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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______TO______
COMMISSION FILE NUMBER: 1-15659
DYNEGY INC.
(Exact name of registrant as specified in its charter)
ILLINOIS 74-2928353
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1000 LOUISIANA, SUITE 5800
HOUSTON, TEXAS 77002
(Address of principal executive offices)
(Zip Code)
(713) 507-6400
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
Number of shares outstanding of each of the issuer's classes of common stock, as
of the latest practicable date: Class A Common Stock, no par value per share,
239,427,959 shares outstanding as of October 26, 2001; Class B Common Stock, no
par value per share, 86,499,914 shares outstanding as of October 26, 2001.
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DYNEGY INC.
TABLE OF CONTENTS
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<Table>
<Caption>
Page
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets:
September 30, 2001 and December 31, 2000.......................................................................3
Condensed Consolidated Statements of Operations:
For the three months ended September 30, 2001 and 2000.........................................................4
Condensed Consolidated Statements of Operations:
For the nine months ended September 30, 2001 and 2000..........................................................5
Condensed Consolidated Statements of Cash Flows:
For the nine months ended September 30, 2001 and 2000..........................................................6
Notes to Condensed Consolidated Financial Statements ..............................................................7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .......................................................................20
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.................................................33
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS .........................................................................................34
Item 6. EXHIBITS AND REPORTS ON FORM 8-K...........................................................................34
</Table>
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DYNEGY INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)(IN MILLIONS, EXCEPT SHARE DATA)
================================================================================
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2001 2000
---------------- ----------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 237 $ 86
Accounts receivable, net 3,757 5,036
Accounts receivable, affiliates 74 49
Inventory 342 302
Assets from risk-management activities 5,632 4,437
Prepayments and other assets 520 240
---------------- ----------------
TOTAL CURRENT ASSETS 10,562 10,150
---------------- ----------------
PROPERTY, PLANT AND EQUIPMENT 7,994 7,356
Accumulated depreciation (854) (649)
---------------- ----------------
PROPERTY, PLANT AND EQUIPMENT, NET 7,140 6,707
---------------- ----------------
OTHER ASSETS
Unconsolidated investments 989 799
Assets from risk-management activities 2,770 1,527
Intangible assets, net of amortization 1,585 1,502
Other assets 810 721
---------------- ----------------
TOTAL ASSETS $ 23,856 $ 21,406
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 3,571 $ 4,777
Accounts payable, affiliates 25 46
Accrued liabilities and other 771 628
Liabilities from risk-management activities 5,207 3,838
Notes payable and current portion of long-term debt 382 116
---------------- ----------------
TOTAL CURRENT LIABILITIES 9,956 9,405
LONG-TERM DEBT 3,016 2,828
OTHER LIABILITIES
Transitional funding trust notes 538 605
Liabilities from risk-management activities 2,679 1,568
Deferred income taxes 1,558 1,426
Other long-term liabilities 646 612
---------------- ----------------
TOTAL LIABILITIES 18,393 16,444
---------------- ----------------
MINORITY INTEREST 1,103 1,018
SERIAL PREFERRED SECURITIES OF A SUBSIDIARY 46 46
COMPANY OBLIGATED PREFERRED SECURITIES OF SUBSIDIARY TRUST 200 300
COMMITMENTS AND CONTINGENCIES (NOTE 7)
STOCKHOLDERS' EQUITY
Class A Common Stock, no par value, 900,000,000 and 300,000,000
shares authorized at September 30, 2001 and December 31, 2000,
respectively; 239,185,623 and 237,390,802 shares issued and
outstanding at September 30, 2001 and December 31, 2000,
respectively 2,234 2,190
Class B Common Stock, no par value, 360,000,000 and 120,000,000
shares authorized at September 30, 2001 and December 31, 2000,
respectively; 86,499,914 and 85,330,544 shares issued and
outstanding at September 30, 2001 and December 31, 2000,
respectively 801 760
Accumulated other comprehensive income (loss), net of tax (19) (15)
Retained earnings 1,163 666
Treasury stock, at cost: 1,616,800 shares at September 30, 2001
and 70,000 shares at December 31, 2000 (65) (3)
---------------- ----------------
TOTAL STOCKHOLDERS' EQUITY 4,114 3,598
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 23,856 $ 21,406
================ ================
</Table>
See notes to condensed consolidated financial statements.
3
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<Table>
<Caption>
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA)
===================================================================================================
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2001 2000
----------- -----------
Revenues $ 8,519 $ 8,366
Cost of sales 7,886 7,985
----------- -----------
Operating margin 633 381
Depreciation and amortization 113 93
General and administrative expenses 142 70
----------- -----------
Operating income 378 218
Earnings from unconsolidated investments 104 113
Other income 12 117
Interest expense (62) (54)
Other expenses (28) (37)
Minority interest in income of subsidiaries (6) (6)
----------- -----------
Income before income taxes 398 351
Income tax provision 112 116
----------- -----------
NET INCOME $ 286 $ 235
=========== ===========
Basic earnings per share $ 0.88 $ 0.76
=========== ===========
Diluted earnings per share $ 0.85 $ 0.73
=========== ===========
Basic shares outstanding 326 308
=========== ===========
Diluted shares outstanding 337 322
=========== ===========
</Table>
See notes to condensed consolidated financial statements.
4
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<Table>
<Caption>
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA)
===================================================================================================
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2001 2000
----------- -----------
Revenues $ 33,499 $ 19,434
----------- -----------
Cost of sales 31,952 18,363
----------- -----------
Operating margin 1,547 1,071
Depreciation and amortization 333 291
General and administrative expenses 383 235
Operating income 831 545
Earnings from unconsolidated investments 214 183
Other income 69 207
Interest expense (192) (195)
Other expenses (89) (113)
Minority interest in income of subsidiaries (18) (23)
----------- -----------
Income before income taxes 815 604
Income tax provision 246 209
----------- -----------
Income from operations 569 395
Cumulative effect of change in accounting principle 2 ---
----------- -----------
NET INCOME $ 571 $ 395
=========== ===========
NET INCOME PER SHARE:
Net income $ 571 $ 395
Less: preferred stock dividends --- (35)
----------- -----------
Net income applicable to common stockholders $ 571 $ 360
=========== ===========
Basic earnings per share $ 1.76 $ 1.22
=========== ===========
Diluted earnings per share $ 1.69 $ 1.17
=========== ===========
Basic shares outstanding 325 295
=========== ===========
Diluted shares outstanding 338 308
=========== ===========
</Table>
See notes to condensed consolidated financial statements.
