Exhibit 99.1
DYNEGY HOLDINGS INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED AND RESTATED)
Page
----
Consolidated Financial Statements (Unaudited and Restated)
Explanatory Note............................................................................ F-2
Consolidated Balance Sheets as of December 31, 2001 and 2000................................ F-3
Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999.. F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999.. F-5
Consolidated Statements of Changes in Stockholder's Equity for the years ended December 31,
2001, 2000 and 1999....................................................................... F-6
Notes to Consolidated Financial Statements.................................................. F-7
Financial Statement Schedule
Valuation and Qualifying Accounts........................................................... F-45
F-1
DYNEGY HOLDINGS INC.
EXPLANATORY NOTE
Dynegy Holdings Inc. ("Dynegy" or the "Company") has restated its 2001, 2000
and 1999 financial statements to reflect the financial effects of the items
described in the Introductory Note to the consolidated financial statements.
The restated financial statements, which are attached hereto, contain
adjustments to the Company's 2001, 2000 and 1999 financial statements
originally filed with Dynegy's Annual Report on Form 10-K for the year ended
December 31, 2001 (the "Form 10-K"). Arthur Andersen LLP, the Company's
previous independent public accountant, has advised the Company that its 2001
audit opinion should not be relied upon. The unaudited restated financial
statements include all known adjustments that, in the opinion of management,
are necessary for a fair presentation of Dynegy's financial results for the
periods presented. While the preparation of these financial statements is the
responsibility of the Company's management, the restated financial statements
contained herein remain unaudited. Dynegy's independent public accountant,
PricewaterhouseCoopers LLP, is currently re-auditing the Company's historical
financial statements for each of the three years in the period ended December
31, 2001. As a result of this three year re-audit process, it is possible that
additional adjustments to these financial statements may result, some of which
could be material. The Company expects that the re-audit of its 1999 through
2001 consolidated financial statements will be completed early in the first
quarter 2003. The Company will file an amended Form 10-K reflecting the
unaudited restatements described herein as soon as practicable after the date
hereof. Following completion of the re-audit, 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.
F-2
DYNEGY HOLDINGS INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED AND RESTATED)
See Introductory Note--Restatements and Absence of Report of Independent
Accountants
December 31, December 31,
2001 2000
------------ ------------
(in millions)
ASSETS
Current Assets
Cash and cash equivalents..................................................................... $ 144 $ 32
Accounts receivable, net of allowance for doubtful accounts of $102 million and $63 million,
respectively................................................................................. 3,575 4,895
Accounts receivable, affiliates............................................................... 80 49
Inventories................................................................................... 202 242
Assets from risk-management activities........................................................ 4,391 4,466
Prepayments and other assets.................................................................. 1,286 43
--------- ----------
Total Current Assets....................................................................... 9,678 9,727
--------- ----------
Property, Plant and Equipment.................................................................... 6,883 5,377
Less: accumulated depreciation................................................................ (810) (586)
--------- ----------
6,073 4,791
Other Assets
Investments in unconsolidated affiliates...................................................... 809 694
Account receivable, affiliates................................................................ 185 423
Assets from risk-management activities........................................................ 2,678 1,527
Intangible assets, net of amortization........................................................ 785 491
Other assets.................................................................................. 327 120
--------- ----------
Total Assets............................................................................... $ 20,535 $ 17,773
========= ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current Liabilities
Accounts payable.............................................................................. $ 2,254 $ 4,581
Accounts payable, affiliates.................................................................. 40 46
Accrued liabilities and other................................................................. 2,419 428
Liabilities from risk-management activities................................................... 3,790 3,877
Current portion of long-term debt and transitional funding trust notes........................ 262 --
--------- ----------
Total Current Liabilities.................................................................. 8,765 8,932
--------- ----------
Long-Term Debt................................................................................... 2,359 1,374
Other Liabilities
Liabilities from risk-management activities...................................................... 2,196 1,669
Deferred income taxes............................................................................ 684 312
Other long-term liabilities...................................................................... 697 293
--------- ----------
Total Liabilities......................................................................... 14,701 12,580
--------- ----------
Minority Interest (Note 10)...................................................................... 984 972
Company Obligated Preferred Securities of Subsidiary Trust (Note 9).............................. 200 200
Commitments and Contingencies (Note 11)
Stockholder's Equity
Additional paid in capital.................................................................... 2,392 2,336
Accumulated other comprehensive income (loss), net of tax..................................... 16 (15)
Retained earnings............................................................................. 1,210 668
Stockholder's equity.......................................................................... 1,032 1,032
--------- ----------
Total Stockholder's Equity................................................................. 4,650 4,021
--------- ----------
Total Liabilities and Stockholder's Equity.................................................... $ 20,535 $ 17,773
========= ==========
See Notes to Consolidated Financial Statements.
F-3
DYNEGY HOLDINGS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED AND RESTATED)
See Introductory Note--Restatement and Absence of Report of Independent
Accountants
Year Ended December 31,
-------------------------
2001 2000 1999
------- ------- -------
(in millions)
Revenues............................................................ $41,901 $27,909 $15,418
Cost of sales (exclusive of depreciation shown below)............... 40,413 26,914 14,881
Depreciation and amortization expense............................... 276 234 129
General and administrative expenses................................. 348 238 201
------- ------- -------
Operating income.................................................... 864 523 207
Earnings from unconsolidated investments............................ 202 191 80
Other income........................................................ 117 196 73
Interest expense.................................................... (134) (96) (78)
Other expenses...................................................... (74) (88) (34)
Minority interest expense........................................... (77) (54) (11)
Accumulated distributions associated with trust preferred securities (17) (17) (17)
------- ------- -------
Income before income taxes.......................................... 881 655 220
Income tax provision................................................ 341 226 72
------- ------- -------
Income from operations.............................................. 540 429 148
Cumulative effect of change in accounting principle................. 2 -- --
------- ------- -------
NET INCOME.......................................................... $ 542 $ 429 $ 148
------- ------- -------
See Notes to Consolidated Financial Statements.
F-4
DYNEGY HOLDINGS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED AND RESTATED)
See Introductory Note--Restatements and Absence of Report of Independent
Accountants
Year Ended December 31,
-----------------------
2001 2000 1999
------- ------- -----
(in millions)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income........................................................... $ 542 $ 429 $ 148
Items not affecting cash flows from operating activities:
Depreciation, amortization, impairment and abandonment............... 270 199 108
Earnings from unconsolidated investments, net of cash distributions.. (115) (82) (14)
Risk-management activities........................................... (112) (181) (177)
Deferred income taxes................................................ 90 110 60
Gain on asset sales, net............................................. (34) (108) (50)
Reserve for doubtful accounts........................................ 56 38 --
Income tax benefit from stock option exercise and other.............. 41 92 16
Change in assets and liabilities resulting from operating activities:
Accounts receivable.................................................. 1,510 (4,942) (455)
Inventories.......................................................... 5 (124) (27)
Prepayments and other assets......................................... (186) 29 50
Accounts payable and accrued liabilities............................. (1,940) 4,828 389
Other, net.............................................................. 33 76 (39)
------- ------- -----
Net cash provided by operating activities............................... 160 364 9
------- ------- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures................................................. (1,610) (600) (365)
Investment in unconsolidated affiliates.............................. (32) (104) (84)
Business acquisitions, net of cash acquired.......................... (581) -- --
Proceeds from asset sales............................................ 1,014 802 81
Affiliate transactions............................................... 421 (814) --
Other investing, net................................................. (398) -- 49
------- ------- -----
Net cash used in investing activities................................... (1,186) (716) (319)
------- ------- -----
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term borrowings................................... 778 319 397
Repayments of long-term borrowings................................... -- (89) (44)
Net cash flow from commercial paper and money market lines of credit. 469 (696) (42)
Proceeds from sale of capital stock, options and warrants............ -- -- 22
Dividends and other distributions, net............................... -- -- (8)
Other financing, net................................................. (109) 805 2
------- ------- -----
Net cash provided by financing activities............................... 1,138 339 327
------- ------- -----
Net increase (decrease) in cash and cash equivalents.................... 112 (13) 17
Cash and cash equivalents, beginning of year............................ 32 45 28
------- ------- -----
Cash and cash equivalents, end of year.................................. $ 144 $ 32 $ 45
======= ======= =====
See Notes to Consolidated Financial Statements.
F-5
DYNEGY HOLDINGS INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED AND
RESTATED)
See Introductory Note--Restatements and Absence of Report of Independent
Accountants
Preferred Stock Common Stock Treasury
-------------- ------------ ------------
Paid In Retained Stockholders'
Shares Amount Shares Amount Capital Other Earnings Shares Amount Equity
------ ------ ------ ------ ------- ----- -------- ------ ------ ------
(in millions)
December 31, 1998........................ 5 $ 75 211 $ 1 $ 935 $ -- $ 99 (2) $(17) $ --
Comprehensive income:
Net income............................ -- -- -- -- -- -- 148 -- -- --
Total comprehensive income...............
Options exercised........................ -- -- 5 -- 22 -- -- -- --
Dividends and other distributions........ -- -- -- -- -- -- (8) -- -- --
401(k) plan and profit sharing stock..... -- -- 1 -- 10 -- -- -- --
Options granted.......................... -- -- -- -- 6 -- -- -- --
-- ---- ---- --- ------ ---- ------ -- ---- ------
December 31, 1999........................ 5 $ 75 217 $ 1 $ 973 $ -- $ 239 (2) $(17) $ --
Comprehensive income:
Net income............................ -- -- -- -- -- -- 429 -- -- --
Other comprehensive loss, net of tax.. -- -- -- -- -- (15) -- -- -- --
Total comprehensive income...............
Options exercised........................ -- -- -- -- 73 -- -- -- -- --
401(k) plan and profit sharing stock..... -- -- -- -- 12 -- -- -- -- --
Options granted.......................... -- -- -- -- 15 -- -- -- --
Transformation of former Dynegy Inc. to
Dynegy Holdings Inc..................... (5) (75) (217) (1) (973) -- -- 2 17 1,032
Capital contribution..................... -- -- -- -- 2,236
-- ---- ---- --- ------ ---- ------ -- ---- ------
December 31, 2000........................ -- $ -- -- $-- $2,336 $(15) $ 668 -- $ -- $1,032
Comprehensive income:
Net income............................ -- -- -- -- -- -- 542 -- -- --
Other comprehensive loss, net of tax.. -- -- -- -- -- 31 -- -- --
Total comprehensive income...............
Options exercised........................ -- -- 32 -- -- -- --
401(k) plan and profit sharing stock..... -- -- -- -- 6 -- -- -- --
Options granted.......................... -- -- -- -- 9 -- -- -- --
Treasury stock........................... -- -- -- -- 9 -- -- -- --
-- ---- ---- --- ------ ---- ------ -- ---- ------
December 31, 2001........................ -- $ -- -- $-- $2,392 $ 16 $1,210 0 $ -- $1,032
== ==== ==== === ====== ==== ====== == ==== ======
Total
------
December 31, 1998........................ $1,093
Comprehensive income:
Net income............................ 148
------
Total comprehensive income............... 148
Options exercised........................ 22
Dividends and other distributions........ (8)
401(k) plan and profit sharing stock..... 10
Options granted.......................... 6
------
December 31, 1999........................ $1,271
Comprehensive income:
Net income............................ 429
Other comprehensive loss, net of tax.. (15)
------
Total comprehensive income............... 414
Options exercised........................ 73
401(k) plan and profit sharing stock..... 12
Options granted.......................... 15
Transformation of former Dynegy Inc. to
Dynegy Holdings Inc..................... --
Capital contribution..................... 2,236
------
December 31, 2000........................ $4,021
Comprehensive income:
Net income............................ 542
Other comprehensive loss, net of tax.. 31
------
Total comprehensive income............... 573
Options exercised........................ 32
401(k) plan and profit sharing stock..... 6
Options granted.......................... 9
Treasury stock........................... 9
------
December 31, 2001........................ $4,650
======
See Notes to Consolidated Financial Statements.
F-6
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED AND RESTATED)
INTRODUCTORY NOTE--RESTATEMENTS AND ABSENCE OF REPORT OF INDEPENDENT PUBLIC
ACCOUNTANTS
This Current Report on Form 8-K includes unaudited restatements of the
Company's consolidated financial statements for each of the three years in the
period ended December 31, 2001. These restated financial statements contain
adjustments to the Company's 2001, 2000 and 1999 financial statements
originally filed with Dynegy's Annual Report on Form 10-K for the year ended
December 31, 2001 (the "Form 10-K"). The restatements 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 Statement of Cash Flows for 2001. The effect of this decision was
to reclassify approximately $290 million of previously disclosed 2001 operating
cash flow to financing cash flow. Following the disclosure in the Alpha Form
8-K and in connection with a further review of Project Alpha, Arthur Andersen
("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 approximately $79 million of tax benefit previously
recognized by the Company during the 2001 period. Andersen further advised the
Company that its audit opinion relating to 2001 should no longer be relied upon
as a result of the pending restatements relating to Project Alpha and such
audit opinion was also withdrawn. Dynegy subsequently concluded that its 2001
restated consolidated financial statements would include the consolidation of
ABG Gas Supply, LLC ("ABG"), one of the entities formed in connection with
Dynegy in 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 this consolidation is to
increase Dynegy's consolidated indebtedness by approximately $280 million at
December 31, 2001.
F-7
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Balance Sheet Reconciliation Project. Dynegy originally recognized an
after-tax charge of approximately $80 million ($124 million pre-tax) in the
second quarter 2002 related to a balance sheet reconciliation project
undertaken by the Company at the beginning of 2002. The charge related
principally to the Company's natural gas marketing business. The original $80
million charge has been excluded from the results of operations 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 hedge effectiveness, was inadequate to
support the accounting method previously applied. The resulting restatement
reflects the accounting for these contracts on a mark-to-market basis rather
than on the deferred basis previously employed beginning in the first quarter
2001. The impact of the change in accounting method for these contracts reduced
previously reported 2001 net income by approximately $1 million. The change in
accounting method employed had no impact on previously reported cash flows from
operations in any period.
