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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K/A
AMENDMENT NO. 2
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 1-15659
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DYNEGY INC.
(Exact name of registrant as specified in its charter)
Illinois 74-2928353
(State or other (I.R.S. Employer
jurisdiction of Identification Number)
incorporation or
organization)
1000 Louisiana, Suite 5800
Houston, Texas 77002
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code: (713) 507-6400
Securities registered pursuant to Section 12(b) of
the Act:
Title of each class: Name of each exchange on
which registered:
Class A common stock, no
par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of
the Act:
Title of each class: Name of each exchange on
None which registered:
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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 [_]
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. [_]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 4, 2002, computed by reference to the closing sale price
of the registrant's common stock on the New York Stock Exchange on such date,
was $7,724,959,720, using the definition of beneficial ownership contained in
Rule 13d-3 under the Securities Exchange Act of 1934 and excluding shares held
by directors and executive officers.
Number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: Class A common stock, no par value
per share, 268,881,299 shares outstanding as of March 4, 2002; Class B common
stock, no par value per share, 96,891,014 shares outstanding as of March 4,
2002.
DOCUMENTS INCORPORATED BY REFERENCE. Part III (items 10, 11, 12 and 13)
incorporates portions of the Notice and Proxy Statement for the 2002 Annual
Meeting of Shareholders to be filed not later than 120 days after December 31,
2001.
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DYNEGY INC. FORM 10-K/A
INTRODUCTORY NOTE
Dynegy Inc. is filing this Amendment No. 2 on Form 10-K/A ("Amendment No.
2") to reflect the audited restatement of its 1999-2001 financial statements.
These financial statements were originally included in Dynegy's Annual Report
on Form 10-K for the fiscal year ended December 31, 2001, which was originally
filed on March 13, 2002 (the "Original Filing"), and were restated on an
unaudited basis in Dynegy's Amendment No. 1 to its Annual Report on Form
10-K/A, which was filed on February 14, 2003 ("Amendment No. 1"). This
Amendment No. 2 also includes certain other revisions to the Original Filing.
The financial information contained in the Original Filing has been revised to
reflect the restatement items described in the Explanatory Note to the
accompanying Consolidated Financial Statements. These restatement items include
adjustments previously announced by Dynegy in its Current Reports on Form 8-K
dated November 14, 2002 and January 31, 2003 and in Amendment No. 1, and
further adjustments as described in the Explanatory Note to the accompanying
Consolidated Financial Statements. Dynegy's periodic SEC reports, including
this Amendment No. 2, remain subject to an ongoing review by the SEC Division
of Corporation Finance.
The following Items of the Original Filing are amended by this Amendment No.
2:
Item 1. Business
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Unaffected items have not been repeated in this Amendment No. 2.
PLEASE NOTE THAT THE INFORMATION CONTAINED IN THIS FORM 10-K/A, INCLUDING
THE FINANCIAL STATEMENTS AND THE NOTES THERETO, DOES NOT REFLECT EVENTS
OCCURRING AFTER THE DATE OF THE ORIGINAL FILING. FOR A DESCRIPTION OF THESE
EVENTS, PLEASE READ THE COMPANY'S EXCHANGE ACT REPORTS FILED SINCE MARCH 13,
2002, INCLUDING ITS ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31,
2002. SEE NOTE 19--SUBSEQUENT EVENTS FOR FURTHER DISCUSSION.
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DYNEGY INC. FORM 10-K/A TABLE OF CONTENTS
Page
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PART I
Item 1. Business............................................................................. 2
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................ 18
Item 6. Selected Financial Data.............................................................. 21
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................... 60
Item 8. Financial Statements and Supplementary Data.......................................... 60
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................... 61
Signatures 67
Index to Consolidated Financial Statements...................................................... F-1
Explanatory Note--Restatements.................................................................. F-7
ii
DYNEGY INC.
PART I
PLEASE NOTE THAT THE INFORMATION CONTAINED IN THIS FORM 10-K/A, INCLUDING
THE FINANCIAL STATEMENTS AND THE NOTES THERETO, DOES NOT REFLECT EVENTS
OCCURRING AFTER MARCH 13, 2002 (THE DATE ON WHICH DYNEGY ORIGINALLY FILED ITS
2001 FORM 10-K) . FOR A DESCRIPTION OF THESE EVENTS, PLEASE READ THE COMPANY'S
EXCHANGE ACT REPORTS FILED SINCE MARCH 13, 2002, INCLUDING ITS ANNUAL REPORT ON
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2002. SEE NOTE 19--SUBSEQUENT EVENTS
FOR FURTHER DISCUSSION.
DEFINITIONS
As used in this Form 10-K/A, the abbreviations listed below are defined as
follows:
Accord............. Accord Energy Limited.
Bcf................ Billions of cubic feet.
Bcf/d.............. Billions of cubic feet per day.
BGSL............... BG Storage Limited.
Btu................ British thermal unit--a measure of the amount of
heat required to raise the temperature of one pound
of water one degree Fahrenheit.
Catlin............. Catlin Associates, L.L.C.
Chevron............ Chevron U.S.A. Inc., now a subsidiary of
ChevronTexaco.
ChevronTexaco...... ChevronTexaco Corporation
CERCLA or Superfund Comprehensive Environmental Response,
Compensation and Liability Act.
DEC................ Dynegy Europe Communications.
Destec............. Destec Energy, Inc.
DGC................ Dynegy Global Communications, one of our four
reportable business segments.
DMG................ Dynegy Midwest Generation, Inc.
DMS................ Dynegy Midstream Services, one of our four
reportable business segments.
DOT................ The U.S. Department of Transportation.
DWR................ The California Department of Water Resources.
Dynegy............. Dynegy Inc.
Enron.............. Enron Corp.
EWGs............... Exempt Wholesale Generators.
Extant............. Extant, Inc.
FASB............... Financial Accounting Standards Board.
FERC............... Federal Energy Regulatory Commission.
FPA................ The Federal Power Act.
HLPSA.............. The Hazardous Liquid Pipeline Safety Act.
Holdings........... Dynegy Holdings Inc., a wholly owned subsidiary of
Dynegy Inc.
iaxis.............. iaxis, Limited.
ICC................ Illinois Commerce Commission.
Illinova........... Illinova Corporation, a wholly owned subsidiary of
Dynegy Inc.
Investor........... Black Thunder Investors LLC.
IP................. Illinois Power Company, a wholly owned subsidiary
of Illinova.
ISO................ The California Independent System Operator.
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LNG............. Liquefied natural gas.
LPG............. Liquefied petroleum gas.
MBbls/d......... Thousands of barrels per day.
Mcf............. Thousands of cubic feet.
MMBtu........... Millions of Btu.
MMcf/d.......... Millions of cubic feet per day.
MGP............. Manufactured Gas Plant.
MW.............. Megawatts.
NGA............. The Natural Gas Act of 1938, as amended.
NGLs............ Natural gas liquids.
NGPA............ The Natural Gas Policy Act of 1978, as amended.
NGPSA........... Natural Gas Pipeline Safety Act.
Northern Natural Northern Natural Gas Company.
OSHA............ The Federal Occupational Safety and Health Act.
Project Alpha... A structured natural gas transaction entered into by
Dynegy in April 2001.
PURPA........... The Public Utilities Regulatory Policies Act of 1978.
PX.............. The California Power Exchange.
RCRA............ The Resource Conversation and Recovery Act.
QFs............. "Qualifying facilities" are power generation facilities
that typically sell power to a single purchaser and
are generally exempt from FERC ratemaking
regulation.
RTOs............ Regional transmission organizations established by
the FERC to control electric transmissions facilities
within a particular region.
T&D............. Transmission and Distribution, one of our four
reportable business segments.
VaR............. Value at Risk.
VLGC............ Very Large Gas Carriers.
WEN............. Wholesale Energy Network, one of our four
reportable business segments.
Item 1. BUSINESS
THE COMPANY
Dynegy Inc. (together with its subsidiaries, "Dynegy" or the "Company") is
one of the world's leading energy merchants. Through our global energy delivery
network and marketing, logistics and risk-management capabilities, we provide
innovative solutions to customers in North America, the United Kingdom and
Continental Europe. Our businesses include power generation and wholesale and
direct commercial and industrial marketing of power, natural gas, coal and
other similar products. We are also engaged in the transportation, gathering
and processing of natural gas and natural gas liquids and the transmission and
distribution of electricity and natural gas to retail consumers. Dynegy is also
engaged in the telecommunications business through its global long-haul fiber
optic and metropolitan network located in cities in the United States and
Europe.
Dynegy began operations in 1985 and became incorporated in the State of
Illinois in 1999 in connection with the acquisition of Illinova Corporation.
The Company's principal executive office 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 or regional offices in
Atlanta, Georgia; Aurora, Colorado; Boston, Massachusetts; Calgary, Canada;
Chicago, Illinois; Dallas, Texas; Decatur, Illinois; Elida, Ohio; Hong Kong,
China; Hyderabad, India; London, England; Lucerne, Switzerland; Manama,
Bahrain; Midland, Texas; Milan, Italy; Montreal, Canada; Oakville, Canada;
Oklahoma City, Oklahoma; Omaha, Nebraska; Paris, France; Pleasanton,
California; Richmond, England; Tampa, Florida; and Washington, D.C.
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SEGMENT DISCUSSION
[GRAPHIC DEPICTING SEGMENTS AND SUMMARY INFORMATION]
The Company is a holding company and has four reportable business segments:
Wholesale Energy Network ("WEN"), Dynegy Midstream Services ("DMS"),
Transmission and Distribution ("T&D") and Dynegy Global Communications ("DGC").
Financial information, including revenues from external customers by similar
products or services and by geographic area, net income (loss) and total assets
by geographic area are disclosed by segment as set forth in Note 17 to the
consolidated financial statements.
Wholesale Energy Network Segment
WEN is engaged in the physical generation of electricity, the aggregation of
natural gas supplies and the delivery of customer-focused products and
services, such as risk-management services, around wholesale natural gas,
power, coal and other similar products. This segment is focused on optimizing
the Company's and its customers' global portfolio of assets and capacity
contracts, as well as direct commercial and industrial sales and retail
marketing alliances. The Company provides customer and risk-management
activities to wholesale energy consumers in North America, the United Kingdom
and Continental Europe and continues to assess local, regional and national
markets, regulatory environments and other factors in order to support and
direct future investment.
WEN is focused on the "Energy Value Chain," which is predicated on the
notion that the economy consumes physical quantities of energy commodities,
such as natural gas, electricity and coal and other similar products, and that
consumers of energy expect reliability of supply as well as management of
price. The logistics needed to move energy commodities from points of
production to end-users requires substantial knowledge of energy infrastructure
and the ability to access and utilize this infrastructure. The management of
price risk requires knowledge of market factors impacting the economic
realities of supply and demand. Dynegy's strength is its ability to capitalize
on its extensive network of energy assets, contractual arrangements and market
knowledge to provide its customers with reliable sources of physical energy,
products and services. Dynegy combines physical delivery of energy through its
extensive logistics infrastructure with its price risk-management capabilities
and market expertise to provide our customers with customized products to meet
their services needs.
[GRAPHIC DEPICTING ENERGY VALUE CHAIN]
Dynegy views its gas and power marketing and power generation businesses as
an integrated unit. Control of merchant generation, 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 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, coal and fuel
oil) and outputs (power). Generation capacity, in turn, adds value to the
Company's wholesale marketing franchise by providing an outlet/market for gas
and coal supplies, a source of reliable power supply and an enhanced ability to
structure innovative new products and services for customers.
Natural Gas Purchases. As part of our wholesale energy business, Dynegy
purchases natural gas from a wide variety of suppliers. Dynegy also purchases
at various index prices and markets substantially all of the natural gas
produced or controlled by Chevron U.S.A. Inc. in the United States (except
Alaska). In addition, the Company and ChevronTexaco Corp., ("ChevronTexaco")
have agreed pursuant to a term sheet dated December 12, 2001 to expand this
commercial relationship to include the volumes historically produced by Texaco.
On March 1, 2002, a subsidiary of the Company began buying the historical
Texaco volumes on an interim basis and is in the late stages of negotiations
with ChevronTexaco to finalize a long term commercial agreement to cover
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these volumes. This relationship provides the Company with a significant,
stable supply of natural gas which, when combined with gas supplies available
from our network of other supply sources, allows us to effectively manage gas
supplies and reduces the risk of short-term supply shortages during periods of
peak demand. In 2001, approximately 22 percent of WEN's natural gas purchases
were made from Chevron U.S.A. Inc.
The Company's expanded relationship with ChevronTexaco will increase the
volume of natural gas we purchase from Chevron U.S.A. Inc. and ChevronTexaco
from approximately 2.0 Bcf/d to approximately 3.0 Bcf/d. We also expect to
provide supply and service for in excess of 2.0 Bcf/d of natural gas for the
former Texaco's facilities and third-party term markets.
Transportation. The Company arranges for transportation of the natural gas
it markets from the supplier's receipt point to the purchaser's requested
delivery point. The Company generally retains title to this natural gas from
the receipt point to the delivery point and obtains pipeline transportation.
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 physical supplier of
energy. 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. For the year ended December 31, 2001, the Company
sold an aggregate average of 12.5 Bcf/d of natural gas. As described above,
Dynegy expects future average physical natural gas sales to increase
significantly as a result of additional supply volumes to be provided by
ChevronTexaco.
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 us to manage relatively constant gas supply volumes with uneven demand
levels. Through the use of our storage capabilities, we offer peak delivery
services to satisfy winter heating and summer electric-generating demands.
Storage inventories also provide performance security or "backup" service to
our customers. The Company at various times leases short-term and long-term
firm and interruptible storage. Our recent acquisitions of Northern Natural Gas
Company ("Northern Natural") and BG Storage Limited should enable us to expand
storage services in the U.S. and U.K. markets.
Power. Dynegy markets electricity and power products and services,
providing a 24-hour-a-day resource for the sale and purchase of power through
access to wholesale markets throughout North America and Europe. 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 2001, Dynegy sold 362
million megawatt-hours of electricity.
At December 31, 2001, Dynegy had interests in 41 power projects in
operation, under construction or in development, having gross capacity of
18,833 MW (13,738 MW net) of electricity. Approximately 66 percent of these
facilities were solely gas-fired plants, with the remaining facilities fueled
by coal, heavy fuel oil or some combination of coal, fuel oil and natural gas.
The combined gross capacity of owned facilities in operation at December 31,
2001 approximated 15,856 MW (10,761 MW net) of electricity and 2.7 million
pounds per hour of steam available for sale to customers. Approximately 68
percent of the gross capacity (55 percent net) in operation at December 31,
2001 was under long-term power purchase agreements.
Domestically, our power plants are located in California, Georgia, Illinois,
Kentucky, Louisiana, Michigan, Nevada, New York, North Carolina, Ohio, Texas,
Virginia and Washington. In addition, in connection with our 2000 acquisition
of Illinova Corporation, we acquired a total of seven operating power projects
in China, Costa
4
Rica, Honduras, Jamaica, Pakistan and Panama having an aggregate gross capacity
of 918 MW (228 MW net) of electricity.
In addition to ownership and operation of generation facilities, the Company
provides services to affiliated ventures in the areas of project development,
engineering, regulatory and environmental affairs, operating and maintenance
services, business and energy management and fuel supply.
Commercial and Industrial. Deregulation of the gas and power markets is
evolving to encourage greater competition and access to markets. As a result,
Dynegy is pursuing opportunities to provide energy solutions to regional and
national commercial and industrial customers who need customized energy
solutions for their natural gas and electricity requirements. Dynegy's services
include full requirements energy management, supply delivery or asset
management and price risk-management services. Dynegy believes that its energy
network and physical logistics capability positions the Company to provide
mutually beneficial energy solutions to our customers.
In addition, Dynegy's retail gas and electric strategy is to strengthen key
customer relationships by forming regional retail gas and power alliances,
which require less capital investment and fewer financial risks relative to
other national retail marketing strategies. The combination of Dynegy's
low-cost energy supply 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 Midstream Services Segment
General. DMS consists primarily of the Company's North American midstream
liquids operations, NGL marketing and global LPG transportation and marketing
operations, located principally along the Gulf Coast and in London. North
American midstream liquids operations are actively engaged in gathering and
processing natural gas and fractionating, storing, terminalling, transporting,
distributing and marketing NGLs. This vertically integrated NGL infrastructure
permits the Company to generate revenues throughout all facets of the NGL
business, from inlet natural gas volumes gathered from producing horizons to
distributing and marketing NGLs to end-users throughout the world. This
business provides the Company with broad-based, real-time market information
that allows the Company to capture capacity, demand and distribution
inefficiencies that exist from time to time in the market.
[GRAPHIC DEPICTING LIQUIDS VALUE CHAIN]
DMS attempts to maximize earnings from its vertically integrated core gas
gathering, processing and downstream assets. Similar to WEN's convergence
strategy, ownership and control of upstream processing and downstream
fractionation, storage, terminalling and transportation assets provides
opportunities to DMS' NGL distribution and marketing business. DMS' human and
capital resources are aligned and focused on capturing growth opportunities in
all core areas, including the Gulf of Mexico region and areas outside North
America.
The Company is among the industry leaders in substantially all midstream
component businesses, ranging from natural gas processing to distributing and
marketing NGLs to end-users. Our position as a natural gas processor is
expected to grow as the Company is in the final stages of negotiations with
ChevronTexaco to
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expand its relationship to include the historical Texaco volumes. In December
2001, the Company expanded its commercial agreement with ChevronTexaco to
purchase the undedicated liquid production associated with the processing of
Texaco's natural gas. In January 2002, the Company also purchased Texaco's
wholesale propane marketing business and integrated it into Dynegy's existing
wholesale business.
Natural Gas Gathering and Processing. The natural gas processing industry
is a major oil and gas industry segment, providing the necessary service of
refining raw natural gas into marketable pipeline quality natural gas and NGLs.
We own interests in 23 gas processing plants, including 13 plants we operate,
as well as associated and stand-alone natural gas gathering pipeline systems.
These assets are located in key producing areas of Louisiana, New Mexico and
Texas. During 2001, we processed on average 1.9 Bcf/d of natural gas and
produced on average 84 thousand gross barrels per day of NGLs. We have the
right to process substantially all of Chevron U.S.A. Inc.'s processable natural
gas in those geographic areas where it is economically feasible for us to do
so. We are also in the final stages of negotiations with ChevronTexaco to
process the historical Texaco volumes. In 2002, we estimate that approximately
60 percent of the volume processed will be under percentage of proceeds
contracts, 29 percent will be under processor economic election contracts
(either keep whole or fee based) and the remaining 11 percent will be under
keep whole processing arrangements.
Under percentage of proceeds contracts, we sell the natural gas and NGLs,
return to the producer their share of the proceeds derived from such sale and
keep a portion of the proceeds as our processing fee. If a producer has
negotiated the right to take its share of natural gas and NGLs in kind, the
producer gives to us a percentage of the natural gas and NGLs as our fee and
takes the remaining percentage in kind at the tailgate of the plant. Under
processor economic election contracts, the producer has the election to either
process on a keep whole basis or pay us a fee for processing the natural gas.
This fee could be in the form of a percentage of the natural gas and/or NGLs
processed or a cash payment for providing the processing services. Under keep
whole processing arrangements, the natural gas is processed to remove the NGLs
and other impurities to make the natural gas merchantable. We keep the NGLs and
then return to the producer merchantable natural gas containing the same Btu
content as was delivered to us prior to processing. We are allowed to keep the
NGLs as our fee for processing but must purchase and return to the producer a
volume of merchantable natural gas to replace the Btus that were removed
through processing so that the producer is kept whole on the Btus it delivered
to the plant.
Our natural gas processing services are provided at two types of 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 NGLs and to remove water vapor, solids and other contaminants. Straddle
plants are situated on mainline natural gas pipelines and allow operators to
extract NGLs from a natural gas stream and replace the equivalent Btus with
pipeline quality gas when the market value of NGLs separated from the natural
gas stream is higher than the market value of the same unprocessed natural gas.
Fractionation. Liquids removed from natural gas at processing plants are
generally in the form of a commingled stream of light liquid hydrocarbons (raw
product). The commingled NGLs are separated at fractionation facilities into
component products of ethane, propane, normal butane, isobutane and natural
gasoline. Fractionation contracts typically include a base fee per gallon
subject to adjustment for certain variable costs, such as energy consumed in
operation. The Company has ownership interests in three stand-alone
fractionation facilities: two in Mont Belvieu, Texas and one in Lake Charles,
Louisiana. We operate the Louisiana facility and one of the Mont Belvieu
facilities. During 2001, these facilities fractionated an aggregate average of
226 thousand gross barrels per day.
Transportation Operations. The Company has developed a NGL transportation
and logistics infrastructure that is comprised of a wide range of
transportation and distribution assets designed to satisfy the various delivery
requirements of our distribution and marketing services business. In the United
States, the Company owns over 9,700 miles of gas gathering and gas liquids
pipelines, primarily in the North Texas, Gulf Coast and Permian Basin regions.
We also have access to approximately 2,000 railcars through a services
agreement with ChevronTexaco. We own and operate 88 tank trucks and 21
pressurized barges. These assets are
6
deployed to serve our wholesale distribution terminals, Texas Gulf Coast
fractionators, underground storage facilities, pipeline injection terminals and
many of the nation's crude oil refineries. The Company's large-scale marine
terminals are located in Mississippi, Texas, Florida, Tennessee and Louisiana,
offering importers and wholesalers a variety of methods for transporting
products to the marketplace. We control over 108 million barrels of underground
liquids storage capacity in Texas, Louisiana, and Mississippi, providing
customers with the ability to store, buy and sell specification products.
Distribution and Marketing Services. Dynegy's distribution and marketing
services include: (1) refinery services, (2) wholesale propane marketing and
(3) purchasing mixed NGLs and NGL products from NGL producers and other sources
and selling such NGL products to petrochemical manufacturers, refineries and
other marketing companies.
In connection with our refinery services operations, we purchase NGL
products from refinery customers, such as Chevron U.S.A. Inc, and sell NGL
products to various customers. The Company generally earns a margin in these
operations by retaining a portion of the resale price or a fixed minimum fee
per gallon. Approximately 15 percent of DMS' NGL purchases in 2001 were from
Chevron U.S.A. Inc and approximately 12 percent were from another supplier. In
2001, the Company sold an average of 41 thousand barrels per day through this
refinery services business.
Wholesale propane marketing operations include the sale of propane and
related logistical services to major multi-state retailers, independent
retailers and other end users. Our propane supply comes from our refinery
services operations and from our other distribution and marketing operations.
We generally sell propane at a fixed price based on the current market price
established at Mont Belvieu or for the posted price at the time of delivery. In
2001, the Company sold an average of approximately 51 thousand barrels of
propane per day.
We market our own NGL production and also purchase NGLs from other NGL
producers and marketers for resale. Our distribution and marketing services
business sold an average of 366 thousand barrels per day of NGLs in North
America in 2001. The Company generally purchases NGL products from producers at
a monthly pricing index less applicable fractionation, transportation and
marketing fees and resells these products to petrochemical manufacturers,
refineries and other marketing companies. In addition to margins that the
Company earns from purchasing NGL products from producers pursuant to contract,
we also earn a margin by purchasing and selling NGL products in the spot market
and in the forward market.
Dynegy also markets LPG worldwide via use of chartered large-hull ships. In
2001, 100 thousand barrels per day of LPG were marketed by this business. These
operations acquire and market product from producing areas in the North Sea,
West Africa, Algeria and the Arabian Gulf as well as from the U.S. Gulf Coast
region. Dynegy plans continued expansion of this international business
including developing facilities in producing areas and growing downstream
markets. We charter four VLGC (Very Large Gas Carriers) totaling more than
176,000 tons of capacity supporting our worldwide marketing activities. One
newly built VLGC is committed to charter and is scheduled for September 2002
delivery.
In total, we sold approximately 557 thousand barrels per day of NGLs to
approximately 770 customers (amounts are aggregate totals for marketing,
wholesale and global operations). In 2001, approximately 23 percent of our NGL
sales were made with ChevronTexaco or one of its affiliates and approximately
11 percent were to another customer.
Transmission & Distribution Segment
Our transmission and distribution segment consists of IP's operations
acquired in the Illinova Corporation ("Illinova") acquisition in early 2000. IP
is based in Decatur, Illinois and provides retail electric and natural gas
service to residential, commercial and industrial consumers in substantial
portions of northern, central and southern Illinois. Electric transmission
service also is supplied to numerous utilities, municipalities and power
marketing entities.
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IP supplies retail electric service to an estimated population of 1.4
million. Retail natural gas service is supplied by IP to a population of
approximately 1 million people. IP holds franchises in all of the incorporated
municipalities that it services. As of January 3, 2002, based on the number of
billable meters, IP served over 588,000 active electric customers and over
412,000 active gas customers.
IP has seven underground gas storage fields having a total capacity of
approximately 11.6 Bcf and a total deliverability on a peak day of
approximately 289,000 Mcf. IP also has contracts with various natural gas
pipelines for 5.1 Bcf of underground storage capacity, having total
deliverability on a peak day of approximately 93,000 Mcf. Operation of
underground storage permits IP to increase deliverability to its customers
during peak load periods by extracting gas that was previously put into storage
during the off-peak months.
IP owns an interconnected electric transmission system of approximately
2,600 circuit miles and a distribution system that includes approximately
37,000 circuit miles of overhead and underground lines. Additionally, IP owns
755 miles of gas transmission pipe and 7,543 miles of gas distribution pipe.
All of these properties are located in Illinois.
Dynegy Global Communications Segment
DGC was established during the fourth quarter of 2000 to pursue and capture
opportunities in the communications marketplace through opportunistic asset
acquisitions and strategic partnerships. DGC has refined its strategic business
model to include voice services, storage and government sales and is focused on
controlling costs and capital expenditures until the recovery of the overall
communications industry.
Dynegyconnect, L.P., DGC's North American subsidiary, completed one of the
first optically switched mesh networks in the world in the fourth quarter of
2001. The network spans more than 16,000 route miles and reaches 45 of the
largest cities in the United States.
In May 2001, DGC established its metro strategy with the announcement of a
network services agreement with Telseon, Inc. to develop an 18 city all-optical
network, capable of producing significant, scalable, high-bandwidth solutions
among multiple points of presence ("POPs") in tier 1 metro markets. The metro
strategy is complementary to Dynegyconnect's network and will provide DGC with
access to approximately 80 POPs in select U.S. metro areas.
Dynegy Europe Communications ("DEC") was formed following the acquisition of
iaxis, Limited, a privately held, London-based communications company, in March
2001. As a result of this acquisition, DEC acquired a fiber optic network that
now reaches more than 26 cities in 11 countries. The European network is linked
to the U.S. via a transatlantic connection between New York and London,
providing seamless connectivity to DGC's customers throughout the U.S., the
U.K. and Continental Europe.
DGC believes its network and metro strategy have unique cost advantages and
capability compared to its competitors. As a result, as the telecommunications
industry rebounds, DGC believes it will be able to compete very effectively.
COMPETITION
Dynegy faces strong competition in the development of new electric
generating plants, the acquisition of existing generating facilities and the
marketing and transportation of energy commodities. The Company's primary
competition is with merchant energy companies as well as entities vying for
market share in the deregulating domestic electricity generating and marketing
industries. The Company believes its primary competitors in this business
consist of approximately 25 companies.
Dynegy's wholesale energy network competes with international, national and
regional full-service energy providers, merchants, producers and pipelines for
sales based on its ability to aggregate competitively priced
8
supplies from a variety of sources and locations and to utilize efficient
transportation. Dynegy believes that technological advances in executing
transactions will differentiate the competition in the near term.
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 its level of success through its
wholesale energy network.
Demand for power may be met by generation capacity based on several
competing technologies, such as gas-fired or coal-fired generation 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 to the extent
states continue to move toward retail electric competition, these trends can be
expected to continue for the foreseeable future. However, recent events in the
marketplace, including the California electricity crisis in late 2000 and the
alleged manipulation of electricity prices by Enron and other wholesale
electricity merchants, have caused some states to publicly reconsider their
approach to deregulation, or to retreat from deregulation altogether.
The Company's NGL marketing businesses face significant and varied
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 NGLs, crude oil, residue gas, condensate and
sulfur, and the transportation and storage of natural gas, NGLs and crude oil.
Competition typically is based on location and operating efficiency of
facilities, reliability of services, delivery capabilities and price.
Competition has become a dominant issue for the electric utility industry in
which IP operates. The Public Utilities Regulatory Policies Act of 1978
("PURPA") facilitated development of co-generators and independent power
producers. Promotion of competition continued with the enactment of the Energy
Policy Act of 1992, which authorized the FERC to mandate wholesale wheeling of
electricity by utilities at the request of certain authorized generating
entities and electric service providers. Competition arises not only from
co-generation or independent power production, but also from municipalities
seeking to extend their service boundaries to include customers being served by
utilities. Further competition may be facilitated by the adoption of state
utility deregulation legislation, as has occurred in Illinois, or by federal
regulatory action. The Company believes its primary competitors in this
business consist of approximately 8 companies.
Dynegy's entrance into the communications industry also subjects Dynegy to
competition with industry participants having substantial financial resources
and significant industry expertise. Dynegy competes with a substantial number
of communications companies, many of which have greater resources and/or focus
only on one industry or a niche within a single industry.
REGULATION
The Company is subject to regulation by various federal, state, local and
foreign agencies, including the regulations described below.
Natural Gas Regulation. The transportation (including storage) and sale for
resale of natural gas in interstate commerce is subject to regulation by the
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"). The rates
charged by interstate pipelines for interstate transportation and storage
services, and the terms and conditions for
9
provision of such services, are regulated by the FERC, which generally also
must approve any changes to these rates or terms and conditions prior to their
implementation. The FERC also has jurisdiction over, among other things, the
construction and operation of pipeline and related facilities used in the
transportation and storage of natural gas in interstate commerce, including the
extension, expansion, acquisition, disposition, or abandonment of such
facilities; maintenance of accounts and records; depreciation and amortization
policies; and transactions with and conduct of interstate pipelines relating to
affiliates. Venice Gathering System is a regulated interstate pipeline.
Commencing in 1992, the FERC issued Order No. 636 and subsequent orders
(collectively, "Order No. 636"), which require interstate pipelines to provide
transportation separate, or "unbundled," from the pipelines' sales of gas.
Also, Order No. 636 requires pipelines to provide open-access transportation on
a basis that is equal for all shippers. The FERC intends for Order No. 636 to
foster increased competition within all phases of the natural gas industry.
Prior to its acquisition of Venice Gathering System, Order No. 636 did not
directly regulate any of Dynegy's activities; however, like other interstate
pipelines, Venice Gathering System must comply with FERC's open-access
transportation regulations. The implementation of these orders has not had a
material adverse effect on Dynegy's results of operations. The courts have
largely affirmed the significant features of Order No. 636 and numerous related
orders pertaining to the individual pipelines, although certain appeals remain
pending and the FERC continues to review and modify its open-access regulations.
In 2000, the FERC issued Order No. 637 and subsequent orders (collectively,
"Order No. 637"), which imposed a number of additional reforms designed to
enhance competition in natural gas markets. Among other things, Order No. 637
revised the FERC pricing policy by waiving price ceilings for short-term
released interstate pipeline transportation capacity for a two-year period, and
effected changes in FERC regulations relating to interstate transportation
scheduling procedures, capacity segmentation, pipeline penalties, rights of
first refusal and information reporting. Most major aspects of Order No. 637
are pending judicial review. It is uncertain whether and to what extent FERC's
market reforms will survive judicial review and, if so, whether the FERC's
actions will achieve the goal of further increasing competition in natural gas
markets.
The FERC recently proposed to expand its existing rules governing the
conduct of interstate pipelines and their marketing affiliates to include all
energy affiliates. If adopted, the proposed rule would, among other things,
preclude the exchange of transportation related information among an interstate
pipeline and any of its energy affiliates. The FERC has stated that one purpose
of the proposal is to allow pipeline affiliates and non-affiliates to compete
in energy markets on an even basis. It is uncertain whether or when the FERC
may adopt the proposed rule, or the extent to which it may affect the cost or
other aspects of Dynegy's operations; however, Dynegy does not anticipate that
its regulated transmission providers and their energy affiliates will be
impacted any differently than other similar industry participants.
Pursuant to the NGPA and the Wellhead Decontrol Act of 1989, most sales of
natural gas are no longer subject to price controls. However, the FERC retains
jurisdiction over certain sales made by interstate pipelines or their
affiliates, such as Dynegy has become with its recent acquisitions. The FERC
has authorized such sales to be made at unregulated prices, terms and
conditions. While sales of natural gas can be made at market prices, and upon
unregulated terms and conditions, there is no assurance that such regulatory
treatment will continue indefinitely in the future. Congress or, as to sales
remaining subject to its jurisdiction, the FERC, could re-enact price controls
or other regulation in the future.
Certain federal and provincial regulatory authorities require parties to
transactions involving natural gas exports to hold export or removal permits.
The Company's indirect wholly owned Canadian subsidiary, Dynegy Canada Inc.,
holds various Canadian and U.S. permits for such purposes. In the United
Kingdom, the natural gas business is subject to regulation by the Office of Gas
Supply.
Gas Processing. Dynegy's gas processing operations could become subject to
FERC regulation. The FERC has traditionally maintained that a processing plant
used primarily for removal of NGLs for economic
10
purposes 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. However, the FERC considers a processing plant used primarily for purposes
related to transportation safety and efficiency to be subject to such
regulation. Dynegy believes its gas processing plants are primarily involved in
removing NGLs for economic purposes and, therefore, are exempt from FERC
jurisdiction. Nevertheless, the FERC has made no specific finding as to
Dynegy's gas processing plants. In addition, certain facilities downstream of
processing plants are being considered for use in transporting gas between
pipelines, which may invoke FERC's jurisdiction. Such jurisdiction likely would
apply to the downstream facility as a pipeline, however, and not to the plants
themselves.
Liquified Natural Gas (LNG) Terminals. LNG terminals operating in
interstate commerce are subject to FERC jurisdiction and regulation of rates,
terms and conditions of service such as is described above concerning
interstate natural gas transportation and storage. Dynegy is in the process of
securing approvals to construct such a facility in Louisiana.
Gas Gathering. The NGA exempts gas gathering facilities from the
jurisdiction of the FERC, while interstate transmission facilities remain
subject to FERC jurisdiction, as described above. Dynegy believes its gathering
facilities and operations meet the tests used by the FERC to determine
nonjurisdictional gathering facility status, although the FERC's articulation
and application of such tests have varied over time. Nevertheless, the FERC has
made no specific findings as to the exempt status of any of Dynegy's
facilities. No assurance can be given that all of Dynegy's gas gathering
facilities will remain classified as such and, therefore, remain exempt from
FERC regulation. Some states regulate gathering facilities to varying degrees;
generally rates are not regulated.
Electricity Marketing Regulation. The Company's electricity marketing
operations are regulated by the Federal Power Act ("FPA") and the FERC with
respect to rates, terms and conditions of services and various reporting
requirements. FERC policies permit trading and marketing entities to market
electricity at market-based rates. While FERC has affirmed its desire to move
toward competitive markets with market-based pricing, it is reviewing the
specifics of implementing this policy. For further discussion, please see
"Power Generation Regulation" below.
In December 1999, the FERC issued Order No. 2000, which addressed a number
of issues relating to the regional transmission of electricity. In particular,
Order No. 2000 provided for regional transmission organizations ("RTOs") to
control the transmission facilities within a particular region. After a period
of progress toward voluntary creation of RTOs as envisioned by the FERC,
activity has slowed due to uncertainty concerning required standards and
structures for such entities. Recently, the FERC commenced proceedings designed
to result in the adoption of generally standardized market terms and conditions
governing interstate transmission and RTO operation, including generic
standards and procedures for the interconnection of generation to the
transmission grid. The FERC plans to propose new rules respecting these matters
this year and has directed electric industry participants to establish a single
organization to assist with the development of business practices and protocols
that will be needed to implement such standardized terms and conditions. It is
uncertain what rules the FERC may adopt as the result of these proceedings. The
impact of these RTOs on the Company's electricity marketing operations cannot
be predicted. (For further discussion, please see "Illinois Power Company"
below.)
Power Generation Regulation. The Company's generation assets include
projects that are Exempt Wholesale Generators ("EWGs") or qualifying facilities
("QFs"). One form of EWG is a merchant plant, which operates independently from
designated power purchasers and as a result will generate and sell power to
market when electricity sales prices exceed the cost of production. A QF
typically sells the power it generates to a single power purchaser.
The FPA grants the FERC exclusive ratemaking jurisdiction over wholesale
sales of electricity in interstate commerce. The Company's power generation
operations also are subject to regulation by the FERC under
11
PURPA with respect to rates, the procurement and provision of certain services
and operating standards. Although facilities deemed QFs under PURPA are exempt
from ratemaking and other provisions of the FPA, non-QF independent power
projects and certain power marketing activities are subject to the FPA and the
FERC's ratemaking jurisdiction, as well as the Public Utilities Holding Company
Act of 1935 ("PUHCA") and the Energy Policy Act of 1992. All of the projects
owned or operated by Dynegy as QFs are qualifying facilities and, as such,
under PURPA are exempt from the ratemaking and other provisions of the FPA.
Dynegy's EWGs, which are not QFs, 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.
In some markets where Dynegy owns generation facilities, specifically
California and New York, the FERC has from time to time approved and
subsequently extended temporary price caps on wholesale power sales, or other
market mitigation measures. Due to concerns over potential short supply and
high prices in the summer of 2001, the New York Independent System Operator,
Inc. ("NYISO"), the FERC-approved operator of electric transmission facilities
and centralized electric markets in New York, filed an Automated Mitigation
Procedure ("AMP") proposal with the FERC. The AMP caps bid prices based on the
cost characteristics of generating facilities in New York, such as those owned
or operated by the Company. In an order issued on June 28, 2001, the FERC
accepted the AMP proposal for the summer of 2001. In a subsequent order issued
on November 27, 2001, the FERC extended the AMP through April 30, 2002. The AMP
may be further extended in the future.
Price volatility and other market dislocations in the California market have
precipitated a number of FERC actions related to the California market, in
addition to price caps and market mitigation measures. These include an
investigation of gas pipeline marketing affiliate abuse in the region,
proceedings regarding whether, and to what extent, price refunds are owed by
wholesale electricity suppliers serving the state, and complaints requesting
the FERC to reform or void various long-term power sales contracts. Recently,
as a prelude to possible initiation of a new complaint proceeding, the FERC
began investigating whether any entity has manipulated prices for electricity
or natural gas in the West, since January 1, 2000, possibly resulting in unjust
and unreasonable prices under long-term power sales contracts entered into
since that time. Additional matters in California are discussed below under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--California Market/West Coast Power."
On November 20, 2001, the FERC issued an order that would subject the sales
of all entities with market-based rate tariffs to "refunds or other remedies"
in the event the seller engages in "anticompetitive behavior or the exercise of
market power." The FERC has postponed the effectiveness of this refund
condition pending its consideration of comments submitted by interested
parties. Dynegy and other similarly-situated generators and power marketers
have submitted comments in opposition to the proposed refund condition. It is
uncertain how the FERC will act respecting this matter. If the FERC were to
establish the broad refund condition proposed, it would increase the risk
inherent in electric marketing activities for all wholesale sellers of
electricity, including Dynegy. Establishment of the proposed refund condition,
together with a finding that Dynegy engaged in any of the specified activities,
also could require Dynegy to refund some of the electricity payments it has
collected or reduce the amount it is owed for electricity.
State Regulatory Reforms. The Company's domestic gas and power marketing
and power generation businesses are subject to various regulations from the
states in which they operate. Proposed reforms to these regulations are
proceeding in several states, including California, the results of which could
affect the Company's operations.
Illinois Power Company. IP is an electric utility as defined in PUHCA. Its
direct parent company, Illinova, and Dynegy are holding companies as defined in
PUHCA. However, each of Illinova and Dynegy generally are exempt from
regulation under section 3(a)(1) of PUHCA. They remain subject to regulation
under PUHCA with respect to the acquisition of certain voting securities of
other domestic public utility companies and utility holding companies.
12
IP also is subject to regulation by the FERC under the FPA as to
transmission rates, terms and conditions of service, the acquisition and
disposition of transmission facilities and other matters. The FERC has declared
IP exempt from the NGA and related FERC orders, rules and regulations.
IP is further subject to regulation by the State of Illinois and the
Illinois Commerce Commission ("ICC"). The Illinois Public Utilities Act was
significantly modified in December 1997 by the Electric Service Customer Choice
and Rate Relief Law of 1997, or P.A. 90-561, but the ICC still has broad powers
of supervision and regulation with respect to rates and charges and various
other matters. Under P.A. 90-561, IP must continue to provide bundled retail
electric services to all who choose to continue to take service at tariff rates
and must provide unbundled electric distribution services to all eligible
customers as defined by P.A. 90-561 at rates determined by the ICC.
In January 1998, IP, in conjunction with eight other transmission-owning
entities, filed with the FERC for all approvals necessary to create and to
implement the Midwest Independent System Operator ("MISO"). IP subsequently
withdrew from the MISO to join several transmission owners (the "Alliance
Companies") proposing to form the Alliance RTO. As proposed, the Alliance RTO
would function as an RTO with National Grid, USA ("National Grid") as the
managing member for a period of seven years.
In an order issued on December 20, 2001, the FERC reversed its previous
findings, stated that it would not approve the Alliance RTO, and directed the
Alliance Companies to explore how their business plan could be accommodated
with the MISO or another RTO. Discussions continue with both MISO and another
party, but no agreement has been reached. The Alliance Companies, including IP,
continue to consider other opportunities for participation in an RTO. Any RTO
in which IP ultimately participates will be subject to the outcome of the
FERC's proceedings on standardized market terms and conditions.
IP's retail natural gas sales also are regulated by the ICC. Such sales are
priced under a purchased gas adjustment mechanism under which IP's gas purchase
costs are passed through to its customers if such costs are determined prudent.
Pending Legislation. The U.S. Congress has before it a number of bills that
could impact regulations applied to Dynegy and its subsidiaries. These include
bills that would repeal PUHCA and portions of PURPA and that would affect
FERC's regulatory authority over energy marketing, generation and trading.
Recent market events, including the California electricity crisis in late 2000
and the alleged manipulation of electricity prices by wholesale electricity
merchants, have prompted questions about the wisdom of PUHCA repeal and whether
more stringent regulation may be needed. The outcome of these bills and the
effects that they might have cannot be predicted with certainty.
Foreign Regulation. Dynegy Europe Limited acquired BG Storage Limited in
the fourth quarter of 2001 and, as a result, now owns and operates the Rough
and Hornsea gas storage facilities in the U.K. In connection with that
acquisition, Dynegy Europe Limited gave statutory undertakings to the Secretary
of State for Trade and Industry in the U.K. under the Fair Trading Act of 1973.
The key aspects of these legislatively required undertakings, which relate to
the operation of the storage assets acquired and expire on April 30, 2004, are
as follows:
(1) Dynegy Storage Limited, the Dynegy Europe Limited subsidiary that operates
the assets, will ensure that the maximum physical capacity of the
facilities is made available to the market on non-discriminatory terms and
that 20% of the capacity is sold on one-year terms;
(2) Unless otherwise approved by the regulator, the capacity must be sold in
standard bundled units;
(3) Where there remains any unsold capacity 30 days before the beginning of a
storage year (May 1 to April 30), this capacity must be sold by auction
under prescribed procedures and standard contracts approved by the
regulator (although prior to such time, Dynegy Storage Limited may sell the
capacity in its sole discretion); and
13
(4) Dynegy Storage Limited must maintain a robust financial information and
systems separation (and separate accounts) of the storage business from
other commercial activities.
ENVIRONMENTAL AND OTHER MATTERS
General. 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. In addition,
development of projects in international markets creates exposure to and
obligations under the national, provincial and local laws of each host country,
including environmental standards and requirements imposed by these
governments. Environmental laws and regulations are complex, change frequently
and have tended to become more stringent over time. Many environmental laws
require permits from governmental authorities before construction on a project
may be commenced or before wastes or other materials may be discharged into the
environment. The process for obtaining necessary permits can be lengthy and
complex, and can sometimes result in the establishment of permit conditions
that make the project or activity for which the permit was sought either
unprofitable or otherwise unattractive. Even where permits are not required,
compliance with environmental laws and regulations can require significant
capital and operating expenditures, and the Company may be required to incur
costs to remediate contamination from past releases of wastes into the
environment. Failure to comply with these statutes, rules and regulations may
result in the assessment of administrative, civil and even criminal penalties.
Furthermore, the failure to obtain or renew an environmental permit could
prevent operation of one or more Dynegy facilities.
In general, the construction and operation of our facilities are subject to
federal, state and local environmental laws and regulations governing the
siting of energy facilities, the discharge of pollutants and other materials
into the environment, the protection of wetlands, endangered species, and other
natural resources, the control and abatement of noise and other similar
requirements. A variety of permits are typically required before construction
of a project commences, and additional permits are typically required for
facility operation.
