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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2002
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 1-15659
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DYNEGY INC.
(Exact name of registrant as specified in its charter)
Illinois 74-2928353
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1000 Louisiana, Suite 5800
Houston, Texas 77002
(Address of principal executive offices)
(Zip Code)
(713) 507-6400
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: Class A Common Stock, no par value
per share, 274,476,836 shares outstanding as of November 12, 2002; Class B
Common Stock, no par value per share, 96,891,014 shares outstanding as of
November 12, 2002.
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DYNEGY INC.
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets:
September 30, 2002 and December 31, 2001........................... 3
Condensed Consolidated Statements of Operations:
For the three months ended September 30, 2002 and 2001............. 4
Condensed Consolidated Statements of Operations:
For the nine months ended September 30, 2002 and 2001.............. 5
Condensed Consolidated Statements of Cash Flows:
For the nine months ended September 30, 2002 and 2001.............. 6
Notes to Condensed Consolidated Financial Statements................... 7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................ 44
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..... 81
Item 4. CONTROLS AND PROCEDURES........................................ 81
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.............................................. 82
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................... 82
EXPLANATORY NOTE
This quarterly report includes financial statements which have not been
reviewed by an independent public accountant under Rule 10-01(d) of Regulation
S-X. We expect that our independent public accountant, PricewaterhouseCoopers
LLP, will complete the quarterly review required by Rule 10-01(d) of Regulation
S-X following their re-audit of our historical financial statements for the
three-year period ended December 31, 2001. The comparative financial
information contained in this report has been revised to reflect the known
effects of the restatement items described in Note 1 to the accompanying
Condensed Consolidated Financial Statements. In this regard, Arthur Andersen
LLP, our former independent public accountant, has advised that its audit
opinion relating to 2001 should no longer be relied upon and such audit opinion
was also withdrawn. Also, concurrent with the filing of this quarterly report,
Dynegy has filed a Current Report on Form 8-K that includes revised financial
statements for each of the years in the three-year period ended December 31,
2001. These revised financial statements have been prepared by management and
reflect all known restatement items to Dynegy's 2001, 2000 and 1999 financial
statements originally filed with its Annual Report on Form 10-K for the year
ended December 31, 2001. However, as a result of the three-year re-audit and
PricewaterhouseCoopers' subsequent review of Dynegy's 2002 quarterly financial
statements, it is possible that additional adjustments to the unaudited revised
financial statements in the Form 8-K and Dynegy's 2002 quarterly reports may
result, some of which could be material. Dynegy expects to file an amended Form
10-K reflecting the unaudited restatements described in the Form 8-K as soon as
practicable after the date of this report. Following completion of the
re-audit, which the Company expects will occur early in the first quarter 2003,
further amendment of the Form 10-K will be necessary in order to include the
audit report of PricewaterhouseCoopers LLP as well as to reflect other changes
resulting from the re-audit, if any.
2
DYNEGY INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
December 31,
September 30, 2001
2002 Unaudited
Unaudited Restated
------------- ------------
ASSETS
Current Assets
Cash and cash equivalents......................... $ 881 $ 218
Restricted cash................................... 189 --
Accounts receivable, net of allowance for
doubtful accounts of $114 million and $107
million, respectively............................ 3,108 3,688
Accounts receivable, affiliates................... 69 80
Inventory......................................... 211 258
Assets held for sale (Note 4)..................... 32 --
Assets from risk-management activities............ 4,142 4,399
Prepayments and other assets...................... 792 1,301
------- -------
Total Current Assets......................... 9,424 9,944
------- -------
Property, Plant and Equipment..................... 9,631 9,130
Accumulated depreciation.......................... (1,197) (921)
------- -------
Property, Plant and Equipment, Net........... 8,434 8,209
Other Assets
Unconsolidated investments (Note 7)............... 770 950
Investment in Northern Natural Gas Company (Note
4)............................................... -- 1,501
Assets held for sale (Note 4)..................... 644 --
Assets from risk-management activities............ 4,715 2,680
Goodwill.......................................... 404 1,579
Other assets...................................... 756 852
------- -------
Total Assets................................. $25,147 $25,715
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable.................................. $ 2,145 $ 2,392
Accounts payable, affiliates...................... 274 40
Accrued liabilities and other..................... 1,323 2,497
Liabilities from risk-management activities....... 4,025 3,805
Notes payable and current portion of long-term
debt............................................. 1,526 458
Liabilities held for sale (Note 4)................ 30 --
------- -------
Total Current Liabilities.................... 9,323 9,192
------- -------
Long-Term Debt.................................... 4,490 3,834
Other Liabilities
Transitional funding trust notes.................. 452 516
Liabilities held for sale (Note 4)................ 211 --
Liabilities from risk-management activities....... 4,141 2,196
Deferred income taxes............................. 1,328 1,768
Other long-term liabilities....................... 724 906
------- -------
Total Liabilities............................ 20,669 18,412
------- -------
Minority Interest................................. 150 1,020
Serial Preferred Securities of a Subsidiary....... 11 46
Company Obligated Preferred Securities of
Subsidiary Trust................................. 200 200
Series B Mandatorily Convertible Redeemable
Preferred Securities............................. 1,527 1,503
Commitments and Contingencies (Note 12)
Stockholders' Equity
Class A Common Stock, no par value, 900,000,000
shares authorized at September 30, 2002 and
December 31, 2001, 272,960,450 and 269,984,456
shares issued and outstanding at September 30,
2002 and December 31, 2001, respectively......... 2,855 2,814
Class B Common Stock, no par value, 360,000,000
shares authorized at September 30, 2002 and
December 31, 2001, 96,891,014 and 86,499,914
shares issued and outstanding at September 30,
2002 and December 31, 2001, respectively......... 1,006 801
Subscriptions receivable (Note 9)................. (13) (38)
Accumulated other comprehensive loss, net of tax.. (3) (21)
Retained earnings (accumulated deficit)........... (1,187) 1,049
Treasury stock, at cost, 1,679,183 shares at
September 30, 2002 and 1,766,800 shares at
December 31, 2001................................ (68) (71)
------- -------
Total Stockholders' Equity........................ 2,590 4,534
------- -------
Total Liabilities and Stockholders' Equity... $25,147 $25,715
======= =======
See the notes to condensed consolidated financial statements.
3
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
Three Months Ended
September 30,
------------------
2001
2002 Unaudited
Unaudited Restated
--------- ---------
Revenues (Note 2)........................................................ $ 1,720 $2,329
Cost of sales, exclusive of depreciation shown separately below (Note 2). 1,718 1,657
Depreciation and amortization............................................ 139 113
Goodwill impairment (Note 5)............................................. 908 --
General and administrative expenses...................................... 115 142
-------- ------
Operating income (loss)............................................... (1,160) 417
Earnings (losses) from unconsolidated investments (Note 7)............... (68) 104
Other income............................................................. 24 12
Interest expense......................................................... (100) (63)
Other expenses (Note 5).................................................. (93) (14)
Minority interest expense................................................ (2) (14)
Accumulated distributions associated with trust preferred securities..... (4) (6)
-------- ------
Income (loss) from continuing operations before income taxes............. (1,403) 436
Income tax provision (benefit)........................................... (154) 162
-------- ------
Income (loss) from continuing operations................................. (1,249) 274
Discontinued operations (Note 4):
Loss from discontinued operations (including loss on disposal of Northern
Natural of $586 million)............................................... (569) --
Income tax benefit....................................................... (14) --
-------- ------
Loss on discontinued operations.......................................... (555) --
-------- ------
Net Income (Loss)........................................................ $(1,804) $ 274
======== ======
Net Income (Loss) Per Share:
Net income (loss)........................................................ $(1,804) $ 274
Less: preferred stock dividends.......................................... 8 --
-------- ------
Net income (loss) applicable to common stockholders...................... $(1,812) $ 274
======== ======
Basic earnings (loss) per share:
Income (loss) from continuing operations.............................. $ (3.41) $ 0.84
Loss from discontinued operations..................................... (1.51) --
-------- ------
Basic earnings (loss) per share.......................................... $ (4.92) $ 0.84
======== ======
Diluted earnings (loss) per share (Note 10):
Income (loss) from continuing operations.............................. $ (3.41) $ 0.81
Loss from discontinued operations..................................... (1.51) --
-------- ------
Diluted earnings (loss) per share (Note 10).............................. $ (4.92) $ 0.81
======== ======
Basic shares outstanding................................................. 368 326
======== ======
Diluted shares outstanding............................................... 416 337
======== ======
See the notes to condensed consolidated financial statements.
