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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended 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: 000-29311
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DYNEGY HOLDINGS INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3248415
(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 [_]
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DYNEGY HOLDINGS 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............................................ 39
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..... 72
Item 4. CONTROLS AND PROCEDURES........................................ 72
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.............................................. 73
Item 5. OTHER.......................................................... 73
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................... 73
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. 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 HOLDINGS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
December 31,
September 30, 2001
2002 Unaudited
Unaudited Restated
------------- -------------
ASSETS
Current Assets
Cash and cash equivalents......................... $ 839 $ 144
Restricted cash................................... 189 --
Accounts receivable, net of allowance for
doubtful accounts of $106 million and $102
million, respectively............................ 3,034 3,575
Accounts receivable, affiliates................... 69 80
Inventory......................................... 184 202
Assets held for sale (Note 4)..................... 32 --
Assets from risk-management activities............ 4,138 4,391
Prepayments and other assets...................... 726 1,286
------------- -------------
Total Current Assets......................... 9,211 9,678
------------- -------------
Property, Plant and Equipment..................... 7,471 6,883
Accumulated depreciation.......................... (988) (810)
------------- -------------
Property, Plant and Equipment, Net........... 6,483 6,073
Other Assets
Unconsolidated investments (Note 7)............... 702 809
Accounts receivable, affiliates................... 28 185
Assets held for sale (Note 4)..................... 644 --
Assets from risk-management activities............ 4,715 2,678
Goodwill.......................................... 15 785
Other assets...................................... 331 327
------------- -------------
Total Assets................................. $ 22,129 $ 20,535
============= =============
LIABILITIES AND STOCKHOLDER'S EQUITY
Current Liabilities
Accounts payable.................................. $ 2,240 $ 2,254
Accounts payable, affiliates...................... 1,234 40
Accrued liabilities and other..................... 943 2,419
Liabilities from risk-management activities....... 4,022 3,790
Notes payable and current portion of long-term
debt............................................. 846 262
Liabilities held for sale (Note 4)................ 30 --
------------- -------------
Total Current Liabilities.................... 9,315 8,765
------------- -------------
Long-Term Debt.................................... 3,490 2,359
Other Liabilities
Liabilities held for sale (Note 4)................ 211 --
Liabilities from risk-management activities....... 4,141 2,196
Deferred income taxes............................. 431 684
Other long-term liabilities....................... 522 697
------------- -------------
Total Liabilities............................ 18,110 14,701
------------- -------------
Minority Interest................................. 114 984
Company Obligated Preferred Securities of
Subsidiary Trust................................. 200 200
Commitments and Contingencies (Note 10)
Stockholder's Equity
Additional paid in capital........................ 2,396 2,392
Accumulated other comprehensive income, net of tax 17 16
Retained earnings................................. 259 1,210
Stockholder's equity.............................. 1,033 1,032
------------- -------------
Total Stockholder's Equity........................ 3,705 4,650
------------- -------------
Total Liabilities and Stockholder's Equity... $ 22,129 $ 20,535
============= =============
See the notes to condensed consolidated financial statements.
3
DYNEGY HOLDINGS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions)
Three Months Ended
September 30,
------------------
2001
2002 Unaudited
Unaudited Restated
--------- ---------
Revenues (Note 2)........................................................ $ 1,436 $1,910
Cost of sales, exclusive of depreciation shown separately below (Note 2). 1,558 1,358
Depreciation and amortization............................................ 84 68
Goodwill impairment (Note 5)............................................. 737 --
General and administrative expenses...................................... 85 107
------- ------
Operating income (loss)............................................... (1,028) 377
Earnings (losses) from unconsolidated investments (Notes 5 and 7)........ (39) 96
Other income............................................................. 23 11
Interest expense......................................................... (71) (33)
Other expenses (Note 5).................................................. (53) (12)
Minority interest expense................................................ (2) (19)
Accumulated distributions associated with trust preferred securities..... (4) (4)
------- ------
Income (loss) from continuing operations before income taxes............. (1,174) 416
Income tax provision (benefit)........................................... (155) 155
------- ------
Income (loss) from continuing operations................................. (1,019) 261
Discontinued operations (Note 4):
Loss from discontinued operations (including loss on disposal of Northern
Natural of $62 million)................................................ (45) --
Income tax provision..................................................... (4) --
------- ------
Loss on discontinued operations.......................................... (49) --
------- ------
Net Income (Loss)........................................................ $(1,068) $ 261
======= ======
See the notes to condensed consolidated financial statements.