F-8
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
A synopsis of the financial impact of these restatements on the consolidated
financial statements is as follows (in millions):
2001 2000
--------- ---------
Balance Sheet:
Current Assets:
As Reported........ $ 9,464 $ 9,760
Restatement Effect. 214 (33)
--------- ---------
As Restated........ $ 9,678 $ 9,727
========= =========
Total Assets:
As Reported........ $ 19,973 $ 17,805
Restatement Effect. 562 (32)
--------- ---------
As Restated........ $ 20,535 $ 17,773
========= =========
Current Liabilities:
As Reported........ $ 8,442 $ 8,876
Restatement Effect. 323 56
--------- ---------
As Restated........ $ 8,765 $ 8,932
========= =========
Total Liabilities:
As Reported........ $ 13,998 $ 12,558
Restatement Effect. 703 22
--------- ---------
As Restated........ $ 14,701 $ 12,580
========= =========
Stockholders' Equity:
As Reported........ $ 4,801 $ 4,076
Restatement Effect. (151) (55)
--------- ---------
As Restated........ $ 4,650 $ 4,021
========= =========
F-9
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
2001 2000 1999
--------- --------- ---------
Results of Operations:
Net Income (Loss):
As Reported........ $ 652 $ 446 $ 152
Restatement Effect. (110) (17) (4)
--------- --------- ---------
As Restated........ $ 542 $ 429 $ 148
========= ========= =========
Cash Flow Statement:
Operating Cash Flows:
As Reported........ $ 452 $ 364 $ 9
Restatement Effect. (292) -- --
--------- --------- ---------
As Restated........ $ 160 $ 364 $ 9
========= ========= =========
Investing Cash Flows:
As Reported........ $ (1,186) $ (716) $ (319)
Restatement Effect. -- -- --
--------- --------- ---------
As Restated........ $ (1,186) $ (716) $ (319)
========= ========= =========
Financing Cash Flows:
As Reported........ $ 846 $ 339 $ 327
Restatement Effect. 292 -- --
--------- --------- ---------
As Restated........ $ 1,138 $ 339 $ 327
========= ========= =========
Dynegy's independent public accountant, PricewaterhouseCoopers LLP, is
currently re-auditing the Company's historical financial statements for each of
the three years in the period ended December 31, 2001. The Company expects that
the re-audit of these financial statements will be completed early in the first
quarter 2003. Accordingly, while the preparation of these financial statements
is the responsibility of the Company's management, no independent public
accountant has rendered an audit opinion on these financial statements. As a
result of the three-year re-audit, there may be other revisions to the
Company's historical financial statements in addition to those reflected
herein, some of which could be material. Dynegy will file an amended Form 10-K
reflecting the restatements described herein as soon as practicable after the
date hereof. Following completion of the re-audit, further amendment(s) to the
Form 10-K will be necessary in order to include PricewaterhouseCoopers LLP's
audit report as well as to reflect other changes resulting from the re-audit,
if any.
PLEASE NOTE THAT THESE FINANCIAL STATEMENTS AND THE NOTES THERETO DO NOT
REFLECT EVENTS OCCURRING AFTER THE ORIGINAL FILING OF DYNEGY'S 2001 FORM 10-K
ON MARCH 22, 2002 EXCEPT TO REFLECT THE RESTATEMENT ITEMS DESCRIBED ABOVE. SEE
NOTE 20--SUBSEQUENT EVENTS FOR FURTHER DISCUSSION.
NOTE 1--ORGANIZATION AND OPERATIONS OF THE COMPANY
Dynegy is an energy merchant. Through its global energy delivery network and
marketing, logistics and risk-management capabilities, the Company provides
solutions to customers in North America, the United Kingdom and Continental
Europe. The Company's businesses include power generation and wholesale and
direct commercial and industrial marketing of power, natural gas, coal and
other similar products. The Company is also engaged in the transportation,
gathering and processing of natural gas liquids ("NGLs").
F-10
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
The Company is a wholly owned subsidiary of Dynegy Inc. Dynegy Inc. acquired
Illinova Corporation ("Illinova") in the first quarter of 2000. As part of the
acquisition of Illinova, the former Dynegy Inc., which as renamed Dynegy
Holdings Inc., became a wholly owned subsidiary of a new holding company,
Dynegy Inc. The assets, liabilities and operations of the former Dynegy Inc.
before the acquisition became the assets, liabilities and operations of the
Company after the acquisition.
At the end of September 2000, Dynegy Inc. contributed Dynegy Midwest
Generation ("DMG") to the Company. DMG owns and operates the fossil fuel
generating assets formerly held by Illinois Power Company ("IP"), a wholly
owned subsidiary of Illinova. The net contribution of approximately $2.2
billion was accounted for in a manner similar to a pooling of interests. As a
result, DMG's results of operations are reflected in Dynegy's results of
operations for all of 2000.
NOTE 2--ACCOUNTING POLICIES
The accounting policies of Dynegy conform to generally accepted accounting
principles in the United States. The more significant of such accounting
policies are described below. The preparation of the consolidated financial
statements in conformity with generally accepted accounting principles requires
management to develop estimates and make assumptions that affect reported
financial position and results of operations and that impact the nature and
extent of disclosure, if any, of contingent assets and liabilities. Actual
results could differ materially from those estimates.
Principles of Consolidation. The accompanying consolidated financial
statements include the accounts of the Company and its majority-owned
subsidiaries after elimination of intercompany accounts and transactions.
Certain reclassifications have been made to prior-period amounts to conform
with current-period financial statement classifications.
Cash and Cash Equivalents. Cash and cash equivalents consist of all demand
deposits and funds invested in short-term investments with original maturities
of three months or less.
Investment in Unconsolidated Affiliates. Investments in affiliates in which
the Company has a significant ownership interest, generally 20 percent to 50
percent, are accounted for by the equity method. Any excess of the Company's
investment in these entities over its equity in the underlying net assets of
the affiliates is amortized over the estimated economic service lives of the
underlying assets. Effective January 1, 2002, the Company adopted Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("Statement No. 142"). Statement No. 142 discontinues the amortization of
goodwill associated with equity investments. Other investments less than 20
percent owned with readily determinable fair value are considered
available-for-sale and are recorded at quoted market value or at the lower of
cost or net realizable value, if there is no readily determinable fair value.
For securities with a readily determinable fair value, the change in the
unrealized gain or loss, net of deferred income tax, is recorded as a separate
component of other comprehensive income in the consolidated statement of
stockholders' equity. Realized gains and losses on investment transactions are
determined on the specific-identification basis.
Concentration of Credit Risk. Dynegy provides multiple energy commodity
solutions principally to customers in the electric and gas distribution
industries and to entities engaged in industrial and petrochemical businesses.
These industry concentrations have the potential to impact the Company's
overall exposure to credit risk, either positively or negatively, in that the
customer base may be similarly affected by changes in economic, industry,
weather or other conditions. Receivables generally are not collateralized;
however, Dynegy believes the credit risk posed by industry concentration is
largely offset by the diversification and creditworthiness of the Company's
customer base.
F-11
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Inventories. Inventories consisted primarily of natural gas in storage of
$6 million and $40 million, NGLs of $73 million and $134 million and coal of
$58 million and $24 million at December 31, 2001 and 2000, respectively, and
crude oil of $10 million at December 31, 2001. Such inventory is valued at the
lower of weighted average cost or at market. Materials and supplies inventory
of $55 million and $44 million at December 31, 2001 and 2000, respectively, is
carried at the lower of cost or market using the specific-identification method.
Property, Plant and Equipment. Property, plant and equipment consisting
principally of gas gathering, processing, fractionation, terminaling and
storage facilities, natural gas transmission lines, pipelines, power generating
facilities and communications equipment is recorded at cost. Expenditures for
major replacements, renewals, and major maintenance are capitalized. The
Company considers major maintenance to be expenditures incurred on a cyclical
basis in order to maintain and prolong the efficient operation of its assets.
Expenditures for repairs and minor renewals to maintain facilities in operating
condition are expensed. Depreciation is provided using the straight-line method
over the estimated economic service lives of the assets, ranging from three to
40 years. Composite depreciation rates are applied to functional groups of
property having similar economic characteristics. The approximate depreciation
rates are as follows:
Annual
Asset Group Range of Years Percentage
----------- -------------- -------------
Gathering and Processing Systems.. 10 to 25 years 4.0% to 10.0%
Power Generation Facilities....... 27 to 35 years 2.9% to 3.7%
Transportation Equipment.......... 10 to 25 years 4.0% to 10.0%
Buildings and Improvements........ 10 to 40 years 2.5% to 10.0%
Office and Miscellaneous Equipment 3 to 35 years 2.9% to 33.3%
Storage Assets.................... 14 to 30 years 3.3% to 7.1%
Gains and losses are not recognized for retirements of property, plant and
equipment subject to composite depreciation rates ("composite rate") until the
asset group subject to the composite rate is retired. Gains and losses on the
sale of individual assets are reflected in Other income or Other expense,
respectively, in the Consolidated Statement of Operations. Through the end of
the period, the Company has reviewed the carrying value of its long-lived
assets in accordance with provisions of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed of" ("Statement No. 121"). In August 2001, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("Statement No. 144"). Statement No. 144 addresses the accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
Statement No. 121 and APB Opinion No. 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions." The
Company's adoption of Statement No. 144 on January 1, 2002 did not have any
impact on the Company's financial position or results of operations.
Environmental Costs and Other Contingencies. Environmental costs relating
to current operations are expensed or capitalized, as appropriate, depending on
whether such costs provide future economic benefit. Liabilities are recorded
when environmental assessment indicates that remedial efforts are probable and
the costs can be reasonably estimated. Measurement of liabilities is based on
currently enacted laws and regulations, existing technology and site-specific
costs. Such liabilities may be recognized on a discounted basis if the amount
and timing of anticipated expenditures for a site are fixed or reliably
determinable; otherwise, such liabilities are recognized on an undiscounted
basis. Environmental liabilities in connection with assets that are
F-12
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
sold or closed are recognized upon such sale or closure, to the extent they are
probable, can be estimated and have not previously been reserved. In assessing
environmental liabilities, no offset is made for potential insurance
recoveries. Recognition of any joint and several liability is based upon the
Company's best estimate of its final pro rata share of such liability.
Liabilities for other contingencies are recognized upon identification of an
exposure, which when fully analyzed indicates that it is both probable that an
asset has been impaired or that a liability has been incurred and that such
loss amount can be reasonably estimated. Costs to remedy such contingencies or
other exposures are charged to a reserve, if one exists, or otherwise to
current operations. When a range of probable loss exists, the Company accrues
the lesser end of the range.
During 2001, the FASB issued Statement of Financial Accounting Standards No.
143, "Accounting for Asset Retirement Obligations" ("Statement No. 143").
Statement No. 143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred with
the associated asset retirement costs being capitalized as a part of the
carrying amount of the long-lived asset. The Company is evaluating the future
financial effects of adopting Statement No. 143 and expects to adopt the
standard effective January 1, 2003.
Goodwill and Other Intangible Assets. Intangible assets, principally
goodwill, have been amortized on a straight-line basis over their estimated
useful lives of 25 to 40 years. However, during 2001, the FASB issued Statement
No. 142 which discontinues goodwill amortization over its estimated useful
life; rather, goodwill will be subject to at least an annual fair-value based
impairment test. The Company is currently analyzing any impact the adoption of
Statement No. 142 effective January 1, 2002 will have on its financial position
and results of operations.
Revenue Recognition. Dynegy utilizes two comprehensive accounting models in
reporting its consolidated financial position and results of operations as
required by generally accepted accounting principles--an accrual model and a
fair value model. Dynegy determines the appropriateness of application of one
comprehensive accounting model over the other in accounting for its varied
operations based on guidance provided in numerous accounting standards and
positions adopted by the FASB or the Securities and Exchange Commission.
The accrual model is used to account for the Company's physically owned
asset businesses. Ownership and operation of physical assets characterize these
businesses. Dynegy uses these physical assets in various manufacturing and
delivery processes. These processes include the generation of electricity and
the separation of natural gas liquids into their component parts from a stream
of natural gas. End sales from these businesses result in physical delivery of
commodities or services to Dynegy wholesale, commercial and industrial and
retail customers.
Revenues for product sales and gas processing and marketing services are
recognized when title passes to the customer or when the service is performed.
Fractionation and transportation revenues are recognized based on volumes
received in accordance with contractual terms. Revenues derived from power
generation are recognized upon output, product delivery or satisfaction of
specific targets, all as specified by contractual terms. Fees derived from
engineering and construction contracts and development and other activities
received from joint ventures in which Dynegy holds an equity interest are
deferred to the extent of Dynegy's ownership interest and amortized on a
straight-line basis over appropriate periods, which vary according to the
nature of the service provided and the ventures' operations. Shipping and
handling costs are included in revenue when billed to customers in conjunction
with the sale of products.
F-13
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
The fair value model is used to account for certain forward physical and
financial transactions in the WEN and DMS segments, which meet criteria defined
by the FASB or the Emerging Issues Task Force. These criteria require these
contracts to be related to future periods and contain fixed price and volume
components and must have terms that require or permit net settlement of the
contract in cash or its equivalent. As these transactions may be settled in
cash, the value of the assets and liabilities associated with these
transactions is reported at estimated settlement value based on current prices
and rates as of each balance sheet date. The net gains or losses resulting from
the revaluation of these contracts during the period are recognized currently
in the Company's result of operations. Assets and liabilities associated with
these transactions are reflected on the Company's balance sheet as risk
management assets and liabilities, classified as short-term or long-term
pursuant to each contract's individual tenor. Net unrealized gains and losses
from these contracts are classified as revenue in the accompanying Consolidated
Statements of Operations. Transactions that have been realized and settled are
reflected gross in revenues and cost of sales.
The Company routinely enters into financial instrument contracts to hedge
purchase and sale commitments, fuel requirements and inventories in its NGLs,
electricity and coal businesses in order to minimize the risk of changes in
market prices in these commodities. Dynegy also monitors its exposure to
fluctuations in interest rates and foreign currency exchange rates and may
execute swaps, forward-exchange contracts or other financial instruments to
manage these exposures. Gains and losses from hedging transactions are
recognized in income in the periods for which the underlying commodity,
interest rate or foreign currency transaction impacts earnings. If the
underlying being hedged by the commodity, interest rate or foreign currency
transaction is disposed of or otherwise terminated, the gain or loss associated
with such contract is no longer deferred and is recognized in the period the
underlying contract is eliminated.
