ========
OPERATING STATISTICS (2) :
Natural Gas Marketing (Bcf/d) -
Domestic Sales Volumes (3) 5.9 6.1 4.3
Canadian Sales Volumes (4) 2.3 1.9 ---
UK Sales Volumes (6) 0.7 0.2 ---
-------- -------- --------
8.9 8.2 4.3
======== ======== ========
Electric Power Marketing - Million Megawatt Hours Sold 120.8 94.7 14.9
Power Generation (Million Megawatt Hours Generated) -
Gross 15.9 7.2 ---
Net 9.8 4.3 ---
Natural Gas Liquids Processed (MBbls/d - Gross) -
Field Plants 91.8 89.8 57.4
Straddle Plants 30.9 46.4 36.9
Fractionation - Barrels Received for Fractionation (MBbls/d) (7) 192.5 201.3 169.1
NGL Marketing - Sales Volumes (MBbls/d) 410.7 413.9 245.0
Crude Oil Marketing - Sales Volumes (MBbls/d) 239.6 168.3 106.0
Natural Gas Gathering and Transmission (MMcf/d) 0.3 0.4 0.3
International LPG Sales Volumes (MMBbls) (5) 26.7 33.5 1.7
===================================================================================================================
34
(1) Financial contribution is defined by the Company as the sum of the
segment's operating margin and equity earnings from unconsolidated
affiliates. The Company considers this a key financial benchmark for its
operations due to the significance of the Company's investments in
unconsolidated affiliates as a component of overall results. During 1998,
1997 and 1996, the Company received cash dividends on these investments
approximating $85 million, $64 million and $7 million, respectively.
(2) The Destec acquisition was accounted for as an acquisition of a business in
accordance with the purchase method of accounting and the results of
operations attributed to the acquired business are included in the
Company's financial statements and operating statistics effective July 1,
1997. The Chevron Combination was accounted for as an acquisition of
assets under the purchase method of accounting and the results of
operations attributed to the acquired assets are included in the Company's
financial statements and operating statistics effective September 1, 1996.
(3) Includes immaterial amounts of inter-company gas sales for all periods.
(4) Represents volumes sold by Dynegy Canada, Inc. for the period from April 1,
1997 through December 31, 1997 and for the year ended December 31, 1998.
Volumes sold by NCL prior to the reorganization are not comparable.
(5) Includes 5.8 MMBbls of inter-company sales for the year ended December 31,
1997. A material amount of volumes sold in 1996 are inter-company sales
volumes.
(6) Represents volumes sold by Dynegy UK Ltd. for the years ended December 31,
1998 and 1997, respectively. Volumes sold by Accord prior to the
reorganization are not comparable.
(7) Effective January 1, 1997, the Company sold its interest in the Mont
Belvieu I fractionator and in 1998 the Company reduced its interest in the
Cedar Bayou Fractionator from 100 percent to 88 percent.
THREE YEARS ENDED DECEMBER 31, 1998
For the year ended December 31, 1998, the Company realized net income of
$108.4 million, or $0.66 per diluted share. This compares with a net loss of
$102.5 million, or $0.68 per share, and net income of $113.3 million, or $0.83
per diluted share, in 1997 and 1996, respectively. The comparability of results
period to period was impaired by the recognition of net non-recurring, after-tax
gains totaling $10.8 million during 1998, net after-tax charges totaling $218.5
million recognized in 1997 and after-tax charges of $2.5 million recognized in
1996. In addition, the comparability of results for the three years is
influenced by the Destec Acquisition that was effective July 1, 1997, and the
Chevron Combination that was effective September 1, 1996. Revenues in each of
the three years in the period ended December 31, 1998, totaled $14.3 billion,
$13.4 billion and $7.3 billion, respectively. Operating cash flows totaled
$250.8 million for the year ended December 31, 1998, compared with cash flows of
$278.6 million in 1997 and a use of cash from operations during the 1996 period
of $31.0 million.
Non-recurring items in the current period relate to a $17.1 million after-tax
gain on the sale of Ozark offset by a $6.3 million after-tax severance charge.
The 1997 loss included one-time charges principally associated with the
abandonment and impairment of certain operating and non-operating assets,
inventory obsolescence and lower-of-cost-or-market writedowns, reserves for
contingencies and other obligations, a charge for a hedging related loss and a
charge associated with a change in the method of accounting for certain business
process re-engineering and information technology transformation costs. The 1996
charge related to relocation of the Company's corporate headquarters.
After consideration of the non-recurring items described above, Dynegy's
normalized net income for the year ended December 31, 1998, approximated $97.6
million, or $0.59 per diluted share, compared with normalized net income of
$108.7 million, or $0.65 per diluted share, in 1997 and $115.8 million, or $0.85
per diluted share, in 1996. The lower normalized results in 1998 as compared
with the previous two years generally reflect a material increase in earnings
derived from the Company's Wholesale Gas and Power segment offset by the
significant negative impact that crude and NGL commodity prices had on the
Liquids segment in 1998, as well as a trend towards higher overhead,
depreciation and interest costs during the three-year period.
Consolidated operating margin for each of the three years in the period ended
December 31, 1998, totaled $428.7 million, $385.3 million and $369.5 million,
respectively. For the year ended December 31, 1998, the Company reported
operating income of $120.1 million, compared with an operating loss of $143.4
million and operating income of $197.8 million for the 1997 and 1996 periods,
respectively. Operating income in both the 1998 and 1997 periods was negatively
impacted by the pre-tax effect of portions of the aforementioned non-recurring
items. The increase in depreciation and amortization expense during the three
year period reflects the depreciable assets acquired in the Chevron Combination
and the Destec Acquisition as well as the continued expansion of the Company's
depreciable asset base through other asset acquisitions and capital projects
completed during the three-year period. Depreciation and amortization expense in
the 1998 period benefited from the prospective effect of the asset impairments
and abandonments recognized in 1997. The increase in general and administrative
expenses period to period principally reflects the incremental costs associated
with the operations acquired in the strategic acquisitions, the restructuring of
the Company's businesses in Canada and the United Kingdom, the expansion of
ECI's operations, the growth of the international LPG operations, non-
capitalizable consulting and other costs required to support technology
infrastructure improvements and, to a lesser degree, expenses related to
identifying and resolving Year 2000 issues.
35
During the three-year period ended December 31, 1998, the Company
significantly increased its investment in unconsolidated affiliates, principally
as a result of the ownership interests and legal structures employed in a
majority of the investments made by the Wholesale Gas and Power segment. As a
result, the financial results of Dynegy's equity investments to its consolidated
operating results have become more significant. The Company has structured these
investments to mitigate financial risk to the corporation. In addition, the
bylaws of a majority of these investments require periodic cash distributions
allowing Dynegy to manage its share of cash flow generated by these investments
in an efficient manner. The Company's equity share in the earnings of its
unconsolidated affiliates contributed an aggregate $91.0 million to 1998 pre-tax
results, compared to $59.0 million in 1997 and $28.1 million in 1996. Cash
distributions received from these investments during each of the three years in
the period ended December 31, 1998 approximated $85 million, $64 million and $7
million, respectively. The following table provides a summary of equity earnings
by investment for the comparable periods:
DYNEGY'S EQUITY EARNINGS FROM UNCONSOLIDATED AFFILIATES
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
1998 1997 1996
--------------------------------------------------------------
($ IN THOUSANDS)
Accord Energy Limited (1) $ 21,822 $ 25,885 $ 17,131
Other Gas Marketing Investments, Including (3,469) (2,942) 2,959
NCL (1)
Electric Power Marketing Investments 509 518 606
Power Generation Investments 56,380 12,780 --
Gulf Coast Fractionators 3,741 6,624 3,360
West Texas LPG Pipeline Limited Partnership 6,428 7,162 1,661
Venice Energy Services Company, L.L.C. 4,310 8,052 2,429
Other Liquids Businesses Investments, net 1,317 880 (71)
--------- --------- ---------
$ 91,038 $ 58,959 $ 28,075
========= ========= =========
============================================================================================================
1. For a discussion of the Accord and NCL restructurings, refer to Note 11 of
the Consolidated Financial Statements.
Interest expense totaled $75.0 million for the year ended December 31,
1998, compared with $63.5 million and $46.2 million for the comparable 1997 and
1996 periods. The higher interest expense period to period is attributed to
higher average outstanding principal amounts resulting primarily from debt
assumed in and resulting from the Chevron Combination and the Destec Acquisition
offset partially by interest rates that trended lower over the three-year
period.
Other income and expenses, net benefited the operating results in 1998
and 1997 by $39.1 million and $7.9 million, respectively, while the 1996 period
reflected a net charge of $10 million. Each of the net amounts results
principally from the pre-tax effect of certain of the aforementioned non-
recurring items recognized in each period as well as numerous other less
significant recurring and non-recurring income and expense items.
During the second quarter of 1997, the Company sold $200 million
aggregate liquidation amount of 8.316% Subordinated Capital Income Securities.
Accumulated distributions associated with these Securities totaled $16.6 million
and $9.8 million for the years ended December 31, 1998 and 1997, respectively.
The Company reported an income tax provision of $50.3 million in 1998,
compared to an income tax benefit of $62.2 million in 1997 and an income tax
provision of $56.3 million in 1996, reflecting effective rates of 32 percent,
(41) percent and 33 percent, respectively. In general, differences between the
aforementioned effective rates and the statutory rate of 35 percent result
primarily from permanent differences attributable to amortization of certain
intangibles, permanent differences arising from the effect of certain foreign
equity investments and state income taxes.
WHOLESALE GAS AND POWER -
Aggregate operating margin and equity earnings reported by this
segment totaled $311.5 million for the year ended December 31, 1998, compared to
$163.0 million in 1997 and $124.3 million in 1996. The material increase in
financial contribution by this segment period to period results from, among
other things, the successful execution of the Merchant Leverage Effect during
the 1998 period, the expansion of the Company's investment in power generation
over the three-year period and the impetus placed by this segment on quality of
operating margins over the quantity of sales volumes.
36
Worldwide gas marketing operations generated operating margin and
equity earnings for the year ended December 31, 1998 of $148.4 million compared
to $126.2 million in 1997 and $120.3 million in 1996, a 23 percent growth during
the three-year period. Market conditions in 1998 and 1997 were influenced by
unseasonably warm weather in the winter months that eliminated any significant
volatility in commodity prices during those periods. Conversely, the 1996 period
included a very cold first quarter that resulted in significant regional swings
in commodity prices, benefiting per unit margins in that period. The growth in
financial contribution from this business reflects the Company's expanded gas
marketing operations in Canada and in the United Kingdom as well as the emphasis
on the quality of the Company's customer base, which had its most significant
impact on domestic operations. Worldwide sales volumes totaled 8.9 Bcf/d in
1998, 8.2 Bcf/d in 1997 and 4.3 Bcf/d in 1996. Worldwide per-unit margins were
$0.040, $0.035 and $0.064 for each of three years in the period ended December
31, 1998, respectively.
Power marketing operations generated operating margin and equity earnings
for the year ended December 31, 1998 of $43.3 million compared to $5.0 million
in 1997 and $4.0 million in 1996. The dramatic growth in financial contribution
from this business in 1998 reflects the value extraction derived from the
extreme market volatility experienced in certain U.S. markets, particularly in
the mid-west, during the 1998 summer coupled with an eightfold increase in sales
volumes during the three-year period. Operating margins in this business also
benefited from the selectivity analysis performed on its customer base.
The power generation business reported explosive growth in 1998, generating
operating margin and equity earnings for the year of $119.8 million. Results for
1998 are not comparable with 1997 as a result of the acquisition of Destec in
mid-year 1997. However, the execution of Dynegy's strategy of integrating the
businesses in this segment and leveraging off the physical assets to enhance the
returns from its marketing and trading businesses was successful during the 1998
period.
LIQUIDS -
Aggregate operating margin and equity earnings reported by this
segment totaled $208.2 million for the year ended December 31, 1998, compared to
$281.2 million in 1997 and $273.3 million in 1996. The decrease in financial
contribution by this segment period to period results primarily from the
negative impact that NGL and crude oil commodity prices had on operations.
During 1998, NGL prices averaged $0.25 per gallon compared to $0.34 per gallon
in 1997 and $0.39 per gallon in 1996. Likewise, crude oil prices gravitated
downward during the three-year period averaging $11.97 per barrel in 1998,
$18.64 per barrel in 1997 and $20.42 per barrel in 1996. The commodity price
environment during 1998 placed significant downward pressure on operating
margins. The initiatives undertaken by this segment beginning in the fourth
quarter of 1997 and executed throughout 1998 allowed the businesses to improve
operating efficiencies, reduce costs and mitigate exposure to asset impairments
resulting from commodity price variability. During 1997, operating margins from
these businesses were negatively impacted by high-cost inventory purchased
during the fourth quarter of 1996, which was recognized in operating results
during the first quarter of 1997, culminating in a lower-of-cost-or-market
writedown of $12.3 million at March 31, 1997. Additionally, included in the 1997
period are pre-tax charges related to a lower-of-cost-or-market writedown of
crude oil inventory of $2.7 million and a hedge-related loss of $8.3 million.
The 1996 period results are not comparable as a result of the acquisition of the
mid-stream operations of Chevron effective September 1, 1996.
Operationally, this segment's businesses continue to reflect a
leadership position in significantly all domestic mid-stream businesses.
Aggregate domestic natural gas liquids processing volumes totaled 122.7 thousand
gross barrels per day in 1998 compared to an average 136.2 thousand gross
barrels per day during 1997 and 94.3 thousand gross barrels per day in 1996. The
lower volumes in 1998 reflect the economic decisions made during the 1998 period
to reduce production at its straddle processing plants principally as a result
of the relationship of natural gas and NGL commodity prices. Fractionation
volumes and natural gas liquids marketing volumes remained relatively level with
1997 amounts averaging 192.5 and 410.7 thousand barrels per day, respectively,
during 1998. Crude oil marketing volumes increased 126 percent during the three-
year period averaging 239.6 thousand barrels per day during 1998. The Company's
LPG sales volumes reduced during 1998 as compared with 1997. However, the
effect of lower sales volumes was more than offset by significantly higher unit
margins in 1998.
OPERATING CASH FLOW
Cash flow from operating activities totaled $250.8 million during the
year ended December 31, 1998 compared to $278.6 million during 1997. For the
year ended December 31, 1996, the Company used $31 million in support of its
operations. Changes in operating cash flow reflect the operating results
previously discussed herein and the continued focus on management of working
capital, particularly trade accounts receivables and payables and the reduction
of discretionary inventory volume purchases period to period. Changes in other
working capital accounts, which include prepayments, other current assets and
37
accrued liabilities, reflect expenditures or recognition of liabilities for
insurance costs, certain deposits, salaries, taxes other than on income, certain
deferred revenue accounts and other similar items. Fluctuations in these
accounts, period to period, reflect changes in the timing of payments or
recognition of liabilities and are not directly impacted by seasonal factors.
The 1997 period benefited from the advance payment for future gas deliveries
previously discussed.
CAPITAL EXPENDITURES, COMMITMENTS AND DIVIDEND REQUIREMENTS
Capital Expenditures and Investing Activities. During the year ended
December 31, 1998, the Company invested a net $379.5 million, principally on
discrete asset acquisitions primarily focused in the Wholesale Gas and Power
segment. Expenditures were also made to complete construction of the Lake
Charles, Louisiana fractionator, for capital improvements at existing facilities
and on capital additions at the Company's headquarters. During the period, the
Company divested itself of its investment in Ozark, as well as certain non-
strategic Liquids Segment assets. Aggregate net proceeds from these dispositions
approximated $84 million.
During the year ended December 31, 1997, the Company spent a net $510.7
million, principally on the Destec Acquisition, the purchase of NCL's gas
marketing operations and on acquisitions of additional interests in gas
processing facilities, pipelines and other mid-stream assets. Expenditures were
also made on capital improvements at existing facilities and on capital
additions at the Company's headquarters. The Company invested $27.7 million in
its unconsolidated affiliates, principally for amounts committed to VESCO.
During the period, the Company divested itself of the Mont Belvieu I
fractionation facility pursuant to an agreement reached with the Federal Trade
Commission related to the Chevron Combination. Further, Dynegy sold its 49.9
percent interest in NCL, as part of the restructuring of that investment and
consummated the sales of certain non-strategic assets acquired in the Destec
Acquisition. Aggregate net proceeds from these dispositions, plus proceeds from
other immaterial dispositions, approximated $453 million.
Dynegy acquired Destec on June 27, 1997, in a transaction valued at $1.26
billion, or $21.65 per share of Destec common stock. Concurrent with this
acquisition, Dynegy sold Destec's international facilities and operations to The
AES Corporation for $439 million. In July and August 1997, the Company sold
Destec's interest in a partnership that owned a power generation facility and
certain oil, gas and lignite reserves, respectively, for aggregate proceeds of
$296 million. Proceeds from the sales of these non-strategic assets were used to
retire debt incurred in the acquisition.