5
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<Table>
<Caption>
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) (IN MILLIONS)
===================================================================================================
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2001 2000
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 571 $ 395
Items not affecting cash flows from operating activities:
Depreciation, amortization, impairment and abandonment 329 272
Earnings from unconsolidated investments, net of cash distributions (184) (142)
Risk-management activities 236 (122)
Deferred income taxes 166 117
Other (15) (100)
Change in assets and liabilities resulting from operating activities:
Accounts receivable 1,422 (1,100)
Inventory (10) 20
Prepayments and other assets (132) 109
Accounts payable and accrued liabilities (1,751) 998
Other, net 8 (73)
----------- -----------
Net cash provided by operating activities 640 374
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (1,544) (514)
Unconsolidated investments (52) (97)
Business acquisitions, net of cash acquired (21) (1,203)
Proceeds from asset sales 1,051 847
Other investing, net (237) ---
----------- -----------
Net cash used in investing activities (803) (967)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term borrowings 683 1,153
Repayments of long-term borrowings (251) (282)
Net cash flow from commercial paper and money market lines of credit (14) (640)
Proceeds from sale of capital stock, options and warrants 57 594
Purchase of treasury stock (59) (3)
Redemption of Illinois Power Company Serial Preferred Stock --- (93)
Dividends and other distributions, net (74) (84)
Other financing, net (28) ---
----------- -----------
Net cash provided by financing activities 314 645
----------- -----------
Net increase in cash and cash equivalents 151 52
Cash and cash equivalents, beginning of period 86 45
----------- -----------
Cash and cash equivalents, end of period $ 237 $ 97
=========== ===========
</Table>
See notes to condensed consolidated financial statements.
6
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DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
NOTE 1 - ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the instructions to interim financial
reporting as prescribed by the Securities and Exchange Commission ("SEC"). These
interim financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Annual Report on Form
10-K of Dynegy Inc. ("Dynegy" or the "Company") for the year ended December 31,
2000, as filed with the SEC.
The financial statements include all material adjustments, which, in
the opinion of management, are necessary for a fair presentation of the results
for the interim periods. Interim period results are not necessarily indicative
of the results for the full year. The preparation of the condensed consolidated
financial statements in conformity with generally accepted accounting principles
requires management to develop estimates and make assumptions that affect
reported financial position and results of operations and that impact the nature
and extent of disclosure, if any, of contingent assets and liabilities. Actual
results could differ materially from those estimates. Certain reclassifications
have been made to prior period amounts in order to conform to current year
presentation.
NOTE 2 - CHANGES IN ACCOUNTING PRINCIPLES
The Financial Accounting Standards Board ("FASB") issued, and
subsequently amended, Statement of Financial Accounting Standards 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 qualify as hedges of future cash flows or net investments. For
derivatives qualifying as hedges of future cash flows, the effective portion of
changes in fair value is recorded in equity until the related hedged items
impact earnings. Any ineffective portion of a hedge is reported in earnings
immediately.
The nature of the Company's business necessarily involves certain
market and financial risks. The Company routinely enters into financial
instrument contracts in an attempt to mitigate or eliminate these various risks.
These risks and the Company's strategy for mitigating these risks are more fully
described in Note 3 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2000.
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):
<Table>
<Caption>
OTHER
COMPREHENSIVE
NET INCOME INCOME
Adjustment to fair value of derivatives $ 3 $ 64
Income tax effects (1) (23)
---------- -------------
Total $ 2 $ 41
========== =============
</Table>
7
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DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
Changes in stockholders' equity related to derivatives for the
nine-month period ended September 30, 2001 were as follows, net of taxes (in
millions):
<Table>
Transition adjustment as of January 1, 2001 $ 41
Current period declines in fair value, net (19)
Reclassifications to earnings, net 3
-----------
Balance at September 30, 2001 $ 25
===========
</Table>
Accumulated Other Comprehensive Income (Loss), Net of Tax is included
in Stockholders' Equity on the Condensed Consolidated Balance Sheet as follows
(in millions):
<Table>
Statement No. 133, Net $ 25
Currency Translation Adjustment, Net (18)
Unrealized Loss on Available-for-Sale Securities, Net (26)
-----------
Accumulated Other Comprehensive Income, Net of
Tax, at September 30, 2001 $ (19)
===========
</Table>
Additional disclosures required by Statement No. 133, as amended, are
provided in the following paragraphs.
The Company enters into various financial derivative instruments
related to its energy convergence and midstream liquids businesses that qualify
as cash flow hedges. Such instruments 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. In 2001, the Company also executed two
interest-rate swaps that were designated as cash flow hedges of the benchmark
interest rate component of certain operating lease rentals.
During the three and nine months ended September 30, 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 accumulated balance in other comprehensive income at September 30,
2001 is expected to be reclassified to future earnings, contemporaneously with
the related purchases of fuel, sales of liquids and recognition of operating
lease expense, as applicable to each type of hedge. Of this amount,
approximately $34 million, net of taxes, is estimated to be reclassified into
earnings over the 12-month period ending September 30, 2002. The actual amounts
that will be reclassified to earnings over the next 12 months could vary
materially from this estimated amount as a result of changes in market
conditions.
The Company has also entered into foreign exchange forward contracts to
hedge its net investment in certain wholly owned subsidiaries. A cumulative
translation adjustment loss of approximately $2 million was recorded in the
third quarter of 2001 related to these contracts.
On July 20, 2001, the FASB issued Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement No. 142").
Statement No. 142 discontinues goodwill amortization over its estimated useful
life; rather, goodwill will be subject to at least an annual fair-value based
impairment test. Similarly, goodwill associated with equity-method investments
is no longer amortized. With regard to intangible assets, Statement No. 142
states that acquired intangible assets should be recognized separately if the
benefit of the intangible asset is obtained through contractual rights or if the
intangible asset can be sold, transferred, licensed, rented or exchanged,
without regard to the acquirer's intent. The Company is evaluating the future
financial effects of adopting Statement No. 142 and expects to adopt the
standard effective January 1, 2002. Goodwill amortization for the nine months
ended September 30, 2001 and 2000 was $35 million and $29 million, respectively.
In June 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. Statement No. 143 also includes
disclosure requirements that provide a description of asset retirement
obligations and reconciliation of changes in the components of those
8
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DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
obligations. The Company is evaluating the future financial effects of adopting
Statement No. 143 and expects to adopt the standard effective January 1, 2003.
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("Statement No. 144"). Statement No. 144 addresses the accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of" and APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The objective of Statement No. 144 is to establish one accounting
model for long-lived assets to be disposed of by sale as well as resolve
implementation issues related to Statement No. 121. The Company expects to adopt
Statement No. 144 effective January 1, 2002 and does not expect such adoption to
have a material impact on its financial condition and results of operations.
NOTE 3 - BUSINESS COMBINATIONS AND OTHER ACQUISITIONS
In the first quarter of 2001, Dynegy completed its previously announced
acquisition of the 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 megawatts ("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.
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 plant and equipment and agreed to lease it back for terms
expiring within 34 years, exclusive of renewal options.
On July 16, 2001, Dynegy announced its agreement to purchase BG Storage
Limited ("BGSL"), a wholly owned subsidiary of BG Group plc. Under the terms of
the purchase agreement, Dynegy agreed to pay approximately 420 million United
Kingdom Pound Sterling (approximately $603 million at October 26, 2001) for BGSL
and its existing assets. 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 transaction is subject to approvals from The Gas and
Electricity Markets Authority and The Department of Trade and Industry and
clearance from the Office of Fair Trading in the United Kingdom. In September
2001, in accordance with the advice of the Director General of Fair Trading, the
United Kingdom's Minister for Competition, Consumers and Markets announced her
intention to seek certain undertakings from Dynegy relating to the proposed
acquisition. Discussions relating to these undertakings have delayed the
approvals required to close the acquisition. There is no guarantee that such
approvals will be obtained or that the acquisition will be closed.
NOTE 4 - EARNINGS PER SHARE
Basic earnings per share represents the amount of earnings for the
period available to each share of common stock outstanding during the period.