Income Taxes. The Company files a consolidated United States federal income
tax return and, for financial reporting purposes, provides income taxes for the
difference in the tax and financial reporting bases of its assets and
liabilities in accordance with Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes."
Foreign Currency Translations. For subsidiaries whose functional currency
is not the U.S. Dollar, assets and liabilities are translated at year-end rates
of exchange and revenues and expenses are translated at average exchange rates
prevailing for each month. Translation adjustments for the asset and liability
accounts are included as a separate component of other comprehensive income in
stockholders' equity. Currency transaction gains and losses are recorded in
income.
NOTE 3--COMMERCIAL OPERATIONS, RISK MANAGEMENT ACTIVITIES AND FINANCIAL
INSTRUMENTS
Dynegy's operations and periodic returns are impacted by a myriad of risk
factors, some of which may, and some of which may not, be mitigated by risk
management methods. These risks include, but are not limited to, commodity
price, interest rate and foreign exchange rate fluctuations, weather patterns,
counterparty risk, management estimations, strategic investment decisions,
changes in competition, operational risks, environmental risks and changes in
regulation.
The potential for changes in the market value of Dynegy's commodity,
interest rate and currency portfolios is referred to as "market risk". A
description of each market risk is set forth below:
. Commodity price risks result from exposures to changes in spot prices,
forward prices and volatilities of commodities, such as electricity,
natural gas, crude oil and other similar products;
F-14
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
. Interest rate risks primarily result from exposures to changes in the
level, slope and curvature of the yield curve and the volatility of
interest rates; and
. Currency rate risks result from exposures to changes in spot prices,
forward prices and volatilities of currency rates.
Dynegy seeks to manage these market risks through diversification,
controlling position sizes and executing hedging strategies. The ability to
manage an exposure may, however, be limited by adverse changes in market
liquidity or other factors. Dynegy cannot guarantee the ultimate effectiveness
of its risk management activities.
Dynegy generally attempts to balance its fixed-price physical and financial
purchase and sales commitments in terms of contract volumes, and the timing of
performance and delivery obligations. However, the Company may, at times, have
a bias in the market within guidelines established by management and Dynegy's
Board of Directors, resulting from the management of its portfolio. In
addition, as a result of marketplace illiquidity and other factors, the Company
may, at times, be unable to hedge its portfolio fully for certain market risks.
The financial performance and cash flow derived from certain merchant
generating capacity (e.g., peaking facilities) are impacted annually, either
favorably or unfavorably, by changes in and the relationship between the cost
of the commodity fueling the facilities and electricity prices, which in turn
influences the volume of electricity generated by these assets.
Operating results associated with natural gas gathering, processing and
fractionation activities are sensitive to changes in NGL prices and the
availability of inlet volumes. In addition, similar to peaking electricity
generating facilities, straddle processing plants are impacted by changes in,
and the relationship between, natural gas and NGL prices, which in turn
influence the volumes of gas processed at these facilities. The impact from
changes in NGL prices on upstream operations results principally from the
nature of contractual terms under which natural gas is processed and products
are sold. The availability of inlet volumes directly affects the utilization
and profitability of this segment's businesses. Commodity price volatility may
also affect operating margins derived from the Company's NGL marketing
operations.
Dynegy's commercial groups manage, on a portfolio basis, the resulting
market risks inherent in commercial transactions, subject to parameters
established by the Dynegy Board of Directors. Market risks are monitored by a
risk control group that operates independently from the commercial units to
ensure compliance with Dynegy's risk-management policies. Risk measurement is
also practiced daily against the Dynegy portfolios with Value at Risk, stress
testing and scenario analysis on the commercial portfolios.
Quantitative and Qualitative Market Risk Disclosures. In addition to
applying business judgment, senior management uses a number of quantitative
tools to manage Dynegy's exposure to market risk. These tools include:
. Risk limits based on a summary measure of market risk exposure, referred
to as VaR; and
. Stress and scenario analyses as performed daily that measure the
potential effects of various market events, including substantial swings
in volatility factors, absolute commodity price changes and the impact of
interest rate movements.
VaR represents the potential loss in value of Dynegy's enterprise-wide
marketing portfolio due to adverse market movements over a defined time horizon
with a specified confidence level.
F-15
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
The modeling of the risk characteristics of Dynegy's marketing portfolio
involves a number of assumptions and approximations. Dynegy estimates VaR using
a JP Morgan RiskMetrics(TM) approach assuming a one-day holding period and a 95
percent confidence level. While management believes that these assumptions and
approximations are reasonable, there is no uniform industry methodology for
estimating VaR, and different assumptions and/or approximations could produce
materially different VaR estimates.
Dynegy uses historical data to estimate the Company's VaR and, to better
reflect current asset and liability volatilities, these historical data are
weighted to give greater importance to more recent observations. Given its
reliance on historical data, VaR is most effective in estimating risk exposures
in markets in which there are not sudden fundamental changes or shifts in
market conditions. An inherent limitation of VaR is that past changes in market
risk factors, even when weighted toward more recent observations, may not
produce accurate predictions of future market risk. VaR should be evaluated in
light of this and the methodology's other limitations.
Credit and Market Reserves. In connection with the market valuation of its
energy commodity contracts, the Company maintains certain reserves for a number
of risks associated with these future commitments. Among others, these include
reserves for credit risks based on the financial condition of counterparties,
reserves for price and product location ("basis") differentials and
consideration of the time value of money for long-term contracts.
Counterparties in its marketing portfolio consist principally of financial
institutions, major energy companies and local distribution companies. The
creditworthiness of these counterparties may impact overall exposure to credit
risk, either positively or negatively. However, with regard to its
counterparties Dynegy maintains credit policies that management believes
minimize overall credit risk. Determination of the credit quality of its
counterparties is based upon a number of factors, including credit ratings,
financial condition, project economics and collateral requirements. When
applicable, the Company employs standardized agreements that allow for the
netting of positive and negative exposures associated with a single
counterparty.
Based on these policies, its current exposures and its credit reserves,
Dynegy does not anticipate a material adverse effect on its financial position
or results of operations as a result of counterparty nonperformance. As a
result of Enron Corp.'s ("Enron") bankruptcy, the Company reserved an after-tax
amount of $51 million in the fourth quarter of 2001 related to the Company's
net exposure for commercial transactions with the bankrupt enterprise. The
global netting agreement between Dynegy and Enron as well as the valuation of
these commercial transactions covered by the agreement are subject to approval
from the bankruptcy court.
The following table displays the value of Dynegy's marketing transactions at
December 31, 2001:
Investment Below Investment
Grade Grade Credit
Credit Quality Quality or Unrated Total
-------------- ------------------ ------
(in millions)
Utilities and power generators..... $ 562 $(23) $ 539
Financial institutions............. (102) 1 (101)
Oil and gas producers.............. 166 129 295
Commercial and industrial companies 367 94 461
Other.............................. 48 6 54
------ ---- ------
Value of portfolio before reserves. $1,041 $207 1,248
====== ==== ======
Credit and market reserves (199)
------
1,049
Other................................................................ 34
------
Net risk management assets........................................... $1,083
======
F-16
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
The net risk management asset of $1,083 million is the aggregate of the
following line items on the Consolidated Balance Sheet: Current Assets--Assets
from risk-management activities, Other Assets--Assets from risk-management
activities, Current Liabilities--Liabilities from risk-management activities
and Other Liabilities--Liabilities from risk-management activities.
At December 31, 2001, the term of Dynegy's marketing portfolio extends to
2016 and the average remaining life of an individual transaction was five
months.
Accounting for Derivative Instruments and Hedging Activities. The Financial
Accounting Standards Board ("FASB") issued, and subsequently amended, Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("Statement No. 133"), which became effective January 1, 2001. Provisions in
Statement No. 133, as amended, affect the accounting and disclosure of certain
contractual arrangements and operations of the Company. Under Statement No.
133, as amended, all derivative instruments are recognized in the balance sheet
at their fair values and changes in fair value are recognized immediately in
earnings, unless the derivatives which are not a part of the Company's
marketing activities qualify and are designated as hedges of future cash flows,
fair values, net investments or qualify and are designated as normal purchases
and sales. For derivatives treated as hedges of future cash flows, the
effective portion of changes in fair value is recorded in other comprehensive
income until the related hedged items impact earnings. Any ineffective portion
of a hedge is reported in earnings immediately. For derivatives treated as fair
value hedges, changes in the fair value of the derivative and changes in the
fair value of the related asset or liability are recorded in current period
earnings. For derivatives treated as hedges of net investment in foreign
operations, the effective portion of changes in the fair value of the
derivative is recorded in the cumulative translation adjustment. Derivatives
treated as normal purchases or sales are recorded and recognized in income
using accrual accounting.
The Company recorded the impact of the adoption of Statement No. 133, as
amended, as a cumulative effect adjustment in the Company's consolidated
results on January 1, 2001. The amounts recorded, which are immaterial to net
income and the Company's financial position, are as follows (in millions):
Other
Net Comprehensive
Income Income
------ -------------
Adjustment to fair value of derivatives $ 3 $ 62
Income tax effects..................... (1) (29)
--- ----
Total........................... $ 2 $ 33
=== ====
Changes in stockholder's equity related to derivatives for the year ended
December 31, 2001 were as follows, net of taxes (in millions):
Transition adjustment as of January 1, 2001 $ 33
Current period decline in fair value....... 4
Reclassifications to earnings, net......... (11)
----
Balance at December 31, 2001........ $ 26
====
F-17
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Accumulated Other Comprehensive Loss, Net of Tax is included in
Stockholders' Equity on the Consolidated Balance Sheet as follows (in millions):
Statement No. 133, Net............................................................ $ 26
Currency Translation Adjustment................................................... 4
Unrealized Loss on Available-for-Sale Securities, Net............................. (14)
----
Accumulated Other Comprehensive Loss, Net of Tax, at December 31, 2001..... $ 16
====
Additional disclosures required by Statement No. 133, as amended, are
provided in the following paragraphs.
From time to time, the Company may enter into various financial derivative
instruments which qualify as cash flow hedges. Instruments related to its
energy convergence and midstream liquids businesses are entered into for
purposes of hedging forward fuel requirements for certain power generation
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.
The Company determined that its assessment of hedge effectiveness related to
certain contracts entered into to hedge fuel requirements and power sales
commitments was incomplete. As a result, the accounting for these contracts has
been restated herein. Otherwise, during the year ended December 31, 2001, there
was no material ineffectiveness from changes in fair value of hedge positions,
and no amounts were excluded from the assessment of hedge effectiveness related
to the hedge of future cash flows. Additionally, no amounts were reclassified
to earnings in connection with forecasted transactions that were no longer
considered probable of occurring.
The balance in other comprehensive income at December 31, 2001 is expected
to be reclassified to future earnings, contemporaneously with the related
purchases of fuel, sales of electricity or liquids, payments of interest and
recognition of operating lease expense, as applicable to each type of hedge. Of
this amount, approximately $26 million of income, net of taxes, is estimated to
be reclassified into earnings over the year ending December 31, 2002. The
actual amounts that will be reclassified to earnings over the next year and
beyond could vary materially from this estimated amount as a result of changes
in market conditions.
The Company also enters into derivative instruments which qualify as
fair-value hedges. The Company used interest rate-swaps to convert a portion of
its nonprepayable fixed-rate debt into variable-rate debt. During the twelve
months ended December 31, 2001, there was no ineffectiveness from changes in
fair value of hedge positions, and no amounts were excluded from the assessment
of hedge effectiveness. Additionally, no amounts were recognized in relation to
firm commitments that no longer qualified as fair-value hedge items.
The Company has investments in foreign subsidiaries, and the net assets of
these subsidiaries are exposed to currency exchange-rate volatility. The
Company uses derivative financial instruments, including foreign exchange
forward contracts and cross currency interest rate swaps, to hedge this
exposure. For the year ended December 31, 2001, approximately $29 million of
net losses related to these contracts were included in the cumulative
translation adjustment. This amount neutralizes the cumulative translation
gains of the underlying net investments in foreign subsidiaries for the period
the derivative financial instruments were outstanding.
F-18
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Fair Value of Financial Instruments. The following disclosure of the
estimated fair value of financial instruments is made in accordance with the
requirements of Statement of Financial Accounting Standards No. 107,
"Disclosures About Fair Value of Financial Instruments." The estimated
fair-value amounts have been determined by the Company using available market
information and selected valuation methodologies. Considerable judgment is
required in interpreting market data to develop the estimates of fair value.
The use of different market assumptions or valuation methodologies could have a
material effect on the estimated fair-value amounts.
The carrying values of current financial assets and liabilities approximate
fair values due to the short-term maturities of these instruments. The carrying
amounts and fair values of the Company's other financial instruments were:
December 31,
--------------------------------
2001 2000
--------------- ---------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------ -------- ------
(in millions)
Dynegy Holdings Inc.
Commercial Paper.......................................... $ 6 $ 6 $ 115 $ 115
Revolving Credit Facilities............................... 600 600 -- --
Canadian Credit Agreement................................. 40 40 59 59
Senior Notes, 6.75% through 8.125%, due 2002 through 2026. 1,693 1,488 1,200 1,200
ABG Gas Supply............................................ 282 267 -- --
Preferred Securities of a Subsidiary Trust................ 200 159 200 189
Fair Value Hedge Interest Rate Swap....................... (7) (7) -- --
Cash Flow Hedge Interest Rate Swap........................ 1 1 -- --
Interest Rate Risk-Management Contracts................... 6 6 -- --
Commodity Risk-Management Contracts....................... 292 292 970 958
The financial statement carrying amounts of the Company's credit agreement
and variable-rate debt obligations were assumed to approximate fair value. The
fair values of the Company's other long-term indebtedness, including the
Preferred Securities of a Subsidiary Trust, were based on quoted market prices
by financial institutions that actively trade these debt securities. The fair
value of interest rate, foreign currency and commodity risk-management
contracts were based upon the estimated consideration that would be received to
terminate those contracts in a gain position and the estimated cost that would
be incurred to terminate those contracts in a loss position.