Environmental Expenditures. 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 were
approximately $81 million in 2001, compared to approximately $121 million in
2000. The 2000 costs exceeded 2001 costs due in large part to expenditures by
the Company to bring certain power generation turbines into compliance with new
environmental regulations ahead of the dates when such compliance was actually
required. The Company estimates that total environmental expenditures (both
capital and operating) in 2002 will be approximately $103 million. A
substantial majority of the Company's environmental expenditures relate to the
federal Clean Air Act ("CAA") and comparable state laws and regulations.
Management does not expect capital spending on environmental matters to
increase materially over the near term; however, changes in environmental
regulations or the outcome of litigation could result in additional legal
requirements that would necessitate increased spending. Please read "--The
Clean Air Act" below for a discussion of the litigation brought by the
Environmental Protection Agency against two Dynegy affiliates relating to
activities at its Baldwin generating station in Illinois.
The Clean Air Act. The CAA and comparable state laws and regulations
relating to air emissions impose responsibilities on owners and operators of
sources of air emissions, including requirements to obtain construction and
operating permits and annual compliance and reporting obligations. Although the
impact of air quality regulations cannot be predicted with certainty, these
regulations are expected to become increasingly stringent, particularly for
electric power generating facilities. CAA requirements include the following:
. The CAA Amendments of 1990 required a two-phase reduction by electric
utilities in emissions of sulfur dioxide and nitrogen oxide by 2000 as
part of an overall plan to reduce acid rain in the eastern United States.
Installation of control equipment and changes in fuel mix and operating
practices have been completed to comply with the emission reduction
requirements of the acid rain provision of the CAA Amendment of 1990.
14
. In October 1998, the EPA issued a final rule on regional ozone control
that required 22 eastern states and the District of Columbia to revise
their State Implementation Plans (SIPs) to significantly reduce emissions
of nitrogen oxide. The compliance deadline for implementation of these
emission reductions is May 31, 2004. In January 2000, the EPA finalized
another ozone-related rule under Section 126 of the CAA that has similar
emission control requirements. Installation of the necessary emission
control equipment may involve large technical, design and construction
projects that require significant time or expense for completion.
. Significant reductions in air emissions from Dynegy's facilities could be
required if the U.S. Congress adopts legislation requiring additional
reductions in emissions of sulfur dioxide, nitrogen oxides and mercury as
outlined in various multi-pollutants proposals. Some of these proposals
also include reductions in carbon dioxide and other "greenhouse gases"
that allegedly contribute to global warming. The emissions reductions
contemplated by these initiatives, if they are enacted, could eventually
require significant capital expenditures for new pollution control
equipment, but the adoption of emission reduction requirements pursuant
to any of the various pending proposals is highly uncertain. Although the
impact of possible future environmental requirements cannot be predicted
with any degree of certainty, any expenditures that are ultimately
required are not anticipated to have a more significant effect on
Dynegy's operations or financial condition than on any similarly situated
company that generates electricity through the burning of fossil fuels.
. The EPA and the Department of Justice ("DOJ") filed complaints against IP
and DMG, alleging Clean Air Act violations, which are described in Item
8, Financial Statements and Supplementary Data, Note 11. In general,
these allegations involve whether repair, maintenance, and replacement
projects at the Baldwin facility required permitting under the Clean Air
Act. The EPA has the authority to seek penalties for the alleged
violations at the rate of up to $27,500 per day for each violation. The
EPA may also seek to require installation of the "best available control
technology" at the Baldwin facility and possibly other Company plants. An
adverse ruling could impose liability on Dynegy, as well as increase the
costs of ongoing operations to Dynegy. In the opinion of management,
although significant capital expenditures could be required, 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.
Remedial Laws. The Company is also subject to environmental remediation
requirements, including provisions of the Comprehensive Environmental Response,
Compensation and Liability Act ("CERCLA" or "Superfund") and the corrective
action provisions of the federal Resource Conservation and Recovery Act
("RCRA") and similar state laws. The Superfund law imposes liability,
regardless of fault or the legality of the original conduct, on 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 some
cases, 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 affected parties to file claims for personal
injury and property damage allegedly caused by the hazardous substances
released into the environment. RCRA applies to facilities that have been used
to manage or are managing hazardous waste and which are either still in
operation or have recently been closed. RCRA also requires facilities to remedy
any releases of hazardous wastes or hazardous waste constituents at waste
treatment, storage or disposal facilities. CERCLA or RCRA could impose remedial
obligations at a variety of Dynegy facilities, including our electric power
generating plants and NGL facilities.
IP previously operated more than two dozen sites at which synthetic gas was
manufactured from coal. Operation of these manufactured gas plant ("MGP") sites
was generally discontinued in the 1950s when natural gas became available from
interstate gas transmission pipelines. Many of these MGP sites were
contaminated with residues from the gas manufacturing process and remediation
of this historic contamination may be required under CERCLA or RCRA or
analogous state laws.
15
Pipeline Safety. 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 U.S. Department of Transportation ("DOT") pursuant to the Natural Gas
Pipeline Safety Act ("NGPSA") and the Hazardous Liquid Pipeline Safety Act
("HLPSA"), or by state regulations meeting the requirements of the NGPSA and
the HLPSA, or to similar statutes, rules and regulations in Canada or other
jurisdictions. In December 2000, DOT adopted new regulations requiring
operators of interstate pipelines to develop and follow an integrity management
program that provides for continual assessment of the integrity of all pipeline
segments that could affect so-called "high consequence" environmental impact
areas, through periodic internal inspection, pressure testing, or other equally
effective assessment means. An operator's program to comply with the new rule
must also provide for periodically evaluating the pipeline segments through
comprehensive information analysis, remediating potential problems found
through the required assessment and evaluation, and assuring additional
protection for the high consequence segments through preventative and
mitigative measures. The requirements of this new DOT rule could increase the
costs of pipeline operations.
Health and Safety. 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 the Superfund
Amendments and Reauthorized Act and similar state statutes require that
information be organized and maintained about hazardous materials used or
produced in the Company's operations. Certain of this information must be
provided to employees, state and local government authorities and citizens. The
Company believes it is in substantial compliance, and expects to continue to
comply in all material respects, with these rules and regulations.
Other Environmental Issues. Dynegy is also subject to a variety of other
environmental laws, such as the Clean Water Act, which regulates facilities
that discharge wastewater into the environment. Under the Clean Water Act and
analogous state laws, permits are required for the discharge of any pollutant,
including heat, into any regulated body of water. Failure to obtain or renew
any environmental permit in a timely manner or the loss of a permit due to
legal challenge could require a cessation of operations that involve discharges
of pollutants or other materials into the environment.
Subject to resolution of the complaints filed by the EPA and the DOJ against
IP and Dynegy Midwest Generation, which are described in Item 8, Financial
Statements and Supplementary Data, Note 11, management believes that 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 management's knowledge, other than the previously
referenced complaints, 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.
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,
terrorist attacks 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, or
the failure of a party to meet its indemnification obligations, could
materially and adversely affect Dynegy's operations and financial condition. In
addition, the terrorist attacks on September 11, 2001 and the changes in the
insurance markets attributable to those attacks may make some types of
insurance more difficult to obtain. We may be unable to secure the levels
16
and types of insurance we would otherwise have secured prior to September
11/th/. No assurance can be given that Dynegy will be able to maintain
insurance in the future at rates it considers reasonable.
SIGNIFICANT CUSTOMER
For the year ended December 31, 2001, approximately 10% of the Company's
consolidated revenues were derived from transactions with Enron Corp. and its
affiliates. No other customer accounted for more than 10% of the Company's
consolidated revenues.
EMPLOYEES
At December 31, 2001, the Company had approximately 3,019 employees at its
administrative offices and approximately 3,120 employees at its operating
facilities. Approximately 1,880 employees at Company-operated facilities are
subject to collective bargaining agreements with one of the following unions:
Paper, Allied-Industrial, Chemical & Workers International Union; International
Brotherhood of Electrical Workers; Laborers International Union of North
America; United Association of Journeymen Plumbers and Gas Fitters;
International Association of Machinists and Aerospace Workers; and
Communications, Energy and Paperworkers Union. Management believes that its
relations with employees of the Company are satisfactory.
17
DYNEGY INC.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Class A common stock, no par value per share (the "Class A
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 Class A common
stock as of March 4, 2002, based upon records of registered holders maintained
by the Company's transfer agent, was 23,408.
The Company's Class B common stock, no par value per share, is neither
listed nor traded on any exchange. All of the shares of Class B common stock
are owned by Chevron U.S.A. Inc.
The following table sets forth the high and low sales prices for the Class A
common stock for each full quarterly period during the fiscal years ended
December 31, 2001 and 2000, respectively, as reported on the New York Stock
Exchange Composite Tape, and related dividends paid per share during such
periods. Such prices and dividends paid are adjusted for a two-for-one stock
split on August 22, 2000. Such prices and dividends paid per share prior to
February 1, 2000 are adjusted for the 0.69-to-one exchange ratio used in the
Illinova acquisition.
Summary of Dynegy's Common Stock Price and Dividend Payments
High Low Dividend
------ ------ --------
2001:
Fourth Quarter. $46.94 $20.90 $0.075
Third Quarter.. 48.24 31.27 0.075
Second Quarter. 57.95 42.00 0.075
First Quarter.. 53.15 39.25 0.075
2000:
Fourth Quarter. $56.63 $43.31 $0.075
Third Quarter.. 57.58 34.76 0.075
Second Quarter. 39.94 27.63 0.075
First Quarter.. 31.37 17.30 0.022
Dynegy intends to continue to pay a quarterly cash dividend of $0.075 per
common share, subject to the availability of funds legally available therefor
and declaration by the Board of Directors.
In July 2001, the Company established the Dynegy Short-Term Executive Stock
Purchase Loan Program. Under this program, the Company may loan eligible
employees funds to acquire Class A common stock through market purchases. The
related notes have a two-year maturity, bear interest at the greater of 5
percent or the Applicable Federal Rate as of the loan date and are full
recourse to the participants. At December 31, 2001, the Company had outstanding
approximately $13 million of loans pursuant to this program.
In December 2001, ten members of the Company's senior management purchased
approximately 1.2 million shares of Class A common stock in a private placement
transaction pursuant to Section 4(2) of the Securities Act of 1933. These
officers received loans from the Company to purchase the common stock at $19.75
per share, the same price as the net proceeds to the Company in the December
2001 public offering. The officers paid for the shares by entering into
promissory notes with the Company for an initial term of 60 days. The maturity
date of the notes was extended for an additional 30 days with the approval of
the Board of Directors. These loans bear interest at a rate of 3.25 percent and
are full recourse to the borrowers. The Company recognized compensation expense
in 2001 of approximately $1.2 million related to the shares purchased by these
officers. This amount,
18
which was recorded as "General and Administrative Expense," is derived from the
$1.00 per share discount these officers received based on the initial public
offering price of $20.75 per share.
SHAREHOLDER AGREEMENT
In June 1999, Chevron U.S.A. Inc. ("Chevron"), now a subsidiary of
ChevronTexaco Corporation, entered into a shareholder agreement with Dynegy
governing certain aspects of their relationship, the material provisions of
which are discussed below. The agreement was executed in February 2000 upon
closing of the Illinova acquisition and reflected agreements negotiated between
Dynegy and Chevron relating to Chevron's significant ownership interest in
Dynegy. The agreement amended certain of the rights and obligations previously
agreed between Dynegy and Chevron at the time of Chevron's initial investment
in Dynegy in 1996. Before the Illinova acquisition, Chevron owned 38,789,876
shares of Dynegy common stock and 7,815,363 shares of Dynegy preferred stock.
In connection with the Illinova acquisition, Chevron exchanged its common stock
and preferred stock and paid $200 million in return for an aggregate of
40,521,250 shares of Dynegy's Class B common stock.
The shareholder agreement grants Chevron preemptive rights to acquire shares
of Dynegy common stock in proportion to its then-existing interest in the
equity value of Dynegy whenever Dynegy issues any equity securities, including
securities issued pursuant to employee benefit plans. In addition, Chevron and
its affiliates may acquire up to 40 percent of the total combined voting power
of Dynegy's outstanding voting securities without restriction in the
shareholder agreement. If Chevron or its affiliates wish to acquire more than
40 percent of the total combined voting power of Dynegy's outstanding voting
securities, the shareholder agreement requires Chevron to make an offer to
acquire all of the outstanding voting securities of Dynegy for cash or freely
tradable securities listed on a national securities exchange. Any offer by
Chevron and its affiliates for all of Dynegy's outstanding voting securities
would be subject to the auction procedures outlined in the agreement.
Chevron's ownership of Class B common stock entitles it to designate three
members of Dynegy's Board of Directors. The shareholder agreement prohibits
Chevron from selling or transferring shares of Class B common stock except in
the following transactions:
. in a widely-dispersed public offering;
. an unsolicited sale to a third party, provided that Dynegy or its
designee is given the opportunity to purchase the shares proposed to be
sold by Chevron; or
. a solicited sale to an acceptable third party, provided that if Dynegy
advises Chevron that the sale to a third party is not acceptable, Dynegy
must purchase all of the offered shares for cash at a purchase price
equal to 105% of the third party offer.
Upon the sale or transfer to any person other than an affiliate of Chevron,
the shares of Class B common stock automatically convert into shares of Class A
common stock.
The shareholder agreement further provides that Dynegy may require Chevron
and its affiliates to sell all of the shares of Class B common stock under
specified circumstances. These rights are triggered if Chevron or its Board
designees block--which they are entitled to do under Dynegy's Bylaws--any of
the following transactions two times in any 24-month period or three times over
any period of time:
. the issuance of new shares of stock where the aggregate consideration to
be received exceeds the greater of $1 billion or one-quarter of Dynegy's
total market capitalization;
. any disposition of all or substantially all of Dynegy's liquids business
or gas marketing business while substantial agreements between Chevron
and Dynegy exist (except for a contribution of such liquids business to
an entity in which Dynegy has a majority direct or indirect interest);
. any merger, consolidation, joint venture, liquidation, dissolution,
bankruptcy, acquisition of stock or assets, or issuance of common or
preferred stock, any of which would result in payment or receipt of
19
consideration having a fair market value exceeding the greater of $1
billion or one-quarter of Dynegy's total market capitalization; or
. any other material transaction or series of related transactions which
would result in the payment or receipt of consideration having a fair
market value exceeding the greater of $1 billion or one-quarter of
Dynegy's total market capitalization.
However, upon occurrence of one of these triggering events and in lieu of
selling Class B common stock, Chevron may elect to retain the shares of Class B
common stock but forfeit its right and the right of its Board designees to
block the transaction listed above. A block consists of a vote against a
proposed transaction by either (a) all of Chevron's representatives on the
Board of Directors present at the meeting where the vote is taken (if the
transaction would otherwise be approved by the Board of Directors) or (b) any
of the Class B common stock held by Chevron and its affiliates if the
transaction otherwise would be approved by at least two-thirds of all other
shares entitled to vote on the transaction, excluding shares held by
management, directors or subsidiaries of Dynegy.
The shareholder agreement also prohibits Dynegy from taking the following
actions:
. issuing any shares of Class B common stock to any person other than
Chevron and its affiliates;
. amending any provisions in Dynegy's Articles of Incorporation or Bylaws
which, in each case, contain or implement the special rights of holders
of Class B common stock, without the consent of the holders of the shares
of Class B common stock or the three directors elected by such holders;
. adopting a shareholder rights plan, "poison pill" or similar device that
prevents Chevron from exercising its rights to acquire shares of common
stock or from disposing of its shares when required by Dynegy; and
. acquiring, owning or operating a nuclear power facility, other than being
a passive investor in a publicly-traded company that owns a nuclear
facility.
Generally, the provisions of the shareholder agreement terminate on the date
Chevron and its affiliates cease to own shares representing at least 15 percent
of the outstanding voting power of Dynegy. At such time all of the shares of
Class B common stock held by Chevron would convert to shares of Class A common
stock.
20
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. Earnings (loss) per share
("EPS"), shares outstanding for EPS calculation and cash dividends per common
share are adjusted for a two-for-one stock split on August 22, 2000 and, for
all periods prior to February 1, 2000, for the 0.69-to-one exchange ratio in
the Illinova acquisition.
As discussed in the Explanatory Note to the accompanying Consolidated
Financial Statements, the accompanying Consolidated Financial Statements have
been restated to correct certain errors and to reflect other adjustments
arising since the date of the Original Filing. Please read the Explanatory Note
to the accompanying Consolidated Financial Statements for additional
information about these restatements. The selected financial data that follows
has been adjusted to reflect these restatements.
Dynegy's Selected Financial Data
Year Ended December 31,
-------------------------------------------
2001 2000 1999 1998 1997
------- ------- ------- ------- -------
($ in millions, except per share data)
(Restated)
Statement of Operations Data/(1)(4)/:
Revenues............................................... $42,613 $29,327 $15,410 $14,258 $13,378
General and administrative expenses.................... 547 345 219 186 149
Depreciation and amortization expense.................. 488 393 115 113 104
Asset impairment, abandonment and other charges........ -- -- -- 10 275
Operating income (loss)................................ 802 787 226 65 (143)
Net income (loss)...................................... $ 406 $ 436 $ 137 $ 53 $ (102)
Earnings (loss) per diluted share...................... $ 1.07 $ 1.27 $ 0.60 $ 0.23 $ (0.49)
Shares outstanding for diluted EPS calculation......... 340 315 230 227 208
Cash dividends per common share........................ $ 0.30 $ 0.25 $ 0.04 $ 0.04 $ 0.04
Cash Flow Data:
Cash flows from operating activities................... $ 550 $ 420 $ 40 $ 251 $ 279
Cash flows from investing activities................... (3,828) (1,539) (391) (295) (511)
Cash flows from financing activities................... 3,450 1,131 399 50 205
Other Financial Data:
Cash dividends or distributions to partners, net....... (98) (112) (8) (8) (8)
Capital expenditures, acquisitions and investments/(3)/ (4,687) (2,415) (521) (478) (1,034)
21
December 31,
------------------------------------
2001 2000 1999 1998 1997
------- ------- ------ ------ ------
($ in millions)
(Restated)
Balance Sheet Data/(2)(4)/:
Current assets............................................ $ 8,956 $10,827 $2,658 $2,117 $2,019
Current liabilities....................................... 8,538 10,286 2,467 2,026 1,753
Property and equipment, net............................... 9,201 7,081 2,090 1,932 1,522
Total assets.............................................. 25,168 22,662 6,451 5,264 4,517
Long-term debt............................................ 4,500 3,151 1,372 953 1,002
Transitional funding notes................................ 516 603 -- -- --
Non-recourse debt......................................... -- -- 35 94 --
Serial preferred securities of a subsidiary............... 46 46 -- -- --
Company obligated preferred securities of subsidiary trust 200 300 200 200 200
Series B convertible preferred securities/(5)/............ 882 -- -- -- --
Minority interest/(6)/.................................... 1,040 1,022 -- -- --
Capital leases............................................ 44 15 -- -- --
Total equity.............................................. 4,937 3,441 1,165 1,073 1,019
--------
/(1)/ The following acquisitions were accounted for in accordance with the
purchase method of accounting and the results of operations attributable
to the acquired businesses are included in the Company's financial
statements and operating statistics beginning on the acquisitions'
effective date for accounting purposes:
. BG Storage Limited ("BGSL")--December 1, 2001;
. iaxis, Limited ("iaxis")--March 1, 2001;
. Extant, Inc. ("Extant")--October 1, 2000;
. Illinova Corporation ("Illinova")--January 1, 2000; and
. Destec Energy, Inc. ("Destec")--July 1, 1997.
/(2)/ The BGSL, iaxis, Extant, Illinova, and Destec acquisitions 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. See footnote 1 above for respective effective dates.
/(3)/ Includes the value assigned to the assets acquired in various business
and asset acquisitions. Also includes expenditures associated with the
leased assets brought onto the Company's balance sheet as a result of the
restatement items described in the Explanatory Note to the Consolidated
Financial Statements. The 1997 amount is before reduction for value
received upon sale of Destec's foreign and non-strategic assets of
approximately $735 million.
/(4) /As described elsewhere in this report, the financial statements contained
herein have been restated to reflect various items. Approximately $55
million of the restatement items relate to periods prior to 1999, the most
significant of which is related to the re-allocation of an $80 million
after-tax charge (previously recognized in the second quarter 2002)
associated with the Company's natural gas marketing business. For purposes
of this Selected Financial Data table, we have included the entire $55
million in the balance sheet, statement of operations, cash flow and other
financial data for the year ended December 31, 1998. Management does not
believe that the failure to allocate this $55 million charge to periods
prior to 1999 is material to the presentation of the Company's financial
results, known material trends or contingencies in the Company's business.
/(5)/ Amount equals the $1.5 billion in proceeds related to the Series B
convertible preferred securities less the $660 million implied dividend
recognized in connection with the beneficial conversion option plus the
$42 million in accretion of the implied dividend through December 31,
2001.
/(6)/ Includes amounts relating to the Catlin transaction discussed under
"Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources--Financing Trigger Events"
below.
22
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
consolidated financial statements of Dynegy Inc. ("Dynegy" or the "Company")
and the notes thereto included herein. As discussed in the Introductory Note to
this Form 10-K/A, the financial information contained in this report has been
revised to reflect the restatement items described in the Explanatory Note to
the accompanying Consolidated Financial Statements. These restatement items
include adjustments previously announced by Dynegy in its Current Reports on
Form 8-K dated November 14, 2002 and January 31, 2003 and in Amendment No. 1 to
its Form 10-K, which was filed on February 14, 2003, as well as further
adjustments as described in the Explanatory Note to the accompanying
Consolidated Financial Statements. Dynegy's shelf registration statement filed
on March 25, 2002 and the documents incorporated by reference therein,
including this Form 10-K/A, remain subject to an ongoing review by the SEC
Division of Corporation Finance.
PLEASE NOTE THAT THE INFORMATION CONTAINED IN THIS FORM 10-K/A, INCLUDING
THE FINANCIAL STATEMENTS AND THE NOTES THERETO, DOES NOT REFLECT EVENTS
OCCURRING AFTER MARCH 13, 2002 (THE DATE ON WHICH DYNEGY FILED ITS 2001 FORM
10-K) . FOR A DESCRIPTION OF THESE EVENTS, PLEASE READ THE COMPANY'S EXCHANGE
ACT REPORTS FILED SINCE MARCH 13, 2002, INCLUDING ITS ANNUAL REPORT ON FORM
10-K FOR THE YEAR ENDED DECEMBER 31, 2002. SEE NOTE 19--SUBSEQUENT EVENTS FOR
FURTHER DISCUSSION.
Dynegy is one of the world's leading energy merchants. Through its global
energy delivery network and marketing, logistics and risk-management
capabilities, the Company provides innovative solutions to customers in North
America, the United Kingdom and Continental Europe. Dynegy's operations are
reported in four segments: Wholesale Energy Network ("WEN"), Dynegy Midstream
Services ("DMS"), Transmission and Distribution ("T&D") and Dynegy Global
Communications ("DGC"). WEN is engaged in the physical supply of and
risk-management activities around wholesale natural gas, power, coal and other
similar products. This segment is focused on optimizing the Company's and its
customers' global portfolio of energy assets and contracts, as well as direct
commercial and industrial sales and retail marketing alliances. DMS consists of
the Company's North American midstream gas processing and NGL marketing
businesses and worldwide natural gas liquids marketing and transportation
operations. Dynegy's T&D segment includes the operations of Illinois Power
Company ("IP"), an energy delivery company engaged in the transmission,
distribution and sale of electricity and natural gas to customers across a
15,000-square-mile area of Illinois. DGC is engaged in the telecommunications
business. DGC has a global long-haul fiber optic and metropolitan network
located in cities in the United States and Europe.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business strategy has historically focused on acquiring,
constructing or contracting for a regionally diverse network of energy assets
to capture potential synergies existing among these types of assets and
Dynegy's marketing businesses. Dynegy relies upon operating cash flow along
with borrowings under a combination of commercial paper programs, money market
lines of credit, credit facilities and project-specific debt financings, as
well as public debt and equity issuances for its liquidity and capital resource
requirements.
In December 2001, Dynegy announced a $1.25 billion capital program to
respond to concerns of credit rating agencies and trade counterparties
regarding balance sheet strength in the merchant energy sector. In accordance
with the plan, Dynegy raised $744 million in net proceeds by selling
approximately 37.9 million shares of common stock, including 10.4 million
shares purchased by ChevronTexaco. Net proceeds from the sale of these shares
were used to reduce indebtedness under Holdings' revolving credit facility by
approximately $540 million. The remainder of the proceeds were held as cash.
23
In addition, the Company reduced its original 2002 capital-spending program
by over $500 million to approximately $1.2 billion. This reduction in capital
spending related to funds originally budgeted for capital expenditure
opportunities that were anticipated to arise during the year. The Company's
primary capital expenditure focus will be the acquisition and/or construction
of energy assets that will enable the Company to expand its energy network.
Expenditures will include maintenance capital at existing facilities of
approximately $430 million. The Company also anticipates limiting future
capital expenditures associated with its communications network.
The Company believes it prudent to continue to increase liquidity and
strengthen its balance sheet and, as a result, is assessing additional
alternatives, including possible joint ventures or sales of assets and
businesses. These steps are designed to continue the Company's capital program.
Such steps are also being taken to reduce leverage and to establish revised
targets for debt to capitalization and coverage ratios.
In January 2002, the Company completed its acquisition of Northern Natural.
Enron Corp. ("Enron") has the option to reacquire Northern Natural through June
30, 2002 for $1.5 billion plus various adjustments. Dynegy's acquisition of
this asset increases the Company's financial leverage. This increased leverage
results partially from Northern Natural's $950 million of indebtedness and
partially from the $1.5 billion of Series B Mandatorily Convertible Redeemable
Preferred Stock ("Series B Preferred Stock") sold to ChevronTexaco, the
proceeds of which were used to purchase preferred stock in Northern Natural.
The Series B Preferred Stock is mandatorily redeemable by Dynegy in November
2003. The Company is actively assessing alternatives regarding the Series B
Preferred Stock and its capital structure to accommodate Northern Natural in
the event Enron does not exercise its repurchase option. See "--Enron/Northern
Natural."
Available Credit Capacity
The following table provides the components of the Company's available
credit capacity.
Available Credit Capacity as of December 31, 2001
Dynegy
Dynegy Holdings Illinois
($ in millions) Total Inc. Inc. Power
--------------------------------------------------------- ------ ------ -------- --------
Outstanding Commercial Paper, Loans and Letters of Credit $1,300 $ -- $1,022 $278
Unused Borrowing Capacity................................ 940 300 618 22
------ ---- ------ ----
Total Credit Capacity.................................... $2,240 $300 $1,640 $300
====== ==== ====== ====
Dynegy does not have access to the commercial paper markets and has relied
on bank credit facilities, operating cash flow, public equity and debt
issuances and cash on hand for its short-term liquidity requirements. Sales of
common stock in December 2001 and January 2002 generated aggregate net proceeds
of approximately $744 million which were used to pay down approximately $540
million of indebtedness under Holdings' revolving credit facility; the
remainder was invested in cash. In February 2002, Holdings issued $500 million
of 8.75% senior notes due 2012 and used the net proceeds to pay down
approximately $250 million of indebtedness under Holdings' revolving credit
facility; the remainder was invested in cash. The Company's 364-day revolving
credit facilities--a $1.2 billion facility at Holdings, a $300 million facility
at IP, a $300 million facility at Dynegy and a $400 million facility at
Holdings--mature in May 2002, May 2002, November 2002 and May 2003,
respectively. In addition, Northern Natural has a $450 million 364-day
revolving credit facility that matures in November 2002.
As of February 27, 2002, the Company and its subsidiaries had committed
credit lines of approximately $2.7 billion (including the Northern Natural
revolving credit facility). As of such date, there were outstanding borrowings
of approximately $1.1 billion and outstanding letters of credit of
approximately $427 million under
24
these credit facilities, leaving approximately $1.2 billion of available
borrowing capacity under these credit facilities. In addition, the Company had
cash of approximately $560 million. As a result, the Company's liquidity
position was approximately $1.7 billion. Management believes this level of
liquidity is adequate to allow Dynegy to operate its business, even in the
event of a downgrade in credit rating.
Credit Rating Discussion
Credit ratings impact the Company's ability to obtain short- and long-term
financing, the cost of such financing and the execution of its commercial
strategies in a cost-effective manner. In determining the Company's credit
ratings, the rating agencies consider a number of factors. Quantitative factors
that appear to be given significant weight include, among other things,
earnings before interest, taxes and depreciation and amortization ("EBITDA");
operating cash flow; total debt outstanding; off balance sheet obligations and
other commitments; fixed charges such as interest expense, rent or lease
payments; payments to preferred stockholders; liquidity needs and availability;
and various ratios calculated from these factors. Qualitative factors include,
among other things, predictability of cash flows, business strategy, industry
position and contingencies. Although these factors are among those considered
by the rating agencies, each agency may calculate and weigh each factor
differently.
Substantially all of the credit ratings of Dynegy Inc. and its subsidiaries
are under review for possible downgrade in part due to uncertainties regarding
the litigation by Enron against Dynegy (which is more fully discussed in Note
11 to the consolidated financial statements). In addition, the credit rating
agencies have refocused their attention on the credit characteristics and
credit protection measures of industry participants, and appear to have
tightened the standards for a given rating level. Before Dynegy's capital
program was announced, Moody's downgraded its ratings of Dynegy and its
subsidiaries. The initial phase of the capital program was designed to restore
the Moody's ratings and maintain the Fitch and Standard & Poors' ratings. There
can be no assurance that these results will be achieved, but the Company
believes it is taking action to accomplish these results.
As of February 28, 2002, Dynegy's senior unsecured debt ratings, as assessed
by the three major credit rating agencies, were as follows:
Standard & Poors' Moody's Fitch
Rated Enterprises ----------------- ------- -----
Senior Unsecured Debt Rating:
Dynegy Holdings Inc./(1)/.......... BBB+ Baa3 BBB+
Dynegy Inc./(2)/................... BBB Ba1 BBB
Illinois Power/(3)/................ BBB Baa3 BBB+
Illinova Corporation/(4)/.......... BBB Ba1 BBB
Northern Natural/(5)/.............. CC B3 CC
Commercial Paper/Short-Term Rating:
Dynegy Holdings Inc................ A-2 P-3 F2
Dynegy Inc......................... A-2 NP F2
Illinois Power..................... A-2 P-3 F2
--------
/(1)/ Dynegy Holdings Inc. is the primary debt financing entity for the
enterprise. This entity is a subsidiary of Dynegy Inc. and is a holding
company that includes substantially all of the operations of the WEN and
DMS business segments.
/(2)/ Dynegy Inc. is the parent holding company. This entity generally provides
financing to the enterprise through issuance of capital stock.
/(3)/ Illinois Power is a stand-alone entity from a financial credit
perspective. This entity includes the Company's regulated transmission
and distribution business in Illinois.
/(4)/ Illinova Corporation is the holding company for Illinois Power and is not
used to raise capital.
/(5)/ Ratings have not changed since Dynegy's acquisition of Northern Natural
and reflect Enron's repurchase option.
25
The abbreviations for the investment grade credit ratings assigned by the
three major credit rating agencies are set forth below, in order of declining
credit:
Standard & Poor's Moody's Fitch
----------------- ------- -----
AAA Aaa AAA
AA+ Aa1 AA+
AA Aa2 AA
AA- Aa3 AA-
A+ A1 A+
A A2 A
A- A3 A-
BBB+ Baa1 BBB+
BBB Baa2 BBB
BBB- Baa3 BBB-
A downgrade in Dynegy's credit ratings to below investment grade would cause
a material reduction in the amount of trade credit expected to be extended by
Dynegy's counterparties until these ratings could be restored. The Company also
anticipates that counterparties would increase their collateral demands
relating to its wholesale marketing and risk-management business. Downgrades in
Dynegy's credit ratings to below investment grade also would trigger the
financing covenants described below under "--Financing Trigger Events." Such a
downgrade also could increase the risk that the Company would be unable to
refinance debt obligations as they mature and could increase the borrowing
costs incurred by the Company in connection with any such refinancings. The
Company's financial flexibility would likewise be reduced as a result of
restrictive covenants and other terms that are typically imposed on
non-investment grade borrowers.
Financing Trigger Events
Dynegy's debt instruments and other financial obligations include routine
provisions, which, if not met, could require early payment, additional
collateral support or similar actions. For Dynegy, these trigger events include
leverage ratios, insolvency events, defaults on scheduled principal or interest
payments, acceleration of other financial obligations and change of control
provisions. Dynegy does not have any trigger events tied to specified credit
ratings or stock price in its debt instruments and has not executed any
transactions that require it to issue equity based on credit rating or other
trigger events.
The Company has two non-commercial agreements that have trigger events tied
to credit ratings. At December 31, 2001, the amount of cash collateral that the
Company could be required to post in the event of a ratings trigger under these
two agreements was approximately $300 million. The Company's investment in
Catlin Associates, LLC, described below, accounts for $270 million of the
possible $300 million in possible cash collateralization and would be triggered
only if the senior unsecured debt ratings for Dynegy Holdings were below
investment grade with both Standard & Poor's and Moody's. The remaining
approximate $30 million relates to the Company's guarantee of environmental
obligations of West Coast Power, a 50 percent owned equity investment. This
obligation would be triggered by a downgrade in Dynegy Holdings' credit rating
to below investment grade by either Moody's or Standard & Poor's. Dynegy's
credit ratings are under review for possible downgrade by Moody's, Standard &
Poor's and Fitch. Please see "--Credit Rating Discussion."
In June 2000, Dynegy and Black Thunder Investors LLC ("Investor") invested
in Catlin Associates, L.L.C. ("Catlin"), an entity that is consolidated by
Dynegy into its financial statements, with the Investor's ownership in Catlin
reflected as Minority Interest in the Consolidated Balance Sheet. Dynegy
invested approximately $95 million in Catlin and the Investor invested $850
million. As a result of its investment, the Investor received a preferred
interest in Catlin, which has a security interest in the stock of Dynegy
Midwest Generation, Inc. ("DMG"), an entity holding certain of Dynegy's midwest
generation assets, including the coal-fired generation units in Illinois. This
preferred interest is a passive interest and generally is not entitled to
management rights.
26
On or before June 29, 2005, Dynegy is effectively obligated to purchase the
Investor's preferred interest for $850 million unless the Investor agrees to
extend or refinance this obligation. Alternatively, Dynegy could liquidate
Catlin's assets, including DMG's generating assets, to satisfy this obligation.
In addition to granting Catlin a security interest in the stock of DMG,
Dynegy also has agreed to pay to DMG, to the extent that DMG has either
distributed or loaned money directly or indirectly to Dynegy, an amount not to
exceed $275 million. This payment obligation builds over time to a maximum of
$275 million in 2005. As of December 31, 2001, Dynegy's obligation to DMG under
the agreement was approximately $35 million. In addition, in the event
projected cash flow is insufficient to cover capital expenditures and certain
other fixed charges, Dynegy may be required to make an additional capital
contribution of up to $60 million to Catlin. The $60 million contingent
obligation expires on December 31, 2002.
If Holdings' senior unsecured debt is downgraded below investment grade by
both Standard & Poor's and Moody's, Dynegy would be required to post cash
collateral in an aggregate amount of $270 million and, within 30 days, obtain
an investment grade rating for the Catlin membership interest held by the
Investor by either Standard & Poor's or Moody's or obtain a waiver from the
Investor.
If Dynegy were unable to obtain the required rating for the interest held by
the Investor or waiver, Dynegy would have the option of purchasing or
refinancing the Investor's interest in Catlin. If Dynegy was unable or
otherwise elected not to exercise this option, it could ultimately result in an
election by the Investor to cause the liquidation of the underlying generation
assets in an amount sufficient to redeem the Investor's interest. Given the
strategic importance of these generation assets, it is likely that Dynegy would
seek to refinance or purchase the Investor's interest under such circumstances.
Trade Credit
The Company's commercial agreements typically include adequate assurance
provisions relating to trade credit and some agreements also have credit rating
triggers. These trigger events typically would give counterparties the right to
suspend or terminate credit if the Company's credit ratings were downgraded to
non-investment grade status. Under such circumstances, Dynegy would need to
post collateral to continue transacting risk-management business with many of
its counterparties under either adequate assurance or specific credit rating
trigger clauses. The cost of posting collateral would increase the Company's
financing costs and could adversely impact the Company's profitability. If such
collateral was not posted, the Company's ability to continue transacting its
risk-management business as before the downgrade would be materially adversely
affected.
Following the Enron bankruptcy, there has been a general industry-wide
contraction in trade credit in the wholesale energy markets. Open or unsecured
credit lines generally have been reduced, and counterparties are more stringent
in requiring credit support in the form of cash in advance, letters of credit
or guarantees as a condition to transacting business above open credit limits.
In addition, parties engaged in the wholesale marketing business, including
Dynegy, are moving towards the implementation of standardized agreements that
allow for the netting of positive and negative exposures associated with a
single counterparty. Most commercial agreements typically include "adequate
assurance" provisions or specific ratings triggers. These clauses typically
give counterparties the right to suspend or terminate credit if the Company's
credit ratings fall below investment grade.
Dynegy's wholesale marketing and risk-management business has historically
relied upon Holdings' senior unsecured debt investment grade credit rating to
satisfy the credit support requirements of many counterparties.
27
Disclosure of Financial Obligations and Contingent Financial Commitments
Dynegy has incurred financial obligations and commitments in the normal
course of its operations and financing activities. Financial obligations
include future cash payments required under existing contractual arrangements,
such as debt and lease agreements. These obligations may result from both
general financing activities as well as from commercial arrangements that are
directly supported by related revenue-producing activities. Financial
commitments represent contingent obligations, which become payable only if
pre-defined events were to occur, such as financial guarantees.
As discussed in the Explanatory Note to the accompanying Consolidated
Financial Statements, the accompanying Consolidated Financial Statements
reflect various restatement items that have become known to management since
the date of the Original Filing. Please read the Explanatory Note to the
accompanying Consolidated Financial Statements for additional information about
these restatements. The tables that follow have been adjusted since the
Original Filing to reflect these restatements.
The following table provides a summary of general financial obligations as
of December 31, 2001. This table includes cash obligations related to
outstanding debt, redeemable preferred stock and similar financing
transactions. This table also includes cash obligations for minimum lease
payments associated with general corporate services, such as office and
equipment leases.
General Financial Obligations as of December 31, 2001
Payments Due By Period
----------------------------------------------
Cash Obligations*
($ in millions) Total 2002 2003 2004 2005 2006 Thereafter
------------------------------------------ ------ ---- ------ ---- ------ ---- ----------
Current Portion of Long Term Debt and
Transitional Funding Trust Notes/(1)/... $ 458 $458 $ -- $ -- $ -- $ -- $ --
Long Term Debt/(1)/....................... 4,500 -- 254 169 918 388 2,771
Transitional Funding Trust Notes/(1)/..... 516 -- 86 86 86 86 172
Series B Mandatorily Convertible Preferred
Securities/(1)/......................... 1,500 -- 1,500 -- -- -- --
Other Mezzanine Preferred Securities/(1)/. 246 -- -- -- -- -- 246
Operating Leases/(2)/..................... 305 48 44 43 42 40 88
Other Long Term Obligations/(3)/.......... 15 5 5 5 -- -- --
------ ---- ------ ---- ------ ---- ------
Total General Financial Obligations....... $7,540 $511 $1,889 $303 $1,046 $514 $3,277
====== ==== ====== ==== ====== ==== ======
--------
* Cash obligations herein are not discounted and do not include related
interest, accretion or dividends.
/(1)/ Total amounts are included in the December 31, 2001 consolidated balance
sheet. Debt amounts include borrowings outstanding under the following
arrangements:
. U.S. telecommunications network debt ($324 million);
. Commercial paper at Dynegy Holdings and Illinois Power ($44 million);
. Revolving credit facilities at Dynegy Holdings ($600 million in
borrowings) and Illinois Power ($240 million in borrowings);
. Canadian credit agreements ($40 million);
. Dynegy Holdings senior notes ($1,693 million);
. ABG Gas Supply debt financing ($282 million);
. Lease arrangements relating to the Heard and Riverside generating
facilities in Georgia and Kentucky ($342 million);
. Illinova Corporation senior and medium-term notes ($122 million);
. Illinois Power mortgage bonds and pollution control bonds ($1,185
million); and
. Transitional Funding Trust Notes issued by a special purpose trust and
serviced by Illinois Power ($602 million).
28
Please read Note 7--Debt to the Consolidated Financial Statements. The
approximate $900 million increase in Long-Term Debt over the amount
originally reported primarily relates to the consolidation of ABG Gas
Supply, an entity originally formed in connection with Project Alpha, and
the recognition of debt related to generation and telecommunications assets
previously accounted for under operating leases.
/(2)/ Includes primarily minimum lease payment obligations associated with
office and office equipment leases.
/(3)/ Includes decommissioning costs related to the sale of the Clinton nuclear
facility in 1999.
The following table provides a summary of contingent financial commitments
as of December 31, 2001. These commitments represent contingent obligations of
the Company, which may require a payment of cash upon pre-defined events.
Contingent Financial Commitments as of December 31, 2001
Expiration By Period
------------------------------------------
Contingent Obligations*
($ in millions) Total 2002 2003 2004 2005 2006 Thereafter
-------------------------------------- ------ ---- ---- ---- ---- ---- ----------
Letters of Credit/(1)/................ $ 474 $453 $21 $-- $ -- $-- $--
Surety Bonds/(2)/..................... 288 204 31 12 13 14 14
Guarantees/(3)/....................... 270 -- -- 69 145 -- 56
------ ---- --- --- ---- --- ---
Total Contingent Financial Commitments $1,032 $657 $52 $81 $158 $14 $70
====== ==== === === ==== === ===
--------
* Contingent obligations are presented on an undiscounted basis.
/(1)/ Amounts include outstanding letters of credit and uncommitted lines.
/(2)/ Surety bonds are generally on a rolling twelve-month basis.
/(3)/ Amounts include $214 million of residual value guarantees related to
commercial leasing arrangements, further discussed in footnote (1) to the
Commercial Financial Obligations table below. Based on the estimated fair
value of the underlying assets, the Company does not anticipate funding
such amounts. Approximately $30 million of the balance represents a cash
collateralization requirement as described in "Trigger Events" above and
is related to West Coast Power. The remaining $25 million relates to an
insurance program also for West Coast Power. These guarantees do not have
specific expiration dates, thus they have been included in the
"Thereafter" category.
The following table provides a summary of commercial financial obligations,
which are directly associated with revenue-producing activities. These
arrangements provide Dynegy access to assets that provide it with manufacturing
and logistical capacity needed to execute its business strategy, which is
focused upon the physical delivery of energy products to its customers. These
obligations include unconditional purchase obligations associated with
generation turbines, minimum lease payments associated with operating leases on
generation assets, long-haul fiber optic network capacity and other assets used
in its operations, as well as capacity payments under generation supply tolling
arrangements and transportation, transmission and storage arrangements.
Commercial Financial Obligations as of December 31, 2001
Payments Due By Period
----------------------------------------
Cash Obligations*
($ in millions) Total 2002 2003 2004 2005 2006 Thereafter
--------------------------------------- ------ ---- ---- ---- ---- ---- ----------
Operating Leases/(1)/.................. $1,845 $ 98 $ 99 $ 94 $ 77 $ 73 $1,404/(5)/
Unconditional Purchase Obligations/(2)/ 75 60 5 4 3 3 --
Firm Capacity Payments/(3)/............ 2,726 328 297 273 241 226 1,361
Conditional Purchase Obligations/(4)/.. 400 9 57 76 124 110 24
Other Long Term Obligations............ 44 14 5 5 5 5 10
------ ---- ---- ---- ---- ---- ------
Total Commercial Financial Obligations. $5,090 $509 $463 $452 $450 $417 $2,799
====== ==== ==== ==== ==== ==== ======
29
--------
* Cash obligations are presented on an undiscounted basis.
/(1)/ Amounts include the minimum lease payment obligations associated with
various lease arrangements. These lease arrangements are as follows:
. Four lease arrangements relating to generation facilities located in New
York (Central Hudson), Texas (CoGen Lyondell) and Illinois (Tilton); and
. Five lease arrangements relating to five VLGCs utilized in the DMS
segment.
The Contingent Financial Commitments table above includes residual value
guarantees of $214 million related to two of these lease arrangements
(CoGen Lyondell and Tilton). Please read Note 11 to the consolidated
financial statements for a description of these residual value guarantees.
Such leasing arrangements are accounted for as operating leases, thus the
related future obligations are not recorded as liabilities on the Company's
consolidated balance sheet and the depreciation of these assets is not
included in the consolidated statement of operations. The Company elected
to utilize leasing structures to optimize the capital resource allocation,
earnings and tax attributes of the enterprise. Dynegy may ultimately
acquire some or all of the leased assets through exercise of purchase
options established at lease inception based on the then fair market value,
but does not have any plans to do so at this time.
/(2)/ Amounts include natural gas, coal, systems design, and power purchase
agreements.