During 1996, the Company spent a net $111 million in acquisition, capital
project and asset maintenance activities. These funds were expended principally
for maintenance of existing assets, the acquisition of processing plants,
gathering lines, pipelines and on discrete capital assets. In addition, during
1996, the Company completed the acquisitions of LPG Services Group, Inc., a
propane gas marketing and distribution company, and Wilmar Energy Marketing, a
Calgary based crude oil marketer. Investments in unconsolidated affiliates
included contributions of $18.6 million to VESCO. As reflected in the
accompanying notes to the consolidated financial statements, the Chevron
Combination was consummated principally through the assumption of debt and the
issuance of capital stock.
DIVIDEND REQUIREMENTS AND STOCK REPURCHASES. Dynegy declares quarterly
dividends on its outstanding common stock at the discretion of its Board of
Directors. The holders of the Series A Preferred Stock are entitled to receive
dividends or distributions equal per share in amount and kind to any dividend or
distribution payable on shares of the Company's common stock, when and as the
same are declared by the Company's Board of Directors. During the years ended
December 31, 1998, 1997 and 1996, the Company paid approximately $8.0 million,
$7.9 million and $6.7 million in cash dividends and distributions, respectively.
In May 1997, the Board of Directors approved a stock repurchase program
that allows the Company to repurchase, from time to time, up to 1.6 million
shares of common stock in open-market transactions. The timing and number of
shares ultimately repurchased will depend upon market conditions and
consideration of alternative investments. Pursuant to this program, the Company
acquired 545,800 shares of its stock through open-market trades during the year
ended December 31, 1998, at a total cost of $6.9 million, or $12.65 per share on
a weighted average cost basis. For the year ended December 31, 1997, the
Company acquired 654,900 shares of its common stock in open-market transactions
for an aggregate cost of $10.5 million, or $16.04 per share on a weighted
average cost basis.
38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and financial statement schedule of the Company
are set forth at pages F-1 through F-36 inclusive, found at the end of this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain of the information required by this Item 10 will be contained in
the definitive Proxy Statement of the Company for its 1999 Annual Meeting of
Stockholders (the "Proxy Statement") under the headings "Proposal 1 -- Election
of Directors" and "Executive Compensation -- Section 16(a) Beneficial Ownership
Reporting Compliance" and is incorporated herein by reference. The Proxy
Statement will be filed with the Securities and Exchange Commission not later
than 120 days after December 31, 1998. Reference is also made to the information
appearing in Part I of this Annual Report on Form 10-K under the caption "Item
1A. Executive Officers."
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation will be contained in the
Proxy Statement under the heading "Executive Compensation" and is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding ownership of certain of the Company's outstanding
securities will be contained in the Proxy Statement under the heading "Principal
Stockholders" and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding related party transactions will be contained in the
Proxy Statement under the headings "Principal Stockholders", "Proposal 1 --
Election of Directors" and "Executive Compensation -- Indebtedness of
Management" and "-- Certain Relationships and Related Transactions" and is
incorporated herein by reference.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON 8-K
The following documents, which have been filed by the Company with the
Securities and Exchange Commission pursuant to the Securities and Exchange Act
of 1934, as amended, are by this reference incorporated in and made a part of
this statement:
a. Financial Statements -- Consolidated financial statements of the Company
and its subsidiaries are incorporated under Item 8. of this Form 10-K.
c. b. Exhibits -- The following instruments and documents are included as
exhibits to this Form 10-K.
39
EXHIBIT
NUMBER DESCRIPTION
2.1 - Combination Agreement and Plan of Merger, dated May, 22, 1996, by and between NGC
Corporation, Chevron U.S.A. Inc. and Midstream Combination Corp.(7)
2.2 - Amendment to Combination Agreement, dated as of August 29, 1996, by and among NGC
Corporation, Chevron U.S.A. Inc. and Midstream Combination Corp.(5)
2.3 - Agreement and Plan of Merger by and among Destec Energy, Inc., The Dow Chemical Company, NGC
Corporation and NGC Acquisition Corporation II dated as of February 17, 1997. (8)
2.4 - Asset Purchase Agreement by and between NGC Corporation and The AES Corporation dated as of
February 17, 1997. (8)
2.5 - First Amendment to Asset Purchase Agreement by and between NGC Corporation and The AES
Corporation dated June 29, 1997.(9)
2.6 - Asset Purchase Agreement between Destec Energy, Inc. and ECT EOCENE Enterprises, Inc. dated
July 1, 1997.(9)
3.1 - Restated Certificate of Incorporation of NGC Corporation. (8)
3.2 - Certificate of Amendment to Restated Certificate of Incorporation of NGC Corporation (14)
3.3 - Bylaws of Dynegy Inc. (14)
4.1 - Warrant exercisable for 6,228 shares of Common Stock of NGC Corporation registered in the
name of J. Otis Winters. (2)
4.2 - Indenture, dated as of December 11, 1995, by and between NGC Corporation, the Subsidiary
Guarantors named therein and the First National Bank of Chicago, as Trustee.(4)
4.3 - First Supplemental Indenture, dated as of August 31, 1996, by and among NGC Corporation, the
Subsidiary Guarantors named therein, and The First National Bank of Chicago, as Trustee,
supplementing and amending the Indenture dated as of December 11, 1995. (5)
4.4 - Second Supplemental Indenture, dated as of October 11, 1996, by and among NGC Corporation,
the Subsidiary Guarantors named therein, and The First National Bank of Chicago, as Trustee,
supplementing and amending the Indenture dated as of December 11, 1995. (5)
4.5 - Amended and Restated Credit Agreement dated as of June 27, 1997, among NGC Corporation and
The First National Bank of Chicago, Individually and as Agent, The Chase Manhattan Bank and
NationsBank of Texas, N.A., Individually and as Co-Agents, and the Lenders Named therein.(9)
4.6 - First Amendment to Amended and Restated Credit Agreement, dated November 24, 1997, among NGC
Corporation and The First National Bank of Chicago, Individually and as Agent, The Chase
Manhattan Bank and NationsBank of Texas, N.A., Individually and as Co-Agents for the Lenders
named therein. (13)
4.7 - Second Amendment to Amended and Restated Credit Agreement, dated as of February 20, 1998,
among NGC Corporation and The First National Bank of Chicago, Individually and as Agent, The
Chase Manhattan Bank and NationsBank of Texas, N.A., Individually and as Co-Agents for the
Lenders named therein. (13)
40
EXHIBIT
NUMBER DESCRIPTION
4.8 - Subordinated Debenture Indenture between NGC Corporation and The First National Bank of
Chicago, as Debenture Trustee, dated as of May 28, 1997. (10)
4.9 - Amended and Restated Declaration of Trust among NGC Corporation, Wilmington Trust Company,
as Property Trustee and Delaware Trustee, and the Administrative Trustees named therein, dated
as of May 28, 1997. (10)
4.10 - Series A Capital Securities Guarantee executed by NGC Corporation and The First National Bank
of Chicago, as Guarantee Trustee, dated as of May 28, 1997. (10)
4.11 - Common Securities Guarantee of NGC Corporation dated as of May 28, 1997. (10)
4.12 - Registration Rights Agreement, dated as of May 28, 1997, among NGC Corporation, NGC
Corporation Capital Trust I, Lehman Brothers, Salomon Brothers Inc. and Smith Barney Inc. (10)
4.13 - Second Supplemental Indenture among NGC Corporation, Destec Energy, Inc. and The First
National Bank of Chicago, as Trustee, dated as of June 30, 1997, supplementing and amending the
Indenture dated as of June 30, 1997. (11)
4.14 - Fourth Supplemental Indenture among NGC Corporation, Destec Energy, Inc. and The First
National Bank of Chicago, as Trustee, dated as of June 30, 1997, supplementing and amending the
Indenture dated as of December 11, 1995. (11)
4.15 - Fifth Supplemental Indenture among NGC Corporation, The Subsidiary Guarantors named therein
and The First National Bank of Chicago, as Trustee, dated as of September 30, 1997,
supplementing and amending the Indenture dated as of December 11, 1995. (13)
4.16 - Sixth Supplemental Indenture among NGC Corporation, The Subsidiary Guarantors named therein
and The First National Bank of Chicago, as Trustee, dated as of January 5, 1998, supplementing
and amending the Indenture dated as of December 11, 1995. (13)
4.17 - Seventh Supplemental Indenture among NGC Corporation, The Subsidiary Guarantors named therein
and The First National Bank of Chicago, as Trustee, dated as of February 20, 1998, supplementing
and amending the Indenture dated as of December 11, 1995. (13)
4.18 - Indenture, dated as of September 26, 1996, restated as of March 23, 1998, to include
amendments in the First through Fifth Supplemental Indentures, between NGC Corporation and The
First National Bank of Chicago, as Trustee. (13)
4.19 - Credit Agreement dated as of May 27, 1998, among NGC Corporation and The First National
Bank of Chicago, Individually and as Administrative Agent, The Chase Manhattan Bank,
Individually and as Syndication agent and NationsBank, N.A., Individually and as Documentation
Agent and the Lenders named therein. (12)
4.20 - 364-Day Revolving Credit Agreement dated as of May 27, 1998, among NGC Corporation and The
First National Bank of Chicago, Individually and as Administrative Agent, The Chase Manhattan
Bank, Individually and as Syndication agent and NationsBank, N.A., Individually and as
Documentation Agent and the Lenders named therein. (12)
10.1 - Agreement of Sale and Purchase of Assets, dated as of May 5, 1991, as amended on June 6,
1991 and August 30, 1991, by and between OXY USA Inc. and Trident Energy, Inc. (1)
41
EXHIBIT
NUMBER DESCRIPTION
10.2 - Master Agreement on Gas Processing, dated as of May 5, 1991, by and between OXY USA Inc. and
Trident NGL, Inc.(1)
+ 10.3 - Dynegy Inc. Amended and Restated 1991 Stock Option Plan.
+ 10.4 - Dynegy Inc. 1998 U.K. Stock Option Plan
+ 10.5 - Dynegy Inc. Amended and Restated Employee Equity Option Plan.
10.6 - The Amended and Restated Natural Gas Clearinghouse Deferred Compensation Plan, dated February
28, 1992.(3)
10.7 - Employment Agreement dated April 2, 1996 by and between NGC Corporation and Stephen A.
Furbacher.(6)
10.8 - Employment Agreement, dated as of April 30, 1997, between Charles L. Watson and NGC
Corporation. (13)
10.9 - Employment Agreement, dated as of May 8, 1997, between Stephen W. Bergstrom and NGC
Corporation. (13)
10.10 - Employment Agreement, dated as of April 14, 1997, between John U. Clarke and NGC Corporation.
(13)
+ 10.11 - First Amendment to Employment Agreement, dated December 11, 1998, between John U. Clarke and
NGC Corporation (n/k/a Dynegy Inc.).
10.12 - Employment Agreement, dated as of May 21, 1997, between Kenneth E. Randolph and NGC
Corporation. (13)
+ 10.12a - Employment Agreement, dated as of July 1, 1997, by and between Dan Ryser and NGC Corporation.
10.13 - Lease Agreement entered into on June 12, 1996 between Metropolitan Life Insurance Company and
Metropolitan Tower Realty Company, Inc., as landlord, and NGC Corporation, as tenant. (6)
10.14 - First Amendment to Lease Agreement entered into on June 12, 1996 between Metropolitan Life
Insurance Company and Metropolitan Tower Realty Company, Inc., as landlord, and NGC Corporation,
as tenant. (6)
10.15 - Contribution and Assumption Agreement, dated as of August 31, 1996, among Chevron U.S.A.
Inc., Chevron Pipe Line Company, Chevron Chemical Company and Midstream Combination Corp. (5)
10.16 - Scope of Business Agreement, dated May 22, 1996 between Chevron Corporation and NGC
Corporation. (6)
10.17 - Stockholders Agreement dated, May 22, 1996, among BG Holdings, Inc., NOVA Gas Services (U.S.)
Inc. and Chevron U.S.A. Inc. (6)
10.18 - Registration Rights Agreement, dated as of August 31,1996, among NGC Corporation, BG
Holdings, Inc., NOVA Gas Services (U.S.) Inc. and Chevron U.S.A. Inc. (5)
42
EXHIBIT
NUMBER DESCRIPTION
10.19 - Master Alliance Agreement, dated as of September 1, 1996, among Chevron U.S.A. Inc., Chevron
Chemical Company, Chevron Pipe Line Company, and other Chevron U.S.A. Inc. affiliates, NGC
Corporation, Natural Gas Clearinghouse, Warren Petroleum Company, Limited Partnership, Electric
Clearinghouse, Inc. and other NGC Corporation affiliates. (5)
* 10.20 - Natural Gas Purchase and Sale Agreement, dated as of August 30, 1996, among Chevron U.S.A.
Inc. and Natural Gas Clearinghouse. (5)
* 10.21 - Master Natural Gas Processing Agreement, dated as of September 1, 1996, among Chevron U.S.A.
Inc. and Warren Petroleum Company, Limited Partnership. (5)
* 10.22 - Master Natural Gas Liquids Purchase Agreement, dated as of September 1, 1996, among Warren
Petroleum Company, Limited Partnership and Chevron U.S.A. Inc. (5)
* 10.23 - Gas Supply and Service Agreement, dated as of September 1, 1996, among Chevron Products
Company and Natural Gas Clearinghouse. (5)
10.24 - Master Power Service Agreement, dated as of May 16, 1996, among Electric Clearinghouse, Inc.
and Chevron U.S.A. Production Company. (6)
10.25 - Master Power Service Agreement, dated as of May 16, 1996, among Electric Clearinghouse, Inc.
and Chevron Chemical Company. (6)
10.26 - Master Power Service Agreement, dated as of May 16, 1996, among Electric Clearinghouse, Inc.
and Chevron Products Company. (6)
* 10.27 - Feedstock Sale and Refinery Product Purchase Agreements, dated as of September 1, 1996, among
Chevron Products Company and Warren Petroleum Company, Limited Partnership.(5)
* 10.28 - Refinery Product Sale Agreement (Hawaii), dated as of September 1, 1996, among Warren
Petroleum Company, Limited Partnership and Chevron Products Company. (5)
* 10.29 - Feedstock Sale and Refinery Product Master Services Agreement, dated as of September 1, 1996,
among Chevron Products Company and Warren Petroleum Company, Limited Partnership. (5)
* 10.30 - CCC Product Sale and Purchase Agreement dated as of September 1, 1996, among Warren Petroleum
Company, Limited Partnership and Chevron Chemical Company. (5)
* 10.31 - CCC/WPC Services Agreement, dated as of September 1, 1996, among Chevron Chemical Company and
Warren Petroleum Company, Limited Partnership. (5)
* 10.32 - Operating Agreement, dated as of September 1, 1996, among Warren Petroleum Company, Limited
Partnership and Chevron Pipe Line Company. (5)
10.33 - Galena Park Services Agreement, dated as of September 1, 1996, among Chevron Products Company
and Midstream Combination Corp. (5)
* 10.34 - Venice Complex Operating Agreement, dated as of September 1, 1996, among Chevron U.S.A. Inc.
and Warren Petroleum Company, Limited Partnership. (6)
43
EXHIBIT
NUMBER DESCRIPTION
* 10.35 - Product Storage Lease and Terminal Access Agreement, dated as of September 1, 1996, among
Chevron U.S.A. Inc. and Warren Petroleum Company, Limited Partnership. (6)
10.36 - Lone Star Swap Transaction Confirmation Term Sheet, dated as of September 1, 1996, among
Chevron U.S.A. Inc. and NGC Corporation. (5)
* 10.37 - West Texas LPG Pipeline Limited Partnership Agreement, dated as of September 1, 1996, by and
between Chevron Pipe Line Company, or an affiliate thereof, and an affiliate of NGC Corporation.
(5)
* 10.38 - West Texas LPG Pipeline Operating Agreement, dated as of September 1, 1996, by and between
Chevron Pipe Line Company, or an affiliate thereof, and the West Texas LPG Pipeline Partnership.
(5)
* 10.39 - Time Charter, dated as of August 31, 1996, by and between Midstream Barge Company, L.L.C. and
Warren Petroleum Company, Limited Partnership. (5)
* 10.40 - Limited Liability Company Agreement of Midstream Barge Company, L.L.C., dated as of August
31, 1996, by and between Chevron U.S.A. Inc. and Warren Petroleum Company, Limited Partnership.
(5)
+ 10.41 - Dynegy Inc. Severance Pay Plan.
+ 10.42 - NGC Profit Sharing/401(k) Savings Plan.
+ 10.43 - First Amendment to NGC Profit Sharing/401(k) Savings Plan.
+ 10.44 - Second Amendment to NGC Profit Sharing/401(k) Savings Plan.
+ 12.1 - Computation of Ratio of Earnings to Fixed Charges.
+ 22.1 - Subsidiaries of the Registrant.
+ 23.1 - Consent of Arthur Andersen LLP.
+ 27.1 - Financial Data Schedule.
- ---------------
+ Filed herewith
* Exhibit omits certain information which the Company has filed separately with
the Commission pursuant to a confidential treatment request pursuant to Rule
406 promulgated under the Securities Act of 1933, as amended.
(1) Incorporated by reference to exhibits to the Registration Statement of
Trident NGL, Inc. on Form S-1, Registration No. 33-43871.
(2) Incorporated by reference to exhibits to the Quarterly Report on Form 10-Q
for the Quarterly Period Ended September 30, 1993 of Trident NGL Holding,
Inc., Commission File No. 1-11156.