F-19
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
The absolute notional contract amounts associated with the commodity
risk-management, interest rate and foreign currency exchange contracts,
respectively, were as follows:
December 31,
------------------------
2001 2000 1999
------- -------- -------
Natural Gas (Trillion Cubic Feet)................................. 11.894 7.709 5.702
Electricity (Million Megawatt Hours).............................. 77.997 162.321 42.949
Natural Gas Liquids (Million Barrels)............................. 5.655 6.410 19.902
Weather Derivatives (In thousands of $/Degree Day)................ $ 190 $ 385 $ --
Crude Oil (Million Barrels)....................................... -- -- 35.554
Coal (Millions of Tons)........................................... 18.5 17.3 --
Fair Value Hedge Interest Rate Swaps (In millions of U.S. Dollars) $ 206 $ -- $ 37
Fixed Interest Rate Received on Swaps (Percent)................ 5.284 -- 8.210
Cash Flow Hedge Interest Rate Swaps (In millions of U.S. Dollars). $ 100 $ -- $ --
Fixed Interest Rate Paid on Swaps (Percent).................... 4.397 -- --
Interest Rate Risk-Management Contract............................ $ 206 $ -- $ --
Fixed Interest Rate Paid on Swaps (Percent).................... 5.310 -- --
Interest Rate Risk-Management Contract............................ $ 100 $ -- $ --
Fixed Interest Rate Received (Percent)......................... 4.370 -- --
U.K. Pound Sterling (In millions of U.S. Dollars)................. $ 595 $ -- $ 86
Average U.K. Pound Sterling Contract Rate (U.S. Dollars).......... $1.4125 $ -- $1.6191
Euro Dollars (In millions of U.S. Dollars)........................ $ -- $ -- $ --
Average Euro Dollar Contract Rate (U.S. Dollars).................. $ -- $ -- $ --
Canadian Dollar (In Millions of U.S. Dollars)..................... $ -- $ -- $ 289
Average Canadian Dollar Contract Rate (U.S. Dollars).............. $ -- $ -- $0.6775
In 2001, approximately 11% of the Company's consolidated revenues and 12% of
consolidated costs of sales were derived from transactions with Enron. Based on
the terms of these transactions, Dynegy can fulfill these needs through other
counterparties.
F-20
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
NOTE 4--CASH FLOW INFORMATION
Detail of supplemental disclosures of cash flow and non-cash investing and
financing information was:
Year Ended
December 31,
----------------
2001 2000 1999
----- ---- ----
($ in millions)
Interest paid (net of amount capitalized).... $ 118 $103 $80
===== ==== ===
Taxes paid (net of refunds).................. $ 87 $ 40 $ 2
===== ==== ===
Detail of business acquired:(1)
Current assets and other..................... $ 35 $ -- $--
Fair value of non-current assets............. 823 -- --
Liabilities assumed, including deferred taxes (263) -- --
Capital stock issued and options exercised... -- -- --
Cash balance acquired........................ (14) -- --
----- ---- ---
Cash paid, net of cash acquired.............. $ 581 $ -- $--
===== ==== ===
- --------
(1) The business acquired is BG Storage Limited ("BGSL"), a wholly owned
subsidiary of BG Group plc. See Note 14 for more information regarding this
acquisition.
NOTE 5--PROPERTY, PLANT AND EQUIPMENT
Investments in property, plant and equipment consisted of:
December 31,
--------------
2001 2000
------ ------
($ in millions)
Wholesale Energy Network:
Generation assets...................... $4,023 $3,490
Storage facilities (U.K.).............. 795 --
Dynegy Midstream Services:
Natural gas processing................. 1,000 934
Fractionation.......................... 200 198
Liquids marketing...................... 204 268
Natural gas gathering and transmission. 225 193
Crude oil.............................. -- 9
IT Systems and Other...................... 436 285
------ ------
6,883 5,377
Less: accumulated depreciation............ (810) (586)
------ ------
$6,073 $4,791
====== ======
Interest capitalized related to costs of projects in process of development
totaled $19 million, $30 million and $17 million for the years ended December
31, 2001, 2000 and 1999, respectively. In 2000, a $25 million impairment
reserve was recorded related to Canadian gas processing assets.
F-21
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
NOTE 6--INVESTMENTS IN UNCONSOLIDATED AFFILIATES AND NORTHERN NATURAL GAS
COMPANY
Investments in affiliates that are not controlled by the Company but where
the Company has significant influence over operations are accounted for by the
equity method. The Company's share of net income from these affiliates is
reflected in the Consolidated Statements of Operations as Equity in earnings of
unconsolidated affiliates. The Company's principal equity method investments
consist of entities that operate generation assets and natural gas liquids
assets. These equity investments totaled $768 million and $663 million at
December 31, 2001 and 2000, respectively. The Company entered into these
ventures principally for the purpose of sharing risk and leveraging existing
commercial relationships. These ventures maintain independent capital
structures and have financed their operations on a non-recourse basis to the
Company.
Generation Assets. Investments include ownership interests in seven joint
ventures that own fossil fuel electric generation facilities in diverse
geographic regions. The Company's ownership is generally 50 percent in the
majority of these ventures. The Company's net investment of $609 million at
December 31, 2001 represents approximately 2,400 MW of net generating capacity.
At December 31, 2001, the Company's investment exceeded its equity in the
underlying assets by approximately $143 million. Dynegy's most significant
investment is comprised of its interest in West Coast Power, LLC ("West Coast
Power"), a 50 percent owned venture with NRG, which totaled approximately $330
million at December 31, 2001 and generated equity earnings of $162 million in
2001.
Midstream Investments. Investments include ownership interests in three
ventures that operate natural gas liquids processing, extraction, fractionation
and storage facilities in the Gulf Coast region as well as an interstate NGL
pipeline. The Company's ownership interest in these ventures ranges from 23
percent to 39 percent. At December 31, 2001, the Company's investment exceeded
its equity in the underlying net assets by approximately $43 million.
Summarized aggregate financial information for these investments and
Dynegy's equity share thereof was:
December 31,
-----------------------------------------
2001 2000(1) 1999(1)
------------- ------------- -------------
Equity Equity Equity
Total Share Total Share Total Share
------ ------ ------ ------ ------ ------
($ in millions)
Current assets......... $1,098 $ 488 $ 887 $ 345 $ 525 $ 184
Non-current assets..... 2,301 1,002 2,483 1,147 2,787 1,193
Current liabilities.... 685 320 650 262 847 374
Non-current liabilities 644 322 910 444 1,183 487
Revenues............... 3,503 1,459 3,462 1,479 1,339 526
Operating margin....... 738 321 704 299 443 174
Net income............. 445 208 402 181 135 58
- --------
(1) The financial data for 2000 and 1999 are exclusive of amounts attributable
to the Company's investment in Accord Energy Limited ("Accord") as data was
unavailable for these periods. For competitive reasons, Accord was
unwilling to provide the Company with detailed financial information
concerning its operations. The Company contractually agreed not to require
the production of such information in its negotiations with Accord.
Dynegy's share of Accord earnings for each of the years ended December 31,
2000 and 1999 totaled $9 million and $21 million, respectively. The Company
sold its investment in Accord in the third quarter of 2000.
F-22
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Other Investments. In addition to these equity investments, the Company
holds interests in companies for which it does not have significant influence
over the operations. These investments are accounted for by the cost method.
Such investments totaled $32 million and $14 million at December 31, 2001 and
2000, respectively. The Company also owns securities that have a readily
determinable fair market value and are considered available-for-sale. The
market value of these investments at December 31, 2001 and 2000 was estimated
to be $9 million and $17 million, respectively.
In November 2001, Dynegy Inc. acquired 1,000 shares of Series A Preferred
Stock ("Series A Preferred Stock") in Northern Natural Gas Company ("Northern
Natural") for $1.5 billion. Concurrent with this investment in Northern
Natural, the Company entered into an option agreement with a subsidiary of
Enron that indirectly owned the common stock of Northern Natural, under which a
Dynegy subsidiary had the option to purchase all of the equity of that Enron
subsidiary. In connection with Dynegy Inc.'s termination of a merger agreement
with Enron, the Company gave notice of its intention to exercise its option to
purchase such equity. The exercise price for the option was $23 million subject
to adjustment based on Northern Natural's indebtedness and for the amount of
working capital at closing. Subsequent litigation relating to the option was
settled by the parties on January 3, 2002 and the closing of the option
exercise occurred on January 31, 2002. At January 31, 2002, Northern Natural
had approximately $950 million of debt outstanding. Approximately $500 million
of this debt is in the form of senior unsecured notes with maturities ranging
from 2005 to 2011. The remaining $450 million is in the form of a secured line
of credit due November 2002. Dynegy has agreed to commence a tender offer by
April 1, 2002 for $100 million of the senior unsecured notes due in 2005. An
Enron subsidiary has the option to reacquire Northern Natural through June 30,
2002 for $1.5 billion plus accrued and unpaid dividends on the Series A
Preferred Stock and the option exercise price, subject to adjustments based on
Northern Natural's indebtedness and working capital.
NOTE 7--DEBT
Long-term debt outstanding consisted of the following at December 31:
2001 2000
------ ------
($ in millions)
Long-Term Debt:
Commercial Paper.......................... $ 6 $ 115
Revolving Credit Facilities............... 600 --
Canadian Credit Agreements................ 40 59
Senior Notes, 6.875% due 2002............. 200 200
Senior Notes, 6.75% due 2005.............. 150 150
Senior Notes, 8.125% due 2005............. 300 300
Senior Notes, 7.45% due 2006.............. 200 200
Senior Notes, 6.875% due 2011............. 493 --
Senior Debentures, 7.125% due 2018........ 175 175
Senior Debentures, 7.625% due 2026........ 175 175
ABG Gas Supply............................ 282 --
------ ------
2,621 1,374
Less: Amounts due within one year..... 262 --
------ ------
Total Long-Term Debt......................... $2,359 $1,374
====== ======
Aggregate maturities of the principal amounts of all long-term indebtedness
are: 2002--$256 million; 2003--$64 million; 2004--$69 million; 2005--$524
million; 2006--$219 million and beyond $1.5 billion.
F-23
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Commercial Paper, Money Market Lines of Credit and Extendible Floating Rate
Loans. The Company utilizes commercial paper proceeds and borrowings under
uncommitted money market lines of credit for general corporate purposes,
including short-term working capital requirements. The commercial paper program
is limited to and fully supported by committed credit agreements. Weighted
average interest rates on amounts outstanding under the commercial paper
program were 3.2% and 8.1% at December 31, 2001 and 2000, respectively. The
Company classifies outstanding commercial paper and borrowings under money
market lines of credit as long-term debt to the extent of availability under
committed credit facilities, as management's intent is to maintain these
obligations for longer than one year, subject to an overall reduction in
corporate debt levels.
Credit Agreements: The following table displays certain terms of the
Company's revolving credit agreements as of December 31, 2001:
Total Unused Maturity Eurodollar Facility
Capacity Capacity Date Term Margin Fee
-------- -------- -------- ---------- ---------- --------
($ in millions)
$ 400 $ 18 05/27/03 Multi-year 0.200% 0.100%
1,200 600 05/01/02 364-day 0.400% 0.100%
40 -- 11/20/02 1-year 0.600% 0.250%
These credit agreements provide funding for working capital, capital
expenditures and general corporate purposes, including support for lines of
credit and commercial paper programs. Generally, borrowings under the credit
agreements bear interest at a Eurodollar rate plus a margin that is determined
based on designated unsecured debt ratings. Financial covenants in the credit
agreements are limited to a debt-to-capitalization test. Letters of credit
under the credit agreements aggregated $377 million at December 31, 2001.
ABG Gas Supply Credit Agreement. On April 10, 2001, ABG Gas Supply ("ABG")
entered into a credit agreement with a consortium of lenders in order to
provide financing associated with Project Alpha (the "ABG Credit Agreement").
Advances under the agreement allowed ABG to purchase NYMEX natural gas
contracts with the underlying physical gas supply being sold to Dynegy
Marketing and Trade under an existing natural gas purchase and sales agreement.
The ABG Credit Agreement requires ABG to repay the advances in monthly
installments commencing February 2002 through December 2004 from funds received
from Dynegy Marketing and Trade under the natural gas purchases and sales
agreement. The advances bear interest at a Eurodollar rate plus a margin as
defined in the agreement. Advances of $282 million were outstanding under the
ABG Credit Agreement at December 31, 2001.
Long-Term Debt. The Company has a series of notes, debentures, new mortgage
bonds, pollution control bonds and transitional funding trust notes having
maturities that extend through 2026. Certain of these securities are redeemable
at the Company's option, in whole or in part, from time-to-time, at
formula-based redemption prices as defined in the applicable indenture.
Certain of Dynegy's debt instruments contain routine provisions which, if
not met, could require early payment, additional collateral support or similar
actions. For Dynegy, these events include leverage ratios, bankruptcy or
insolvency, defaults on principal or interest payments and change of control
provisions. These instruments generally provide for a cure period should any of
these events occur.
In February 2002, Dynegy issued $500 million of 8.75% Senior Notes due 2012.
Interest will be paid on a semi-annual basis beginning in August 2002. These
notes can be redeemed prior to 2012, in whole or in part, at a price equal to
the redemption price included in the related prospectus supplement.
F-24
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
NOTE 8--INCOME TAXES
The Company is subject to U.S. federal, foreign and state income taxes on
its operations. Components of income tax expense (benefit) were:
Year Ended
December 31,
----------------
2001 2000 1999
---- ---- ----
($ in millions)
Current tax expense:
Domestic.................... $216 $105 $ --
Foreign..................... 5 25 12
Deferred tax expense (benefit):
Domestic.................... 137 116 53
Foreign..................... (17) (20) 7
---- ---- ----
Income tax provision:.......... $341 $226 $ 72
==== ==== ====
Components of income before income taxes were as follows:
Year Ended
December 31,
---------------
2001 2000 1999
---- ---- ----
($ in millions)
Income (loss) before income taxes:
Domestic....................... $909 $629 $159
Foreign........................ (28) 26 61
---- ---- ----
$881 $655 $220
==== ==== ====
Deferred income taxes are provided for the temporary differences between the
tax basis of Dynegy's assets and liabilities and their reported financial
statement amounts.