/(3)/ Firm capacity payments include payments aggregating $2 billion that
provide Dynegy with the option to convert natural gas to electricity at
third-party owned facilities ("tolling arrangements"). These amounts
include tolling payments that are reflected on the Consolidated Balance
Sheet in "Risk-Management Assets" or "Risk-Management Liabilities" and
those that are accounted for on an accrual basis, each as determined by
the applicable contractual terms and in accordance with generally
accepted accounting principles. Approximately 91 percent of the $2
billion of aggregate tolling capacity payments are accounted for on an
accrual basis. These contracts provide Dynegy access to regional
generation capacity to fulfill physical contract requirements of its
customers. These $2 billion in capacity payments, on a discounted basis,
totaled $1.4 billion. Dynegy previously reported in its Form 10-K that
the estimated market value of electricity available for sale under these
arrangements as of the date of the Original Filing, discounted for
credit, price and market liquidity reserves, exceeded the amount of
capacity payments by approximately $325 million. As a result of Dynegy's
correction of its forward power curve methodology effective beginning the
third quarter 2001, the estimated market value of electricity available
for sale under these arrangements at December 31, 2001, discounted for
market liquidity reserves, is approximately $52 million less than the
amount of capacity payments. The other firm capacity payments of
approximately $715 million include fixed obligations associated with
transmission, transportation and storage arrangements routinely used in
the physical movement and storage of energy consistent with the Company's
business strategy.
/(4)/ Amounts include the Company's obligations as of December 31, 2001 to
purchase 14 gas-fired turbines and an information systems service
agreement. Commitments under the turbine purchase orders are payable
consistent with the delivery schedule. The purchase orders include
milestone requirements by the manufacturer and provide the Company with
the ability to cancel each discrete purchase order commitment in exchange
for a fee, which escalates over time. The amounts herein assume all 14
turbines will be purchased. However, Dynegy can cancel these arrangements
at anytime, subject to a termination fee. If Dynegy had terminated the
turbine purchase orders at December 31, 2001, the termination fee would
have been approximately $48 million, reducing Dynegy's conditional
purchase commitment by $435 million. Additionally, if Dynegy had
terminated the service agreement at December 31, 2001, the termination
fee would have been $9 million, reducing Dynegy's commitment by $21
million.
/(5)/ Amounts primarily relate to leases of the Central Hudson generating
assets discussed further in Note 14 to the consolidated financial
statements.
IP has entered into other generating unit specific contracts that stipulate
fixed payments for the supply of energy as well as variable payments for the
reimbursement of operating costs. The costs associated with these arrangements
are included in IP's revenue requirements under its rate-making process.
30
Dynegy has entered into various joint ventures (see Note 6 to the
consolidated financial statements) principally for the purpose of sharing risk
or to optimize existing commercial relationships. These joint ventures maintain
independent capital structures and have financed their operations on a
non-recourse basis to Dynegy.
Enron/Northern Natural
On November 9, 2001, Dynegy entered into a merger agreement with Enron. The
closing of the merger was conditioned upon the accuracy of representation and
warranties, approval of the shareholders of both Dynegy and Enron, the receipt
of applicable regulatory approvals, the absence of material adverse changes and
other customary conditions.
On November 13, 2001, in connection with the merger agreement, ChevronTexaco
purchased 150,000 shares of Dynegy's Series B Preferred Stock for $1.5 billion.
Dynegy used the $1.5 billion of proceeds from this issuance to purchase 1,000
shares of Series A Preferred Stock in Northern Natural. The Series A Preferred
Stock has a 6% cumulative dividend which accrues from the issue date but is not
payable until January 31, 2003. In connection with the preferred stock
investment in Northern Natural, Dynegy paid $1 million to acquire an option to
purchase all of the equity of Northern Natural's indirect parent company. The
exercise price for the option was $23 million, subject to adjustment based on
Northern Natural's indebtedness and working capital.
On November 28, 2001, Dynegy exercised its right to terminate the merger
agreement with Enron. The above-mentioned agreements were impacted as follows:
. Dynegy exercised its option to purchase the indirect parent company of
Northern Natural. The closing of the transaction occurred on January 31,
2002. An Enron subsidiary has the option to reacquire Northern Natural
through June 30, 2002 for $1.5 billion plus accrued but unpaid dividends
on the Series A Preferred Stock and the option exercise price, subject to
adjustment based on Northern Natural's indebtedness and working capital.
. At January 31, 2002, Northern Natural had approximately $950 million of
debt outstanding. Approximately $500 million of this debt is in the form
of senior unsecured notes and the remaining $450 million is in the form
of a secured line of credit. Dynegy has agreed to commence a tender offer
by April 1, 2002 for $100 million of the senior unsecured notes due May
2005. The significant terms of the Northern Natural debt are as follows
($ in millions):
Senior Notes, 6.875% due May 2005.................................. $100
Senior Notes, 6.75% due September 2008............................. 150
Senior Notes, 7.00% due June 2011.................................. 250
Borrowing under Revolving Credit Agreement, 4.66% due November 2002 450
----
Total debt...................................................... $950
====
. Management believes, based on an internal analysis of Northern Natural's
credit capacity, including a review of other regulated pipelines, that
Northern Natural will be able to refinance the $450 million secured line
of credit, and it is Northern Natural's management's intention to do so.
. Each share of Dynegy's Series B Preferred Stock became convertible, at
the option of ChevronTexaco, for a period of two years, into shares of
Dynegy Class B common stock at the conversion price of $31.64. This
conversion price represents a 5% discount to the Company's stock price on
November 7, 2001, the date the conversion price was negotiated. As a
result of this event, ChevronTexaco acquired a beneficial conversion
option, which will be accreted by Dynegy over the two-year option
conversion term as an implied dividend. Based on the implied value of the
beneficial conversion option as of November 7, the Company originally
recognized a special preferred stock dividend of approximately $65
million. The Company was recognizing this dividend over the two-year
period from the issuance date of the preferred stock to the mandatory
redemption date. For purposes of calculating the value of the beneficial
conversion option, the Company originally used November 7, 2001 as the
commitment
31
date. The Company has since determined that it should have used November
13, the date ChevronTexaco funded its preferred stock purchase and the
preferred securities were issued, as the commitment date. The Company's
stock price increased significantly between these two dates after the
announcement of the proposed Enron Corp. merger resulting in an implied
value of $660 million rather than the previously disclosed $65 million.
The restated preferred stock dividend amount is calculated based on a
two-year amortization of the beneficial conversion option's implied value
of approximately $660 million. Unless ChevronTexaco exercises its
conversion right, Dynegy is required to redeem the Series B Preferred
Stock for $1.5 billion two years from the date of issuance. The Series B
Preferred Stock is not entitled to a dividend. For further discussion of
Dynegy's accounting for the implied dividend, please read "Explanatory
Note--Restatements and Absence of Report of Independent Public
Accountants" to the accompanying financial statements.
On December 2, 2001, Enron filed for federal bankruptcy protection in the
United States Bankruptcy Court, Southern District of New York. Enron also filed
an adversary proceeding in the bankruptcy court against Dynegy Inc. and Dynegy
Holdings Inc. seeking damages of $10 billion for wrongful termination of the
merger agreement and the wrongful exercise of its option to take ownership of
Northern Natural. (Please refer to Note 11 of the financial statements for
further discussion of this dispute).
As a result of Enron's bankruptcy filing, Dynegy recognized in its fourth
quarter 2001 financial statements a pre-tax charge related to the Company's net
exposure for commercial transactions with Enron. As of December 31, 2001, the
Company's net exposure to Enron, inclusive of certain liquidated damages and
other amounts relating to the termination of the transactions, was
approximately $84 million and was calculated by setting off approximately $230
million owed from various Dynegy entities to various Enron entities against
approximately $314 million owed from various Enron entities to various Dynegy
entities. The master netting agreement between Dynegy and Enron and the
valuation of the commercial transactions covered by the agreement, which
valuation is based principally on the parties' assessment of market prices for
such period, remain subject to dispute by Enron with respect to which there
have been negotiations between the parties. These negotiations have focused on
the scope of the transactions covered by the master netting agreement and the
parties' valuations of those transactions. If any disputes cannot be resolved
by the parties, the agreements call for arbitration. If the setoff rights were
modified or disallowed, either by agreement or otherwise, the amount available
for Dynegy entities to set off against sums that might be due Enron entities
could be reduced materially.
Recent Acquisitions
In the fourth quarter of 2001, Dynegy completed the purchase of BG Storage
Limited ("BGSL"), a wholly owned subsidiary of BG Group plc. Under the terms of
the purchase agreement, Dynegy paid approximately (Pounds)421 million
(approximately $595 million at November 28, 2001) for BGSL. The storage assets,
which are located in the United Kingdom, consist of 30 gas storage injection
wells with five offshore platforms, nine salt caverns, approximately 19 miles
of pipelines and an onshore natural gas processing terminal. The acquisition of
BGSL established Dynegy's physical asset presence in the United Kingdom. In the
first quarter of 2001, Dynegy finalized the acquisition of iaxis, Limited, a
London-based communications company.
Also in the first quarter of 2001, Dynegy completed the acquisition of two
Central Hudson power generation facilities in New York. The Central Hudson
facilities consist of a combination of base load, intermediate and peaking
facilities aggregating approximately 1,700 MW. The facilities are located
approximately 50 miles north of New York City and were acquired for
approximately $903 million cash, plus inventory and working capital
adjustments. The acquisition of these facilities established Dynegy's physical
power presence in the region.
In May 2001, subsidiaries of Dynegy completed a sale-leaseback transaction
with a third party to provide term financing with respect to the Central Hudson
facilities. Under the terms of the sale-leaseback transaction, subsidiaries of
Dynegy sold certain plants and equipment and agreed to lease them back for
terms expiring within 34 years, exclusive of renewal options. Please read the
"Commercial Financial Obligations as of December 31, 2001" table set forth
above for additional information.
32
Capital Spending
The 2002 budget of $1.2 billion includes construction projects in progress,
maintenance capital projects, environmental projects, technology infrastructure
and software enhancements, contributions to equity investments, leasing
transactions and discretionary capital investment funds. The capital budget is
subject to revision as opportunities arise or circumstances change. Funds
approved to be spent for the aforementioned items by the various segments in
2002 are as follows:
Capital Budget for 2002
Estimated
Segment or Category Capital
($ in millions) Spending
-------------------------------- ---------
Wholesale Energy Network........ $ 733
Dynegy Midstream Services....... 75
Transmission and Distribution... 194
Dynegy Global Communications.... 50
Information Technology and Other 144
------
$1,196
======
Included within WEN's capital budget are funds to complete three power
plants under construction that are expected to begin commercial operation
during the summer of 2002. The natural gas-fired facilities will provide
additional generation of approximately 1,500 MW in the aggregate and are
located in Kentucky and Michigan. Additionally, construction has also started
on an 800 MW natural gas-fired peaking facility in Ohio which is expected to
begin operations during the summer of 2003.
Commitments and Contingencies
See Item 8, Financial Statements and Supplementary Data, Note 11, which is
incorporated herein by reference, for a discussion of the Company's commitments
and contingencies.
California Market/West Coast Power
Dynegy and NRG Energy each own 50 percent of West Coast Power, a joint
venture owning power generation plants in southern California. Dynegy's net
interest in West Coast Power represents approximately 1,400 MW of generating
capacity. Dynegy also participates in the California markets independently, as
a wholesale marketer of gas and power. Through its interest in West Coast
Power, Dynegy has credit exposure to state agencies ("ISO" and "PX"), which
primarily relied on receipts from California utilities to pay their bills. West
Coast Power also sells directly to the California Department of Water Resources
("DWR") and pursuant to other bilateral agreements. Pursuant to a November 7,
2001 FERC order, the DWR was ordered for the period of January 17, 2001 forward
to pay for all power purchased on behalf of the net short loads of PG&E and
Southern California Edison. DWR has complied with this order, though there
remain a number of disputes. Additionally, on February 25, 2002, the California
Public Utilities Commission and the California Electricity Oversight Board
filed complaints with the FERC asking that it void or reform power supply
contracts between DWR and, among others, West Coast Power. The complaints
allege that prices under the contracts exceed just and reasonable prices
permitted under the Federal Power Act. While the Company believes the terms of
its contracts are just and reasonable and do not reflect alleged market
manipulation, it cannot predict how the FERC will respond to these complaints.
The Company is vigorously defending against these complaints.
Between the fourth quarter of 2000 and the second quarter of 2001, the power
and natural gas markets in California experienced substantial volatility driven
by a fundamental imbalance in supply and demand and the retail electricity
price caps imposed on the state's two largest utilities. The California market
situation had many
33
impacts, the most significant of which include: (a) a Chapter 11 bankruptcy
filing by PG&E; (b) Dynegy's inclusion on PG&E's creditor committee; (c)
separate rulings by the Ninth Circuit Court of Appeals and the FERC
acknowledging that generators in California are not required to sell to
noncreditworthy counterparties; (d) the FERC's decision to investigate gas
pipeline marketing affiliate abuse in the region; (e) the FERC's imposition of
a market mitigation plan for the Western States Coordinating Council; (f) FERC
orders directing electricity suppliers to either refund a portion of sales
revenue or justify their prices above approved pricing amounts; (g) a failed
settlement conference to determine potential refunds; (h) the scheduling and
subsequent rescheduling of a FERC hearing to calculate any such refunds; (i)
continued debate over the validity and legality of long-term power supply
contracts executed by state agencies; and (j) a settlement agreement between
Southern California Edison and the California Public Utilities Commission that
is designed to allow Southern California Edison to pay its past due debts and
return it to creditworthy status. In addition, Dynegy and several of its
officers were named in various lawsuits associated with the California
situation, which are more fully discussed in Note 11 to the Consolidated
Financial Statements. Additionally, on March 11, 2002, the California Attorney
General filed, on behalf of the People of the State of California, complaints
in San Francisco Superior Court against several energy generators, including
those owned directly by West Coast Power and indirectly by Dynegy Inc. The
complaints allege that since June 1998, these generators sold power in the open
market that should have been held in emergency reserve for the State. In the
aggregate, the complaints seek more than $150 million in penalties, restitution
and return profits from the generators. The Company will vigorously defend
these claims. In the opinion of management, the amount of ultimate liability
with respect to this action will not have a material adverse effect on the
financial position or results of operations of the Company.
As a result of West Coast Power's previously announced long-term sales
arrangement with the DWR, ongoing management of credit risk associated with
direct sales to customers in California and the Ninth Circuit Court of Appeals
and the FERC decisions regarding counterparty choice for generators as well as
other factors, management believes that Dynegy's primary exposure relates to
the realization of its share of West Coast Power's receivables from the ISO and
PX and potential refunds or offsets associated with related transactions.
Transactions with the aforementioned counterparties, other than the ISO and PX,
are current under the terms of each individual arrangement. At December 31,
2001, Dynegy's portion of the receivables owed to West Coast Power by the ISO
and PX approximated $227 million. Management is continually assessing Dynegy's
exposure, as well as its exposure through West Coast Power, relative to its
California receivables and establishes reserves for contingent liabilities
where the amount of potential loss is determined to be probable and estimable.
During 2001, 2000 and 1999, our share of reserves recorded by West Coast Power
totalled $122.5 million, $24.5 million and $4.7 million, respectively. Our
share of the total reserve at December 31, 2001 and 2000 was $151.8 million and
$29.3 million, respectively.
ChevronTexaco Commercial Relationship
Dynegy and ChevronTexaco are in the late stages of negotiations to expand
existing commercial relationships to include natural gas and domestic mixed
NGLs and NGL products produced or controlled by the former Texaco. The expanded
term agreements would extend through August 2006. This expanded relationship
will increase the volume of natural gas we purchase from ChevronTexaco from
approximately 2 Bcf/d to approximately 3 Bcf/d. We also expect to provide
supply and service for approximately 2 Bcf/d of natural gas for the former
Texaco's facilities and third-party term markets. In addition, DMS' expanded
contract with ChevronTexaco is expected to include substantially all of the
U.S. NGL production of the former Texaco. Concurrent with the expanded
commercial agreements, the two companies are exploring alternative security
provisions that would be mutually beneficial. Alternatives could include
replacement of existing credit support arrangements with a perfected security
interest in a portion of our trade receivables.
Dividend Policy
In 2002, Dynegy intends to pay an annual dividend of $0.30 per share of
common stock, subject to declaration by the Board of Directors of the Company
and the availability of funds legally available therefore. The Class B common
stock has conversion features and maintains preemptive rights under the Chevron
U.S.A. Inc. shareholder agreement (See Item 5. "Shareholder Agreement" for more
details).
34
Concentration of Credit Risk
As a result of recent volatility in both the commodity and equity markets,
Dynegy has reviewed in-depth its industry credit concentration as well as
specific counterparty credit risks. Based on this reassessment, Dynegy
continues to believe that credit risk imposed by industry concentration is
largely offset by the diversification and creditworthiness of its customer
base. The Company believes that its corporate credit policies are aligned with
business risks in support of minimizing enterprise credit risk.
Accounting Pronouncements
See Item 8, Financial Statements and Supplementary Data, Note 2, which is
incorporated herein by reference, for a discussion of Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("Statement No. 142"), Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations" ("Statement No. 143") and
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("Statement No. 144").
In addition, the Company has interests in joint ventures, equity investments
and financing arrangements that existing accounting guidance precludes us from
consolidating. In the wake of the Enron bankruptcy, accounting standard
setters, including the SEC and the Financial Accounting Standards Board, are
evaluating the existing accounting and disclosure rules and requirements. One
area that has received a high level of scrutiny is the accounting rules related
to consolidations, specifically those that address special purpose entities.
Standard setting bodies and regulators are evaluating the consolidation rules
to determine whether the existing accounting framework should change. There is
a risk that existing standards will change, particularly in light of the events
of 2001, and that these changes could result in the consolidation in the
Company's financial statements of entities that it does not currently
consolidate.
Conclusion
The Company believes it will 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 and equity or debt issuances, if required.
35
RESULTS OF OPERATIONS
The following table reflects certain operating and financial data for the
Company's business segments for the years ended December 31, 2001, 2000 and
1999, respectively. This financial data has been revised to reflect the
restatement items described in the Explanatory Note to the accompanying
Consolidated Financial Statements. Please read this Explanatory Note for
further discussion of these restatement items.
The impact of acquisition and disposition activity during the three-year
period reduces the comparability of certain historical financial and volumetric
data. This is especially true as it relates to power generation, gas processing
and transmission and distribution volumes and to certain financial data
associated with the operations purchased in the Illinova acquisition and the
financial results reflected in the DGC segment.
For segment reporting purposes, all general and administrative expenses
incurred by Dynegy on behalf of its subsidiaries are charged to the applicable
subsidiary as incurred. Dynegy allocates indirect general and administrative
expenses to its subsidiaries using a two-step formula that considers both
payroll expense and the net book value of property, plant and equipment.
Interest expense incurred by Dynegy on behalf of its subsidiaries is allocated
based on the subsidiaries' debt to equity relationship. Other income (expense)
items incurred by Dynegy on behalf of its subsidiaries are allocated equally
among sub-components of the four segments.
DYNEGY'S RESULTS OF OPERATIONS
WEN DMS T & D DGC Total
---- ---- ----- ----- -----
($ in Millions)
(Restated)
2001
Operating Income (Loss):
Wholesale Energy Network:
Customer and Risk-Management Activities. $250 $ -- $ -- $ -- $ 250
Asset Businesses........................ 383 -- -- -- 383
Dynegy Midstream Services:
Upstream................................ -- 82 -- -- 82
Downstream.............................. -- 49 -- -- 49
Transmission & Distribution................ -- -- 180 -- 180
Communications............................. -- -- -- (142) (142)
---- ---- ---- ----- -----
Operating Income (Loss).................... 633 131 180 (142) 802
Equity Earnings............................ 178 13 -- 26 217
Other Items, Net........................... (56) (3) 2 24 (33)
Net Income (Loss).......................... $382 $ 56 $ 32 $ (64) $ 406
2000
Operating Income (Loss):
Wholesale Energy Network:
Customer and Risk-Management Activities. $135 $ -- $ -- $ -- $ 135
Asset Businesses........................ 380 -- -- -- 380
Dynegy Midstream Services:
Upstream................................ -- 44 -- -- 44
Downstream.............................. -- 40 -- -- 40
Transmission & Distribution................ -- -- 206 -- 206
Communications............................. -- -- -- (18) (18)
---- ---- ---- ----- -----
Operating Income (Loss).................... 515 84 206 (18) 787
Equity Earnings............................ 181 24 -- -- 205
Other Items, Net........................... (13) (39) (10) 3 (59)
Net Income (Loss).......................... $386 $ 16 $ 46 $ (12) $ 436
36
WEN DMS T & D DGC Total
---- ---- ----- --- -----
($ in Millions)
(Restated)
1999
Operating Income:
Wholesale Energy Network:
Customer and Risk-Management Activities. $106 $ -- $-- $-- $106
Asset Businesses........................ 38 -- -- -- 38
Dynegy Midstream Services:
Upstream................................ -- 18 -- -- 18
Downstream.............................. -- 64 -- -- 64
Transmission & Distribution................ -- -- -- -- --
Communications............................. -- -- -- -- --
---- ---- --- --- ----
Operating Income........................... 144 82 -- -- 226
Equity Earnings............................ 62 18 -- -- 80
Other Items, Net........................... (13) (18) -- -- (31)
Net Income................................. $107 $ 30 $-- $-- $137
37
DYNEGY'S OPERATING DATA
2001 2000 1999
------- ------- -------
Wholesale Energy Network:
Domestic Gas Marketing Volumes (Bcf/d)/(1)/..... 8.1 7.5 6.5
Canadian Gas Marketing Volumes (Bcf/d)/(2)/..... 3.1 2.2 2.3
European Gas Marketing Volumes (Bcf/d)/(3)/..... 1.3 1.2 1.1
------- ------- -------
Total Gas Marketing Volumes.............. 12.5 10.9 9.9
======= ======= =======
Million Megawatt Hours Generated--Gross......... 40.3 36.8 21.5
Million Megawatt Hours Generated--Net........... 34.5 30.3 12.8
Total Physical Million Megawatt Hours Sold...... 361.8 137.0 79.3
Coal Marketing Volumes (Millions of Tons)....... 43.0 10.4 --
Average Natural Gas Price--Henry Hub ($/Mmbtu).. $ 4.26 $ 3.89 $ 2.29
Average On-Peak Market Power Prices:
Cinergy...................................... $ 35.19 $ 36.43 $ 51.40
TVA.......................................... 34.87 39.73 51.96
PJM.......................................... 40.76 39.96 38.29
CALPX SP15................................... 121.04 113.51 31.99
Dynegy Midstream Services:
Natural Gas Processing Volumes (MBbls/d):
Field Plants................................. 56.1 61.2 85.9
Straddle Plants.............................. 27.7 35.6 36.6
------- ------- -------
Total Natural Gas Processing Volumes..... 83.8 96.8 122.5
======= ======= =======
Fractionation Volumes (MBbls/d)................. 226.2 224.3 210.9
Natural Gas Liquids Sold (MBbls/d).............. 557.4 564.6 537.1
Average Commodity Prices:
Crude Oil--Cushing ($/Bbl)................... $ 26.39 $ 28.97 $ 17.10
Natural Gas Liquids ($/Gal).................. 0.45 0.55 0.34
Fractionation Spread ($/MMBtu)............... 0.89 2.40 1.68
Transmission and Distribution:/(4)/
Electric Sales in kWh (Millions):
Residential.................................. 5,202 5,046 4,949
Commercial................................... 4,377 4,272 4,173
Industrial................................... 8,958 9,271 8,722
Other........................................ 373 412 6,897
------- ------- -------
Total Electric Sales..................... 18,910 19,001 24,741
======= ======= =======
Gas Sales in Therms (Millions):
Residential.................................. 315 337 323
Commercial................................... 136 141 134
Industrial................................... 70 77 71
Transportation of Customer-Owned Gas......... 264 278 297
------- ------- -------
Total Gas Delivered...................... 785 833 825
======= ======= =======
--------
/(1) /Includes immaterial amounts of inter-affiliate gas sales.
/(2) /Represents volumes sold by Dynegy Inc.'s Canadian subsidiary.
/(3) /Represents volumes sold by Dynegy Inc.'s European operations.
/(4) /Volumes for 1999 reflect the operations of IP prior to its acquisition by
Dynegy.
38
Three Years Ended December 31, 2001
For the year ended December 31, 2001, the Company realized net income of
$406 million, or $1.07 per diluted share. This compares with $436 million, or
$1.27 per diluted share, and $137 million, or $0.60 per diluted share, in 2000
and 1999, respectively. Net income and diluted earnings per share include the
following items:
2001 2000 1999
-------------- -------------- -------------
Income Income Income
($ in millions, except per share data) (Charge) EPS (Charge) EPS (Charge) EPS
---------------------------------------------- -------- ----- -------- ----- -------- ----
Enron bankruptcy exposure/(1)/................ (84) (0.25) -- -- -- --
Terminated merger related costs/(2)/.......... (7) (0.02) -- -- -- --
Illinois Power severance costs/(3)/........... (9) (0.03) -- -- -- --
Cumulative effect of an accounting change/(5)/ 2 0.00 -- -- -- --
Gain on Sale--Accord Energy Limited/(6)/...... -- -- 58 0.18 -- --
Gain on Sale--QFs/(7)/........................ -- -- 34 0.11 -- --
Loss on Sale--Crude Business/(8)/............. -- -- (11) (0.03) -- --
Loss on Sale--Mid-continent Assets/(9)/....... -- -- (6) (0.02) -- --
Impairment of a Liquids Asset/(10)/........... -- -- (16) (0.05) -- --
Illinova Acquisition Costs/(11)/.............. -- -- (10) (0.03) -- --
Special Dividend/(4)(12)/..................... -- (0.12) -- (0.10) -- --
Gain on Sale--Quicktrade Investment/(13)/..... -- -- -- -- 6 0.03
--------
/(1)/ The Company recognized an after-tax charge of $84 million ($129 million
pre-tax) related to its net exposure to Enron Corp. as a result of that
company's bankruptcy filing. The pre-tax charge is included in "Cost of
Sales" in the accompanying Consolidated Statements of Operations
("Statements").
/(2)/ The Company terminated its proposed merger with Enron Corp. on November
28, 2001. Transaction costs associated with this terminated merger
approximated $7 million after-tax ($10 million pre-tax). The pre-tax
charge is included in "General and administrative expenses" in the
accompanying Statements.
/(3)/ The Company incurred approximately $9 million of severance costs ($15
million pre-tax) related to a restructuring at Illinois Power. The
pre-tax charge is included in "General and administrative expenses" in
the accompanying Statements.
/(4)/ The special dividend in 2001 relates to the accretion of the beneficial
conversion option in the Series B Preferred Stock held by ChevronTexaco.
/(5)/ Effective January 1, 2001, the Company adopted Financial Accounting
Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended, realizing an after-tax cumulative effect gain of
approximately $2 million.
/(6)/ The Company sold its 25% participating preferred interest in Accord
Energy Limited in the third quarter of 2000. The after-tax gain of
approximately $58 million ($83 million pre-tax) is included in " Loss
(gain) on asset sales" in the accompanying Statements.
/(7)/ The Company sold interests in certain Qualifying Facilities pursuant to
statutory requirements related to the Illinova acquisition. The after-tax
gain of approximately $34 million ($52 million pre-tax) is included in
"Loss (gain) on asset sales" in the accompanying Statements.
/(8)/ The Company sold its non-strategic domestic crude oil marketing and trade
business in the first quarter of 2000. The charge of approximately $11
million after-tax ($18.3 million pre-tax) is included in " Loss (gain) on
asset sales" in the accompanying Statements.
/(9)/ The Company sold its Mid-Continent liquids processing assets in the first
quarter of 2000. The after-tax charge of approximately $6 million ($9
million pre-tax) is included in "Loss (gain) on asset sales" in the
accompanying Statements.
/(10)/ The impairment reserve is associated with a Canadian gas processing
asset. The after-tax charge of approximately $16 million ($25 million
pre-tax) is included in "Depreciation and amortization expense" in the
accompanying Statements.
/(11)/ Amounts relate to non-capitalizable merger related costs associated with
the Illinova acquisition. The after-tax charge of approximately $10
million ($15 million pre-tax) is included in "General and administrative
expenses" in the accompanying Statements.
39
/(12)/ The special dividend in 2000 relates to amounts paid to certain
shareholders pursuant to the execution of the Illinova acquisition.
/(13)/ The Company sold a non-strategic investment in the first quarter of 1999.
Revenues in each of the three years in the period ended December 31, 2001
totaled $42.6 billion, $29.3 billion and $15.4 billion, respectively. Operating
cash flows totaled $550 million for the year ended December 31, 2001, compared
with $420 million in 2000 and $40 million in 1999.
For the year ended December 31, 2001, the Company reported operating income
of $802 million, compared with operating income of $787 million and $226
million for the 2000 and 1999 periods, respectively. The growth in operating
margin is partially offset by higher depreciation and amortization and general
and administrative expenses. Increases in depreciation and amortization expense
during the three-year period reflect the impact of continued expansion of the
Company's depreciable operating and technology asset base. The increased level
of general and administrative expenses period-to-period reflects the
infrastructure required to support a larger operation. Increased overhead costs
are primarily a result of expansion of the Company's operations, primarily in
the DGC segment and in Europe. Additionally, variable compensation costs were
higher in 2001 as compared with both the 2000 and 1999 periods. Gain (loss) on
asset sales principally reflects the pre-tax effect of the gains on the sales
of Accord Energy Limited and certain QFs in 2000, partially offset by the
losses on the sales of the domestic crude business and the Mid-Continent
liquids processing assets. The Company sold its 25 percent participating
preferred interest in Accord Energy Limited for an after tax gain of $58
million ($83 million pre-tax) and sold interests in certain QFs for an after
tax gain of $34 million ($52 million pre-tax). The Company received cash
proceeds of $95 million and $257 million in the Accord and QF transactions,
respectively. The carrying values for the Accord investment and the QFs were
$12 million and $205 million, respectively.
Incremental to Dynegy's consolidated results was the Company's share in the
earnings of its unconsolidated affiliates, which contributed approximately $217
million, $205 million and $80 million in 2001, 2000 and 1999, respectively.
West Coast Power contributed approximately $162 million, $122 million and $16
million to such earnings in 2001, 2000 and 1999, respectively. Cash
distributions received from these investments during each of the three years in
the period ended December 31, 2001 approximated $100 million, $118 million and
$66 million, respectively.
Interest expense totaled $270 million for the year ended December 31, 2001,
compared with $251 million and $78 million for the comparable 2000 and 1999
periods, respectively. The increase in interest expense in 2001 is due
primarily to increased principal, partially offset by lower variable rates than
in 2000. The increase in interest expense in 2000 from 1999 is attributable to
the increased indebtedness resulting from the acquisition of Illinova, both in
terms of Illinova indebtedness assumed in the transaction and principal
borrowed to effect the transaction. Additionally, interest rates on the
variable rate borrowings were higher in 2000 than in 1999.
Other income and expenses, net, reduced 2001 operating results by $33
million, 2000 operating results by $59 million and 1999 operating results by
$31 million. The net amounts for all three years include the financial effects
of minority shareholder investments in some of the Company's operations and
other income and expense items including interest and dividend income, foreign
currency gains and losses, insurance proceeds and other similar items.
The Company reported an income tax provision of $312 million in 2001,
compared to income tax provisions of $246 million and $60 million in 2000 and
1999, respectively. These amounts reflect effective rates of 44 percent, 36
percent and 30 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 goodwill,
book-tax basis differences and other liabilities; and the effect of foreign and
state income taxes. Income tax payments are not expected to have a material
impact on liquidity and capital resources. See Item 8, Financial Statements and
Supplementary Data, Note 8, which is incorporated herein by reference.
40
Wholesale Energy Network
WEN reported segment net income of $382 million for the year ended December
31, 2001, compared with net income of $386 million and $107 million for the
years ended December 31, 2000 and 1999, respectively. Results of operations
during the three-year period were influenced either positively or negatively by:
. New regionally diverse merchant power generating capacity acquired or
placed in service in 2001 and 2000;
. Increased earnings from the equity investment in West Coast Power
year-over-year during the three-year period, partially attributable to
higher price realization for power purchased from West Coast Power;
. An increase in customer risk management activities in 2001, as compared
to 2000, as a result of a long-term power origination contract that
contributed approximately $35 million of operating income during 2001;
. An increase in European and Canadian marketing operations due to
increased customer origination and service demand during the three-year
period;
. Results for 2001 included approximately $82 million exposure to Enron
(net of tax) and an allocation of transaction costs associated with both
the terminated proposed merger with Enron and the execution of Project
Alpha; and
. Results for 2000 include gains of approximately $92 million (net of tax)
on the sale of Accord and QF interests, offset by an allocated portion of
the Illinova acquisition costs.
The new generating capacity in 2001 included the addition of the Central
Hudson power generating facilities in New York and development projects in
Georgia, Kentucky and Louisiana for a total of approximately 2,865 MW, while
new capacity in 2000 included the generation assets from the Illinova
acquisition and development projects in Illinois, Louisiana and North Carolina
for a total of 8,091 MW.
Total electric power produced and sold during 2001 aggregated 361.8 million
megawatt hours compared to 137.0 million and 79.3 million megawatt hours during
2000 and 1999, respectively. The 2001 and 2000 volumes reflect the impact of
additional generating capacity. Total natural gas volumes sold increased to
12.5 billion cubic feet per day from 10.9 billion cubic feet per day in 2000
and 9.9 billion cubic feet per day in 1999. The 2001 increase in natural gas
volumes sold reflects greater market origination, including sales to commercial
and industrial customers, sales volumes on Dynegydirect and increased gas
marketing in Canada. The 2000 increase in natural gas volumes sold reflects the
increased demand by gas-fired generation, expanding European operations and
greater volumes sold to Dynegy's retail alliances.
As described in Note 19--Subsequent Events to the Consolidated Financial
Statements, the Company is in the process of exiting third-party risk
management aspects of the marketing and trading business. The WEN segment's
future results of operations will be affected by this development.
Dynegy Midstream Services
DMS reported net income of approximately $56 million for the year ended
December 31, 2001 compared with net income of $16 million and $30 million in
2000 and 1999, respectively. Results of operations during the three-year period
were influenced either positively or negatively by:
. Higher price realization in 2001, as compared to 2000, resulting from an
active forward sales program and contract restructuring activities,
despite a depressed pricing environment resulting from larger industry
wide inventories;
. Substantial focus on lowering costs throughout the three-year period;
. Lower price realization in 2000, as compared to 1999, resulting from an
active forward sales program and contract restructuring activities;
. NGL commodity prices in 2000, and the volatility associated therewith,
were generally improved over 1999 levels;
41
. Fluctuating world-wide demand for NGLs, particularly in Europe and Asia,
enhanced 2000 revenues from global marketing operations;
. Results for 2001 include approximately $2 million exposure to Enron (net
of tax) as a result of that company's bankruptcy filing and an allocation
of transaction costs associated with the terminated proposed merger with
Enron; and
. Results for 2000 include losses of approximately $17 million (net of tax)
on sales of the Crude Oil Marketing and Trade business (which was sold in
April 2000 and contributed approximately $9 million after tax in 1999)
and Mid-Continent gas processing assets, an impairment of approximately
$16 million (net of tax) relating to Canadian gas processing assets and
an allocation of costs related to the Illinova acquisition.
Average domestic NGL processing volumes totaled 84 MBbls/d in 2001 compared
to an average of 97 MBbls/d and 123 MBbls/d in 2000 and 1999, respectively.
Lower volumes processed in 2001 reflect the impact of market conditions on
straddle plant production during the three-year period and the aforementioned
non-strategic asset dispositions. Volumes processed in 2000 were flat with
volumes processed in 1999 after adjusting for the effects of the asset sales.
NGL market prices during 2001 averaged $0.45 per gallon compared to $0.55 per
gallon and $0.34 per gallon in 2000 and 1999, respectively.
Transmission and Distribution
The Transmission and Distribution segment was formed at the beginning of
2000 and reflects the transmission and distribution operations of IP acquired
in the Illinova acquisition. The segment had net income of approximately $32
million for the year ended December 31, 2001 compared to net income of $46
million for the year ended December 31, 2000. Segment results in 2001 include
approximately $9 million of after-tax severance and early retirement charges
related to a restructuring at IP, offset by an approximate $10 million
after-tax credit related to IP's exit from a nuclear mutual insurance company.
The 2000 results include an approximate $2 million after-tax merger cost charge
related to the Illinova acquisition. In addition to the severance and early
retirement charges, operating income decreased in 2001 as a result of decreased
industrial electricity revenues resulting from increased competition and an
economic downturn, offset by weather-driven sales from electric residential and
commercial customers. Additionally, operating expenses were slightly higher due
to fees paid in connection with an independent system operator and bad debt
expense, offset by lower general and administrative expenses.
Dynegy Global Communications
This segment was formed at the beginning of the fourth quarter of 2000 and
had $64 million and $12 million net losses for the years ended December 31,
2001 and 2000, respectively, resulting from start-up investments associated
with the expansion of the Company's global communications business, which has
operations in the U.S. and Europe.
42
Operating Cash Flow
The following table is a condensed version of the operating section of the
Consolidated Statements of Cash Flows included in Item 8, Financial Statements
and Supplementary Data. Reported amounts reflect the restatement items further
described in the Explanatory Note to the Condensed Financial Statements,
including the reclassification of approximately $290 million of previously
disclosed 2001 operating cash flow to financing cash flow as a result of
restatements relating to Project Alpha.
Dynegy's Condensed Consolidated Cash Flows
2001 2000 1999
------ ----- ----
($ in millions)
Operating Cash Flow:
Net Income........................................... $ 406 $ 436 $137
Net Non-Cash Items Included in Net Income............ 664 284 (72)
------ ----- ----
Operating Cash Flow Before Changes in Working Capital 1,070 720 65
Changes in Working Capital........................... (520) (300) (25)
------ ----- ----
Net Cash Provided by Operating Activities............ $ 550 $ 420 $ 40
====== ===== ====
Increases in operating cash flow in 2001 primarily reflect higher non-cash
add-backs such as depreciation and amortization, reserve for doubtful accounts
and risk management activities. The depreciation and amortization is higher due
to a larger asset base. The reserve for doubtful accounts includes the Enron
exposure write-off of approximately $78 million on a pre-tax basis. Changes in
working capital had a negative impact on operating cash flow in 2001 due
primarily to the timing of cash inflows and outflows related to trade accounts
and certain other deposits.
Operating cash flow results in 2000 primarily reflected higher net income
compared to 1999. Higher net income is offset by increased investments in
inventory and the negative impact on operating cash flows due primarily to the
timing of cash inflows and outflows related to trade accounts.
Operating cash flow in 1999 primarily reflected increased non-cash earnings
from marketing operations.
Changes in other working capital accounts, which include prepayments, other
current assets and 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.
Capital Expenditures and Investing Activities
Funds used in 2001 investing activities totaled $3.8 billion. Included in
the capital expenditures in 2001 is the purchase of the Central Hudson power
generation facilities for $903 million. Additional capital expenditures of
approximately $1.7 billion principally related to the construction of power
generation assets, improvements of existing facilities related to the T&D
segment and investments associated with technology infrastructure. Also during
2001, Dynegy invested $1.5 billion related to its purchase of Northern Natural
Series A Preferred Stock. Business acquisitions for the year ended December 31,
2001 included acquisition costs related to the purchase of BGSL of
approximately $595 million and acquisition costs incurred in 2001 related to
iaxis, Limited. Proceeds from asset sales in 2001 included the sale of the
Central Hudson facilities in May 2001 for $920 million pursuant to a leveraged
lease transaction, in addition to proceeds from the disposal of non-strategic
Canadian assets and investments. Other investing activities in 2001 primarily
include investments relating to a generation and a telecommunications lease
arrangement.
43
In 2000, capital expenditures of approximately $1.1 billion primarily
related to construction of power generation assets, improvements of existing
facilities related to the T&D segment and investments associated with
technology infrastructure. Also during 2000, Dynegy made investments in
unconsolidated affiliates of approximately $142 million, while the $1.2 billion
in business acquisitions in 2000 related primarily to the Illinova and Extant
Inc. acquisitions. Proceeds from asset sales in 2000 of $876 million relate to
sales of QFs and liquids assets.
During the year ended December 31, 1999, the Company invested a net $437
million principally in power generation assets, including a power generation
partnership, and additional expenditures related to capital improvements at
existing facilities and capital investment associated with technology
infrastructure improvements. Also during 1999, the Company sold certain DMS
assets, an investment held by WEN and a 50 percent interest in a power
generation partnership, netting proceeds of $81 million.
Financing Activities
Net cash inflows associated with financing activities in 2001 totaled
approximately $3.5 billion.
Dynegy sold approximately 29.8 million shares of common stock during 2001.
The offerings included approximately 27.5 million shares of Class A common
stock sold to the public in December 2001. The Company also sold approximately
1.2 million shares of Class B common stock to ChevronTexaco in private
transactions pursuant to the exercise of ChevronTexaco's preemptive rights.
Total net proceeds to Dynegy from these sales and proceeds from options and
401(k) plan sales approximated $604 million. This amount is net of underwriting
commissions and expenses of approximately $32 million.
Proceeds of $1.5 billion relate to the sale of 150,000 shares of Series B
Mandatorily Convertible Redeemable Preferred Stock to ChevronTexaco, concurrent
with Dynegy's purchase of Northern Natural Series A Preferred Stock.
Additional 2001 proceeds of $496 million, net of issuance costs, resulted
from the issuance of $500 million of 6.875 percent Senior Notes due April 1,
2011. Such proceeds were used to repay credit facility borrowings obtained to
finance the purchase of the Central Hudson generation facilities, while the
acquisition of BGSL was financed primarily with borrowings under revolving
credit agreements.
In April 2001, Dynegy entered into a structured natural gas transaction
referred to as Project Alpha. The cash inflow of $282 million associated with
the borrowings entered into by ABG Gas Supply is presented as a financing
activity in Dynegy's Consolidated Statement of Cash Flows for 2001.
Also during 2001, IP received proceeds of $187 million from the issuance of
variable rate pollution control bonds. Contemporaneously, the Company retired
and repaid pollution control bonds with a higher rate. During 2001, IP also
redeemed $100 million of Trust Originated Preferred Securities issued by
Illinois Power Financing I. The redemption was financed with $85 million from
cash on hand and $15 million in commercial paper.
Also during 2001, proceeds from lease arrangements of approximately $340
million were used in the construction of two generation facilities and the U.S.
fiber optic network.
During 2001, the Company repurchased approximately 1.7 million shares of its
outstanding Class A common stock pursuant to its stock repurchase plan at a
cost of $68 million.
Dividends and other distributions paid were $98 million, $112 million and $8
million in the years ended December 31, 2001, 2000 and 1999, respectively. The
2000 amount includes a non-recurring dividend payment of approximately $31.8
million related to the Illinova acquisition.
44
Financing activities in 2000 resulted in cash inflows of $1,131 million.
Approximately $1.2 billion was raised through sales of common equity, $200
million of which includes purchases of Class B common stock by Chevron U.S.A.
Inc. The proceeds of the equity sales, in addition to dispositions of
non-strategic assets, proceeds from minority interest contribution and
operational cash inflows, were used as long-term financing for the purchase of
Illinova. The Company also issued $300 million of 8.125 percent Senior Notes
due March 5, 2005. Further, IP redeemed $93 million of tax advantaged Monthly
Income Preferred Securities. Also during 2000, proceeds from lease arrangements
of approximately $250 million were used in the construction of two generation
facilities and the U.S. fiber optic network. Other financing, net in 2000
relates primarily to the $850 million received from a third-party investor for
a minority interest in Catlin LLC, which is consolidated by Dynegy. (See Note
10 to the consolidated financial statements for more information.)
In December 2001, Dynegy announced an approximately $1.25 billion capital
program designed to strengthen its balance sheet and restore market confidence.
In accordance with the plan, Dynegy reduced the original 2002 capital-spending
program by approximately $500 million and raised $744 million through sales of
common stock. The equity offering provided net proceeds of approximately $539
million in December 2001 resulting from the sale of 27.5 million shares of
Class A common stock to the public and proceeds of approximately $205 million,
resulting from the sale of approximately 10.4 million shares of Class B common
stock to ChevronTexaco in January 2002. Concurrent with the December Class A
common stock sale, members of the Company's senior management purchased
approximately 1.2 million shares of Class A common stock in a private placement
transaction pursuant to Section 4(2) of the Securities Act of 1933. The
officers paid $19.75 per share for the stock, the same price as the net
proceeds to the Company in the public offering. The officers paid for the
shares by entering into promissory notes with the Company for an initial term
of 60 days. The maturity date of the notes was extended for an additional 30
days with the approval of the Board of Directors. The loans bear interest at
3.25 percent and are full recourse to the borrowers. Such loans are accounted
for as "Subscriptions Receivable" within Stockholders' Equity on the
Consolidated Balance Sheet at December 31, 2001. The Company recognized
compensation expense in 2001 of approximately $1.2 million, which was recorded
as "General and Administrative Expense."
SEASONALITY
Dynegy's revenues and operating margin are subject to fluctuations during
the year, primarily due to the impact seasonal factors have on sales volumes
and the prices of natural gas, electricity and NGLs. Natural gas sales volumes
and operating margin have historically been 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 and electricity generating facilities have higher
volatility and demand, respectively, in the summer cooling months, while the
transmission and distribution business has higher seasonal gas sales in the
winter and higher seasonal electricity sales in the summer. These trends may
change over time as demand for natural gas increases in the summer months as a
result of increased gas-fired electricity generation. DMS businesses are also
subject to seasonal factors; however, such factors typically have a greater
impact on sales prices than on sales volumes.