4
DYNEGY HOLDINGS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS--(Continued)
(in millions)
Nine Months Ended
September 30,
------------------
2001
2002 Unaudited
Unaudited Restated
--------- ---------
Revenues (Note 2)...................................................................... $ 3,997 $6,221
Cost of sales, exclusive of depreciation shown separately below (Note 2)............... 3,614 5,083
Depreciation and amortization.......................................................... 220 200
Goodwill impairment (Note 5)........................................................... 737 --
Impairment and other charges (Note 5).................................................. 28 --
General and administrative expenses.................................................... 245 274
------- ------
Operating income (loss)............................................................. (847) 664
Earnings (losses) from unconsolidated investments (Notes 5 and 7)...................... (8) 186
Other income........................................................................... 8 68
Interest expense....................................................................... (154) (96)
Other expenses (Note 5)................................................................ (23) (50)
Minority interest expense.............................................................. (23) (54)
Accumulated distributions associated with trust preferred securities................... (12) (12)
------- ------
Income (loss) from continuing operations before income taxes and change in accounting
principle............................................................................ (1,059) 706
Income tax provision (benefit)......................................................... (114) 270
------- ------
Income (loss) from continuing operations............................................... (945) 436
Discontinued operations (Note 4):
Income from discontinued operations (including loss on disposal of Northern Natural
of $62 million)................................................................... 13 --
Income tax provision................................................................ 24 --
------- ------
Loss on discontinued operations........................................................ (11) --
Cumulative effect of change in accounting principle, net (Note 6)...................... -- 2
------- ------
Net Income (Loss)...................................................................... $ (956) $ 438
======= ======
See the notes to condensed consolidated financial statements.
5
DYNEGY HOLDINGS 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)...................................................................... $(956) $ 438
Items not affecting cash flows from operating activities:
Depreciation and amortization....................................................... 285 196
Goodwill impairment (Note 5)........................................................ 737 --
Impairment and other charges........................................................ 32 --
(Earnings) losses from unconsolidated investments, net of cash distributions........ 74 (152)
Risk-management activities.......................................................... 444 (76)
Deferred income taxes............................................................... (97) 137
Loss on sale of Northern Natural (Note 4)........................................... 62 --
Cumulative effect of change in accounting principle (Note 6)........................ -- (2)
Other............................................................................... 5 (13)
----- -------
Operating cash flows before changes in working capital................................. 586 528
Changes in working capital:
Accounts receivable................................................................. 495 1,390
Inventory........................................................................... (5) 169
Prepayments and other assets (includes $270 million cash collateral postings in the
2002 period)...................................................................... (311) (207)
Accounts payable and accrued liabilities............................................ (509) (1,423)
Other, net.......................................................................... (107) --
----- -------
Net cash provided by operating activities.............................................. 149 457
----- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................................................... (539) (1,320)
Unconsolidated investments............................................................. (12) (52)
Business acquisitions, net of cash acquired............................................ (20) --
Proceeds from asset sales.............................................................. 270 1,001
Affiliate transactions................................................................. 862 (63)
Other investing, net................................................................... 85 (195)
----- -------
Net cash provided by (used in) investing activities.................................... 646 (629)
----- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from long-term borrowings................................................. 532 668
Repayments of long-term borrowings..................................................... (409) (200)
Net proceeds from short-term borrowings................................................ 437 --
Net cash flow from commercial paper and revolving lines of credit...................... (402) (118)
Increase in restricted cash............................................................ (189) --
Other financing, net................................................................... (14) (26)
----- -------
Net cash provided by (used in) financing activities.................................... (45) 324
----- -------
Effect of exchange rate changes on cash................................................ (55) 3
Net increase in cash and cash equivalents.............................................. 695 155
Cash and cash equivalents, beginning of period......................................... 144 32
----- -------
Cash and cash equivalents, end of period............................................... $ 839 $ 187
===== =======
See the notes to condensed consolidated financial statements.
6
DYNEGY HOLDINGS 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 Holdings 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 and 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"). 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. 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 HOLDINGS 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 months Three months Three months Three months Six months Nine months Twelve 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 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.