4
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS--(Continued)
(in millions, except per share data)
Nine Months Ended
September 30,
------------------
2001
2002 Unaudited
Unaudited Restated
--------- ---------
Revenues (Note 2)....................................................................... $ 4,769 $7,323
Cost of sales, exclusive of depreciation shown separately below (Note 2)................ 4,089 5,863
Depreciation and amortization........................................................... 355 333
Goodwill impairment (Note 5)............................................................ 908 --
Impairment and other charges (Note 5)................................................... 319 --
General and administrative expenses..................................................... 353 383
------- ------
Operating income (loss).............................................................. (1,255) 744
Earnings (losses) from unconsolidated investments (Notes 5 and 7)....................... (86) 214
Other income............................................................................ 75 69
Interest expense........................................................................ (239) (192)
Other expenses (Note 5)................................................................. (128) (44)
Minority interest expense............................................................... (22) (45)
Accumulated distributions associated with trust preferred securities.................... (13) (18)
------- ------
Income (loss) from continuing operations before income taxes and change in accounting
principle............................................................................. (1,668) 728
Income tax provision (benefit).......................................................... (254) 278
------- ------
Income (loss) from continuing operations................................................ (1,414) 450
Discontinued operations (Note 4):
Loss from discontinued operations (including loss on disposal of Northern Natural of
$586 million)...................................................................... (511) --
Income tax provision................................................................. 6 --
------- ------
Loss on discontinued operations......................................................... (517) --
Cumulative effect of change in accounting principle, net (Notes 2 and 5)................ (234) 2
------- ------
Net Income (Loss)....................................................................... $(2,165) $ 452
======= ======
Net Income (Loss) Per Share:
Net income (loss)....................................................................... $(2,165) $ 452
Less: preferred stock dividends......................................................... 24 --
------- ------
Net income (loss) applicable to common stockholders..................................... $(2,189) $ 452
======= ======
Basic earnings (loss) per share:
Income (loss) from continuing operations............................................. $ (3.94) $ 1.38
Loss from discontinued operations.................................................... (1.42) --
Cumulative effect of change in accounting principle, net............................. (0.64) 0.01
------- ------
Basic earnings (loss) per share......................................................... $ (6.00) $ 1.39
======= ======
Diluted earnings (loss) per share (Note 10):
Income (loss) from continuing operations............................................. $ (3.94) $ 1.33
Loss from discontinued operations.................................................... (1.42) --
Cumulative effect of change in accounting principle, net............................. (0.64) 0.01
------- ------
Diluted earnings (loss) per share (Note 10)............................................. $ (6.00) $ 1.34
======= ======
Basic shares outstanding................................................................ 365 325
======= ======
Diluted shares outstanding.............................................................. 416 338
======= ======
See the notes to condensed consolidated financial statements.
5
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Interim Periods Ended September 30, 2002 and 2001
(in millions)
Nine Months
Ended September 30,
------------------
2001
2002 Unaudited
Unaudited Restated
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)...................................................................... $(2,165) $ 452
Items not affecting cash flows from operating activities:
Depreciation and amortization....................................................... 426 328
Goodwill impairment (Note 5)........................................................ 908 --
Impairment and other charges........................................................ 323 --
(Earnings) losses from unconsolidated investments, net of cash distributions........ 160 (184)
Risk-management activities.......................................................... 444 (76)
Deferred income taxes............................................................... (242) 177
Loss on sale of Northern Natural (Note 4)........................................... 586 --
Cumulative effect of change in accounting principle (Notes 2 and 6)................. 234 (2)
Other............................................................................... 61 (13)
------- -------
Operating cash flows before changes in working capital................................. 735 682
Changes in working capital:
Accounts receivable................................................................. 502 1,414
Inventory........................................................................... (1) 170
Prepayments and other assets (includes $270 million cash collateral postings in the
2002 period)...................................................................... (317) (159)
Accounts payable and accrued liabilities............................................ (543) (1,699)
Other, net.......................................................................... (115) 44
------- -------
Net cash provided by operating activities.............................................. 261 452
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................................................... (736) (1,593)
Unconsolidated investments............................................................. (12) (52)
Business acquisitions, net of cash acquired............................................ (20) (21)
Proceeds from asset sales.............................................................. 1,105 1,051
Other investing, net................................................................... 75 (237)
------- -------
Net cash provided by (used in) investing activities.................................... 412 (852)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from long-term borrowings................................................. 532 855
Repayments of long-term borrowings..................................................... (571) (251)
Net proceeds from short-term borrowings................................................ 437 --
Net cash flow from commercial paper and revolving lines of credit...................... (303) 38
Proceeds from sale of capital stock, options and warrants.............................. 240 57
Purchase of serial preferred securities of a subsidiary................................ (28) --
Purchase of treasury stock............................................................. (1) (59)
Dividends and other distributions, net................................................. (55) (74)
Increase in restricted cash............................................................ (189) --
Other financing, net................................................................... (14) (18)
------- -------
Net cash provided by financing activities.............................................. 48 548
------- -------
Effect of exchange rate changes on cash................................................ (58) 3
Net increase in cash and cash equivalents.............................................. 663 151
Cash and cash equivalents, beginning of period......................................... 218 86
------- -------
Cash and cash equivalents, end of period............................................... $ 881 $ 237
======= =======
See the notes to condensed consolidated financial statements.
6
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 2002 and 2001
Note 1--Restatements
This Quarterly Report on Form 10-Q of Dynegy Inc. ("Dynegy" or the
"Company") gives effect to the unaudited restatements of the Company's
consolidated financial statements as of December 31, 2001 and for the three-
and nine-month periods ended September 30, 2002 and 2001, respectively.
Concurrent with the filing of this Form 10-Q, Dynegy has filed a Current Report
on Form 8-K that includes unaudited restated financial statements for each of
the three years in the period ended December 31, 2001. The restatements herein
and therein relate to the Project Alpha structured natural gas transaction, a
balance sheet reconciliation project relating principally to the Company's
natural gas marketing business, adjustments relating to a change in the
accounting for certain contracts from hedge accounting to mark-to-market
accounting under Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended
("Statement No. 133"), and an overstatement of the valuation used in the
Company's 2000 acquisition of Extant, Inc. 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 decided to present the cash flow
associated with the related gas supply contract as a financing activity in its
Consolidated Statements of Cash Flows for 2001. The effect of this decision was
to reclassify approximately $180 million of previously disclosed operating cash
flow to financing cash flow for the nine-month period ended September 30, 2001.
Following the disclosure in the Alpha Form 8-K and in connection with a further
review of Project Alpha, Arthur Andersen ("Andersen") informed the Company that
it could no longer support its tax opinion relating to the transaction.
Andersen's change in position was based in part on its conclusion that the
reclassification of cash flow from operations to cash flow from financing
lessened the factual basis for the opinion. Dynegy's financial statement
recognition of the tax benefit in 2001 was based principally on the Company's
assessment of the relevant issues, as corroborated by Andersen's tax opinion.
After the withdrawal of Andersen's tax opinion, management concluded that
sufficient support to include the income tax benefit for financial statement
presentation purposes no longer existed, the effect of which was a reversal of
the annual tax benefit previously recognized by the Company during the 2001
period. This decision resulted in the reversal of $36 million and $63 million,
respectively, of tax benefit previously reported for the three- and nine-month
periods ended September 30, 2001. Andersen further advised the Company that its
audit opinion relating to 2001 should no longer be relied upon as a result of
the pending restatements relating to Project Alpha and such audit opinion was
also withdrawn. Dynegy subsequently concluded that its restated consolidated
financial statements should 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. Such compilations
have not been audited and may change upon further assessment by Dynegy. The
most significant impact of consolidating ABG is to increase Dynegy's
consolidated indebtedness by approximately $280 million and $270 million at
December 31, 2001 and September 30, 2002, respectively.
7
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Balance Sheet Reconciliation Project. Dynegy originally reported 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. The original $80
million charge has been excluded from net income for the nine-months ended
September 30, 2002. The table below reflects the impact on net income of the
re-allocation of the $80 million charge from the second quarter 2002 back to
the periods in which the transactions giving rise to the charge originally
occurred (in millions).
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,
--------- -------- ------------- ------------ -------- ------------- ------------
1998 and prior..... (34)
1999............... (4)
2000............... 1 5 2 (25) 6 8 (17)
2001............... 11 (69) 22 6 (58) (36) (30)
2002............... 4 1 -- -- 5 5 5
---
Total Re-allocation (80)
===
Changes in Accounting Classification Under Statement No. 133. 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 the periodic assessment of hedge effectiveness, was inadequate to
support the accounting method previously applied. The resulting restatement
reflects the accounting for these contracts on a mark-to-market basis rather
than on the deferred basis previously employed beginning in the first quarter
2001. The impact of the change in accounting method for these contracts
increased previously reported net income for the three-month period ended
September 30, 2001 by $1 million and reduced previously reported net income
from the nine-month period ended September 30, 2001 by $21 million. The impact
of the change in accounting method for these contracts reduced reported net
income for the nine-month period ended September 30, 2002 by $3 million. The
change in accounting method employed had no impact on previously reported cash
flows from operations in any period.
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. As a result, the
purchase price allocated to the assets acquired and liabilities assumed in the
purchase was overstated by $23 million in 2000. This error resulted in an
overstatement of the amortization of goodwill acquired in the transaction
during 2000 and 2001. The resulting restatement reflects an increase in net
income in the three- and nine-month periods ended September 30, 2001 by
approximately $300,000 and $900,000, 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."