FACTORS AFFECTING FUTURE OPERATING RESULTS
Dynegy's results of operations in 2002 and beyond may be significantly
affected by the following factors:
. changes in demand for the Company's power generation, pipeline, NGL or
other facilities caused by general economic or industry conditions,
commodity pricing or competition;
. the volatility and level of prices for energy commodities in North
America and Europe;
. the timing and pace of energy deregulation in North America and Europe
and the effect of the Enron bankruptcy on the pace of deregulation;
. the addition of the historical Texaco U.S. gas and liquids volumes to the
Company's commercial relationship with ChevronTexaco;
45
. the acquisition of Northern Natural and possible repurchase of Northern
Natural by Enron;
. the effect of market uncertainties and the Enron litigation on Dynegy's
credit ratings, costs of borrowing and trade credit; and
. the execution by DGC of its business plans in the telecommunications
market and the resulting impact such execution may have on the
realizability of Dynegy's investment in that business segment.
The Company's results also will be significantly affected by its ability to
execute the business plan and strategy described elsewhere herein, including
the 2002 capital plan, and the ability to manage risk throughout the
enterprise. Additional information regarding our risk management and governance
activities follows. References are also made to the section "Uncertainty of
Forward Looking Statements and Information" for additional factors which might
impact future operating results.
CORPORATE RISK GOVERNANCE
Dynegy's operations and periodic returns are impacted by a myriad of
factors, some of which may, and some of which may not, be mitigated by risk
management methods. These risks include, but are not limited to, commodity
price, interest rate and foreign exchange rate fluctuations, weather patterns,
counterparty risk, management estimations, strategic investment decisions,
changes in competition, operational risks, environmental risks and changes in
regulation.
The effective management of risk is critical to Dynegy's success. Dynegy's
Board of Directors has approved a Risk Policy Statement (referred to herein as
the "Dynegy Risk Policy Statement") that identifies business risks confronting
the enterprise, establishes controls and procedures relating to these risks,
and assigns responsibility for executing the Board's directives. As a
complement to the active management of business risks, Dynegy incorporates a
multi-level control environment that is consistent and aligned with the Dynegy
Risk Policy Statement. The Company's comprehensive risk management process
monitors, evaluates and manages the principal risks assumed in conducting
Dynegy's operations consistent with the Company's corporate strategies and
objectives.
Governance Committees Structure
Dynegy seeks to monitor and control its exposure to risk through a variety
of separate but complementary accounting, financial, credit, operational and
legal reporting systems. Structurally, Dynegy has formed a series of committees
at both the Board and executive leadership levels responsible for establishing
limits, for monitoring adherence to these limits and for general oversight of
the Company's risk management process. Each level of committee has increasingly
greater policy-setting responsibility migrating from a monitoring and managing
role to the role of establishing enterprise-wide risk management policy. These
committees, which are described below, meet regularly and consist of Board
members and senior members of both the Company's revenue-producing units and
departments that are independent of revenue-producing units.
Governance Committees Structure
[GRAPHIC DEPICTING COMMITTEE STRUCTURE]
46
Board of Directors. Ultimate responsibility for ensuring that risks are
appropriately identified and managed lies with the Board of Directors. The
Board's focus is on enterprise risk, which includes market, credit, interest
rate, currency, operational, legal and reputational exposures. All risk
management and control functions ultimately report to the Board. The Board is
solely responsible for approving and amending Dynegy's Risk Policy Statement.
This responsibility has been delegated to the Audit Committee.
Audit Committee. The Audit Committee is a sub-committee of Dynegy's Board.
A key responsibility of this committee is the periodic review of the control
structure governing the enterprise's internal control and risk management
activities, including limit structures, risk procedures and oversight matrices.
The Audit Committee governs internal control and risk-management activities
through the Executive Risk Committee and the Corporate Compliance and Internal
Audit Function.
Audit and Compliance Committee. The Vice President of Corporate Compliance
and Internal Audit is the Company's Business Ethics and Chief Audit Executive,
who reports directly to the Audit Committee. This position is responsible for
the planning and execution of internal financial and operational audits
regarding the adequacy and effectiveness of accounting and financial and
operational controls. This individual works with the Chairman of the Audit
Committee in determining the scope of this committee's function.
Executive Risk Committee. The Executive Risk Committee sets limits, capital
allocation and return targets for enterprise risk, including investment,
commodity and financial risks. Dynegy's Chief Executive Officer, Chief
Operating Officer, Chief Financial Officer and Chief Risk Officer comprise this
committee. This committee reports to the Audit Committee.
Risk Committee. The Risk Committee is focused on the assessment of
financial risks inherent in the enterprise and the establishment of policies
and limits around these risks. Activities performed by this committee include
review of:
. the activities of existing businesses;
. new businesses and products;
. divisional market risk limits;
. business unit market risk limits; and
. currency and interest rate risk limits.
Dynegy's risk limit structure involves five independent limits, which
include: (a) Value at Risk; (b) equity change limits; (c) stop-loss limits; (d)
cash outlay limits; and (e) option limits related to time decay and volatility
factors. These independent limits are applied to each of the Company's
commodity, interest rate and currency portfolios on a segment and business unit
basis. The business unit managers further allocate business unit risk limits to
individuals or desks responsible for executing the Company's strategies. This
process results in a risk control structure, aggregating risk limits throughout
the organization, culminating in an enterprise-wide risk tolerance assessment.
This committee reports to the Executive Risk Committee.
Finance Committee. The Finance Committee is also a sub-committee of
Dynegy's Board. This committee also functions pursuant to a charter that
governs its responsibilities. The Finance Committee is responsible for
oversight of the Company's capital, liquidity and funding needs as well as
reviewing capital allocation and target return criteria.
Risk and Environment Committee. The Risk and Environment Committee provides
oversight of the Company's ongoing development and operational risk policies,
framework and methodologies including policies related to the environment and
occupational health and safety. The committee also determines insurance
coverage and the risk retention policy related thereto. The committee monitors
the effectiveness of this framework. This committee is a sub-committee of
Dynegy's Board.
47
Credit Policy Committee. The Credit Policy Committee establishes and
reviews broad credit policies and parameters for the enterprise. This committee
reports to the Finance Committee.
Risk Limits and Governance
The Board has appointed a Chief Risk Officer who reports to the Audit
Committee. The Chief Risk Officer heads an enterprise-wide risk control
department. This department is independent of any revenue-producing unit of the
organization and conducts its activities independent of any active management
of risk exposures confronting the enterprise. The enterprise-wide risk
department is charged with assuring adherence to Dynegy's Risk Policy
Statement, the independent validation of valuation methodologies employed by
the enterprise as well as assuring compliance with approved risk strategies.
Risk limits are monitored on a daily basis by this department, and the results
of this monitoring activity is reviewed regularly by the appropriate risk
committees. Limit violations are reported to the appropriate Board and
management committees and business unit managers pursuant to a hierarchical
reporting matrix defined in the Dynegy Risk Policy Statement. Resolution of
each limit violation is consistent with protocol detailed in such statement.
The Chief Risk Officer ensures quality assurance of the Risk Policy
Statement by maintaining the Dynegy Risk Management and Control Policy Manual
that governs all business activity and the risk exposure therein. The Dynegy
Risk Management and Control Policy Manual is a comprehensive manual advising
employees of known and potential risks, processes and procedures and knowledge
of all policy-related matters of risk.
Accounting Methodology
Dynegy's Controller Department is responsible for the development and
application of accounting policy and control procedures for the organization's
financial and operational accounting functions. This department conducts its
activities independent of any active management of risk exposures confronting
the enterprise, is independent of revenue-producing units and reports to the
Chief Financial Officer.
The Company has identified three critical accounting policies that require a
significant amount of judgment and are considered to be the most important to
the portrayal of Dynegy's financial position and results of operations. These
policies include the accounting for long-lived assets, the evaluation of
counterparty credit and other similar risks and revenue recognition. See Note 3
to the consolidated financial statements for a discussion of the process
surrounding the evaluation of counterparty credit and other similar risks. For
disclosure on the Company's accounting for long-lived assets and revenue
recognition, refer to Note 2 to the consolidated financial statements. The
following narrative provides additional discussion of the Company's revenue
recognition policy. The bankruptcy of Enron has placed substantial focus on
accounting principles and the application of these principles. The focus has
been around the transparency of disclosures relating primarily to liquidity and
capital resource matters, the valuation of energy trading activities,
transactions with related parties and the use of special purpose entities. As a
result, accounting guidance is expected to continue to evolve and the impact of
potential future revisions in accounting principles will be addressed by the
Company when, and if, they occur.
Dynegy utilizes two comprehensive accounting models in reporting its
consolidated financial position and results of operations as required by
generally accepted accounting principles-an accrual model and a fair value
model. Dynegy determines the appropriate model for its various operations based
on guidance provided in numerous accounting standards and positions adopted by
the Financial Accounting Standards Board ("FASB") or the Securities and
Exchange Commission. The Company has applied these accounting policies on a
consistent basis during the three years in the period ended December 31, 2001,
except for the adoption of Financial Accounting Standard No. 133 ("FAS No.
133"), which was effective January 1, 2001. The implementation of FAS No. 133
was not material to the Company's results of operations or financial position.
The accrual model is used to account for substantially all of the operations
conducted in Dynegy's DMS, T&D and DGC segments as well as all physically
operated assets owned by the WEN segment. These businesses
48
consist largely of the ownership and operation of physical assets. Dynegy uses
these physical assets in various manufacturing and delivery processes. These
processes include the generation of electricity, the separation of natural gas
liquids into their component parts from a stream of natural gas, the
transportation or transmission of commodities through pipelines or over
transmission lines and the delivery of data and voice bits over communication
networks. End sales from these businesses result in physical delivery of
commodities to Dynegy's wholesale, commercial and industrial and retail
customers.
The fair value model is used to account for forward physical and financial
transactions in the WEN, DMS and DGC segments, which meet criteria defined by
the FASB or the Emerging Issues Task Force. The criteria are complex but
generally require these contracts to be related to future periods and contain
fixed price and volume components and have terms that require or permit net
settlement of the contract in cash or its equivalent. The FASB determined that
the fair value model is the most appropriate method for accounting for these
types of contracts. In part, this conclusion is based on the cash settlement
provisions in these agreements, as well as the volatility in commodity prices,
interest rates and, if applicable, foreign exchange rates, which impact the
valuation of these contracts. Since these transactions may be settled in cash,
the value of the assets and liabilities associated with these transactions is
reported at estimated settlement value based on current prices and rates as of
each balance sheet date. Under applicable accounting standards, failure to
present these transactions at other than estimated present settlement value
based on current prices and rates would result in an inaccurate portrayal of
the assets and obligations of an enterprise.
In addition, the Company routinely enters into financial instrument
contracts to hedge purchase and sale commitments, fuel requirements and
inventories in its natural gas, NGLs, electricity and coal businesses in order
to minimize the risk of changes in market prices in these commodities. Dynegy
will also execute financial instrument transactions to hedge exposure to
fluctuations in interest rates and foreign currency exchange rates. These
transactions are accounted for as either cash flow hedges, fair value hedges or
foreign currency hedges in accordance with generally accepted accounting
principles.
49
The following chart provides detail on the accounting principle applications
used by the organization:
Application of Comprehensive Accounting Methodologies
Physical Asset Businesses Marketing and Other Activities
------------------------------------------- --------------------------------------------
Accounting Model Accrual Hedge Accrual Fair Value
--------------------------------------------------------------------------------------------------------------------------
Businesses . Physical Generation . Physical Generation . Current Supply and . Future Supply and
Impacted . (WEN) . (WEN) Market Activities . Market Activities
Owned Storage Gas Processing (Spot Market . Meeting Certain
. Capacity (WEN, DMS, (DMS) Transactions) (WEN, Criteria (WEN, DMS)
. T&D) DMS) Risk Management
. Gas Processing (DMS) Services (WEN, DMS)
Fractionation (DMS) Certain Investments
Transportation & (DGC)
. Transmission
Regulated Businesses
(T&D)
Network Capacity
(DGC)
--------------------------------------------------------------------------------------------------------------------------
Transactions . Normal Purchases . Cash Flow Hedges . Current Supply and . Future Supply and
Impacted and Sales . Fair Value Hedges Market Activities . Market Activities
. Equity Earnings . Foreign Currency (Spot Market Meeting Certain
from Investment in Hedges Transactions) Criteria
Physical Assets Available-for-Sale
Securities
--------------------------------------------------------------------------------------------------------------------------
Revenue Recognition . Revenue and . Recognized When . Revenue and . Future Supply and
Expense is . Item Hedged is Expense is Market Activities and
Recognized When Recognized Recognized When Risk Management
Title Passes or Ineffectiveness of Title Passes or Services Transactions
Service is Performed Hedges Recognized Service is Performed Marked-to-Market
Immediately When Executed with
Changes in Fair
Value Recognized
Throughout Contract
. Term
Certain Gains and
Losses on
Available-for-Sale
Securities
--------------------------------------------------------------------------------------------------------------------------
Balance Sheet Effects . Trade Receivables . Unrealized Gains and Trade Receivables Unrealized Gains and
. and Payables Losses in Risk and Payables Losses from Future
Investment in Management Supply and Market
Unconsolidated Accounts Activities and Risk
Affiliates . Effective Portion of Management Services
Unrealized Gains and in Risk Management
Losses in Other Accounts
Comprehensive Unrealized Gains and
Income Losses on
Available-for-Sale
Securities in
Investment Account
and Other
. Comprehensive
. . Income
--------------------------------------------------------------------------------------------------------------------------
Cash Flow Effects . Disclosed in Net . Periodic Settlements . Disclosed in Net . Unrealized Gains and
Income and Working Disclosed in Net Income and Working Losses are Disclosed
Capital Accounts Income and Working Capital Accounts as Non-Cash
Capital Accounts Adjustments to Net
Income
50
ENTERPRISE RISK MANAGEMENT, VALUATION AND MONITORING
Market Risk
The Company is exposed to commodity price variability related to its natural
gas, NGLs, crude oil, electricity and coal businesses. In addition, fuel
requirements at its power generation, gas processing and fractionation
facilities represent additional commodity price risks to the Company. In order
to manage these commodity price risks, Dynegy routinely utilizes various
fixed-price forward purchase and sales contracts, futures and option contracts
traded on the New York Mercantile Exchange and swaps and options traded in the
over-the-counter financial markets to:
. Manage and hedge its fixed-price purchase and sales commitments;
. Provide fixed-price commitments as a service to its customers and
suppliers;
. Reduce its exposure to the volatility of cash market prices;
. Protect its investment in storage inventories; and
. Hedge fuel requirements.
The potential for changes in the market value of Dynegy's commodity,
interest rate and currency portfolios is referred to as "market risk." A
description of each market risk category is set forth below:
. Commodity price risks result from exposures to changes in spot prices,
forward prices and volatilities in commodities, such as electricity,
natural gas, coal, NGLs, crude oil and other similar products;
. Interest rate risks primarily result from exposures to changes in the
level, slope and curvature of the yield curve and the volatility of
interest rates; and
. Currency rate risks result from exposures to changes in spot prices,
forward prices and volatilities in currency rates.
Dynegy seeks to manage these market risks through diversification,
controlling position sizes and executing hedging strategies. The ability to
manage an exposure may, however, be limited by adverse changes in market
liquidity or other factors.
Valuation Criteria and Management Estimates
As discussed previously, Dynegy utilizes a fair value accounting model for
some aspects of its operations as required by generally accepted accounting
principles. The net gains or losses resulting from the revaluation of these
contracts during the period is recognized in the Company's results of
operations. For financial reporting purposes, assets and liabilities associated
with these transactions are reflected on the Company's balance sheet as risk
management assets and liabilities, classified as short- or long-term pursuant
to each contract's individual tenor. Net unrealized gains and losses from these
contracts are classified as revenue in the accompanying statement of
operations. Transactions that have been realized and settled are reflected
gross in revenues and cost of sales.
The following table provides an assessment of the factors impacting the
change in net value of the risk management asset and liability accounts during
the year ended December 31, 2001 ($ in millions).
Fair value of portfolio at January 1, 2001.................................... $ 398
Gains (losses) recognized through the income statement in the period, net/(1)/ 647
Cash received related to contracts settled during the period, net............. (201)
Changes in fair value as a result of a change in valuation technique/(2)/..... (149)
Other changes in fair value, net/(3)/......................................... 240
-----
Fair value of portfolio at December 31, 2001.................................. $ 935
=====
51
--------
/(1)/ This amount includes approximately $300 million which represents
management's estimate of the initial value of new contracts entered into
in 2001.
/(2) /Dynegy corrected its modeling methodology effective the third quarter
2001. This amount represents the difference in the value of the portfolio
based on the previous methodology and the value as recorded based on the
new methodology. This corrected curve methodology was applied beginning in
the third quarter 2001, as this was the period in which the Company began
to enter into longer-term power transactions in the United States. See
description of the corrected methodology below.
/(3)/ Consists primarily of the effect of terminating the Company's commercial
positions with Enron.
The net risk management asset of $935 million is the aggregate of the
following line items on the Consolidated Balance Sheet: Current Assets--Assets
from risk-management activities, Other Assets--Assets from risk-management
activities, Current Liabilities--Liabilities from risk-management activities
and Other Liabilities--Liabilities from risk-management activities. The
increase in the net value of the risk management asset and liability accounts
at December 31, 2001 from the previously reported amount of $712 million is
primarily due to the following:
. a $340 million increase due to the consolidation of ABG Gas Supply, an
entity formed in connection with Project Alpha. This $340 million
increase reflects the recognition of ABG Gas Supply's net risk-management
assets on Dynegy's Consolidated Balance Sheet; and
. a $40 million reclassification of inventory.
These items are offset by a $149 million reduction resulting from the
correction to the forward power curves.
Dynegy estimates the fair value of its marketing portfolio using a
liquidation value approach assuming that the ability to transact business in
the market remains at historical levels. The estimated fair value of the
portfolio is computed by multiplying all existing positions in the portfolio by
estimated prices, reduced by a LIBOR-based time value of money adjustment and
deduction of reserves for credit, price and market liquidity risks.
A key aspect of Dynegy's operations and business strategy is its ability to
provide customers with competitively priced bundled products and services that
address customer specific energy and risk management needs. Many of these
customized products and services are not exchange traded. In addition, the
availability of reliable market quotations in certain regions and for certain
commodities is limited as a result of liquidity and other factors. As a result,
Dynegy uses a combination of market quotations, derivatives of market
quotations and proprietary models to periodically value its portfolio as
required by generally accepted accounting principles. Market quotations are
validated against broker quotes, regulated exchanges or third-party
information. Derivatives of market quotations use validated market quotes, such
as actively traded natural gas or power prices, as key inputs in determining
market valuations.
In certain markets or for certain products, market quotes or derivatives of
market quotes are not available or are not considered appropriate valuation
techniques as a result of the newness of markets or products, a lack of
liquidity in such markets or products or other factors. However, under
generally accepted accounting principles, estimating the value of these types
of contracts is required. Consequently, prior to the third quarter 2001, Dynegy
used models principally derived from market research to estimate forward price
curves for valuing positions in these markets. Dynegy models generate pricing
estimates primarily for regional power markets in the United States and Europe.
Price curves are derived by incorporating a number of factors, including broker
quotes, near-term market indicators and a proprietary model based on a required
rate of return on investment in new generation facilities. Dynegy believes that
new generation needs in the United States and Europe primarily will be met
through the construction of new gas-fired generation. Power prices, over the
long term, will thus reflect the cost of building new gas fired generation, the
cost of natural gas fuel and a cost of capital return on new construction
investment. While Dynegy believes its pricing model is based on reasonable and
sound assumptions, the application of forecasted pricing curves to contractual
commitments may result in realized cash return on these commitments that vary
significantly, either positively or negatively, from the estimated values.
52
The Company has reviewed the applicability of the methodology utilized to
estimate forward power curves based on the increasing term length of
contractual arrangements within its U.S. power portfolio. Based on this
assessment, the Company corrected its methodology utilized to estimate forward
U.S. power curves effective for the third quarter 2001. The corrected power
curve methodology incorporates forward energy prices derived from broker quotes
and values from executed transactions to develop mathematical forward price
curves for periods where broker quotes and transaction data cannot be obtained.
Please read "Explanatory Note--Restatements" to the accompanying Consolidated
Financial Statements for further discussion of this correction in methodology.
The Company continues to apply its previous modeling methodology to its
European power portfolio because of the lack of liquidity in that market.
Risk-Management Asset and Liability Disclosures
The following chart depicts the mark-to-market value and cash flow
components of the Company's net risk management assets and liabilities at
December 31, 2001:
Net Risk-Management Asset and Liability Disclosures
At December 31, 2001
Risk-Management Assets and Liabilities/(1)/: ------------------------------------------
Total 2002 2003 2004 2005 2006 Thereafter
($ in Millions) ------ ---- ---- ---- ---- ---- ----------
Mark-to-Market/(2)/.............. $ 901 $576 $113 $ 70 $21 $30 $ 91
Cash Flow........................ 1,304 646 154 112 53 58 281
--------
/(1)/ The table reflects the fair value of Dynegy's risk-management asset
position after deduction of time value, credit, price and other reserves
necessary to determine fair value. The cash flow value reflects
anticipated undiscounted cash inflows and outflows by contract based on
tenor of individual contract position and have not been adjusted for
counterparty credit or other reserves. These amounts exclude the fair
value and cash flows associated with certain derivative instruments
designated as hedges, which are included in other comprehensive income (a
component of Stockholders' Equity).
/(2)/ The increase in the net value of the risk management assets and
liabilities at December 31, 2001 from the previously reported amount of
$678 million is primarily due to a $340 million increase as a result of
the consolidation of ABG Gas Supply and a $40 million reclassification of
inventory. These items are offset by a $149 million reduction resulting
from the correction to the forward power curve.
The following table provides an assessment of net contract values by year
based on the Company's valuation methodology described above. Approximately 97
percent of Dynegy's net risk-management asset value at December 31, 2001 was
determined by market quotations or validation against industry posted prices.
Net Fair Value of Marketing Portfolio/(4)/
Total 2002 2003 2004 2005 2006 Thereafter
($ in Millions) ----- ---- ---- ---- ---- ---- ----------
Market Quotations/(1)/..... $663 $576 $ 50 $ 23 $(21) $(8) $43
---- ---- ---- ---- ---- --- ---
Other External Sources/(2)/ $213 $ -- $ 75 $ 60 $ 47 $35 $(4)
---- ---- ---- ---- ---- --- ---
Prices Based on Models/(3)/ $ 25 $ -- $(12) $(13) $ (5) $ 3 $52
---- ---- ---- ---- ---- --- ---
--------
/(1)/ Prices obtained from actively traded, liquid markets.
/(2)/ Mid-term prices validated against industry posted prices.
/(3)/ See previous discussion of the Company's use of long-term models.
/(4) /The increase in the net fair value of the marketing portfolio at December
31, 2001 from the previously reported amount of $678 million is primarily
due to a $340 million increase as a result of the consolidation of ABG Gas
Supply and a $40 million reclassification of inventory. These items are
offset by a $149 million reduction resulting from the correction to the
forward power curve.
53
Value at Risk ("VaR")
In addition to applying business judgment, senior management uses a number
of quantitative tools to manage the Company's exposure to market risk. These
tools include:
. Risk limits based on a summary measure of market risk exposure, referred
to as VaR; and
. Stress and scenario analyses performed daily that measure the potential
effects of various market events, including substantial swings in
volatility factors, absolute commodity price changes and the impact of
interest rate movements.
The modeling of the risk characteristics of Dynegy's marketing portfolio
involves a number of assumptions and approximations. Dynegy estimates VaR using
a JP Morgan RiskMetrics(TM) approach assuming a one-day holding period. Inputs
for the VaR calculation are prices, positions, instrument valuations and the
variance-covariance matrix. While management believes that these assumptions
and approximations are reasonable, there is no uniform industry methodology for
estimating VaR, and different assumptions and/or approximations could produce
materially different VaR estimates.
Dynegy uses historical data to estimate the Company's VaR and, to better
reflect current asset and liability volatilities, these historical data are
weighted to give greater importance to more recent observations. Given its
reliance on historical data, VaR is effective in estimating risk exposures in
markets in which there are not sudden fundamental changes or shifts in market
conditions. An inherent limitation of VaR is that past changes in market risk
factors, even when weighted toward more recent observations, may not produce
accurate predictions of future market risk. VaR should be evaluated in light of
this and the methodology's other limitations.
VaR represents the potential loss in value of Dynegy's enterprise-wide
marketing portfolio due to adverse market movements over a defined time horizon
within a specified confidence level. For the VaR numbers reported below, a
one-day time horizon and a 95% confidence level were used. This means that
there is a one in 20 statistical chance that the daily portfolio value will
fall below the expected maximum potential reduction in portfolio value at least
as large as the reported VaR. Thus, a change in portfolio value greater than
the expected change in portfolio value on a single trading day would be
anticipated to occur, on average, about once a month. Gains or losses on a
single day can exceed reported VaR by significant amounts. Gains or losses can
also accumulate over a longer time horizon such as a number of consecutive
trading days.
In addition, Dynegy has provided its VaR using a one-day time horizon and a
99% confidence level. The purpose of this disclosure is to provide an
indication of earnings volatility using a higher confidence level. Under this
presentation, there is one in one hundred chance that the daily portfolio value
will fall below the expected maximum potential reduction in portfolio value at
least as large as the reported VaR. The Company has also disclosed an average
VaR for the year and a two-year comparison of daily and average VaR in order to
provide context around the one-day amounts.
The following table sets forth the aggregate daily VaR of Dynegy's marketing
portfolio:
Daily and Average VaR for Marketing Portfolio
At December 31,
---------------
2001 2000
($ in millions) ---- ----
One Day VaR--95% Confidence Level........................... $17 $10
--- ---
One Day VaR--99% Confidence Level........................... $24 $14
--- ---
Average VaR for Past Twelve Months--95% Confidence Level (1) $12 $11
--- ---
(1) Amounts have not been updated for the restatement items discussed in the
Explanatory Note--Restatements to the accompanying Consolidated Financial
Statements as such amounts cannot be retroactively recalculated.
54
The following table provides a rolling daily and average VaR for the
Company's marketing portfolio over the past two years:
[GRAPHIC DEPICTING DAILY AND AVERAGE VAR]
As the graph above illustrates, the growth in one day VaR from 2000 to 2001
is representative of the Company's growth in business and higher market
volatility in the 2001 period.
Credit Risk
Credit risk represents the loss that the Company would incur if a
counterparty fails to perform under its contractual obligations. To reduce the
Company's credit exposure, the Company seeks to enter into netting agreements
with counterparties that permit Dynegy to offset receivables and payables with
such counterparties. Dynegy attempts to further reduce credit risk with certain
counterparties by entering into agreements that enable the Company to obtain
collateral or to terminate or reset the terms of transactions after specified
time periods or upon the occurrence of credit-related events. The Company may,
at times, use credit derivatives or other structures and techniques to provide
for third-party guarantees of the Company's counterparty's obligations.
Dynegy's industry typically operates under negotiated credit lines for
physical delivery contracts. Dynegy's Credit Department, based on guidelines
set by Dynegy's Credit Policy Committee, establishes Dynegy's counterparty
credit limits. For collateralized transactions, the Company also evaluates
potential exposure over a shorter collection period and gives effect to the
value of collateral received. The Company further seeks to measure credit
exposure through the use of scenario analyses and other quantitative tools.
Dynegy's credit management systems monitor current and potential credit
exposure to individual counterparties and on an aggregate basis to
counterparties and their affiliates.
The following table displays the value of Dynegy's marketing portfolio,
inclusive of hedging activities, at December 31, 2001:
Below
Investment
Investment Grade Credit
Grade Credit Quality or
Quality Unrated Total
------------ ------------ ------
($ in millions)
Utilities and power generators..... $ 474 $(26) $ 448
Financial institutions............. (106) 1 (105)
Oil and gas producers.............. 129 124 253
Commercial and industrial companies 400 95 495
Other.............................. 52 6 58
----- ---- ------
Value of portfolio before reserves. $ 949 $200 1,149
===== ==== ------
Credit and market reserves......... (248)
------
901
Other.............................. 34
------
Net risk-management assets......... $ 935
======
The net risk management asset of $935 million is the aggregate of the
following line items on the Consolidated Balance Sheet: Current Assets--Assets
from risk-management activities, Other Assets--Assets from risk-management
activities, Current Liabilities--Liabilities from risk-management activities
and Other Liabilities--Liabilities from risk-management activities. The
increase in the net risk-management assets at
55
December 31, 2001 from the previously reported amount of $712 million is
primarily due to a $340 million increase as a result of the consolidation of
ABG Gas Supply and a $40 million reclassification of inventory. These items are
offset by a $149 million reduction resulting from the adjustments to the
forward power curves.
Interest Rate Risk
Interest rate risk results from variable rate debt obligations and from
providing risk-management services to customers, since changing interest rates
impact the discounted value of future cash flows used to value risk-management
assets and liabilities. Management continually monitors its exposure to
fluctuations in interest rates and may execute swaps or other financial
instruments to hedge and mitigate this exposure.
Marketing portfolio. The following table sets forth the daily and average
VaR associated with the interest rate component of the marketing portfolio.
Dynegy seeks to manage its interest rate exposure through application of
various hedging strategies. Hedging instruments executed to mitigate such
interest rate exposure in the marketing portfolio are included in the VaR as of
December 31, 2001 reflected in the table below.
Daily and Average VaR on Interest Component of Marketing Portfolio
At December 31,
---------------
($ in millions)
2001
One Day VaR--95% Confidence Level........................... $0.1
====
Average VaR for Past Twelve Months--95% Confidence Level (1) $1.6
====
--------
(1) Amounts have not been updated for the restatement items discussed in the
Explanatory Note to the accompanying Consolidated Financial Statements as
such amounts cannot be retroactively recalculated.
Variable Rate Financial Obligations. Based on sensitivity analysis as of
December 31, 2001, it is estimated that one percentage point interest rate
movement in the average market interest rates (either higher or (lower)) in
2002 would decrease (increase) income before taxes by approximately $35
million. This amount was determined based on hypothetical interest rate
movement on the Company's variable rate financial obligations as of December
31, 2001. Since December 31, 2001, the Company has entered into approximately
$2.0 billion of interest rate swaps and increased the ratio of fixed interest
obligations to total financial obligations through the acquisition of Northern
Natural and the sale of $500 million of fixed rate debt in February 2002.
Considering these events, the sensitivity at December 31, 2001 would have been
reduced from $35 million to $19 million.
Foreign Currency Exchange Rate Risk
Foreign currency risk arises from the Company's investments in affiliates
and subsidiaries owned and operated in foreign countries. Such risk is also a
result of risk management transactions with customers in countries outside the
U.S. Management continually monitors its exposure to fluctuations in foreign
currency exchange rates. When possible, contracts are denominated in or indexed
to the U.S. dollar, or such risk may be hedged through debt denominated in the
foreign currency or through financial contracts.
At December 31, 2001, the Company's primary foreign currency exchange rate
exposures were the United Kingdom Pound, Canadian Dollar, European Euro and
Norwegian Kroner. Dynegy seeks to manage its foreign currency exchange rate
exposure through application of various hedging strategies.
56
The following table sets forth the daily and average Foreign Currency
Exchange VaR:
Daily and Average Foreign Currency Exchange VaR
At December 31,
2001
---------------
($ in millions)
One Day VaR--95% Confidence Level....................... $0.6
====
Average VaR for Past Twelve Months--95% Confidence Level $1.1
====
Derivative Contracts
The absolute notional contract amounts associated with the Company's
commodity risk-management, interest rate and foreign currency exchange
contracts were as follows:
Absolute Notional Contract Amounts
December 31,
------------------------
2001 2000 1999
------- -------- -------
Natural Gas (Trillion Cubic Feet)................................. 12.044 8.699 5.702
Electricity (Million Megawatt Hours).............................. 79.931 162.321 42.949
Natural Gas Liquids (Million Barrels)............................. 5.655 6.410 19.902
Weather Derivatives (in thousands of $/ Degree Day)............... 190 385 --
Crude Oil (Million Barrels)....................................... -- -- 35.554
Coal (Millions of Tons)........................................... 18.5 17.3 --
Fair Value Hedge Interest Rate Swaps (in Millions of U.S. Dollars) $ 206 $ -- $ 37
Fixed Interest Rate Received on Swaps (Percent)................ 5.284 -- 8.210
Cash Flow Hedge Interest Rate Swaps (in millions of U.S. Dollars). $ 100 $ -- $ --
Fixed Interest Rate Paid on Swaps (Percent).................... 4.397 -- --
Interest Rate Risk-Management Contract............................ $ 503 $ -- $ --
Fixed Interest Rate Paid (Percent)............................. 6.151 -- --
Interest Rate Risk-Management Contract............................ $ 100 $ -- $ --
Fixed Interest Rate Received (Percent)......................... 4.370 -- --
U.K. Pound Sterling (in millions of U.S. Dollars)................. $ 906 $ 15 $ 86
Average U.K. Pound Sterling Contract Rate (in U.S. Dollars)....... $1.4233 $ 1.4658 $1.6191
Euro Dollars (in millions of U.S. Dollars)........................ $ 18 $ 36 $ --
Average Euro Dollar Contract Rate (in U.S. Dollars)............... $0.8863 $ 1.0200 $ --
Canadian Dollar (in millions of U.S. Dollars)..................... $ 1,395 $ 738 $ 289
Average Canadian Dollar Contract Rate (in U.S. Dollars)........... $0.6435 $ 0.6768 $0.6775
Legal Risks
Derivative transactions may also involve the legal risk that they are not
authorized or appropriate for a counterparty, that documentation has not been
properly executed or that executed agreements may not be enforceable against
the counterparty. The Company attempts to minimize these risks by employing the
use of standard contracts, where applicable, or by routinely obtaining advice
of counsel on the enforceability of agreements as well as on the authority of a
counterparty to effect the derivative transaction.
Operational Risks
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,
terrorist attacks and product spillage, any or all of which could result in
57
damage to or destruction of operating assets and other property or personal
injury, loss of life or pollution of the environment, as well as curtailment or
suspension of operations at the affected facility. Dynegy's Risk and
Environment Committee establishes metrics and assesses compliance with
corporate risk guidelines. 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 or the failure of a party to meet its
indemnification obligations could materially and adversely affect Dynegy's
results of operations and financial condition. Events impacting the economics
of the insurance industry have brought into question companies' ability to
obtain insurance coverage at reasonable rates. Dynegy will continue to assess
the various coverage alternatives and may decide in the future to increase its
reliance on self-insurance.
In addition to these commercial operational risks, the Company faces
reputational damage and financial loss as a result of inadequate or failed
internal processes, people and systems. A systems failure or failure to enter a
transaction properly into the records may result in an inability to settle
transactions in a timely manner or in a breach of the contract. To minimize
these risks, the Company has developed policies and controls with respect to
data entry and processing of transactions, clearance and settlement of
transactions and the detection and prevention of employee error or improper or
fraudulent activity.
Conclusion
Management believes the Company has effective procedures for evaluating and
managing the market, credit and other risks to which it is exposed.
Nonetheless, the effectiveness of these policies and procedures for managing
risk exposure can never be completely predicted or fully assured. For example,
unexpectedly large or rapid movements or disruptions in one or more markets or
other unforeseen developments can have a material adverse effect on results of
operations and financial condition. The consequences of these developments can
include decreases in the liquidity of trading positions, higher earnings
volatility, increased credit exposure to customers and counterparties and
increased general systemic risk.
Uncertainty of Forward-Looking Statements and Information
This annual report includes statements reflecting assumptions, expectations,
projections, intentions or beliefs about future events that are intended as
"forward-looking statements" under the Private Securities Litigation Reform Act
of 1995. You can identify these statements by the fact that they do not relate
strictly to historical or current facts. They use words such as "anticipate,"
"estimate," "project," "forecast," "may," "will," "should," "expect" and other
words of similar meaning. In particular, these include, but are not limited to,
statements relating to the following:
. Projected operating or financial results;
. Expectations regarding capital expenditures, dividends and other matters;
. Pending or recent acquisitions such as the Northern Natural and BG
Storage Limited acquisitions, including the anticipated closing date,
expected cost savings or synergies and the accretive or dilutive impact
of an acquisition on earnings;
. Expectations regarding transaction volume and liquidity in wholesale
energy markets in the North America and Europe;
. The Company's beliefs and assumptions relating to trade credit in the
wholesale energy market and its liquidity position, including its ability
to meet its obligations in the event of a downgrade in its credit ratings;
. The Company's ability to execute additional capital enhancing
transactions such as asset sales, joint ventures or financings to enhance
its liquidity position;
58
. The Company's ability to refinance its bank credit facilities in the
ordinary course of business and to satisfy debt service and other
obligations as they become due;
. Beliefs or assumptions about the outlook for deregulation of retail and
wholesale energy markets in North America and Europe and anticipated
business developments in such markets;
. The Company's ability to effectively compete for market share with
industry participants;
. Beliefs about the outcome of legal and administrative proceedings,
including matters involving Enron, the California power market and
environmental matters;
. The Company's expectations relating to the completion of the three-year
re-audit;
. The expected commencement date for commercial operations for new power
plants; and
. Anticipated developments with respect to demand for broadband services
and applications and the Company's strategic plans in connection
therewith.
Any or all of Dynegy's forward-looking statements may turn out to be wrong.
They can be affected by inaccurate assumptions or by known or unknown risks and
uncertainties, including the following:
. The timing and extent of changes in commodity prices for energy,
particularly natural gas, electricity and NGLs, or communications
products or services;
. The timing and extent of deregulation of energy markets in North America
and Europe and the rules and regulations adopted on a transitional basis
in such markets;
. The condition of the capital markets generally, which will be affected by
interest rates, foreign currency fluctuations and general economic
conditions, and Dynegy's financial condition, including Dynegy Holdings'
ability to maintain its investment grade credit ratings;
. Developments in the California power markets, including, but not limited
to, governmental intervention, deterioration in the financial condition
of our counterparties, default on receivables due and adverse results in
current or future litigation;
. The effectiveness of Dynegy's risk-management policies and procedures and
the ability of Dynegy's counterparties to satisfy their financial
commitments;
. The liquidity and competitiveness of wholesale trading markets for energy
commodities, including the impact of electronic or online trading in
these markets;
. The direct or indirect effects on our business resulting from the
financial difficulties of Enron, or other competitors of Dynegy,
including, but not limited to, their effects on liquidity in the trading
and power industry, and its effects on the capital markets views of the
energy or trading industry and our ability to access the capital markets
on the same favorable terms as in the past;
. Operational factors affecting the start up or ongoing commercial
operations of Dynegy's power generation or midstream natural gas
facilities, including catastrophic weather related damage, unscheduled
outages or repairs, unanticipated changes in fuel costs or availability
or the availability of fuel emission credits, the unavailability of gas
transportation, the unavailability of electric transmission service or
workforce issues;
. The cost of borrowing, availability of trade credit and other factors
affecting Dynegy's financing activities;
. The direct or indirect effects on our business of a lowering of our
credit rating (or actions we may take in response to changing credit
ratings criteria), including, increased collateral requirements to
execute our business plan, demands for increased collateral by our
counterparties, refusal by our counterparties to enter into transactions
with us and our inability to obtain credit or capital in amounts or on
terms favorable to us;
59
. Uncertainties regarding the development of, and competition within, the
market for broadband services in North America and Europe, including
risks relating to competing technologies and standards, regulation,
capital costs and the timing and amount of customer demand for high
bandwidth applications;
. Cost and other effects of legal and administrative proceedings,
settlements, investigations and claims, including matters involving Enron
and environmental liabilities that may not be covered by indemnity or
insurance;
. Other North American or European regulatory or legislative developments
that affect the demand for energy generally, increase the environmental
compliance cost for Dynegy's power generation or midstream gas facilities
or impose liabilities on the owners of such facilities; and
. General political conditions, including any extended period of war or
conflict involving North America or Europe.
Many of these factors will be important in determining Dynegy's actual
future results. Consequently, no forward-looking statement can be guaranteed.
Dynegy's actual future results may vary materially from those expressed or
implied in any forward-looking statements.
All of Dynegy's forward-looking statements, whether written or oral, are
expressly qualified by these cautionary statements and any other cautionary
statements that may accompany such forward-looking statements. In addition,
Dynegy disclaims any obligation to update any forward-looking statements to
reflect events or circumstances after the date of this report.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Quantitative and Qualitative Disclosures About Market Risk are set forth
in "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations" herein.
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-61 inclusive, found at the end of this report,
and are incorporated herein by reference.
60
DYNEGY INC.
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON 8-K
(a) The following documents, which have been filed by the Company with the SEC
pursuant to the Securities Exchange Act of 1934, as amended, are by this
reference incorporated in and made a part of this report:
1. Financial Statements--Consolidated financial statements of the Company
and its subsidiaries are incorporated under Item 8. of this Form 10-K/A.
2. Financial Statement Schedules--Financial Statement Schedules are
incorporated under Item 8. of this Form 10-K/A.
3. Exhibits--The following instruments and documents are included as
exhibits to this Form 10-K/A. All management contracts or compensation
plans or arrangements set forth in such list are marked with a ++.
Exhibit
Number Description
------- -----------
3.1 Amended and Restated Articles of Incorporation of Dynegy Inc. (incorporated by reference to
Appendix A to the Definitive Proxy Statement on Schedule 14A of Dynegy Inc., File No. 1-15659,
filed with the SEC on April 25, 2001).
3.2 Statement of Resolution Establishing Series of Series B Mandatorily Convertible Redeemable
Preferred Stock of Dynegy Inc. (incorporated by reference to Exhibit 4.1 to the Current Report on
Form 8-K of Dynegy Inc., File No. 1-15659, dated November 9, 2001).
3.3 Amended and Restated Bylaws of Dynegy Inc. (incorporated by reference to Exhibit 3.4 to the
Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1999 of Dynegy Inc., File
No. 1-11156).
4.1 Indenture, dated as of December 11, 1995, by and among NGC Corporation, the Subsidiary
Guarantors named therein and the First National Bank of Chicago, as Trustee (incorporated by
reference to exhibits to the Registration Statement on Form S-3 of NGC Corporation, Registration
No. 33-97368).
4.2 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 (incorporated by
reference to Exhibit 4.4 to the Quarterly Report on Form 10-Q for the Quarterly Period Ended
September 30, 1996 of NGC Corporation, File No. 1-11156).
4.3 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 (incorporated by
reference to Exhibit 4.5 to the Quarterly Report on Form 10-Q for the Quarterly Period Ended
September 30, 1996 of NGC Corporation, File No. 1-11156).
4.4 Subordinated Debenture Indenture between NGC Corporation and The First National Bank of
Chicago, as Debenture Trustee, dated as of May 28, 1997 (incorporated by reference to Exhibit 4.5
to the Quarterly Report on Form 10-Q for the Quarterly Period Ended June 30, 1997 of NGC
Corporation, File No. 1-11156).
4.5 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 (incorporated by reference to Exhibit 4.6 to the Quarterly Report on Form
10-Q for the Quarterly Period Ended June 30, 1997 of NGC Corporation, File No. 1-11156).
61
DYNEGY INC.
PART IV
Exhibit
Number Description
------- -----------
4.6 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 (incorporated by reference to Exhibit 4.9
to the Quarterly Report on Form 10-Q for the Quarterly Period Ended June 30, 1997 of NGC
Corporation, File No. 1-11156).
4.7 Common Securities Guarantee of NGC Corporation dated as of May 28, 1997 (incorporated by
reference to Exhibit 4.10 to the Quarterly Report on Form 10-Q for the Quarterly Period Ended
June 30, 1997 of NGC Corporation, File No. 1-11156).
4.8 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.
(incorporated by reference to Exhibit 4.11 to the Quarterly Report on Form 10-Q for the Quarterly
Period Ended June 30, 1997 of NGC Corporation, File No. 1-11156).
4.9 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 (incorporated by reference to Exhibit 4.12 to the
Quarterly Report on Form 10-Q for the Quarterly Period Ended September 30, 1997 of NGC
Corporation, File No. 1-11156).
4.10 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 (incorporated by
reference to Exhibit 4.18 to the Annual Report on Form 10-K for the Fiscal Year Ended December
31, 1997 of NGC Corporation, File No. 1-11156).
4.11 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 (incorporated by reference to Exhibit
4.19 to the Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1997 of NGC
Corporation, File No. 1-11156).
4.12 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 (incorporated by reference to Exhibit
4.20 to the Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1997 of NGC
Corporation, File No. 1-11156).
4.13 Indenture, dated as of September 26, 1996, restated as of March 23, 1998, and amended and restated
as of March 14, 2001, between Dynegy Holdings Inc. and Bank One Trust Company, National
Association, as Trustee (incorporated by reference to Exhibit 4.17 to the Annual Report on Form
10-K for the Fiscal Year Ended December 31, 2000 of Dynegy Holdings Inc., File No. 0-29311).