(3) Incorporated by reference to exhibits to the Registration Statement of
Trident NGL Holding, Inc. on Form S-4, Registration No. 33-88907.
(4) Incorporated by reference to the Registration Statement of NGC Corporation
on Form S-3, Registration No. 33-97368.
(5) Incorporated by reference to exhibits to the Quarterly Report on Form 10-Q
for the Quarterly Period Ended September 30, 1996, of NGC Corporation,
Commission File No. 1-11156.
44
(6) Incorporated by reference to exhibits to the Registration Statement of
Midstream Combination Corp. on Form S-4, Registration No. 333-09419.
(7) Incorporated by reference to exhibits to the Current Report on Form 8-K of
NGC Corporation, dated May 22, 1996, Commission File No. 1-11156.
(8) Incorporated by reference to exhibits to the Annual Report on Form 10-K for
the Fiscal Year Ended December
31, 1996, of NGC Corporation, Commission File No. 1-11156.
(9) Incorporated by reference to exhibits to the Current Report on Form 8-K of
NGC Corporation, Commission File No. 1-11156, dated June 27, 1997.
(10) Incorporated by reference to exhibits to the Quarterly Report on Form 10-Q
for the Quarterly Period Ended June 30, 1997, Commission File No. 1-11156.
(11) Incorporated by reference to exhibits to the Quarterly Report on Form 10-Q
for the Quarterly Period Ended September 30, 1997, Commission File No.
1-11156
(12) Incorporated by reference to exhibits to the Quarterly Report on Form 10-Q
for the Quarterly Period Ended June 30, 1998, Commission File No. 1-11156.
(13) Incorporated by reference to exhibits to the Annual Report on Form 10-K for
the Fiscal Year Ended December 31, 1997, of NGC Corporation, Commission
File No. 1-11156.
(14) Incorporated by reference to exhibits to the Quarterly Report on Form 10-Q
for the Quarterly Period ended September 30, 1998, Commission File No.
1-11156.
(b) Reports on Form 8-K of Dynegy Inc..
None.
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Dynegy Inc.
Date: February 26, 1999 By: /s/ C. L. Watson
-------------------------------------
C. L. Watson, Chairman of the Board,
Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: February 26, 1999 By: /s/ C. L. Watson
-------------------------------------
C. L. Watson, Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)
Date: February 26, 1999 By: /s/ John U. Clarke
-------------------------------------
John U. Clarke, Senior Vice President,
Chief Financial Officer (Principal
Financial Officer) and Advisory Director
Date: February 26, 1999 By: /s/ Bradley P. Farnsworth
-------------------------------------
Bradley P. Farnsworth, Vice President and
Controller (Principal Accounting
Officer)
Date: February 26, 1999 By: /s/ Stephen W. Bergstrom
-------------------------------------
Stephen W. Bergstrom, President and Chief
Operating Officer of Dynegy Marketing and
Trade and Director
Date: February 26, 1999 By: /s/ Stephen J. Brandon
-------------------------------------
Stephen J. Brandon, Director
Date: February 26, 1999 By: /s/ Stanley I. Rubenfeld
-------------------------------------
Stanley I. Rubenfeld, Director
Date: February 26, 1999 By: /s/ P. Nicholas Woollacott
-------------------------------------
P. Nicholas Woollacott, Director
46
Date: February 26, 1999 By: /s/ Jack S. Mustoe
--------------------------------------
Jack S. Mustoe, Director
Date: February 26, 1999 By: /s/ Jeffrey M. Lipton
--------------------------------------
Jeffrey M. Lipton, Director
Date: February 26, 1999 By: /s/ A. Terrance Poole
--------------------------------------
A. Terence Poole, Director
Date: February 26, 1999 By: /s/
--------------------------------------
Darald W. Callahan, Director
Date: February 26, 1999 By: /s/ Patricia A. Woertz
--------------------------------------
Patricia A. Woertz, Director
Date: February 26, 1999 By: /s/ Peter J. Robertson
--------------------------------------
Peter J. Robertson, Director
Date: February 26, 1999 By: /s/ Daniel L. Dienstbier
--------------------------------------
Daniel L. Dienstbier, Director
Date: February 26, 1999 By: /s/ J. Otis Winters
--------------------------------------
J. Otis Winters, Director
47
DYNEGY INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Consolidated Financial Statements
Report of Independent Public Accountants....................... F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997... F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996............................. F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996............................. F-5
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 1998, 1997 and 1996......... F-6
Notes to Consolidated Financial Statements..................... F-7
FINANCIAL STATEMENT SCHEDULE
Condensed Financial Statements of the Registrant............... F-32
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of Dynegy Inc.:
We have audited the accompanying consolidated balance sheets of Dynegy Inc.
(a Delaware corporation formerly known as NGC Corporation) and subsidiaries as
of December 31, 1998 and 1997, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1998. These financial statements and the
schedule referred to below are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Dynegy Inc. and subsidiaries
as of December 31, 1998 and 1997, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The information included in Schedule I is
presented for the purposes of complying with the Securities and Exchange
Commission's rules and is not a required part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in our
audits of the basic financial statements and, in our opinion, is fairly stated
in all material respects in relation to the basic financial statements taken as
a whole.
ARTHUR ANDERSEN LLP
Houston, Texas
February 24, 1999
F-2
DYNEGY INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
DECEMBER 31, DECEMBER 31,
1998 1997
ASSETS ------------ ------------
Current Assets
Cash and cash equivalents $ 28,367 $ 23,047
Accounts receivable, net 1,563,558 1,536,451
Accounts receivable, affiliates 60,180 139,321
Inventories 149,901 136,485
Assets from risk-management activities 219,105 127,929
Prepayments and other assets 96,130 55,547
---------- ----------
2,117,241 2,018,780
---------- ----------
PROPERTY, PLANT AND EQUIPMENT 2,446,878 1,958,250
Less: accumulated depreciation (514,771) (436,674)
---------- ----------
1,932,107 1,521,576
---------- ----------
OTHER ASSETS
Investments in unconsolidated affiliates 502,613 470,477
Assets from risk-management activities 135,100 111,341
Other assets 577,176 394,729
---------- ----------
$5,264,237 $4,516,903
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $1,370,902 $1,404,736
Accounts payable, affiliates 113,827 24,187
Accrued liabilities and other 290,381 192,159
Liabilities from risk-management activities 251,213 132,012
---------- ----------
2,026,323 1,753,094
LONG-TERM DEBT 1,046,890 1,002,054
OTHER LIABILITIES
Liabilities from risk-management activities 40,747 42,679
Deferred income taxes 317,537 254,059
Other long-term liabilities 504,677 245,892
---------- ----------
3,936,174 3,297,778
---------- ----------
COMPANY OBLIGATED PREFERRED SECURITIES OF
SUBSIDIARY TRUST 200,000 200,000
COMMITMENTS AND CONTINGENCIES (NOTE 9)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, 50,000,000
shares authorized; 8,000,000 shares designated
as Series A Participating Preferred Stock,
7,815,363 shares issued and outstanding at
December 31, 1998 and 1997, respectively 75,418 75,418
Common stock, $.01 par value, 400,000,000
shares authorized; 153,298,220 shares issued
at December 31, 1998 and 151,796,622
shares issued at December 31, 1997 1,533 1,518
Additional paid-in capital 935,183 919,720
Retained earnings 133,340 32,975
Less: treasury stock, at cost: 1,200,700
shares at December 31, 1998 and 654,900
shares at December 31, 1997 (17,411) (10,506)
---------- ----------
1,128,063 1,019,125
---------- ----------
$5,264,237 $4,516,903
========== ==========
See Notes to Consolidated Financial Statements.
F-3
DYNEGY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
YEAR ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
----------- ----------- ----------
Revenues $14,257,997 $13,378,380 $7,260,202
Cost of sales 13,829,310 12,993,086 6,890,702
----------- ----------- ----------
Operating margin 428,687 385,294 369,500
Depreciation and amortization 113,202 104,391 71,676
Impairment, abandonment and other charges 9,644 275,000 ---
General and administrative expenses 185,708 149,344 100,032
----------- ----------- ----------
Operating income (loss) 120,133 (143,441) 197,792
Equity in earnings of unconsolidated affiliates 91,038 58,959 28,075
Other income 46,821 28,113 5,485
Relocation costs --- --- (4,000)
Interest expense (74,992) (63,455) (46,202)
Other expenses (7,677) (20,230) (11,505)
Minority interest in income of a subsidiary (16,632) (9,841) ---
----------- ----------- ----------
Income (loss) before income taxes 158,691 (149,895) 169,645
Income tax provision (benefit) 50,338 (62,210) 56,323
----------- ----------- ----------
Net income (loss) from continuing operations before
cumulative effect of accounting change 108,353 (87,685) 113,322
Cumulative effect of change in accounting
principle (net of income tax benefit of $7,913) --- (14,800) ---
----------- ----------- ----------
NET INCOME (LOSS) $ 108,353 $ (102,485) $ 113,322
=========== =========== ==========
Net Income Per Share:
Net income (loss) from continuing operations $ 108,353 $ (87,685) $ 113,322
Cumulative effect of change in accounting
principle (net of income tax benefit of $7,913) --- (14,800) ---
Less: preferred stock dividends (391) (391) (132)
----------- ----------- ----------
Net income (loss) applicable to common stockholders $ 107,962 $ (102,876) $ 113,190
=========== =========== ==========
Basic earnings (loss) per share $ 0.71 $ (0.68) $ 0.99
=========== =========== ==========
Diluted earnings per share $ 0.66 $ n/a $ 0.83
=========== =========== ==========
Basic shares outstanding 151,619 150,653 114,093
=========== =========== ==========
Diluted shares outstanding 164,605 167,009 136,099
=========== =========== ==========
See Notes to Consolidated Financial Statements.
F-4
DYNEGY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
YEAR ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
----------- ----------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 108,353 $ (102,485) $ 113,322
Items not affecting cash flows from operating activities:
Depreciation, amortization, impairment and abandonment 102,577 378,916 73,176
Equity in earnings of affiliates, net of cash distributions (6,477) (4,073) (21,729)
Risk management activities (7,422) (8,757) (11,220)
Deferred income taxes 52,308 (86,424) 45,896
Amortization of bond premium (2,572) (6,768) (4,892)
Other, including gains on sale of assets (22,540) 1,249 7,466
Change in assets and liabilities resulting from
operating activities:
Accounts receivable 51,046 (35,845) (954,418)
Inventories (17,380) 86,077 (116,353)
Prepayments and other assets (30,605) (20,686) 7,726
Accounts payable 44,113 (22,601) 778,767
Accrued liabilities (27,699) 14,064 47,148
Other, net 7,078 85,922 4,157
--------- ----------- -----------
Net cash provided by (used in) operating activities 250,780 278,589 (30,954)
--------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (298,738) (220,003) (97,651)
Investment in unconsolidated affiliates (78,096) (27,708) (30,875)
Business acquisitions, net of cash acquired (2,644) (715,589) (714)
Proceeds from asset sales 45,044 452,565 3,600
Other, net 39,352 --- 14,500
--------- ----------- -----------
Net cash used in investing activities (295,082) (510,735) (111,140)
--------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term borrowings 212,259 2,218,500 1,542,000
Repayments of long-term borrowings (493,277) (2,198,275) (1,360,081)
Net proceeds from commercial paper and money market lines
of credit 350,758 --- ---
Proceeds from sale of capital stock, options and warrants 3,863 5,147 858
Issuance of company obligated preferred securities of a
subsidiary trust, net --- 198,043 ---
Treasury stock acquisitions (6,905) (10,506) ---
Dividends and other distributions, net (7,988) (7,925) (6,740)
Other, net (9,088) --- ---
--------- ----------- -----------
Net cash provided by financing activities 49,622 204,984 176,037
--------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 5,320 (27,162) 33,943
Cash and cash equivalents, beginning of year 23,047 50,209 16,266
--------- ----------- -----------
Cash and cash equivalents, end of year $ 28,367 $ 23,047 $ 50,209
========= =========== ===========
See Notes to Consolidated Financial Statements.
F-5
DYNEGY INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands)
SERIES A PREFERRED COMMON STOCK ADDITIONAL TREASURY STOCK
------------------------- ---------------------- PAID-IN RETAINED ------------------------
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT
----------- ------------ ---------- ----------- ----------- ---------- ----------- ----------
Balance at December 31,
1995 --- $ --- 110,493 $1,105 $515,785 $ 35,490 --- $ ---
Chevron Combination 7,815 75,418 38,623 386 372,328 --- --- ---
Net income --- --- --- --- --- 113,322 --- ---
Options exercised --- --- 374 3 1,320 --- --- ---
Dividends and other
distributions --- --- --- --- --- (5,427) --- ---
401(k) plan and profit
sharing stock --- --- 309 4 4,175 --- --- ---
issuances
Options granted --- --- --- --- 2,824 --- --- ---
Other --- --- 48 --- --- --- --- ---
------ ------- -------- ------ -------- --------- ----- --------
Balance at December 31,
1996 7,815 75,418 149,847 1,498 896,432 143,385 --- ---
Net loss --- --- --- --- --- (102,485) --- ---
Options exercised --- --- 1,541 15 11,577 --- --- ---
Dividends and other
distributions --- --- --- --- --- (7,925) --- ---
401(k) plan and profit
sharing stock --- --- 385 5 7,401 --- --- ---
issuances
Options granted --- --- --- --- 4,044 --- --- ---
Treasury stock --- --- --- --- --- --- (655) (10,506)
acquisitions
Other --- --- 24 --- 266 --- --- ---
------ ------- -------- ------ -------- --------- ----- --------
Balance at December 31,
1997 7,815 75,418 151,797 1,518 919,720 32,975 (655) (10,506)
Net income --- --- --- --- --- 108,353 --- ---
Options exercised --- --- 1,032 10 3,808 --- --- ---
Dividends and other
distributions --- --- --- --- --- (7,988) --- ---
401(k) plan and profit
sharing stock --- --- 457 5 6,822 --- --- ---
issuances
Options granted --- --- --- --- 4,675 --- --- ---
Treasury stock --- --- --- --- --- --- (546) (6,905)
acquisitions
Other --- --- 12 --- 158 --- --- ---
------ ------- -------- ------ -------- --------- ----- --------
Balance at December 31,
1998 7,815 $75,418 153,298 $1,533 $935,183 $ 133,340 (1,201) $(17,411)
====== ======= ======== ====== ======== ========= ===== =======
See Notes to Consolidated Financial Statements.
F-6
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- ACCOUNTING POLICIES
Dynegy Inc. ("Dynegy" or the "Company") is a holding company that conducts
substantially all of its business through its subsidiaries. The Company is a
leading provider of energy products and services in North America and the United
Kingdom. Products marketed by the Company's wholesale marketing operations
include natural gas, electricity, coal, natural gas liquids, crude oil, liquid
petroleum gas and related services. The Company's wholesale marketing operations
are supported by ownership or control of an extensive asset base and
transportation network that includes unregulated power generation, gas and
liquids storage capacity, gas, power and liquids transportation capacity and gas
gathering, processing and fractionation assets.
The accounting policies of Dynegy reflect industry practices and conform to
generally accepted accounting principles. The more significant of such
accounting policies are described below. The preparation of the 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 from those estimates.
PRINCIPLES OF CONSOLIDATION. The accompanying consolidated financial
statements include the accounts of the Company and its majority-owned
subsidiaries after elimination of intercompany accounts and transactions.
Investments in affiliates in which the Company has a significant ownership
interest, generally 20 percent to 50 percent, are accounted for by the equity
method. Other investments are carried at cost. Certain reclassifications have
been made to prior-period amounts to conform with current period financial
statement classifications.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents consist of all demand
deposits and funds invested in short-term investments with original maturities
of three months or less.
CONCENTRATION OF CREDIT RISK. Dynegy provides multiple energy commodity
solutions principally to customers in the electric and gas distribution
industries and to entities engaged in industrial and petrochemical businesses.
These industry concentrations have the potential to impact the Company's overall
exposure to credit risk, either positively or negatively, in that the customer
base may be similarly affected by changes in economic, industry or other
conditions. Receivables are generally not collateralized; however, Dynegy
believes the credit risk posed by industry concentration is offset by the
diversification and creditworthiness of the Company's customer base.
INVENTORIES. Inventories consisting primarily of natural gas in storage of
$78.2 million and $35.2 million, natural gas liquids of $23.4 million and $55.4
million, and crude oil of $25.2 million and $23.2 million at December 31, 1998
and 1997, respectively, are valued at the lower of weighted average cost or at
market. Materials and supplies inventory of $23.1 million and $19.8 million at
December 31, 1998 and 1997, respectively, is carried at the lower of cost or
market using the specific identification method.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment consisting
principally of gas gathering, processing, fractionation, terminaling and storage
facilities, natural gas transmission lines, pipelines, power generating
facilities and supporting infrastructure is recorded at cost. Expenditures for
major replacements and renewals are capitalized while expenditures for
maintenance, repairs and minor renewals to maintain facilities in operating
condition are expensed. Depreciation is provided using the straight-line method
over the estimated economic service lives of the assets, ranging from three to
30 years. Composite depreciation rates are applied to functional groups of
property having similar economic characteristics. Gains and losses are not
recognized for retirements of property, plant and equipment subject to composite
depreciation rates ("composite rate") until the asset group subject to the
composite rate is retired. The Company reviews the carrying value of its long-
lived assets in accordance with provisions of Financial Accounting Standard No.