8
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Following is a synopsis of the financial impact of these restatements on the
condensed consolidated financial statements for the periods indicated (in
millions, except per share data):
December 31,
2001
------------
(unaudited)
Balance Sheet:
Current Assets:
As Reported.......... $ 9,730
Restatement Effect... 214
-------
As Restated.......... $ 9,944
=======
Total Assets:
As Reported.......... $25,175
Restatement Effect... 540
-------
As Restated.......... $25,715
=======
Current Liabilities:
As Reported.......... $ 8,869
Restatement Effect... 323
-------
As Restated.......... $ 9,192
=======
Total Liabilities:
As Reported.......... $17,709
Restatement Effect... 703
-------
As Restated.......... $18,412
=======
Stockholders' Equity:
As Reported.......... $ 4,707
Restatement Effect... (173)
-------
As Restated.......... $ 4,534
=======
Three Months Nine Months
Ended Ended
September 30, September 30,
2001 2001
------------- -------------
Statement of Operations:
Net Income (Loss):
As Reported................... $ 286 $ 571
Restatement Effect............ (12) (119)
------ ------
As Restated................... $ 274 $ 452
====== ======
Diluted Earnings (Loss) Per Share:
As Reported................... $ 0.85 $ 1.69
Restatement Effect............ (0.04) (0.35)
------ ------
As Restated................... $ 0.81 $ 1.34
====== ======
Statements of Cash Flows:
Operating Cash Flows:
As Reported................... $ 634
Restatement Effect............ (182)
------
As Restated................... $ 452
======
Investing Cash Flows:
As Reported................... $ (852)
Restatement Effect............ --
------
As Restated................... $ (852)
======
Financing Cash Flows:
As Reported................... $ 366
Restatement Effect............ 182
------
As Restated................... $ 548
======
9
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Note 2--Accounting Policies
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions to interim financial
reporting as prescribed by the SEC, except that they have not been reviewed by
an independent public accountant under Rule 10-01(d) of Regulation S-X. These
interim financial statements should be read in conjunction with the unaudited
restated consolidated financial statements and notes thereto included in the
Company's Current Report on Form 8-K dated November 14, 2002, which includes
unaudited restated financial statements for 1999-2001 reflecting the known
revisions described in Note 1 above (the "Restatement Form 8-K").
The financial statements contained in this quarterly report include all
material adjustments that, in the opinion of management, are necessary for a
fair presentation of the results for the interim periods. Interim period
results are not necessarily indicative of the results for the full year. The
preparation of the condensed consolidated financial statements in conformity
with generally accepted accounting principles requires management to develop
estimates and make assumptions that affect reported financial position and
results of operations and that impact the nature and extent of disclosure, if
any, of contingent assets and liabilities. The Company reviews significant
estimates affecting its consolidated financial statements on a recurring basis
and records the effect of any necessary adjustments prior to their publication.
Judgments and estimates are based on the Company's beliefs and assumptions
derived from information available at the time such judgments and estimates are
made. Adjustments made with respect to the use of these estimates often relate
to information not previously available. Uncertainties with respect to such
estimates and assumptions are inherent in the preparation of financial
statements. Estimates are primarily used in (1) developing fair value
assumptions, including estimates of future cash flows and discount rates, (2)
analyzing tangible and intangible assets for impairment and (3) determining the
amounts to accrue related to contingencies. Actual results could differ
materially from any such estimates. Certain reclassifications have been made to
prior period amounts in order to conform to current year presentation.
Change in Accounting Principle. EITF Issue 98-10. In October 2002, the
Emerging Issues Task Force ("EITF" or "Task Force") reached a consensus to
rescind EITF Issue 98-10, "Accounting for Contracts Involved in Energy Trading
and Risk Management Activities" ("EITF Issue 98-10"). As such, all new energy
trading contracts entered into after October 25, 2002 that do not qualify as
derivatives under Statement No. 133 will not be accounted for using mark to
market accounting. All derivative contracts will continue to be accounted for
in accordance with Statement No. 133. With the rescission of this standard,
Dynegy will no longer record trading inventories at fair market value. The
effective date for the full rescission of EITF Issue 98-10 will be January 1,
2003. The effect of the rescission of EITF Issue 98-10 will be reported as the
cumulative effect of a change in accounting principle at the time of adoption;
however, the impact is not currently known.
Accounting Principles Adopted. EITF Issue 02-3. In June 2002, the Task
Force reached consensus on two of three issues presented in EITF Issue 02-3,
"Accounting for Contracts Involved in Energy Trading and Risk Management
Activities" ("EITF Issue 02-3"). First, the Task Force concluded that all
mark-to-market gains and losses on energy trading contracts (whether realized
or unrealized) should be shown net in the income statement, irrespective of
whether the contract is physically or financially settled. Beginning in the
third quarter 2002, Dynegy is presenting all mark-to-market gains and losses on
a net basis to reflect this change in accounting principle. In accordance with
the transition provisions in the consensus, comparative period financial
statements have been conformed to reflect this change in accounting principle.
Dynegy has historically classified net unrealized gains and losses from energy
trading contracts as revenue in its consolidated statement of operations.
Transactions that were realized and settled were previously reflected gross in
revenues and cost of sales. This
10
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
change in accounting classification has no impact on operating income, net
income, earnings per share or cash flow from operations.
The following table reconciles the revenues and costs of sales as previously
reported to the restated amounts herein (in millions):
Three Months Nine Months
Ended Ended
September 30, 2001 September 30, 2001
------------------ ------------------
Revenues as previously reported..... $ 8,519 $ 33,499
Restatements (see Note 1)........... 32 (32)
------- --------
Adjusted revenues................... 8,551 33,467
Change in accounting principle...... (6,222) (26,144)
------- --------
Revenues as reported herein......... $ 2,329 $ 7,323
======= ========
Cost of sales as previously reported $ 7,886 $ 31,952
Restatements (see Note 1)........... (7) 55
------- --------
Adjusted cost of sales.............. 7,879 32,007
Change in accounting principle...... (6,222) (26,144)
------- --------
Cost of sales as reported herein.... $ 1,657 $ 5,863
======= ========
The second consensus reached by the Task Force in June 2002 related to
required disclosures regarding energy trading operations. However, in October
2002, the Task Force rescinded its earlier consensus. With the rescission of
EITF Issue 98-10, as discussed above, the additional disclosures previously
called for under EITF Issue 02-3 are no longer applicable.
The third issue addressed by the Task Force in EITF Issue 02-3 deals with
the recognition of unrealized gains and losses at inception of an energy
trading contract (commonly referred to as dealer profit). The Task Force did
not reach a consensus on this issue in October 2002.
Finally, it is unclear whether the scope of future activities will include a
comprehensive conclusion regarding the appropriateness of the use of models as
a fundamental method for valuing transactions when market quotations are
unavailable. Should the Task Force issue definitive guidance on one or more of
these issues, such guidance may impact Dynegy. However, the extent of the
financial impact to Dynegy, if any, cannot be predicted with any degree of
certainty until the scope of the Task Force's conclusion is known and the
transition alternative is determined. If the Task Force prefers a retroactive
or a cumulative effect transition alternative, then Dynegy's historical
financial position and results of operations will be impacted negatively. If
the Task Force prefers a prospective transition alternative, then Dynegy's
current financial position will be unaffected and the impact to future
operations is not expected to be material as a result of the Company's decision
to exit third party risk management aspects of the marketing and trading
business. Please see Note 4 for further discussion.
FASB Statement No. 142. In July 2001, the FASB issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("Statement No. 142"). Statement No. 142 discontinued goodwill amortization
over its estimated useful life and provided that goodwill is subject to at
least an annual fair-value based impairment test. The Company adopted Statement
No. 142 effective January 1, 2002. The
11
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
estimation of fair value is highly subjective, inherently imprecise and can
change materially from period to period based on, among other things, an
assessment of market conditions, projected cash flows and discount rate.
Accordingly, if conditions change in the future, the Company may record further
impairment losses. On an annual basis, absent any impairment indicators, the
Company expects to perform its annual impairment analysis in the fourth quarter
after the annual budgetary process. The changes in the carrying amount of
goodwill for each of Dynegy's reportable business segments for the nine-month
period ended September 30, 2002 are as follows (in millions):
Wholesale Dynegy Transmission Dynegy
Energy Midstream & Global
Network Services Distribution Communications Total
--------- --------- ------------ -------------- ------
Balances as of January 1, 2002........... $ 940 $16 $ 389 $ 234 $1,579
Cumulative effect of change in accounting
principle (see Note 5)................. -- -- -- (234) (234)
Goodwill acquired during the period (see
Note 4)................................ -- -- 887 -- 887
Purchase price adjustments............... (32) -- (28) -- (60)
Goodwill impaired during the period (see
Note 5)................................ (908) -- -- -- (908)
Sale of Canadian crude business.......... -- (1) -- -- (1)
Sale of Northern Natural Gas Company (see
Note 4)................................ -- -- (859) -- (859)
----- --- ----- ----- ------
Balances as of September 30, 2002........ $ -- $15 $ 389 $ -- $ 404
===== === ===== ===== ======
The purchase price adjustments relate to the United Kingdom natural gas
storage assets purchased in late 2001 and to the acquisition of Northern
Natural Gas Company ("Northern Natural") in early 2002, each of which was sold
within one year. Please see Note 4 for further discussion.