There have not been filed or incorporated as exhibits to this Form 10-K other debt instruments
defining the rights of holders of long-term debt of Dynegy and its subsidiaries, none of which
relates to authorized indebtedness that exceeds 10% of the consolidated assets of Dynegy and its
subsidiaries. Dynegy hereby agrees to furnish a copy of any such instrument not previously filed to
the SEC upon request.
10.1 Dynegy Inc. Amended and Restated 1991 Stock Option Plan (incorporated by reference to Exhibit
10.3 to the Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1998 of Dynegy
Inc., File No. 1-11156).++
62
DYNEGY INC.
PART IV
Exhibit
Number Description
------- -----------
10.2 Dynegy Inc. 1998 U.K. Stock Option Plan (incorporated by reference to Exhibit 10.4 to the Annual
Report on Form 10-K for the Fiscal Year Ended December 31, 1998 of Dynegy Inc., File No. 1-
11156).++
10.3 Dynegy Inc. Amended and Restated Employee Equity Option Plan (incorporated by reference to
Exhibit 10.5 to the Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1998 of
Dynegy Inc., File No. 1-11156).++
10.4 Dynegy Inc. 1999 Long Term Incentive Plan (incorporated by reference to Exhibit 10.6 to the
Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1999 of Dynegy Inc., File
No. 1-11156).++
10.5 Dynegy Inc. 2000 Long Term Incentive Plan (incorporated by reference to Exhibit 10.7 to the
Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1999 of Dynegy Inc., File
No. 1-11156).++
10.6 Dynegy Inc. 2001 Non-Executive Stock Incentive Plan (incorporated by reference to Exhibit 4.5 to
the Registration Statement on Form S-8 of Dynegy Inc., Registration No. 333-76080).++
10.7 Extant, Inc. Equity Compensation Plan (incorporated by reference to Exhibit 10.1 to the Registration
Statement on Form S-8 of Dynegy Inc., Registration No. 333-47422).++
10.8 Employment Agreement, effective February 1, 2000, between Charles L. Watson and Dynegy Inc.
(incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1999 of Dynegy Inc., File No. 1-11156).++
10.9 Employment Agreement, effective February 1, 2000, between Stephen W. Bergstrom and Dynegy
Inc. (incorporated by reference to Exhibit 10.10 to the Annual Report on Form 10-K for the Fiscal
Year Ended December 31, 1999 of Dynegy Inc., File No. 1-11156).++
10.10 Employment Agreement, effective February 1, 2000, between Robert D. Doty, Jr. and Dynegy Inc.
(incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 2000 of Dynegy Inc., File No. 1-15659).++
10.11 Employment Agreement, effective February 1, 2000, between Kenneth E. Randolph and Dynegy Inc.
(incorporated by reference to Exhibit 10.12 to the Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1999 of Dynegy Inc., File No. 1-11156).++
10.12 Employment Agreement, effective as of February 1, 2000, between R. Blake Young and Dynegy Inc.
(incorporated by reference to Exhibit 10.11 to the Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 2000 of Dynegy Inc., File No. 1-15659).++
10.13 Employment Agreement, effective February 1, 2000, between Matthew K. Schatzman and Dynegy
Inc. (incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the
Quarterly Period Ended March 31, 2000 of Dynegy Inc., File No. 1-15659).++
10.14 Dynegy Inc. Deferred Compensation Plan for Certain Directors (incorporated by reference to Exhibit
10.1 to the Quarterly Report on Form 10-Q for the Quarterly Period Ended March 31, 2000 of
Dynegy Inc., File No. 1-15659).++
10.15 Dynegy Inc. 401(k) Savings Plan, as amended and restated effective January 1, 2002 (incorporated
by reference to Exhibit 10.1 to the Registration Statement on Form S-8 of Dynegy Inc.,
Registration No. 383-76570).++
10.16 Dynegy Inc. 401(k) Savings Plan Trust Agreement (incorporated by reference to Exhibit 10.2 to the
Registration Statement on Form S-8 of Dynegy Inc., Registration No. 333-76570).++
63
DYNEGY INC.
PART IV
Exhibit
Number Description
------- -----------
10.17 Dynegy Inc. Deferred Compensation Plan (incorporated by reference to Exhibit 4.6 to the
Registration Statement on Form S-8 of Dynegy Inc., Registration No. 333-76080).++
10.18 Dynegy Inc. Deferred Compensation Plan Trust Agreement (incorporated by reference to Exhibit 4.7
to the Registration Statement on Form S-8 of Dynegy Inc., Registration No. 333-76080).++
+ 10.19 Dynegy Inc. Short-Term Executive Stock Purchase Loan Program.++
10.20 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
(incorporated by reference to exhibits to the Registration Statement on Form S-4 of Midstream
Combination Corp., Registration No. 333-09419).
10.21 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 (incorporated by reference to exhibits to the Registration Statement on
Form S-4 of Midstream Combination Corp., Registration No. 333-09419).
10.22 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.
(incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the Quarterly
Period Ended September 30, 1996 of NGC Corporation, File No. 1-11156).
10.23 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 (incorporated by reference to
Exhibit 10.5 to the Quarterly Report on Form 10-Q for the Quarterly Period Ended September 30,
1996 of NGC Corporation, File No. 1-11156).
*10.24 Natural Gas Purchase and Sale Agreement, dated as of August 30, 1996, between Chevron U.S.A.
Inc. and Natural Gas Clearinghouse (incorporated by reference to Exhibit 10.6 to the Quarterly
Report on Form 10-Q for the Quarterly Period Ended September 30, 1996 of NGC Corporation,
File No. 1-11156).
*10.25 Master Natural Gas Liquids Purchase Agreement, dated as of September 1, 1996, between Warren
Petroleum Company, Limited Partnership and Chevron U.S.A. Inc. (incorporated by reference to
Exhibit 10.8 to the Quarterly Report on Form 10-Q for the Quarterly Period Ended September 30,
1996 of NGC Corporation, File No. 1-11156).
10.26 Shareholder Agreement of Energy Convergence Holding Company with Chevron U.S.A. Inc.
(incorporated by reference to Exhibit 10.6 to the Current Report on Form 8-K of Dynegy Inc., File
No. 1-11156, dated June 14, 1999).
10.27 Dynegy Inc. Severance Pay Plan (incorporated by reference to Exhibit 10.41 to the Annual Report on
Form 10-K for the Fiscal Year Ended December 31, 1998 of Dynegy Inc., File No. 1-11156).++
10.28 Registration Rights Agreement Chevron U.S.A. Inc. (incorporated by reference to Exhibit 10.8 to the
Current Report on Form 8-K of Dynegy Inc., File No. 1-11156, dated June 14, 1999).
10.29 First Amendment to Registration Rights Agreement Chevron U.S.A. Inc. (incorporated by reference
to Exhibit 10.9 to the Current Report on Form 8-K of Dynegy Inc., File No. 1-15659, dated
November 9, 2001).
64
DYNEGY INC.
PART IV
Exhibit
Number Description
------- -----------
10.30 Subscription Agreement dated as of November 9, 2001 by and among Enron Corp., Northern
National Gas Company and Dynegy Inc. (incorporated by reference to Exhibit 10.3 to the Current
Report on Form 8-K of Dynegy Inc., File No. 1-15659, dated November 9, 2001).
10.31 Option Agreement dated as of November 9, 2001 by and among CGNN Holding Company, Inc.,
MCTJ Holding Co. LLC, Enron Corp., Dynegy Holdings Inc. and, solely for the provisions of
Section 5.1 thereof, Dynegy Inc. (incorporated by reference to Exhibit 10.4 to the Current Report
on Form 8-K of Dynegy Inc., File No. 1-15659, dated November 9, 2001).
10.32 Amendment to Option Agreement among CGNN Holding Company, Inc., MCTJ Holding Co. LLC,
Enron Corp., Dynegy Holdings Inc. and Dynegy Inc. dated as of November 19 2001
(incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K of Dynegy Inc.,
File No. 1-15659, dated November 19, 2001).
10.33 Purchase Option Agreement dated as of November 9, 2001 by and among CGNN Holding
Company, Inc., MCTJ Holding Co. LLC, Northern Natural Gas Company, Enron Corp., Dynegy
Holdings Inc. and Dynegy Inc. (incorporated by reference to Exhibit 10.5 to the Current Report
on Form 8-K of Dynegy Inc., File No. 1-15659, dated November 9, 2001).
10.34 Amendment to Purchase Option Agreement among CGNN Holding Company, Inc., MCTJ Holding
Co. LLC, Northern Natural Gas Company, Enron Corp., Dynegy Holdings Inc. and Dynegy Inc.
dated as of November 19, 2001 (incorporated by reference to Exhibit 10.3 to the Current Report
on Form 8-K of Dynegy Inc., File No. 1-15659, dated November 19, 2001).
10.35 Series B Preferred Stock Subscription Agreement dated as of November 9, 2001 by and between
ChevronTexaco Corp. and Dynegy Inc. (incorporated by reference to Exhibit 10.8 to the Current
Report on Form 8-K of Dynegy Inc., File No. 1-15659, dated November 9, 2001).
10.36 Certificate of Designations of Series A Preferred Stock of Northern National Gas Company
(incorporated by reference to Exhibit 99.2 to the Current Report on Form 8-K of Dynegy Inc.,
File No. 1-15659, dated November 9, 2001).
10.37 Certificate of Correction of Certificate of Designations of Series A Preferred Stock of Northern
National Gas Company (incorporated by reference to Exhibit 99.3 to the Current Report on Form
8-K of Dynegy Inc., File No. 1-15659, dated November 9, 2001).
10.38 Settlement Agreement among Dynegy Inc., Dynegy Holdings Inc., CGNN Holding Company, Inc.
and MCTJ Holding Co. LLC dated as of January 3, 2002 (incorporated by reference to Exhibit
99.1 to the Current Report on Form 8-K of Dynegy Inc., File No. 1-15659, dated January 3,
2002).
10.39 Agreement among Dynegy Inc., Dynegy Holdings Inc., Enron Corp. and Enron Transportation
Services Co. dated as of January 3, 2002 (incorporated by reference to Exhibit 99.2 to the Current
Report on Form 8-K of Dynegy Inc., File No. 1-15659, dated January 3, 2002).
+ 21.1 Subsidiaries of the Registrant.
+ +23.1 Consent of PricewaterhouseCoopers LLP.
**99.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
**99.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
--------
+ Previously filed.
++ Consent of PricewaterhouseCoopers LLP.
* Exhibit omits certain information, which the Company has filed separately
with the SEC pursuant to a confidential treatment request pursuant to Rule
406 promulgated under the Securities Act of 1933, as amended.
** Furnished herewith.
65
(b) Reports on Form 8-K of Dynegy Inc. for the fourth quarter of 2001.
1. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated November 9, 2001. Items 5 and 7 were reported and
no financial statements were filed.
2. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated November 19, 2001. Items 5 and 7 were reported and
no financial statements were filed.
3. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated November 28, 2001. Items 5, 7 and 9 were reported
and no financial statements were filed.
4. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated December 2, 2001. Items 5, 7 and 9 were reported
and no financial statements were filed.
5. During the quarter ended December 31, 2001, the Company filed a Current
Report on Form 8-K dated December 19, 2001. Items 5, 7 and 9 were reported
and no financial statements were filed.
66
DYNEGY INC.
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: April 11, 2003 By: /s/ NICK J. CARUSO
-------------------------------
Nick J. Caruso, Executive Vice President and
Chief Financial Officer
67
SECTION 302 CERTIFICATION
I, Bruce A. Williamson, certify that:
1. I have reviewed this Amendment No. 2 to the 2001 Annual Report on
Form 10-K of Dynegy Inc. ("Amendment No. 2");
2. Based on my knowledge, this Amendment No. 2 does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this Amendment No. 2; and
3. Based on my knowledge, the financial statements, and other financial
information included in this Amendment No. 2, fairly presents in all
material respects the financial condition, results of operations and cash
flows of Dynegy Inc. as of, and for, the periods presented in this Amendment
No. 2.
/s/ Bruce A. Williamson
Date: April 11, 2003 -------------------------------------
Bruce A. Williamson
President and Chief Executive Officer
68
SECTION 302 CERTIFICATION
I, Nick J. Caruso, certify that:
1. I have reviewed this Amendment No. 2 to the 2001 Annual Report on Form
10-K of Dynegy Inc. ("Amendment No. 2");
2. Based on my knowledge, this Amendment No. 2 does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this Amendment No. 2; and
3. Based on my knowledge, the financial statements, and other financial
information included in this Amendment No. 2, fairly present in all material
respects the financial condition, results of operations and cash flows of
Dynegy Inc. as of, and for, the periods presented in this Amendment No. 2.
/s/ Nick J. Caruso
Date: April 11, 2003 ----------------------------
Nick J. Caruso
Executive Vice President and
Chief Financial Officer
69
DYNEGY INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Consolidated Financial Statements (Restated)
Report of Independent Accountants................................................................ F-2
Consolidated Balance Sheets as of December 31, 2001 and 2000..................................... F-3
Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999....... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999....... F-5
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2001,
2000 and 1999.................................................................................... F-6
Notes to Consolidated Financial Statements....................................................... F-7
Financial Statement Schedule (Restated)
Valuation and Qualifying Accounts................................................................ F-64
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Dynegy Inc.:
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Dynegy Inc. and its subsidiaries at December 31, 2001 and 2000, and
the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the accompanying index
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
These financial statements and this financial statement schedule are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements and this financial statement schedule
based on our audits. We conducted our audits of these statements in accordance
with auditing standards generally accepted in the United States of America,
which 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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 11, the Company is the subject of substantial
litigation. The Company's ongoing liquidity, financial position and operating
results may be adversely impacted by the nature, timing and amount of the
resolution of such litigation. The consolidated financial statements do not
include any adjustments, beyond existing accruals applicable under Statement of
Financial Accounting Standards No. 5, "Accounting for Contingencies," that
might result from the ultimate resolution of such matters.
See Note 9 for a discussion of the Company's plan with respect to the Series
B Preferred Stock held by ChevronTexaco and its mandatory redemption date of
November 13, 2003.
As discussed in the Explanatory Note--Restatements, the consolidated
financial statements, which were originally audited by other independent
accountants who have ceased operations, include restatements of the Company's
previously filed consolidated financial statements at December 31, 2001 and
2000 and for each of the three years in the period ended December 31, 2001. As
disclosed in the Explanatory Note--Restatements, the Company has reduced its
retained earnings at December 31, 1998 from amounts previously reported on by
other independent accountants in the amount of $55 million.
As discussed in Note 3, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" as of January 1, 2001.
PricewaterhouseCoopers LLP
Houston, Texas
April 9, 2003
F-2
DYNEGY INC.
CONSOLIDATED BALANCE SHEETS
(RESTATED)
See Explanatory Note--Restatements
December 31, December 31,
2001 2000
------------ ------------
(in millions,
except share data)
ASSETS
Current Assets
Cash and cash equivalents............................................................................. $ 208 $ 59
Restricted cash....................................................................................... 28 27
Accounts receivable, net of allowance for doubtful accounts of $113 million and $69 million,
respectively......................................................................................... 3,083 4,717
Accounts receivable, affiliates....................................................................... 36 209
Inventories........................................................................................... 256 280
Assets from risk-management activities................................................................ 3,953 5,222
Prepayments and other assets.......................................................................... 1,392 313
------- -------
Total Current Assets............................................................................ 8,956 10,827
------- -------
Property, Plant and Equipment......................................................................... 10,135 7,730
Less: accumulated depreciation........................................................................ (934) (649)
------- -------
9,201 7,081
Other Assets
Investments in unconsolidated affiliates.............................................................. 944 799
Investment in Northern Natural Gas Company............................................................ 1,501 --
Assets from risk-management activities................................................................ 2,214 1,794
Intangible assets, net of amortization................................................................ 1,561 1,449
Other assets.......................................................................................... 791 712
------- -------
Total Assets.................................................................................... $25,168 $22,662
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable...................................................................................... $ 2,064 $ 4,676
Accounts payable, affiliates.......................................................................... 38 67
Accrued liabilities and other......................................................................... 2,617 715
Liabilities from risk-management activities........................................................... 3,361 4,710
Current portion of long-term debt and transitional funding trust notes................................ 458 118
------- -------
Total Current Liabilities....................................................................... 8,538 10,286
------- -------
Long-Term Debt........................................................................................ 4,500 3,151
Other Liabilities
Transitional funding trust notes...................................................................... 516 603
Liabilities from risk-management activities........................................................... 1,871 1,908
Deferred income taxes................................................................................. 1,568 1,240
Other long-term liabilities........................................................................... 1,070 665
------- -------
Total Liabilities............................................................................... 18,063 17,853
------- -------
Minority Interest (Note 10)........................................................................... 1,040 1,022
Serial Preferred Securities of a Subsidiary (Note 9).................................................. 46 46
Company Obligated Preferred Securities of Subsidiary Trust (Note 9)................................... 200 300
Series B Convertible Preferred Securities (Note 9).................................................... 882 --
Commitments and Contingencies (Note 11)...............................................................
Stockholders' Equity..................................................................................
Class A common stock, no par value, 900,000,000 and 300,000,000 shares authorized at December 31,
2001 and 2000, respectively; 269,984,456 and 237,390,802 shares issued and outstanding at December
31, 2001 and 2000, respectively...................................................................... 2,786 2,152
Class B common stock, no par value, 360,000,000 and 120,000,000 shares authorized at December 31,
2001 and 2000, respectively; 86,499,914 and 85,330,544 shares issued and outstanding at December 31,
2001 and 2000, respectively.......................................................................... 801 760
Additional paid-in capital (Note 9)................................................................... 688 15
Subscriptions receivable (Note 13).................................................................... (38) --
Accumulated other comprehensive loss, net of tax...................................................... (27) (15)
Retained earnings..................................................................................... 798 532
Less: treasury stock, at cost: 1,766,800 and 70,000 shares at December 31, 2001 and 2000, respectively (71) (3)
------- -------
Total Stockholders' Equity...................................................................... 4,937 3,441
------- -------
Total Liabilities and Stockholders' Equity............................................................ $25,168 $22,662
======= =======
See Notes to Consolidated Financial Statements.
F-3
DYNEGY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(RESTATED)
See Explanatory Note--Restatements
Year Ended December 31,
-------------------------
2001 2000 1999
------- ------- -------
(in millions,
except per share data)
Revenues............................................................ $42,613 $29,327 $15,410
Cost of sales (exclusive of depreciation shown below)............... 40,812 27,934 14,900
Depreciation and amortization expense............................... 488 393 115
Loss (gain) on asset sales.......................................... (36) (132) (50)
General and administrative expenses................................. 547 345 219
------- ------- -------
Operating income.................................................... 802 787 226
Earnings of unconsolidated affiliates............................... 217 205 80
Other income........................................................ 80 52 12
Interest expense.................................................... (270) (251) (78)
Other expenses...................................................... (13) (30) (15)
Minority interest expense........................................... (78) (52) (11)
Accumulated distributions associated with trust preferred securities (22) (29) (17)
------- ------- -------
Income before income taxes.......................................... 716 682 197
Income tax provision................................................ 312 246 60
------- ------- -------
Income from operations.............................................. 404 436 137
Cumulative effect of change in accounting principle................. 2 -- --
------- ------- -------
NET INCOME.......................................................... $ 406 $ 436 $ 137
------- ------- -------
Net income.......................................................... $ 406 $ 436 $ 137
Less: preferred stock dividends..................................... 42 35 --
------- ------- -------
Net income applicable to common stockholders........................ $ 364 $ 401 $ 137
======= ======= =======
Net Income Per Share:
Basic earnings per share............................................ $ 1.12 $ 1.33 $ 0.64
======= ======= =======
Diluted earnings per share.......................................... $ 1.07 $ 1.27 $ 0.60
======= ======= =======
Basic shares outstanding............................................ 326 302 213
======= ======= =======
Diluted shares outstanding.......................................... 340 315 230
======= ======= =======
See Notes to Consolidated Financial Statements.
F-4
DYNEGY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(RESTATED)
See Explanatory Note--Restatements
Year Ended December 31,
-----------------------
2001 2000 1999
------- ------- -----
(in millions)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................................. $ 406 $ 436 $ 137
Items not affecting cash flows from operating activities:
Depreciation, amortization, impairment and abandonment.............. 486 362 93
Earnings from unconsolidated investments, net of cash distributions. (117) (87) (14)
Risk-management activities.......................................... (17) (145) (174)
Deferred income taxes............................................... 242 170 57
Gain on asset sales, net............................................ (36) (132) (50)
Reserve for doubtful accounts....................................... 55 45 --
Income tax benefit from stock option exercise and other............. 51 71 16
Change in assets and liabilities resulting from operating activities:
Accounts receivable................................................. 1,622 (5,060) (428)
Inventories......................................................... 24 (129) (20)
Prepayments and other assets........................................ (183) 93 51
Accounts payable and accrued liabilities............................ (2,011) 4,870 404
Other, net............................................................. 28 (74) (32)
------- ------- -----
Net cash provided by operating activities.............................. 550 420 40
------- ------- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures................................................... (2,551) (1,071) (437)
Investment in unconsolidated affiliates................................ (1,533) (142) (84)
Business acquisitions, net of cash acquired............................ (603) (1,202) --
Proceeds from asset sales.............................................. 1,078 876 81
Other investing, net................................................... (219) -- 49
------- ------- -----
Net cash used in investing activities.................................. (3,828) (1,539) (391)
------- ------- -----
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term borrowings..................................... 1,537 570 469
Repayments of long-term borrowings..................................... (504) (359) (44)
Net cash flow from commercial paper and money market lines of credit... 599 (906) (42)
Increase in restricted cash............................................ (1) (27) --
Proceeds from sale of capital stock, options and warrants.............. 604 1,216 22
Proceeds from issuance of convertible preferred stock.................. 1,500 -- --
Purchase of treasury stock............................................. (68) (3) --
Redemption of Illinois Power Preferred Securities...................... (100) (93) --
Dividends and other distributions, net................................. (98) (112) (8)
Other financing, net................................................... (19) 845 2
------- ------- -----
Net cash provided by financing activities.............................. 3,450 1,131 399
Effect of exchange rates on cash....................................... (23) (29) --
Net increase (decrease) in cash and cash equivalents................... 149 (17) 48
Cash and cash equivalents, beginning of year........................... 59 76 28
------- ------- -----
Cash and cash equivalents, end of year................................. $ 208 $ 59 $ 76
======= ======= =====
See Notes to Consolidated Financial Statements.
F-5
DYNEGY INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(RESTATED)
See Explanatory Note--Restatements
Preferred Stock Common Stock Treasury
-------------- ------------- Paid In Retained ------------
Shares Amount Shares Amount Capital Other Earnings Shares Amount Total
------ ------ ------ ------ ------- ----- -------- ------ ------ ------
(in millions)
December 31, 1998..................... 5 $ 75 211 $ 1 $ 935 $ -- $ 79 (2) $(17) $1,073
Comprehensive income:
Net income......................... -- -- -- -- -- -- 137 -- -- 137
------
Total comprehensive income............ 137
Options exercised..................... -- -- 5 -- 22 -- -- -- -- 22
Dividends and other distributions..... -- -- -- -- -- -- (8) -- -- (8)
401(k) plan and profit sharing stock.. -- -- 1 -- 10 -- -- -- -- 10
Options granted....................... -- -- -- -- 6 -- -- -- -- 6
-- ---- --- ------ ----- ---- ----- -- ---- ------
December 31, 1999..................... 5 $ 75 217 $ 1 $ 973 $ -- $ 208 (2) $(17) $1,240
Comprehensive income:
Net income......................... -- -- -- -- -- -- 436 -- -- 436
Other comprehensive loss, net of
tax............................... -- -- -- -- -- (15) -- -- -- (15)
------
Total comprehensive income............ 421
Illinova acquisition.................. 1 (75) 59 1,817 (973) -- -- 2 17 786
Common Stock issued................... -- -- 23 858 -- -- -- -- -- 858
Preferred Stock conversion............ (6) -- 12 -- -- -- -- -- -- --
Extant acquisition.................... -- -- 2 67 -- -- -- -- -- 67
Options exercised..................... -- -- 9 157 -- -- -- -- -- 157
Dividends and other distributions..... -- -- -- -- -- -- (112) -- -- (112)
401(k) plan and profit sharing stock.. -- -- 1 12 -- -- -- -- -- 12
Options granted....................... -- -- -- -- 15 -- -- -- -- 15
Treasury stock........................ -- -- -- -- -- -- -- -- (3) (3)
-- ---- --- ------ ----- ---- ----- -- ---- ------
December 31, 2000..................... -- $ -- 323 $2,912 $ 15 $(15) $ 532 -- $ (3) $3,441
Comprehensive income:
Net income......................... -- -- -- -- -- -- 406 -- -- 406
Other comprehensive loss, net of
tax............................... -- -- -- -- -- (12) -- -- -- (12)
------
Total comprehensive income............ 394
Common Stock issued................... -- -- 31 605 -- -- -- -- -- 605
Subscriptions receivable.............. -- -- -- (38) -- -- -- -- -- (38)
Implied dividend on Series B Preferred
Stock................................ -- -- -- -- 660 -- -- -- -- 660
Options exercised..................... -- -- 3 57 -- -- -- -- -- 57
Dividends and other distributions..... -- -- -- -- -- -- (140) -- -- (140)
401(k) plan and profit sharing stock.. -- -- -- 13 -- -- -- -- -- 13
Options granted....................... -- -- -- -- 13 -- -- -- -- 13
Treasury stock........................ -- -- -- -- -- -- -- 2 (68) (68)
-- ---- --- ------ ----- ---- ----- -- ---- ------
December 31, 2001..................... -- $ -- 357 $3,549 $ 688 $(27) $ 798 2 $(71) $4,937
== ==== === ====== ===== ==== ===== == ==== ======
See Notes to Consolidated Financial Statements.
F-6
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(RESTATED)
EXPLANATORY NOTE--RESTATEMENTS
This Amendment No. 2 on Form 10-K/A includes restatements of the Company's
consolidated financial statements for each of the three years in the period
ended December 31, 2001. These restated financial statements contain
corrections to the Company's 2001, 2000 and 1999 financial statements
previously filed with Dynegy's Annual Report on Form 10-K for the year ended
December 31, 2001, as amended by Amendment No. 1 to Dynegy's Annual Report for
the year ended December 31, 2001, which was filed on February 14, 2003. The
restatements relate to the following items:
. the Project Alpha structured natural gas transaction,
. a balance sheet reconciliation project relating principally to the
Company's natural gas marketing business,
. corrections to the Company's previous hedge accounting for certain
contracts resulting in the Company accounting for these contracts
pursuant to the mark-to-market method under Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended ("Statement No. 133"); in addition, the
Company determined that it had incorrectly accounted for certain
derivative transactions prior to the adoption of Statement No. 133,
. the valuation used in the Company's 2000 acquisition of Extant, Inc.,
. the restatement of the Company's forward power curve methodology to
reflect forward power and market prices more closely,
. the recognition of additional assets, accrued liabilities and debt
associated with certain lease arrangements, as well as depreciation and
amortization expense for the related assets,
. a correction to the measurement date relating to the implied dividend the
Company previously recorded related to the in-the-money beneficial
conversion option in the $1.5 billion in Series B preferred stock issued
to ChevronTexaco in November 2001,
. the recognition of an other-than-temporary decline in value of a
technology investment in the third quarter of 2001 rather than the second
quarter of 2002,
. corrections to our previous accounting for income taxes, and
. other adjustments that arose during the re-audit of the Company's
1999-2001 financial statements.
Quarterly information in this Explanatory Note is unaudited. Specifically,
the restatements are as follows:
Project Alpha. Dynegy entered into the Project Alpha structured natural gas
transaction in April 2001. As described in a Current Report on Form 8-K dated
April 25, 2002 (the "Alpha Form 8-K"), Dynegy restated the cash flow associated
with the related gas supply contract as a financing activity in its
Consolidated Statement of Cash Flows for 2001. The effect of this restatement
was to reclassify approximately $290 million of previously disclosed 2001
operating cash flow to financing cash flow. Following the disclosure in the
Alpha Form 8-K and in connection with a further review of Project Alpha, Arthur
Andersen LLP ("Andersen") informed the Company that it could no longer support
its tax opinion relating to the transaction. Andersen's change in position was
based in part on its conclusion that the reclassification of cash flow from
operations to cash flow from financing lessened the factual basis for the
opinion. Dynegy's financial statement recognition of the tax benefit in 2001
was based principally on the Company's assessment of the relevant issues, as
corroborated by Andersen's tax
F-7
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
opinion. After the withdrawal of Andersen's tax opinion, management concluded
that sufficient support to include the income tax benefit for financial
statement presentation purposes no longer existed, the effect of which was a
reversal of approximately $79 million ($0.23 per diluted share) of tax benefit
previously recognized by the Company during the 2001 period. Andersen further
advised the Company that its audit opinion relating to 2001 should no longer be
relied upon as a result of the pending restatements relating to Project Alpha
and such audit opinion has been withdrawn. Dynegy subsequently concluded that
its 2001 restated consolidated financial statements would include the
consolidation of ABG Gas Supply, LLC ("ABG"), one of the entities formed in
connection with the transaction. The consolidation of ABG is included herein
based on compilations of financial information received from an agent of ABG's
equity holders. The most significant impact of this consolidation is to
increase Dynegy's consolidated indebtedness by approximately $280 million and
to increase net risk management assets by $340 million, in each case at
December 31, 2001. This $340 million increase reflects the recognition of ABG's
net risk-management assets on Dynegy's Consolidated Balance Sheet.
The table below reflects the quarterly and year-to-date impact of the
Project Alpha restatements on net income as originally reported:
Three Three Three Three Six Twelve
Months Months Months Months Months Nine Months Months
Ended Ended Ended Ended Ended Ended Ended
March 31 June 30 September 30 December 31 June 30 September 30 December 31
-------- ------- ------------ ----------- ------- ------------ -----------
($ in millions)
2001 $-- $(27) $(36) $(16) $(27) $(63) $(79)
Balance Sheet Reconciliation Project. Dynegy originally recognized an
after-tax charge of approximately $80 million ($124 million pre-tax) in the
second quarter 2002 related to a balance sheet reconciliation project
undertaken by the Company at the beginning of 2002. The charge related
principally to the Company's natural gas marketing business and was associated
with the process of reconciling accrued to actual results. Accrual accounting
for natural gas marketing involves the estimation of gas volumes bought, sold,
transported and stored, as well as the subsequent reconciliation of estimated
to actual volumes. The Company has restated its financial statements to
allocate this $80 million charge from the second quarter 2002 back to the
periods in which the transactions giving rise to the charge originally
occurred. The table below reflects the impact on net income of this
restatement. The table below reflects revisions to the table originally
included in the Company's Current Report on Form 8-K dated November 14, 2002.
The effect of these revisions is to re-allocate the charge among the periods
presented.
Six Twelve
Three Three Three Three Months Months
Months Months Months Months Ended Nine Months Ended
Ended Ended Ended Ended June Ended December
March 31 June 30 September 30 December 31 30 September 30 31
- -------- ------- ------------ ----------- ------ ------------ --------
($ in millions)
1998 and prior..... $(33)
1999............... $(12) $ 3 $ 4 $ 9 $(9) $(5) 4
2000............... (7) 3 1 (35) (4) (3) (38)
2001............... 22 (18) (4) (26) 4 -- (26)
2002............... 4 9 -- -- 13 13 13
----
Total Re-allocation $(80)
====
F-8
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
The restatement decreased diluted earnings per share by $0.08, decreased
diluted earnings per share by $0.12 and increased diluted earnings per share by
$0.02 for the years ended December 31, 2001, 2000 and 1999, respectively.
Corrected Hedge Accounting. The Company adopted Statement No. 133 effective
January 1, 2001 and reflected certain contracts as cash flow hedges upon such
adoption. Management has subsequently determined that following the initial
adoption of Statement No. 133, the documentation of compliance requirements
under the standard, particularly as it relates to documentation and the
periodic assessment of hedge effectiveness, was inadequate to support the
accounting method previously applied. In addition, the Company determined that
it had incorrectly accounted for certain derivative transactions prior to the
adoption of Statement No. 133. The resulting restatement reflects the
accounting for these contracts on a mark-to-market basis rather than on the
deferred basis previously employed. The correction in the accounting method for
these contracts increased previously reported 1999 net income by $2 million
($0.01 per diluted share), decreased previously reported 2000 net income by
approximately $19 million ($0.06 per diluted share) and increased previously
reported 2001 net income by approximately $45 million ($0.13 per diluted
share). This correction had no impact on previously reported cash flows from
operations in any period.
The table below reflects the impact of this restatement on net income as
originally reported:
Three Three Three Three Six Twelve
Months Months Months Months Months Nine Months Months
Ended Ended Ended Ended Ended Ended Ended
March 31 June 30 September 30 December 31 June 30 September 30 December 31
-------- ------- ------------ ----------- ------- ------------ -----------
($ in millions)
1999 $-- $ -- $ -- $ 2 $-- $-- $ 2
2000 19 14 (14) (38) 33 19 (19)
2001 15 (12) 5 37 3 8 45
Valuation of Extant, Inc. Purchase. On September 29, 2000, Dynegy completed
the acquisition of Extant, Inc., a privately held entity engaged in the
communications business. The transaction was accounted for as a purchase. In
2000, the Company incorrectly valued the shares of Class A common stock it
issued as consideration for the acquisition at $49.59 per share, rather than
$36.59 per share, which amount represented the average share price during the
five days surrounding the announcement of the acquisition. The $49.59 per share
originally utilized in the valuation was incorrectly based on the average
closing price of Dynegy's Class A common stock during the 30 days prior to the
closing date, which was consistent with the valuation provisions in the merger
agreement. As a result, the purchase price allocated to the assets acquired and
liabilities assumed in the purchase was overstated by approximately $23 million
in 2000. This error resulted in an overstatement of the amortization of
goodwill acquired in the transaction during 2001 and 2000. The resulting
restatement reflects an increase in net income in 2001 and 2000 by
approximately $1 million and approximately $300,000, respectively.
Additionally, as a result of this error, the Company overstated by $22 million
the impairment of goodwill recorded in 2002 associated with the Company's
January 1, 2002 adoption of Statement of Financial Accounting Standard No. 142,
"Goodwill and Other Intangible Assets."
Restated Forward Power Curve Methodology. The Company values substantially
all of its natural gas marketing, power marketing and portions of its natural
gas liquids marketing operations under a mark-to-market accounting methodology.
The estimated fair value of the marketing and trading portfolio is computed by
multiplying all existing positions in the portfolio by estimated prices,
reduced by a LIBOR-based time value of
F-9
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
money adjustment and deduction of reserves for credit, price and market
liquidity risks. Dynegy uses a combination of market quotes, derivatives of
market quotes and proprietary models to periodically value this portfolio as
required by generally accepted accounting principles. Market quotes are used
for near-term transactions, where such quotes are generally available;
derivatives of market quotes are used for mid-term transactions, where broker
quotes are only marginally available; and proprietary models are used for
long-term transactions, where broker quotes or other objective pricing
indicators typically are not available. Beginning in the third quarter 2001,
the Company began to enter into longer-term power transactions in the United
States with respect to which no broker quotes or other market data was
available; consequently, the Company applied a proprietary model to estimate
forward prices and, in turn, the fair market value of these longer-term power
transactions.
During January 2003, in connection with the re-audit of the Company's
1999-2001 financial statements and an assessment of various accounting
policies, the Company reconsidered the model-based methodology used to value
the portions of its power marketing and trading portfolio for which broker
quotes were not available. Under the Company's prior methodology, forward
curves used to calculate the value of its long-term U.S. power contracts were
derived from a proprietary model based on a required rate of return on
investments in new generation facilities. This methodology had been confirmed
by the Company's former independent auditors prior to the withdrawal of their
audit opinion for unrelated matters. The primary disadvantage of this
methodology is that, in certain circumstances, it may not reflect true market
prices in future years. After reconsidering the appropriateness of this
methodology in light of changing industry circumstances in late January 2003
the Company determined that, beginning with the third quarter 2001, its prior
forward power curve methodology failed to appropriately reflect the value of
its long-term power contracts.
Upon making this determination, the Company corrected the forward power
curve methodology it used to estimate the fair market value of its U.S. power
marketing and trading portfolio. This corrected methodology incorporates
forward energy prices derived from broker quotes and values from executed
transactions to estimate forward price curves for periods where broker quotes
and transaction data cannot be obtained. Further, the Company determined that
in order to adequately reflect its results, it was appropriate to restate its
prior period financial statements, beginning with the third quarter 2001, to
reflect the corrected methodology.
This correction in the methodology resulted in a $94 million ($0.28 per
diluted share) reduction to previously reported 2001 net income.
The table below reflects the impact of this restatement on net income as
originally reported:
Three Three Three Three Six Twelve
Months Months Months Months Months Nine Months Months
Ended Ended Ended Ended Ended Ended Ended
March 31 June 30 September 30 December 31 June 30 September 30 December 31
-------- ------- ------------ ----------- ------- ------------ -----------
($ in millions)
2001 $-- $-- $(25) $(69) $-- $(25) $(94)
F-10
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Restated Lease Accounting. The Company previously accounted for seven
generation lease arrangements and one communications lease arrangement as
operating leases. Its previous accounting treatment of these lease
arrangements, which was confirmed by the Company's former independent auditors
prior to the withdrawal of their audit opinion for unrelated matters, reflected
its belief that these arrangements satisfied the applicable generally accepted
accounting principles ("GAAP") requirements so as to justify their treatment as
operating leases. However, these requirements are very technical and subject to
a high degree of interpretation. During the course of the re-audit of the
Company's financial statements for 1999-2001, the Company analyzed its
accounting for these arrangements and considered a variety of factors,
including interpretations of the applicable GAAP requirements. Upon completion
of this analysis and discussions with PricewaterhouseCoopers LLP, in January
2003, the Company determined it was necessary to correct its accounting for
these lease arrangements to recognize on its balance sheet the related assets
as of the inception of six of these arrangements. Although the Company
previously amended the agreements relating to six generation lease arrangements
so as to require them to be treated as capital leases in the second quarter
2002, the restatement of the accounting originally applied to these arrangement
results in the recognition of the related assets as of an earlier date.
Consequently, the Company's previously reported net income for 2001 is reduced
by approximately $9 million ($0.03 per diluted share), reflecting the
recognition of depreciation and amortization expenses associated with the
related assets. In addition, balance sheet amounts have been adjusted for this
change as follows:
December 31
-------------------
2001 2000 1999
------ ----- ----
($ in millions)
Restricted cash.............. $ 17 $ 14 $ --
Property, plant and equipment 1,094 374 72
Accrued liabilities and other (445) (65) --
Long-term debt............... (666) (323) (72)
Please read Note 7--Debt for further discussion.
The table below reflects the impact of this restatement on net income as
originally reported:
Three Three Three Three Six Twelve
Months Months Months Months Months Nine Months Months
Ended Ended Ended Ended Ended Ended Ended
March 31 June 30 September 30 December 31 June 30 September 30 December 31
-------- ------- ------------ ----------- ------- ------------ -----------
($ in millions)
2001 $-- $-- $(2) $(7) $-- $(2) $(9)
Change in Implied Preferred Dividends. In November 2001, the Company issued
$1.5 billion in Series B preferred stock to ChevronTexaco. This preferred stock
is convertible by ChevronTexaco into shares of Dynegy's Class B common stock at
a conversion price of $31.64. This conversion price represents an approximate
5% discount to the Company's stock price on November 7, 2001, the date the
conversion price was negotiated. Based on the implied value of this beneficial
conversion option as of November 7, Dynegy recognized a $65 million preferred
stock dividend to be amortized over the two-year period leading up to the
mandatory redemption date for the shares. During the course of the three-year
re-audit, we analyzed our accounting for the beneficial conversion option and
determined it necessary to correct the commitment date used for valuing this
beneficial conversion option to November 13, 2001, the date ChevronTexaco
funded and
F-11
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
consummated its preferred stock purchase and the preferred securities were
issued. The Company's stock price increased significantly between November 7
and November 13 after the announcement of the proposed Enron Corp. merger. As a
result of the increase in the implied value of ChevronTexaco's beneficial
conversion option, the restated preferred stock dividend amount is calculated
based on a two-year amortization of the beneficial conversion option's implied
value of approximately $660 million--an increase of approximately $595 million
over the $65 million originally reported. Net income available to common
stockholders as originally reported for 2001 is accordingly reduced by
approximately $39 million ($0.11 per diluted share) as a result of this
commitment date change.
The table below reflects the impact of this restatement on net income
available to common stockholders as originally reported. The adjustment had no
impact on net income or cash flows.
Three Three Three Three Six Twelve
Months Months Months Months Months Nine Months Months
Ended Ended Ended Ended Ended Ended Ended
March 31 June 30 September 30 December 31 June 30 September 30 December 31
-------- ------- ------------ ----------- ------- ------------ -----------
($ in millions)
2001 $-- $-- $-- $(39) $-- $-- $(39)
Valuation of Technology Investment. We acquired the common stock of a
technology investment in the second quarter 2000. In the second quarter 2002,
after several quarters of declines in the market price of the investment, we
determined that the decline in value was other-than-temporary. As such, we
recognized a $12 million after-tax charge ($0.04 per diluted share) during the
second quarter 2002. Upon further review, we determined that we incorrectly
delayed recognition of the charge associated with this investment, as the
decline in value through September 30, 2001 met the "other-than-temporary"
threshold. Therefore, we have restated the financial statements to record the
impairment in the third quarter 2001.
The table below reflects the impact of this restatement on net income as
originally reported:
Three Three Three Three Six Nine Twelve
Months Months Months Months Months Months Months
Ended Ended Ended Ended Ended Ended Ended
March 31 June 30 September 30 December 31 June 30 September 30 December 31
-------- ------- ------------ ----------- ------- ------------ -----------
($ in millions)
2001 $-- $-- $(12) $-- $-- $(12) $(12)
Correction for Income Taxes. During the course of the re-audit of our
1999-2001 financial statements, we determined that we made errors in accounting
for certain tax matters. These errors related to book-tax basis differences
that were reflected as permanent differences as opposed to temporary
differences, the failure to record differences between the amounts recognized
as income tax provision and the amounts actually reflected in the applicable
income tax returns, adjustments related to book and tax-basis balance sheet
reconciliations and changes in estimates of tax contingencies. We have restated
our financial statements to correct these errors, resulting in additional
deferred tax expense as further detailed below.
F-12
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
The table below reflects the impact of these restatements on net income as
originally reported:
Three Three Three Three Six Twelve
Months Months Months Months Months Nine Months Months
Ended Ended Ended Ended Ended Ended Ended
March 31 June 30 September 30 December 31 June 30 September 30 December 31
-------- ------- ------------ ----------- ------- ------------ -----------
1998 and prior $(19)
1999.......... $(2) $-- $-- $ -- $(2) $ (2) (2)
2000.......... (7) -- -- (5) (7) (7) (12)
2001.......... (5) (3) (3) (26) (8) (11) (37)
Other Adjustments Arising During the Re-Audit. The Company has restated its
1999-2001 financial statements to correct various errors in our historical
financial statements that we discovered during the course of the re-audit.
These restatements, which principally relate to the timing on which various
transactions were recorded in the ordinary course of business, result in
increases (reductions) to previously reported 1999, 2000 and 2001 net income of
approximately $(19) million ($(0.09) per diluted share), $4 million ($0.01 per
diluted share) and $(30) million ($(0.09) per diluted share), respectively. The
$19 million reduction to previously reported 1999 net income primarily related
to the following items impacting the WEN and DMS segments: a purchase
accounting adjustment relating to a prior acquisition, and adjustments
impacting the timing on which certain items were previously recognized relating
to inventory valuations, intercompany balances and the power marketing business.
The table below reflects the impact of these restatements on net income as
originally reported:
Three Three Three Three Six Twelve
Months Months Months Months Months Nine Months Months
Ended Ended Ended Ended Ended Ended Ended
March 31 June 30 September 30 December 31 June 30 September 30 December 31
-------- ------- ------------ ----------- ------- ------------ -----------
($ in millions)
1998 and prior $ (3)
1999.......... $ 15 $ (9) $ (9) $(16) $ 6 $ (3) (19)
2000.......... 9 3 (13) 5 12 (1) 4
2001.......... (16) (47) 29 4 (63) (34) (30)
Adjustments to Previously Announced Restatements. Since the filing of its
Amendment No. 1 to Form 10-K on February 14, 2003, the Company has determined
that additional adjustments to its 1999, 2000 and 2001 financial statements are
required. These adjustments are due primarily to corrections in accounting for
income taxes and further changes to two previously announced restatement
items--further adjustments related to Statement No. 133 and further adjustments
arising during the re-audit. The net effect of these further restatement items
is to reduce 2001 net income as previously reported by approximately $15
million, reduce 2000 net income as previously reported by $58 million and
increase 1999 net income as previously reported by $19 million.