121, "Accounting for the Impairment of Long-Lived Assets."
ENVIRONMENTAL COSTS. Environmental costs relating to current operations
are expensed or capitalized, as appropriate, depending on whether such costs
provide future economic benefit. Liabilities are recorded when environmental
assessment indicates that remedial efforts are probable and the costs can be
reasonably estimated. Measurement of liabilities is based on currently enacted
laws and regulations, existing technology and undiscounted,
F-7
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
site-specific costs. Environmental liabilities in connection with assets that
are sold or closed are realized upon such sale or closure, to the extent they
are probable, can be estimated and have not previously been reserved. In
assessing environmental liabilities, no offset is made for potential insurance
recoveries. Recognition of any joint and several liability is based upon the
Company's best estimate of its final pro rata share of such liability.
INTANGIBLE ASSETS. Intangible assets are generally amortized by the
straight-line method over an estimated useful life of up to 30 years.
REVENUE RECOGNITION. Revenues for product sales and gas processing and
marketing services are recognized when title passes to the customer or when the
service is performed. Fractionation and transportation revenues are recognized
based on volumes received in accordance with contractual terms. Revenues derived
from power generation are recognized upon output, product delivery or
satisfaction of specific targets, all as specified by contractual terms. Fees
derived from engineering and construction contracts and development and other
activities received from joint ventures in which Dynegy holds an equity interest
are deferred to the extent of Dynegy's ownership interest and amortized on a
straight-line basis over appropriate periods, which vary according to the nature
of the service provided and the ventures' operations.
The Company accounts for its North American fixed-price natural gas
transactions using the mark-to-market method of accounting. Under such method,
all fixed-price natural gas contracts are recorded at fair value, net of future
servicing costs and reserves. Changes in the market value of these contracts are
recognized as gain or loss in the period of change. The resulting unrealized
gains and losses are recorded as assets and liabilities from risk management
activities. The accrual method of accounting is used for fixed-price natural gas
transactions in the United Kingdom and for accounting for fixed-price commodity
transactions in its wholesale power, NGL and crude marketing activities.
The Company routinely enters into financial instrument contracts to hedge
purchase and sale commitments, fuel requirements and inventories in its natural
gas liquids, crude oil, electricity and coal businesses in order to minimize the
risk of market fluctuations. Dynegy also monitors its exposure to fluctuations
in interest rates and foreign currency exchange rates and may execute swaps,
forward-exchange contracts or other financial instruments to manage these
exposures. Gains and losses from hedging transactions are recognized in income
and are reflected as cash flows from operating activities in the periods for
which the underlying commodity, interest rate or foreign currency transaction
was hedged. If the necessary correlation to the commodity, interest rate or
foreign currency transaction being hedged ceases to exist, the gain or loss
associated with such contract(s) is no longer deferred and is recognized in the
period correlation is lost.
INCOME TAXES. The Company files a consolidated United States federal
income tax return and, for financial reporting purposes, provides income taxes
for the difference in the tax and financial reporting bases of its assets and
liabilities in accordance with Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes."
EARNINGS PER SHARE. Basic earnings per share represents the amount of
earnings for the period available to each share of common stock outstanding
during the period. Diluted earnings per share represents the amount of earnings
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. Differences between basic and diluted shares outstanding in all periods
are attributed to the Series A Convertible Participating Preferred Stock,
options outstanding and a warrant.
FOREIGN CURRENCY TRANSLATIONS. For subsidiaries whose functional currency
is other than U.S. dollar, assets and liabilities are translated at year-end
rates of exchange and revenues and expenses are translated at average exchange
rates prevailing during the year. For each of the three years in the period
ended December 31, 1998, items of other comprehensive income were immaterial to
the Company's operating results.
F-8
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 -- RISK MANAGEMENT AND FINANCIAL INSTRUMENTS
Dynegy's operating results are impacted by commodity price, interest rate
and foreign exchange rate fluctuations. The Company routinely enters into
financial instrument contracts to hedge purchase and sale commitments, fuel
requirements and inventories in its natural gas, natural gas liquids, crude oil,
electricity and coal businesses in order to minimize the risk of market
fluctuations. However, as a result of marketplace liquidity and other factors,
the Company may, at times, be unable to hedge certain identified market risks.
Further, the Company may, at times, have a bias in the market, within
established guidelines, resulting from the management of its commodity
portfolios. Dynegy also monitors its exposure to fluctuations in interest rates
and foreign currency exchange rates and may execute swaps, forward-exchange
contracts or other financial instruments to manage these exposures.
Operating margins in the Wholesale Gas and Power segment are separated into
three integrated component businesses: wholesale gas marketing, wholesale power
marketing and power generation. Operating margins earned by wholesale gas and
power marketing, exclusive of risk-management activities, are relatively
insensitive to commodity price fluctuations since most of the purchase and sales
contracts do not contain fixed-price provisions. Generally, prices contained in
these contracts are tied to a current spot or index price and, therefore, adjust
directionally with changes in overall market conditions. However, market price
fluctuations for natural gas and electricity can have a significant impact on
the operating margin derived from risk-management activities in these
businesses. Further, differences in the comprehensive methods of accounting for
North American fixed-price natural gas transactions, which are accounted for
under the mark-to-market method, and natural gas marketing transactions in the
U.K. and power marketing transactions, which are both accounted for under
accrual accounting, create differences in the timing of the recognition of such
commodity price movements. Fuel costs, principally natural gas, represent the
primary variable cost impacting margins at the Company's power generating
facilities. Historically, operating margins have been relatively insensitive to
commodity price fluctuations since most of this business's purchase and sales
contracts contain variable power sales contract features tied to a current spot
or index natural gas price, allowing revenues to adjust directionally with
changes in natural gas prices. However, the financial performance and cash flow
derived from the Company's investment in merchant generation capacity is
sensitive to changes in, and the relationship between, natural gas and
electricity prices.
Operating margins associated with the Liquids segment's natural gas
gathering, processing and fractionation activities are very sensitive to changes
in natural gas liquids prices, principally as a result of contractual terms
under which natural gas is processed and products are sold by these, businesses
and the availability of inlet volumes. In addition, certain of the Liquids
Businesses' processing plant assets are impacted by changes in, and the
relationship between, natural gas and natural gas liquids prices which, in turn
influences the volumes of gas processed. Commodity price fluctuations also
impact the operating margins derived from the Liquids segment's natural gas
liquids and crude oil marketing businesses.
Dynegy's commercial groups manage, on a portfolio basis, the market risks
inherent in their transactions, subject to parameters established by the Dynegy
Board of Directors. Market risks are monitored by a risk control group that
operates independently from the commercial units that create or actively manage
these risk exposures to ensure compliance with Dynegy's risk management
policies. Risk measurement is also practiced against the Dynegy portfolios with
stress testing and scenario analysis.
ACCOUNTING FOR PRICE RISK MANAGEMENT ACTIVITIES -- NATURAL GAS. The
Company uses the mark-to-market method of accounting for its North American
fixed-price natural gas transactions. Under mark-to-market accounting, fixed-
price forwards, swaps, options, futures and other financial instruments with
third parties are reflected at market value, net of future servicing costs and
reserves, with resulting unrealized gains and losses recorded as assets and
liabilities from risk management activities in the consolidated balance sheets.
These assets and liabilities are affected by the actual timing of settlements
related to these contracts and current-period changes resulting primarily from
newly originated transactions and the impact of price movements. These changes
are recognized as revenues in the consolidated statements of operations in the
period in which the change occurs. Market prices used to value outstanding
financial instruments reflect management's consideration of, among other things,
closing exchange and over-the-counter quotations, the time value of money and
volatility factors underlying the commitments. These market
F-9
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
prices are adjusted to reflect the potential impact of liquidating Dynegy's
position in an orderly manner over a reasonable period of time under present
market conditions.
MARKET RISK. Dynegy generally attempts to balance its fixed-price physical
and financial purchase and sales contracts in terms of contract volumes and the
timing of performance and delivery obligations. However, net open positions
often exist or are established due to the origination of new transactions and
the Company's assessment of, and response to, changing market conditions. Dynegy
will take advantage of its bias in the market when it believes, based upon
competitive information gained from its energy marketing activities, that future
price movements will be consistent with its net open position. To the extent a
net open position exists, Dynegy is exposed to the risk that fluctuating market
prices may adversely impact its financial position or results of operations. The
net open position is actively managed, and the impact of a change in price on
the Company's financial condition at a point in time is not necessarily
indicative of the impact of price movements throughout the year.
MARKET RESERVES. In connection with the market valuation of its fixed-
price contracts, the Company maintains certain reserves for a number of risks
and costs associated with these future commitments. Among others, these include
reserves for credit risks based on the financial condition of counterparties,
reserves for product location ("basis") differentials and consideration of the
time value of money for long-term contracts. Counterparties in its trading
portfolio consist principally of financial institutions, major energy companies
and local distribution companies. The creditworthiness of these counterparties
may impact overall exposure to credit risk, either positively or negatively;
however, with regard to its counterparties Dynegy maintains credit policies that
management believes minimize overall credit risk. Determination of the credit
quality of its counterparties is based upon a number of factors, including
credit ratings, financial condition, project economics and collateral
requirements. When applicable, the Company employs standardized agreements that
allow for the netting of positive and negative exposures associated with a
single counterparty. Based on these policies, its current exposures and its
credit reserves, Dynegy does not anticipate a material adverse effect on its
financial position or results of operations as a result of counterparty
nonperformance. The following table displays the mark-to-market portfolio value
of Dynegy's natural gas fixed-price transactions at December 31, 1998:
BELOW
INVESTMENT INVESTMENT
GRADE GRADE
CREDIT CREDIT
QUALITY QUALITY TOTAL
----------------------------
($ IN THOUSANDS)
Utilities and power generators $ 47,752 $13,213 $ 60,965
Financial institutions (22,217) --- (22,217)
Oil and gas producers 14,697 12,605 27,302
Industrial companies 352 5,103 5,455
Other 3,347 204 3,551
-------- ------- --------
Value of fixed-price transactions before reserves $ 43,931 $31,125 75,056
Reserves ======== ======= (6,346)
--------
Net fixed-price value $ 68,710
========
At December 31, 1998, the term of Dynegy's natural gas portfolio extends
to 2007, and the average remaining life of an individual transaction was 3
months.
COMPREHENSIVE CHANGE IN ACCOUNTING PRINCIPLES. As a result of recent
pronouncements issued by the Financial Accounting Standards Board and the
Emerging Issues Task Force, the Company's comprehensive method of accounting for
energy-related contracts and/or derivative instruments and hedging transactions
is changing. Previously, only North American fixed-price natural gas
transactions were recorded at fair value, net of future servicing costs and
reserves as estimated by the Company. The Company does not anticipate that its
current mark-to-market accounting for fixed-price natural gas contracts will be
significantly affected by the adoption of Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("Statement No.
133") or by the Emerging Issues Task Force's conclusions in EITF 98-10,
"Accounting for Energy Trading and Risk Management
F-10
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Activities" ("EITF 98-10"). However, provisions in Statement No. 133 and in EITF
98-10 will affect the accounting for other trading and marketing operations that
are currently accounted for under the accrual method. Further, provisions in
Statement No. 133 will affect the accounting for and disclosure of other
contractual arrangements and operations of the Company. The Company is required
to adopt the provisions of EITF 98-10 effective January 1, 1999. The cumulative
effect of the change in accounting resulting from adoption of the provisions of
EITF 98-10 is immaterial. The transition rules under Statement No. 133 provide
for early adoption as of the beginning of any fiscal quarter subsequent to June
15, 1998. Dynegy intends to adopt the provisions of Statement No. 133 within the
timeframe and in accordance with the requirements provided by that statement.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The following disclosure of the
estimated fair value of financial instruments is made in accordance with the
requirements of SFAS No. 107, "Disclosures About Fair Value of Financial
Instruments." The estimated fair-value amounts have been determined by the
Company using available market information and selected valuation methodologies.
Considerable judgment is required in interpreting market data to develop the
estimates of fair value. The use of different market assumptions or valuation
methodologies could have a material effect on the estimated fair-value amounts.
The carrying values of current assets and liabilities approximate fair
values due to the short-term maturities of these instruments. The carrying
amounts and fair values of the Company's other financial instruments were:
DECEMBER 31,
------------------------------------------------------------
1998 1997
--------------------------- ---------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ------------ ---------- ------------
($ IN THOUSANDS)
Commercial Paper $518,643 $518,643 $229,500 $229,500
Money market lines of credit 20,000 20,000 --- ---
Credit Agreement --- --- 110,000 110,000
Canadian Credit Agreement 40,000 40,000 --- ---
6.75% Senior Notes, due 2005 150,000 152,000 150,000 152,000
7.625% Senior Notes, due 2026 175,000 179,000 175,000 188,000
7.125% Senior Notes, due 2018 175,000 172,000 --- ---
Power Generation Notes 103,126 103,126 --- ---
Chevron Note --- --- 156,982 159,000
14% Senior Subordinated Notes, due 2001 --- --- 70,063 71,000
10.25% Subordinated Notes, due 2003 --- --- 110,234 111,000
Preferred Securities of a Subsidiary Trust 200,000 204,000 200,000 223,000
Interest rate risk-management contracts --- 8,474 --- 3,470
Foreign currency risk-management contracts 4,418 5,491 892 (375)
Commodity risk-management contracts (29,222) (30,977) (23,167) (25,047)
The financial statement carrying amounts of the Company's credit
agreement and variable-rate debt were assumed to approximate fair value. The
fair values of the Company's other long-term indebtedness, including the
Preferred Securities of a Subsidiary Trust but excluding the Chevron Note, were
based on quoted market prices by financial institutions that actively trade
these debt securities. The fair value of the Chevron Note was determined by
comparison to publicly traded instruments having similar terms and conditions.
The fair value of the Company's cost basis investments was not estimated as the
investments were considered immaterial. The fair value of interest rate, foreign
currency and commodity risk-management contracts were based upon the estimated
consideration that would be received to terminate those contracts in a gain
position and the estimated cost that would be incurred to terminate those
contracts in a loss position. The interest rate swap contracts, foreign currency
forward exchange contracts and commodity swap and option agreements extend for
periods of up to 12, 2 and 9 years, respectively. The absolute notional contract
amounts associated with the commodity risk-management, interest rate and forward
exchange contracts, respectively, were as follows:
F-11
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,
-----------------------------------
1998 1997 1996
-----------------------------------
Natural Gas (Trillion Cubic Feet) 4.179 2.558 1.535
Electricity (Million Megawatt Hours) 1.835 2.244 ---
Natural Gas Liquids (Million Barrels) 6.397 4.355 3.270
Crude Oil (Million Barrels) 18.800 14.920 2.034
Interest Rate Swaps (in thousands of US Dollars) $ 69,332 $180,000 $ ---
Fixed Interest Rate Paid on Swaps 8.067 6.603 ---
U.K. Pound Sterling (in thousands of US Dollars) $ 69,254 $ 74,638 $ ---
Average U.K. Pound Sterling Contract Rate (in US Dollars) $ 1.6143 $ 1.5948 $ ---
Canadian Dollar (in thousands of US Dollars) $268,307 $ 37,041 $ ---
Average Canadian Dollar Contract Rate (in US Dollars) $ 0.6710 $ 0.7240 $ ---
Cash-flow requirements for these commodity risk-management, interest rate
and foreign exchange contracts were estimated based upon market prices in effect
at December 31, 1998. Cash-flow requirements were as follows:
1999 2000 2001 2002 2003 Beyond
------ ------ ------ ------ ------ --------
($ in thousands)
Future estimated net inflows
(outflows) based on year
end market prices/rates $38,104 $(9,574) $(3,475) $(2,473) $ 180 $1,073
======= ======= ======= ======= ===== ======
NOTE 3 -- CASH FLOW INFORMATION
Detail of supplemental disclosures of cash flow and non-cash investing
and financing information was:
Year Ended December 31,
--------------------------------------------
1998 1997 1996
--------------------------------------------
($ in thousands)
Interest paid (net of amount capitalized) $ 83,376 $ 60,323 $ 22,647
========= ========= =========
Taxes paid (net of refunds) $ (8,000) $ 8,043 $ 1,467
========= ========= =========
Detail of businesses acquired:
Current assets and other $ 5,144 $ 547,505 $ 76,490
Fair value of non-current assets 101,630 503,789 967,575
Liabilities assumed, including deferred taxes (104,130) (268,092) (595,219)
Capital stock issued and options exercised --- --- (448,132)
Cash balance acquired --- (67,613) ---
--------- --------- ---------
Cash paid, net of cash acquired $ 2,644 $ 715,589 $ 714
========= ========= =========
F-12
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 -- PROPERTY, PLANT AND EQUIPMENT
Investments in property, plant and equipment consisted of:
DECEMBER 31,
--------------------------
1998 1997
($ IN THOUSANDS)
Wholesale Gas and Power Segment:
Natural gas and power marketing $ 1,514 $ 2,588
Power generation 351,378 48,866
Liquids Segment:
Natural gas processing 1,241,658 1,211,727
Fractionation 185,198 152,501
Liquids marketing 139,328 178,820
Natural gas gathering and transmission 429,631 275,116
Crude oil 43,118 44,977
Other 55,053 43,655
---------- ----------
2,446,878 1,958,250
Less: accumulated depreciation (514,771) (436,674)
---------- ----------
$1,932,107 $1,521,576
========== ==========
Interest capitalized related to costs of projects in process of development
totaled $7.6 million, $8.8 million and $1.2 million for each of the three years
in the period ended December 31, 1998.