Diluted earnings per share represents the amount of earnings for the period
available to each share of common stock outstanding during the period plus each
share that would have been outstanding assuming the issuance of common shares
for all dilutive potential common shares outstanding during the period.
Differences between basic and diluted shares outstanding in all periods are
attributed to options outstanding. Common shares outstanding and the resulting
computation of basic and diluted earnings per share for the three and nine
months ended September 30, 2000 have been restated for the two-for-one stock
split effected by means of a stock dividend distributed on August 22, 2000.
NOTE 5 - CAPITAL STOCK
Chevron purchased an additional 1.2 million shares of Class B Common
Stock in the nine-month period ended September 30, 2001 pursuant to its
shareholder agreement with Dynegy.
On June 21, 2001, Dynegy announced a stock repurchase program of up to
6 million shares or $250 million of its outstanding Class A Common Stock. The
program permits the Company to repurchase the shares in the open market and
through private transactions. Repurchased shares are held as treasury stock and
are available for general corporate purposes.
9
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DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
During the quarter ended September 30, 2001, Dynegy repurchased 966,800
shares for an aggregate $37.9 million purchase price. From October 1, 2001
through October 30, 2001, the Company repurchased an additional 150,000
shares for an aggregate $5.6 million purchase price.
NOTE 6 - UNCONSOLIDATED INVESTMENTS
At September 30, 2001, Dynegy's unconsolidated investments accounted
for by the equity method included an approximate 23 percent interest in Venice
Energy Services Company, L.L.C.; a 38.75 percent partnership interest in Gulf
Coast Fractionators; a 39 percent partnership interest in West Texas LPG
Pipeline, Limited Partnership; interests ranging from 17.55 to 50 percent in
various entities, each formed to build (or buy), own and operate power
generation facilities located in the United States, Asia and South America; a
33.33 percent interest in Waskom Gas Processing Company, a partnership that owns
and operates a natural gas processing, extraction and fractionation facility; a
50 percent interest in NICOR Energy L.L.C., a retail energy alliance located in
the Midwest; and a 20 percent interest in SouthStar Energy Services L.L.C., a
retail energy alliance located in the Southeast.
Summarized unaudited combined income statement information for the
unconsolidated affiliates accounted for by the equity method is presented in the
following table (in millions):
<Table>
<Caption>
-------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------
2001 2000
--------------------------- ----------------------------
EQUITY EQUITY
TOTAL SHARE TOTAL SHARE
------ ------- ------ --------
Revenues (1) $2,032 $627 $2,435 $943
------ ------- ------ --------
Operating margin (1) $319 $102 $359 $118
------ ------- ------ --------
Net income (1) $458 $198 $407 $170
------ ------- ------ --------
-------------------------------------------------------------------------------------------------
</Table>
---------------------
(1) The interim financial data for September 30, 2000 is exclusive of
amounts attributable to the Company's investment in Accord Energy
Limited ("Accord") as such information was unavailable. The Company
sold its investment in Accord in the third quarter of 2000.
Also included in unconsolidated investments at September 30, 2001 are
Dynegy's various cost basis investments and certain warrants to acquire common
stock of other entities.
NOTE 7 - 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.
10
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DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
Following dismissal of its federal court suit, MID filed suit in
California state court asserting breach of contract and tortious interference
with prospective economic relations claims against Destec and tortious
interference with contract and interference with prospective economic relations
claims against PG&E. Motions to dismiss MID's state court claims were heard by
the state court and by order dated April 6, 2000, MID was directed to amend its
complaint. MID filed its amended complaint on April 20, 2000, including Dynegy
as a defendant. Dynegy filed a motion to dismiss MID's amended complaint against
Dynegy, and the Court partially granted Dynegy's motion to dismiss while also
granting MID leave to amend its complaint. Before MID filed its amended
complaint, MID agreed with PG&E and Dynegy to execute a tolling agreement on all
claims and to dismiss the state court case until the federal appeal is decided.
After executing the tolling agreement, on October 23, 2000, MID filed in the
state court a Request for Dismissal, which the court granted on October 25,
2000. Dynegy believes 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 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 either or both the
Prevention of Significant Deterioration ("PSD") and the New Source Performance
Standards regulations. When non-exempt "major modifications" occur, the Clean
Air Act and related regulations generally require that generating facilities
meet more stringent emissions standards. 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
liability.
The regulations under the Clean Air Act provide certain exemptions to
the definition of "major modifications," 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 exemption, there
were no 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
provide an exemption for increased hours of operations or production rate and
for increases in emissions resulting from demand growth. Although none of the
Defendants' other facilities are covered in the complaint and NOV, the EPA has
officially requested information concerning activities at the Defendants'
Vermilion, Wood River and Hennepin 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
also will be seeking installation of the "best available control technology" (or
the equivalent) at the Baldwin Station and possibly at the other three plants.
The parties are engaged in discovery and numerous discovery-related
disputes have arisen. The United States Magistrate heard arguments on a number
of the discovery disputes in December 2000 and issued orders favorable to the
Defendants on most of the disputed issues. Notwithstanding the favorable order,
discovery disputes continue to arise.
The National Energy Policy Report issued in May 2001 by the National
Energy Policy Development Group recommended that the EPA Administrator examine
the new source review regulations, including the PSD regulations, and report to
the President within 90 days on the impact of new source review on investment in
new utility and refinery generation capacity, energy efficiency and
environmental protection. The report also recommended that the Attorney General
review existing enforcement actions regarding new source review to ensure that
the enforcement actions are consistent with the Clean Air Act and its
regulations. These reviews have been undertaken by the respective agencies. 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 review, which remains ongoing.
11
<Page>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
Two utilities, Virginia Power and Cinergy, reached tentative
settlements with the United States on several issues in 2000. The tentative
settlements 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 credits. These settlements are not expected to be finalized until after
the EPA review of the new source review regulations is completed.
The Company believes the allegations are without merit and will
vigorously defend this claim. 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.
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. The defendants subsequently
removed the case to United States District Court for the Southern
District of California.
2. Hendricks v. Dynegy Power Marketing Inc., et al. was filed on
November 29, 2000 in San Diego Superior Court. The defendants
subsequently removed the case to the United States District Court
for the Southern District of California.
3. People of the State of California v. Dynegy Power Marketing Inc.,
et al. was filed on January 18, 2001 in San Francisco Superior
Court. The defendants subsequently removed the case to the United
States District Court for the Northern District of California.
4. Pier 23 Restaurant v. PG&E Energy Trading, et al. was filed on
January 24, 2001 in San Francisco Superior Court. The defendants
subsequently removed the case to the United States District Court
for the Northern District of California.
5. Sweetwater Authority et al. v. Dynegy Inc., et al. was filed on
January 16, 2001 in San Diego Superior Court. The defendants
subsequently removed the case to the United States District Court
for the Southern District of California.
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 defendants
subsequently removed the case to the United States District Court
for the Northern District of California.