12
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
The following table sets forth what Dynegy's net income and earnings per
share ("EPS") would have been in the three- and nine-month periods ended
September 30, 2001 if goodwill had not been amortized during those periods,
compared to the net loss and loss per share Dynegy recorded for the three- and
nine-month periods ended September 30, 2002 (in millions, except per share
data).
Three Months Nine Months
Ended September 30, Ended September 30,
------------------ ------------------
2002 2001 2002 2001
------- ------- ------- -------
Net income (loss) as previously reported.......... $(1,804) $ 286 $(2,165) $ 571
Restatements (see Note 1)......................... -- (12) -- (119)
------- ------- ------- -------
Restated net income............................... (1,804) 274 (2,165) 452
Add back: Goodwill amortization................... -- 12 -- 36
------- ------- ------- -------
Adjusted net income (loss)........................ $(1,804) $ 286 $(2,165) $ 488
Less: preferred stock dividends................... 8 -- 24 --
------- ------- ------- -------
Net income (loss) available to common stockholders $(1,812) $ 286 $(2,189) $ 488
======= ======= ======= =======
Basic EPS:
Net income (loss) as previously reported.......... $ (4.92) $ 0.88 $ (6.00) $ 1.74
Restatements (see Note 1)......................... -- (0.04) -- (0.37)
------- ------- ------- -------
Restated net income (loss)........................ (4.92) 0.84 (6.00) 1.37
Goodwill amortization............................. -- 0.04 -- 0.11
------- ------- ------- -------
Adjusted net income (loss)........................ $ (4.92) $ 0.88 $ (6.00) $ 1.48
======= ======= ======= =======
Diluted EPS:
Net income (loss) as previously reported.......... $ (4.92) $ 0.85 $ (6.00) $ 1.69
Restatements (see Note 1)......................... -- (0.04) -- (0.35)
------- ------- ------- -------
Restated net income (loss)........................ (4.92) 0.81 (6.00) 1.34
Goodwill amortization............................. -- 0.04 -- 0.11
------- ------- ------- -------
Adjusted net income (loss)........................ $ (4.92) $ 0.85 $ (6.00) $ 1.45
======= ======= ======= =======
FASB Statement No. 144. In August 2001, the FASB issued Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("Statement No. 144"). Statement No. 144
addresses the accounting and reporting for the impairment or disposal of
long-lived assets and supersedes FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
and APB Opinion No. 30, "Reporting the Results of Operations--Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." The Company's adoption of
Statement No. 144 on January 1, 2002 did not have any impact on its financial
position, results of operations or cash flows. However, see Note 4 below
regarding the Company's treatment of assets held for sale at September 30,
2002, and see Note 5 below regarding the impairment of the telecommunications
business in the second quarter 2002.
Accounting Principles Not Yet Adopted. FASB Statement No. 143. Also during
2001, the FASB issued Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations" ("Statement No. 143"). Statement
No. 143 requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred with the
associated asset retirement costs being capitalized as a part of the carrying
amount of the long-lived asset. The Company is evaluating the future financial
effects of adopting Statement No. 143 and will adopt the standard effective
January 1, 2003.
13
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
FASB Statement No. 146. In July 2002, the FASB issued Statement of
Financial Accounting Standards No. 146, "Accounting for Exit or Disposal
Activities" ("Statement No. 146"). Statement No. 146 addresses issues regarding
the recognition, measurement and reporting of costs that are associated with
exit and disposal activities, including restructuring activities that are
currently accounted for pursuant to the guidance that the EITF has set forth in
EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." The scope of Statement No. 146 also includes (1) costs
related to terminating a contract that is not a capital lease and
(2) termination benefits that employees who are involuntarily terminated
receive under the terms of a one-time benefit arrangement that is not an
ongoing benefit arrangement or an individual deferred compensation contract.
Statement No. 146 will be effective for exit or disposal activities that are
initiated after December 31, 2002, although early adoption of the standard is
encouraged. The Company is evaluating the impact of this standard on its
current restructuring initiative and will apply provisions of the standard
accordingly.
Note 3--Liquidity and Industry Conditions
Dynegy believes its current liquidity position should be sufficient to
permit the Company to meet its debt maturities and other obligations through
the first quarter 2003. The sufficiency of the Company's liquidity will depend
upon:
. Dynegy's continued compliance with the covenants in its bank credit and
other debt instruments or its ability to negotiate waivers in the event
of a covenant default;
. Dynegy's ability to repay or refinance the Dynegy Holdings Inc. ("DHI")
and Illinois Power Company ("IP") credit facilities that mature in the
second quarter 2003;
. Dynegy's ability to manage its exit from third party risk management
aspects of the marketing and trading business and the timing of the
expected cash flows and reduction in collateral from this exit;
. the level of earnings and cash flow from Dynegy's assets and businesses,
which is subject to the effect of changes in commodity prices,
particularly natural gas and power;
. Dynegy's non-investment grade credit ratings, the effect of these ratings
on Dynegy's ability to access capital markets and to conduct normal
commercial operations and the effect of any further downgrade in these
credit ratings on refinancings;
. ongoing investigations and litigation relating to Project Alpha, Dynegy's
trading practices and its activities in the California power markets;
. confidence in Dynegy's financial reporting in light of the previously
announced restatements and the ongoing re-audit of its 1999-2001
financial statements; and
. Dynegy's ability to eliminate or further reduce net cash outflows
associated with its telecommunications business.
Dynegy's liquidity may be significantly adversely affected if it is unable
to refinance the DHI and IP credit facilities that mature in the second quarter
2003. Dynegy also faces the risk of a covenant default on these facilities or
other debt instruments prior to maturity. The DHI and IP credit facilities and
the Company's telecommunications lease financing contain various covenants,
including EBITDA-to-interest and debt-to-capitalization financial covenants.
The Company was in compliance with the covenants in its credit facilities and
other debt instruments at September 30, 2002. While many of the charges
incurred by the Company during 2002
14
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
are excluded from the compliance calculations, continued weakness in the
Company's operating results compared with results in 2001 will make it more
difficult for the Company to continue to comply with certain of its financial
covenants. Compliance with these financial covenants is measured on a quarterly
basis.
Any failure to satisfy one or more of these financial covenants would
constitute a breach giving rise to a default under the applicable debt
instrument and would permit the lenders under such debt instrument to
accelerate the maturity of Dynegy's outstanding obligations thereunder.
Depending upon the particular debt instrument, such a breach or any action by
the lenders to accelerate the maturity of amounts owing would result in a
default under or trigger cross-acceleration provisions in a significant portion
of the Company's other outstanding debt instruments. In the event of
non-compliance, Dynegy would seek waivers from the lenders under these debt
instruments or attempt to repay or refinance the affected debt instruments. The
Company cannot provide any assurance that it could repay, obtain waivers with
respect to or refinance such debt instruments in the event of any such default.
Dynegy has executed on the principal elements of its capital plan in order
to meet its current obligations as they mature and provide the necessary
collateral to support its commercial operations. Dynegy believes that the
combination of its liquidity initiatives and the roll off of collateral and
cash flow from its exit from third party risk management aspects of the
marketing and trading business should enable the Company to refinance all or a
sufficient portion of its second quarter 2003 maturities. However, the Company
faces significant risks related to its ongoing operations and other matters
discussed above. Dynegy also faces the risk that it may not be able to reach
agreement with its lenders on mutually acceptable terms. If Dynegy fails to
execute the remaining elements of its strategy, it may be forced to consider
other strategic alternatives including a possible reorganization under the
protection of federal bankruptcy laws.
The accompanying unaudited condensed consolidated financial statements have
been prepared assuming that the Company will continue as a going concern. This
basis of accounting contemplates the recovery of the Company's assets and the
satisfaction of its liabilities in the normal course of conducting business,
which in turn is subject to the risks and contingencies discussed above.
Management believes that actions presently being taken relative to the
Company's capital plan, its revolving credit facilities and other strategic
alternatives should enable the Company to meet its obligations in a manner
consistent with this accounting treatment.
Note 4--Acquisitions and Dispositions
Northern Natural Gas. In November 2001, Dynegy acquired 1,000 shares of
Series A Preferred Stock ("Series A Preferred Stock") in Northern Natural for
$1.5 billion. DHI, a wholly owned subsidiary of Dynegy, concurrently acquired
an option to purchase all of the equity of Northern Natural's indirect parent
company. DHI exercised its option to acquire the indirect parent of Northern
Natural in November 2001 upon termination of Dynegy's merger agreement with
Enron Corp. ("Enron"), and the closing of the option exercise occurred on
January 31, 2002.