During the second quarter of 1998, the Company purchased all of the
outstanding partnership interests held by third parties in three limited
partnerships, each formed for the purpose of owning and operating a discrete
power generation facility in the State of California. As a result, the Company
now consolidates the aggregate assets, liabilities and results of operations
associated with these projects.
NOTE 5 -- UNCONSOLIDATED AFFILIATES
The equity method of accounting is used for investments in certain
partnerships and for investments in companies in which Dynegy has a voting
interest between 20 percent and 50 percent. Such investments include:
ACCORD ENERGY LIMITED. Accord was formed in 1994 to market energy
resources in the United Kingdom and Europe. Prior to 1997, Dynegy owned a 49
percent limited partner interest in Accord. In January 1997, such interest was
converted to a 25 percent participating preferred stock interest.
NICOR ENERGY, L.L.C. ("NICOR"). NICOR is a retail energy alliance formed
with NICOR Energy Management Services, a subsidiary of NICOR Inc., to provide
energy services to industrial, commercial and residential customers in the
Midwest. Dynegy owns a 50 percent interest in this Delaware limited liability
company.
SOUTHSTAR ENERGY SERVICES L.L.C. SouthStar is a retail energy alliance
formed with AGL Resources Inc. and Piedmont Natural Gas Company. The company
offers a combination of unregulated energy products and services to industrial,
commercial and residential customers in the southeast. Dynegy owns a 20 percent
interest in this Delaware limited liability company.
POWER GENERATION PARTNERSHIPS. Dynegy owns interests in fifteen joint
ventures, each formed to build, own and operate cogeneration facilities. The
Company's interests in these joint ventures range from eight to 50 percent. Each
partnership interest is accounted for under the equity method. Construction of
the cogeneration facilities owned by each of the joint ventures was project
financed and the obligations of the joint ventures are non-recourse to the
Company. At December 31, 1998, the unamortized excess of the Company's
investment in these joint ventures over its equity in the
F-13
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
underlying net assets of the affiliates approximated $160 million. This amount
is being amortized on the straight-line method over the estimated economic
service lives of the underlying assets.
QUICKTRADE L.L.C. ("QUICKTRADE"). Quicktrade, a Delaware limited liability
company, was formed to develop, implement and operate an electronic trading
system. Dynegy owned a 65.5 percent interest in this LLC during 1998 and the LLC
was consolidated in the accompanying financial statements during 1998. During
1996 and 1997, the Company owned varying interests in Quicktrade and accounted
for its interest under the equity method for the majority of those years.
Effective January 1, 1999, the Company sold its interest in Quicktrade.
GULF COAST FRACTIONATORS ("GCF"). GCF is a Texas limited partnership that
owns and operates a natural gas liquids fractionation facility located in Mont
Belvieu, Texas. Dynegy owns a 38.75 percent limited partner interest in GCF. At
December 31, 1998, the unamortized excess of the Company's investment in GCF
over its equity in the underlying net assets of the affiliate approximated $16
million. This amount is being amortized on the straight-line method over the
estimated economic service life of the GCF assets.
WEST TEXAS LPG PIPELINE PARTNERSHIP ("WEST TEXAS PARTNERSHIP"). The West
Texas Partnership, a Texas limited partnership, holds all of the assets
comprising the West Texas Pipeline, an interstate natural gas liquids pipeline.
Dynegy owns a 49 percent interest in the West Texas Partnership acquired as part
of the Chevron Combination. At December 31, 1998, the unamortized excess of the
Company's investment in the West Texas Partnership over its equity in the
underlying net assets of the affiliate approximated $43 million. This amount is
being amortized on the straight-line method over the estimated economic service
life of the underlying assets.
VENICE ENERGY SERVICES COMPANY, L.L.C. ("VESCO"). VESCO is a Delaware
limited liability company that owns and operates a natural gas processing,
extraction, fractionation and storage facility located in Plaquemines Parish,
Louisiana. Dynegy is operator of the facility and originally acquired a 37
percent interest in Venice Gas Processing Company ("Venice") effective November
1, 1996. In 1997, Venice reorganized as a limited liability company and, in
September 1997, the VESCO members agreed to expand ownership in VESCO to include
an affiliate of Shell Midstream Enterprises, a subsidiary of Shell Oil Company
("Shell"), effective September 1, 1997, in exchange for Shell's commitment of
certain offshore reserves to VESCO. The transaction reduced Dynegy's interest
in VESCO from 37 percent to approximately 32 percent, as of the effective date.
Koch Energy Services Company ("Koch") acquired an interest in VESCO during 1998
pursuant to its contribution of a cryogenic gas-processing unit to VESCO. The
transaction reduced Dynegy's interest in VESCO to approximately 23 percent.
Dynegy operates the facility and has commercial responsibility for product
distribution and sales.
WASKOM GAS PROCESSING COMPANY ("WASKOM"). Waskom is a Texas general
partnership that owns and operates a natural gas processing, extraction and
fractionation facility located in Henderson County, Texas. Dynegy owns a 33.33
percent in Waskom. Dynegy operates the facility and has commercial
responsibility for product distribution and sales.
BARGE CO. Barge Co., a Delaware limited liability company, owns pressurized
LPG barges used in transporting LPGs principally in the Gulf of Mexico. Dynegy
owns a 25 percent interest in Barge Co. At December 31, 1998, the unamortized
excess of the Company's investment in Barge Co. over its equity in the
underlying net assets of the affiliate approximated $10 million. This amount is
being amortized on the straight-line method over the estimated economic service
lives of the underlying assets.
Aggregate equity method investment at December 31, 1998, 1997 and 1996, was
$498.5 million, $466.4 million and $177.8 million, respectively. Dividends
received on these investments during each of the three years in the period ended
December 31, 1998, totaled $84.0 million, $63.6 million and $7.3 million,
respectively. Summarized aggregate financial information for these investments
and Dynegy's equity share thereof was:
F-14
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,
------------------------------------------------------------------------------------------------
1998 1997 1996
------------------------------------------------------------------------------------------------
Total Equity Share Total Equity Share Total Equity Share
--------- -------------- --------- --------------- -------- ---------------
($ in thousands)
Current assets (1)(2) $ 324,462 $131,169 $ 283,787 $112,895 $ 93,949 $ 35,321
Non-current assets (1)(2) 1,983,731 803,333 1,830,106 736,667 324,210 122,882
Current liabilities (1)(2) 292,481 124,016 202,754 86,476 30,459 11,893
Non-current liabilities (1)(2) 1,160,639 485,673 1,249,874 521,691 47,250 18,309
Operating margin (1)(2)(3) 397,391 159,288 209,877 86,154 37,296 14,500
Net income (1)(2)(3) 157,054 68,706 83,601 33,799 19,024 7,360
1. The financial data for all periods presented is exclusive of amounts
attributable to the Company's investment in Accord as disclosure data was
unavailable for the current period. Dynegy's share of Accord earnings for
each of the three years in the period ended December 31, 1998, totaled $21.8
million, $25.9 million and $18.0 million, respectively.
2. The financial data for all periods presented is exclusive of amounts
attributable to the Company's investment in NCL as such information was not
comparable period-to-period, as a result of the NCL restructuring. Dynegy
sold its interest in NCL effective April 1, 1997. Dynegy's share of NCL's
loss for the three months ended March 31, 1997, totaled $892,000. Dynegy's
share of NCL's earnings for the year ended December 31, 1996 totaled $3.6
million.
3. Equity earnings derived from investments acquired in the Destec acquisition
accrue to Dynegy commencing July 1, 1997.
The cost method of accounting is generally used to account for investment in
partnerships or companies in which Dynegy has a voting interest of less than 20
percent. At December 31, 1998, the Company had two cost basis investments:
Indeck North American Power Fund, L.P. and Indeck North American Power Partners,
L.P. (collectively "Indeck"). Indeck is engaged in the acquisition and operation
of electric power generating facilities. Dynegy's aggregate investment in these
entities totaled $4.1 million and $4.0 million at December 31, 1998 and 1997,
respectively, and Dynegy received an aggregate $0.5 million, $0.5 million and
$0.6 million of dividends from Indeck during each of the three years in the
period ended December 31, 1998.
NOTE 6 -- LONG-TERM DEBT
DECEMBER 31,
-----------------------------------
1998 1997
---------- ----------
($ IN THOUSANDS)
Commercial Paper $ 518,643 $ 229,500
Money market lines of credit 20,000 ---
Credit Agreement --- 110,000
Canadian Credit Agreement 40,000 ---
6.75% Senior Notes, due 2005 150,000 150,000
7.625% Senior Debentures, due 2026 175,000 175,000
7.125% Senior Debentures, due 2018 175,000 ---
Power Generation Notes 103,126 ---
Chevron Note --- 155,373
14% Senior Subordinated Notes, due 2001 --- 65,000
10.25% Subordinated Notes, due 2003 --- 105,000
Other, non-interest bearing 275 550
Unamortized premium --- 11,906
---------- ----------
1,182,044 1,002,329
Less: long-term debt due within one year 135,154 275
---------- ----------
$1,046,890 $1,002,054
========== ==========
F-15
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMERCIAL PAPER AND MONEY MARKET LINES OF CREDIT. The Company utilizes
commercial paper proceeds and borrowings under uncommitted money market lines of
credit for general corporate purposes, including short-term working capital
requirements. The commercial paper program is for amounts up to $800 million,
as supported by existing credit agreements. Weighted average interest rates on
amounts outstanding under the commercial paper program were 6.1 percent and 6.8
percent at December 31, 1998 and 1997, respectively. Amounts outstanding under
the uncommitted money market lines of credit bore interest at an average rate of
6.0 percent at December 31, 1998. The Company classifies outstanding commercial
paper and borrowings under money market lines of credit as long-term debt to the
extent of availability under existing committed credit facilities, as
management's intent is to maintain these obligations for longer than one year,
subject to an overall reduction in corporate debt levels.
CREDIT AGREEMENTS. In May 1998, Dynegy refinanced its then existing
revolving credit agreement with a $400 million, five-year revolving credit
agreement that matures May 27, 2003, and a $400 million, 364-day revolving
credit agreement maturing in May, 1999 (the "Credit Agreements"). The Credit
Agreements provide funding for letters of credit, working capital, capital
expenditures and general corporate purposes, including commercial paper support.
The Credit Agreements also require payment of various costs and fees, including
an annual fee of 0.09 percent of the committed amount under the Credit
Agreements. Generally, borrowings under the Credit Agreements bear interest at a
Eurodollar rate plus a margin that is determined based on the Company's
unsecured senior debt rating. At December 31, 1998, such margin was 0.21
percent. Financial covenants in the Credit Agreements are limited to a debt to
capitalization test. Letters of credit under the Credit Agreements aggregated
approximately $27 million at December 31, 1998.
The Company maintains an additional $240 million, 364-day revolving credit
facility having a current maturity date of December 17, 1999. The facility
provides funding for general corporate purposes. The facility also requires
payment of various costs and fees, including an annual fee of 0.125 percent of
the committed amount under the facility. Generally, borrowings under the
facility bear interest at a Eurodollar rate plus a margin that is determined
based on the Company's unsecured senior debt rating. At December 31, 1998, such
margin was 0.525 percent. Financial covenants are limited to a debt to
capitalization test. No amounts were outstanding under this agreement at
December 31, 1998.
After consideration of the outstanding commercial paper, the unused
borrowing capacity under the Credit Agreements and additional 364-day facility
approximated $495 million at December 31, 1998.
CANADIAN CREDIT AGREEMENT. In November 1998, an indirect wholly owned
Canadian subsidiary of the Company entered into a $60 million, two-year
revolving credit facility, which matures on November 24, 2000 (the "Canadian
Credit Agreement"). The Canadian Credit Agreement provides funding for general
corporate purposes. The Canadian Credit Agreement requires payment of various
costs and fees, including an annual fee of 0.25 percent of the committed amount
under the Canadian Credit Agreement. Generally, borrowings under the Canadian
Credit Agreement bear interest at a Eurodollar rate plus a margin that is
determined based on the Company's unsecured senior debt rating. At December 31,
1998, such margin was 0.40 percent. The Canadian subsidiary's obligations under
the Canadian Credit Agreement are fully and unconditionally guaranteed by the
Company. At December 31, 1998, outstanding amounts under the facility totaled
$40.0 million, at an average interest rate of 6.09 percent.
6.75% SENIOR NOTES DUE 2005. In December 1995, the Company sold $150
million of 6.75 percent Senior Notes due December 15, 2005 ("Senior Notes"). The
Senior Notes were issued at a price of 99.984 percent, which, after deducting
underwriting discounts and commissions, resulted in net proceeds to the Company
of approximately $149 million. Proceeds from the sale of the Senior Notes were
used to repay a portion of the outstanding indebtedness under the then existing
revolving credit agreement. Interest on the Notes is payable semiannually on
June 15 and December 15 of each year. Upon issuance, the Senior Notes were
priced based on the then existing yield for 10-year U.S. Treasury Notes ("10-
Year Base Treasury Rate") plus a spread based principally on the Company's
credit rating. Prior to issuing the Senior Notes, the Company entered into two
separate transactions with two separate financial institutions, the effect of
which was to lock in the 10-Year Base Treasury Rate at approximately 6.2 percent
on the full $150 million face value of the Senior Notes.
F-16
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7.625% SENIOR DEBENTURES DUE 2026. In October 1996, Dynegy sold $175
million of 7.625 percent Senior Debentures due October 15, 2026 ("Senior
Debentures"). The Senior Debentures were issued at a price of 99.522 percent,
which, after deducting underwriting discounts and commissions, resulted in net
proceeds to the Company of approximately $173 million. The net proceeds from the
sale of such Senior Debentures were used to repay a portion of the outstanding
indebtedness under the then existing revolving credit agreement. Interest on the
Senior Debentures is payable semiannually on April 15 and October 15 of each
year. The Senior Debentures are redeemable, at the option of the Company, in
whole or in part from time to time, at a formula based redemption price as
defined in the associated indenture. Upon issuance, the Senior Debentures were
priced based on the then existing yield for 30-year U.S. Treasury Notes ("30-
Year Base Treasury Rate") plus a spread based principally on the Company's
credit rating. Prior to issuing the Senior Debentures, the Company entered into
a transaction, the effect of which was to lock in the 30-Year Base Treasury Rate
at approximately 7.0 percent on $150 million of the $175 million face value of
the Senior Debentures.
In February 1998, the Company completed an amendment to the then existing
revolving credit agreement and the filing of supplemental indentures to each of
the Senior Debentures and Senior Notes, the effect of which was to eliminate all
clauses, provisions and terms in such documents requiring certain wholly owned
subsidiaries of the Company to fully and unconditionally guarantee, on a joint
and several basis, the obligations of the Company under such credit agreement,
debentures and notes, respectively.
7.125% SENIOR DEBENTURES DUE 2018. In May 1998, Dynegy sold $175 million
of 7.125 percent Senior Debentures due May 15, 2018 ("Debentures"). The
Debentures were issued at a price of 99.654 percent, which, after deducting
underwriting discounts and commissions, resulted in net proceeds of
approximately $173 million. Proceeds from the sale of the Debentures were used
to retire short-term debt incurred in connection with the redemption of certain
high-cost debt discussed below. Interest on the Debentures is payable
semiannually on May 15 and November 15 of each year. The Debentures are
redeemable, at the option of the Company, in whole or in part from time to time,
at a formula based redemption price as defined in the associated indenture. Upon
issuance, the Debentures were priced based on the then existing 30-Year Base
Treasury Rate plus a spread based principally on the Company's credit rating.
Prior to issuing the Debentures, the Company entered into a series of
transactions, the effect of which was to lock in the 30-Year Base Treasury Rate
at approximately 6.0% on $148 million of the $175 million face value of the
Debentures.
POWER GENERATION NOTES. Included in the December 31, 1998 consolidated
long-term debt balance was $103.1 million representing the aggregate principal
balance outstanding under three separate notes, each having recourse only to the
assets of one of the three power generation projects acquired in 1998 as
described in Note 4. Each of the three notes represents a fifteen-year term loan
obligation payable in semi-annual installments of principal plus accrued
interest. Each note bears interest at a base rate plus a margin, as defined in
each agreement. Interest rate swaps effectively fix the base rate on $69.3
million of the indebtedness at a weighted average rate of 8.067 percent.
RETIRED DEBT. During 1998, the Company retired the 14 percent Senior
Subordinated Notes, the 10.25 percent Subordinated Notes and the Chevron Note.
The retirement of these notes was funded through a combination of borrowings
under existing credit agreements and the sale of commercial paper. There was no
financial gain or loss related to these retirements.
Aggregate maturities of all long-term indebtedness are: 1999 - $135.2
million; 2000 - $40.0 million; 2001 - none; 2002 - none; 2003 and beyond - $1.0
billion.