Significant components of deferred tax liabilities and assets were:
December 31,
-----------------
2001 2000
-------- --------
($ in millions)
Deferred tax assets:
Loss carry forward................................ $ 59 $ 49
Alternative Minimum Tax ("AMT") and other credits. 5 3
-------- --------
64 52
Valuation allowance.................................. -- --
-------- --------
64 52
Deferred tax liabilities:
Items associated with capitalized costs........... 748 364
-------- --------
Net deferred tax liability........................... $ 684 $ 312
======== ========
Realization of the aggregate deferred tax asset is dependent on the
Company's ability to generate taxable earnings in the future. There was no
valuation allowance established at December 31, 2001 or 2000, as management
believes the aggregate deferred asset is more likely than not to be fully
realized in the future.
F-25
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Income tax provisions for the years ended December 31, 2001, 2000 and 1999,
were equivalent to effective rates of 39 percent, 34 percent and 33 percent,
respectively. Differences between taxes computed at the U.S. federal statutory
rate and the Company's reported income tax provision were:
Year Ended
December 31,
--------------
2001 2000 1999
---- ---- ----
($ in millions)
Expected tax at U.S. statutory rate $309 $230 $77
State taxes........................ 19 13 4
Foreign tax benefit................ 1 (4) (3)
Basis differentials and other...... 12 (13) (6)
---- ---- ---
Income tax provision............... $341 $226 $72
==== ==== ===
At December 31, 2001, the Company had approximately $165 million of regular
tax net operating loss carryforwards and $137 million of AMT net operating loss
carryforwards. The net operating loss carryforwards expire from 2009 through
2020. The AMT credit carryforwards do not expire. Certain provisions of the
Internal Revenue Code place an annual limitation on the Company's ability to
utilize tax carryforwards existing as of the date of a 1995 and a 2000 business
acquisition. Management believes such carryforwards will be fully realized
prior to expiration.
NOTE 9--PREFERRED SECURITIES
In May 1997, NGC Corporation Capital Trust I ("Trust") issued, in a private
transaction, $200 million aggregate liquidation amount of 8.316% Subordinated
Capital Income Securities ("Trust Securities") representing preferred undivided
beneficial interests in the assets of the Trust. The Trust invested the
proceeds from the issuance of the Trust Securities in an equivalent amount of
8.316% Subordinated Debentures ("Subordinated Debentures") of the Company. The
sole assets of the Trust are the Subordinated Debentures. The Trust Securities
are subject to mandatory redemption in whole but not in part on June 1, 2027,
upon payment of the Subordinated Debentures at maturity, or in whole but not in
part at any time, contemporaneously with the optional prepayment of the
Subordinated Debentures, as allowed by the associated indenture. The
Subordinated Debentures are redeemable, at the option of the Company, in whole
at any time or in part from time to time, at formula-based redemption prices,
as defined in the indenture. The Subordinated Debentures represent unsecured
obligations of the Company and rank subordinate and junior in right of payment
to all Senior Indebtedness to the extent and in the manner set forth in the
associated indenture. The Company has irrevocably and unconditionally
guaranteed, on a subordinated basis, payment for the benefit of the holders of
the Trust Securities the obligations of the Trust to the extent the Trust has
funds legally available for distribution to the holders of the Trust
Securities, as described in the indenture. The Company may defer payment of
interest on the subordinated debentures as described in the indenture.
NOTE 10--MINORITY INTEREST
In June 2000, Dynegy and a third party invested in Catlin Associates, L.L.C.
("Catlin"), an entity that is consolidated by Dynegy, with the third party's
investment reflected in Minority Interest on the consolidated balance sheet.
Dynegy invested $100 million in Catlin and the third party investor contributed
$850 million. As a result of its investment, the third party is entitled to a
non-controlling preferred interest in Catlin, which holds
F-26
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
economic interests in midwest generation assets. On or before June 29, 2005,
Dynegy and the third party investor must agree upon whether and how to make
future investments on behalf of Catlin. If the shareholders are not able to
reach agreement regarding permitted investments or Catlin fails to pay the
preferred return to the third party, Dynegy has the option to purchase the
investor's interest for $850 million or liquidate the assets of Catlin. Dynegy
retains an option to acquire the minority investors' interest in Catlin through
June 2010 for $850 million. Catlin has limited recourse to Dynegy, with such
recourse building over time to a maximum of $270 million in 2005. As of
December 31, 2001, recourse to Dynegy was approximately $35 million. In
addition, under certain circumstances, Dynegy may be required to make an
additional capital contribution of $60 million to Catlin. The $60 million
contingent obligation expires on December 31, 2002. If Dynegy's credit rating
from Standards & Poors' and Moody's falls below investment grade, the Company
would be required to post approximately $270 million of cash collateral.
Minority interest on the consolidated balance sheet also includes
third-party investments in certain other consolidated entities, principally
relating to Dynegy Midstream Services ("DMS") operations. The net pre-tax
results attributed to minority interest holders in consolidated entities are
classified in minority interest expense in the accompanying statements of
operations.
NOTE 11--COMMITMENTS AND CONTINGENCIES
Legal Proceedings. On August 3, 1998, Modesto Irrigation District ("MID")
filed a lawsuit against PG&E and Destec Energy, Inc. ("Destec") in federal
court for the Northern District of California, San Francisco division. The
lawsuit alleges violation of federal and state antitrust laws and breach of
contract against Destec. The allegations are related to a power sale and
purchase arrangement in the city of Pittsburg, California. MID seeks actual
damages from PG&E and Destec in amounts not less than $25 million. MID also
seeks a trebling of any portion of damages related to its antitrust claims. By
order dated February 2, 1999, the federal District Court dismissed MID's state
and federal antitrust claims against PG&E and Destec; however, the Court
granted MID leave of thirty days to amend its complaint to state an antitrust
cause of action. On March 3, 1999, MID filed an amended complaint recasting its
federal and state antitrust claims against PG&E and Destec and restated its
breach of contract claim against Destec. PG&E and Destec filed motions to
dismiss MID's revised federal and state antitrust claims and a hearing on the
motions to dismiss was held in July 1999. On August 20, 1999, the District
Court again dismissed MID's antitrust claims against PG&E and Destec, this time
without leave to amend the complaint. As a result of the dismissal of the
antitrust claims, the District Court also dismissed the pendant state law
claims. MID has appealed the District Court's dismissal of its suit to the
Ninth Circuit Court of Appeal. Oral arguments before the Ninth Circuit occurred
on March 15, 2001. The Ninth Circuit has yet to deliver its decision on the
case. Although PG&E filed a Chapter 11 bankruptcy proceeding on April 6, 2001,
the automatic stay applicable in the proceeding will be lifted to permit the
Ninth Circuit to decide the pending appeal.
Following dismissal of its federal court suit, MID filed suit in California
state court asserting breach of contract and tortious interference with
prospective economic relations claims against Destec and tortious interference
with contract and interference with prospective economic relations claims
against PG&E. Motions to dismiss MID's state court claims were heard by the
state court and by order dated April 6, 2000, MID was directed to amend its
complaint. MID filed its amended complaint on April 20, 2000, including Dynegy
as a defendant. Dynegy filed a motion to dismiss MID's amended complaint
against Dynegy, and the Court partially granted Dynegy's motion to dismiss
while also granting MID leave to amend its complaint. Before MID filed its
amended complaint, MID agreed with PG&E and Dynegy to execute a tolling
agreement on all claims and to
F-27
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
dismiss the state court case until the federal appeal is decided. After
executing the tolling agreement, on October 23, 2000, MID filed in the state
court a Request for Dismissal, which the court granted on October 25, 2000.
Dynegy believes the allegations made by MID are without merit and will continue
to vigorously defend MID's claims. In the opinion of management, the amount of
ultimate liability with respect to these actions will not have a material
adverse effect on the financial position or results of operations of the
Company.
On November 3, 1999, the United States Environmental Protection Agency
("EPA") issued a Notice of Violation ("NOV") against Illinois Power Company
("IP") and, with the Department of Justice ("DOJ"), filed a complaint against
IP in the U.S. District Court for the Southern District of Illinois, No.
99C833. Subsequently, the DOJ and EPA amended the NOV and complaint to include
Illinova Power Marketing, Inc. (now known as Dynegy Midwest Generation Inc.
("DMG")) (IP and DMG collectively the "Defendants"). Similar notices and
lawsuits have been filed against a number of other utilities. Both the NOV and
complaint allege violations of the Clean Air Act (the "Act") and regulations
thereunder. More specifically, both allege, based on the same events, that
certain equipment repairs, replacements and maintenance activities at the
Defendants' three Baldwin Station generating units constituted "major
modifications" under the Prevention of Significant Deterioration ("PSD") and/or
the New Source Performance Standards regulations. When such activities occur
and they are not otherwise exempt the Act and related regulations generally
require that generating facilities meet more stringent emissions standards,
which may entail the installation of potentially costly pollution control
equipment. The DOJ amended its complaint to assert the claims found in the NOV.
The Defendants filed an answer denying all claims and asserting various
specific defenses. By order dated October 19, 2001, a trial date of February
11, 2003 has been set. The initial trial is limited to determining whether a
violation occurred.
The regulations under the Act provide certain exemptions from the
applicability of these provisions particularly an exemption for routine repair,
replacement or maintenance. The Company has analyzed each of the activities
covered by the EPA's allegations and believes each activity represents prudent
practice regularly performed throughout the utility industry as necessary to
maintain the operational efficiency and safety of equipment. As such, the
Company believes that each of these activities is covered by the exemption for
routine repair, replacement and maintenance and that the EPA is changing, or
attempting to change, through enforcement actions, the intent and meaning of
its regulations. The Company also believes that, even if some of the activities
in question were found not to qualify for routine exemptions, the Act and
regulations also require that the activities cause certain levels of increases
in emissions and there were no such increases either in annual emissions or in
the maximum hourly emissions achievable at any of the units caused by any of
the activities. The regulations include exemptions for increased hours of
operations or production rate and the PSD regulations exclude increases in
emissions resulting from demand growth. None of the Defendants' other
facilities are covered in the complaint and NOV, but the EPA has officially
requested information concerning activities at the Defendants' Vermilion, Wood
River, Hennepin and Danskammer Plants. It is possible that the EPA will
eventually commence enforcement actions against those plants as well. The
asset(s) subject to the complaint are part of the consolidated assets of Dynegy.
The EPA has the authority to seek penalties for the alleged violations in
question at the rate of up to $27,500 per day for each violation. The EPA may
also seek to require installation of the "best available control technology"
(or the equivalent) at the Baldwin Station, and possibly at the Vermilion, Wood
River, Hennepin and Danskammer Plants if the EPA successfully prosecutes
enforcement actions against those plants. The Company has recorded a reserve
for potential penalties that could be imposed if the EPA were to successfully
prosecute its claims.
The National Energy Policy Report issued in May 2001 by the National Energy
Policy Development Group recommended that the EPA Administrator examine the new
source review regulations, including the PSD
F-28
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
regulations, and report to the President within 90 days on the impact of new
source review on investment in new utility and refinery generation capacity,
energy efficiency and environmental protection. The report also recommended
that the Attorney General review existing enforcement actions regarding new
source review to ensure that the enforcement actions are consistent with the
Clean Air Act and its regulations. The EPA Administrator announced in August
2001 that the review would be completed in September 2001. The events of
September 11, 2001 have resulted in further delay of the EPA review, which
remains ongoing. The Department of Justice issued its report concerning the
existing enforcement actions on January 15, 2002. The report concluded that EPA
has a reasonable legal basis for proceeding with the cases.
Tampa Electric Company ("TECO") and the government agreed to a Consent
Decree to resolve the similar case brought against TECO and that Consent Decree
was entered by the court hearing that case in 2000. Two other utilities,
Virginia Power and Cinergy, reached agreements in principle with the United
States in 2000 concerning their possible liability for similar alleged
violations, but these agreements have still not been finalized. Additionally,
PSEG Fossil LLC entered into a consent decree in January 2002 to resolve
similar claims. Generally, the TECO Consent Decree and the settlements and
agreements in principle would require the utilities to pay civil fines; fund
various environmental projects; reduce nitrogen oxides, sulfur oxides,
particulate matter and mercury emissions through the installation of pollution
control devices over periods extending through 2012 to 2013; and forfeit
certain emission allowances.
The Company believes the allegations are without merit and will vigorously
defend against these claims. In the opinion of management, although significant
capital expenditures could be required, the amount of ultimate liability with
respect to this action will not have a material adverse effect on the financial
position or results of operations of the Company.
The following six class action lawsuits have been filed against various
Dynegy entities, including Dynegy Inc. and Dynegy Power Marketing Inc.:
1. Gordon v. Reliant Energy Inc., et al. was filed on November 27, 2000 in
San Diego Superior court.
2. Hendricks v. Dynegy Power Marketing Inc., et al. was filed on November
29, 2000 in a San Diego Superior Court.
3. People of the State of California v. Dynegy Power Marketing Inc., et al.
was filed on January 19, 2001 in San Francisco Superior Court.
4. Pier 23 Restaurant v. PG&E Energy Trading, et al. was filed on January
24, 2001 in San Francisco Superior Court.
5. Sweetwater Authority et al. v. Dynegy Inc., et al. was filed on January
16, 2001 in San Diego Superior Court.
6. Bustamante v. Dynegy Inc., et al. was filed on May 2, 2001 in Los
Angeles Superior court. The suit was filed on behalf of California
taxpayers by Lieutenant Governor Cruz Bustamante and Assembly Woman
Barbara Matthews, both acting in their capacity as taxpayers and not in
their capacity as elected officials.
The six class action lawsuits are based on the events occurring in the
California power market during the summer of 2000. The complaints allege
violations of California's Business and Professions Code, Unfair Trade
Practices Act and various other statutes. Specifically, the named plaintiffs
allege that the defendants, including
F-29
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
the owners of in-state generation and various power marketers, conspired to
manipulate the California wholesale power market to the detriment of California
consumers. Included among the acts forming the basis of the plaintiffs' claims
are the alleged improper sharing of generation outage data, improper
withholding of generation capacity and the manipulation of power market bid
practices. The plaintiffs seek unspecified treble damages. The Bustamante suit
includes claims against various Dynegy entities, including Dynegy Inc. and
Dynegy Marketing and Trade, as well as against three corporate officers
individually. The allegations in this suit are similar to those in the other
five suits, with the exception that the Bustamante suit includes a claim of
unfair business practices based on "price gouging" during an emergency declared
by Governor Gray Davis.