8
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
A synopsis of the financial impact of these restatements on the condensed
consolidated financial statements is as follows (in millions):
December 31,
2001
------------
(unaudited)
Balance Sheet:
Current Assets:
As Reported........ $ 9,464
Restatement Effect. 214
-------
As Restated........ $ 9,678
=======
Total Assets:
As Reported........ $19,973
Restatement Effect. 562
-------
As Restated........ $20,535
=======
Current Liabilities:
As Reported........ $ 8,442
Restatement Effect. 323
-------
As Restated........ $ 8,765
=======
Total Liabilities:
As Reported........ $13,998
Restatement Effect. 703
-------
As Restated........ $14,701
=======
Stockholder's Equity:
As Reported........ $ 4,801
Restatement Effect. (151)
-------
As Restated........ $ 4,650
=======
Three Months Nine Months
Ended Ended
September 30, September 30,
2001 2001
------------- -------------
Statement of Operations:
Net Income:
As Reported........... $273 $ 558
Restatement Effect.... (12) (120)
---- -----
As Restated........... $261 $ 438
==== =====
Statements of Cash Flows:
Operating Cash Flows:
As Reported........... $ 639
Restatement Effect.... (182)
-----
As Restated........... $ 457
=====
Investing Cash Flows:
As Reported........... $(629)
Restatement Effect.... --
-----
As Restated........... (629)
=====
Financing Cash Flows:
As Reported........... $ 142
Restatement Effect.... 182
-----
As Restated........... $ 324
=====
9
DYNEGY HOLDINGS 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 19, 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 recission 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 HOLDINGS 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..... $ 8,100 $ 32,397
Restatements (see Note 1)........... 32 (32)
------- --------
Adjusted revenues................... 8,132 32,365
Change in accounting principle...... (6,222) (26,144)
------- --------
Revenues as reported herein......... 1,910 6,221
======= ========
Cost of sales as previously reported 7,587 31,172
Restatements (see Note 1)........... (7) 55
------- --------
Adjusted cost of sales.............. 7,580 31,227
Change in accounting principle...... (6,222) (26,144)
------- --------
Cost of sales as reported herein.... 1,358 5,083
======= ========
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 estimation of fair value is highly
subjective, inherently imprecise and can change materially from period to
11
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
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
Energy Midstream &
Network Services Distribution Total
--------- --------- ------------ -----
Balances as of January 1, 2002................... $ 769 $16 $ -- $ 785
Goodwill acquired during the period (see Note 4). -- -- 887 887
Purchase price adjustments....................... (32) -- (28) (60)
Goodwill impaired during the period (see Note 5). (737) -- -- (737)
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 $ -- $ 15
===== === ===== =====
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.
The following table sets forth what Dynegy's net income 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 Dynegy recorded
for the three- and nine-month periods ended September 30, 2002 (in millions).
Three Months Nine Months
Ended Ended
September 30, September 30,
------------- ------------
2002 2001 2002 2001
------- ---- ----- -----
Net income (loss) as previously reported $(1,068) $273 $(956) $ 558
Restatements (see Note 1)............... -- (12) -- (120)
------- ---- ----- -----
Restated net income (loss).............. (1,068) 261 (956) 438
Add back: Goodwill amortization......... -- 4 -- 10
------- ---- ----- -----
Adjusted net income (loss).............. $(1,068) $265 $(956) $ 448
======= ==== ===== =====
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.
12
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Accounting Principles Not Yet Adopted. FASB Statement No. 143. Also during
2001, the FASB issued Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations" ("Statement No. 143"). Statement
No. 143 requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred with the
associated asset retirement costs being capitalized as a part of the carrying
amount of the long-lived asset. The Company is evaluating the future financial
effects of adopting Statement No. 143 and will adopt the standard effective
January 1, 2003.
FASB Statement No. 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 its 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; and
. confidence in Dynegy's financial reporting in light of the previously
announced restatements and the ongoing re-audit of its 1999-2001
financial statements.
Dynegy's liquidity may be significantly adversely affected if it is unable
to refinance the 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 credit facilities contain various
covenants, including EBITDA-to-interest and debt-to-capitalization financial
covenants. The Company was in compliance with the covenants in its credit
13
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
facilities and other debt instruments at September 30, 2002. While many of the
charges incurred by the Company during 2002 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 Inc., Dynegy's parent,
acquired 1,000 shares of Series A Preferred Stock ("Series A Preferred Stock")
in Northern Natural for $1.5 billion. The Company concurrently acquired an
option to purchase all of the equity of Northern Natural's indirect parent
company. The Company exercised its option to acquire the indirect parent of
Northern Natural in November 2001 upon termination of Dynegy Inc.'s merger
agreement with Enron Corp. ("Enron"), and the closing of the option exercise
occurred on January 31, 2002.