On August 16, 2002, Dynegy sold Northern Natural to MidAmerican for $928
million in cash, subject to adjustment for changes in working capital. Under
the terms of this agreement, MidAmerican acquired all of the common and
preferred stock of Northern Natural and assumed all of Northern Natural's $950
million of debt, which debt had a book value of approximately $890 million.
Dynegy incurred a pre-tax loss of $586 million ($566 million after-tax)
associated with the sale. Subject to resolution of the working capital
adjustments relating to the sale, Dynegy could incur an additional loss in the
fourth quarter 2002.
15
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
On September 30, 2002, DHI sold $90 million in 6.875 percent senior notes of
Northern Natural due May 2005 for approximately $96 million in cash. DHI
acquired the notes at par value in April 2002 pursuant to a tender offer that
it agreed to effect in order to obtain a bondholder consent in connection with
the acquisition of Northern Natural. The gain on sale of approximately $4
million is reflected in Other Income and is net of accrued interest.
As a result of the disposition during the quarter, Northern Natural is
reported as a discontinued operation in the accompanying financial statements
and these notes. Revenues from Northern Natural were $30 million and $201
million, respectively, for the three- and nine-month periods ended September
30, 2002. Income before taxes was zero and $38 million for the three- and
nine-month periods ended September 30, 2002.
Illinois Power Transmission. On October 9, 2002, IP announced that it
agreed to sell its high-voltage electric transmission system to Trans-Elect
Inc., an independent transmission company, for $239 million. The sale is
expected to close in the first half of 2003 and is subject to customary closing
conditions, including required approvals from the SEC, the Federal Trade
Commission, the Illinois Commerce Commission and the FERC. With respect to the
FERC, the sale is conditioned on its approving the levelized rates application
to be filed by Trans-Elect seeking a 13% return on equity. If the FERC does not
approve levelized rates in substantially the form sought by Trans-Elect, then
Trans-Elect is not obligated to close on the sale. The purchase price also is
subject to adjustment with respect to certain items, including a final
determination of the transmission assets to be sold, any variance in the
assumed amount of inventory on hand and the amount of accounts payable at
closing. A change in interest rates from those estimated by Trans-Elect in
contemplating its financing for the sale also could cause an adjustment to the
purchase price or postponement of the closing, at IP's option. The pre-tax gain
on the sale, which will be recorded at closing, is estimated to be
approximately $47 million. In addition, as a result of the sale, IP expects to
accelerate approximately $90 million of regulatory asset amortization.
Marketing & Trading. In October 2002, the Company announced it would exit
third party risk management aspects of the marketing and trading business. The
decision to exit this business is expected to reduce significantly the
Company's collateral requirements and overall corporate expenses. The Company
expects to complete a significant portion of this exit over the next three to
six months. During this period and thereafter, the Company will maintain the
resources and make the necessary arrangements to meet its customer commitments,
including retaining personnel and risk management capabilities. This decision
to exit third party risk management aspects of the marketing and trading
business will not change the commercial activities of Dynegy's midstream or
generation businesses. The midstream business will continue to manage commodity
price risk associated with its operations related to fuel procurement and to
market natural gas and natural gas liquids. Further, the generation business
will continue to manage commodity price risk existing in its physical asset
positions through optimizing fuel procurement and to market power from these
assets.
Canadian Gas Marketing. On October 17, 2002, Dynegy entered into a letter
of intent to sell a portion of its Canadian natural gas marketing business to
The Seminole Group Inc. The sale is expected to close in November 2002, subject
to regulatory approvals and other customary closing conditions. Any loss on the
sale is expected to be less than $10 million and will be recorded upon
consummation of the sale. The remaining Canadian business will consist
primarily of existing power marketing positions and physical gas in storage.
United Kingdom Storage. On September 30, 2002, the Company sold a
subsidiary that owned the Hornsea onshore natural gas storage facility in the
United Kingdom for net cash proceeds of approximately $189 million. No gain or
loss was recognized on the transaction. On November 14, 2002, the Company sold
the subsidiaries that owned the Rough offshore natural gas field in the North
Sea and the Easington natural gas processing
16
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
terminal on the East Yorkshire coast for cash proceeds of approximately $500
million. The Company does not expect to recognize a material gain or loss on
this transaction. The results of operations for the United Kingdom storage
business are included within discontinued operations in the accompanying
Condensed Consolidated Statements of Operations. Revenues from the United
Kingdom storage business were $47 million and $128 million, respectively, for
the three- and nine-month periods ended September 30, 2002. Income before taxes
was $17 million and $37 million, respectively, for the three- and nine-month
periods ended September 30, 2002. Additionally, at September 30, 2002, the
Rough and Easington assets were classified as held for sale in accordance with
Statement No. 144. The major classes of assets and liabilities classified as
"Assets Held for Sale" or "Liabilities Held for Sale" in the accompanying
September 30, 2002 Condensed Consolidated Balance Sheet are as follows (in
millions):
September 30,
2002
-------------
Current Assets:
Accounts receivable............... $ 13
Inventory......................... 15
Other............................. 4
----
Total Current Assets........... 32
====
Other Assets:
Property, plant and equipment, net 638
Other............................. 6
----
Total Other Assets............. 644
----
Total Assets................... $676
====
Current Liabilities............... $ 30
Other Liabilities:
Deferred taxes.................... 133
Other............................. 78
----
Total Other Liabilities........ 211
----
Total Liabilities.............. $241
====
Note 5--Restructuring and Impairment Charges
In the first quarter 2002, the Company recognized a $234 million pre-tax
charge to write-down goodwill in its telecommunications business in connection
with the adoption of Statement No. 142 and reflected such charge as a
cumulative effect of a change in accounting principle. As there was no tax
basis in this goodwill, $234 million represents the pre-tax and after-tax
impact on earnings. The Company also recorded pre-tax charges of $64 million
($42 million after-tax) primarily related to its investment in the
telecommunications business.
During the second quarter 2002, the Company recognized a $375 million
pre-tax ($244 million after-tax) charge principally related to the impairment,
write-off or obsolescence of certain assets and an accrual for severance
related to a corporate restructuring. The charge primarily relates to the
impairment of the Company's investment in the telecommunications business, the
impairment of investments in securities of entities engaged in
technology-related ventures and a severance charge related to the corporate
restructuring.
During the third quarter 2002, the Company recognized a $1,873 million
pre-tax ($1,752 million after-tax) charge principally related to the impairment
of goodwill associated with the Company's Wholesale Energy Network ("WEN")
segment, a loss on the sale of Northern Natural, the recognition of a liquidity
reserve relating to the Company's marketing and trading portfolio, an
impairment of investments in generating facilities and the write-off of other
obsolete assets.
17
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
The pre-tax charges consisted of the following for the periods ended
September 30, 2002 (in millions):
Three Months Nine Months
Ended Ended
September 30, September 30,
2002 2002
------------- -------------
Impairment of goodwill............................. $ 908 $ 908
Loss on sale of Northern Natural................... 586 586
Cumulative effect of change in accounting principle -- 234
Impairment of telecommunications business.......... -- 305
Liquidity reserve.................................. 223 223
Impairment of generation investments............... 90 90
Impairment of technology investments............... 12 97
Severance charge................................... -- 37
Enron settlement................................... 25 25
Write-off of other obsolete assets................. 29 41
------ ------
$1,873 $2,546
====== ======
Impairment of goodwill. The value of goodwill associated with the WEN
segment was reviewed for impairment at September 30, 2002. Based on this
assessment, an after-tax charge to earnings of $908 million was recorded to
impair substantially all of the goodwill associated with the WEN segment. The
fair value of WEN consists of value associated with marketing and trading as
well as the value associated with power generation. The fair values of the
respective components were estimated utilizing the expected discounted future
cash flows. The primary factors leading to this impairment are: (1) the
reduction in near-term power prices, (2) an increase in the rate of return
required for investors to enter the energy merchant sector and (3) the
Company's decision to exit third party risk management aspects of the marketing
and trading business. The charge was recorded in Goodwill Impairment in the
accompanying Condensed Consolidated Statement of Operations.
Loss on Sale of Northern Natural. On August 16, 2002, Dynegy sold Northern
Natural to MidAmerican for $928 million in cash, subject to adjustment for
changes in working capital. MidAmerican acquired all of the common and
preferred stock of Northern Natural and assumed all of Northern Natural's $950
million of debt, which debt had a book value of approximately $890 million.
Dynegy incurred a pre-tax loss of $586 million ($566 million after-tax)
associated with the sale. This charge is recorded in Discontinued Operations in
the accompanying Condensed Consolidated Statement of Operations.
For federal income tax purposes, the sale resulted in a capital loss, which
may be deducted solely against capital gains, if any, realized by the
enterprise in its consolidated federal tax returns. There is a five-year
carryforward for capital losses under existing federal statutes. For financial
reporting purposes, the Company recorded a valuation allowance against
substantially all of the potential tax benefit as a result of uncertainty of
realization.