The six lawsuits are at preliminary stages. Defendants in the six lawsuits
have yet to file answers. The plaintiffs filed motions to remand five of the
cases to state court. In respect to the sixth case, the Bustamante suit, the
parties agreed that, based on a judge's decision to remand the other five
lawsuits, the case should go back to state court. All six lawsuits will be
consolidated before a single California state court judge.
After the actions were remanded, the parties agreed that they should be
coordinated. On December 12, 2001, the California Judicial Council resolved a
dispute among the parties as to the county in which the actions should be
coordinated and assigned the Coordination Proceedings (Nos. 4204 & 4205) to the
Superior Court of California, County of San Diego. On December 20, 2001, the
presiding judge of the San Diego Superior Court designated Judge Sammartino as
the Coordination Trial Judge for the Coordination Proceedings. On January 17,
2002, Judge Sammartino set a preliminary trial conference for March 4, 2002 to,
among other things, set schedules for: (a) determining legal issues that might
expedite disposition of the Coordination Proceedings; (b) establishing a
discovery schedule; and (c) resolving matters pertinent to the class action
issue.
The defendants in the six lawsuits have formed various joint defense groups
in an effort to coordinate the defense of the claims and to share certain costs
of defense. The Company believes the allegations are without merit and will
vigorously defend these claims. In the opinion of management, the amount of
ultimate liability with respect to these actions will not have a material
adverse effect on the financial position or results of operations of the
Company.
On March 11, 2002, the California Attorney General filed, on behalf of the
People of the State of California, complaints in San Francisco Superior Court
against several energy generators, including those owned directly by West Coast
Power and indirectly by Dynegy Inc. The complaints allege that since June 1998,
these generators sold power in the open market that should have been held in
emergency reserve for the State. In the aggregate, the complaints seek more
than $150 million in penalties, restitution and return profits from the
generators. The Company believes the allegations are without merit and will
vigorously defend these claims. In the opinion of management, the amount of
ultimate liability with respect to this action will not have a material adverse
effect on the financial position or results of operations of the Company.
In response to the filing of a number of complaints challenging the level of
wholesale prices, the Federal Energy Regulatory Commission ("FERC") initiated a
staff investigation and issued an order on December 15, 2000 implementing a
series of wholesale market reforms and made subject to refund all spot market
sales through the California Independent System Operator (the "ISO") and the
California Power Exchange (the "PX") markets beginning October 2, 2000. FERC
also included an interim price review procedure for prices above a $150/MW hour
"breakpoint" on sales to the ISO and PX. The order does not prohibit sales
above the "breakpoint," but the seller was subject to weekly reporting and
monitoring requirements. In an order issued March 9, 2001, FERC determined that
only sales during so-called "Stage 3" emergency hours would be subject
F-30
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
to refund beginning January 1, 2001 though sales between October 2, 2000 and
December 31, 2000 remained subject to refund. Various parties sought rehearing
of this market mitigation measure and, as explained below, the FERC ruled on
the matter in an order issued on July 25, 2001.
On April 26, 2001, the FERC revised its market mitigation plan, effective
May 29, 2001, to cover all emergency hours. The mitigated price was to be in
effect only during reserve deficiency hours. Suppliers charging prices above
the mitigated price during those hours could file to justify those prices.
On June 19, 2001, the FERC again revised its market mitigation plan,
effective June 20, 2001. Pursuant to this plan, the FERC is mitigating prices
charged in all hours throughout the Western Systems Coordinating Council based
on the mitigated price in the ISO markets. During reserve deficiency hours, the
mitigated price is set pursuant to an average index for gas times the heat rate
of the last unit dispatched by the ISO during a "Stage 1" emergency, plus a 10
percent adder for credit risk. Nitrogen oxide charges, start-up costs and
additional fuel costs will be collected through an ISO uplift charge. During
non-reserve deficiency hours, the market clearing price is capped at 85 percent
of the mitigated price. The Company has filed for rehearing and clarification
of the order. The FERC also ordered all parties to participate in a 15-day
settlement conference to determine refunds, which proved unsuccessful. Pursuant
to that order, the settlement judge has issued a refund recommendation to the
FERC, stating that refunds from all market participants since October 2000
probably total between several hundred million dollars and a billion dollars.
It should be noted that the April 26 and June 19, 2001 orders apply only to
sales made on a daily basis, that is, within 24 hours of delivery. The vast
majority of power sold by West Coast Power LLC, a 50% equity investee of
Dynegy, is committed to long-term contracts exempt from these orders.
On July 25, 2001, as modified on December 31, 2001,the FERC initiated refund
hearing procedures related to California wholesale spot market sales that
occurred between October 2, 2000 and June 20, 2001. Dynegy Power Marketing (as
Scheduling Coordinator for West Coast Power LLC) is subject to possible
refunds. The July 25/th/ order supercedes prior refund orders issued by the
FERC that cover this period. In the July 25/th/ order, the FERC developed a
methodology to redetermine allegedly competitive market outcomes during each
hour of this period. An administrative law judge has been appointed to
determine: (1) the mitigated price for power during each hour of the refund
period; (2) the amount of refunds owed by each supplier according to the FERC's
methodology; and (3) the amount currently owed to each supplier (with separate
quantities due from each entity) by the ISO, the investor-owned utilities and
the State of California. Any refunds owed would then be offset against amounts
not paid. Management does not expect the administrative law judge to issue his
findings before August 2002. Dynegy is actively participating in these
proceedings and is appealing these and related orders.
On December 19, 2001, FERC issued an order that in part focused on the
FERC-established price mitigation plan, which includes a formula prescribed by
FERC to determine maximum rates for wholesale power transactions in spot
markets in the Western Systems Coordinating Council between June 21, 2001 and
September 30, 2002. In this order, the FERC made some changes in its mitigation
plan. Certain of these changes were put in place retroactively and might have
the effect of reducing the applicable maximum rate in past periods. Dynegy
Power Marketing and West Coast Power have sought rehearing or clarification of
this decision, pointing out that various other aspects of the December 19
order, coupled with other recent FERC orders, indicate that the FERC did not
intend to modify past prices under this mitigation plan. The Company cannot
predict how the FERC will ultimately resolve this matter.
On February 13, 2002, the FERC initiated an investigation of possible
manipulation of natural gas and power prices in the western United States
during the period from January 2001 through the present. Dynegy has
F-31
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
been active in these markets during the relevant period and, as a result,
expects that its pricing policies will be investigated. Management believes
that much of what would be investigated has already been examined pursuant to
other investigations by government entities and in private litigation. To date,
there has been no finding of market manipulation by Dynegy in these markets and
management does not believe that any factual basis to support such a finding
exists.
In addition to the FERC investigation discussed above, several state and
other federal regulatory investigations and complaints have commenced in
connection with the wholesale electricity prices in California and other
neighboring Western states to determine the causes of the high prices and
potentially to recommend remedial action. In California, the California Public
Utilities Commission, the California Electricity Oversight Board, the
California Bureau of State Audits, the California Office of the Attorney
General and several California state legislative committees all have separate
ongoing investigations into the high prices and their causes. With the
exception of a report by the California Bureau of State Audits, none of these
investigations has been completed and no findings have been made in connection
with any of them. The California state audit report concluded that the primary
causes of the market disruptions in California were fundamental flaws in the
structure of the power market. Additionally, on February 25, 2002, the
California Public Utilities Commission and the California Electricity Oversight
Board filed complaints with the FERC asking that it void or reform power supply
contracts between DWR and, among others, West Coast Power. The complaints
allege that prices under the contracts exceed just and reasonable prices
permitted under the Federal Power Act. While the Company believes the terms of
its contracts are just and reasonable and do not reflect alleged market
manipulation, it cannot predict how the FERC will respond to these complaints.
Management has closely monitored developments in California in an effort to
manage Dynegy's credit risk. The Company and its affiliates recorded reserves
that are determined to be probable and are considered estimable. Although such
reserves may change over time as the market uncertainties are resolved,
management believes such changes will not ultimately be material to the
Company's consolidated financial position or results of operations.
On December 2, 2001, Enron Corp. and Enron Transportation Services Co.
(collectively, "Enron") filed suit against Dynegy and Dynegy Inc. in the United
States Bankruptcy Court for the Southern District of New York, Adversary
Proceeding No. 01-03626 (AJG). Enron claims that Dynegy materially breached the
Merger Agreement dated November 9, 2001 between Enron and Dynegy and related
entities by wrongfully terminating that Agreement on November 28, 2001. Enron
also claims that Holdings wrongfully exercised its option to take ownership of
Northern Natural under an Option Agreement dated November 9, 2001. Enron seeks
damages in excess of $10 billion and declaratory relief against Dynegy for
breach of the Merger Agreement. Enron also seeks unspecified damages against
Dynegy and Holdings for breach of the Option Agreement. Dynegy filed an answer
on February 4, 2002, denying all material allegations. Dynegy subsequently
filed a motion to transfer venue in the proceeding to the United States
District Court for the Southern District of Texas (Houston division). Discovery
has not yet commenced.
On December 20, 2001, Dynegy and Dynegy Inc. were sued by Ann C. Pearl and
Joel Getzler in the United States District Court for the Southern District of
New York, Cause No. 01 CV 11652. Plaintiffs filed the lawsuit as a purported
class action on behalf of all persons or entities who owned common stock of
Enron Corp. as of November 28, 2001. Plaintiffs allege that they are intended
third party beneficiaries of the Merger Agreement dated November 9, 2001
between Enron and Dynegy and related entities. Plaintiffs claim that Dynegy
materially breached the Merger Agreement by, inter alia, wrongfully terminating
that Agreement. Plaintiffs also claim that
F-32
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Dynegy breached the implied covenant of good faith and fair dealing. Plaintiffs
seek an award of damages and other relief. On February 4, 2002, Dynegy filed a
notice of motion to dismiss or transfer venue to the United States District
Court for the Southern District of Texas (Houston Division). Discovery has not
yet commenced.
On January 3, 2002, Dynegy and Dynegy Inc. were sued by Bernard D. Shapiro
and Peter Strub in the 129th Judicial District Court for Harris County, Texas,
Cause No. 2002-00080. Plaintiffs filed the lawsuit as a purported class action
on behalf of all persons or entities who owned common stock of Enron Corp. as
of November 28, 2001. Plaintiffs allege that they are intended third party
beneficiaries of the Merger Agreement dated November 9, 2001 between Enron and
Dynegy and related entities. Plaintiffs claim that Dynegy materially breached
the Merger Agreement by, inter alia, wrongfully terminating that Agreement.
Plaintiffs also claim that Dynegy breached the implied covenant of good faith
and fair dealing. Plaintiffs seek an award of damages and other relief. Dynegy
filed an answer on February 4, 2002, denying all allegations. Discovery has not
yet commenced.
The Company believes the allegations in Enron's adversary proceeding and the
other cases arising out of the terminated merger are without merit and will
vigorously defend against these claims. An adverse result in these proceedings,
however, could have a material adverse effect on the Company's financial
position and results of operations.
The Company is subject to various other legal proceedings and claims that
arise in the normal course of business. Further, the Company has assumed
liability for various claims, assessments and litigation in connection with
some of its strategic acquisitions. In the opinion of management, the amount of
ultimate liability with respect to these actions will not have a material
adverse effect on the financial position or results of operations of the
Company.
Purchase Obligations. In conducting its operations, the Company routinely
enters into long-term commodity purchase and sale commitments, as well as
agreements that commit future cash flow to the lease or acquisition of assets
used in its businesses. These commitments are typically associated with
commodity supply arrangements, capital projects, reservation charges associated
with firm transmission, transportation, storage and leases for office space,
equipment, plant sites, ships, and power generation assets. The following
describes the more significant commitments outstanding at December 31, 2001.
The Company routinely enters into supply and market contracts for the
purchase and sale of electricity, some of which contain fixed capacity
payments. Such obligations are generally payable on a ratable basis, the terms
of which extend through November 2014. In return for such fixed capacity
payments, Dynegy receives volumes of electricity at agreed prices, which it
then may re-market. These fixed capacity payments totaled approximately $2
billion at December 31, 2001. Based on current estimates, the market value of
electricity available for sale under these contracts, which are not already
recorded at fair value on the balance sheet, exceed the value of the capacity
payments by $325 million, after adjusting for market, credit and other
reserves. Additionally, the Company has $44 million of unconditional purchase
obligations related to the purchase of coal.
The Company has $75 million of unconditional purchase obligations related to
the purchase of gas, coal and systems design. Dynegy has other firm capacity
payments related to storage and transportation of natural gas and transmission
of electricity. Such arrangements are routinely used in the physical movement
and storage of energy consistent with the Company's business strategy. The
total of such obligations was $614 million as of December 31, 2001, with $302
million of the $614 million due after 2006.
F-33
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
The Company is engaged in a continual capital asset expansion program
consistent with its business plan and growth strategies. The emphasis of this
program is on the acquisition or construction of strategically located power
generation assets. Consistent with this strategy and as a result of the long
lead time required by industry manufacturers, the Company has executed or is
currently negotiating purchase orders to acquire at least 11 gas-fired
turbines, representing a capital commitment of approximately $370 million.
Commitments under these purchase orders are generally payable consistent with
the delivery schedule. Approximately 95% are scheduled to be delivered by the
end of 2006. The purchase orders include milestone requirements by the
manufacturer and provide Dynegy with the ability to cancel each discrete
purchase order commitment in exchange for a fee, which escalates over time. At
December 31, 2001, the fee would have been approximately $12 million.