14
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
On August 16, 2002, Dynegy Inc. and the Company sold all of their investment
in the preferred stock and the common stock, respectively, of Northern Natural
to MidAmerican for $928 million in cash, subject to adjustment for changes in
working capital. Pursuant to the sales agreement, 95 percent of the purchase
price was allocated to the preferred stock held by Dynegy Inc. and five percent
of the purchase price was allocated to the common stock held by the Company.
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. The
Company incurred a pre-tax loss of $62 million ($60 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.
On September 30, 2002, the Company sold $90 million in 6.875 percent senior
notes of Northern Natural due May 2005 for approximately $96 million in cash.
The Company had 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.
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 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
15
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
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
During the six-months ended June 30, 2002, the Company recognized a $70
million pre-tax ($46 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 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 $1,121 million
pre-tax ($1,028 million after-tax) charge principally related to the impairment
of goodwill associated with the Company's Wholesale Energy Network ("WEN")
segment, the recognition of a liquidity reserve relating to the Company's
marketing and trading portfolio, an impairment of investments in generating
facilities, a loss on the sale of Northern Natural and the write-off of other
obsolete assets.
16
DYNEGY HOLDINGS 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.............. $ 737 $ 737
Liquidity reserve................... 223 223
Impairment of generation investments 62 62
Loss on sale of Northern Natural.... 62 62
Impairment of technology investments 8 34
Severance charge.................... -- 32
Write-off of other obsolete assets.. 29 41
------ ------
$1,121 $1,191
====== ======
Impairment of goodwill. The value of goodwill associated with the WEN
segment was reviewed for impairment at September 30, 2002. Based on this
assessment, a pre-tax charge to earnings of $737 million was recorded to impair
substantially all of the goodwill associated with the WEN segment. There was no
tax basis in this intangible asset resulting in an after-tax charge equal to
the pre-tax amount. 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.
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
$62 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.
Loss on Sale of Northern Natural. On August 16, 2002, Dynegy Inc. and the
Company sold all of their investment in the preferred stock and the common
stock, respectively, of 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,
17
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
which debt had a book value of approximately $890 million. Pursuant to the
sales agreement, 95 percent of the purchase price was allocated to the
preferred stock held by Dynegy Inc. and five percent of the purchase price was
allocated to the common stock held by the Company. The Company incurred a
pre-tax loss of $62 million ($60 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.
Impairment of technology investments. The Company has investments that
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 resulted in an impairment charge relative to
these investments. In the second quarter 2002, the Company recorded a $26
million pre-tax ($17 million after-tax) charge.
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 $8 million ($5 million
after-tax). The cumulative pre-tax charge related to technology investments for
the nine months ended September 30, 2002 was $34 million ($22 million
after-tax) and is included in Earnings (Losses) From Unconsolidated Investments
in the accompanying Condensed Consolidated Statements of Operations.
Severance charge. The Company recognized a pre-tax charge of approximately
$32 million ($21 million after-tax) in the second quarter 2002 for severance
benefits for approximately 309 employees who were from various segments and
included all staffing levels, including the Company's former Chief Executive
Officer and Chief Financial Officer. $28 million ($18 million after-tax) of the
charge is included in Impairment and Other Charges in the accompanying
Condensed Consolidated Statements of Operations. The additional severance
charge of $4 million ($3 million after-tax) was allocated to Northern Natural,
which is included in Discontinued Operations in the accompanying Condensed
Consolidated Statement 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
------------- ----------- ------------------
$32 $(12) $20
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.
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.
18
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Corporate Restructuring. In October 2002, Dynegy Inc. announced that it is
implementing a restructuring plan designed to improve operational efficiencies
and performance across its lines of business. As part of this restructuring the
Company will adopt a decentralized business structure consisting of a
streamlined corporate center and operating units in power generation and
natural gas liquids. As a result of this restructuring, the Company will
recognize pre-tax charges of approximately $38 million ($25 million after-tax)
and $5 million ($3 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 Annual Report on Form 10-K for the year ended
December 31, 2001 (the "Form 10-K").
Changes in stockholder's 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
Stockholder's Equity on the Condensed Consolidated Balance Sheets as follows
(in millions):
Statement No. 133, net................................................. $(13)
Currency translation adjustment........................................ 30
----
Accumulated other comprehensive loss, net of tax, at September 30, 2002 $ 17
====
19
DYNEGY HOLDINGS 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)................ $(956) $438
Other comprehensive income....... 1 26
----- ----
Total comprehensive income (loss) $(955) $464
===== ====
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, approximately $16 million in losses, 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
20
DYNEGY HOLDINGS 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 $690 million and $768 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 8 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 $574 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 joint venture 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 $146 million of investments at
December 31, 2001 included Dynegy's investment in West Texas LPG Pipeline
Limited Partnership ("WTLPS"), which was transferred to ChevronTexaco
Corporation in August 2002. Please see Note 9 for further discussion of this
transaction.