Cumulative effect of change in accounting principle. During the first
quarter 2002, the Company recognized a $234 million charge to impair goodwill
related to its Dynegy Global Communications ("DGC") segment in accordance with
Statement No. 142 and reflected such charge as a cumulative effect of a change
in accounting principle. The fair value of that reporting segment was estimated
using the expected present value of future cash flows. The value was negatively
impacted by continued weakness in the telecommunications and broadband markets.
This charge is reflected as a Cumulative Effect of Change in Accounting
Principle in the accompanying Condensed Consolidated Statement of Operations.
18
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Impairment of telecommunications business. During the second quarter 2002,
prospects for the telecommunications sector continued to deteriorate as
evidenced by an increased number of bankruptcies in the sector, continued
devaluation of debt and equity securities, a lack of financing sources and
further pricing pressures resulting from challenges faced by major industry
participants. As a result of this deterioration, a continuing negative outlook
for the industry and Dynegy's desire to improve its own liquidity, management
began to take measures to reduce cash losses in the business, including
reducing capital spending and lowering operating and administrative expenses.
Management is pursuing partnership and sale opportunities for this business
segment, although no formal plans are currently in place.
Dynegy's impairment analysis at June 30, 2002, calculated in accordance with
the guidelines set forth in Statement No. 144, indicated future cash flows from
DGC's operations were insufficient to cover the carrying value of that
segment's long-lived assets. As a result, a pre-tax non-cash impairment charge
totaling $286 million ($186 million after-tax) was recorded in the second
quarter 2002 in Impairment and Other Charges. For the nine-month period ended
September 30, 2002, a cumulative impairment charge totaling $305 million ($200
million after-tax) was recorded in Impairment and Other Charges, Cost of Sales
and Other Expenses in the accompanying Condensed Consolidated Statements of
Operations.
In addition, the impairment analysis indicated that future cash flows were
insufficient to support the lessor's obligation related to a telecommunications
lease, of which Dynegy has guaranteed approximately $306 million. In accordance
with EITF Issue 96-21, "Implementation Issues in Accounting for Leasing
Transactions involving Special-Purpose Entities," the loss under the guarantee
will be accrued under a straight-line method over the remaining term of the
lease. This non-cash pre-tax charge approximates $22 million per quarter and is
included in Depreciation and Amortization in the accompanying Condensed
Consolidated Statement of Operations. The Company began recognizing this loss
in the third quarter 2002 and will continue to accrue for such loss through the
remaining term of the lease, unless the obligation is accelerated or terminated
as a result of a business combination, joint venture or other similar
transaction involving this business.
Liquidity reserve. The Company recognized a pre-tax charge of $223 million
($145 million after-tax) associated with its recognition of a liquidity reserve
in the third quarter 2002 that impairs the mark-to-market value of the
Company's marketing and trading portfolio at September 30, 2002. The
recognition of an incremental liquidity reserve in determining estimated fair
value reflects a substantial reduction during the quarter in market transaction
volumes, principally in the U.S. power marketing and trading business, and
recognizes the negative estimated impact on the realizability of the net asset
value of the portfolio. This charge is included in Revenues in the accompanying
Condensed Consolidated Statement of Operations.
Impairment of generation investments. In conjunction with its review of the
carrying value of goodwill, the Company assessed the carrying value of its
generation portfolio on an asset-by-asset basis. The generation portfolio
includes wholly owned generating facilities, which are reflected in Property,
Plant and Equipment, as well as investments in partnerships and limited
liability companies that own generating facilities, which are reflected in
Unconsolidated Investments. Based on this review, the carrying value associated
with the wholly owned generation facilities was considered realizable. However,
certain investments were considered impaired, resulting in a pre-tax charge of
$90 million, which is reflected in Earnings (Losses) from Unconsolidated
Investments in the accompanying Condensed Consolidated Statement of Operations.
This diminution in the fair value of these investments is a result of depressed
energy prices and an increase in the rate of return required by investors to
enter into the power generating business.
Impairment of technology investments. At June 30, 2002, the valuations of
technology investments were assessed in light of the Company's decision to
pursue partnership and sale opportunities for its
19
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
telecommunications business. These investments were originally entered into in
order to leverage existing commercial relationships or as a means of expanding
new relationships. Historically, the Company viewed these investments as
strategic and core to its telecommunications strategy. Accordingly, Dynegy
expected to hold these investments for the long term and viewed trends in the
sector as cyclical. These investments include ownership in public and private
companies and investment funds focused in the technology sector. The continued
downturn in the technology sector during the second quarter 2002 combined with
the Company's change in strategy resulted in an impairment charge relative to
these investments. In the second quarter 2002, the Company recorded a $40
million pre-tax ($26 million after-tax) charge in Earnings (Losses) From
Unconsolidated Investments in the accompanying Condensed Consolidated
Statements of Operations. This is in addition to the first quarter pre-tax
charge of $45 million ($30 million after-tax) resulting from unfavorable market
conditions.
These investments were reevaluated at September 30, 2002 based on the
Company's inability to sell certain investments for their adjusted carrying
values and the continued depressed conditions in the technology sector. Based
on this assessment, the remaining carrying values of such investments were
written off, resulting in a pre-tax charge of $12 million ($8 million
after-tax). The cumulative pre-tax charge related to technology investments for
the nine months ended September 30, 2002 was $97 million ($64 million
after-tax).
Severance charge. The Company recognized a pre-tax charge of approximately
$37 million ($24 million after-tax) in the second quarter 2002 for severance
benefits for approximately 325 employees who were from various segments and
included all staffing levels, including the Company's former Chief Executive
Officer and Chief Financial Officer. The charge is included in Impairment and
Other Charges in the accompanying Condensed Consolidated Statements of
Operations. The following is a schedule of the reduction in the liability
related to this charge (in millions):
Original Cash Balance at
Charge Amount Utilization September 30, 2002
------------- ----------- ------------------
$37 $(15) $22
A substantial amount of the balance at September 30, 2002 relates to
severance that has not been paid to the Company's former Chief Executive
Officer and Chief Financial Officer.
Enron settlement. In August 2002, Dynegy agreed to pay Enron $25 million to
settle the lawsuit Enron had filed alleging wrongful termination of the
parties' November 2001 merger agreement, $10 million of which was paid to Enron
upon approval of the settlement agreement by the Bankruptcy Court, with the
remaining $15 million escrowed until the settlement becomes final. This pre-tax
$25 million ($16 million after-tax) charge was recorded in Other Expenses in
the accompanying Condensed Consolidated Statements of Operations for the nine
months ended September 30, 2002. Please see Note 12 for further discussion.
Write-off of other obsolete assets. The Company recognized a pre-tax charge
of $12 million ($8 million after-tax) in the second quarter 2002 related to the
retirement of partially depreciated information technology equipment and
software replaced during the quarter with new system applications and
arrangements as well as miscellaneous deposits that are not expected to provide
future value. The charge was recorded in Other Expenses in the accompanying
Condensed Consolidated Statements of Operations.
As a result of the Company's decision to exit third party risk management
aspects of the marketing and trading business, its investment in Dynegydirect
was written-off in the third quarter 2002, resulting in a pre-tax charge of $29
million ($19 million after-tax). The charge was recorded in Other Expenses in
the accompanying Condensed Consolidated Statements of Operations.
20
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Corporate Restructuring. In October 2002, the Company announced that it is
implementing a restructuring plan designed to improve operational efficiencies
and performance across its lines of business. The Company will adopt a
decentralized business structure consisting of a streamlined corporate center
and operating units in power generation, natural gas liquids, regulated energy
delivery and communications. As a result of this restructuring, the Company
will recognize pre-tax charges of approximately $50 million ($33 million
after-tax) and $6 million ($4 million after-tax) in the fourth quarter 2002 and
first quarter 2003, respectively, for severance benefits for approximately 780
employees who were from various segments and included all staff levels.
The Company is currently assessing other potential fourth quarter charges,
which may include, but are not limited to, charges associated with the recently
announced reduction in workforce and organizational restructuring and charges
associated with exiting third party risk management aspects of the marketing
and trading business.
Note 6--Commercial Operations, Risk Management Activities and Financial
Instruments
Provisions in Statement No. 133 affect the accounting and disclosure of
certain contractual arrangements and operations of the Company. Under Statement
No. 133, all derivative instruments are recognized in the balance sheet at
their fair values and changes in fair value are recognized immediately in
earnings, unless the derivatives (which are not a part of the Company's
marketing activities) qualify and are designated as hedges of future cash
flows, fair values or net investments or qualify, and are designated, as normal
purchases or sales. Derivatives treated as normal purchases or sales are
recorded and recognized in income using accrual accounting.
The nature of the Company's business necessarily involves certain market and
financial risks. The Company routinely enters into financial instrument
contracts in an attempt to mitigate or eliminate these various risks. These
risks and the Company's strategy for mitigating these risks are more fully
described in Note 3 to the Form 10-K.