F-13
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
The following table reconciles selected financial data as reported in
various filings:
Form 10-K Form 8-K Form 8-K Form 10-K/A
filed filed filed filed
March 13, Adjustment and November 14, January 31, February 14,
2002 Reclassification(2) 2002 Adjustment 2003(1) Adjustment 2003
--------- ------------------- ------------ ---------- ----------- ---------- ------------
($ in millions, except earnings (losses) per diluted share)
Selected Balance Sheet Data
December 31, 2001
Current Assets........... $ 9,507 $ 437 $ 9,944 $ 40 $ 9,984
Total Assets............. 24,874 841 25,715 586 26,301
Current Liabilities...... 8,555 637 9,192 414 9,606
Total Liabilities........ 17,396 1,016 18,412 707 19,119
Stockholders' Equity..... 4,719 (185) 4,534 480 5,014
December 31, 2000
Current Assets........... $10,150 $ (33) $10,117 $ (36) $10,081
Total Assets............. 21,406 (56) 21,350 334 21,684
Current Liabilities...... 9,379 56 9,435 46 9,481
Total Liabilities........ 16,444 22 16,466 353 16,819
Stockholders' Equity..... 3,598 (78) 3,520 (23) 3,497
Results of Operations
Year ended December 31, 2001
Net Income (Loss)........ $ 648 $ (109) $ 539 $ (107) $ 432 $ (11) $ 421
Net Income (Loss)
Applicable to Common
Stockholders............ 645 (109) 536 (145) 391 (12) 379
Earnings (Losses) Per
Diluted Share........... $ 1.90 $(0.32) $ 1.58 $(0.43) $1.15 $(0.04) $ 1.11
Year ended December 31, 2000
Net Income (Loss)........ $ 501 $ (17) $ 484 $ 10 $ 494
Net Income (Loss)
Applicable to Common
Stockholders............ 466 (17) 449 10 459
Earnings (Losses) Per
Diluted Share........... $ 1.48 $(0.05) $ 1.43 $ 0.03 $ 1.46
Year ended December 31, 1999
Net Income (Loss)........ $ 152 $ (4) $ 148 $ (30) $ 118
Net Income (Loss)
Applicable to Common
Stockholders............ 152 (4) 148 (30) 118
Earnings (Losses) Per
Diluted Share........... $ 0.66 $(0.02) $ 0.64 $(0.13) $ 0.51
Selected Cash Flow Data
Year ended December 31, 2001
Operating Cash Flow...... $ 811 $ (291) $ 520 $ 15 $ 535
Investing Cash Flow...... (3,413) -- (3,413) (423) (3,836)
Financing Cash Flow...... 2,734 291 3,025 423 3,448
Year ended December 31, 2000
Operating Cash Flow...... $ 438 $ -- $ 438 $ (28) $ 410
Investing Cash Flow...... (1,304) -- (1,304) (254) (1,558)
Financing Cash Flow...... 907 -- 907 237 1,144
Year ended December 31, 1999
Operating Cash Flow...... $ 9 $ -- $ 9 $ 31 $ 40
Investing Cash Flow...... (319) -- (319) (72) (391)
Financing Cash Flow...... 327 -- 327 72 399
Form 10-K/A
filed
Adjustment and April 11,
Reclassification(3) 2003
------------------- -----------
Selected Balance Sheet Data
December 31, 2001
Current Assets........... $(1,028) $ 8,956
Total Assets............. (1,133) 25,168
Current Liabilities...... (1,068) 8,538
Total Liabilities........ (1,056) 18,063
Stockholders' Equity..... (77) 4,937
December 31, 2000
Current Assets........... $ 746 $10,827
Total Assets............. 978 22,662
Current Liabilities...... 805 10,286
Total Liabilities........ 1,034 17,853
Stockholders' Equity..... (56) 3,441
Results of Operations
Year ended December 31, 2001
Net Income (Loss)........ $ (15) $ 406
Net Income (Loss)
Applicable to Common
Stockholders............ (15) 364
Earnings (Losses) Per
Diluted Share........... $ (0.04) $ 1.07
Year ended December 31, 2000
Net Income (Loss)........ $ (58) $ 436
Net Income (Loss)
Applicable to Common
Stockholders............ (58) 401
Earnings (Losses) Per
Diluted Share........... $ (0.19) $ 1.27
Year ended December 31, 1999
Net Income (Loss)........ $ 19 $ 137
Net Income (Loss)
Applicable to Common
Stockholders............ 19 137
Earnings (Losses) Per
Diluted Share........... $ 0.09 $ 0.60
Selected Cash Flow Data
Year ended December 31, 2001
Operating Cash Flow...... $ 15 $ 550
Investing Cash Flow...... 8 (3,828)
Financing Cash Flow...... 2 3,450
Year ended December 31, 2000
Operating Cash Flow...... $ 10 $ 420
Investing Cash Flow...... 19 (1,539)
Financing Cash Flow...... (13) 1,131
Year ended December 31, 1999
Operating Cash Flow...... $ -- $ 40
Investing Cash Flow...... -- (391)
Financing Cash Flow...... -- 399
--------
(1) The Form 8-K filed January 31, 2003 only included 2001 results of
operations data. As a result, the only adjustments associated with such
Form 8-K relate to 2001 results of operations.
(2) This column includes increases to the December 31, 2001 balances of current
assets, total assets, current liabilities and total liabilities of $223
million, $301 million, $314 million and $313 million, respectively and a
decrease to stockholders' equity of $12 million related to
reclassifications to the December 31, 2001 balance sheet to conform to
December 31, 2002 balance sheet classifications.
(3) This column includes increases (decreases) to the operating cash flow,
investing cash flow and financing cash flow data of $15 million, $8 million
and $2 million, respectively, for the year ended December 31, 2001 and $30
million, $(1) million and $(13) million, respectively, for the year ended
December 31, 2000 to conform to cash flow classifications for the year
ended December 31, 2002.
F-14
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
PLEASE NOTE THAT THESE FINANCIAL STATEMENTS AND THE NOTES THERETO DO NOT
REFLECT EVENTS OCCURRING AFTER MARCH 13, 2002 (THE DATE ON WHICH DYNEGY FILED
ITS 2001 FORM 10-K). FOR A DESCRIPTION OF THESE EVENTS, PLEASE READ THE
COMPANY'S EXCHANGE ACT REPORTS FILED SINCE MARCH 13, 2002, INCLUDING ITS ANNUAL
REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2002. SEE NOTE
19--SUBSEQUENT EVENTS FOR FURTHER DISCUSSION.
Note 1--ORGANIZATION AND OPERATIONS OF THE COMPANY
Dynegy Inc. ("Dynegy" or the "Company") is one of the world's leading energy
merchants. Through its global energy delivery network and marketing, logistics
and risk-management capabilities, the Company provides innovative solutions to
customers in North America, the United Kingdom and Continental Europe. The
Company's businesses include power generation and wholesale and direct
commercial and industrial marketing of power, natural gas, coal and other
similar products. The Company is also engaged in the transportation, gathering
and processing of natural gas and natural gas liquids ("NGLs") and the
transmission and distribution of electricity and natural gas to retail
consumers. Dynegy also is engaged in the telecommunications business through
its global long-haul fiber optic and metropolitan network located in cities in
the United States and Europe.
Note 2--ACCOUNTING POLICIES
The accounting policies of Dynegy conform to generally accepted accounting
principles in the United States. The more significant of such accounting
policies are described below. The preparation of the consolidated financial
statements in conformity with GAAP requires management to develop estimates and
make assumptions that affect reported financial position and results of
operations and that impact the nature and extent of disclosure, if any, of
contingent assets and liabilities. Actual results could differ materially from
those estimates.
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.
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.
Restricted Cash. Restricted cash represents funds received in excess of
disbursements made in connection with the lease arrangements relating to the
generation facilities and the U.S. fiber optic network. Please read
Note 7--Debt for further discussion.
Investment in Unconsolidated Affiliates. 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. Any excess of the Company's
investment in these entities over its equity in the underlying net assets of
the affiliates is amortized over the estimated economic service lives of the
underlying assets. Effective January 1, 2002, the Company adopted Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("Statement No. 142"). Statement No. 142 discontinues the amortization of
goodwill associated with equity investments. Other investments less than 20
percent owned with readily determinable fair value are considered
available-for-sale and are recorded at quoted market value or at the lower of
cost or net realizable value, if there is no readily determinable fair value.
For securities with a readily determinable fair value, the change in the
F-15
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
unrealized gain or loss, net of deferred income tax, is recorded as a separate
component of other comprehensive income in the consolidated statement of
stockholders' equity. Realized gains and losses on investment transactions are
determined on the specific-identification basis.
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,
weather or other conditions. Receivables generally are not collateralized;
however, Dynegy believes the credit risk posed by industry concentration is
largely offset by the diversification and creditworthiness of the Company's
customer base.
Inventories. Inventories consisted primarily of natural gas in storage of
$50 million and $89 million, NGLs of $49 million and $129 million and coal of
$62 million and $24 million at December 31, 2001 and 2000, respectively, and
crude oil of $19 million at December 31, 2001. Such inventory is valued at the
lower of weighted average cost or at market. Materials and supplies inventory
of $76 million and $38 million at December 31, 2001 and 2000, respectively, is
carried at the lower of cost or market using the specific-identification method.
Property, Plant and Equipment. Property, plant and equipment, which
consists principally of gas gathering, processing, fractionation, terminaling
and storage facilities, natural gas transmission lines, pipelines, power
generating facilities and communications equipment, is recorded at cost.
Expenditures for major replacements, renewals, and major maintenance are
capitalized. The Company considers major maintenance to be expenditures
incurred on a cyclical basis in order to maintain and prolong the efficient
operation of its assets. Expenditures for 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 40 years. Composite depreciation
rates are applied to functional groups of property having similar economic
characteristics. The approximate depreciation rates are as follows:
Asset Group Range of Years Annual Percentage
----------- -------------- -----------------
Gathering and Processing
Systems 10 to 25 years 4.0% to 10.0%
Power Facilities 27 to 35 years 2.9% to 3.7%
Transportation
Equipment 10 to 25 years 4.0% to 10.0%
Telecommunications
Equipment 7 to 20 years 8.3% to 14.3%
Buildings and
Improvements 10 to 40 years 2.5% to 10.0%
Office and Miscellaneous
Equipment 3 to 35 years 2.9% to 33.3%
Storage Assets 14 to 30 years 3.3% to 7.1%
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. Gains and losses on the
sale of individual assets are reflected in Loss (gain) on asset sales in the
Consolidated Statement of Operations. Through the end of the period, the
Company has reviewed the carrying value of its long-lived assets
F-16
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
in accordance with provisions of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed of" ("Statement No. 121"). In August 2001, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("Statement No. 144"). Statement No. 144 addresses the accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
Statement No. 121 and APB Opinion No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions." The
Company's adoption of Statement No. 144 on January 1, 2002 did not have any
impact on the Company's financial position or results of operations.
Environmental Costs and Other Contingencies. Environmental costs relating
to 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 site-specific
costs. Such liabilities may be recognized on a discounted basis if the amount
and timing of anticipated expenditures for a site are fixed or reliably
determinable; otherwise, such liabilities are recognized on an undiscounted
basis. Environmental liabilities in connection with assets that are sold or
closed are recognized 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.
Liabilities for other contingencies are recognized upon identification of an
exposure, which when fully analyzed indicates that it is both probable that an
asset has been impaired or that a liability has been incurred and that such
loss amount can be reasonably estimated. Costs to remedy such contingencies or
other exposures are charged to a reserve, if one exists, or otherwise to
current-period operations. When a range of probable loss exists, the Company
accrues the lesser end of the range.
During 2001, the FASB issued Statement of Financial Accounting Standards No.
143, "Accounting for Asset Retirement Obligations" ("Statement No. 143").
Statement No. 143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred with
the associated asset retirement costs being capitalized as a part of the
carrying amount of the long-lived asset. The Company is evaluating the future
financial effects of adopting Statement No. 143 and expects to adopt the
standard effective January 1, 2003.
Goodwill and Other Intangible Assets. Intangible assets, principally
goodwill, have been amortized on a straight-line basis over their estimated
useful lives of 25 to 40 years. However, during 2001, the FASB issued Statement
No. 142 which discontinues goodwill amortization over its estimated useful
life; rather, goodwill will be subject to at least an annual fair-value based
impairment test. The Company is analyzing any impact the adoption of Statement
No. 142 effective January 1, 2002 will have on its financial position and
results of operations.
Revenue Recognition. Dynegy utilizes two comprehensive accounting models in
reporting its consolidated financial position and results of operations as
required by generally accepted accounting principles - an accrual model and a
fair value model. Dynegy determines the appropriateness of application of one
comprehensive accounting model over the other in accounting for its varied
operations based on guidance provided in numerous accounting standards and
positions adopted by the FASB or the Securities and Exchange Commission.
F-17
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
The accrual model is used to account for substantially all of the operations
conducted in the Dynegy Midstream Services ("DMS"), Transmission and
Distribution ("T&D") and Dynegy Global Communications ("DGC") segments as well
as all physically operated assets owned by the Wholesale Energy Network ("WEN")
segment. Ownership and operation of physical assets characterize these
businesses. Dynegy uses these physical assets in various manufacturing and
delivery processes. These processes include the generation of electricity, the
separation of natural gas liquids into their component parts from a stream of
natural gas, the transportation or transmission of commodities through
pipelines or over transmission lines and the delivery of data and voice bits
over communication networks. End sales from these businesses result in physical
delivery of commodities or services to Dynegy wholesale, commercial and
industrial and retail customers.
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. The Company's
transmission and distribution revenues are recognized when services are
provided to customers. 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. Shipping and handling costs are included in revenue when
billed to customers in conjunction with the sale of products.
Revenues derived from communications activities are recognized in the month
the service is provided. Amounts billed in advance of providing services are
recorded as unearned revenue until the period such services are either provided
or expire unused. Revenue related to installation of service and sale of
customer equipment is recognized when equipment is delivered and installation
is completed.
The fair value model is used to account for certain forward physical and
financial transactions in the WEN, DMS and DGC segments, which meet criteria
defined by the FASB or the Emerging Issues Task Force. These criteria require
these contracts to be related to future periods and contain fixed price and
volume components and must have terms that require or permit net settlement of
the contract in cash or its equivalent. As these transactions may be settled in
cash, the value of the assets and liabilities associated with these
transactions is reported at estimated settlement value based on current prices
and rates as of each balance sheet date. The net gains or losses resulting from
the revaluation of these contracts during the period are recognized in the
Company's result of operations. Assets and liabilities associated with these
transactions are reflected on the Company's balance sheet as risk management
assets and liabilities, classified as short-term or long-term pursuant to each
contract's individual tenor. Net unrealized gains and losses from these
contracts are classified as revenue in the accompanying statements of
operations. Transactions that have been realized and settled are reflected
gross in revenues and cost of sales.
The Company routinely enters into financial instrument contracts to hedge
purchase and sale commitments, fuel requirements and inventories in its NGLs,
electricity and coal businesses in order to minimize the risk of changes in
market prices in these commodities. 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 in the periods for which the underlying commodity,
interest rate or foreign currency transaction impacts earnings. If the
underlying being hedged by the commodity, interest rate or foreign currency
transaction is disposed of or otherwise terminated, the gain or loss associated
with such contract is no longer deferred and is recognized in the period the
underlying contract is eliminated.
F-18
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
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 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. Dilutive potential common shares consisted of approximately 10
million common shares subject to stock options and preferred stock convertible
into approximately 4 million common shares. For 2000 and 1999, dilutive
potential common shares consisted of stock options to purchase approximately 13
million and 17 million common shares, respectively. Common shares outstanding
and the resulting computation of basic and diluted earnings per share for all
periods prior to December 31, 1999 have been restated to give effect to the
0.69 fixed exchange ratio contained in the terms of the Illinova acquisition.
Also, all common shares outstanding, price per share, dividends per share and
earnings per share amounts relating to transactions or periods prior to August
22, 2000 have been restated for the two-for-one stock split effected by means
of a stock dividend distributed on August 22, 2000.
Foreign Currency Translations. For subsidiaries whose functional currency
is not the 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 for each month. Translation adjustments for the asset and liability
accounts are included as a separate component of other comprehensive income in
stockholders' equity. Currency transaction gains and losses are recorded in
income.
Employee Stock Options. The Company applies the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25") and related interpretations in accounting for its stock
compensation plans. Accordingly, compensation expense is not recognized for
employee stock options unless the options were granted at an exercise price
lower than the market value on the grant date. The Company has granted
below-market options in the past and continues to recognize compensation
expense over the applicable vesting periods. Stock options are no longer issued
at less than market price. Additionally, in 2001, a charge of $1 million
recognized in "General and Administrative Expenses" was incurred due to the
extension of the exercise period of various stock options and the acceleration
of vesting for various other stock options.
Regulatory Assets. Financial Accounting Standards No. 71, "Accounting for
the Effects of Certain Types of Regulation" ("Statement No. 71") allows
companies whose service obligations and prices are regulated to maintain
balance sheet assets representing costs they expect to recover through
inclusion in future rates. Illinois Power Company ("IP"), the Company's wholly
owned subsidiary, records regulatory assets in accordance with Statement No.
71. Regulatory assets represent probable future revenues associated with
certain costs that are expected to be recovered from customers through the
ratemaking process. The significant components of regulatory assets at December
31, 2001 and 2000 were approximately $336 million and $385 million,
respectively, and are included in other long-term assets.
F-19
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Note 3--COMMERCIAL OPERATIONS, RISK MANAGEMENT ACTIVITIES AND FINANCIAL
INSTRUMENTS
Dynegy's operations and periodic returns are impacted by a myriad of risk
factors, some of which may, and some of which may not, be mitigated by risk
management methods. These risks include, but are not limited to, commodity
price, interest rate and foreign exchange rate fluctuations, weather patterns,
counterparty risk, management estimations, strategic investment decisions,
changes in competition, operational risks, environmental risks and changes in
regulation.
The potential for changes in the market value of Dynegy's commodity,
interest rate and currency portfolios is referred to as "market risk". A
description of each market risk is set forth below:
. Commodity price risks result from exposures to changes in spot prices,
forward prices and volatilities of commodities, such as electricity,
natural gas, crude oil and other similar products;
. Interest rate risks primarily result from exposures to changes in the
level, slope and curvature of the yield curve and the volatility of
interest rates; and
. Currency rate risks result from exposures to changes in spot prices,
forward prices and volatilities of currency rates.
Dynegy seeks to manage these market risks through diversification,
controlling position sizes and executing hedging strategies. The ability to
manage an exposure may, however, be limited by adverse changes in market
liquidity or other factors. Dynegy cannot guarantee the ultimate effectiveness
of its risk management activities.
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 guidelines established by management and Dynegy's
Board of Directors, resulting from the management of its portfolio. In
addition, as a result of marketplace illiquidity and other factors, the Company
may, at times, be unable to hedge its portfolio fully for certain market risks.
The financial performance and cash flow derived from certain merchant
generating capacity (e.g., peaking facilities) are impacted annually, either
favorably or unfavorably, by changes in and the relationship between the cost
of the commodity fueling the facilities and electricity prices, which in turn
influences the volume of electricity generated by these assets.
Operating results associated with natural gas gathering, processing and
fractionation activities are sensitive to changes in NGL prices and the
availability of inlet volumes. In addition, similar to peaking electricity
generating facilities, straddle processing plants are impacted by changes in,
and the relationship between, natural gas and NGL prices, which in turn
influence the volumes of gas processed at these facilities. The impact from
changes in NGL prices on upstream operations results principally from the
nature of contractual terms under which natural gas is processed and products
are sold. The availability of inlet volumes directly affects the utilization
and profitability of this segment's businesses. Commodity price volatility may
also affect operating margins derived from the Company's NGL marketing
operations.
Operating results in the transmission and distribution business may be
impacted by commodity price fluctuations resulting from purchases of
electricity used in supplying service to its customers. IP has contracted for
volumes from various suppliers under contracts having various terms. Certain of
these contracts do not obligate the supplier to provide replacement power to IP
in the event of a curtailment or shutdown of operating facilities. If the
commodity volumes supplied from these agreements are inadequate to cover IP's
native load, the
F-20
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Company will be required to purchase its supply needs in open-market purchases
at prevailing market prices. Such purchases would expose IP to commodity price
risk. Price risk associated with the gas marketing operations of IP is
mitigated through contractual terms applicable to the business, as allowed by
the Illinois Commerce Commission (ICC).
Dynegy's commercial groups manage, on a portfolio basis, the resulting
market risks inherent in commercial 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 to
ensure compliance with Dynegy's risk-management policies. Risk measurement is
also practiced daily against the Dynegy portfolios with Value at Risk, stress
testing and scenario analysis on the commercial portfolios.
Quantitative and Qualitative Market Risk Disclosures. In addition to
applying business judgment, senior management uses a number of quantitative
tools to manage Dynegy's exposure to market risk. These tools include:
. Risk limits based on a summary measure of market risk exposure, referred
to as VaR; and
. Stress and scenario analyses as performed daily that measure the
potential effects of various market events, including substantial swings
in volatility factors, absolute commodity price changes and the impact of
interest rate movements.
VaR represents the potential loss in value of Dynegy's enterprise-wide
marketing portfolio due to adverse market movements over a defined time horizon
with a specified confidence level.
The modeling of the risk characteristics of Dynegy's marketing portfolio
involves a number of assumptions and approximations. Dynegy estimates VaR using
a JP Morgan RiskMetrics(TM) approach assuming a one-day holding period and a 95
percent confidence level. While management believes that these assumptions and
approximations are reasonable, there is no uniform industry methodology for
estimating VaR, and different assumptions and/or approximations could produce
materially different VaR estimates.
Dynegy uses historical data to estimate the Company's VaR and, to better
reflect current asset and liability volatilities, these historical data are
weighted to give greater importance to more recent observations. Given its
reliance on historical data, VaR is most effective in estimating risk exposures
in markets in which there are not sudden fundamental changes or shifts in
market conditions. An inherent limitation of VaR is that past changes in market
risk factors, even when weighted toward more recent observations, may not
produce accurate predictions of future market risk. VaR should be evaluated in
light of this and the methodology's other limitations.
Credit and Market Reserves. In connection with the market valuation of its
energy commodity contracts, the Company maintains certain reserves for a number
of risks associated with these future commitments. Among others, these include
reserves for credit risks based on the financial condition of counterparties,
reserves for price and product location ("basis") differentials and
consideration of the time value of money for long-term contracts.
Counterparties in its marketing 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.
F-21
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
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. As a
result of Enron Corp.'s ("Enron") bankruptcy, the Company reserved an after-tax
amount of $84 million in the fourth quarter of 2001 related to the Company's
net exposure for commercial transactions with the bankrupt enterprise. The
global netting agreement between Dynegy and Enron as well as the valuation of
these commercial transactions covered by the agreement are subject to approval
from the bankruptcy court.
The following table displays the value of Dynegy's marketing transactions at
December 31, 2001:
Below
Investment Investment
Grade Grade Credit
Credit Quality or
Quality Unrated Total
---------- ------------ ------
($ in millions)
Utilities and power generators..... $ 474 $(26) $ 448
Financial institutions............. (106) 1 (105)
Oil and gas producers.............. 129 124 253
Commercial and industrial companies 400 95 495
Other.............................. 52 6 58
----- ---- ------
Value of portfolio before reserves. $ 949 $200 $1,149
===== ==== ------
Credit and market reserves......... (248)
------
901
Other.............................. 34
------
Net risk-management assets......... $ 935
======
The net risk management asset of $935 million is the aggregate of the
following line items on the Consolidated Balance Sheet: Current Assets--Assets
from risk-management activities, Other Assets--Assets from risk-management
activities, Current Liabilities--Liabilities from risk-management activities
and Other Liabilities--Liabilities from risk-management activities. The
increase in the net risk management assets at December 31, 2001 from the
previously reported amount of $712 million is primarily due to a $340 million
increase from the consolidation of ABG, one of the entities formed in
connection with Project Alpha, and a $40 million reclassification of inventory.
These items are offset by a $149 million reduction resulting from the
adjustment to the forward power curve.
At December 31, 2001, the term of Dynegy's marketing portfolio extends to
2016 and the average remaining life of an individual transaction was five
months.
Accounting for Derivative Instruments and Hedging Activities. The Financial
Accounting Standards Board ("FASB") issued, and subsequently amended, Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("Statement No. 133"), which became effective January 1, 2001. Provisions in
Statement No. 133, as amended, affect the accounting and disclosure of certain
contractual arrangements and operations of the Company. Under Statement No.
133, as amended, all derivative instruments are recognized in the balance sheet
at their fair values and changes in fair value are recognized immediately in
earnings, unless the derivatives which are not a part of the Company's
marketing activities qualify and are designated as hedges of future cash flows,
fair values, net investments or qualify and are designated as normal purchases
and sales. For
F-22
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
derivatives treated as hedges of future cash flows, the effective portion of
changes in fair value is recorded in other comprehensive income until the
related hedged items impact earnings. Any ineffective portion of a hedge is
reported in earnings immediately. For derivatives treated as fair value hedges,
changes in the fair value of the derivative and changes in the fair value of
the related asset or liability are recorded in current period earnings. For
derivatives treated as hedges of net investment in foreign operations, the
effective portion of changes in the fair value of the derivative is recorded in
the cumulative translation adjustment. Derivatives treated as normal purchases
or sales are recorded and recognized in income using accrual accounting.
The Company recorded the impact of the adoption of Statement No. 133, as
amended, as a cumulative effect adjustment in the Company's consolidated
results on January 1, 2001. The amounts recorded, which are immaterial to net
income and the Company's financial position, are as follows (in millions):
Other
Net Comprehensive
Income Income
------ -------------
Adjustment to fair value of
derivatives.............. $ 3 $105
Income tax effects......... (1) (44)
--- ----
Total...................... $ 2 $ 61
=== ====
Changes in stockholders' equity related to derivatives for the year ended
December 31, 2001 were as follows, net of taxes (in millions):
Transition adjustment as of January 1, 2001 $ 61
Current period increase in fair value...... 4
Reclassifications to earnings, net......... (57)
----
Balance at December 31, 2001............... $ 8
====
Accumulated Other Comprehensive Loss, Net of Tax is included in
Stockholders' Equity on the Consolidated Balance Sheet as follows (in millions):
Statement No. 133, Net................................................ $ 8
Currency Translation Adjustment....................................... (28)
Unrealized Loss on Available-for-Sale Securities, Net................. (7)
----
Accumulated Other Comprehensive Loss, Net of Tax, at December 31, 2001 $(27)
====
Additional disclosures required by Statement No. 133, as amended, are
provided in the following paragraphs.
From time to time, the Company may enter into various financial derivative
instruments which qualify as cash flow hedges. Instruments related to its
energy convergence and midstream liquids businesses are entered into for
purposes of hedging forward fuel requirements for certain power generation and
fractionation facilities, locking in future margin in the domestic midstream
liquids business and hedging price risk in the global liquids business.
Interest rate swaps are used to convert the floating interest-rate component of
certain obligations to fixed rates.
F-23
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
The Company determined that its documentation and assessment of hedge
effectiveness related to certain contracts entered into to hedge fuel
requirements and power sales commitments was incomplete. As a result, the
accounting for these contracts has been restated herein. Otherwise, during the
year ended December 31, 2001, there was no material ineffectiveness from
changes in fair value of hedge positions, and no amounts were excluded from the
assessment of hedge effectiveness related to the hedge of future cash flows.
Additionally, no amounts were reclassified to earnings in connection with
forecasted transactions that were no longer considered probable of occurring.
The balance in other comprehensive income at December 31, 2001 is expected
to be reclassified to future earnings, contemporaneously with the related
purchases of fuel, sales of electricity or liquids, payments of interest and
recognition of operating lease expense, as applicable to each type of hedge. Of
this amount, approximately $4 million of income, net of taxes, is estimated to
be reclassified into earnings over the year ending December 31, 2002. The
actual amounts that will be reclassified to earnings over the next year and
beyond could vary materially from this estimated amount as a result of changes
in market conditions.
The Company also enters into derivative instruments which qualify as
fair-value hedges. The Company used interest rate-swaps to convert a portion of
its nonprepayable fixed-rate debt into variable-rate debt. During the twelve
months ended December 31, 2001, there was no ineffectiveness from changes in
fair value of hedge positions, and no amounts were excluded from the assessment
of hedge effectiveness. Additionally, no amounts were recognized in relation to
firm commitments that no longer qualified as fair-value hedge items.
The Company has investments in foreign subsidiaries, and the net assets of
these subsidiaries are exposed to currency exchange-rate volatility. The
Company uses derivative financial instruments, including foreign exchange
forward contracts and cross currency interest rate swaps, to hedge this
exposure. For the year ended December 31, 2001, approximately $29 million of
net losses related to these contracts were included in the cumulative
translation adjustment. This amount neutralizes the cumulative translation
gains of the underlying net investments in foreign subsidiaries for the period
the derivative financial instruments were outstanding.
Fair Value of Financial Instruments. The following disclosure of the
estimated fair value of financial instruments is made in accordance with the
requirements of Statement of Financial Accounting Standards No. 107,
"Disclosures About Fair Value of Financial Instruments." The estimated
fair-value amounts have been determined by the Company using available market
information and selected valuation methodologies. Considerable judgment is
required in interpreting market data to develop the estimates of fair value.
The use of different market assumptions or valuation methodologies could have a
material effect on the estimated fair-value amounts.
F-24
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
The carrying values of current financial assets and liabilities approximate
fair values due to the short-term maturities of these instruments. The carrying
amounts and fair values of the Company's other financial instruments were:
December 31,
--------------------------------
2001 2000
--------------- ---------------
Carrying Fair Carrying Fair
Amount Value Amount Value
($ in millions) -------- ------ -------- ------
Dynegy Inc.
Series B Convertible Preferred Securities/(1)/.................. $1,500 $1,418 $ -- $ --
Foreign Currency Risk-Management Contracts...................... (11) (11) 2 2
Dynegy Holdings Inc.
Commercial Paper................................................ 6 6 115 115
Revolving Credit Facilities..................................... 600 600 -- --
Canadian Credit Agreement....................................... 40 40 59 59
Senior Notes, 6.75% through 8.125%, due 2002 through 2026....... 1,693 1,488 1,200 1,200
ABG Gas Supply.................................................. 282 267 -- --
Preferred Securities of a Subsidiary Trust...................... 200 159 200 189
Fair Value Hedge Interest Rate Swap............................. (7) (7) -- --
Cash Flow Hedge Interest Rate Swap.............................. 1 1 -- --
Interest Rate Risk-Management Contracts......................... 6 6 -- --
Commodity Risk-Management Contracts............................. 293 293 924 922
Generation Facility Debt........................................ 342 342 261 261
Illinova Corporation
Senior Notes, 7.125%, due 2004.................................. 102 100 103 101
Medium Term Notes, 6.15% through 6.46%, due 2001 through
2002.......................................................... 20 20 50 50
Serial Preferred Securities of a Subsidiary..................... 46 39 46 27
Illinois Power Company
Commercial Paper................................................ 38 38 148 148
Revolving Credit Facilities..................................... 240 240 -- --
Mortgage Bonds, 6% through 7.5%, due 2002 through 2025.......... 674 649 674 671
Pollution Control Revenue Refunding Bonds, 5.4%--7.4%, due
2024 through 2028............................................. 175 183 175 173
Adjustable Rate Pollution Control Revenue Refunding Bonds, due
2032.......................................................... 150 150 150 150
Floating Rate Pollution Control Revenue Refunding Bonds, due
2017 through 2028............................................. 186 186 186 186
Transitional Funding Trust Notes, 5.26% through 5.65%, due 2001
through 2008.................................................. 602 607 689 677
Trust Originated Preferred Securities........................... -- -- 100 99
Dynegy Global Communications
Investment in Warrants.......................................... 37 37 14 14
U.S. Network Debt............................................... 324 324 62 62
--------
/(1) /Carrying value represents $882 million included in Series B Convertible
Preferred Securities, $660 million in additional paid-in capital and $(42)
million in retained earnings in the consolidated balance sheet.
F-25
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
The financial statement carrying amounts of the Company's credit agreement
and variable-rate debt obligations 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, were based on quoted market prices
by financial institutions that actively trade these debt securities. The fair
value of the Series B Convertible Preferred Securities was based on discounted
cash flows. 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 investment in warrants is recorded at fair value estimated using
the Black-Scholes valuation methodology.
The absolute notional contract amounts associated with the derivative
instruments designated as hedges were as follows:
December 31,
------------
2001
------------
Fair Value Hedge Interest Rate Swaps (In millions of U.S. Dollars)..... $ 206
Fixed Interest Rate Received on Swaps (Percent)..................... 5.284
Cash Flow Hedge Interest Rate Swaps (In millions of U.S. Dollars)...... $ 100
Fixed Interest Rate Paid on Swaps (Percent)......................... 4.397
U.K. Pound Sterling Net Investment Hedges (In millions of U.S. Dollars) $ 906
Average U.K. Pound Sterling Contract Rate (U.S. Dollars)............ $1.4233
In 2001, approximately 10% of the Company's consolidated revenues and 12% of
consolidated costs of sales were derived from transactions with Enron. Based on
the terms of these transactions, Dynegy can fulfill these needs through other
counterparties.
F-26
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Note 4--CASH FLOW INFORMATION
Detail of supplemental disclosures of cash flow and non-cash investing and
financing information was:
Year Ended December 31,
-----------------------
2001 2000 1999
----- ------- ----
($ in millions)
Interest paid (net of amount capitalized).... $ 248 $ 238 $80
===== ======= ===
Taxes paid (net of refunds).................. $ 79 $ 40 $ 2
===== ======= ===
Detail of businesses acquired:/(1)/
Current assets and other..................... $ 62 $ 648 $--
Fair value of non-current assets............. 863 7,509 --
Liabilities assumed, including deferred taxes (308) (4,782) --
Subordinated capital assumed................. -- (239) --
Capital stock issued and options exercised... -- (1,884) --
Cash balance acquired........................ (14) (50) --
----- ------- ---
Cash paid, net of cash acquired.............. $ 603 $ 1,202 $--
===== ======= ===
--------
/(1)/ The businesses acquired included: 2001--BG Storage Limited ("BGSL"), a
wholly owned subsidiary of BG Group plc, and iaxis, Limited ("iaxis") and
2000--Extant, Inc. ("Extant") and Illinova Corporation ("Illinova"). See
Note 14 for more information regarding these acquisitions.
Note 5--PROPERTY, PLANT AND EQUIPMENT
Investments in property, plant and equipment consisted of:
December 31,
---------------
2001 2000
------- ------
($ in millions)
Wholesale Energy Network:
Generation assets...................... $ 4,757 $3,766
Storage facilities (U.K.).............. 795 --
Dynegy Midstream Services:
Natural gas processing................. 1,000 934
Fractionation.......................... 200 198
Liquids marketing...................... 204 268
Natural gas gathering and transmission. 225 193
Crude oil.............................. -- 9
Transmission and Distribution............. 1,993 1,906
Dynegy Global Communications.............. 544 171
IT Systems and Other...................... 417 285
------- ------
10,135 7,730
Less: accumulated depreciation............ (934) (649)
------- ------
$ 9,201 $7,081
======= ======
F-27
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Interest capitalized related to costs of projects in process of development
totaled $20 million, $31 million and $17 million for the years ended December
31, 2001, 2000 and 1999, respectively. In 2000, a $25 million impairment
reserve was recorded related to Canadian gas processing assets.
As a result of the changes in accounting for six generation lease
arrangements and one communications lease arrangement, the Company recognized
additional generation assets of $787 million and additional Dynegy Global
Communications assets of $307 million. For further discussion of these
adjustments, see the Explanatory Note.
Note 6--INVESTMENTS IN UNCONSOLIDATED AFFILIATES AND NORTHERN NATURAL GAS
COMPANY
Investments in affiliates that are not controlled by the Company but where
the Company has significant influence over operations are accounted for by the
equity method. The Company's share of net income from these affiliates is
reflected in the Consolidated Statements of Operations as Equity in earnings of
unconsolidated affiliates. The Company's principal equity method investments
consist of entities that operate generation assets and natural gas liquids
assets. These equity investments totaled $830 million and $727 million at
December 31, 2001 and 2000, respectively. The Company entered into these
ventures principally for the purpose of sharing risk and leveraging existing
commercial relationships. These ventures maintain independent capital
structures and have financed their operations on a non-recourse basis to the
Company. The Company holds investments in three joint ventures in which Chevron
U.S.A. or its affiliates are investors. For additional information about these
investments, please read "Note 16--Related Party Transactions."
Generation Assets. Investments include ownership interests in seven joint
ventures that own fossil fuel electric generation facilities in diverse
geographic regions. The Company's ownership is generally 50 percent in the
majority of these ventures. The Company's net investment of $684 million at
December 31, 2001 represents approximately 2,400 MW of net generating capacity.
At December 31, 2001, the Company's investment exceeded its equity in the
underlying assets by approximately $143 million. Dynegy's most significant
investment is comprised of its interest in West Coast Power, LLC ("West Coast
Power"), a 50 percent owned venture with NRG, which totaled approximately $330
million at December 31, 2001 and generated equity earnings of $162 million in
2001.
Midstream Investments. Investments include ownership interests in three
ventures that operate natural gas liquids processing, extraction, fractionation
and storage facilities in the Gulf Coast region as well as an interstate NGL
pipeline. The Company's ownership interest in these ventures ranges from 23
percent to 39 percent. At December 31, 2001, the Company's investment exceeded
its equity in the underlying net assets by approximately $43 million.
Summarized aggregate financial information for these investments and
Dynegy's equity share thereof was:
December 31,
-----------------------------------------------------------
2001 2000/(1)/ 1999/(1)/
------------------- ------------------- -------------------
Total Equity Share Total Equity Share Total Equity Share
($ in millions) ------ ------------ ------ ------------ ------ ------------
Current assets......... $1,208 $ 513 $1,029 $ 374 $ 525 $ 184
Non-current assets..... 2,800 1,179 2,934 1,233 2,787 1,193
Current liabilities.... 791 339 734 276 847 374
Non-current liabilities 1,056 392 1,363 520 1,183 487
Revenues............... 4,000 1,540 3,988 1,568 1,339 526
Operating margin....... 920 352 857 324 443 174
Net income............. 541 218 481 196 135 58
F-28
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
--------
/(1)/ The financial data for 2000 and 1999 are exclusive of amounts
attributable to the Company's investment in Accord Energy Limited
("Accord") as data was unavailable for these periods. For competitive
reasons, Accord was unwilling to provide the Company with detailed
financial information concerning its operations. The Company
contractually agreed not to require the production of such information in
its negotiations with Accord. Dynegy's share of Accord earnings for each
of the years ended December 31, 2000 and 1999 totaled $9 million and $21
million, respectively. The Company sold its investment in Accord in the
third quarter of 2000.
Other Investments. In addition to these equity investments, the Company
holds interests in companies for which it does not have significant influence
over the operations. These investments are accounted for by the cost method.
Such investments totaled $91 million and $55 million at December 31, 2001 and
2000, respectively. The Company also owns securities that have a readily
determinable fair market value and are considered available-for-sale. The
market value of these investments at December 31, 2001 and 2000 was estimated
to be $23 million and $17 million, respectively.
In November 2001, Dynegy acquired 1,000 shares of Series A Preferred Stock
("Series A Preferred Stock") in Northern Natural Gas Company ("Northern
Natural") for $1.5 billion. The Series A Preferred Stock is entitled to
cumulative dividends, as and if declared by the board of directors of Northern
Natural, at a rate of 6%, payable annually beginning on January 31, 2003.
Dividends of $13 million are reflected in "Other Income" on the 2001
Consolidated Statement of Operations. The Series A Preferred Stock is
redeemable at the option of Northern Natural under specified circumstances at a
redemption price equal to the liquidation preference plus accrued and unpaid
dividends and other items.
Concurrent with the investment in Northern Natural, Dynegy entered into an
option agreement with a subsidiary of Enron that indirectly owned the common
stock of Northern Natural, under which a Dynegy subsidiary had the option to
purchase all of the equity of that Enron subsidiary. In connection with
Dynegy's termination of a merger agreement with Enron, it gave notice of its
intention to exercise its option to purchase such equity. The exercise price
for the option was $23 million subject to adjustment based on Northern
Natural's indebtedness and for the amount of working capital at closing.
Subsequent litigation relating to the option was settled by the parties on
January 3, 2002 and the closing of the option exercise occurred on January 31,
2002. At January 31, 2002, Northern Natural had approximately $950 million of
debt outstanding. Approximately $500 million of this debt is in the form of
senior unsecured notes with maturities ranging from 2005 to 2011. The remaining
$450 million is in the form of a secured line of credit due November 2002.
Dynegy has agreed to commence a tender offer by April 1, 2002 for $100 million
of the senior unsecured notes due in 2005. An Enron subsidiary has the option
to reacquire Northern Natural through June 30, 2002 for $1.5 billion plus
accrued and unpaid dividends on the Northern Natural Series A Preferred Stock
and the option exercise price, subject to adjustments based on Northern
Natural's indebtedness and working capital.
F-29
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Note 7--DEBT
Long-term debt and transitional funding trust notes outstanding consisted of
the following at December 31:
2001 2000
------ ------
($ in millions)
Long-Term Debt:
Dynegy Global Communications
U.S. Network Debt........................................................... $ 324 $ 62
Dynegy Holdings Inc.
Commercial Paper............................................................ 6 115
Revolving Credit Facilities................................................. 600 --
Canadian Credit Agreements.................................................. 40 59
Senior Notes, 6.875% due 2002............................................... 200 200
Senior Notes, 6.75% due 2005................................................ 150 150
Senior Notes, 8.125% due 2005............................................... 300 300
Senior Notes, 7.45% due 2006................................................ 200 200
Senior Notes, 6.875% due 2011............................................... 493 --
Senior Debentures, 7.125% due 2018.......................................... 175 175
Senior Debentures, 7.625% due 2026.......................................... 175 175
ABG Gas Supply.............................................................. 282 --
Generation Facility Debt.................................................... 342 261
Illinova Corporation
Senior Notes, 7.125%, due 2004.............................................. 102 103
Medium Term Notes, 6.15% due 2001........................................... -- 30
Medium Term Notes, 6.46% due 2002........................................... 20 20
Illinois Power Company
Commercial Paper............................................................ 38 148
Revolving Credit Facilities................................................. 240 --
Mortgage Bonds, 6.25% due 2002.............................................. 96 96
Mortgage Bonds, 6.5% due 2003............................................... 101 101
Mortgage Bonds, 6% due 2003................................................. 90 90
Mortgage Bonds, 6.75% due 2005.............................................. 71 71
Mortgage Bonds, 7.5% due 2009............................................... 250 250
Mortgage Bonds, 7.5% due 2025............................................... 66 66
Floating Rate Pollution Control Revenue Refunding Bonds, due 2017........... 75 75
Floating Rate Pollution Control Revenue Refunding Bonds, due 2028........... 111 111
Adjustable Rate Pollution Control Revenue Refunding Bonds, due 2032......... 150 150
Pollution Control Revenue Refunding Bonds, 5.4%-7.4%, due 2024 through 2028. 175 175
------ ------
4,872 3,183
Less: Amounts due within one year....................................... 372 32
------ ------
Total Long-Term Debt........................................................... $4,500 $3,151
====== ======
F-30
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
2001 2000
---- ----
($ in millions)
Transitional Funding Trust Notes:
Transitional Funding Trust Notes, 5.26% due 2001......... $ -- $ 38
Transitional Funding Trust Notes, 5.31% due 2002......... 31 80
Transitional Funding Trust Notes, 5.34% due through 2003. 85 85
Transitional Funding Trust Notes, 5.38% due through 2005. 174 174
Transitional Funding Trust Notes, 5.54% due through 2007. 174 174
Transitional Funding Trust Notes, 5.65% due through 2008. 138 138
---- ----
$602 $689
Less: Amounts due within one year.................... 86 86
---- ----
Total Transitional Funding Trust Notes...................... $516 $603
==== ====
Aggregate maturities of the principal amounts of all long-term indebtedness
are: 2002-$458 million; 2003-$340 million; 2004-$255 million; 2005-$1,004
million; 2006-$474 million and beyond $2,943 million.
Commercial Paper, Money Market Lines of Credit and Extendible Floating Rate
Loans. The Company utilizes commercial paper proceeds and borrowings under
uncommitted money market lines of credit for general corporate purposes,
including short-term working capital requirements. The commercial paper
programs for Dynegy, Dynegy Holdings Inc. ("Holdings") and IP are limited to
and fully supported by committed credit agreements. Weighted average interest
rates on amounts outstanding under the commercial paper program for Holdings
were 3.2% and 8.1% at December 31, 2001 and 2000, respectively. The weighted
average interest rate on amounts outstanding under IP's commercial paper
program were 3.3% and 8.0% at December 31, 2001 and 2000, respectively. The
Company classifies outstanding commercial paper and borrowings under money
market lines of credit as long-term debt to the extent of availability under
committed credit facilities, as management's intent is to maintain these
obligations for longer than one year, subject to an overall reduction in
corporate debt levels.