21
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Summarized aggregate financial information for these generation and
midstream investments and Dynegy's equity share thereof was ($ in millions):
Nine Months Ended
September 30,
----------------------------
2002 2001
------------- --------------
Equity Equity
Total Share Total Share
------ ------ ------- ------
Revenues........ $2,330 $998 $3,000 $1,266
====== ==== ======= ======
Operating margin $ 429 $179 $ 552 $ 262
====== ==== ======= ======
Net income...... $ 205 $ 96 $ 387 $ 183
====== ==== ======= ======
In addition to its equity share of net income from these investments, the
Company recognized an impairment charge of $62 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 $12 million and $32 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.
Note 8--Debt
As of November 14, 2002, the Company's debt maturities and related
obligations through December 31, 2003 were as follows:
Date Type Amount Outstanding/Owed
---- ---- -----------------------
Fourth Quarter 2002 Canadian Credit Facility $40 million
ABG Gas Supply/(1)/ $11.7 million
First Quarter 2003. Renaissance/Rolling Hills Interim Financing $200 million
Black Thunder Financing/ (2)/ $18.9 million
ABG Gas Supply/(1)/ $17.8 million
Second Quarter 2003 DHI $900 million Revolving Credit Facility $789 million/(3)/
DHI $400 million Revolving Credit Facility $382 million/(4)/
Black Thunder Financing/(2)/ $21.6 million
ABG Gas Supply/(1)/ $18.1 million
Third Quarter 2003. Black Thunder Financing/(2)/ $21.6 million
ABG Gas Supply/(1)/ $18.4 million
Fourth Quarter 2003 Black Thunder Financing/(2)/ $21.6 million
ABG Gas Supply/(1)/ $18.7 million
- --------
(1) Reflects required payments associated with Project Alpha as further
described in Note 1.
22
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
(2) Reflects required quarterly payments under Dynegy's Black Thunder financing.
(3) Reflects amounts currently outstanding under the DHI $900 million revolving
credit facility, including $661 million in outstanding letters of credit.
(4) 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 of approximately
$455 million and borrowed approximately $53 million under the revolving credit
facilities. Additionally, during the nine months ended September 30, 2002,
Dynegy issued an aggregate of $501 million of letters of credit under the
revolving credit facilities. During the period from September 30, 2002 through
November 13, 2002, Dynegy repaid $75 million under the revolving credit
facilities 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.
Revolvers. On April 29, 2002, the Company 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 14, 2002 amounts outstanding under this facility
included $128 million of borrowings and $661 million in letters of credit.
Financial covenants under this revolver include debt-to-capitalization tests
(which take into account certain lease and similar commitments of Dynegy 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, restrictions on liens and limitations prohibiting
23
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
subsidiary debt at Dynegy Marketing & Trade, Dynegy Power Marketing, Inc. and
Dynegy Midstream Services, Limited Partnership. Default provisions include
cross-payment default of Dynegy, or any principal subsidiary with respect to
debt or other similar obligations that exceed $100 million, cross acceleration
of Dynegy, or any principal subsidiary under any instrument covering debt or
similar obligations that exceed $100 million and bankruptcy or receivership of
Dynegy, or any principal subsidiary. The facility does not contain any defaults
relating to material adverse changes in the condition of Dynegy after the
closing date or to changes in Dynegy's credit 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 covenant.
Management will continue to analyze its 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
facilities or attempt to repay or refinance the affected facilities. The
Company cannot provide any assurance that it could repay, obtain waivers or
amendments with respect to or refinance these facilities 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 the ABG Credit Agreement at September 30,
2002.
DHI Senior Notes. On February 21, 2002, Dynegy 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.