Changes in stockholders' equity related to derivatives for the nine-month
period ended September 30, 2002 were as follows, net of tax (in millions):
Balance at December 31, 2001............. $ 26
Current period changes in fair value, net (22)
Reclassifications to earnings, net....... (17)
----
Balance at September 30, 2002............ $(13)
====
Accumulated other comprehensive loss, net of tax, is included in
Stockholders' Equity on the Condensed Consolidated Balance Sheets as follows
(in millions):
Statement No. 133, net................................................. $(13)
Currency translation adjustment........................................ 10
----
Accumulated other comprehensive loss, net of tax, at September 30, 2002 $ (3)
====
21
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Other comprehensive income (loss) is as follows (in millions):
Nine Months
Ended
September 30,
-------------
2002 2001
---- ----
Net income (loss)................ $(2,165) $452
Other comprehensive income (loss) 18 6
------- ----
Total comprehensive income (loss) $(2,147) $458
======= ====
The Company adopted Statement No. 133, effective January 1, 2001, resulting
in an after-tax cumulative effect gain of approximately $2 million.
From time to time the Company enters into various financial derivative
instruments which qualify as cash flow hedges. For derivatives treated as
hedges of future cash flows, the effective portion of changes in fair value is
recorded in other comprehensive income until the related hedged items impact
earnings. Any ineffective portion of a hedge is reported in earnings
immediately. Instruments related to the Company's customer and risk-management
and midstream liquids businesses are entered into for purposes of hedging
forward fuel requirements for certain power generation facilities, locking in
future margin in the domestic midstream liquids business and hedging price risk
in the global liquids business. Interest rate swaps are used to convert the
floating interest rate component of certain obligations to fixed rates.
Dynegy recognized a charge of less than $1 million relating to hedge
ineffectiveness during the nine months ended September 30, 2002, and no amounts
were excluded from the assessment of hedge effectiveness related to the hedge
of future cash flows. Additionally, no amounts were reclassified to earnings in
connection with forecasted transactions that were no longer considered probable
of occurring.
The balance in other comprehensive income at September 30, 2002 associated
with these cash flow hedges is expected to be reclassified to future earnings
contemporaneously with the related purchases of fuel, sales of electricity or
liquids and payments of interest as applicable to each type of hedge. Of this
amount, an approximate $16 million loss, net of taxes, is estimated to be
reclassed into earnings over the 12-month period ending September 30, 2003.
Actual amounts ultimately reclassed to earnings over the next 12 months could
vary materially from this estimated amount as a result of changes in market
conditions.
The Company also enters into derivative instruments which qualify as fair
value hedges. For derivatives treated as fair value hedges, changes in the fair
value of the derivative and changes in the fair value of the related asset or
liability are recorded in current period earnings. The Company uses interest
rate swaps to convert a portion of its fixed-rate debt into variable-rate debt.
During the nine months ended September 30, 2002 and 2001, there was no
ineffectiveness from changes in fair value of hedge positions, and no amounts
were excluded from the assessment of hedge effectiveness. Additionally, no
amounts were recognized in relation to firm commitments that no longer
qualified as fair value hedge items.
The Company has investments in foreign subsidiaries, the net assets of which
are exposed to currency exchange-rate volatility. The Company uses derivative
financial instruments to hedge this exposure. For derivatives treated as hedges
of net investments in foreign operations, the effective portion of changes in
the fair value of the derivative is recorded in the cumulative translation
adjustment. Any ineffective portion of a hedge is reported in earnings
immediately. For the nine months ended September 30, 2002, approximately $31
million of
22
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
net losses related to these contracts were included in the cumulative
translation adjustment. During the nine months ended September 30, 2002,
ineffectiveness from changes in fair value of net investment hedge positions
was a loss of approximately $7 million. There were no net investment hedges
during the nine months ended September 30, 2001.
Note 7--Unconsolidated Investments
Investments in affiliates that are not controlled by the Company but where
the Company has significant influence over operations are accounted for by the
equity method. The Company's share of net income from these affiliates is
reflected in the Condensed Consolidated Statements of Operations as Earnings
(Losses) from Unconsolidated Investments. The Company's principal equity method
investments consist of entities that operate generation assets and natural gas
liquids assets. These equity investments totaled $738 million and $843 million
at September 30, 2002 and December 31, 2001, respectively. The Company entered
into these ventures principally for the purpose of sharing risk and leveraging
existing commercial relationships. These ventures maintain independent capital
structures and have financed their operations on a non-recourse basis to the
Company.
Generation Assets. Generation investments primarily include ownership
interests in eight joint ventures that own fossil fuel electric generation
facilities as well as a limited number of international ventures. The Company's
ownership is 50 percent in the majority of these ventures. The Company's
aggregate net investment of $622 million at September 30, 2002 represents
approximately 2,400 MW of net generating capacity. Dynegy's most significant
investment in generating capacity is its interest in West Coast Power,
representing approximately 1,400 MW of net generating capacity in California.
The net investment in West Coast Power totaled approximately $355 million and
$330 million at September 30, 2002 and December 31, 2001, respectively. West
Coast Power provided equity earnings of approximately $49 million and $157
million in the nine months ended September 30, 2002 and 2001, respectively. NRG
Energy Inc., the parent company of Dynegy's partner in two joint ventures,
including West Coast Power, recently announced that it has presented a
restructuring proposal to representatives of its bank lenders and bondholders.
NRG Energy also indicated that a Chapter 11 filing may ultimately be the means
for it to implement any restructuring proposal with its creditors. Dynegy
cannot predict with any degree of certainty the effects of these or similar
actions by NRG Energy on the operations or collateral obligations of these two
joint ventures.
Midstream Investments. Midstream investments include a 23 percent ownership
interest in a venture that operates a natural gas liquids ("NGL") processing,
extraction, fractionation and storage facility in the Gulf Coast region as well
as a 39 percent ownership interest in a venture that fractionates NGLs on the
Gulf Coast. At September 30, 2002 and December 31, 2001, the Company's
aggregate net investment in these midstream businesses totaled approximately
$116 million and $146 million, respectively. The $146 million of investments at
December 31, 2001 included Dynegy's investment in West Texas LPG Pipeline
Limited Partnership ("WTLPS"), which was transferred to ChevronTexaco
Corporation in August 2002. Please see Note 9 for further discussion of this
transaction.
23
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Summarized aggregate financial information for these generation and
midstream investments and Dynegy's equity share thereof was (in millions):
Nine Months Ended
September 30,
---------------------------
2002 2001
------------- -------------
Equity Equity
Total Share Total Share
------ ------ ------ ------
Revenues........ $2,786 $1,075 $3,444 $1,333
====== ====== ====== ======
Operating margin $ 572 $ 204 $ 764 $ 299
====== ====== ====== ======
Net income...... $ 281 $ 108 $ 461 $ 193
====== ====== ====== ======
In addition to its equity share of net income from these investments, the
Company recognized an impairment charge of $90 million, which is also included
in Earnings (Losses) from Unconsolidated Investments. See Note 5 for further
discussion regarding the impairment of certain of these assets in the third
quarter 2002.
Other Investments. In addition to these equity investments, the Company
holds interests in non-public companies for which it does not have significant
influence over operations. These investments are generally accounted for by the
cost method. Such investments totaled $32 million and $84 million at September
30, 2002 and December 31, 2001, respectively. The change is primarily
attributed to the impairment of technology investments resulting from
unfavorable market conditions. See Note 5 for further discussion regarding
these impairments.
The Company also owned equity securities that had readily determinable fair
market values and were considered available-for-sale. During the nine months
ended September 30, 2002, the Company impaired the carrying value of these
investments, consistent with a continuing decline in market values, and
eventually sold substantially all of these investments realizing a loss of $2
million. At September 30, 2002, there is no remaining carrying value associated
with these investments.
24
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Note 8--Debt
As of the date of this report, the Company's debt maturities and related
obligations through December 31, 2003 were approximately as follows:
Date Type Amount Outstanding/Owed
---- ---- -----------------------
Fourth Quarter 2002 Canadian Credit Facility $40 million
IP Transitional Funding Trust Notes/(1)/ $21.6 million
ABG Gas Supply/(2)/ $11.7 million
First Quarter 2003. Renaissance/Rolling Hills Interim Financing $200 million
IP Transitional Funding Trust Notes/(1)/ $21.6 million
Black Thunder Financing/ (3)/ $18.9 million
ABG Gas Supply/(2)/ $17.8 million
Second Quarter 2003 DHI $900 million Revolving Credit Facility $789 million/(4)/
DHI $400 million Revolving Credit Facility $382 million/(5)/
IP Bank Credit Facility $300 million
IP Transitional Funding Trust Notes/(1)/ $21.6 million
Black Thunder Financing/(3)/ $21.6 million
ABG Gas Supply/(2)/ $18.1 million
Third Quarter 2003. IP Maturing Mortgage Bonds $190 million
IP Transitional Funding Trust Notes/(1)/ $21.6 million
Black Thunder Financing/(3)/ $21.6 million
ABG Gas Supply/(2)/ $18.4 million
Fourth Quarter 2003 IP Transitional Funding Trust Notes/(1)/ $21.6 million
Black Thunder Financing/(3)/ $21.6 million
ABG Gas Supply/(2)/ $18.7 million
- --------
(1) Reflects required quarterly payments which are made with cash set aside
from IP customer billings.