Advance Agreement. In 1997, Dynegy received cash from a gas purchaser as an
advance payment for future natural gas deliveries over a ten-year period
("Advance Agreement"). As a condition of the Advance Agreement, Dynegy entered
into a natural gas swap with a third party under which Dynegy became a
fixed-price payer on identical volumes to those to be delivered under the
Advance Agreement at prices based on current market rates. The cash receipt is
included as deferred revenue in "Other Long-Term Liabilities" on the
Consolidated Balance Sheets and is ratably reduced as gas is delivered to the
purchaser under the terms of the Advance Agreement. The balance at December 31,
2001 approximated $65 million. The Advance Agreement contains certain
non-performance penalties that impact both parties and as a condition
precedent, Dynegy purchased a surety bond in support of its obligations under
the Advance Agreement.
Other Minimum Commitments. During 2001 and prior years, the Company entered
into lease arrangements associated with natural gas-fired generating
facilities, natural gas liquids transportation assets and certain fiber optic
and telecommunications-related assets, which are accounted for as operating
leases. Under the terms of certain of these arrangements, the Company provided
residual value guarantees associated with the leased assets. Pursuant to these
guarantees, the Company has the option to acquire at the end of the lease term
the leased assets for a purchase price determined at lease inception and
estimated to represent fair market value at the end of the lease term. If the
Company does not choose to purchase the leased asset, it must perform under the
terms of the residual value guarantee. At lease inception, the Company as
lessee, guaranteed to the owner of the leased asset that the leased asset would
maintain a value equal to at least 80-86% (depending on the particular lease
contract) of its originally estimated fair value. In each of these
arrangements, the Company will receive any sales proceeds that the owner of the
leased asset receives in excess of the originally estimated fair value. If the
value of the asset is less than 80-86% of the fair market value at lease
termination, we are obligated to pay the owner the difference in valuation.
In addition, Company subsidiaries are designing and constructing generating
facilities as agent for a third party, and the Company may be obligated to
guarantee up to approximately 90 percent of the actual cost of these facilities
during the construction phase. It is anticipated that a subsidiary of the
Company will subsequently lease the completed facilities from the relevant
third parties for initial terms of four to five years. Under certain
circumstances, the Company maintains an option to purchase the relevant
facility from the third party.
Minimum commitments in connection with office space, equipment, plant sites
and other leased assets at December 31, 2001, were as follows: 2002--$126
million; 2003--$127 million; 2004--$191 million, 2005--$296 million; 2006--$102
million and beyond--$1.6 billion.
F-34
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Rental payments made under the terms of these arrangements totaled--$108
million in 2001, $75 million in 2000 and $31 million in 1999.
Guarantees. The Company has $288 million of surety bonds as of December 31,
2001 in which Dynegy indemnifies the respective surety bond companies.
Approximately $204 million of these contingent financial commitments expire in
2002, however, these bonds are generally renewed on a rolling twelve-month
basis.
As mentioned above, the Company has residual value guarantees related to
certain leases. At December 31, 2001, the residual value guarantees totaled
approximately $382 million. Additionally, the Company has made certain
guarantees related to West Coast Power for approximately $56 million.
Approximately $31 million of this $56 million has a cash collateralization
requirement if the Company's debt is downgraded to below investment grade.
Additionally, the Company has posted a $4 million letter of credit for West
Coast Power that expires in 2002.
Other guarantees at December 31, 2001 include additional letters of credit
of $470 million and parental guarantees of debt of approximately $3 million in
connection with its power generation projects.
On March 11, 2002, the California Attorney General filed, on behalf of the
People of the state of California, complaints in San Francisco Superior Court
against several energy generators, including those owned directly by West Coast
Power and indirectly by Dynegy Inc. The complaints allege that since June 1998,
these generators sold power in the open market that should have been held in
emergency reserve for the State. In the aggregate, the complaints seek more
than $150 million in penalties, restitution and return profits from the
generators. The Company believes the allegations are without merit and will
vigorously defend these claims. In the opinion of management, the amount of
ultimate liability with respect to this action will not have a material adverse
effect on the financial position or results of operations of the Company.
NOTE 12--REGULATORY ISSUES
The Company is subject to regulation by various federal, state, local and
foreign agencies, including extensive rules and regulations governing
transportation, transmission and sale of energy commodities as well as the
discharge of materials into the environment or otherwise relating to
environmental protection. Compliance with these regulations requires general
and administrative, capital and operating expenditures including those related
to monitoring, pollution control equipment, emission fees and permitting at
various operating facilities and remediation obligations. In addition, the U.S.
Congress has before it a number of bills that could impact regulations or
impose new regulations applicable to Dynegy and its subsidiaries. The Company
cannot predict the outcome of these bills or other regulatory developments or
the effects that they might have on its business.
NOTE 13--CAPITAL STOCK
All of Dynegy's outstanding equity securities are held by its parent, Dynegy
Inc. There is no established trading market for such securities, and they are
not traded on any exchange.
Stock Options. The Company's parent grants stock options, from time to
time, to certain employees of the Company. Options granted to and exercised by
Company employees are treated as capital transactions in the accompanying
statements, with the associated tax attributes included in determination of the
Company's income tax provision. Each option granted is valued at an option
price, which ranges from $1.47 per share to $57.95 per share at date of grant.
The difference, if any, between the option price and the fair market value of
each option on the date of grant is recorded as compensation expense over the
respective vesting period. Options granted at prices below fair market do not
become exercisable until the fifth anniversary date of the grant, at which time
F-35
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
they become fully exercisable. Options granted at market value vest and become
exercisable ratably over a three-year period. Compensation expense related to
options granted totaled $9 million, $15.4 million and $6.0 million for the
years ended December 31, 2001, 2000 and 1999, respectively. Total options
outstanding and exercisable for 2001, 2000 and 1999 were (options in thousands)
as follows:
Year Ended December 31,
- ----------------------------------------------------------------
2001 2000 1999
--------------------- --------------------- --------------------
Options Option Price Options Option Price Options Option Price
------- ------------- ------- ------------- ------- ------------
Outstanding at beginning of period.... 19,768 $ 1.47-$57.02 24,022 $ 1.47-$16.62 25,777 $1.47-$15.67
Granted............................... 7,771 $27.80-$57.95 4,258 $22.01-$56.50 4,203 $1.47-$16.62
Exercised............................. (2,217) $ 1.47-$38.34 (7,531) $ 1.47-$22.01 (4,658) $1.47-$13.68
Cancelled or expired.................. (521) $ 1.47-$56.50 (981) $ 1.47-$57.02 (1,232) $1.47-$13.77
Other, contingent share issuance...... -- -- -- -- (68) $1.47-$ 4.10
------ ------ ------
Outstanding at end of period.......... 24,801 $ 1.47-$57.95 19,768 $ 1.47-$57.02 24,022 $1.47-$16.62
====== ====== ======
Exercisable at end of period.......... 11,168 $ 1.47-$57.02 11,928 $ 1.47-$17.17 9,983 $1.47-$15.67
====== ====== ======
Weighted average fair value of options
granted during the period at market.. $ 21.58 $ 19.14 $ 7.76
============= ============= ============
Weighted average fair value of options
granted during the period at below
market............................... $ 0.00 $ 0.00 $ 9.65
============= ============= ============
Options outstanding as of December 31, 2001 (options in thousands) are
summarized below:
Options Outstanding Options Exercisable
- ------------------------------------------------------ --------------------------------
Number of Number of
Options Weighted Average Weighted Options Weighted
Range of Outstanding at Remaining Contractual Average Exercisable at Average
Exercise Prices December 31, 2001 Life (Years) Exercise Price December 31, 2001 Exercise Price
- --------------- ----------------- --------------------- -------------- ----------------- --------------
$ 1.47-$ 5.80 7,876 6.4 $ 2.80 3,793 $ 2.12
$ 5.81-$11.59 2,468 6.3 $ 9.99 2,430 $ 9.98
$11.60-$17.39 5,921 6.6 $15.72 4,581 $15.46
$17.40-$23.18 16 8.0 $22.45 4 $22.77
$23.19-$28.98 742 8.6 $23.91 155 $24.14
$28.99-$34.77 2,472 9.0 $34.33 5 $32.38
$34.78-$40.57 220 8.8 $37.79 65 $37.26
$40.58-$46.36 505 9.4 $43.70 107 $43.34
$46.37-$52.16 4,466 9.2 $47.24 20 $48.62
$52.17-$57.95 115 9.1 $56.25 8 $54.66
------ ------
24,801 11,168
====== ======
Pursuant to terms of the Illinova acquisition, certain vesting requirements
on outstanding options were accelerated and the option shares and strike prices
were subject to the exchange ratios described in the acquisition documents.
Additionally, Dynegy's parent instituted new option plans on the effective date
of the acquisition.
F-36
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model, with the following weighted-average
assumptions used for grants in 2001, 2000 and 1999; dividend per year of $0.30
per share per annum for 2001 and 2000 and a historical dividend of $0.04 per
share for 1999; expected volatility of 46.4 percent, 44 percent and 40.3
percent, respectively; risk-free interest rate of 4.26 percent, 6.30 percent
and 6.42 percent, respectively; and an expected life of ten years for all
periods. As stated previously, the Company accounts for its stock option plan
in accordance with APB No. 25. Had compensation cost been determined on a fair
value basis consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net income amounts would have approximated $606
million, $432 million, and $143 million for the years ended December 31, 2001,
2000 and 1999 respectively.
NOTE 14--BUSINESS COMBINATIONS AND OTHER ACQUISITIONS
In the first quarter of 2001, Dynegy completed the acquisition of Central
Hudson power generation facilities in New York. The Central Hudson facilities
consist of a combination of base load, intermediate and peaking facilities
aggregating 1,700 MW. The facilities are located approximately 50 miles north
of New York City and were acquired for approximately $903 million cash, plus
inventory and certain working capital adjustments. The acquisition of these
facilities established Dynegy's physical presence in the region. In May 2001,
subsidiaries of Dynegy completed a sale-leaseback transaction to provide the
term financing with respect to the Central Hudson facilities. Under the terms
of the sale-leaseback transaction, subsidiaries of Dynegy sold certain plants
and equipment and agreed to lease it back for terms expiring within 34 years,
exclusive of renewal options.
In the fourth quarter of 2001, Dynegy completed the purchase of BGSL. Under
the terms of the purchase agreement, Dynegy paid approximately (Pounds)421
million (approximately $595 million at November 28, 2001) for BGSL and its
existing assets. BGSL's results of operations are included in Dynegy's
consolidated statement of operations beginning December 1, 2001. A condensed
balance sheet as of the acquisition date is as follows (in millions):
Current assets................ $ 35
Property, plant, and equipment 792
Goodwill...................... 31
----
Total assets acquired......... 858
----
Current liabilities........... 56
Long-term liabilities......... 207
----
Total liabilities assumed..... 263
----
Net assets acquired........... $595
====
Consideration paid for this acquisition was as follows (in millions):
Cash Purchase of Stock...... $581
Capital Stock Issued........ --
Liabilities Assumed......... 263
Subordinated capital assumed --
----
Total Consideration......... $844
====
F-37
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
The assets, which are located in the United Kingdom, consist of 30 gas
storage injection wells with five offshore platforms, nine salt caverns,
approximately 19 miles of pipelines and an onshore natural gas processing
terminal. The acquisition of BGSL established Dynegy's physical presence in the
United Kingdom.
Note 15--EMPLOYEE COMPENSATION, SAVINGS AND PENSION PLANS
Corporate Incentive Plan. Dynegy's parent maintains a discretionary
incentive plan to provide employees competitive and meaningful rewards for
reaching corporate and individual objectives. Specific awards are at the
discretion of the Compensation Committee of the Dynegy Inc. Board of Directors
("Compensation Committee").
401(k) Savings Plan. The Company's parent established the Dynegy Inc.
401(k) Savings Plan ("Dynegy Plan"), which meets the requirements of Section
401(k) of the Internal Revenue Code, and is a defined contribution plan subject
to the provisions of the Employee Retirement Income Security Act of 1974
("ERISA"). The Plan and related trust fund are established and maintained for
the exclusive benefit of participating employees in the United States and
certain expatriates. Similar plans are available to other employees resident in
foreign countries and are subject to the laws of each country. All employees of
certain entities are eligible to participate in the Plan. Employee pre-tax
contributions to the Plan are matched 100%, up to a maximum of five percent of
base pay, subject to IRS limitations. Vesting in Company contributions is based
on years of service. The Company may also make discretionary contributions to
employee accounts, subject to the Company's performance. Matching contributions
to the Plan and discretionary contributions are made in Dynegy common stock.
The Company discontinued the additional 5% profit sharing contribution to
active employee accounts in 2001. However, active employees who normally would
have received the profit sharing contribution under the Dynegy Plan began
participating in the pension plan in 2001 (see below).
Certain eligible employees participate in the Dynegy Northeast Generation,
Inc. Savings Incentive Plan ("Northeast Plan"), which meets the requirements of
Section 401(k) of the Internal Revenue Code and is a defined contribution plan
subject to the provisions of ERISA. The Company matches either 24% or 50% of
employee contributions to the Northeast Plan. The Company guaranteed match is
subject to a maximum of six or eight percent of base pay, subject to IRS
limitations. Employees are immediately 100% vested in Company contributions.
Matching contributions to the Northeast Plan are made in cash.
During the years ended December 31, 2001, 2000 and 1999, Dynegy recognized
aggregate costs related to these employee compensation plans of $17 million,
$15 million and $25 million, respectively.