The six class action lawsuits are based on the events occurring in the
California power market during the summer of 2000. The complaints allege
violations of California's Business and Professions Code, Unfair Trade Practices
Act and various other statutes. Specifically, the named plaintiffs allege that
the defendants, including the owners of in-state generation and various power
marketers, conspired to manipulate the California wholesale power market to the
detriment of California consumers. Included among the acts forming the basis of
the plaintiffs' claims are the alleged improper sharing of generation outage
data, improper withholding of generation capacity and the manipulation of power
market bid practices. The plaintiffs seek unspecified treble damages. The
Bustamante suit includes claims against various Dynegy entities, including
Dynegy Inc. and Dynegy Marketing and Trade, as well as against three corporate
officers individually. The allegations in this suit are similar to those in the
other five suits, with the exception that the Bustamante suit includes a claim
of unfair business practices based on "price gouging" during an emergency
declared by Governor Gray Davis.
The six lawsuits are at preliminary stages. Defendants in the six
lawsuits have yet to file answers. The plaintiffs filed motions to remand the
cases to state court. The California federal judges originally assigned to the
lawsuits recused themselves on the basis that they and their families have an
economic stake in the litigation. The defendants in the first five lawsuits
invoked federal multi-district litigation procedures and the multi-district
panel, comprised of federal judges, assigned the cases to Judge Robert Whaley, a
visiting Judge from the State of Washington sitting in the Southern District of
California. The Bustamante suit was subsequently assigned to Judge Whaley. By
order issued on July 31, 2001, Judge Whaley remanded the first five cases back
to state court.
In respect to the Bustamante suit, the parties agreed that, based on
Judge Whaley's decision to remand the other five lawsuits, the case should go
back to state court. All six lawsuits are in the process of being consolidated
in California state court. Eventually the cases will be consolidated before a
single California state court judge.
12
<Page>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
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.
In addition, 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, including
an interim price review procedure for prices above a $150/MW hour "breakpoint"
on sales to the California Independent System Operator (the "ISO") and through
the California Power Exchange (the "PX"). The order does not prohibit sales
above the "breakpoint," but the seller was subject to weekly reporting and
monitoring requirements. In an order issued March 9, 2001, FERC determined that
only sales during so-called "Stage 3" emergency hours would be subject to refund
beginning January 1, 2001. However, sales between October 2, 2000 and December
31, 2000 remained subject to refund under the FERC's December 15 order. 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 June 1, 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 Counsel 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, the FERC ordered a hearing to calculate the refunds
that power generators allegedly owe California for overcharges in spot
electricity markets 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 FERC endorsed the settlement judge's
recommendation to calculate the refunds largely based on a formula used in the
FERC's June 19, 2001 order. The Company believes that refund claims are
overstated and has entered into a joint defense arrangement with other
California generators. An administrative law judge will certify his proposed
findings of fact to the FERC on March 8, 2002.
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 recently released 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.
Management has closely monitored developments in California in an
effort to manage Dynegy's credit risk. The Company has recorded reserves for
probable losses incurred based on market conditions. 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.
13
<Page>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
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.
NOTE 8 - REGULATORY ISSUES
GENERAL. The Company is subject to regulation by various federal,
state, local and foreign agencies. These rules and regulations affect the
industry as a whole; therefore, the Company does not believe that it is affected
in a manner significantly different from its competitors.
ILLINOIS POWER COMPANY. IP is an electric utility as defined in the
Public Utility Holding Company Act of 1935 ("PUHCA"). Its direct parent company,
Illinova Corporation ("Illinova"), and Dynegy are holding companies as defined
in PUHCA. However, Illinova and Dynegy generally are each exempt from regulation
under section 3(a)(1) of PUHCA. They remain subject to regulation under PUHCA
with respect to the acquisition of certain voting securities of other domestic
public utility companies and utility holding companies.
IP also is subject to regulation by the Federal Power Act ("FPA") and
the FERC as to transmission rates and certain other matters. The FERC has
declared IP exempt from the Natural Gas Act of 1938 and related FERC orders,
rules and regulations.
IP is further subject to regulation by the State of Illinois and the
Illinois Commerce Commission (the "ICC"). The Illinois Public Utilities Act was
significantly modified in December 1997 by the Electric Service Customer Choice
and Rate Relief Law of 1997, or P.A. 90-561, but the ICC still has broad powers
of supervision and regulation with respect to IP's rates and charges and various
other matters. Under P.A. 90-561, IP must continue to provide bundled retail
electric services to all who choose to continue to take service at tariff rates
and must provide unbundled electric distribution services to all eligible
customers as defined by P.A. 90-561 at rates determined by the ICC.
Among other things, P.A. 90-561 also required IP to participate in an
independent system operator. To that end, in January 1998, IP, in conjunction
with eight other transmission-owning entities, filed with the FERC for all
approvals necessary to create and to implement the Midwest Independent
Transmission System Operator, Inc. ("MISO"). On September 20, 2000, IP announced
its intention to withdraw its participation in the MISO and to become a member
of the Alliance Regional Transmission Organization ("Alliance RTO"), pending
necessary regulatory approval. On October 13, 2000, IP filed a notice of its
intent to withdraw from the MISO with FERC. On February 23, 2001, IP reached a
settlement in principle with all parties that allows it to withdraw from the
MISO and join the Alliance RTO, effective upon the FERC's approval of the
settlement, which occurred May 8, 2001. IP has fulfilled its obligations under
the MISO settlement.
On August 21, 2001, IP and seven of the transmission owners that are
part of the Alliance RTO entered into a letter of intent with National Grid, USA
pursuant to which National Grid would serve as the Alliance RTO's managing
member for a period of seven years. Pursuant to the letter of intent, the FERC
must determine that National Grid is a non-market participant. On August 27,
2001, IP, in coordination with the other transmission owners comprising the
Alliance RTO, filed the terms of the transaction with the FERC as the proposed
business and independence plan for the Alliance RTO.
The Alliance RTO will own transmission facilities divested by
transmission owners in exchange for passive ownership interests in the Alliance
RTO or partially for cash. Alternatively, the Alliance RTO will enter into
seven-year operating agreements to functionally control the transmission
facilities of transmission owners that elect not to divest. Non-divesting
transmission owners will maintain the physical operations of their transmission
facilities.
If approved as managing member, National Grid would be responsible for
operating the Alliance RTO's transmission facilities and would operate the
Alliance RTO as a for-profit corporation. National Grid would receive a
management fee of $14 million, fixed rate of return on its investment in the
Alliance RTO, reimbursement of operating and maintenance expenditures and
incentive compensation. In return, National Grid would be required to contribute
$1 billion to the Alliance RTO by 2005, $75 million of which would be used to
reimburse members for start-up costs and an additional $75 million of which
would be used to fund capital expenditures for future system costs. The
remaining $850 million would be used to purchase transmission assets for
transmission expansions.
14
<Page>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
NOTE 9 - SEGMENT INFORMATION
Dynegy's operations are divided into four reportable segments: Dynegy
Marketing and Trade ("DMT"), Dynegy Midstream Services ("DMS"), Transmission and
Distribution and Dynegy Global Communications ("DGC"). DMT is engaged in a broad
array of businesses, including the physical supply of and risk-management
activities around wholesale natural gas, power, coal, emission allowances and
weather derivatives. This segment is focused on optimizing the Company's and its
customers' global portfolio of assets and capacity contracts, as well as direct
commercial and industrial sales and retail marketing alliances. DMS consists of
the Company's North American midstream liquids processing and marketing business
and worldwide natural gas liquids marketing and transportation operations.