F-17
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 -- INCOME TAXES
The Company is subject to U.S. federal, foreign and state income taxes on
its operations. Components of income tax expense (benefit) were:
Year Ended December 31,
------------------------------------
1998 1997 1996
-------- --------- --------
($ in thousands)
Current tax expense (benefit):
Domestic $ (608) $ 13,230 $ 10,427
Foreign (1,362) 3,071 ---
Deferred tax expense (benefit):
Domestic 44,565 (81,306) 45,510
Foreign 7,743 2,795 386
------- -------- --------
Income tax provision (benefit) $50,338 $(62,210) $ 56,323
======= ======== ========
Components of income (loss) before income taxes was as follows:
Year Ended December 31,
------------------------------------
1998 1997 1996
-------- --------- --------
($ in thousands)
Income (loss) before income taxes:
Domestic $133,867 $(180,127) $150,705
Foreign 24,824 30,232 18,940
-------- --------- --------
$158,691 $(149,895) $169,645
======== ========= ========
Deferred income taxes are provided for the temporary differences between
the tax basis of Dynegy's assets and liabilities and their reported financial
statement amounts. Significant components of deferred tax liabilities and assets
were:
December 31,
----------------------
1998 1997
-------- --------
($ in thousands)
Deferred tax assets:
Clearinghouse partnership basis differential $ 990 $ 19,211
Loss carryforward 132,445 76,885
Tax credits 10,798 23,162
Other --- 8,499
144,233 127,757
-------- --------
Valuation allowance --- ---
-------- --------
144,233 127,757
-------- --------
Deferred tax liabilities:
Items associated with capitalized costs 461,770 381,816
-------- --------
Net deferred tax liability $317,537 $254,059
======== ========
Realization of the aggregate deferred tax asset is dependent on the Company's
ability to generate taxable earnings in the future. There was no valuation
allowance established at December 31, 1998 or 1997, as management believes the
aggregate deferred asset is more likely than not to be fully realized in the
future.
F-18
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Income tax provision (benefit) for the years ended December 31, 1998, 1997
and1996, was equivalent to effective rates of 32 percent, (41) percent and 33
percent, respectively. Differences between taxes computed at the U.S. federal
statutory rate and the Company's reported income tax provision (benefit) were:
Year Ended December 31,
---------------------------------
1998 1997 1996
------- -------- -------
($ in thousands)
Expected tax at U.S. statutory rate $55,444 $(52,463) $59,376
State taxes 2,564 (3,676) 3,393
Foreign tax benefit (2,300) (5,415) (6,621)
Basis differentials and other (5,370) (656) 175
------- -------- -------
Income tax provision (benefit) $50,338 $(62,210) $56,323
======= ======== =======
At December 31, 1998, the Company had approximately $358 million of
regular tax net operating loss carryforwards. The net operating loss
carryforwards expire from 2006 through 2012. Certain provisions of the Internal
Revenue Code place an annual limitation on the Company's ability to utilize tax
carryforwards existing as of the date of a 1995 business acquisition. Management
believes such carryforwards will be fully realized prior to expiration.
NOTE 8 -- COMPANY OBLIGATED PREFERRED SECURITIES OF A SUBSIDIARY TRUST
In May 1997, NGC Corporation Capital Trust I ("Trust") issued, in a private
transaction, $200 million aggregate liquidation amount of 8.316% Subordinated
Capital Income Securities ("Trust Securities") representing preferred undivided
beneficial interests in the assets of the Trust. The Trust invested the
proceeds from the issuance of the Trust Securities in an equivalent amount of
8.316% Subordinated Debentures ("Subordinated Debentures") of the Company. The
sole assets of the Trust are the Subordinated Debentures. The Trust Securities
are subject to mandatory redemption in whole but not in part on June 1, 2027,
upon payment of the Subordinated Debentures at maturity, or in whole but not in
part at any time, contemporaneously with the optional prepayment of the
Subordinated Debentures, as allowed by the associated indenture. The
Subordinated Debentures are redeemable, at the option of the Company, in whole
at any time or in part from time to time, at formula-based redemption prices, as
defined in the indenture. The Subordinated Debentures represent unsecured
obligations of the Company and rank subordinate and junior in right of payment
to all Senior Indebtedness to the extent and in the manner set forth in the
associated indenture. The Company has irrevocably and unconditionally
guaranteed, on a subordinated basis, payment for the benefit of the holders of
the Trust Securities the obligations of the Trust to the extent the Trust has
funds legally available for distribution to the holders of the Trust Securities,
as described in the indenture ("Guarantee"). Distributions on the Trust
Securities are payable each June 1 and December 1, coinciding with the interest
payment due dates on the Subordinated Debentures, and are classified in the
accompanying Statement of Operations as "minority interest in income of a
subsidiary." The periodic distributions accruing at an annual rate of 8.316
percent of the aggregate liquidation amount are recorded as minority interest in
income of a subsidiary in the Company's consolidated statement of operations. So
long as no Debenture Event of Default, as defined, has occurred and continues,
the Company has the right to defer the payment of interest on the Subordinated
Debentures for any Extension Period elected by the Company, which period cannot
extend beyond 10 consecutive semi-annual periods, end on a date other than an
Interest Payment Date or extend beyond the Stated Maturity Date. During October
1997, the Trust completed an exchange offer through which all of the outstanding
Trust Securities were exchanged by the holders thereof for registered securities
having substantially the same rights and obligations.
Note 9 -- COMMITMENTS AND CONTINGENCIES
Litigation. On April 17, 1997, Pacific Gas and Electric Company ("PG&E")
filed a lawsuit in the Superior Court of the State of California, City and
County of San Francisco, against Destec, Destec Holdings, Inc. and Destec
Operating Company (wholly-owned subsidiaries of the Company now known
respectively as Dynegy Power Corp.,
F-19
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Dynegy Power Holdings, Inc. and Dynegy Operating Company) as well as against San
Joaquin CoGen Limited ("San Joaquin" or the "Partnership") and its general
partners (collectively the "Dynegy Defendants"). Dynegy Power Corp. and its
affiliates now own all of the partnership interests in the Partnership as a
result of the purchase of the interests of the two outside partners in the
Partnership. In the lawsuit, PG&E asserts claims and alleges unspecified damages
for fraud, negligent misrepresentation, unfair business practices, breach of
contract and breach of the implied covenant of good faith and fair dealing. PG&E
alleges that due to the insufficient use of steam by San Joaquin's steam host,
the Partnership did not qualify as a cogenerator pursuant to the California
Public Utilities Code ("CPUC") Section 218.5, and thus was not entitled under
CPUC Section 454.4 to the discount the Partnership received under gas
transportation agreements entered into between PG&E and San Joaquin in 1989,
1991, 1993 and 1995. All of PG&E's claims in this suit arise out of the
Partnership's alleged failure to comply with CPUC Section 218.5. The defendants
filed a response to the suit on May 15, 1997. On October 20, 1997, PG&E named
Libbey-Owens-Ford ("LOF"), the Partnership's steam host, as an additional
defendant in the action. On February 23, 1998, PG&E served its Second Amended
Complaint on all defendants. On March 30, 1998, the defendants filed their
response to PG&E's Second Amended Complaint, denying PG&E's allegations and
alleging certain counterclaims against PG&E. By Order dated July 20, 1998, the
court dismissed certain of defendants' counterclaims against PG&E, and abated
certain others, pending resolution by the CPUC. The trial date is currently June
15, 1999. The Partnership has previously advised the FERC of PG&E's claims, and
stated that it would submit any appropriate filings upon completion of its
investigation. If the facility was found not to have satisfied the California
cogeneration facility standards, there is a strong likelihood that it would also
fail to satisfy the more stringent federal standards. In accordance with the
terms of a Protective Order entered into by the parties at the commencement of
the litigation, PG&E has notified San Joaquin that it may make a FERC filing
seeking damages from San Joaquin and decertification of its status as a
qualifying facility under the federal standards. Under FERC precedent, if the
San Joaquin facility were found not to have been a qualifying facility, San
Joaquin could be required to refund to PG&E payments it received pursuant to the
Power Purchase Agreement in excess of PG&E's short-term energy costs during the
period of non-compliance, plus interest. In the event the court or FERC were to
determine that San Joaquin is liable to PG&E under the Gas Transportation
Agreement or Power Purchase Agreement due to LOF's failure to use sufficient
quantities of steam, San Joaquin will seek to recover such amounts from LOF
under the terms of the Steam Purchase Agreement between San Joaquin and LOF. The
parties have been actively engaged in settlement discussions, which resulted in
the execution of a Termination and Settlement Agreement between PG&E and the
Dynegy Defendants on March 9, 1999 (the "Settlement Agreement"). The Settlement
Agreement provides for, upon the receipt of CPUC approval, a dismissal with
prejudice of PG&E's claims against the Dynegy Defendants, a release by PG&E of
all claims relative to FERC matters and a termination of the San Joaquin power
purchase agreement as of December 31, 1999, whereupon the San Joaquin facility
will continue to operate as a merchant plant. The Dynegy Defendants will seek to
recover from LOF any losses resulting from the settlement with PG&E. However, if
the settlement is not ultimately concluded, the Dynegy Defendants will seek to
recover from LOF any losses or amounts for which it may be found liable.
Further, the Company's subsidiaries intend to continue to vigorously defend this
action. In the opinion of management, the ultimate resolution of this lawsuit
will not have a material adverse effect on the Company's financial position or
results of operations.
On March 24, 1995, Southern California Gas Company ("SOCAL") filed a
lawsuit in the Superior Court of the State of California for the County of Los
Angeles, against Destec, Destec Holdings and Destec Gas Services, Inc. (now
known respectively as Dynegy Power Corp., Dynegy Holdings, Inc. and Dynegy Gas
Services, Inc.), wholly-owned direct and indirect subsidiaries of the Company
(collectively, the "Defendants"), as well as against Chalk Cliff Limited and
McKittrick Limited (collectively, the "Partnerships"). The Company owns an
indirect 50 percent limited partnership interest in McKittrick Limited, and
Chalk Cliff Limited is now wholly owned by subsidiaries of the Company through
the purchase of the interests of Dominion Energy, Inc. All general partners of
the Partnerships are also named defendants. The lawsuit alleged breach of
contract against the Partnerships and their respective general partners, and
interference and conspiracy to interfere with contracts against the Defendants.
The breach of contract claims arose out of the "transport-or-pay" provisions of
the gas transportation service agreements between the Partnerships and SOCAL.
SOCAL sought damages from the Partnerships for past damages and anticipatory
breach damages in an amount equal to approximately $31,000,000. On October 24,
1997, the Court granted SOCAL's Motion for Summary Judgment relating to the
breach of contract causes of action against the Partnerships and their
respective general partners, and requested that SOCAL submit a proposed order
consistent with that ruling for the Court's signature. On November 21, 1997, the
Partnerships filed for voluntary Chapter 11 bankruptcy protection in the Eastern
District of California. Normal business
F-20
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
operations by the Partnerships continued throughout the course of these
reorganization proceedings. On January 12, 1998, the Court entered a Final Order
that (a) severed out the Partnerships due to their Chapter 11 bankruptcy
filings, (b) included a finding of contract liability against the Defendants,
(c) dismissed the tortious interference claims against the Defendants, and (d)
assessed damages in an aggregate amount of approximately $31,000,000. On the
same day, the Defendants filed their Notice of Appeal, and posted a security
bond with the Second Appellate District in Los Angeles based on the lack of
allegations made or proven by SOCAL which support holding those entities liable
in contract. On March 11, 1998, the Partnerships and their respective general
partners filed Notices of Appeal with respect to certain findings of fact in the
Court's January 12, 1998 Final Order that were adverse to those defendants. On
or about April 15, 1998, the Court entered a final judgment against the
Partnerships themselves in recognition of the lifting of the automatic stay
against those entities by the Bankruptcy Court. The Partnerships filed their
appeal of that final judgment on June 4, 1998. On October 21, 1998, the
Bankruptcy Court dismissed the voluntary bankruptcy filings of the Partnerships
and their respective lenders thereafter notified each of the Partnerships of the
occurrences of an Event of Default under the Partnerships' respective credit
agreements due to the existence of the SOCAL judgment against them, and have
instituted foreclosure proceedings as to the projects. Additionally, receivers
were named by the lenders and approved by the Court for each of the projects. In
early December 1998, the defendants filed their opening appellate briefs in the
appeal of the Court's final judgment. On February 23, 1999, the Court granted a
motion by SOCAL to amend the Court's final judgment to include a finding that
Dynegy Power Corp. is the alter ego of the Partnerships and their respective
general partners. Dynegy Power Corp. will appeal the Court's ruling, and will
vigorously defend SOCAL's claims.
The PG&E and SOCAL litigations represent pre-acquisition contingencies
acquired by the Company in the Destec Acquisition. In a related matter, Chalk
Cliff and San Joaquin have each guaranteed the obligations of the other
partnership, represented by the project financing loans used to construct the
power generation facilities owned by the respective Partnerships. In the
opinion of management, the election by the lender of its option under the terms
of such arrangements would not have a material adverse effect on the Company's
financial position or results of operations.
On August 3, 1998, Modesto Irrigation District ("MID") filed a lawsuit
against PG&E and Destec in federal court for the Northern District of
California, San Francisco division. The lawsuit alleges violation of federal
and state antitrust laws and breach of contract against Destec. The allegations
are related to a power sale and purchase arrangement in the city of Pittsburg,
CA. MID seeks actual damages from PG&E and Destec in amounts not less than $25
million. MID also seeks a trebling of any portion of damages related to its
antitrust claims. By order dated February 2, 1999, the federal District Court
dismissed MID's state and federal antitrust claims against PG&E and Destec;
however, the Court granted MID leave of thirty days to amend its complaint to
state an antitrust cause of action. On March 3, 1999, MID filed an amended
complaint recasting its federal and state antitrust claims against PG&E and
Destec and restating its breach of contract claim against Destec. Dynegy
believes the allegations made by MID are meritless and will continue to
vigorously defend MID's claims. In the opinion of management, the amount of
ultimate liability with respect to these actions will not have a material
adverse effect on the financial position or results of operations of the
Company.
The Company assumed liability for various claims and litigation in
connection with the Chevron Combination, the Trident Combination, the Destec
Acquisition and in connection with the acquisition of certain gas processing and
gathering facilities from Mesa Operating Limited Partnership. The Company
believes, based on its review of these matters and consultation with outside
legal counsel, that the ultimate resolution of such items will not have a
material adverse effect on the Company's financial position or results of
operations. Further, the Company is subject to various legal proceedings and
claims, which arise in the normal course of business. In the opinion of
management, the amount of ultimate liability with respect to these actions will
not have a material adverse effect on the financial position or results of
operations of the Company.
COMMITMENTS. In conducting its operations, the Company routinely enters
into long-term commodity purchase and sale commitments, as well as agreements
that commit future cash flow to the lease or acquisition of assets used in its
businesses. These commitments are typically associated with capital projects,
reservation charges associated with firm transmission, transportation and
storage capacity, lease agreements for ship charters and other distribution
assets and leases for office space, equipment and other similar items. The
following describes the more significant commitments outstanding at December 31,
1998.
F-21
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A subsidiary of the Company has entered into binding agreements committing
the Company to expend approximately $14 million for the acquisition of
combustion turbine generators and related equipment. This equipment will be used
in the construction of electricity generating capacity in selected sites
throughout the U.S. A significant portion of the current commitment relates to
agreements that include cancellation provisions providing for termination at
Dynegy's option during the construction phase in exchange for variable penalty
payments.
In 1997, Dynegy received cash from a gas purchaser as an advance payment
for future natural gas deliveries over a ten-year period ("Advance Agreement").
As a condition of the Advance Agreement, Dynegy entered into a natural gas swap
with a third party under which Dynegy became a fixed-price payor on identical
volumes to those to be delivered under the Advance Agreement at prices based on
then current market rates. The cash payment was classified as an advance on the
balance sheet and is ratably reduced as gas is delivered to the purchaser under
the terms of the Advance Agreement. In addition, the purchaser pays a monthly
fee to Dynegy associated with delivered volumes. The Advance Agreement contains
certain non-performance penalties that impact both parties and as a condition
precedent, Dynegy purchased a surety bond in support of its obligations under
the Advance Agreement.
For a two-year period beginning January 1, 1998, the Company contracted for
1.3 billion cubic feet per day of firm transportation capacity to California on
the El Paso Natural Gas pipeline system. Pursuant to this arrangement, Dynegy is
obligated to pay a minimum of $38 million of reservation charges during 1999.
A wholly owned subsidiary of the Company leases certain power generating
assets under agreements that are classified as operating leases. These
agreements have aggregate future minimum lease payments of approximately $432
million at December 31, 1998.
Minimum commitments in connection with office space, equipment, reservation
charges under purchase and firm transportation contracts, power generating and
other leased assets were: 1999 - $134.4 million; 2000 - $232.6 million; 2001 -
$239.0 million; 2002 - $29.0 million; and 2003 and beyond - $99.6 million.
Rental payments made under the terms of these arrangements totaled - $126.1
million in 1998, $85.2 million in 1997 and $45.2 million in 1996.