Credit Agreements: The following table displays certain terms of the
Company's revolving credit agreements as of December 31, 2001:
Unused Eurodollar
Total Capacity Capacity Maturity Date Term Margin Facility Fee
-------------- -------- ------------- ---------- ---------- ------------
($ in millions)
Dynegy.. $ 300 $300 11/02/02 Multi-year 0.450% 0.150%
Holdings $ 400 $ 18 05/27/03 Multi-year 0.200% 0.100%
1,200 600 05/01/02 364-day 0.400% 0.100%
40 -- 11/20/02 1-year 0.600% 0.250%
IP...... $ 300 $ 22 05/20/02 364-day 0.625% 0.125%
The Dynegy, Holdings and IP credit agreements provide funding for working
capital, capital expenditures and general corporate purposes, including support
for lines of credit and commercial paper programs. Generally, borrowings under
the credit agreements bear interest at a Eurodollar rate plus a margin that is
determined based on designated unsecured debt ratings. Financial covenants in
the credit agreements are limited to a debt-to-capitalization test. Letters of
credit under the credit agreements aggregated $377 million at December 31, 2001.
ABG Gas Supply Credit Agreement. On April 10, 2001, ABG Gas Supply ("ABG")
entered into a credit agreement with a consortium of lenders in order to
provide financing associated with Project Alpha (the "ABG
F-31
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Credit Agreement"). Advances under the agreement allowed ABG to purchase NYMEX
natural gas contracts with the underlying physical gas supply to be sold to
Dynegy Marketing and Trade under an existing natural gas purchase and sales
agreement. The ABG Credit Agreement requires ABG to repay the advances in
monthly installments commencing February 2002 through December 2004 from the
funds received from Dynegy Marketing and Trade under the natural gas purchases
and sales agreement. The advances bear interest at a Eurodollar rate plus a
margin as defined in the agreement. Advances of $282 million were outstanding
under this agreement at December 31, 2001.
Long-Term Debt. The Company has a series of notes, debentures, new mortgage
bonds, pollution control bonds and transitional funding trust notes having
maturities that extend through 2032. The transitional funding trust notes are
non-recourse to the Company. Certain of these securities are redeemable at the
Company's option, in whole or in part, from time-to-time, at formula-based
redemption prices as defined in the applicable indenture.
Certain of Dynegy's debt instruments contain routine provisions which, if
not met, could require early payment, additional collateral support or similar
actions. For Dynegy, these events include leverage ratios, bankruptcy or
insolvency, defaults on principal or interest payments and change of control
provisions. These instruments generally provide for a cure period should any of
these events occur.
In February 2002, Dynegy Holdings issued $500 million of 8.75% Senior Notes
due 2012. Interest will be paid on a semi-annual basis beginning in August
2002. These notes can be redeemed prior to 2012, in whole or in part, at a
price equal to the redemption price included in the related prospectus
supplement.
U.S. Network and Generation Facility Debt. The Company has executed lease
arrangements for the purpose of constructing two generation facilities located
in Georgia and Kentucky and its U.S. fiber optic network. These arrangements
require variable-rate interest only payments and include an option to purchase
the related assets at maturity of the facility for a balloon payment equal to
the principal balance on the financing.
Other Obligations. The Company previously accounted for four fully
collateralized generation lease arrangements as operating leases. As a result
of the three-year re-audit, the Company has determined it necessary to
recognize on its balance sheet the related assets as of the inception of these
arrangements, resulting in an increase in Property, Plant and Equipment of $65
million and $445 million at December 31, 2000 and 2001, respectively.
In addition, an adjustment has been made to record a construction agency
liability of the Company related to the increase in Property, Plant and
Equipment. The construction agency liability is included in Accrued Liabilities
and Other in the accompanying Consolidated Balance Sheets, resulting in an
increase of $65 million and $445 million at December 31, 2000 and 2001,
respectively. The construction agency liability was secured by a note
receivable owed to the Company, which is included in Prepaids & Other Assets on
the accompanying Consolidated Balance Sheets, and there is no cash exposure to
the Company associated with this liability. This adjustment has no impact on
equity, net income or cash flows for any period.
F-32
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Note 8--INCOME TAXES
The Company is subject to U.S. federal, foreign and state income taxes on
its operations. The following amounts have been adjusted to reflect the tax
impact of the restatement items discussed in the Explanatory Note to these
Consolidated Financial Statements. Components of income tax expense (benefit)
were:
Year Ended
December 31,
----------------
2001 2000 1999
---- ---- ----
($ in millions)
Current tax expense (benefit):
Domestic.................... $ 59 $ 25 $--
Foreign..................... 11 51 3
Deferred tax expense (benefit):
Domestic.................... 254 196 39
Foreign..................... (12) (26) 18
---- ---- ---
Income tax provision:.......... $312 $246 $60
==== ==== ===
Components of income before income taxes were as follows:
Year Ended
December 31,
---------------
2001 2000 1999
---- ---- ----
($ in millions)
Income (loss) before income taxes:
Domestic....................... $794 $649 $134
Foreign........................ (78) 33 63
---- ---- ----
$716 $682 $197
==== ==== ====
F-33
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Deferred income taxes are provided for the temporary differences between the
tax basis of the Company's assets and liabilities and their reported financial
statement amounts. Significant components of deferred tax liabilities and
assets were:
December 31,
---------------
2001 2000
------ ------
($ in millions)
Deferred tax assets:
NOL carryforwards.............................. $ 128 $ 95
AMT credit carryfowards and other.............. 138 228
Book/tax differences from liabilities.......... 173 260
Miscellaneous book/tax recognition differences. 402 189
------ ------
Total deferred tax assets............... 841 772
------ ------
Deferred tax liabilities:
Investments.................................... 767 130
Depreciation and other property differences.... 1,510 1,747
Miscellaneous book/tax recognition differences. 132 135
------ ------
Total deferred tax liabilities.......... 2,409 2,012
------ ------
Net deferred tax liability........................ $1,568 $1,240
====== ======
Realization of the aggregate deferred tax asset is dependent on the
Company's ability to generate taxable earnings in the future and regular tax in
excess of tentative minimum tax. There was no valuation allowance established
at December 31, 2001 or 2000, as management believes the aggregate deferred
asset is more likely than not to be fully realized in the future based on
management's estimates of future net income and related taxes.
Income tax provisions for the years ended December 31, 2001, 2000 and 1999,
were equivalent to effective rates of 44 percent, 36 percent and 30 percent,
respectively. Differences between taxes computed at the U.S. federal statutory
rate and the Company's reported income tax provision were:
Year Ended December
31,
------------------
2001 2000 1999
---- ---- ----
($ in millions)
Expected tax at U.S. statutory rate $251 $239 $ 69
State taxes........................ 17 13 3
Foreign taxes...................... 8 3 --
Basis differentials and other...... 36 (9) (12)
---- ---- ----
Income tax provision............... $312 $246 $ 60
==== ==== ====
At December 31, 2001, the Company had approximately $340 million of regular
tax net operating loss carryforwards, $138 million of AMT credit carryforwards
and $730 million of AMT net operating loss carryforwards. The net operating
loss carryforwards expire from 2009 through 2020. The AMT credit carryforwards
do not expire. Certain provisions of the Internal Revenue Code place an annual
limitation on the
F-34
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Company's ability to utilize tax carryforwards existing as of the date of a
1995 and a 2000 business acquisition. Management believes such carryforwards
will be fully realized prior to expiration.
The Company plans to reinvest earnings of foreign subsidiaries and no U.S.
taxes or foreign withholding taxes were provided on these earning in 1999, 2000
or 2001. It is not practicable to estimate the amount of unrecognized U.S.
deferred taxes or foreign withholding taxes, if any, that might be payable on
the actual or deemed remittance of such earnings. As of December 31, 2001, the
Company has no material undistributed earnings of foreign subsidiaries.
Note 9--PREFERRED SECURITIES
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. The Company may defer payment of
interest on the subordinated debentures as described in the indenture.
Illinois Power Financing Inc. ("IPFI") is a statutory business trust in
which IP serves as sponsor. In 1996, IPFI issued $100 million aggregate
liquidation amount of 8% Trust Originated Preferred Securities ("TOPrS") in a
private transaction. The TOPrS were to mature on January 31, 2045 and could be
redeemed at IP's option, in whole or in part, from time to time on or after
January 31, 2001. On September 30, 2001, IP redeemed all $100 million of the
TOPrS. The redemption was financed with $85 million cash and $15 million in
commercial paper.
Serial Preferred Securities of a Subsidiary of approximately $46 million
consists of six series of preferred stock issued by IP, with interest rates
ranging from 4.08% to 7.75%. Certain series are redeemable at the option of IP,
in whole or in part. On February 25, 2002, Illinova commenced a tender offer
relating to the shares of IP's preferred stock. Concurrently, IP commenced a
solicitation of consents from its preferred stockholders to amend IP's Restated
Articles of Incorporation to eliminate a provision restricting IP's ability to
incur unsecured debt. The completion of the tender offer and consent
solicitation is conditioned on, among other things, the approval of the
proposed amendment by holders of at least two-thirds of the outstanding shares
of preferred stock, voting together as one class.
On November 13, 2001, ChevronTexaco purchased 150,000 shares of Dynegy's
Series B Mandatorily Convertible Redeemable Preferred Stock ("Series B
Preferred Stock") for $1.5 billion. The proceeds from this issuance were used
to finance Dynegy's investment in Northern Natural, which is discussed in
detail in Note 6.
F-35
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Each share of Dynegy's Series B Preferred Stock is convertible, at the option
of ChevronTexaco, for a period of two years into shares of Dynegy Class B
common stock at the conversion price of $31.64.
The Company originally recognized a special preferred stock dividend of
approximately $65 million based on the intrinsic value of the two-year
beneficial conversion option granted to ChevronTexaco because the conversion
price was an approximate 5% discount to the market price for the Company's
stock on November 7, 2001, the date the conversion price was negotiated. The
Company was recognizing this dividend over the two-year period from the
issuance date of the preferred stock to the mandatory redemption date. For
purposes of calculating the value of the beneficial conversion option, the
Company originally used its stock price on November 7, 2001, the date the
preferred stock conversion price was negotiated. The Company has since
determined that it should have used November 13, 2001, the date ChevronTexaco
funded its preferred stock purchase and the preferred securities were issued,
as the commitment date. The Company's stock price increased significantly
between November 7 and November 13, primarily as a result of the announcement
during the period of the proposed Enron Corp. merger. Because of this increase,
and the resulting increase in the implied value of ChevronTexaco's beneficial
conversion option, the restated preferred stock dividend amount is calculated
based on a two-year amortization of the beneficial conversion option's implied
value of approximately $660 million, an increase of approximately $595 million
over the $65 million originally reported. Unless ChevronTexaco exercises its
conversion right, Dynegy is required to redeem the Series B Preferred Stock for
$1.5 billion two years from the date of issuance. Our Board of Directors will
evaluate this redemption obligation prior to November 13, 2003. Please read
Note 19--Subsequent Events for discussion of events affecting Dynegy since the
date on which Dynegy originally filed its 2001 Form 10-K. Based on Dynegy's
substantial debt obligations, liquidity position, limitations under applicable
state law and limitations in its restructured credit facility in respect of
redemptions of equity securities, Dynegy does not currently expect to redeem
the preferred shares in November 2003. The Series B Preferred Stock does not
have a cash dividend.
Note 10--MINORITY INTEREST
In June 2000, Dynegy and Black Thunder Investors LLC ("Investor") invested
in Catlin Associates, L.L.C. ("Catlin"), an entity that is consolidated by
Dynegy, with the Investor's ownership in Catlin reflected as Minority interest
on the consolidated balance sheet. Dynegy invested approximately $95 million in
Catlin and the Investor contributed $850 million. As a result of its
investment, the Investor received a preferred interest in Catlin, which holds
indirect economic interests in midwest generation assets, including the
coal-fired generation units in Illinois. This preferred interest is a passive
interest and generally is not entitled to management rights.
On or before June 29, 2005, Dynegy is effectively obligated to purchase the
Investor's preferred interest for $850 million unless the Investor agrees to
extend or refinance this obligation. Alternatively, Dynegy could liquidate
Catlin's assets, including DMG's generating assets, to satisfy this obligation.
In addition to granting Catlin a security interest in the stock of DMG,
Dynegy also has agreed to pay to DMG, to the extent that DMG has either
distributed or loaned money directly or indirectly to Dynegy, an amount not to
exceed $275 million. This payment obligation builds over time to a maximum of
$275 million in 2005. As of December 31, 2001, Dynegy's obligation to DMG under
the agreement was approximately $35 million. In addition, in the event
projected cash flow is insufficient to cover capital expenditures and certain
other fixed charges, Dynegy may be required to make an additional capital
contribution of up to $60 million to Catlin. The $60 million contingent
obligation expires on December 31, 2002.
F-36
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
If Dynegy Holdings' senior unsecured debt is downgraded below investment
grade by both Standard & Poor's and Moody's, Dynegy would be required to post
cash collateral in an aggregate amount of $270 million and, within 30 days,
obtain an investment grade rating for the Catlin membership interest held by
the Investor by either Standard & Poor's or Moody's or obtain a waiver from the
Investor.
If Dynegy were unable to obtain the required rating for the interest held by
the Investor or waiver, Dynegy would have the option of purchasing or
refinancing the Investor's interest in Catlin. If Dynegy was unable or
otherwise elected not to exercise this option, it could ultimately result in an
election by the Investor to cause the liquidation of the underlying generation
assets in an amount sufficient to redeem the Investor's interest. Given the
strategic importance of these generation assets, it is likely that Dynegy would
seek to refinance or purchase the Investor's interest under such circumstances.
Minority interest on the consolidated balance sheet also includes
third-party investments in certain other consolidated entities, principally
relating to Dynegy Midstream Services ("DMS") operations and Dynegy Global
Communications ("DGC"). The net pre-tax results attributed to minority interest
holders in consolidated entities are classified in minority interest expense in
the accompanying statements of operations.
Note 11--COMMITMENTS AND CONTINGENCIES
Set forth below is a description of our material legal proceedings. In
addition to the matters described below, Dynegy is a party to legal proceedings
arising in the ordinary course of its business. In the opinion of management,
the resolution of these ordinary course matters will not have a material
adverse effect on our financial condition, results of operations or cash flows.
Dynegy records reserves for estimated losses from contingencies when
information available indicates that a loss is probable and the amount of the
loss is reasonably estimable in accordance with SFAS No. 5, "Accounting for
Contingencies." For environmental matters, Dynegy records liabilities when
environmental assessment indicates that remedial efforts are probable and the
costs can be reasonably estimated.
With respect to several of the items listed below, Dynegy has determined
that a loss is not probable or that any such loss, to the extent probable, is
not reasonably estimable. Notwithstanding the foregoing, Dynegy's management
has assessed the matters described below based on currently available
information and made an informed judgment concerning the likely outcome of such
matters, giving due consideration to the nature of the claim, the amount and
nature of damages sought and the probability of success. Management's judgment
may, as a result of facts arising prior to resolution of these matters or other
factors, prove inaccurate and investors should be aware that such judgment is
made subject to the known uncertainty of litigation.
Legal Proceedings. On August 3, 1998, Modesto Irrigation District ("MID")
filed a lawsuit against PG&E and Destec Energy, Inc. ("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, California. While MID's
pleadings indicate that it cannot measure its damages with specificity, it has
indicated that the actual damages sought from PG&E and Destec may exceed $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 restated its breach of
F-37
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
contract claim against Destec. PG&E and Destec filed motions to dismiss MID's
revised federal and state antitrust claims and a hearing on the motions to
dismiss was held in July 1999. On August 20, 1999, the District Court again
dismissed MID's antitrust claims against PG&E and Destec, this time without
leave to amend the complaint. As a result of the dismissal of the antitrust
claims, the District Court also dismissed the pendant state law claims. MID has
appealed the District Court's dismissal of its suit to the Ninth Circuit Court
of Appeal. Oral arguments before the Ninth Circuit occurred on March 15, 2001.
The Ninth Circuit has yet to deliver its decision on the case. Although PG&E
filed a Chapter 11 bankruptcy proceeding on April 6, 2001, the automatic stay
applicable in the proceeding will be lifted to permit the Ninth Circuit to
decide the pending appeal.
Following dismissal of its federal court suit, MID filed suit in California
state court asserting breach of contract and tortious interference with
prospective economic relations claims against Destec and tortious interference
with contract and interference with prospective economic relations claims
against PG&E. Motions to dismiss MID's state court claims were heard by the
state court and by order dated April 6, 2000, MID was directed to amend its
complaint. MID filed its amended complaint on April 20, 2000, including Dynegy
as a defendant. Dynegy filed a motion to dismiss MID's amended complaint
against Dynegy, and the Court partially granted Dynegy's motion to dismiss
while also granting MID leave to amend its complaint. Before MID filed its
amended complaint, MID agreed with PG&E and Dynegy to execute a tolling
agreement on all claims and to dismiss the state court case until the federal
appeal is decided. After executing the tolling agreement, on October 23, 2000,
MID filed in the state court a Request for Dismissal, which the court granted
on October 25, 2000. Dynegy believes that it has meritorious defenses to MID's
claims and intends to vigorously defend against them. However, if the plaintiff
were to successfully prosecute its claims, Dynegy could be required to fund a
judgment in excess of $25 million.
On November 3, 1999, the United States Environmental Protection Agency
("EPA") issued a Notice of Violation ("NOV") against Illinois Power Company
("IP") and, with the Department of Justice ("DOJ"), filed a complaint against
IP in the U.S. District Court for the Southern District of Illinois, No.
99C833. Subsequently, the DOJ and EPA amended the NOV and complaint to include
Illinova Power Marketing, Inc. (now known as Dynegy Midwest Generation Inc.
("DMG")) (IP and DMG collectively the "Defendants"). Similar notices and
lawsuits have been filed against a number of other utilities. Both the NOV and
complaint allege violations of the Clean Air Act (the "Act") and regulations
thereunder. More specifically, both allege, based on the same events, that
certain equipment repairs, replacements and maintenance activities at the
Defendants' three Baldwin Station generating units constituted "major
modifications" under the Prevention of Significant Deterioration ("PSD") and/or
the New Source Performance Standards regulations. When such activities occur
and they are not otherwise exempt the Act and related regulations generally
require that generating facilities meet more stringent emissions standards,
which may entail the installation of potentially costly pollution control
equipment. The DOJ amended its complaint to assert the claims found in the NOV.
The Defendants filed an answer denying all claims and asserting various
specific defenses. By order dated October 19, 2001, a trial date of February
11, 2003 has been set. The initial trial is limited to determining whether a
violation occurred.
The regulations under the Act provide certain exemptions from the
applicability of these provisions particularly an exemption for routine repair,
replacement or maintenance. The Company has analyzed each of the activities
covered by the EPA's allegations and believes each activity represents prudent
practice regularly performed throughout the utility industry as necessary to
maintain the operational efficiency and safety of equipment. As such, the
Company believes that each of these activities is covered by the exemption for
routine repair, replacement and maintenance and that the EPA is changing, or
attempting to change, through enforcement actions, the intent and meaning of
its regulations. The Company also believes that, even if some of the activities
in question were found not to qualify for routine exemptions, the Act and
regulations also require that the
F-38
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
activities cause certain levels of increases in emissions and there were no
such increases either in annual emissions or in the maximum hourly emissions
achievable at any of the units caused by any of the activities. The regulations
include exemptions for increased hours of operations or production rate and the
PSD regulations exclude increases in emissions resulting from demand growth.
None of the Defendants' other facilities are covered in the complaint and NOV,
but the EPA has officially requested information concerning activities at the
Defendants' Vermilion, Wood River, Hennepin and Danskammer Plants. It is
possible that the EPA will eventually commence enforcement actions against
those plants as well. The asset(s) subject to the complaint are part of the
consolidated assets of Dynegy.
The EPA has the authority to seek penalties for the alleged violations in
question at the rate of up to $27,500 per day for each violation. The EPA may
also seek to require installation of the "best available control technology"
(or the equivalent) at the Baldwin Station, and possibly at the Vermilion, Wood
River, Hennepin and Danskammer Plants if the EPA successfully prosecutes
enforcement actions against those plants. The Company has recorded a reserve
for penalties that could be imposed if the EPA were to successfully prosecute
its claims based on its assessment of the probability and estimability thereof.
The National Energy Policy Report issued in May 2001 by the National Energy
Policy Development Group recommended that the EPA Administrator examine the new
source review regulations, including the PSD regulations, and report to the
President within 90 days on the impact of new source review on investment in
new utility and refinery generation capacity, energy efficiency and
environmental protection. The report also recommended that the Attorney General
review existing enforcement actions regarding new source review to ensure that
the enforcement actions are consistent with the Clean Air Act and its
regulations. The EPA Administrator announced in August 2001 that the review
would be completed in September 2001. The events of September 11, 2001 have
resulted in further delay of the EPA review, which remains ongoing. The
Department of Justice issued its report concerning the existing enforcement
actions on January 15, 2002. The report concluded that EPA has a reasonable
legal basis for proceeding with the cases.
Tampa Electric Company ("TECO") and the government agreed to a Consent
Decree to resolve the similar case brought against TECO and that Consent Decree
was entered by the court hearing that case in 2000. Two other utilities,
Virginia Power and Cinergy, reached agreements in principle with the United
States in 2000 concerning their possible liability for similar alleged
violations, but these agreements have still not been finalized. Additionally,
PSEG Fossil LLC entered into a consent decree in January 2002 to resolve
similar claims. Generally, the TECO Consent Decree and the settlements and
agreements in principle would require the utilities to pay civil fines; fund
various environmental projects; reduce nitrogen oxides, sulfur oxides,
particulate matter and mercury emissions through the installation of pollution
control devices over periods extending through 2012 to 2013; and forfeit
certain emission allowances.
The Company believes that it has meritorious defenses against these claims
and will vigorously defend against them. However, Dynegy may be required to
incur significant capital expenditures in connection with the installation of
pollution control devices and related remedial actions. To the extent the
Company is required to incur material capital expenditures to resolve this
matter, the Company's financial position and results of operations could be
material adversely affected.
The following six class action lawsuits have been filed against various
Dynegy entities, including Dynegy Inc. and Dynegy Power Marketing Inc.:
1. Gordon v. Reliant Energy Inc., et al. was filed on November 27, 2000 in
San Diego Superior court.
2. Hendricks v. Dynegy Power Marketing Inc., et al. was filed on November
29, 2000 in a San Diego Superior Court.
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DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
3. People of the State of California v. Dynegy Power Marketing Inc., et al.
was filed on January 19, 2001 in San Francisco Superior Court.
4. Pier 23 Restaurant v. PG&E Energy Trading, et al. was filed on January
24, 2001 in San Francisco Superior Court.
5. Sweetwater Authority et al. v. Dynegy Inc., et al. was filed on January
16, 2001 in San Diego Superior Court.
6. Bustamante v. Dynegy Inc., et al. was filed on May 2, 2001 in Los
Angeles Superior court. The suit was filed on behalf of California
taxpayers by Lieutenant Governor Cruz Bustamante and Assembly Woman
Barbara Matthews, both acting in their capacity as taxpayers and not in
their capacity as elected officials.
The six class action lawsuits are based on the events occurring in the
California power market during the summer of 2000. The complaints allege
violations of California's Business and Professions Code, Unfair Trade
Practices Act and various other statutes. Specifically, the named plaintiffs
allege that the defendants, including the owners of in-state generation and
various power marketers, conspired to manipulate the California wholesale power
market to the detriment of California consumers. Included among the acts
forming the basis of the plaintiffs' claims are the alleged improper sharing of
generation outage data, improper withholding of generation capacity and the
manipulation of power market bid practices. The plaintiffs seek unspecified
treble damages. The Bustamante suit includes claims against various Dynegy
entities, including Dynegy Inc. and Dynegy Marketing and Trade, as well as
against three corporate officers individually. The allegations in this suit are
similar to those in the other five suits, with the exception that the
Bustamante suit includes a claim of unfair business practices based on "price
gouging" during an emergency declared by Governor Gray Davis.
The six lawsuits are at preliminary stages. Defendants in the six lawsuits
have yet to file answers. The plaintiffs filed motions to remand five of the
cases to state court. In respect to the sixth case, the Bustamante suit, the
parties agreed that, based on a judge's decision to remand the other five
lawsuits, the case should go back to state court. All six lawsuits will be
consolidated before a single California state court judge.
After the actions were remanded, the parties agreed that they should be
coordinated. On December 12, 2001, the California Judicial Council resolved a
dispute among the parties as to the county in which the actions should be
coordinated and assigned the Coordination Proceedings (Nos. 4204 & 4205) to the
Superior Court of California, County of San Diego. On December 20, 2001, the
presiding judge of the San Diego Superior Court designated Judge Sammartino as
the Coordination Trial Judge for the Coordination Proceedings. On January 17,
2002, Judge Sammartino set a preliminary trial conference for March 4, 2002 to,
among other things, set schedules for: (a) determining legal issues that might
expedite disposition of the Coordination Proceedings; (b) establishing a
discovery schedule; and (c) resolving matters pertinent to the class action
issue.
The defendants in the six lawsuits have formed various joint defense groups
in an effort to coordinate the defense of the claims and to share certain costs
of defense. The Company believes that it has meritorious defenses to these
claims and intends to vigorously defend against them. Dynegy is unable to
estimate the range of possible loss that could be incurred with respect to
these lawsuits. However, an adverse result in any of these proceedings could
have a material adverse effect on our financial condition and results of
operations.
On March 11, 2002, the California Attorney General filed, on behalf of the
People of the State of California, complaints in San Francisco Superior Court
against several energy generators, including those owned directly by West Coast
Power and indirectly by Dynegy Inc. The complaints allege that since June 1998,
these generators
F-40
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
sold power in the open market that should have been held in emergency reserve
for the State. The complaint against the Company and certain of its
subsidiaries seeks unspecified amounts of restitution and return profits as
well as civil penalties of $2,500 for each alleged violation. The Company
believes that it has meritorious defenses to these claims and intends to
vigorously defend against them. Dynegy is unable to estimate the range of
possible loss that could be incurred with respect to these lawsuits. However,
an adverse result in any of these proceedings could have a material adverse
effect on our financial condition and results of operations.
In response to the filing of a number of complaints challenging the level of
wholesale prices, the Federal Energy Regulatory Commission ("FERC") initiated a
staff investigation and issued an order on December 15, 2000 implementing a
series of wholesale market reforms and made subject to refund all spot market
sales through the California Independent System Operator (the "ISO") and the
California Power Exchange (the "PX") markets beginning October 2, 2000. FERC
also included an interim price review procedure for prices above a $150/MW hour
"breakpoint" on sales to the ISO and PX. The order does not prohibit sales
above the "breakpoint," but the seller was subject to weekly reporting and
monitoring requirements. In an order issued March 9, 2001, FERC determined that
only sales during so-called "Stage 3" emergency hours would be subject to
refund beginning January 1, 2001 though sales between October 2, 2000 and
December 31, 2000 remained subject to refund. Various parties sought rehearing
of this market mitigation measure and, as explained below, the FERC ruled on
the matter in an order issued on July 25, 2001.
On April 26, 2001, the FERC revised its market mitigation plan, effective
May 29, 2001, to cover all emergency hours. The mitigated price was to be in
effect only during reserve deficiency hours. Suppliers charging prices above
the mitigated price during those hours could file to justify those prices.
On June 19, 2001, the FERC again revised its market mitigation plan,
effective June 20, 2001. Pursuant to this plan, the FERC is mitigating prices
charged in all hours throughout the Western Systems Coordinating Council based
on the mitigated price in the ISO markets. During reserve deficiency hours, the
mitigated price is set pursuant to an average index for gas times the heat rate
of the last unit dispatched by the ISO during a "Stage 1" emergency, plus a 10
percent adder for credit risk. Nitrogen oxide charges, start-up costs and
additional fuel costs will be collected through an ISO uplift charge. During
non-reserve deficiency hours, the market clearing price is capped at 85 percent
of the mitigated price. The Company has filed for rehearing and clarification
of the order. The FERC also ordered all parties to participate in a 15-day
settlement conference to determine refunds, which proved unsuccessful. Pursuant
to that order, the settlement judge has issued a refund recommendation to the
FERC, stating that refunds from all market participants since October 2000
probably total between several hundred million dollars and a billion dollars.
It should be noted that the April 26 and June 19, 2001 orders apply only to
sales made on a daily basis, that is, within 24 hours of delivery. The vast
majority of power sold by West Coast Power LLC, a 50% equity investee of
Dynegy, is committed to long-term contracts exempt from these orders.
On July 25, 2001, as modified on December 31, 2001, the FERC initiated
refund hearing procedures related to California wholesale spot market sales
that occurred between October 2, 2000 and June 20, 2001. Dynegy Power Marketing
(as Scheduling Coordinator for West Coast Power LLC) is subject to possible
refunds. The July 25/th/ order supercedes prior refund orders issued by the
FERC that cover this period. In the July 25/th/ order, the FERC developed a
methodology to redetermine allegedly competitive market outcomes during each
hour of this period. An administrative law judge has been appointed to
determine: (1) the mitigated price for power during each hour of the refund
period; (2) the amount of refunds owed by each supplier according to the FERC's
methodology; and (3) the amount owed to each supplier (with separate quantities
due from each entity) by the ISO, the investor-owned utilities and the State of
California. Any refunds owed would then be offset against
F-41
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
amounts not paid. Management does not expect the administrative law judge to
issue his findings before August 2002. Dynegy is actively participating in
these proceedings and is appealing these and related orders.
On December 19, 2001, FERC issued an order that in part focused on the
FERC-established price mitigation plan, which includes a formula prescribed by
FERC to determine maximum rates for wholesale power transactions in spot
markets in the Western Systems Coordinating Council between June 21, 2001 and
September 30, 2002. In this order, the FERC made some changes in its mitigation
plan. Certain of these changes were put in place retroactively and might have
the effect of reducing the applicable maximum rate in past periods. Dynegy
Power Marketing and West Coast Power have sought rehearing or clarification of
this decision, pointing out that various other aspects of the December 19
order, coupled with other recent FERC orders, indicate that the FERC did not
intend to modify past prices under this mitigation plan. The Company cannot
predict how the FERC will ultimately resolve this matter.
On February 13, 2002, the FERC initiated an investigation of possible
manipulation of natural gas and power prices in the western United States
during the period from January 2001 through the present. Dynegy has been active
in these markets during the relevant period and, as a result, expects that its
pricing policies will be investigated. Management believes that much of what
would be investigated has already been examined pursuant to other
investigations by government entities and in private litigation. To date, there
has been no finding of market manipulation by Dynegy in these markets and
management does not believe that any factual basis to support such a finding
exists.
In addition to the FERC investigation discussed above, several state and
other federal regulatory investigations and complaints have commenced in
connection with the wholesale electricity prices in California and other
neighboring Western states to determine the causes of the high prices and
potentially to recommend remedial action. In California, the California Public
Utilities Commission, the California Electricity Oversight Board, the
California Bureau of State Audits, the California Office of the Attorney
General and several California state legislative committees all have separate
ongoing investigations into the high prices and their causes. With the
exception of a report by the California Bureau of State Audits, none of these
investigations has been completed and no findings have been made in connection
with any of them. The California state audit report concluded that the primary
causes of the market disruptions in California were fundamental flaws in the
structure of the power market. Additionally, on February 25, 2002, the
California Public Utilities Commission and the California Electricity Oversight
Board filed complaints with the FERC asking that it void or reform power supply
contracts between DWR and, among others, West Coast Power. The complaints
allege that prices under the contracts exceed just and reasonable prices
permitted under the Federal Power Act. While the Company believes the terms of
its contracts are just and reasonable and do not reflect alleged market
manipulation, it cannot predict how the FERC will respond to these complaints.
Management is continually assessing Dynegy's exposure, as well as its
exposure through West Coast Power, relative to its California receivables and
establishes reserves for contingent liabilities where the amount of potential
loss is determined to be probable and estimable. During 2001, 2000 and 1999,
our share of reserves recorded by West Coast Power totalled $134.3 million,
$17.5 million and $5.4 million, respectively. Our share of the total reserve at
December 31, 2001 and 2000 was $151.8 million and $17.5 million, respectively.
On December 2, 2001, Enron Corp. and Enron Transportation Services Co.
(collectively, "Enron") filed suit against Dynegy and Holdings in the United
States Bankruptcy Court for the Southern District of New York, Adversary
Proceeding No. 01-03626 (AJG). Enron claims that Dynegy materially breached the
Merger Agreement dated November 9, 2001 between Enron and Dynegy and related
entities by wrongfully terminating
F-42
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
that Agreement on November 28, 2001. Enron also claims that Holdings wrongfully
exercised its option to take ownership of Northern Natural under an Option
Agreement dated November 9, 2001. Enron seeks damages in excess of $10 billion
and declaratory relief against Dynegy for breach of the Merger Agreement. Enron
also seeks unspecified damages against Dynegy and Holdings for breach of the
Option Agreement. Dynegy filed an answer on February 4, 2002, denying all
material allegations. Dynegy subsequently filed a motion to transfer venue in
the proceeding to the United States District Court for the Southern District of
Texas (Houston division). Discovery has not yet commenced.
On December 20, 2001, Dynegy and Holdings were sued by Ann C. Pearl and Joel
Getzler in the United States District Court for the Southern District of New
York, Cause No. 01 CV 11652. Plaintiffs filed the lawsuit as a purported class
action on behalf of all persons or entities who owned common stock of Enron
Corp. as of November 28, 2001. Plaintiffs allege that they are intended third
party beneficiaries of the Merger Agreement dated November 9, 2001 between
Enron and Dynegy and related entities. Plaintiffs claim that Dynegy materially
breached the Merger Agreement by, inter alia, wrongfully terminating that
Agreement. Plaintiffs also claim that Dynegy breached the implied covenant of
good faith and fair dealing. Plaintiffs seek an award of damages and other
relief. On February 4, 2002, Dynegy filed a notice of motion to dismiss or
transfer venue to the United States District Court for the Southern District of
Texas (Houston Division). Discovery has not yet commenced.
On January 3, 2002, Dynegy and Holdings were sued by Bernard D. Shapiro and
Peter Strub in the 129th Judicial District Court for Harris County, Texas,
Cause No. 2002-00080. Plaintiffs filed the lawsuit as a purported class action
on behalf of all persons or entities who owned common stock of Enron Corp. as
of November 28, 2001. Plaintiffs allege that they are intended third party
beneficiaries of the Merger Agreement dated November 9, 2001 between Enron and
Dynegy and related entities. Plaintiffs claim that Dynegy materially breached
the Merger Agreement by, inter alia, wrongfully terminating that Agreement.
Plaintiffs also claim that Dynegy breached the implied covenant of good faith
and fair dealing. Plaintiffs seek an award of damages and other relief. Dynegy
filed an answer on February 4, 2002, denying all allegations. Discovery has not
yet commenced.
The Company believes that it has meritorious defenses to the allegations in
Enron's adversary proceeding and the other cases arising out of the terminated
merger and will vigorously defend against these claims. Given the magnitude of
Enron's claims, however, an adverse result in these proceedings could have a
material adverse effect on the Company's financial position and results of
operations.
Purchase Obligations. 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
commodity supply arrangements, capital projects, reservation charges associated
with firm transmission, transportation, storage and leases for office space,
equipment, plant sites, ships, power generation assets and long-haul fiber
optic and metropolitan networks. The following describes the more significant
commitments outstanding at December 31, 2001.
The Company has $75 million of unconditional purchase obligations related to
the purchase of gas, coal, systems design and power purchase agreements. The
Company also routinely enters into supply and market contracts for the purchase
and sale of electricity, some of which contain fixed capacity payments. Such
obligations are generally payable on a ratable basis, the terms of which extend
through November 2014. In return for such fixed capacity payments, Dynegy
receives volumes of electricity at agreed prices, which it then may re-market.
These fixed capacity payments totaled approximately $2 billion at December 31,
2001. The capacity
F-43
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
payments for contracts that are accounted for on an accrual basis, which are
not already recorded at fair value on the balance sheet, exceed the market
value of electricity available for sale under these contracts by $27 million.
The market value of electricity available for sale under these contracts has
not been reduced for credit or price reserves.
Dynegy has other firm capacity payments related to storage and
transportation of natural gas and transmission of electricity. Such
arrangements are routinely used in the physical movement and storage of energy
consistent with the Company's business strategy. The total of such obligations
was $715 million as of December 31, 2001, with $305 million of the $715 million
due after 2006.
The Company is engaged in a continual capital asset expansion program
consistent with its business plan and growth strategies. The emphasis of this
program is on the acquisition or construction of strategically located power
generation assets. Consistent with this strategy and as a result of the long
lead time required by industry manufacturers, the Company has executed or is
negotiating purchase orders to acquire at least 11 gas-fired turbines,
representing a capital commitment of approximately $370 million. Commitments
under these purchase orders are generally payable consistent with the delivery
schedule. Approximately 95% are scheduled to be delivered by the end of 2006.
The purchase orders include milestone requirements by the manufacturer and
provide Dynegy with the ability to cancel each discrete purchase order
commitment in exchange for a fee, which escalates over time. At December 31,
2001, the fee would have been approximately $12 million.
The Company also has an information systems service agreement under which it
is obligated to pay $6 million a year through 2006.
Advance Agreement. 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 payer on identical volumes to those to be delivered under the
Advance Agreement at prices based on current market rates. The cash receipt is
included as deferred revenue in "Other Long-Term Liabilities" on the
Consolidated Balance Sheets and is ratably reduced as gas is delivered to the
purchaser under the terms of the Advance Agreement. The balance at December 31,
2001 approximated $65 million. 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.
Other Minimum Commitments. During 2001 and prior years, the Company entered
into lease arrangements associated with natural gas-fired generating
facilities, natural gas liquids transportation assets and certain fiber optic
and telecommunications-related assets, some of which are accounted for as
operating leases and others as capital leases. Under the terms of certain of
these arrangements, the Company provided residual value guarantees associated
with the leased assets. Pursuant to these guarantees, the Company has the
option to acquire at the end of the lease term the leased assets for a purchase
price determined at lease inception and estimated to represent fair market
value at the end of the lease term. If the Company does not choose to purchase
the leased asset, it must perform under the terms of the residual value
guarantee. At lease inception, the Company as lessee, guaranteed to the owner
of the leased asset that the leased asset would maintain a value equal to at
least 80-85% (depending on the particular lease contract) of its originally
estimated fair value. In each of these arrangements, the Company will receive
any sales proceeds that the owner of the leased asset receives in excess of the
originally estimated fair value. If the value of the asset is less than 80-85%
of the fair market value at lease termination, the Company is obligated to pay
the owner the difference.
F-44
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
The Company also has a commitment to pay decommissioning costs of
approximately $5 million a year for the years 2002 to 2004 related to the sale
of the Clinton nuclear facility in 1999. This sale occurred prior to Dynegy's
acquisition of Illinova in 2000; thus, Dynegy was not involved with the sale.
However, Dynegy assumed this decommissioning obligation in connection with its
acquisition of Illinova.
Minimum commitments in connection with office space, equipment, plant sites
and other leased assets at December 31, 2001, were as follows: 2002 - $160
million; 2003--$148 million; 2004--$211 million, 2005--$268 million; 2006--$118
million and beyond--$1.5 billion.
Rental payments made under the terms of these arrangements totaled--$132
million in 2001, $75 million in 2000 and $31 million in 1999.
Guarantees. The Company has $288 million of surety bonds as of December 31,
2001 in which Dynegy indemnifies the respective surety bond companies.
Approximately $204 million of these contingent financial commitments expire in
2002, however, these bonds are generally renewed on a rolling twelve-month
basis.
As mentioned above, the Company has residual value guarantees related to
certain leases. At December 31, 2001, the residual value guarantees totaled
approximately $214 million. Additionally, the Company has made certain
guarantees related to West Coast Power for approximately $56 million.
Approximately $31 million of this $56 million has a cash collateralization
requirement if the Company's debt is downgraded to below investment grade.
Additionally, the Company has posted a $4 million letter of credit for West
Coast Power that expires in 2002.
Other guarantees at December 31, 2001 include additional letters of credit
and uncommitted lines of $470 million and parental guarantees of debt of
approximately $3 million in connection with its power generation projects.
Note 12--REGULATORY ISSUES
The Company is subject to regulation by various federal, state, local and
foreign agencies, including extensive rules and regulations governing
transportation, transmission and sale of energy commodities as well as the
discharge of materials into the environment or otherwise relating to
environmental protection. Compliance with these regulations requires general
and administrative, capital and operating expenditures including those related
to monitoring, pollution control equipment, emission fees and permitting at
various operating facilities and remediation obligations. In addition, the U.S.
Congress has before it a number of bills that could impact regulations or
impose new regulations applicable to Dynegy and its subsidiaries. The Company
cannot predict the outcome of these bills or other regulatory developments or
the effects that they might have on its business.
Note 13--CAPITAL STOCK
At December 31, 2001, the Company had authorized capital stock consisting of
900,000,000 shares of Class A Common stock, 360,000,000 shares of Class B
Common stock and 70,000,000 shares of preferred 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 Amended and Restated Articles of
Incorporation.
Pursuant to the terms of the Illinova acquisition, Dynegy established a
series of preferred stock, designated as Series A Convertible Preferred Stock,
which was issued to British Gas Atlantic ("BG") and NOVA
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DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Corporation ("NOVA") in accordance with the exchange ratios provided in the
acquisition documents. On the effective date of the acquisition, BG and NOVA
held an aggregate 6.7 million shares of this Series A Convertible Preferred
Stock. All of these shares were converted into shares of Class A common stock
in the second quarter of 2000. In addition 8,000,000 shares of preferred stock,
previously designated as Dynegy Series A Participating Preferred Stock ("Series
A Preferred"), were converted to shares of Class B common stock on a
0.69-for-one exchange ratio.
Common Stock. At December 31, 2001, there were 356,484,370 shares of Class
A and B common stock issued in the aggregate and 1,766,800 shares were held in
treasury. During 2001, Dynegy paid quarterly cash dividends on its common stock
of $0.075 per share, or $0.30 per share on an annual basis.
Pursuant to the terms of the Illinova acquisition, Dynegy split its common
shares into two classes, Class A and Class B. All of the Class B common stock
is owned by Chevron U.S.A. Inc. ("Chevron"). Generally, holders of Class A and
Class B common stock are entitled to one vote per share on all matters to be
voted upon by the shareholders. Holders of Class A common stock may cumulate
votes in connection with the election of directors. The election of directors
and all other matters will be by a majority of shares represented and entitled
to vote, except as otherwise provided by law. Holders of Class B common stock
vote together with holders of Class A common stock as a single class on every
matter acted upon by the shareholders except for the following matters:
. the holders of Class B common stock vote as a separate class for the
election of three directors of Dynegy, while the holders of Class A
common stock vote as a separate class for the remaining eleven directors;
. any amendment to the special corporate governance rights of Class B
common stock must be approved by a majority of the directors elected by
holders of Class B common stock and a majority of all Dynegy directors or
by a 66 2/3 percent of the outstanding shares of Class B common stock
voting as a separate class, and the affirmative vote of a majority of the
shares of Class A and Class B common stock, voting together as a single
class; and
. any amendment to the provision of the Amended and Restated Articles of
incorporation addressing the voting rights of holders of Class A and
Class B common stock requires the approval of 66 2/3 percent of the
outstanding shares of Class B common stock voting as a separate class,
and the affirmative vote of a majority of the shares of Class A and Class
B common stock, voting together as a single class.
Subject to the preferences of preferred stock, holders of Class A and Class
B common stock have equal ratable rights to dividends, when and if dividends
are declared by the board of directors. Holders of Class A and Class B common
stock are entitled to share ratably, as a single class, in all of the assets of
Dynegy available for distribution to holders of shares of common stock upon the
liquidation, dissolution or winding up of the affairs of Dynegy, after payment
of Dynegy's liabilities and any amounts to holders of preferred stock.
A share of Class B common stock automatically converts into a share of Class
A common stock upon the transfer to any person other than an affiliate of
Chevron. Additionally, each share of Class B common stock automatically
converts into a share of Class A common stock if the holders of all Class B
common stock cease to own collectively 15 percent of the outstanding common
stock of Dynegy. Conversely, any shares of Class A common stock acquired by
Chevron or its affiliates will automatically convert into shares of Class B
common stock, so long as Chevron and its affiliates continue to own 15 percent
or more of the outstanding voting power of Dynegy.
Holders of Class A and Class B common stock generally are not entitled to
preemptive rights, subscription rights, or redemption rights, except that
Chevron is entitled to preemptive rights under the shareholder
F-46
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
agreement. The rights and preferences of holders of Class A common stock are
subject to the rights of any series of preferred stock Dynegy may issue.
In December 2001, 27.5 million shares of Class A common stock were sold
through a public offering which resulted in proceeds of approximately $539
million, net of underwriting commission and expenses of approximately $32
million. Concurrent with the public offering, members of the Company's senior
management purchased approximately 1.2 million shares of Class A common stock
from the Company in a private placement. The officers paid $19.75 per share for
the stock, the same price as the net proceeds to the Company in the public
offering, yielding net proceeds of $25 million. The officers paid for the
shares by entering into promissory notes with the Company for an initial term
of 60 days. The maturity date of the notes was extended for an additional 30
days with the approval of the Board of Directors. The loans bear interest at
3.25 percent and are full recourse to the borrowers. Such loans are accounted
for as "Subscriptions Receivable" within Stockholders' Equity on the
Consolidated Balance Sheet at December 31, 2001. The net proceeds from these
equity sales were used to reduce indebtedness under Dynegy Holdings' revolving
credit facility by approximately $539 million and the remainder of the proceeds
were invested in cash.