F-38
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Pension and Other Post-Retirement Benefits. The Company has various defined
benefit pension plans and post-retirement benefit plans. All domestic employees
participate in the pension plans, but only some of the Company's domestic
employees participate in the other post-retirement benefit plans. The Company
added a cash balance feature effective for 2001 and thereafter with respect to
employees who would have otherwise received a profit sharing contribution under
the Dynegy Plan for 2001 and thereafter (the contribution credit under such
cash balance feature shall generally be 6% of base pay). The following tables
contain information about these plans on a combined basis:
Pension Other
Benefits Benefits
------------ ------------
2001 2000 2001 2000
----- ----- ------ ----
($ in millions)
Projected benefit obligation, beginning of the year.............. $ 9 $ 9 $ -- $--
Business combination.......................................... 14 -- 5 --
Service cost.................................................. 1 -- -- --
Interest cost................................................. 2 1 1 --
Plan amendments............................................... -- -- -- --
Actuarial (gain) loss......................................... 1 (1) -- --
Benefits paid................................................. (1) -- (-- ) --
----- ----- ------ ---
Projected benefit obligation, end of the year.................... $ 26 $ 9 $ 6 $--
===== ===== ====== ===
Fair value of plan assets, beginning of the year................. $ 12 $ 10 $ -- $--
Business combination.......................................... 16 -- -- --
Actual return on plan assets.................................. (1) 2 -- --
Employer contributions........................................ -- -- -- --
Participant contributions..................................... -- -- -- --
Benefits paid................................................. (1) -- -- --
----- ----- ------ ---
Fair value of plan assets, end of the year....................... $ 26 $ 12 $ -- $--
===== ===== ====== ===
Funded status.................................................... $ -- $ 3 $ (6) $--
Unrecognized prior service costs................................. -- -- -- --
Unrecognized actuarial gain...................................... (2) (7) -- --
----- ----- ------ ---
Accrued benefit liability........................................ $ (2) $ (4) $ (6) $--
===== ===== ====== ===
Amounts recognized in the consolidated balance sheets consist of:
Prepaid benefit cost.......................................... $ 2 $ -- $ -- $--
Accrued benefit liability..................................... (4) (4) (6) --
----- ----- ------ ---
Net amount recognized......................................... $ (2) $ (4) $ (6) $--
===== ===== ====== ===
Pension Other
Benefits Benefits
------------ ------------
2001 2000 2001 2000
----- ----- ------ ----
Weighted Average Assumptions:
Discount rate at December 31.................................. 7.50% 7.50% 7.50% --
Expected return on plan assets as of January 1................ 8.96% 8.00% 9.50% --
Rate of compensation increase................................. 4.11% 3.50% 4.50% --
Medical trend--initial trend.................................. -- -- 12.00% --
Medical trend--ultimate trend................................. -- -- 5.00% --
Medical trend--year of ultimate trend......................... -- -- 2015 --
The changes in the projected benefit obligations and in plan assets
attributable to business combination in 2001 are the result of the Central
Hudson acquisition.
F-39
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
The components of net periodic benefit cost were:
Other
Pension Benefits Benefits
------------------- ---------
2001 2000 1999 2001 2000 1999
---- ---- ---- ---- ---- ----
($ in millions)
Service cost benefits earned during period... $ 1 $-- $-- $-- $-- $--
Interest cost on projected benefit obligation 2 1 1 1 -- --
Expected return on plan assets............... (2) (1) (1) -- -- --
Amortization of unrecognized actuarial gain.. (1) -- -- -- -- --
--- --- --- --- --- ---
Net periodic benefit cost.................... $-- $-- $-- $ 1 $-- $--
Additional cost due to curtailment........... -- -- (2) -- -- --
=== === === === === ===
Total net periodic benefit cost (income)..... $-- $-- $(2) $ 1 $-- $--
=== === === === === ===
Impact of a 1% increase/decrease in medical trend:
Increase Decrease
-------- --------
($ in millions)
Aggregate impact on service cost and interest cost...... $-- $--
Impact on accumulated post-retirement benefit obligation $ 1 $(1)
NOTE 16--RELATED PARTY TRANSACTIONS
In addition to related party transactions described elsewhere herein, the
following are additional items requiring disclosure.
Transactions with Chevron U.S.A. Inc. result from purchases and sales of
natural gas, NGLs and crude oil between subsidiaries of Dynegy and Chevron
U.S.A. Inc. affiliates. Management believes that these transactions are
executed at prevailing market rates. During the years ended December 31, 2001,
2000 and 1999, the Company recognized in its statement of operations aggregate
sales to this significant shareholder of $1.3 billion, $1.4 billion and $1.1
billion, respectively. In the same years, purchases from this shareholder were
$3.6 billion, $3.1 billion and $2.0 billion, respectively.
The Company also holds investments in three joint ventures in which Chevron
U.S.A. or its affiliates are also investors. These investments include a 22.9%
ownership interest in Venice Energy Services Company, L.L.C., which holds a
pipeline gathering system in Louisiana; a 39.2% ownership interest in West
Texas LPG Pipeline Limited Partnership, which holds a pipeline gathering system
in West Texas; and a 50% ownership interest in Nevada Cogeneration Associates
#2, a power generation facility. During the years ended December 31, 2001, 2000
and 1999, the Company's portion of the net income from the Venice Energy, West
Texas and Nevada Cogeneration joint ventures was approximately $4.6 million,
$5.5 million and $3.8 million, respectively; approximately $9.6 million, $5.6
million and $2.2 million, respectively; and approximately $7.0 million, $5.0
million and $3.5 million, respectively.
The Company routinely conducts business with subsidiaries of Dynegy Inc.
that are not a part of this consolidated group. As a result of such
transactions, the Company has an approximate $185 million and $423 million
accounts receivable, affiliates balance as of December 31, 2001 and 2000,
respectively.
F-40
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Additionally, certain subsidiaries of the Company received revenues of
approximately $459 million and $557 million from IP during the years ended
December 31, 2001 and 2000, respectively. The subsidiaries also purchased
approximately $10 million and $11 million of natural gas from IP during the
years ended December 31, 2001 and 2000, respectively.
The Company also has purchases and sales of natural gas, NGLs, crude oil and
power and, in some instances, earns management fees from certain entities in
which it has equity investments. Revenues recognized from these transactions in
2001, 2000 and 1999 were $2.0 billion, $827 million and $377 million,
respectively. Expenses recognized were $385 million, $217 million and $125
million, respectively. Revenues relate to the supply of fuel for use at
generation facilities, primarily West Coast Power, and the supply of natural
gas sold by retail affiliates. Expenses primarily represent the purchase of
natural gas liquids that are subsequently sold in the Company's marketing
operations.
Also during 2001, the Company earned approximately $8 million of interest
income related to cash lent to West Coast Power. The loan was created as a
result of natural gas fuel costs owed from West Coast Power to a subsidiary of
Dynegy. As of December 31, 2001, West Coast Power had repaid in full all
amounts owed to Dynegy. Dynegy has guaranteed $31 million of estimated
environmental obligations as well as $25 million associated with an insurance
program for West Coast Power.
NOTE 17--SEGMENT INFORMATION
Dynegy's operations are reported in two segments: Wholesale Energy Network
("WEN") and Dynegy Midstream Services ("DMS"). WEN is engaged in a broad array
of businesses, including physical supply of and risk-management activities
around wholesale natural gas, power, coal, and other similar products. This
segment is focused on optimizing the Company's and its customers' global
portfolio of energy assets and contracts, as well as direct commercial and
industrial sales and retail marketing alliances. DMS consists of the Company's
North American midstream liquids processing and marketing businesses and
worldwide NGLs marketing and transportation operations. Dynegy accounts for
intercompany transactions at prevailing market rates. Operating segment
information for the years ended December 31, 2001, 2000 and 1999 is presented
below. See Introductory Note for a discussion of the restatements made to the
financial information included herein.
F-41
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Dynegy's Segment Data for the Year Ended December 31, 2001
WEN DMS Elimination Total
------- ------ ----------- -------
($ in millions)
Unaffiliated revenues:
Domestic...................................................... $26,750 $4,708 $ -- $31,458
Canadian...................................................... 4,622 1,463 -- 6,085
European & Other.............................................. 3,899 -- -- 3,899
------- ------ ----- -------
35,271 6,171 -- 41,442
Affiliated revenues.............................................. 459 -- -- 459
Intersegment revenues
Domestic....................................................... 126 237 $(363) --
------- ------ ----- -------
Total revenues................................................ $35,856 $6,408 $(363) $41,901
------- ------ ----- -------
Depreciation and amortization.................................... (194) (82) -- (276)
Operating income................................................. 727 137 -- 864
Interest expense................................................. (82) (52) -- (134)
Other expense.................................................... (41) (10) -- (51)
Earnings of unconsolidated affiliates............................ 189 13 -- 202
Income tax provision............................................. (309) (32) -- (341)
Net income....................................................... $ 486 $ 56 $ -- $ 542
Identifiable assets:
Domestic...................................................... $15,269 $2,262 $ -- $17,531
Canadian...................................................... 773 130 -- 903
European & Other.............................................. 2,101 -- -- 2,101
Investments in unconsolidated affiliates......................... 387 422 -- 809
Capital expenditures and investments in unconsolidated affiliates (1,251) (391) -- (1,642)
Dynegy's Segment Data for the Year Ended December 31, 2000
WEN DMS Elimination Total
------- ------ ----------- -------
($ in millions)
Unaffiliated revenues:
Domestic...................................................... $17,384 $5,160 $ -- $22,544
Canadian...................................................... 2,316 1,224 -- 3,540
European...................................................... 1,268 -- -- 1,268
------- ------ ----- -------
20,968 6,384 -- 27,352
Affiliated revenues.............................................. 557 557
Intersegment revenues
Domestic....................................................... 186 249 (435)
------- ------ ----- -------
Total revenues................................................ 21,711 6,633 (435) 27,909
------- ------ ----- -------
Depreciation and amortization.................................... (129) (105) -- (234)
Operating income................................................. 433 90 -- 523
Interest expense................................................. (66) (30) -- (96)
Other income (expense)........................................... 92 (55) -- 37
Earnings of unconsolidated affiliates............................ 167 24 -- 191
Income tax provision............................................. (216) (10) -- (226)
Net income....................................................... $ 410 $ 19 $ -- $ 429
Identifiable assets:
Domestic...................................................... $14,130 $2,156 $ -- $16,286
Canadian...................................................... 750 299 -- 1,049
European...................................................... 438 -- -- 438
Investments in unconsolidated affiliates......................... 520 174 -- 694
Capital expenditures and investments in unconsolidated affiliates (590) (114) -- (704)
F-42
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
Dynegy's Segment Data for the Year Ended December 31, 1999
WEN DMS Elimination Total
------- ------ ----------- -------
($ in millions)
Unaffiliated revenues:
Domestic...................................................... $ 8,100 $4,887 $ -- $12,987
Canadian...................................................... 1,445 10 -- 1,455
European...................................................... 976 -- -- 976
------- ------ ----- -------
10,521 4,897 -- 15,418
Intersegment revenues
Domestic....................................................... 131 240 (371) --
------- ------ ----- -------
Total revenues................................................ 10,652 5,137 (371) 15,418
------- ------ ----- -------
Depreciation and amortization.................................... (35) (94) -- (129)
Operating income................................................. 114 93 -- 207
Interest expense................................................. (36) (42) -- (78)
Other income..................................................... 18 (7) -- 11
Earnings of unconsolidated affiliates............................ 62 18 -- 80
Income tax provision............................................. (55) (17) -- (72)
Net income....................................................... $ 103 $ 45 $ -- $ 148
Identifiable assets:
Domestic...................................................... $ 3,321 $2,550 $ -- $ 5,871
Canadian...................................................... 266 68 -- 334
European...................................................... 175 -- -- 175
Investments in unconsolidated affiliates......................... 458 169 -- 627
Capital expenditures and investments in unconsolidated affiliates (357) (92) -- (449)
NOTE 18--QUARTERLY FINANCIAL INFORMATION
The following is a summary of the Company's unaudited quarterly financial
information for the years ended December 31, 2001 and 2000.
Quarter Ended
----------------------------------
March June September December
2001 2001 2001 2001
------- ------- --------- --------
($ in millions)
Revenues.................. $13,646 $10,587 $8,132 $ 9,536
Operating income.......... 234 53 377 200
Income before income taxes 197 93 416 175
Net income................ 133 44 261 104
Quarter Ended
----------------------------------
March June September December
2000 2000 2000 2000
------- ------- --------- --------
($ in millions)
Revenues.................. $ 4,812 $ 5,342 $7,546 $10,209
Operating income.......... 95 69 91 268
Income before income taxes 96 87 257 215
Net income................ 60 54 167 148
F-43
DYNEGY HOLDINGS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(UNAUDITED AND RESTATED)
NOTE 19--DYNEGY ENERGY PARTNERS L.P.
On February 25, 2002, Dynegy Energy Partners L.P., a newly formed limited
partnership created to own and operate a portion of the Company's NGL business,
filed a registration statement on Form S-1 with the Securities and Exchange
Commission for an initial public offering. The partnership will succeed to a
portion of DMS' downstream NGL business, specifically, it will be engaged in
fractionation, storage, terminaling, transportation, distribution and marketing
NGLs to consumers throughout North America. Dynegy will own the general partner
of the partnership. The registration statement relating to the offering has not
yet been declared effective by the Securities and Exchange Commission and
Dynegy cannot guarantee its eventual effectiveness or that once effective,
Dynegy Energy Partners' initial public offering will be successfully completed.
NOTE 20--SUBSEQUENT EVENTS
The Company has experienced a number of materially adverse developments
since the filing of its 2001 Form 10-K on March 13, 2002. For a description of
these events, including Arthur Andersen advising the Company that its 2001
audit opinion should not be relied upon and that such audit opinion was
withdrawn, please read the Company's Exchange Act reports filed subsequent to
the filing of the 2001 Form 10-K. This report does not reflect events occurring
after the original filing of the 2001 Form 10-K except to reflect the
restatement items described above. As a result of these adverse developments
and the Company's decision to exit third party risk management aspects of the
marketing and trading business, together with changes in accounting policies
that have significantly affected the Company's reported financial results, the
results of operations and cash flows covered by the unaudited restated
financial statements in this report should not be considered indicative of the
Company's future results of operations or cash flows.
F-44
Schedule II
DYNEGY HOLDINGS INC. VALUATION AND QUALIFYING ACCOUNTS
(UNAUDITED AND RESTATED)
Years Ended December 31, 2001, 2000, and 1999
Balance Charged Balance
at to Costs Charged at End
Beginning and to Other of
of Period Expenses Accounts Deductions Period
--------- -------- -------- ---------- -------
2001
Allowance for doubtful accounts........ $ 63 $ 87 $(2) $(46) 102
Allowance for risk management assets(1) 146 53 -- -- 199
2000
Allowance for doubtful accounts........ 24 46 1 (8) 63
Allowance for risk management assets(1) 38 108 -- -- 146
1999
Allowance for doubtful accounts........ 24 3 -- (3) 24
Allowance for risk management assets(1) 6 32 -- -- 38
- --------
(1) Changes in price and credit reserves related to risk management activities
are offset in the net mark-to-market income accounts reported in revenues.
F-45