NOTE 10 -- CAPITAL STOCK
The Company has authorized capital stock consisting of 450,000,000 shares,
of which 50,000,000 shares, par value $0.01 per share, are designated preferred
stock and 400,000,000 shares, par value $0.01 per share, are designated common
stock.
PREFERRED STOCK. The Company's preferred stock may be issued from time to
time in one or more series, the shares of each series to have such designations
and powers, preferences, rights, qualifications, limitations and restrictions
thereof as described in the Company's Certificate of Incorporation. In order to
provide for issuance of preferred shares pursuant to the terms of the Chevron
Combination, 8,000,000 shares of preferred stock were designated during 1996 as
Dynegy Series A Participating Preferred Stock ("Series A Preferred"), of which
7,815,363 shares were issued effective September 1, 1996.
Except as provided by law, the holders of the Series A Preferred have no
voting rights and such shares are not redeemable. At the holders option, each
share of the Series A Preferred may be converted, subject to certain adjustments
and certain defined conditions precedent, into one share of Dynegy common stock.
Such shares have certain preferences, as defined, in the event of liquidation or
dissolution of Dynegy over all stock having a junior ranking. Subject to
certain anti-dilutive adjustments, as defined, the holders of the Series A
Preferred are entitled to receive dividends or distributions equal per share in
amount and kind to any dividend or distribution payable on shares of the
Company's common stock, when and as the same are declared by the Company's Board
of Directors out of funds legally available therefor and paid to the holders of
the Company's common stock. Beginning in the third quarter of 1996, the Company
paid quarterly cash dividends on the Series A Preferred of $0.0125 per share, or
$0.05 per share on an annual basis.
F-22
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMON STOCK. At December 31, 1998, there were 153,298,220 shares of
common stock issued. Dynegy pays quarterly cash dividends on common stock of
$0.0125 per share, or $0.05 per share on an annual basis.
In May 1997, the Board of Directors approved a stock repurchase program
that allows the Company to repurchase, from time to time, up to 1.6 million
shares of common stock in open market transactions. The timing and number of
shares ultimately repurchased will depend upon market conditions and
consideration of alternative investments. Pursuant to this program, the Company
has acquired 1,200,700 shares at a total cost of $17.4 million, or $14.50 per
share on a weighted average cost basis, through December 31, 1998.
STOCK WARRANTS. At December 31, 1998, the Company had warrants outstanding
that entitle the holder thereof to purchase an aggregate 6,228 shares of common
stock at an exercise price of $8.13 per share. The warrants expire in October
2003.
STOCK OPTIONS. Each option granted is valued at an option price, which
ranges from $2.03 per share to the fair market value per share at date of grant.
The difference between the option price and the fair market value, if any, of
each option on the date of grant is recorded as compensation expense over a
vesting period. Options granted at prices below fair market do not become
exercisable until the fifth anniversary date of the grant, at which time they
become fully exercisable. Options granted at market value vest and become
exercisable ratably over a three-year period. The average exercise price of
vested options at December 31, 1998 was $2.69. Compensation expense related to
options granted totaled $4.7 million, $4.0 million and $2.8 million for the
years ended December 31, 1998, 1997 and 1996, respectively.
At December 31, 1998, employee stock options aggregating 4.4 million shares
were exercisable at prices ranging from $2.03 to $21.63 per share. Employee
stock option grants made from 1994 to 1998 will become exercisable during 1999
and 2000, respectively, resulting in the potential exercise of approximately 9.6
million options during that two-year period, at exercise prices ranging from
$2.03 to $21.63. Other options currently granted under the Company's option
plans will fully vest periodically and become exercisable through the year 2003
at prices ranging from $2.03 to $21.63. Grants made under the Company's option
plans may be canceled under certain circumstances as provided in the plans.
While the Company cannot predict the timing or the number of shares which may be
issued upon the exercise of option grants by individual employees, the Company
is pursuing a variety of alternatives to help assure an orderly distribution of
shares which may become available to the market. Stock option transactions for
1998, 1997 and 1996 were (shares in thousands):
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------------
1998 1997 1996
-------------------------- -------------------------- --------------------------
SHARES OPTION PRICE SHARES OPTION PRICE SHARES OPTION PRICE
------- ------------- ------- ------------- ------- -------------
Outstanding at beginning of period 14,015 $2.03 - 21.63 13,920 $2.03 - 18.75 12,615 $ 2.03 - 9.38
Granted 7,319 2.03 - 17.50 2,284 2.03 - 21.63 1,842 2.03 - 18.75
Exercised (995) 2.03 - 9.38 (1,469) 2.03 - 9.38 (737) 2.03 - 9.38
Canceled or expired (1,568) 2.03 - 19.00 (629) 2.03 - 18.75 (313) 2.03 - 9.38
Other, contingent share issuance (92) 2.03 - 5.66 (91) 2.03 - 5.66 513 2.03 - 8.13
------- ------------- ------- ------------- ------- -------------
Outstanding at end of period 18,679 $2.03 - 21.63 14,015 $2.03 - 21.63 13,920 $2.03 - 18.75
======= ============= ======= ============= ======= =============
Exercisable at end of period 4,394 $2.03 - 21.63 2,861 $2.03 - 18.75 469 $2.03 - 9.38
======= ============= ======= ============= ======= =============
Weighted average fair value of
Options granted during the period
At market $ 5.77 $ 11.14 $ 15.30
============= ============= =============
Weighted average fair value of
Options granted during the period
At below market $ 7.35 $ 14.63 $ 21.38
============= ============= =============
F-23
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model, with the following weighted-
average assumptions used for grants in 1998, 1997 and 1996: dividends per year
of $0.05 per annum for all years; expected volatility of 40.1 percent, 42.0
percent and 43.3 percent, respectively; risk-free interest rate of 6.28 percent,
6.28 percent and 5.9 percent, respectively; and an expected life of 10 years for
all periods. The Company accounts for its stock option plan in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees". Had compensation cost been determined consistent with SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), the Company's net
income (loss) and per share amounts would have approximated the following pro
forma amounts for the years ended December 31, 1998, 1997 and 1996,
respectively.
Years Ended December 31,
----------------------------------------------------------------------------------------
1998 1997 1996
------------------------- --------------------------- --------------------------
Diluted Loss Diluted
Net Income EPS Net Loss Per Share Net Income EPS
------------ --------- ---------- ----------- ------------ ----------
($ in thousands, except per share data)
Pro forma amounts $104,578 $0.63 $(108,007) $(0.72) $107,580 $0.79
======== ===== ========= ====== ======== =====
As allowed by the transitional disclosure requirements of SFAS No. 123, the
preceding pro forma net income and pro forma EPS amounts do not include the
impact, if any, of applying the accounting methodology of SFAS No. 123 to
options granted prior to January 1, 1995. As a result, the compensation cost
included in the pro forma net income amounts for each of the three years in the
period ended December 31, 1998, may not be indicative of amounts to be expected
in future periods.
NOTE 11 -- BUSINESS COMBINATIONS AND SIGNIFICANT RESTRUCTURINGS
THE DESTEC ACQUISITION. On June 27, 1997, Dynegy acquired Destec Energy,
Inc. ("Destec"), an independent power producer, for $1.26 billion, or $21.65 per
share of Destec common stock. Dynegy financed the transaction through cash on
hand and advances on its credit facilities provided by its existing commercial
banks. Concurrent with this acquisition, Dynegy sold Destec's international
facilities and operations to The AES Corporation ("AES") for $439 million. Also
during 1997, the Company sold certain non-strategic assets acquired in the
purchase for aggregate proceeds of $296 million. Proceeds from the AES and non-
strategic asset sales were used to retire indebtedness.
The Destec acquisition was accounted for under the purchase method of
accounting. Accordingly, the purchase price of approximately $718 million,
inclusive of transaction costs and net of cash acquired, was allocated to the
Destec assets acquired and liabilities assumed based on their estimated fair
values as of June 30, 1997, the effective date of the acquisition for accounting
purposes. The results of operations of the acquired Destec assets are
consolidated with Dynegy's existing operations beginning July 1, 1997. The
following table reflects certain unaudited pro forma information for the periods
presented as if the Destec acquisition had occurred on January 1, 1996 (in
thousands, except per share data):
Years Ended December 31,
-----------------------------
1997 1996
------------ -----------
Pro forma revenues $ 13,498,207 $ 7,529,928
Pro forma net income (loss) (101,175) 125,962
Pro forma earnings (loss) per share (0.67) 0.93
RESTRUCTURING OF NOVAGAS CLEARINGHOUSE, LTD. In June 1997, the Company and
NOVA Corporation ("NOVA") completed the restructuring of the companies' Canadian
natural gas operations formerly executed through Novagas Clearinghouse, Ltd.,
Novagas Clearinghouse Limited Partnership and Novagas Clearinghouse Pipelines
Limited Partnership (collectively "NCL"), a joint venture between Dynegy and
NOVA. Pursuant to the agreements, Dynegy Canada Inc. ("DCI"), a wholly owned
indirect subsidiary of Dynegy, acquired NCL's natural gas marketing
F-24
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
business, excluding the natural gas aggregation business of Pan-Alberta Gas Ltd.
("Pan-Alberta"), from NCL and sold its aggregate 49.9 percent interest in NCL to
NOVA Gas International ("NGI"), a subsidiary of NOVA. NOVA assumed full
ownership of NCL's gathering and processing business and the operations of Pan-
Alberta. The restructuring included amendments to or termination of various
agreements between NCL, Dynegy, NOVA and certain affiliates of both Dynegy and
NOVA. Dynegy realized a pretax gain on the sale of its interest in NCL of $7.8
million, which is classified as other income in the accompanying consolidated
statements of operations for the year ended December 31, 1997. The acquisition
by Dynegy of NCL's marketing business was accounted for under the purchase
method of accounting. Accordingly, the purchase price of $4.0 million, inclusive
of transaction costs, was allocated to the assets acquired and liabilities
assumed based on their estimated fair values as of April 1, 1997, the effective
date of the acquisition for accounting purposes.
RESTRUCTURING OF ACCORD ENERGY LIMITED ("ACCORD"). In early 1997, British
Gas completed a restructuring whereby Centrica plc ("Centrica") was demerged
from British Gas and British Gas was renamed BG plc ("BG"). Centrica became the
Company's joint venture partner in Accord. BG holds the approximate 26 percent
stake in Dynegy's common stock formerly held by British Gas. On May 2, 1997,
Centrica and the Company completed a restructuring of Accord by converting
certain common stock interests in Accord to participating preferred stock
interests as of an effective date of January 1, 1997. Centrica and the Company
own 75 percent and 25 percent, respectively, of the outstanding participating
preferred stock shares of Accord. The participating preferred stock has (a) the
right to receive cumulative dividends on a priority basis to other corporate
distributions by Accord, and (b) limited voting rights. In addition, Centrica
has an option to purchase the Company's participating preferred stock interest
at any time after July 1, 2000, at a formula based price, as defined in the
agreement. As part of the reorganization, Centrica will operate Accord while
Dynegy obtained the right to market natural gas, gas liquids and crude oil in
the United Kingdom, which occurs through its wholly owned subsidiary Dynegy UK
Limited ("Dynegy UK"). In addition, as part of the restructuring, Dynegy UK
acquired Accord's existing crude oil marketing business effective July 1, 1997.
No gain or loss was recognized as a result of this restructuring and Dynegy's
investment in Accord continues to be accounted for under the equity method.
THE CHEVRON COMBINATION. On August 31, 1996, Dynegy completed a strategic
combination (the "Chevron Combination") with Chevron U.S.A. Inc. and certain
Chevron affiliates ("Chevron") pursuant to which Chevron contributed
substantially all of its midstream assets (the "Contribution"), including
substantially all of the assets comprising Warren Petroleum Company and
Chevron's Natural Gas Business Unit and an undivided interest in those assets
that constitute the West Texas LPG Pipeline, into Midstream Combination Corp.
("Midstream"), a Delaware corporation formed for purposes of the transaction.
Dynegy was merged with and into Midstream immediately following the Contribution
and Midstream was renamed Dynegy Corporation. In exchange for the Contribution,
Chevron received approximately 38.6 million shares of Dynegy common stock and
approximately 7.8 million shares of Dynegy Series A Participating Preferred
Stock and Dynegy assumed approximately $283 million of indebtedness. Immediately
following closing of the Chevron Combination, Dynegy paid approximately $128
million to Chevron and funded such payment under its Credit Agreement. The
Chevron Combination was accounted for as an acquisition of assets under the
purchase method of accounting. The purchase price of approximately $740 million,
inclusive of assumed indebtedness and transaction costs, was allocated to the
assets acquired and liabilities assumed based on their estimated fair values as
of an effective date of September 1, 1996.
Note 12 -- IMPAIRMENT, ABANDONMENT AND OTHER CHARGES
During the fourth quarter of 1997, the Company recognized a $275 million
charge principally related to impairment of certain long-lived assets,
abandonment of certain operating assets and reserves for obsolescence,
contingencies and other obligations. The charge primarily resulted from the
completion of a plan of restructuring of the Company's natural gas liquids and
crude oil businesses, which includes rationalization and consolidation of assets
acquired in both the Trident and Chevron Combinations, and the pursuit of a
joint venture partner in order to achieve critical mass in its crude oil
marketing business. In addition, a company-wide reorganization of reporting
responsibilities and improvements in business processes and computer information
systems resulted in the identification during the fourth quarter of 1997 of
other obsolete assets and a reduction of employees involved in non-strategic
operations.
F-25
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The charge, which was substantially non-cash in nature, consisted of the
following (in thousands):
Abandonment of long-lived operating assets $ 154,984
Impairment of operating assets and intangibles 79,550
Inventory obsolescence reserve and write-off 10,340
Write-off of other obsolete assets 12,011
Contingency and other obligation reserves 16,750
Severance charge 1,365
---------
$ 275,000
=========
The fair values of the assets impaired and abandoned were determined using
a discounted cash flow methodology. During 1998, Management substantially
completed its plan of rationalization, reorganization and abandonment of assets
anticipated at the end of 1997. In addition, pursuant to the execution of the
restructuring plan, a charge of $9.6 million related to severance charges was
recognized in the first quarter of 1998. The severance charge was related to the
termination of approximately 200 corporate and field employees. The charge
recognized in the first quarter of 1998 approximated the actual severance
expenditures.
Also during the fourth quarter of 1997, the Company changed its method for
accounting for certain business process re-engineering and information
technology transformation costs pursuant to a consensus reached in November 1997
by the EITF. The EITF concluded that all re-engineering costs, including those
incurred in connection with a software installation, should be expensed as
incurred. The Company had previously capitalized certain re-engineering costs
and was amortizing such costs over the estimated useful lives of the projects.
The cumulative effect of this change in accounting of $14.8 million represented
the one-time charge for the aggregate unamortized re-engineering costs
previously capitalized.
NOTE 13 -- EMPLOYEE COMPENSATION, SAVINGS AND PENSION PLANS
CORPORATE INCENTIVE PLAN. Dynegy maintains a discretionary incentive plan
to provide employees competitive and meaningful rewards for reaching corporate
and individual objectives. Specific rewards are at the discretion of the
Compensation Committee of the Board of Directors ("Compensation Committee").
PROFIT SHARING/SAVINGS PLAN. The Company established the Dynegy Profit
Sharing/401(k) Savings Plan ("Plan"), which meets the requirements of Section
401(k) of the Internal Revenue Code, and is a defined contribution plan subject
to the provisions of the Employee Retirement Income Security Act of 1974. The
Plan and related trust fund are established and maintained for the exclusive
benefit of participating employees in the United States and certain expatriates.
Similar plans are available to other employees resident in foreign countries
subject to the laws of each country. All eligible employees may participate in
the plans and employee contributions are generally matched dollar-for-dollar for
the first 5 percent of compensation, subject to Company performance. Employees
vest in the Company's contributions over various periods. The Company also makes
profit sharing contributions to employees' accounts regardless of their
individual participation in the Profit Sharing/Savings Plans.
Matching contributions to the Plan and certain discretionary profit sharing
contributions are made in Company common stock, other contributions are made in
cash. During the years ended December 31, 1998, 1997 and 1996, Dynegy recognized
aggregate costs related to these employee compensation plans of $12.9 million,
$9.7 million and $5.3 million, respectively.
PENSION PLAN. Through a business acquisition, the Company acquired a
noncontributory defined benefit pension plan and such plan remains in existence
at December 31, 1998. The Trident NGL, Inc. Retirement Plan ("Retirement Plan")
is a qualified plan under the Internal Revenue Service regulations. The
Retirement Plan is closed
F-26
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
to new participants. Benefits are based on years of service and final average
pay, as defined in the Retirement Plan document. Contributions to the Retirement
Plan in 1998 and 1997 represent the minimum amount required by federal law and
regulation. The Retirement Plan's funded status and amount recognized in
Dynegy's balance sheet at December 31, 1998 and 1997, were:
DECEMBER 31,
-----------------------
1998 1997
------- ------
($ IN THOUSANDS)
Projected benefit obligation, beginning of the year $ 9,378 $8,909
Service cost 665 711
Interest cost 722 686
Actuarial (gain) loss 1,137 (807)
Benefits paid (147) (121)
------- ------
Projected benefit obligation, end of the year $11,755 $9,378
======= ======
Fair value of plan assets, beginning of the year $ 8,480 $5,798
Actual return on plan assets 615 1,746
Employer contributions 397 1,057
Benefits paid (147) (121)
------- ------
Fair value of plan assets, end of the year $ 9,345 $8,480
======= ======
Funded status $ 2,410 $ 898
Unrecognized net gain from past experience different from that assumed 3,668 5,025
------- ------
Pension liability $ 6,078 $5,923
======= ======
Current year pension expense is based on measurements of the projected benefit
obligation and the market related value of the Retirement Plan assets as of the
end of the year. The projected benefit obligation at December 31, 1998, was
based on a discount rate of 7.00 percent and an average long-term rate of
compensation growth of 3.5 percent. The expected long-term rate of return on the
Retirement Plan assets was estimated at 8.0 percent.