24
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
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 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 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.................................... 13
2004.................................... 13
2005.................................... 176
2006.................................... 186
2007.................................... 185
----
Total minimum lease payments............... 576
Less: Amount representing interest......... (51)
----
Present value of net minimum lease payments $525
====
Other. Dynegy completed an amendment to the Catlin Associates, LLC minority
interest transaction (also referred to as "Black Thunder") in June 2002, which
permanently removed a $270 million obligation which could have been triggered
by declines in Dynegy's credit ratings. The amended agreement requires a
subsidiary of Dynegy to make periodic payments totaling $275 million over the
remaining three years of the transaction. The subsidiary has already paid
approximately $73 million of this total. Quarterly maturities are approximately
$20 million through the first quarter 2005. In addition, Dynegy agreed to grant
mortgages on the midwest generation assets covered by the transaction, post a
letter of credit to secure a contingent obligation expiring December 31, 2002
and make certain structural changes to enhance the security of the third-party
lenders involved in the transaction. As a result of this amendment, $796
million related to Catlin Associates, LLC was reclassified from Minority
Interest to debt on Dynegy's Condensed Consolidated Balance Sheet.
Also in June 2002, West Coast Power, LLC ("West Coast Power"), a joint
venture owned equally by Dynegy and NRG Energy with generation assets in
California, repaid a non-recourse project financing with cash on hand within
the joint venture entity. This payment eliminated a $31 million obligation
which could have been triggered by declines in Dynegy's credit ratings.
Concurrent with the retirement of the project financing, West Coast Power
entered into an amended $120 million bank facility consisting of a $100 million
letter of credit facility that will be used to collateralize West Coast Power's
obligations, a $10 million term loan and a $10 million working capital
facility. The facility has resulted in the release of approximately $100
million in letters of credit previously posted by Dynegy on behalf of West
Coast Power. Please see "Note 7--Unconsolidated Investments" for a discussion
of recent developments involving NRG Energy.
25
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Dynegy incurred upfront fees aggregating approximately $19 million in
connection with the interim financings, Black Thunder amendment and West Coast
Power transactions described above. Such amounts are capitalized and amortized
over the term of the respective financing transactions.
Note 9--Related Party Transactions
ChevronTexaco Commercial Arrangements. In March 2002, Dynegy and
ChevronTexaco agreed to expand their commercial relationships to include
substantially all of the natural gas and domestic mixed NGLs and NGL products
produced or controlled by the former Texaco.
In August 2002, Dynegy and ChevronTexaco executed an agreement pursuant to
which the parties amended the existing gas purchase agreement, security
agreement, netting agreement and certain related agreements. Under this new
agreement, Dynegy agreed to accelerate payment to the month of delivery for a
portion of the natural gas it purchases from ChevronTexaco, with the amount of
the accelerated payment generally being equal to 75 percent of the value of the
prior month's gas deliveries, after reduction pursuant to a netting agreement
between Dynegy and ChevronTexaco. This payment arrangement was effective upon
the closing of the sale of Northern Natural described in Note 4 above. The
accelerated payment totaled $152 million at September 30, 2002.
In connection with Dynegy's announced exit from third party risk management
aspects of the marketing and trading business, Dynegy and ChevronTexaco have
been negotiating to terminate the natural gas purchase agreement between the
parties and to provide for an orderly transition of responsibility for
marketing ChevronTexaco's domestic natural gas production. These discussions
will not affect Dynegy's current contractual agreements with ChevronTexaco
relative to ChevronTexaco's U.S. natural gas processing and the marketing of
ChevronTexaco's domestic NGLs.
Also in August 2002, in partial satisfaction of certain of its obligations
to ChevronTexaco under these agreements, Dynegy sold to ChevronTexaco its 39.2%
ownership interest in WTLPS, which is the owner of West Texas LPG Pipeline.
ChevronTexaco was already the owner of the largest interest in WTLPS and the
operator of the pipeline. The interest sold to ChevronTexaco was valued at $45
million. This non-cash transaction reduced Accounts Payable to Affiliates and
Unconsolidated Investments by $45 million.
Other. At September 30, 2002, the Company had several financing
arrangements under which it was owed approximately $12 million from one of its
equity investees, Nicor Energy. The interest rate varies from zero to prime
plus two percent. The repayment terms for $4 million are over the next fifteen
months, while the remaining $8 million is due when Nicor Energy is sold.
26
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
Note 10--Commitments and Contingencies
Please see Note 11, "Commitments and Contingencies," in the Form 10-K and
Notes 8 and 11, "Commitments and Contingencies," in the Company's Forms 10-Q
for the quarters ended March 31, 2002 and June 30, 2002 (the "Forms 10-Q"),
respectively, for a description of the Company's material legal proceedings.
Set forth below is a description of any material developments that have
occurred with respect to such proceedings since the Company's filing of the
Form 10-Q for the second quarter 2002 and a description of any new matters that
have arisen during the quarter. Except as otherwise indicated, the Company
cannot currently predict with any degree of certainty the outcome of the
proceedings or the amount of any potential liabilities.