(2) Reflects required payments associated with Project Alpha as further
described in Note 1.
(3) Reflects required quarterly payments under Dynegy's Black Thunder financing.
(4) Reflects amounts currently outstanding under the DHI $900 million revolving
credit facility, including $661 million in outstanding letters of credit.
(5) Reflects amounts currently outstanding under the DHI $400 million revolving
credit facility, including $382 million in outstanding letters of credit.
The Company's decision to exit third party risk management aspects of the
marketing and trading business is expected to reduce significantly its future
requirements to post collateral in the form of cash or letters of credit.
Accordingly, upon successful execution of the Company's exit from this
business, a corresponding reduction in the Company's second quarter 2003
maturities is anticipated. Please read "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources"
for a discussion of the Company's liquidity and capital plan.
During the nine-month period ended September 30, 2002, the Company repaid
commercial paper borrowings and revolving credit facilities for Dynegy, DHI and
IP of approximately $500 million in the aggregate and borrowed an aggregate of
approximately $137 million under the Dynegy and DHI revolving credit facilities
and $60 million under IP's revolving credit facility. Additionally, during the
nine months ended
25
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
September 30, 2002, Dynegy and DHI issued an aggregate of $651 million of
letters of credit under their revolving credit facilities. During the period
from September 30, 2002 through the date of this report, Dynegy repaid $84
million under the Dynegy revolving credit facility that expired on November 2,
2002 and repaid $75 million under the DHI revolving credit facility in order to
allow for capacity to issue additional letters of credit. Additionally, as
described below, Dynegy used $250 million in proceeds from sales of its United
Kingdom natural gas storage facilities to repay an interim financing that
represented an advance on a portion of the proceeds from such sales.
Interim Financings. In July 2002, the Company completed a $200 million
interim financing, bearing interest at LIBOR plus 1.38 percent. This loan
matures in January 2003 and is secured by interests in Dynegy's Renaissance and
Rolling Hills merchant power generation facilities.
In June 2002, the Company completed a $250 million interim financing,
bearing interest at LIBOR plus 1.75 percent. This loan matures in June 2003 and
represents an advance on a portion of the proceeds from the sale of the
Company's United Kingdom natural gas storage facilities. In September 2002,
Dynegy sold the entity that owned the Hornsea storage facility and in October
2002 repaid approximately $189 million of this interim financing with the net
proceeds. On November 14, 2002, Dynegy sold the entities that owned the Rough
facilities and repaid the remaining balance of this financing with a portion of
the proceeds therefrom.
Illinois Power. On May 17, 2002, IP exercised the "term-out" provision
contained in its $300 million 364-day revolving credit facility, which was
scheduled to mature on May 20, 2002. In connection with this conversion, IP
borrowed the remaining $60 million available under this facility. The exercise
of the "term-out" provision converted the facility to a one-year term loan that
matures in May 2003. As such, the amounts outstanding under this loan are
classified as current. Borrowings of $300 million were outstanding under this
loan at September 30, 2002.
DHI Revolvers. On April 29, 2002, DHI closed a $900 million unsecured
revolving credit agreement with a syndicate of commercial banks. This facility
matures on April 28, 2003. Generally, borrowings under the credit agreement
bear interest at a Eurodollar rate plus a margin that is determined based on
designated unsecured debt ratings of Dynegy. Facility fees are payable on the
full amount of the facility and are determined based on designated unsecured
debt ratings. As of September 30, 2002, amounts outstanding under this facility
included $203 million of borrowings and $517 million in letters of credit.
During October 2002, Dynegy repaid $75 million of outstanding borrowings under
this facility in order to allow for capacity to issue additional letters of
credit. As of November 13, 2002, amounts outstanding under this facility
included $128 million of borrowings and $661 million in letters of credit.
Financial covenants under the DHI $900 million revolver include a
debt-to-capitalization test (which takes into account certain lease and similar
commitments of DHI and its subsidiaries) and a 3.5 times EBITDA-to-interest
test. The permissible threshold for the debt-to-capitalization is 60%. Other
covenants in the facility include subordination of certain intercompany debt
owed to Dynegy and its subsidiaries (other than DHI and its subsidiaries),
restrictions on liens and limitations prohibiting subsidiary debt at Dynegy
Marketing & Trade, Dynegy Power Marketing, Inc. and Dynegy Midstream Services,
Limited Partnership. Default provisions include cross-payment default of
Dynegy, DHI or any principal subsidiary with respect to debt or other similar
obligations that exceed $100 million, cross acceleration of Dynegy, DHI or any
principal subsidiary under any instrument covering debt or similar obligations
that exceed $100 million and bankruptcy or receivership of Dynegy, DHI or any
principal subsidiary. The facility does not contain any defaults relating to
material adverse changes in the condition of Dynegy or DHI after the closing
date or to changes in Dynegy's or DHI's credit
26
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
ratings. The facility also does not contain a "term-out" provision that would
permit Dynegy to extend the maturity for borrowings under the facility beyond
the facility's April 28, 2003 maturity date. As such, the amounts outstanding
under this facility are classified as current.
Dynegy was in compliance with the covenants contained in its revolving
credit agreements and other debt instruments at September 30, 2002. Dynegy's
recent operating losses and any further operating losses will make it more
difficult for Dynegy to continue to satisfy the financial covenants in its
revolving credit agreements, particularly the EBITDA-to-interest covenants.
Management will continue to analyze these covenants relative to its results of
operations. The Company is required to deliver a certificate to the lenders
under its revolving credit facilities attesting to its compliance with the
financial covenants under these facilities on a quarterly basis. Any failure to
satisfy one or more of these covenants would constitute a breach giving rise to
a default under the applicable debt instrument and would permit the lenders
under such debt instrument to accelerate the maturity of Dynegy's outstanding
obligations thereunder. Depending upon the particular debt instrument, such a
breach or any action by the lenders to accelerate the maturity of amounts owing
would result in a default under or trigger cross-acceleration provisions in a
significant portion of the Company's other outstanding debt instruments. In the
event of non-compliance, Dynegy would seek waivers from the lenders under these
debt instruments or attempt to repay or refinance the affected debt
instruments. The Company cannot provide any assurance that it could repay,
obtain waivers with respect to or refinance such debt instruments in the event
of any such default.
ABG Gas Supply Credit Agreement. On April 10, 2001, ABG entered into a
credit agreement with a consortium of lenders in order to provide financing
associated with Project Alpha (the "ABG 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 purchases and sales agreement. The ABG Credit Agreement
requires ABG to repay the advances in monthly installments commencing February
2002 through December 2004 from funds received from Dynegy Marketing and Trade
under the natural gas purchases and sales agreement. The advances bear interest
at a Eurodollar rate plus a margin as defined in the agreement. Advances of
$272 million were outstanding under this agreement at September 30, 2002.
DHI Senior Notes. On February 21, 2002, DHI issued $500 million of 8.75%
senior notes due 2012. Interest on the notes is due on February 15 and August
15 of each year, beginning August 15, 2002. The notes are unsecured and are not
subject to a sinking fund.
Capital Leases. In response to the initiatives currently underway at the
FASB, on June 28, 2002 the Company unilaterally undertook certain actions, the
effect of which altered the accounting for some of its existing lease
obligations and anticipated lease obligations relating to assets under
construction. These actions included the delivery of guarantees of lessor debt
in certain existing leases of power generation facilities. In addition, the
Company notified certain lenders of its intent to purchase power generation
facilities that are currently under construction and that were expected to be
placed in synthetic leases upon completion of their construction. As a result
of these actions, approximately $528 million of obligations due in 2005 to 2007
were brought on-balance sheet.
This non-cash action resulted in an increase to Property, Plant and
Equipment and a corresponding increase in Long-Term Debt on the Company's
Condensed Consolidated Balance Sheet. These obligations were previously
reported as lease obligations in the footnotes to the Company's financial
statements and in the Commercial Financial Obligations and Contingent Financial
Commitments tables in the Annual Report on Form 10-K for the year ended
December 31, 2001 (the "Form 10-K"). In addition, actions taken by the Company
relating to assets under construction required the reclassification of
approximately $673 million from Prepayments and Other Assets to Property, Plant
and Equipment on the Company's Condensed Consolidated
27
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Balance Sheet. Property under capital leases of $525 million at September 30,
2002 is included in Property, Plant and Equipment and is amortized over the
useful life of the asset, which approximates 40 years.
The following is a schedule of future minimum lease payments under capital
leases together with the present value of the net minimum lease payments as of
September 30, 2002 (in millions):
Three months ending December 31, 2002...... $ 3
Year ending December 31:
2003......................