Dynegy's regulated Transmission and Distribution segment consists of the
operations of IP, an energy-delivery company engaged in the transmission,
distribution and sale of electricity and natural gas to customers across a
15,000-square-mile area of Illinois. DGC is engaged in pursuing and capturing
opportunities in the converging energy and communications marketplace. DGC has a
global long-haul data network and metropolitan networks in key cities in the
United States. Dynegy accounts for intercompany transactions at prevailing
market rates. Unaudited operating segment information for the three-and
nine-month periods ended September 30, 2001 and 2000 is presented below.
15
<Page>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DYNEGY'S SEGMENT DATA FOR THE QUARTER ENDED SEPTEMBER 30, 2001
($ in millions)
<Table>
<Caption>
TRANSMISSION
AND
DMT DMS DISTRIBUTION DGC ELIMINATIONS TOTAL
Unaffiliated revenues:
Domestic................... $ 5,153 $ 958 $ 395 $ 4 $ --- $ 6,510
Canadian................... 612 447 --- --- --- 1,059
European and other......... 946 --- --- 4 --- 950
--------- --------- -------- -------- --------- ---------
6,711 1,405 395 8 --- 8,519
Intersegment revenues:
Domestic................... 149 43 6 --- (198) ---
--------- --------- -------- -------- --------- ---------
Total revenues........ 6,860 1,448 401 8 (198) 8,519
--------- --------- -------- -------- --------- ---------
Operating margin................ 451 63 125 (6) --- 633
Depreciation and amortization... (46) (21) (41) (5) --- (113)
Interest expense................ (21) (12) (27) (2) --- (62)
Other income (expense).......... (21) 1 1 3 --- (16)
Earnings from unconsolidated
investments................ 96 3 --- 5 --- 104
Income tax provision (benefit).. 99 7 14 (8) --- 112
Net income (loss)............... $ 263 $ 12 $ 26 $ (15) $ --- $ 286
Identifiable assets:
Domestic................... $ 15,594 $ 1,889 $ 3,562 $ 371 $ --- $ 21,416
Canadian................... 441 342 --- --- --- 783
European and other......... 1,447 --- --- 210 --- 1,657
Unconsolidated investments...... 804 160 --- 25 --- 989
Capital expenditures and
unconsolidated investments... (95) (25) (30) (87) --- (237)
</Table>
16
<Page>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DYNEGY'S SEGMENT DATA FOR THE QUARTER ENDED SEPTEMBER 30, 2000
($ in millions)
<Table>
<Caption>
TRANSMISSION
AND
DMT DMS DISTRIBUTION DGC ELIMINATIONS TOTAL
Unaffiliated revenues:
Domestic..................... $ 5,529 $ 1,277 $ 429 $ --- $ --- $ 7,235
Canadian..................... 573 357 --- --- --- 930
European and other........... 201 --- --- --- --- 201
--------- --------- -------- -------- --------- ---------
6,303 1,634 429 --- --- 8,366
--------- --------- -------- -------- --------- ---------
Intersegment revenues:
Domestic .................... 68 71 10 --- (149) ---
--------- --------- -------- -------- --------- ---------
Total revenues.......... 6,371 1,705 439 --- (149) 8,366
--------- --------- -------- -------- --------- ---------
Operating margin............. 192 60 129 --- --- 381
Depreciation and amortization..... (33) (20) (40) --- --- (93)
Interest expense.................. (8) (15) (31) --- --- (54)
Other income (expense)............ 84 (5) 1 --- --- 80
Earnings from unconsolidated
investments................. 106 7 --- --- --- 113
Income tax provision (benefit).... 97 6 13 --- --- 116
Net income........................ $ 200 $ 8 $ 27 $ --- $ --- $ 235
Identifiable assets:
Domestic..................... $ 10,126 $ 1,968 $ 3,352 $ --- $ --- $ 15,446
Canadian..................... 538 183 --- --- --- 721
European and other........... 609 --- --- --- --- 609
Unconsolidated investments........ 669 159 --- --- --- 828
Capital expenditures and
unconsolidated investments... (109) (30) (32) --- --- (171)
</Table>
17
<Page>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DYNEGY'S SEGMENT DATA FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
($ in millions)
<Table>
<Caption>
TRANSMISSION
AND
DMT DMS DISTRIBUTION DGC ELIMINATIONS TOTAL
Unaffiliated revenues:
Domestic...................... $ 20,863 $ 3,678 $ 1,255 $ 8 $ --- $ 25,804
Canadian...................... 3,887 1,128 --- --- --- 5,015
European and other............ 2,672 --- --- 8 --- 2,680
--------- --------- -------- -------- --------- ---------
27,422 4,806 1,255 16 --- 33,499
Intersegment revenues:
Domestic...................... 449 202 20 --- (671) ---
--------- --------- -------- -------- --------- ---------
Total revenues........... 27,871 5,008 1,275 16 (671) 33,499
--------- --------- -------- -------- --------- ---------
Operating margin................... 1,017 217 331 (18) --- 1,547
Depreciation and amortization...... (133) (61) (124) (15) --- (333)
Interest expense................... (61) (39) (87) (5) --- (192)
Other income (expense)............. (40) (7) 24 3 --- (20)
Earnings from unconsolidated
investments................... 186 9 --- 19 --- 214
Income tax provision (benefit)..... 214 26 34 (28) --- 246
Income (loss) from operations...... 513 45 57 (46) --- 569
Cumulative effect of change in
accounting principle............ 2 --- --- --- --- 2
Net income (loss).................. $ 515 $ 45 $ 57 $ (46) $ --- $ 571
Identifiable assets:
Domestic...................... $ 15,594 $ 1,889 $ 3,562 $ 371 $ --- $ 21,416
Canadian...................... 441 342 --- --- --- 783
European and other............ 1,447 --- --- 210 --- 1,657
Unconsolidated investments........ 804 160 --- 25 --- 989
Capital expenditures and
unconsolidated investments.... (1,302) (83) (95) (116) --- (1,596)
</Table>
18
<Page>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DYNEGY'S SEGMENT DATA FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
($ in millions)
<Table>
<Caption>
TRANSMISSION
AND
DMT DMS DISTRIBUTION DGC ELIMINATIONS TOTAL
Unaffiliated revenues:
Domestic...................... $ 11,410 $ 3,680 $ 1,143 $ --- $ --- $ 16,233
Canadian...................... 1,402 800 --- --- --- 2,202
European and other............ 999 --- --- --- --- 999
--------- --------- -------- -------- --------- ---------
13,811 4,480 1,143 --- --- 19,434
--------- --------- -------- -------- --------- ---------
Intersegment revenues:
Domestic...................... 146 167 22 --- (335) ---
--------- --------- -------- -------- --------- ---------
Total revenues........... 13,957 4,647 1,165 --- (335) 19,434
--------- --------- -------- -------- --------- ---------
Operating margin................... 554 188 329 --- --- 1,071
Depreciation and amortization...... (91) (84) (116) --- --- (291)
Interest expense................... (79) (18) (98) --- --- (195)
Other income (expense)............. 133 (40) 1 --- --- 94
Earnings from unconsolidated
investments................... 165 18 --- --- --- 183
Income tax provision............... 188 6 15 --- --- 209
Net income......................... $ 348 $ 13 $ 34 $ --- $ --- $ 395
Identifiable assets:
Domestic...................... $ 10,126 $ 1,968 $ 3,352 $ --- $ --- $ 15,446
Canadian...................... 538 183 --- --- --- 721
European and other............ 609 --- --- --- --- 609
Unconsolidated investments......... 669 159 --- --- --- 828
Capital expenditures and
unconsolidated investments...... (422) (89) (100) --- --- (611)
</Table>
NOTE 10 - REDEMPTION OF PREFERRED SECURITIES OF SUBSIDIARY TRUST. On September
30, 2001, IP redeemed all $100 million of the Trust Originated Preferred
Securities issued by Illinois Power Financing I. The redemption was financed
with $85 million cash and $15 million in commercial paper. Because September 30,
2001 fell on a Sunday, the actual cash redemption occurred on October 1, 2001.