In addition to the matters described below, the Company is party to legal
proceedings arising in the ordinary course of business. In the opinion of
management, the disposition of any such matters will not have a material
adverse effect on the Company's financial condition, results of operations or
cash flows. The Company recognizes estimated losses from contingencies when
information available indicates that a loss is probable and the amount of the
loss is reasonably estimable in accordance with SFAS No. 5, "Accounting for
Contingencies."
Baldwin Station Litigation. Illinois Power and Dynegy Midwest Generation,
Inc. (collectively, the "Defendants") are currently the subject of a Notice of
Violation ("NOV") from the Environmental Protection Agency (the "EPA") and a
complaint filed by the EPA and the Department of Justice alleging violations of
the Clean Air Act (the "Act") and the regulations promulgated under the Act.
Similar notices and complaints have been filed against a number of other
utilities. Both the NOV and the complaint allege that certain equipment
repairs, replacements and maintenance activities at the Defendants' three
Baldwin Station generating units constituted "major modifications" under the
Prevention of Significant Deterioration and/or the New Source Performance
Standards regulations. When activities that meet the definition of "major
modifications" occur and they are not otherwise exempt, the Act and related
regulations generally require that generating facilities meet more stringent
emissions standards, which may entail the installation of potentially costly
pollution control equipment. The Defendants filed an answer denying all claims
and asserting various specific defenses and a trial date of June 3, 2003 has
been set.
The Company believes that it has meritorious defenses to the EPA allegations
and will vigorously defend against these claims. The Company has undertaken
activities to significantly reduce emissions at the Baldwin Station since the
complaint was filed in 1999. In 2000, the Baldwin Station was converted from
high to low sulfur coal. This conversion resulted in sulfur dioxide emission
reductions of over 90% from 1999 levels. Furthermore, selective catalytic
reduction equipment has been installed at two of the three units at Baldwin
Station resulting in significant emission reductions of nitrogen oxides.
However, the EPA may seek to require the installation of the "best available
control technology" (or the equivalent) at the Baldwin Station. Independent
experts hired by Dynegy originally estimated capital expenditures of up to $380
million if the installation of best available control technology is required.
Current estimates suggest that such capital expenditures could be as much as
$410 million. The EPA also has the authority to seek penalties for the alleged
violations in question at the rate of up to $27,500 per day for each violation.
The Company has filed a motion for summary judgment based on the five-year
statute of limitations, which could affect the EPA's ability to collect
penalties. The Company has recorded a reserve for potential penalties that
could be imposed if the EPA were to successfully prosecute its claims.
None of the Defendants' other facilities are covered in the complaint and
NOV, but the EPA has officially requested information concerning activities at
the Defendants' Vermilion, Wood River, and Hennepin Plants as well as the
Danskammer and Roseton Plants operated by other Dynegy subsidiaries. It is
possible that the EPA will eventually commence enforcement actions based on
activities at those plants as well.
27
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
On June 13, 2002, the EPA announced its intention to implement several
reforms to its regulations governing new source review. These reforms, if made,
would clarify the routine maintenance, repair and replacement exclusion,
provide more certainty in evaluating permit requirements and increase
operational flexibility for affected facilities.
California Market Litigation. Six class action lawsuits were filed in 2000
and 2001 against various Dynegy entities based on the events occurring in the
California power market. The complaints allege violations of California's
Business and Professions Code, Unfair Trade Practices Act and various other
statutes. The plaintiffs allege that the defendants, including the owners of
in-state generation and various power marketers, conspired to manipulate the
California wholesale power market to the detriment of California consumers.
Included among the acts forming the basis of the plaintiffs' claims are the
alleged improper sharing of generation outage data, improper withholding of
generation capacity and the manipulation of power market bid practices. The
plaintiffs seek unspecified treble damages.
All six lawsuits were consolidated before Judge Sammartino, Superior Court
Judge for the County of San Diego. Subsequent to the consolidation two
defendants filed cross complaints against a number of corporations and
governmental agencies that sold power in California's wholesale energy markets.
Four cross defendants removed the six cases to the United States District Court
for the Southern District of California (San Diego). Following removal, certain
cross defendants filed motions to dismiss the cross complaints, which motions
are currently pending. The original plaintiffs in the six consolidated
complaints have filed motions to remand the consolidated cases back to state
court, which motions are currently pending. The defendants in the six
consolidated cases have filed motions to dismiss the complaints based on the
filed rate doctrine and preemption defense. The motion to remand and the cross
defendants' motion to dismiss were heard by the Court and taken under
submission by Federal Judge Whaley on September 19, 2002. If the Court decides
that it has jurisdiction over the claims, the defendants' motion to dismiss
will be heard as soon as possible thereafter.