In January 2002, Chevron purchased approximately 10.4 million shares of
Class B common stock in a private transaction, pursuant to the exercise of its
pre-emptive rights under the shareholder agreement. The proceeds from this sale
were approximately $205 million.
In July 2001, Dynegy established the Dynegy Inc. Short-Term Executive Stock
Purchase Loan Program pursuant to which eligible employees were loaned funds to
acquire Class A common stock through market purchases. Outstanding loans bear
interest at the greater of five percent or the applicable federal rate as of
the loan date, are full recourse to the participants and mature on December 19,
2004. At December 31, 2001, approximately $13 million, which included accrued
and unpaid interest, was owed to the Company under this program for 375,800
shares of Class A common stock. The loans are accounted for as Subscriptions
Receivable within Stockholders' Equity on the Consolidated Balance Sheet.
Earlier in 2001, approximately 1.2 million shares of Class B common stock
were sold to Chevron in a private transaction, pursuant to the exercise of its
pre-emptive rights under the shareholder agreement. The proceeds from this
transaction were approximately $41 million.
During 2000, Dynegy sold approximately 22.6 million shares of common stock.
The offerings included approximately 18.4 million shares of Class A common
stock sold to the public and approximately 4.2 million shares of Class B common
stock sold to Chevron. Total net proceeds to Dynegy from these sales
approximated $858 million, net of underwriting commissions and expenses of
approximately $10 million. Additionally, Chevron purchased $200 million of
Class B common stock concurrent with the acquisition of Illinova.
Concurrent with the acquisition of Illinova, BG and NOVA were issued
preferred shares which were convertible into Class A common stock. In the
second quarter of 2000, a non-recurring special dividend payment of $32 million
was made to BG and NOVA prior to the conversion of their preferred shares to
Class A common stock.
F-47
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Common stock activity (in millions) for the three years ended December 31,
2001 was as follows:
Common Stock Class A Common Stock Class B Common Stock
------------ ------------------- --------------------
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
December 31, 1998............. 211 $ 1 -- $ -- -- $ --
Options exercised............. 5 -- -- -- -- --
401(k) plan and profit sharing 1 -- -- -- -- --
---- --- --- ------ -- ----
December 31, 1999............. 217 1 -- -- -- --
Illinova acquisition.......... (217) (1) 195 1,168 81 650
Common stock issued........... -- -- 19 748 4 110
Preferred Stock conversion.... -- -- 12 -- -- --
Extant acquisition............ -- -- 2 67 -- --
Options exercised............. -- -- 9 157 -- --
401(k) plan and profit sharing -- -- 1 12 -- --
---- --- --- ------ -- ----
December 31, 2000............. -- -- 238 2,152 85 $760
Common stock issued........... -- -- 30 564 1 41
Subscriptions receivable...... -- -- -- (38) -- --
Options exercised............. -- -- 3 59 -- --
401(k) plan and profit sharing -- -- -- 11 -- --
---- --- --- ------ -- ----
December 31, 2001............. -- $-- 271 $2,748 86 $801
==== === === ====== == ====
The December 31, 2001 Class A Common Stock balance is net of $38 million in
subscriptions receivable described above (see Note 16 for further discussion).
Such amount is included on the face of the Consolidated Balance Sheet and
classified as a separate line item.
F-48
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Stock Options. Each option granted is valued at an option price, which
ranges from $1.47 per share to $57.95 per share at date of grant. The
difference, if any, between the option price and the fair market value of each
option on the date of grant is recorded as compensation expense over the
respective vesting period. Most 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. Compensation expense
related to options granted totaled $12.7 million, $15.4 million and $6.0
million for the years ended December 31, 2001, 2000 and 1999, respectively.
Total options outstanding and exercisable for 2001, 2000 and 1999 were (options
in thousands) as follows:
Year Ended December 31,
---------------------------------------------------------------
2001 2000 1999
--------------------- -------------------- --------------------
Options Option Price Options Option Price Options Option Price
------- ------------- ------- ------------ ------- ------------
Outstanding at beginning of
period........................ 21,531 $ 1.47-$57.02 24,022 $ 1.47-16.62 25,777 $1.47-$15.67
Granted......................... 8,357 $27.80-$57.95 7,197 $10.44-57.02 4,203 $1.47-$16.62
Exercised....................... (2,543) $ 1.47-$39.67 (8,592) $ 1.47-22.21 (4,658) $1.47-$13.68
Cancelled or expired............ (586) $ 1.47-$56.50 (1,096) $ 1.47-57.02 (1,232) $1.47-$13.77
Other, contingent share issuance -- $ -- -- $ -- (68) $1.47-$ 4.10
------ ------------- ------ ------------ ------ ------------
Outstanding at end of period.... 26,759 $ 1.47-$57.95 21,531 $ 1.47-57.02 24,022 $1.47-$16.62
====== ============= ====== ============ ====== ============
Exercisable at end of period.... 12,550 $ 1.47-$57.02 12,779 $1.47-$23.83 9,983 $1.47-$15.67
====== ============= ====== ============ ====== ============
Weighted average fair value.....
of options granted during the
period at market.............. $ 24.45 $ 14.40 $ 7.76
============= ============ ============
Weighted average fair value of
options granted during the
period at below market........ $ -- $ 24.10 $ 9.65
============= ============ ============
Options outstanding as of December 31, 2001 (shares in thousands) are
summarized below:
Options Outstanding Options Exercisable
-------------------------------------------------------- ----------------------------------
Number of Options Weighted Average Number of Options
Range of Exercise Outstanding at Remaining Contractual Weighted Average Exercisable at Weighted Average
Prices December 31, 2001 Life (Years) Exercise Price December 31, 2001 Exercise Price
----------------- ----------------- --------------------- ---------------- ----------------- ----------------
$1.47--$5.80 7,969 4.2 $ 2.80 4,822 $ 2.25
$5.81--$11.59 2,516 6.6 $ 9.95 2,516 $ 9.95
$11.60--$17.39 6,481 7.3 $15.72 4,653 $15.45
$17.40--$23.18 79 7.4 $21.83 30 $21.80
$23.19--$28.98 860 7.9 $24.02 253 $23.96
$28.99--$34.77 2,549 9.7 $34.32 8 $31.68
$34.78--$40.57 224 8.9 $37.78 74 $37.20
$40.58--$46.36 588 8.7 $43.38 124 $43.33
$46.37--$52.16 5,236 9.1 $47.25 29 $48.78
$52.17--$57.95 257 8.7 $55.88 41 $55.51
------ ------
26,759 12,550
====== ======
F-49
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Pursuant to terms of the Illinova acquisition, certain vesting requirements
on outstanding options were accelerated and the option shares and strike prices
were subject to the exchange ratios described in the acquisition documents.
Additionally, Dynegy instituted new option plans on the effective date of the
acquisition.
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 2001, 2000 and 1999: dividend per year of $0.30
per share per annum for 2001 and 2000 and a historical dividend of $0.04 per
share for 1999; expected volatility of 46.4 percent, 42.1 percent and 40.3
percent, respectively; risk-free interest rate of 4.29 percent, 6.10 percent
and 6.42 percent, respectively; and an expected life of ten years for all
periods. As stated previously, the Company accounts for its stock option plan
in accordance with APB No. 25. Had compensation cost been determined on a fair
value basis consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net income and per share amounts would have
approximated the following pro forma amounts for the years ended December 31,
2001, 2000 and 1999, respectively.
Years Ended December 31,
--------------------------------------------------------------------
2001 2000 1999
---------------------- ---------------------- ----------------------
Net Income Diluted EPS Net Income Diluted EPS Net Income Diluted EPS
- ---------- ----------- ---------- ----------- ---------- -----------
($ in millions, except per share data)
Pro forma amounts $348 $0.90 $420 $1.22 $128 $0.56
==== ===== ==== ===== ==== =====
Note 14--BUSINESS COMBINATIONS AND OTHER ACQUISITIONS
In the first quarter of 2001, Dynegy completed the acquisition of Central
Hudson power generation facilities in New York. The Central Hudson facilities
consist of a combination of base load, intermediate and peaking facilities
aggregating 1,700 MW. The facilities are located approximately 50 miles north
of New York City and were acquired for approximately $903 million cash, plus
inventory and certain working capital adjustments. The acquisition of these
facilities established Dynegy's physical presence in the region. In May 2001,
subsidiaries of Dynegy completed a sale-leaseback transaction to provide the
term financing with respect to the Central Hudson facilities. Under the terms
of the sale-leaseback transaction, subsidiaries of Dynegy sold certain plants
and equipment and agreed to lease it back for terms expiring within 34 years,
exclusive of renewal options.
In the fourth quarter of 2001, Dynegy completed the purchase of BGSL. Under
the terms of the purchase agreement, Dynegy paid approximately (Pounds)421
million (approximately $595 million at November 28, 2001) for BGSL and its
existing assets. BGSL's results of operations are included in Dynegy's
consolidated statement of operations beginning December 1, 2001. A condensed
balance sheet as of the acquisition date is as follows (in millions):
Current assets................ $ 57
Property, plant, and equipment 792
Goodwill...................... 9
----
Total assets acquired......... 858
----
Current liabilities........... 56
Long-term liabilities......... 207
----
Total liabilities assumed..... 263
----
Net assets acquired........... $595
====
F-50
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
The assets, which are located in the United Kingdom, consist of 30 gas
storage injection wells with five offshore platforms, nine salt caverns,
approximately 19 miles of pipelines and an onshore natural gas processing
terminal. The acquisition of BGSL established Dynegy's physical presence in the
United Kingdom. Also in the first quarter of 2001, Dynegy finalized the
acquisition of iaxis, a London-based communications company.
Dynegy completed its acquisition of Illinova on February 1, 2000. The merger
of Dynegy and Illinova involved the creation of a new holding company, now
known as Dynegy Inc. Dynegy accounted for the acquisition as a purchase of
Illinova with an effective date of January 1, 2000. This accounting treatment
was based on various factors present in the merger, including the majority
ownership (and voting control) of Dynegy's shareholders following the merger,
the role of Dynegy's management following the merger (including the service of
C.L. Watson as Chairman and Chief Executive Officer) and the influence of
Chevron because of the size of its ownership interest and its rights under the
shareholder agreement, articles of incorporation and bylaws.
In the combination, Dynegy shareholders, other than Chevron, NOVA and BG,
elected to exchange each former Dynegy share for 0.69 of a share of Dynegy
Class A Common stock, based on a fixed exchange ratio, or elected to receive
$8.25 per share in cash consideration, subject to proration. NOVA and BG
elected cash and thereby reduced their respective ownership in Dynegy as part
of this combination. Additionally, instead of receiving Dynegy Class A common
stock in exchange for their respective shares of former Dynegy common stock,
NOVA and the parent of BG each received a combination of cash, subject to
proration, and shares of Dynegy Series A Convertible Preferred Stock. Chevron
received 0.69 of a share of Dynegy Class B common stock in exchange for each
share of former Dynegy common stock and Series A Participating Preferred Stock
it owned. Additionally, as part of the combination, Chevron purchased $200
million of additional Dynegy Class B common stock. Each share of Illinova
common stock was converted into one share of Dynegy Class A common stock.
Approximately 60 percent of the consideration received by existing Dynegy
shareholders was in the form of Dynegy stock and 40 percent was cash. In the
aggregate, the cash portion of the consideration approximated $1.1 billion.
Dynegy financed the cash component of the acquisition initially with borrowings
under a debt facility and the issuance of $200 million of Class B common stock
to Chevron. On a long-term basis, Dynegy financed the acquisition of Illinova
through a combination of sales of common equity, the disposition of certain
non-strategic assets, the refinancing of Illinova's unregulated generation
assets and cash flow derived from its operations.
The results of operations of the acquired Illinova assets are consolidated
with Dynegy's operations beginning January 1, 2000. The following table
reflects certain unaudited pro forma information for the period presented as if
the Illinova acquisition had taken place on January 1, 1999 (in millions,
except per share data). Unaudited pro forma results for the year ended December
31, 1999 include non-recurring after-tax gains of $41.8 million, or $0.15 per
diluted share (restated for two-for-one stock split effected by means of a
stock dividend distributed on August 22, 2000).
Year Ended
December 31, 1999
-----------------
Pro forma revenues.......... $17,635
Pro forma net income........ 203
Pro forma earnings per share $ 0.63
F-51
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
On September 29, 2000, Dynegy completed the acquisition of Extant, Inc.
("Extant"), a privately held communications solutions company providing
centralized clearinghouse services, OSS (Operations Support System) integration
and network expansion capabilities to communications service providers.
Dynegy's net investment consisted of $92 million in cash and 1.8 million shares
of Class A common stock. Following the transaction, Dynegy established Dynegy
Global Communications, a new segment that, in addition to pursuing other
communications opportunities, owns 80 percent of a limited partnership called
Dynegy Connect, L.P. which conducts many of the activities previously conducted
by Extant.
Consideration paid for these recent acquisitions of businesses was as
follows (in millions):
BGSL iaxis Extant Illinova
---- ----- ------ --------
Cash Purchase of Stock................ $595 $ 40 $ 91 $1,111
Capital Stock and Stock Options Issued -- -- 76 1,817
Liabilities Assumed................... 263 83 75 4,674
Subordinated capital assumed.......... -- -- -- 239
---- ---- ---- ------
Total Consideration................... $858 $123 $242 $7,841
==== ==== ==== ======
In both the Illinova and Extant acquisitions, the Company issued stock as a
component of the total consideration paid. The value of this consideration for
the Extant acquisition was determined based on the average of the Company's
quoted market price for the five trading days surrounding the announcement
date, which was August 2, 2000 ("average stock price"). This period includes
the announcement date and the two trading days just prior to and after the
announcement date. Pursuant to the terms of the merger agreement, each share of
Extant common stock was converted into Dynegy Class A common stock at the
agreed upon exchange ratio of $7.50 divided by the average stock price. Each
share of Extant preferred stock was exchanged for $7.50 in cash.
The value of the stock consideration for the Illinova acquisition was based
on a fixed exchange ratio whereby each share of Illinova common stock was
converted to one share of Dynegy Class A common stock and each Dynegy
shareholder other than BG, NOVA and Chevron was converted into the right to
receive 0.69 shares of Dynegy Class A common stock. (See above for a discussion
of the exchange provisions that impacted these shareholders.) These fixed
exchange ratios were set prior to the circulation of the prospectus in
September 1999. This method of valuing the stock consideration was used since
management did not believe market quotes were a reliable indicator of fair
value. The reasons for this belief included, but were not limited to,
marketplace takeover rumors, Dynegy's stock being thinly traded prior to the
announcement and the merger being premised on leveraging an unregulated
generation capacity position in a deregulating environment. The cash component
of the consideration was deemed to be a more reliable indicator of fair value,
thus an implied value for the stock consideration was calculated by dividing
the $16.50 per share (not adjusted herein for the two-for-one stock split which
occurred on August 22, 2000) cash price by the 0.69 stock exchange ratio.
Note 15--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 awards are at the discretion of the
Compensation Committee of the Board of Directors ("Compensation Committee").
F-52
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
401(k) Savings Plan. The Company established the Dynegy Inc. 401(k) Savings
Plan ("Dynegy 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 ("ERISA").
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 and are subject to the laws of each country. All employees of certain
entities are eligible to participate in the Plan. Employee pre-tax
contributions to the Plan are matched 100%, up to a maximum of five percent of
base pay, subject to IRS limitations. Vesting in Company contributions is based
on years of service. The Company may also make discretionary contributions to
employee accounts, subject to the Company's performance. Matching contributions
to the Plan and discretionary contributions are made in Dynegy common stock.
The Company discontinued the additional 5% profit sharing contribution to
active employee accounts in 2001. However, active employees who normally would
have received the profit sharing contribution under the Dynegy Plan began
participating in the pension plan in 2001 (see below).
Certain eligible employees participate in the Illinois Power Company
Incentive Savings Plan and Illinois Power Company Incentive Savings Plan for
Employees Covered Under A Collective Bargaining Agreement ("IP Plans"), which
meet the requirements of Section 401(k) of the Internal Revenue Code and are
defined contribution plans subject to the provisions of ERISA. The Company
matches 50% of employee contributions to the IP Plans, up to a maximum of six
percent of compensation, subject to IRS limitations. Employees are immediately
100% vested in Company contributions. Matching contributions to the Plan are
made in Dynegy common stock.
Certain eligible employees participate in the Dynegy Northeast Generation,
Inc. Savings Incentive Plan ("Northeast 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 ERISA. The Company matches either 24% or 50% of
employee contributions to the Northeast Plan. The Company guaranteed match is
subject to a maximum of six or eight percent of base pay, subject to IRS
limitations. Employees are immediately 100% vested in Company contributions.
Matching contributions to the Northeast Plan are made in cash.
During the years ended December 31, 2001, 2000 and 1999, Dynegy recognized
aggregate costs related to these employee compensation plans of $27 million,
$35 million and $25 million, respectively.
F-53
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Pension and Other Post-Retirement Benefits. The Company has various defined
benefit pension plans and post-retirement benefit plans. All domestic employees
participate in the pension plans, but only some of the Company's domestic
employees participate in the other post-retirement benefit plans. The Company
added a cash balance feature effective for 2001 and thereafter with respect to
employees who would have otherwise received a profit sharing contribution under
the Dynegy Plan for 2001 and thereafter (the contribution credit under such
cash balance feature shall generally be 6% of base pay). The following tables
contain information about these plans on a combined basis:
Pension
Benefits Other Benefits
---------- -------------
2001 2000 2001 2000
---- ---- ---- ----
($ in millions)
Projected benefit obligation, beginning of the year.............. $448 $ 9 $100 $ --
Business combination.......................................... 14 424 5 97
Service cost.................................................. 10 10 2 2
Interest cost................................................. 34 33 8 7
Plan amendments............................................... 8 -- -- --
Actuarial (gain) loss......................................... 30 (3) 31 (1)
Special termination benefits.................................. 9 -- -- --
Benefits paid................................................. (29) (25) (6) (5)
---- ---- ---- ----
Projected benefit obligation, end of the year.................... $524 $448 $140 $100
==== ==== ==== ====
Fair value of plan assets, beginning of the year................. $627 $ 10 $ 83 $ --
Business combination............................................. 16 579 -- 80
Actual return on plan assets..................................... (30) 63 (8) (4)
Employer contributions........................................... -- -- 9 12
Participant contributions........................................ -- -- 1 1
Benefits paid.................................................... (29) (25) (6) (6)
---- ---- ---- ----
Fair value of plan assets, end of the year....................... $584 $627 $ 79 $ 83
==== ==== ==== ====
Funded status.................................................... $ 60 $179 $(61) $(17)
Unrecognized prior service costs................................. 8 -- -- --
Unrecognized actuarial (gain) loss............................... 101 (17) 55 10
---- ---- ---- ----
Net amount recognized............................................ $169 $162 $ (6) $ (7)
==== ==== ==== ====
Amounts recognized in the consolidated balance sheets consist of:
Prepaid benefit cost............................................. $174 $167 $ -- $ --
Accrued benefit liability........................................ (5) (5) (6) (7)
---- ---- ---- ----
Net amount recognized............................................ $169 $162 $ (6) $ (7)
==== ==== ==== ====
F-54
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Pension
Benefits Other Benefits
---------- ---------------
2001 2000 2001 2000
---- ---- --------- ----
($ in millions)
Weighted Average Assumptions:
Discount rate at December 31................... 7.50% 7.99% 7.50% 8.00%
Expected return on plan assets as of January 1. 9.47% 9.47% 9.50% 9.50%
Rate of compensation increase.................. 4.48% 4.48% 4.50% 4.50%
Medical trend--initial trend................... -- -- 10.09% 6.70%
Medical trend--ultimate trend.................. -- -- 5.48% 5.50%
Medical trend--year of ultimate trend.......... -- -- 2009/2015 2005
The changes in the projected benefit obligation and in plan assets
attributable to business combination in 2000 are the result of the acquisition
of Illinova. The changes in the projected benefit obligations and in plan
assets attributable to business combination in 2001 are the result of the
Central Hudson acquisition. Special termination benefits of approximately $9
million in 2001 reflect the additional expense of the early retirement window
related to the Illinois Power Company Retirement Income Plan for Salaried
Employees.
The components of net periodic benefit cost were:
Pension Benefits Other Benefits
--------------- --------------
2001 2000 1999 2001 2000 1999
---- ---- ---- ---- ---- ----
($ in millions)
Service cost benefits earned during period... $ 10 $ 10 $ 1 $ 2 $ 2 $--
Interest cost on projected benefit obligation 34 33 1 8 7 --
Expected return on plan assets............... (57) (53) (1) (7) (7) --
Amortization of unrecognized actuarial gain.. -- (1) -- 1 -- --
---- ---- --- --- --- ---
Net periodic benefit cost (income)........... $(13) $(11) $ 1 $ 4 $ 2 $--
Additional early retirement window benefits.. 9 -- -- -- -- --
Additional cost due to curtailment........... -- -- (2) -- -- --
---- ---- --- --- --- ---
Total net periodic benefit cost (income)..... $ (4) $(11) $(1) $ 4 $ 2 $--
==== ==== === === === ===
Impact of a 1% increase/decrease in medical trend:
Increase Decrease
-------- --------
($ in millions)
Aggregate impact on service cost
and interest cost............. $ 2 $ (1)
Impact on accumulated post-
retirement benefit
obligation.................... $14 $(13)
F-55
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Note 16--RELATED PARTY TRANSACTIONS
In addition to related party transactions described elsewhere herein, the
following are additional items requiring disclosure.
Transactions with Chevron U.S.A. Inc. result from purchases and sales of
natural gas, NGLs and crude oil between subsidiaries of Dynegy and Chevron
U.S.A. Inc. affiliates. Management believes that these transactions are
executed at prevailing market rates. During the years ended December 31, 2001,
2000 and 1999, the Company recognized in its statement of operations aggregate
sales to this significant shareholder of $1.3 billion, $1.4 billion and $1.1
billion, respectively. In the same years, purchases from this shareholder were
$3.6 billion, $3.1 billion and $2.0 billion, respectively.
The Company also holds investments in three joint ventures in which Chevron
U.S.A. or its affiliates are also investors. These investments include a 22.9%
ownership interest in Venice Energy Services Company, L.L.C., which holds a
pipeline gathering system, processing plant, fractionator and an underground
NGL storage facility in Louisiana; a 39.2% ownership interest in West Texas LPG
Pipeline Limited Partnership, which holds a regulated NGL transportation
pipeline that runs from West Texas to Mont Belvieu, Texas; and a 50% ownership
interest in Nevada Cogeneration Associates #2, a power generation facility.
During the years ended December 31, 2001, 2000 and 1999, the Company's portion
of the net income from the Venice Energy, West Texas and Nevada Cogeneration
joint ventures was approximately $4.6 million, $5.5 million and $3.8 million,
respectively; approximately $9.6 million, $5.6 million and $2.2 million,
respectively; and approximately $7.0 million, $5.0 million and $3.5 million,
respectively.
The Company also purchases and sells natural gas, NGLs, crude oil and power
and, in some instances, earns management fees from certain entities in which it
has equity investments. Revenues recognized from these transactions in 2001,
2000 and 1999 were $2.0 billion, $827 million and $377 million, respectively.
Expenses recognized were $385 million, $217 million and $125 million,
respectively. Revenues relate to the supply of fuel for use at generation
facilities, primarily West Coast Power, and the supply of natural gas sold by
retail affiliates. Expenses primarily represent the purchase of natural gas
liquids that are subsequently sold in the Company's marketing operations.
Also during 2001, the Company earned approximately $8 million of interest
income related to cash lent to West Coast Power. The loan was created as a
result of natural gas fuel costs owed from West Coast Power to a subsidiary of
Dynegy. As of December 31, 2001, West Coast Power had repaid in full all
amounts owed to Dynegy. Dynegy has guaranteed $31 million of estimated
environmental obligations as well as $25 million associated with an insurance
program for West Coast Power.
In July 2001, the Company established the Dynegy Short-Term Executive Stock
Purchase Loan Program. Under this program, the Company may loan eligible
employees funds to acquire Class A common stock through market purchases in
return for a two-year note. The notes bear interest at the greater of 5 percent
or the Applicable Federal Rate as of the loan date and are full recourse to
each payee. At December 31, 2001, the Company had issued approximately $13
million of loans pursuant to this program.
Concurrent with the December 2001 Class A common stock sale, ten members of
the Company's senior management purchased approximately 1.2 million shares of
Class A common stock in a private placement transaction pursuant to Section
4(2) of the Securities Act of 1933. The officers paid $19.75 per share for the
stock, the same price as the net proceeds to the Company in the public
offering. The officers paid for the shares by entering into promissory notes
with the Company for an initial term of 60 days. The maturity date of the notes
was extended for an additional 30 days with the approval of the Board of
Directors. The loans bear interest at
F-56
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
3.25 percent and are full recourse to the borrowers. Such loans are accounted
for as "Subscriptions Receivable" within Stockholders' Equity on the
Consolidated Balance Sheet at December 31, 2001. The Company recognized
compensation expense in 2001 of approximately $1.2 million, which was recorded
as "General and Administrative Expense", related to the shares purchased by the
officer group.
Note 17--SEGMENT INFORMATION
Dynegy's operations are reported in four segments: Wholesale Energy Network
("WEN"), Dynegy Midstream Services ("DMS"), Transmission and Distribution
("T&D") and Dynegy Global Communications ("DGC"). WEN is engaged in a broad
array of businesses, including physical supply of and risk-management
activities around wholesale natural gas, power, coal, and other similar
products. This segment is focused on optimizing the Company's and its
customers' global portfolio of energy assets and contracts, as well as direct
commercial and industrial sales and retail marketing alliances. DMS consists of
the Company's North American midstream liquids processing and marketing
businesses and worldwide NGLs marketing and transportation operations. Dynegy's
T&D segment includes the operations of IP, an energy-delivery company engaged
in the transmission, distribution and sale of electricity and natural gas to
customers across a 15,000-square-mile area of Illinois. DGC is engaged in
pursuing and capturing opportunities in the converging energy and
communications marketplace. DGC has a global long-haul fiber optic network and
metropolitan network in cities in the United States and Europe. Dynegy accounts
for intercompany transactions at prevailing market rates. Operating segment
information for the years ended December 31, 2001, 2000 and 1999 is presented
below. See Explanatory Note for a discussion of the restatements made to the
financial information included herein.
Dynegy's Segment Data for the Year Ended December 31, 2001
WEN DMS T&D DGC Elimination Total
($ in millions) ------- ------ ------ ----- ----------- -------
Unaffiliated revenues:
Domestic................................ $26,191 $4,799 $1,593 $ 17 $ -- $32,600
Canadian................................ 4,622 1,463 -- -- -- 6,085
European & Other........................ 3,918 -- -- 10 -- 3,928
------- ------ ------ ----- ----- -------
34,731 6,262 1,593 27 -- 42,613
Intersegment revenues
Domestic................................ 585 237 25 -- (847) --
------- ------ ------ ----- ----- -------
Total revenues.......................... 35,316 6,499 1,618 27 (847) 42,613
------- ------ ------ ----- ----- -------
Depreciation and amortization.............. (201) (84) (173) (30) -- (488)
Operating income (loss).................... 633 131 180 (142) -- 802
Interest expense........................... (94) (53) (114) (9) -- (270)
Other income (expense)..................... (56) (3) 2 24 -- (33)
Earnings of unconsolidated affiliates...... 178 13 -- 26 -- 217
Income tax (provision) benefit............. (281) (32) (36) 37 -- (312)
Cumulative effect of a change in accounting
principle................................ 2 -- -- -- -- 2
Net income (loss).......................... $ 382 $ 56 $ 32 $ (64) $ -- $ 406
Identifiable assets:
Domestic................................ $14,197 $2,308 $4,500 $ 816 $ -- $21,821
Canadian................................ 773 130 -- -- -- 903
European & Other........................ 2,196 -- -- 248 -- 2,444
Investments in unconsolidated affiliates... 1,348 422 568 107 -- 2,445
Capital expenditures and investments in
unconsolidated affiliates................ (2,496) (391) (701) (496) -- (4,084)
F-57
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Dynegy's Segment Data for the Year Ended December 31, 2000
WEN DMS T&D DGC Elimination Total
------- ------ ------ ---- ----------- -------
($ in millions)
Unaffiliated revenues:
Domestic............................. $17,813 $5,123 $1,581 $ 2 $ -- $24,519
Canadian............................. 2,316 1,224 -- -- -- 3,540
European............................. 1,268 -- -- -- -- 1,268
------- ------ ------ ---- ------- -------
21,397 6,347 1,581 2 -- 29,327
Intersegment revenues
Domestic............................. 743 249 27 -- (1,019) --
------- ------ ------ ---- ------- -------
Total revenues....................... 22,140 6,596 1,608 2 (1,019) 29,327
------- ------ ------ ---- ------- -------
Depreciation and amortization........... (129) (105) (156) (3) -- (393)
Operating income (loss)................. 515 84 206 (18) -- 787
Interest expense........................ (89) (30) (129) (3) -- (251)
Other income (expense).................. (13) (39) (10) 3 -- (59)
Earnings of unconsolidated affiliates... 181 24 -- -- -- 205
Income tax (provision) benefit.......... (208) (23) (21) 6 -- (246)
Net income (loss)....................... $ 386 $ 16 $ 46 $(12) $ -- $ 436
Identifiable assets:
Domestic............................. $14,921 $2,104 $3,569 $302 $ -- $20,896
Canadian............................. 750 299 -- -- -- 1,049
European............................. 644 -- -- 73 -- 717
Investments in unconsolidated affiliates 625 174 -- -- -- 799
Capital expenditures and investments in
unconsolidated affiliates............. (878) (114) (158) (63) -- (1,213)
F-58
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Dynegy's Segment Data for the Year Ended December 31, 1999
WEN DMS T&D DGC Elimination Total
------- ------ --- --- ----------- -------
($ in millions)
Unaffiliated revenues:
Domestic............................. $ 8,097 $4,884 $-- $-- $ -- $12,981
Canadian............................. 1,443 10 -- -- -- 1,453
European............................. 976 -- -- -- -- 976
------- ------ --- --- ----- -------
10,516 4,894 -- -- -- 15,410
Intersegment revenues
Domestic............................. 131 240 -- -- (371) --
------- ------ --- --- ----- -------
Total revenues....................... 10,647 5,134 -- -- (371) 15,410
------- ------ --- --- ----- -------
Depreciation and amortization........... (21) (94) -- -- -- (115)
Operating income........................ 144 82 -- -- -- 226
Interest expense........................ (36) (42) -- -- -- (78)
Other income (expense).................. (13) (18) -- -- -- (31)
Earnings of unconsolidated affiliates... 62 18 -- -- -- 80
Income tax (provision) benefit.......... (50) (10) -- -- -- (60)
Net income.............................. $ 107 $ 30 $-- $-- $ -- $ 137
Identifiable assets:
Domestic............................. $ 3,397 $2,545 $-- $-- $ -- $ 5,942
Canadian............................. 266 68 -- -- -- 334
European............................. 175 -- -- -- -- 175
Investments in unconsolidated affiliates 458 169 -- -- -- 627
Capital expenditures and investments in
unconsolidated affiliates............. (429) (92) -- -- -- (521)
Note 18--QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of the Company's unaudited quarterly financial
information for the years ended December 31, 2001 and 2000.
Quarter Ended
-------------------------------------
March June September December
2001 2001 2001 2001
------- ------- --------- --------
($ in millions, except per share data)
Revenues........................... $13,245 $11,898 $8,578 $8,892
Operating income................... 311 122 380 (11)
Income before income taxes......... 242 86 385 3
Net income......................... 155 39 238 (26)
Net income (loss) per diluted share 0.46 0.12 0.71 (0.21)
Quarter Ended
--------------------------------------
March June September December
2000 2000 2000 2000
------ ------ --------- --------
($ in millions, except per share data)
Revenues.................... $5,373 $5,742 $8,339 $9,873
Operating income............ 234 187 276 90
Income before income taxes.. 148 172 311 51
Net income.................. 83 111 209 33
Net income per diluted share 0.27 0.25 0.65 .0.10
F-59
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
These amounts have been restated from amounts previously reported. For
further discussion of the restatements, see the Explanatory Note.
A synopsis of the aggregate financial impact of these restatements on the
amounts originally reported in the 2001 Form 10-K filed on March 13, 2002 is as
follows ($ in millions):
RESTATED SELECTED BALANCE SHEET DATA BY QUARTER
2001 2000
----------------------------------------- -----------------------------------------
March 31 June 30 September 30 December 31 March 31 June 30 September 30 December 31
-------- ------- ------------ ----------- -------- ------- ------------ -----------
($ in millions)
Current Assets
As Reported......... $ 9,043 $10,741 $10,562 $ 9,507 $ 3,488 $ 5,779 $ 6,138 $10,150
Restatement Effect.. 725 123 280 (551) 67 312 218 677
------- ------- ------- ------- ------- ------- ------- -------
As Restated......... $ 9,768 $10,864 $10,842 $ 8,956 $ 3,555 $ 6,091 $ 6,356 $10,827
======= ======= ======= ======= ======= ======= ======= =======
Total Assets
As Reported......... $21,695 $22,824 $23,856 $24,874 $13,042 $15,724 $16,777 $21,406
Restatement Effect.. 1,284 866 1,281 294 143 578 649 1,256
------- ------- ------- ------- ------- ------- ------- -------
As Restated......... $22,979 $23,690 $25,137 $25,168 $13,185 $16,302 $17,426 $22,662
======= ======= ======= ======= ======= ======= ======= =======
Current Liabilities
As Reported......... $ 8,149 $ 9,469 $ 9,956 $ 8,555 $ 3,496 $ 5,346 $ 5,414 $ 9,381
Restatement Effect.. 834 563 750 (17) 144 344 340 905
------- ------- ------- ------- ------- ------- ------- -------
As Restated......... $ 8,983 $10,032 $10,706 $ 8,538 $ 3,640 $ 5,690 $ 5,754 $10,286
======= ======= ======= ======= ======= ======= ======= =======
Total Liabilities
As Reported......... $16,514 $17,345 $18,393 $17,396 $10,395 $11,864 $12,555 $16,444
Restatement Effect.. 1,411 1,057 1,520 667 95 607 727 1,409
------- ------- ------- ------- ------- ------- ------- -------
As Restated......... $17,925 $18,402 $19,913 $18,063 $10,490 $12,471 $13,282 $17,853
======= ======= ======= ======= ======= ======= ======= =======
Stockholders' Equity
As Reported......... $ 3,810 $ 3,933 $ 4,114 $ 4,719 $ 2,209 $ 2,577 $ 2,906 $ 3,598
Restatement Effect.. (131) (244) (284) 218 (56) (34) (83) (157)
------- ------- ------- ------- ------- ------- ------- -------
As Restated......... $ 3,679 $ 3,689 $ 3,830 $ 4,937 $ 2,153 $ 2,543 $ 2,823 $ 3,441
======= ======= ======= ======= ======= ======= ======= =======
F-60
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
RESTATED RESULTS OF OPERATIONS BY QUARTER
Three Three Three Three Six Nine Twelve
Months Months Months Months Months Months Months
Ended Ended Ended Ended Ended Ended Ended
March 31 June 30 September 30 December 31 June 30 September 30 December 31
-------- ------- ------------ ----------- ------- ------------ -----------
($ in millions, except for earnings (loss) per diluted share)
2001
Results of Operations:
Net Income (Loss):
As Reported.................... $ 139 $ 146 $ 286 $ 77 $ 285 $ 571 $ 648
Restatement Effect............. 16 (107) (48) (103) (91) (139) (242)
----- ------ ------ ------ ------ ------ ------
As Restated.................... $ 155 $ 39 $ 238 $ (26) $ 194 $ 432 $ 406
===== ====== ====== ====== ====== ====== ======
Net Income Available to Common
Stockholders:
As Reported.................... $ 139 $ 146 $ 286 $ 74 $ 285 $ 571 $ 645
Restatement Effect............. 16 (107) (48) (142) (91) (139) (281)
----- ------ ------ ------ ------ ------ ------
As Restated.................... $ 155 $ 39 $ 238 $ (68) $ 194 $ 432 $ 364
===== ====== ====== ====== ====== ====== ======
Earnings (Loss) Per Diluted Share:
As Reported.................... $0.41 $ 0.43 $ 0.85 $ 0.21 $ 0.84 $ 1.69 $ 1.90
Restatement Effect............. 0.05 (0.31) (0.14) (0.42) (0.27) (0.41) (0.83)
----- ------ ------ ------ ------ ------ ------
As Restated.................... $0.46 $ 0.12 $ 0.71 $(0.21) $ 0.57 $ 1.28 $ 1.07
===== ====== ====== ====== ====== ====== ======
2000
Results of Operations:
Net Income:
As Reported.................... $ 69 $ 91 $ 235 $ 106 $ 160 $ 395 $ 501
Restatement Effect............. 14 20 (26) (73) 34 8 (65)
----- ------ ------ ------ ------ ------ ------
As Restated.................... $ 83 $ 111 $ 209 $ 33 $ 194 $ 403 $ 436
===== ====== ====== ====== ====== ====== ======
Net Income Available to Common
Stockholders:
As Reported.................... $ 66 $ 59 $ 235 $ 106 $ 125 $ 360 $ 466
Restatement Effect............. 14 20 (26) (73) 34 8 (65)
----- ------ ------ ------ ------ ------ ------
As Restated.................... $ 80 $ 79 $ 209 $ 33 $ 159 $ 368 $ 401
===== ====== ====== ====== ====== ====== ======
Earnings Per Diluted Share:
As Reported.................... $0.23 $ 0.19 $ 0.73 $ 0.32 $ 0.41 $ 1.17 $ 1.48
Restatement Effect............. 0.04 0.06 (0.08) (0.22) 0.12 0.02 (0.21)
----- ------ ------ ------ ------ ------ ------
As Restated.................... $0.27 $ 0.25 $ 0.65 $ 0.10 $ 0.53 $ 1.19 $ 1.27
===== ====== ====== ====== ====== ====== ======
1999
Results of Operations:
Net Income:
As Reported.................... $ 28 $ 28 $ 51 $ 45 $ 56 $ 107 $ 152
Restatement Effect............. 1 (6) (5) (5) (5) (10) (15)
----- ------ ------ ------ ------ ------ ------
As Restated.................... $ 29 $ 22 $ 46 $ 40 $ 51 $ 97 $ 137
===== ====== ====== ====== ====== ====== ======
Net Income Available to Common
Stockholders:
As Reported.................... $ 28 $ 28 $ 51 $ 45 $ 56 $ 107 $ 152
Restatement Effect............. 1 (6) (5) (5) (5) (10) (15)
----- ------ ------ ------ ------ ------ ------
As Restated.................... $ 29 $ 22 $ 46 $ 40 $ 51 $ 97 $ 137
===== ====== ====== ====== ====== ====== ======
Earnings Per Diluted Share:
As Reported.................... $0.12 $ 0.12 $ 0.21 $ 0.20 $ 0.25 $ 0.46 $ 0.66
Restatement Effect............. 0.01 (0.02) (0.02) (0.03) (0.03) (0.04) (0.06)
----- ------ ------ ------ ------ ------ ------
As Restated.................... $0.13 $ 0.10 $ 0.19 $ 0.17 $ 0.22 $ 0.42 $ 0.60
===== ====== ====== ====== ====== ====== ======
"As Reported" earnings / (loss) per diluted share prior to August 22, 2000
periods are adjusted to reflect the August 2000 two-for-one stock split and the
..69 exchange ratio in the February 2000 Illinova merger.
F-61
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
RESTATED SELECTED CASH FLOW DATA BY QUARTER
Three Six Nine Twelve
Months Months Months Months
Ended Ended Ended Ended
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
($ in millions)
2001
Operating Cash Flows:
As Reported......... $ 267 $ 364 $ 640 $ 811
Restatement Effect.. 9 5 (179) (261)
------- ----- ------- -------
As Restated......... $ 276 $ 369 $ 461 $ 550
======= ===== ======= =======
Investing Cash Flows:
As Reported......... $(1,166) $(541) $ (803) $(3,413)
Restatement Effect.. (127) (354) (605) (415)
------- ----- ------- -------
As Restated......... $(1,293) $(895) $(1,408) $(3,828)
======= ===== ======= =======
Financing Cash Flows:
As Reported......... $ 1,056 $ 607 $ 314 $ 2,734
Restatement Effect.. 132 364 798 716
------- ----- ------- -------
As Restated......... $ 1,188 $ 971 $ 1,112 $ 3,450
======= ===== ======= =======
2000
Operating Cash Flows:
As Reported......... $ 142 $ 349 $ 374 $ 438
Restatement Effect.. (20) (20) (20) (18)
------- ----- ------- -------
As Restated......... $ 122 $ 329 $ 354 $ 420
======= ===== ======= =======
Investing Cash Flows:
As Reported......... $ (679) $(814) $ (967) $(1,304)
Restatement Effect.. (8) (70) (120) (235)
------- ----- ------- -------
As Restated......... $ (687) $(884) $(1,087) $(1,539)
======= ===== ======= =======
Financing Cash Flows:
As Reported......... $ 494 $ 498 $ 645 $ 907
Restatement Effect.. 28 90 140 224
------- ----- ------- -------
As Restated......... $ 522 $ 588 $ 785 $ 1,131
======= ===== ======= =======
1999
Operating Cash Flows:
As Reported......... $ (11) $ 118 $ 96 $ 9
Restatement Effect.. (1) -- (3) 31
------- ----- ------- -------
As Restated......... $ (12) $ 118 $ 93 $ 40
======= ===== ======= =======
Investing Cash Flows:
As Reported......... $ (124) $(237) $ (384) $ (319)
Restatement Effect.. 1 -- (39) (72)
------- ----- ------- -------
As Restated......... $ (123) $(237) $ (423) $ (391)
======= ===== ======= =======
Financing Cash Flows:
As Reported......... $ 119 $ 118 $ 288 $ 327
Restatement Effect.. -- -- 39 72
------- ----- ------- -------
As Restated......... $ 119 $ 118 $ 327 $ 399
======= ===== ======= =======
F-62
DYNEGY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(RESTATED)
Note 19--SUBSEQUENT EVENTS
The Company has experienced a number of material developments since the
filing of its 2001 Form 10-K on March 13, 2002. These developments include,
among others, the following:
. the Company's previously announced exit from third-party risk management
aspects of the marketing and trading business, which business accounted
for approximately 84%, 74% and 66% of the Company's revenues and
approximately 26%, 33% and 34% of the Company's pre-tax earnings for the
years 2001, 2000 and 1999, respectively;
. the Company's previously announced organizational restructuring plan and
the related reductions in force affecting more than 1,000 employees;
. reductions in the Company's credit ratings to low non-investment grade
levels and the resulting increase in collateralization requirements and
financing costs and limitations on financial flexibility; and
. significant changes in senior management of the Company, including a new
Chief Executive Officer and a new Chief Financial Officer.
The Company also adopted the net presentation provisions of EITF 02-3 in the
third quarter 2002, which resulted in a 79 percent, 71 percent and 68 percent
reduction in revenues in each of 2001, 2000 and 1999, respectively. For further
description of these events, including Arthur Andersen advising the Company
that its 2001 audit opinion should not be relied upon and that such audit
opinion was withdrawn, please read the Company's Exchange Act reports filed
subsequent to the filing of the 2001 Form 10-K. This report does not reflect
events occurring after the original filing of the 2001 Form 10-K except to
reflect the restatement items described above and certain other matters. As a
result of these adverse developments, the results of operations and cash flows
covered by the unaudited restated financial statements in this report should
not be considered indicative of the Company's future results of operations or
cash flows.
For further discussion of the events that have affected the Company since
March 13, 2002, please read its Exchange Act reports filed since such date,
including its Annual Report on Form 10-K for the year ended December 31, 2002,
which discussion is incorporated herein by this reference.
F-63
DYNEGY INC. VALUATION AND QUALIFYING ACCOUNTS
(RESTATED)
Schedule II
Years Ended December 31, 2001, 2000, and 1999
Balance at Charged to Charged
Beginning Costs and to Other Balance at
of Period Expenses Accounts Deductions End of Period
---------- ---------- -------- ---------- -------------
2001
Allowance for doubtful accounts............. $ 69 $ 92 $(2) $(46) 113
Allowance for risk management assets/(1)(2)/ 146 102 -- -- 248
2000
Allowance for doubtful accounts............. 24 52 -- (7) 69
Allowance for risk management assets/(1)(2)/ 38 108 -- -- 146
1999
Allowance for doubtful accounts............. 24 3 -- (3) 24
Allowance for risk management assets/(1)(2)/ 6 32 -- -- 38
--------
/(1)/ Changes in price and credit reserves related to risk management
activities are offset in the net mark-to-market income accounts reported
in revenues.
/(2) /Amounts associated with model reserves, which are offset in the net
mark-to-market income accounts reported in revenue, have been adjusted to
reflect the correction in methodology discussed in Enterprise Risk
Management, Valuation and Monitoring--Valuation Criteria and Management
Estimates included in Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations.
F-64