The condensed consolidated balance sheet at September 30, 2001 reflects the
redemption of the securities with the offset to accounts payable.
19
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
The following discussion and analysis should be read in conjunction
with the unaudited condensed consolidated financial statements of Dynegy Inc.
("Dynegy" or the "Company") included elsewhere herein and with the Company's
Annual Report on Form 10-K for the year ended December 31, 2000.
GENERAL
COMPANY PROFILE. Dynegy is a leading provider of energy and
communications solutions to customers in North America, the United Kingdom and
Continental Europe. The Company's leadership position extends across the entire
convergence value chain, including power generation and wholesale and direct
commercial and industrial marketing and trading of power, natural gas, coal,
emission allowances, weather derivatives and broadband. The Company is also
engaged in the transportation, gathering and processing of natural gas liquids
("NGLs") and the transmission and distribution of electricity and natural gas to
retail consumers. A highly integrated and geographically diverse network of
owned and controlled energy assets, managed and optimized by an experienced risk
management, trading and marketing team, enables Dynegy to create value for our
customers and shareholders.
BUSINESS SEGMENTS. Dynegy's operations are divided into four reportable
segments: Dynegy Marketing and Trade ("DMT"), Dynegy Midstream Services ("DMS"),
Transmission and Distribution and Dynegy Global Communications ("DGC"). Each of
our business segments is more fully discussed above in Note 9 - Segment
Information.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business strategy has historically focused on acquiring,
constructing or contracting for a regionally diverse network of energy assets in
order to capture significant synergies existing among these types of assets and
Dynegy's natural gas, power, NGL and broadband marketing businesses. The
Company's energy network is focused on marketing, trading and arbitrage
opportunities involving natural gas and power, centered around the control and
optimization of Btu conversion capacity within the wholesale gas and power
businesses. For the foreseeable future, the Company's primary capital
expenditure focus will be the acquisition and/or construction of energy assets
that will enable the Company to fully realize the commercialization of this
energy network. The Company also anticipates future capital expenditures
associated with the worldwide development and implementation of network and
connectivity solutions relating to its bandwidth communications strategy in the
converging energy and communications marketplace.
Dynegy relies upon operating cash flow and funds provided by a
combination of commercial paper issuances, money market lines of credit,
corporate credit agreements and various public debt and equity issuances for its
liquidity and capital resource requirements. At September 30, 2001, the
Company's various credit agreements totaled $2.27 billion. Of this credit
capacity, $300 million, $1.67 billion and $300 million was authorized for use by
Dynegy, Dynegy Holdings Inc. ("Holdings") and Illinois Power Company ("IP"),
respectively. After consideration of outstanding commercial paper and letters of
credit, the unused borrowing capacity under these agreements at September 30,
2001 approximated $300 million, $1.5 billion and $54 million for Dynegy,
Holdings and IP, respectively. Management believes additional financing
arrangements can be obtained at reasonable terms, if necessary.
Holdings completed a $920 million leveraged lease transaction in May of
2001. The leveraged lease transaction relates to the acquisition of 1,700
megawatts ("MW") of Central Hudson power generation facilities in the Northeast.
The transaction included a private offering of approximately $800 million
aggregate principal amount of nine- and 15-year debt securities, which have
since been exchanged for registered securities, and an equity investment by a
third party in the amount of approximately $120 million. The debt securities are
pass-through trust certificates issued by two pass-through trusts. Rent payable
by two Holdings subsidiaries in the leveraged lease transaction is the source of
payment on these certificates. Holdings, which agreed to guarantee the
subsidiaries' obligations under the leveraged lease transaction, used
approximately $50 million of the proceeds to repay commercial paper and is using
the remainder of the proceeds for general corporate purposes.
20
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
OTHER MATTERS
PENDING ACQUISITION. On July 16, 2001, Dynegy announced its agreement
to purchase BG Storage Limited ("BGSL"), a wholly owned subsidiary of BG Group
plc. Under the terms of the purchase agreement, Dynegy agreed to pay
approximately 420 million United Kingdom Pound Sterling (approximately $603
million at October 26, 2001) for BGSL and its existing assets. 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 transaction is
subject to approvals from The Gas and Electricity Markets Authority and The
Department of Trade and Industry and clearance from the Office of Fair Trading
in the United Kingdom. In September 2001, in accordance with the advice of the
Director General of Fair Trading, the United Kingdom's Minister for Competition,
Consumers and Markets announced her intention to seek certain undertakings from
Dynegy relating to the proposed acquisition. Discussions relating to these
undertakings have delayed the approvals required to close the acquisition. There
is no guarantee that such approvals will be obtained or that the acquisition
will be closed.
COMMITMENTS AND CONTINGENCIES. See Part I, Item 1, Condensed
Consolidated Financial Statements, Note 7, which is incorporated herein by
reference, for a discussion of the Company's Commitments and Contingencies.
CALIFORNIA MARKET. The power and natural gas markets in California have
experienced substantial volatility driven by a fundamental imbalance in supply
and demand and the retail electricity price caps imposed on the state's two
largest utilities. In addition, natural gas available to the state was in tight
supply which caused historic highs in the basis differential between California
and other markets.
Many events related to the California situation have occurred in recent
months. The most significant of these events include: (a) a Chapter 11
bankruptcy filing by PG&E; (b) Dynegy's inclusion on PG&E's creditor committee;
(c) separate rulings by the Ninth Circuit Court of Appeals and the FERC
acknowledging that generators in California are not required to sell to
noncreditworthy counterparties; (d) the FERC's decision to investigate gas
pipeline marketing affiliate abuse in the region; (e) the FERC's imposition of a
market mitigation plan for the Western States Coordinating Council; (f) FERC
orders directing electricity suppliers to either refund a portion of certain
sales revenue or justify their prices above approved pricing amounts; (g) a
failed settlement conference to determine potential refunds; (h) the scheduling
of a FERC hearing to calculate any such refunds; (i) continued debate over the
validity and legality of long-term power supply contracts executed by state
agencies and (j) a settlement agreement between Southern California Edison and
the California Public Utilities Commission that is designed to allow Southern
California Edison to pay its past due debts and return it to creditworthy
status. In addition, Dynegy and certain of its officers have been named in
various lawsuits associated with the California situation, which are more fully
discussed in Note 7 to the Condensed Consolidated Financial Statements.