On March 11, 2002, the California Attorney General filed, on behalf of the
People of the State of California, complaints in San Francisco Superior Court
against several owners of power generation facilities, including subsidiaries
of West Coast Power. The complaints allege that since June 1998, these
generators sold power in the open market that should have been held in
emergency reserve for the State. In the aggregate, the complaints seek more
than $150 million in penalties, restitution and return of profits from the
generators. These lawsuits were subsequently removed to the United States
District Court for the Northern District of California. The California Attorney
General filed motions to remand the cases back to state court. By Order issued
on August 6, 2002, Judge Walker denied the motions to remand, thus keeping the
cases in federal court. The defendants have filed motions to dismiss, which
were argued and taken under submission by Judge Walker.
In addition to the six consolidated lawsuits discussed above, eight new
putative class actions were filed on behalf of business and residential
electricity consumers, including consumers residing in the State of Washington.
The lawsuits were filed in various state courts in Northern California, and in
respect to the lawsuit on behalf of consumers in the State of Washington, in
the United States District Court for the Northern District of California. Named
as defendants are various generators and marketers, including Dynegy and
certain affiliates. The complaints allege unfair, unlawful and deceptive
practices in violation of the California Unfair Business Practices Act and seek
to enjoin illegal conduct, restitution and unspecified damages. While some of
the allegations in these lawsuits are similar to the allegations in the other
six lawsuits, these lawsuits include additional allegations based on events
occurring subsequent to the filing of the other six lawsuits. These additional
allegations include allegations similar to those made by the California
Attorney General in the March 11, 2002 lawsuit described above as well as
allegations that contracts between these generators and the
28
DYNEGY HOLDINGS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the Interim Periods Ended September 30, 2002 and 2001
California Department of Water Resources (the "DWR") constitute unfair business
practices resulting from market manipulation. The lawsuits filed in state court
have been removed to federal courts in the Northern and Eastern Districts of
California. Certain defendants have filed a petition with the Judicial Panel
For Multidistrict Litigation seeking to consolidate the new cases with the six
cases consolidated in the United States District Court for the Southern
District of California. By order dated October 11, 2002, the Judicial Panel for
Multidistrict Litigation ordered the new cases consolidated with the original
six cases in the United States District Court for the Southern District of
California.
Dynegy intends to vigorously defend against the claims made with respect to
its activities in the California power markets. However, an adverse result in
any of these proceedings could have a material adverse effect on the Company's
financial condition and results of operations.
Enron Litigation. Dynegy Inc. and the Company were sued on December 2, 2001
by Enron and Enron Transportation Services Co. in the United States Bankruptcy
Court for the Southern District of New York, Adversary Proceeding No. 01-03626
(AJG). Enron claimed that Dynegy Inc. materially breached the Merger Agreement
dated November 9, 2001 between Enron and Dynegy and related entities by
wrongfully terminating that Agreement on November 28, 2001. Enron also claimed
that the Company wrongfully exercised its option to take ownership of Northern
Natural under an Option Agreement dated November 9, 2001. Enron sought damages
in excess of $10 billion and declaratory relief against Dynegy Inc. for breach
of the Merger Agreement. Enron also sought unspecified damages against Dynegy
Inc. and the Company for breach of the Option Agreement. Dynegy Inc. filed an
answer on February 4, 2002, denying all material allegations. On April 12,
2002, the Bankruptcy Court granted Dynegy Inc.'s motion to transfer venue in
the proceeding to the United States District Court for the Southern District of
Texas (Houston Division).
On August 15, 2002, Dynegy Inc. and Enron entered into an agreement to
settle this lawsuit. Under the terms of the settlement agreement, Dynegy Inc.
agreed to pay Enron $25 million, $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 approval of the settlement becomes final.
In addition, the parties agreed to exchange mutual releases of any and all
claims related to the terminated merger and to dismiss such litigation. Dynegy
also agreed not to pursue any claims for working capital adjustments relating
to its acquisition of Northern Natural. The terms of the settlement were
approved by the Bankruptcy Court on August 29, 2002. On September 6, 2002, an
appeal of the Bankruptcy Court's approval was filed by the plaintiffs who had
filed the class action lawsuits described below, and such appeal remains
pending. The effect of the appeal is to delay the effective date of the
settlement, the release of the remaining $15