The components of net pension expense for the Retirement Plan were:
YEARS ENDED DECEMBER 31,
-----------------------
1998 1997
------- ------
($ IN THOUSANDS)
Service cost benefits earned during period $ 665 $ 712
Interest cost on projected benefit obligation 722 686
Expected return on plan assets (618) (502)
Amortization of unrecognized gain (218) (115)
----- -----
Net periodic pension cost $ 551 $ 781
===== =====
Note 14 -- RELATED PARTY TRANSACTIONS
The Company is a leading North American marketer of natural gas, electricity,
coal, natural gas liquids, crude oil, liquid petroleum gas and related services.
Dynegy is also engaged in natural gas gathering, processing, fractionation and
transportation and electric power generating activities. The Company has
operations in Canada and the United Kingdom and transports liquid petroleum gas
through its international deepwater LPG business. The Company routinely
transacts business directly or indirectly with three of its significant
shareholders, Chevron, NOVA and BG, each of which owns approximately 26 percent
of the outstanding shares of the Company's common stock. Chevron holds all of
the outstanding shares of the Series A Preferred.
Transactions between the Company and Chevron result principally from the
ancillary agreements entered into as part of the Chevron Combination.
Transactions between Dynegy, NOVA and BG result from purchases and sales of
natural gas, natural gas liquids and crude oil between subsidiaries of Dynegy
and these companies. It is management's opinion that these transactions are
executed at prevailing market rates. During the years ended
F-27
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996, the Company recognized in its statement of
operations aggregate sales to, and aggregate costs from, these significant
shareholders of $888 million and $1.7 billion, $788.9 million and $2.4 billion;
and $286.7 million and $1.1 billion, respectively.
Note 15 -- SEGMENT INFORMATION
The Company has adopted Financial Accounting Standard No. 131, "Disclosures
about Segments of an Enterprise and Related Information" and has restated its
segment disclosures for all reporting periods. Dynegy's operations are divided
into two reportable segments: Wholesale Gas and Power and Liquids. The Wholesale
Gas and Power segment is actively engaged in value creation through marketing
and trading of natural gas, power and coal and the generation of electricity
principally under the name Dynegy Marketing and Trade. The Liquids segment
consists of the North American mid-stream liquids operations, as well as the
international liquefied petroleum gas transportation and natural gas liquids
marketing operations located in Houston and London, and certain other
businesses. The North American mid-stream liquids operations are actively
engaged in the gathering and processing of natural gas and the transportation,
fractionation and storage of NGLs. This segment operates principally under the
name Dynegy Mid-Stream Services. Generally, Dynegy accounts for intercompany
transactions at prevailing market rates. Operating segment information for 1998,
1997 and 1996 is presented below.
DYNEGY'S SEGMENT DATA FOR THE YEAR ENDED DECEMBER 31, 1998
WHOLESALE GAS
AND POWER LIQUIDS ELIMINATION TOTAL
----------- ---------- --------- -----------
($ IN THOUSANDS)
Unaffiliated revenues:
Domestic $ 9,149,299 $3,307,320 $ --- $12,456,619
Canadian 969,853 209,830 --- 1,179,683
United Kingdom 621,695 --- --- 621,695
----------- ---------- --------- -----------
10,740,847 3,517,150 --- 14,257,997
----------- ---------- --------- -----------
Intersegment revenues
Domestic 157,492 250,280 (407,772) ---
Canadian 61,223 --- (61,223) ---
United Kingdom --- --- --- ---
----------- ---------- --------- -----------
218,715 250,280 (468,995) ---
----------- ---------- --------- -----------
Total revenues 10,959,562 3,767,430 (468,995) 14,257,997
----------- ---------- --------- -----------
Operating margin 236,238 192,449 --- 428,687
Depreciation and amortization (29,026) (84,176) --- (113,202)
Interest expense (24,944) (50,048) --- (74,992)
Interest and other income 6,763 40,058 --- 46,821
Equity earnings of unconsolidated affiliates 75,242 15,796 --- 91,038
Income tax (provision) benefit (52,262) 1,924 --- (50,338)
Net income from operations 90,750 17,603 --- 108,353
Cumulative effect of change in accounting principle --- --- --- ---
Net income 90,750 17,603 --- 108,353
Identifiable assets:
Domestic $ 2,838,367 $2,036,795 $ --- $ 4,875,162
Canadian 257,070 6,947 --- 264,017
United Kingdom 125,058 --- --- 125,058
Investment in unconsolidated affiliates 343,819 175,863 --- 519,682
Capital expenditures 359,516 118,948 --- 478,464
F-28
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DYNEGY'S SEGMENT DATA FOR THE YEAR ENDED DECEMBER 31, 1997
WHOLESALE GAS
AND POWER LIQUIDS ELIMINATION TOTAL
----------- ---------- --------- -----------
($ IN THOUSANDS)
Unaffiliated revenues:
Domestic $ 8,070,692 $ 4,205,759 $ --- $12,276,451
Canadian 632,411 264,028 --- 896,439
United Kingdom 205,490 --- --- 205,490
----------- ----------- --------- -----------
8,908,593 4,469,787 --- 13,378,380
----------- ----------- --------- -----------
Intersegment revenues
Domestic 83,944 437,567 (521,511) ---
Canadian 30,580 --- (30,580) ---
United Kingdom 1,314 --- (1,314) ---
----------- ----------- --------- -----------
115,838 437,567 (553,405) ---
----------- ----------- --------- -----------
Total revenues 9,024,431 4,907,354 (553,405) 13,378,380
----------- ----------- --------- -----------
Operating margin 126,805 258,489 --- 385,294
Impairment, abandonment and other charges --- 275,000 --- 275,000
Depreciation and amortization (16,425) (87,966) --- (104,391)
Interest expense (12,214) (51,241) --- (63,455)
Interest and other income 13,209 14,904 --- 28,113
Equity earnings of unconsolidated affiliates 36,241 22,718 --- 58,959
Income tax (provision) benefit (8,710) 70,920 --- 62,210
Net income (loss) from operations 24,321 (112,006) --- (87,685)
Cumulative effect of change in accounting principle (7,289) (7,511) --- (14,800)
Net income (loss) 17,033 (119,518) --- (102,485)
Identifiable assets:
Domestic $ 1,882,965 $ 2,299,312 $ --- $ 4,182,277
Canadian 239,090 40,900 --- 279,990
United Kingdom 54,635 --- --- 54,635
Investment in unconsolidated affiliates 310,445 160,032 --- 470,477
Capital expenditures 815,271 189,388 --- 1,004,659
F-29
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DYNEGY'S SEGMENT DATA FOR THE YEAR ENDED DECEMBER 31, 1996
WHOLESALE GAS
AND POWER LIQUIDS ELIMINATION TOTAL
----------- ---------- --------- -----------
($ IN THOUSANDS)
Unaffiliated revenues:
Domestic $ 4,422,849 $ 2,800,813 $ --- $ 7,223,662
Canadian --- 36,540 --- 36,540
United Kingdom --- --- --- ---
----------- ----------- --------- -----------
4,422,849 2,837,353 --- 7,260,202
----------- ----------- --------- -----------
Intersegment revenues
Domestic 80,943 242,297 (323,240) ---
Canadian --- --- --- ---
United Kingdom --- --- --- ---
----------- ----------- --------- -----------
80,943 242,297 (323,240) ---
----------- ----------- --------- -----------
Total revenues 4,503,792 3,079,650 (323,240) 7,260,202
----------- ----------- --------- -----------
Operating margin 103,624 265,876 --- 369,500
Depreciation and amortization (3,897) (67,779) --- (71,676)
Interest expense (2,179) (44,023) --- (46,202)
Interest and other income 4,825 660 --- 5,485
Equity earnings of unconsolidated affiliates 20,696 7,379 --- 28,075
Income tax provision (19,792) (36,531) --- (56,323)
Net income from operations 50,907 62,416 --- 113,323
Cumulative effect of change in accounting principle --- --- --- ---
Net income 50,907 62,416 --- 113,323
Identifiable assets:
Domestic $ 1,467,990 $ 2,635,318 $ --- $ 4,103,308
Canadian 34,917 30,507 --- 65,424
United Kingdom 18,079 --- --- 18,079
Investment in unconsolidated affiliates 52,500 129,188 --- 181,688
Capital expenditures 6,324 821,848 --- 828,172
F-30
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 -- QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of the Company's unaudited quarterly financial
information for the years ended December 31, 1998 and 1997.
Quarter Ended
----------------------------------------------
March June September December
1998 1998 1998 1998
----------------------------------------------
($ in thousands, except per share data)
Revenues $3,315,569 $3,278,214 $4,586,515 $3,077,699
Operating margin 96,989 107,915 105,985 117,798
Income before income taxes 16,411 35,043 63,739 43,498
Net income 12,339 23,441 43,645 28,928
Net income per share (2) 0.07 0.14 0.27 0.18
Quarter Ended
----------------------------------------------
March June September December
1998 1998 1998 1998
----------------------------------------------
($ in thousands, except per share data)
Revenues $3,272,080 $2,684,339 $3,657,456 $3,764,505
Operating margin 67,347 97,767 110,848 109,332
Income (loss) before
income taxes 4,429 43,575 37,326 (235,225)
Net income (loss) (1) 4,614 32,128 25,028 (164,255)
Net income (loss)
per share (2) 0.03 0.19 0.15 (1.09)
1. Fourth quarter results include the impairment, abandonment and other charges
of $275 million, on a pre-tax basis, and the $14.8 million effect of the
change in accounting principle.
2. Net income (loss) per share amounts have been restated to conform to the
provisions of Statement of Financial Accounting Standards No. 128, "Earnings
Per Share."
F-31
SCHEDULE I
DYNEGY INC.
CONDENSED BALANCE SHEETS OF REGISTRANT
(IN THOUSANDS, EXCEPT SHARE DATA)
December 31, December 31,
1998 1997
---------- ----------
ASSETS
CURRENT ASSETS
Cash $ 209,439 $ 375
Accounts receivable 500 32
Intercompany accounts receivable 446,959 177,479
Prepayments and other assets 6,773 4,992
---------- ----------
663,671 182,878
---------- ----------
PROPERTY, PLANT AND EQUIPMENT 3,297 9,590
Less: accumulated depreciation (2,587) (3,755)
---------- ----------
710 5,835
---------- ----------
OTHER ASSETS
Investments in affiliates 1,514,635 1,483,092
Intercompany note receivable 160,000 160,000
Deferred taxes and other assets 205,536 77,366
---------- ----------
$2,544,552 $1,909,171
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Intercompany accounts payable $ 155,131 $ 8,289
Accrued liabilities 146,100 16,764
---------- ----------
301,231 25,053
LONG-TERM DEBT 913,000 664,500
COMPANY OBLIGATED PREFERRED SECURITIES OF SUBSIDIARY TRUST 200,000 200,000
OTHER LIABILITIES 2,258 493
---------- ----------
1,416,489 890,046
---------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value, 50,000,000 shares
authorized: 8,000,000 shares designated as Series A
Participating Preferred Stock, 7,815,363 shares issued and
outstanding at December 31, 1998 and 1997 75,418 75,418
Common stock, $0.01 par value, 400,000,000 shares
authorized: 153,298,220 shares issued at December 31, 1998,
and 151,796,622 shares issued at December 31, 1997 1,533 1,518
Additional paid-in capital 935,183 919,720
Retained earnings 133,340 32,975
Less: treasury stock, at cost: 1,200,700 shares at December 31, 1998
654,900 shares at December 31, 1997 (17,411) (10,506)
---------- ----------
1,128,063 1,019,125
---------- ----------
$2,544,552 $1,909,171
========== ==========
See Note to Registrant's Financial Statements.
F-32
SCHEDULE I
DYNEGY INC.
STATEMENTS OF OPERATIONS OF THE REGISTRANT
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
(IN THOUSANDS)
1998 1997 1996
-------- --------- --------
Depreciation and amortization $ (241) $ (1,292) $ (496)
Impairment, abandonment and other charges (959) (3,886) ---
General and administrative expenses --- --- ---
-------- --------- --------
Operating loss (1,200) (5,178) (496)
Equity in earnings of affiliates 215,928 (115,108) 182,159
Intercompany interest and other income 13,667 16,928 17,968
Interest expense (68,403) (45,790) (28,071)
Other expenses (1,301) (747) (1,915)
-------- --------- --------
Income (loss) before income taxes 158,691 (149,895) 169,645
Income tax provision (benefit) 50,338 (62,210) 56,323
-------- --------- --------
Net income (loss) from continuing operations before
cumulative effect of change in accounting 108,353 (87,685) 113,322
Cumulative effect of change in accounting principle
(net of income tax benefit of $7,913) --- (14,800) ---
-------- --------- --------
NET INCOME (LOSS) $108,353 $(102,485) $113,322
======== ========= ========
See Note to Registrant's Financial Statements.
F-33
SCHEDULE I
DYNEGY INC.
STATEMENTS OF CASH FLOWS OF THE REGISTRANT
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998
(IN THOUSANDS)
1998 1997 1996
--------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 108,353 $ (102,485) $ 113,322
Items not affecting cash flows from operating activities:
Depreciation and amortization 1,864 9,631 1,996
Equity in earnings of affiliates, net of cash distributions 215,928 115,108 (182,159)
Deferred taxes 50,338 (86,424) 45,896
Other --- 12,344 7,466
Change in assets and liabilities resulting from operating activities:
Accounts receivable (468) 76 (108)
Intercompany transactions (192,270) 636,063 (298,592)
Prepayments and other assets (2,212) (2,749) 2,260
Accrued liabilities 3,693 1,529 8,487
Other, net (29,778) 2,493 (1,193)
--------- ----------- -----------
Net cash used in operating activities 155,448 585,586 (302,625)
--------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures --- (5,121) (2,055)
Acquisitions (2,644) (785,349) ---
Other --- --- ---
--------- ----------- -----------
Net cash used in investing activities (2,644) (790,470) (2,055)
--------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term borrowings 212,259 2,218,500 1,542,000
Repayments of long-term borrowings (493,277) (2,198,000) (1,231,000)
Net proceeds from commercial paper and money market lines of credit 350,758 --- ---
Intercompany advances --- --- ---
Proceeds from sale of capital stock, options and warrants 3,863 203,190 858
Treasury stock acquisitions (6,905) (10,506) ---
Capital contributions --- --- ---
Dividends and other distributions (7,988) (7,925) (7,184)
Other financing (2,450) --- ---
--------- ----------- -----------
Net cash provided by financing activities 56,260 205,259 304,674
--------- ----------- -----------
Net (decrease) increase in cash and cash equivalents 209,064 375 (6)
Cash and cash equivalents, beginning of period 375 --- 6
--------- ----------- -----------
Cash and cash equivalents, end of period $ 209,439 $ 375 $ ---
========= =========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid (net of amount capitalized) $ 100,589 $ 60,323 $ 22,341
========= =========== ===========
Taxes paid (net of refunds) $ (8,000) $ 8,043 $ 1,444
========= =========== ===========
Cash dividends paid to parent by consolidated or
unconsolidated subsidiaries $ --- $ --- $ ---
========= =========== ===========
See Note to Registrant's Financial Statements.
F-34
SCHEDULE I
DYNEGY INC.
NOTE TO REGISTRANT'S FINANCIAL STATEMENTS
NOTE 1 -- BASIS OF PRESENTATION
Dynegy Inc. ("Dynegy" or the "Company") is a holding company that
principally conducts all of its business through its subsidiaries. The Company
is the result of a strategic business combination ("Trident Combination")
between Natural Gas Clearinghouse and Trident NGL Holding, Inc. ("Holding"),
under which Holding was renamed NGC Corporation. Pursuant to the terms of the
Trident Combination, Holding was the legally surviving corporation and
Clearinghouse was considered the acquiring company for accounting purposes
resulting in a new historical cost basis for Holding beginning March 1, 1995,
the effective date of the Trident Combination. During 1998, the Company changed
its name to Dynegy Inc. in order to reflect its evolution from a natural gas
marketing company to an energy services company capable of meeting the growing
demands and diverse challenges of the dynamic energy market of the 21st Century.
The accompanying condensed Registrant Financial Statements were prepared
pursuant to rules promulgated by the Securities and Exchange Commission. In
accordance with these rules, the accompanying statements reflect the financial
position, results of operations and cash flows of Dynegy, the holding company of
Dynegy Inc., at December 31, 1998 and 1997, and for the years then ended through
December 31, 1996, respectively. These statements should be read in conjunction
with the Consolidated Statements and notes thereto of Dynegy Inc.
F-35