Dynegy and NRG Energy each own 50 percent of West Coast Power LLC
("West Coast Power"), a joint venture owning power generation plants in southern
California. Dynegy's net interest in West Coast Power represents approximately
1,400 MW of generating capacity. Dynegy also participates in the California
markets as a wholesale marketer and trader of gas and power. Through Dynegy's
interest in West Coast Power, Dynegy has credit exposure to certain state
agencies ("ISO" and "PX"), which primarily relied on receipts from California
utilities to pay their bills. West Coast Power also sells directly to the
California Department of Water Resources ("DWR") and pursuant to other bilateral
agreements. The delay in payments to West Coast Power has resulted in a covenant
default under West Coast Power's bank credit facility. The West Coast Power bank
facility is nonrecourse to Dynegy. West Coast Power has entered into a
forbearance agreement with its lenders in connection with the covenant default.
The covenant default by West Coast Power does not adversely impact any other
credit facilities or borrowing obligations of Dynegy or its subsidiaries.
West Coast Power's generation facilities primarily are intended to
operate as peaking units. Because of the power shortage in California, these
units were running with much greater frequency and for longer durations than is
typically the case. Management continues to monitor the maintenance needs of the
West Coast Power facilities, as well as the availability of emission credits
which are required to operate the facilities.
21
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
In addition to indirect sales to California transacted through West
Coast Power, Dynegy makes direct sales to customers in California. Substantially
all of Dynegy's direct sales made in California represent either gas sales made
under securitized arrangements or bilateral sales made to creditworthy
counterparties.
As a result of West Coast Power's previously announced long-term sales
arrangement with the DWR, ongoing management of credit risk associated with
direct sales to customers in California and the recent Ninth Circuit Court of
Appeals and FERC decisions regarding counterparty choice for generators as well
as other factors, management believes that Dynegy's primary exposure relates to
the realization of its share of West Coast Power's receivables from the ISO and
PX. Transactions with the aforementioned counterparties, other than the ISO and
PX, are current under the terms of each individual arrangement. At September 30,
2001, Dynegy's portion of the receivables owed to West Coast Power by the ISO
and PX approximated $330 million. Management is continually assessing Dynegy's
exposure relative to its California receivables and has established reserves to
reflect market uncertainties.
The Company closely monitors developments in California in an effort to
manage its credit risk. In this regard, there have been press reports of
proposals to renegotiate DWR's long-term contracts. Although Dynegy is mentioned
as having a long-term contract with DWR, these reports focus primarily on
contracts negotiated with others. Dynegy has not been contacted directly by DWR
or the Governor's office at this time. Management views its contract with DWR as
being fair to both sides and therefore does not envision the need for
renegotiations. As a normal matter of business practice, however, management is
open to discussions regarding mutually beneficial changes.
NEW YORK ELECTRIC GENERATION MARKET. The New York Independent System
Operator, Inc. ("NYISO"), the FERC-approved operator of electric transmission
facilities and centralized electric markets in New York, has filed an "Automated
Mitigation Procedure" ("AMP") proposal with the FERC. The AMP caps bid prices
based on the cost characteristics of generating facilities in New York, such as
those owned or operated by the Company. In an order issued on June 28, 2001, the
FERC accepted the AMP proposal for this past summer. As of September 28, 2001,
the NYISO has filed an application at the FERC to extend the AMP until October
31, 2002. Management cannot predict the outcome of this proceeding.
GENERATION UNDER CONSTRUCTION. Dynegy has three power plants under
construction that are expected to begin commercial operation during the summer
of 2002. The natural gas-fired facilities will provide additional generation of
approximately 1,500 MW and are located in Kentucky and Michigan. Additionally,
construction has also started on an 800 MW natural gas-fired peaking facility in
Ohio for which operation is expected to begin during the summer of 2003.
DIVIDEND POLICY. In 2001, Dynegy intends to pay an annual dividend of
$0.30 per share of common stock, subject to declaration by the Board of
Directors of the Company and the availability of funds legally available
therefor. During the nine-month periods ended September 30, 2001 and 2000, the
Company paid approximately $74 million and $84 million in cash dividends and
distributions, respectively, on common and preferred stock.
Dynegy had no preferred stock outstanding during the nine months ended
September 30, 2001 on which it had to pay dividends.
STOCK BUYBACK. On June 21, 2001, Dynegy announced a stock repurchase
program of up to 6 million shares or $250 million of its outstanding Class A
Common Stock. The program permits the Company to repurchase the shares in the
open market and through private transactions. Repurchased shares are held as
treasury stock and are available for general corporate purposes. During the
quarter ended September 30, 2001, Dynegy repurchased 966,800 shares for an
aggregate $37.9 million purchase price. From October 1, 2001 through October 30,
2001, the Company repurchased an additional 150,000 shares for an aggregate $5.6
million purchase price.
CONCENTRATION OF CREDIT RISK. As a result of recent volatility in both
the commodity and equity markets, Dynegy has reassessed its industry credit
concentration as well as specific counterparty credit risks. Based on this
reassessment, Dynegy continues to believe that credit risk imposed by industry
concentration is largely offset by the diversification and creditworthiness of
its customer base. The Company continues to believe that its corporate credit
policies are aligned with business risks in support of minimizing enterprise
credit risk.
22
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
CONCLUSION. The Company believes it will meet all foreseeable cash
requirements, including working capital, capital expenditures and debt service,
from operating cash flow, supplemented with funds provided by its various credit
facilities and equity or debt sales, if required.
RESULTS OF OPERATIONS
Provided below are a narrative and tabular presentation of certain
operating and financial data and statistics for the Company's businesses for the
three- and nine-month periods ended September 30, 2001 and 2000, respectively.
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
For the quarter ended September 30, 2001, Dynegy's net income was $286
million, or $0.85 per diluted share, compared with third quarter 2000 net income
of $235 million and recurring diluted earnings per share of $0.55. Diluted
earnings per share of $0.73 reported in the third quarter 2000 included a
one-time pre-tax gain of $83 million ($58 million after-tax) on the disposition
of Dynegy's non-operating interest in Accord Energy Ltd. ("Accord"), a U.K. gas
marketing joint venture. Third quarter 2001 results were led by a strong
performance in energy convergence operations, particularly in natural gas and
power marketing operations which benefited from increased customer origination
and increased volumes. In addition, power generation operations improved as a
result of greater utilization of our generating facilities, including the
generating facilities recently acquired from Central Hudson in the Northeast.
Consolidated operating margin for the third quarter of 2001 totaled
$633 million compared to $381 million for the same 2000 period, primarily
reflecting improved margins in DMT. DMT contributed $451 million to third
quarter 2001 consolidated operating margin compared to $192 million reported in
the third quarter of 2000, an increase of 134 percent. DMS contributed $63
million to third quarter 2001 consolidated operating margin compared to $60
million reported in the third quarter of 2000. Transmission and Distribution
contributed $125 million to third quarter 2001 consolidated operating margin
compared to $129 million reported in the third quarter of 2000. DGC had negative
margin of $6 million in the 2001 quarter.
Operating income increased $160 million quarter-to-quarter, reflecting
the significantly higher operating results from DMT. Improved operating results
were partially offset by higher depreciation and amortization and general and
administrative expenses. Increases in depreciation and amortization expense
during the 2001 period reflect the impact of the continued expansion of the
Company's depreciable asset base, principally in DMT, and capitalized costs
associated with enhanced information technology infrastructure. The increased
level of general and administrative expenses reflect the impact of continued
expansion of the Company's operations, primarily in Europe and in
communications, and higher company-wide variable compensation accruals.
Incremental to Dynegy's consolidated results was the Company's earnings
from unconsolidated investments, which contributed approximately $104 million
and $113 million to pre-tax quarterly earnings in the 2001 and 2000 periods,
respectively. Variances period-to-period in these results primarily reflect the
impact of unfavorable market conditions, particularly as these conditions
impacted DMT investments.
Other income and expenses, net totaled $16 million in expense in the
quarter ended September 30, 2001 compared with $80 million in income in the 2000
period. The third quarter 2000 amount includes the one-time pre-tax gain of $83
million on the disposition of Dynegy's non-operating interest in Accord. The
2001 and remaining 2000 amounts consist of interest income, minority interest in
consolidated subsidiaries and other miscellaneous income and expense items.
The Company reported an income tax provision of $112 million for the
quarter ended September 30, 2001, compared to an income tax provision of $116
million for the 2000 period. The effective rates approximated 28 and 33 percent
in 2001 and 2000, respectively. The difference from the aforementioned 2001
effective rate and the statutory rate of 35 percent results principally from
permanent differences arising from the amortization of certain intangibles,
book-tax basis differences and the effect of certain foreign equity investments
and state income taxes.
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
23
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
For the nine-month period ended September 30, 2001, Dynegy's net income
was $571 million, or $1.69 per diluted share, compared with net income of $395
million, or $1.17 per diluted share, for the same 2000 period. Recurring net
income was $569 million, or $1.68 per diluted share, in 2001, compared to $347
million, or $1.11 per diluted share, in 2000. The recurring net income for the
nine-month period ended September 30, 2001 excludes the $2 million cumulative
effect of a change in accounting principle recorded in connection with the
Company's adoption of Statement No. 133. Recurring net income for the nine-month
period ended September 30, 2000 excludes the $58 million after-tax gain on the
disposition of Dynegy's non-operating interest in Accord, a non-recurring
after-tax gain on the sale of certain qualifying generation facilities of $34
million and after-tax charges aggregating $44 million related to the sale and
impairment of certain assets and merger-related charges. Recurring earnings per
diluted share for the nine-month period ended September 30, 2000 excludes a
non-recurring special dividend payment of $32 million associated with the
Company's stock offering completed in April 2000. Results for the nine-month
period ended September 30, 2001 were led by a strong performance in energy
convergence operations, particularly in domestic natural gas and power marketing
operations, and increased utilization of developed and acquired generation
facilities, including 1,700 MW of power plants in the Northeast which were
acquired from Central Hudson in the first quarter of 2001.
Consolidated operating margin for the nine-month period ended September
30, 2001 totaled $1.5 billion compared to $1.1 billion for the same 2000 period,
primarily reflecting improved margins in DMT. DMT contributed $1.017 billion to
the nine-month period ended September 30, 2001 consolidated operating margin
compared to $554 million reported in the same 2000 period, an increase of 84
percent. DMS contributed $217 million to the nine-month period ended September
30, 2001 consolidated operating margin compared to $188 million reported in the
same 2000 period. Transmission and Distribution contributed $331 million of
operating margin to the nine-month period ended September 30, 2001, essentially
flat with 2000. DGC reported negative margin of $18 million in the nine-month
period ended September 30, 2001.
Operating income increased $286 million period-to-period, reflecting
significantly higher operating results from DMT. Improved operating results were
partially offset by higher depreciation and amortization and general and
administrative expenses. Increases in depreciation, amortization expense and
general and administrative expenses result primarily from the same factors
impacting quarterly results.
Incremental to Dynegy's consolidated results was the Company's earnings
from unconsolidated investments, which contributed approximately $214 million
and $183 million to pre-tax earnings in the nine months ended September 30, 2001
and 2000, respectively. Variances period-to-period in these results relate
primarily to DMT investments.
Interest expense totaled $192 million for the nine-month period ended
September 30, 2001, compared to $195 million for the equivalent 2000 period. The
variance is attributable to lower interest rates on variable-rate borrowings
partially offset by higher average principal balances in the 2001 period
compared to the 2000 period.
Other income and expenses, net totaled $20 million in expense in the
nine-month period ended September 30, 2001 compared with income of $94 million
in the 2000 period. The 2000 amount includes some of the aforementioned
non-recurring charges described above. The 2001 and remaining 2000 balances
consisted of interest income, minority interest in consolidated subsidiaries and
other miscellaneous income and expense items.
The Company reported an income tax provision of $246 million for the
nine-month period ended September 30, 2001, compared to an income tax provision
of $209 million for the 2000 period. The effective rates approximated 30 and 35
percent in 2001 and 2000, respectively. In general, the difference from the
aforementioned 2001 effective rate and the statutory rate of 35 percent results
principally from permanent differences arising from the amortization of certain
intangibles, book-tax basis differences and the effect of certain foreign equity
investments and state income taxes.
24
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
SEGMENT DISCLOSURES (UNAUDITED)
<Table>
<Caption>
=========================================================================================================================
DYNEGY MARKETING AND TRADE
=======================================================================================================================
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2001 2000 2001 2000
-------------------------------- -------------------------------
($ IN MILLIONS, EXCEPT AVERAGE ON-PEAK POWER PRICES)
Operating Margin $ 451 $ 192 $ 1,017 $ 554
Earnings from Unconsolidated Investments 96 106 186 165
------- ------- ------- -------
SUBTOTAL - FINANCIAL CONTRIBUTION 547 298 1,203 719
Depreciation and Amortization(1) (46) (33) (133) (91)
General and Administrative Expenses (93) (39) (233) (134)
Other Items(1) (21) 84 (40) 133
------- ------- ------- -------
EARNINGS BEFORE INTEREST AND TAXES 387 310 797 627
Interest Expense (25) (13) (70) (91)
------- ------- ------- -------
PRE-TAX EARNINGS 362 297 727 536
Income Tax Provision 99 97 214 188
------- ------- ------- -------
INCOME FROM OPERATIONS 263 200 513 348
Cumulative Effect of Change in Accounting Principle --- --- 2 ---
------- ------- ------- -------
NET INCOME $ 263 $ 200 $ 515 $ 348
======= ======= ======= =======
RECURRING NET INCOME(2) $ 263 $ 142 $ 513 $ 263
======= ======= ======= =======
OPERATING STATISTICS:
Natural Gas Marketing (Bcf/d):
Domestic Sales Volumes 8.1 7.6 7.8 7.3
Canadian Sales Volumes 2.9 2.2 2.9 2.2
European Sales Volumes 1.6 1.1 1.7 1.4
------- ------- ------- -------
12.6 10.9 12.4 10.9
======= ======= ======= =======
Power Produced and Sold:
Million MW Hours Generated - Gross 11.5 11.2 31.7 28.0
======= ======= ======= =======
Million MW Hours Generated - Net 10.1 9.0 26.9 22.9
======= ======= ======= =======
Total Physical Million Megawatt Hours Sold 90.5 48.7 212.6 95.9
======= ======= ======= =======
Coal Marketing Volumes (Millions of Tons) 11.2 2.3 29.7 6.8
======= ======= ======= =======
Average On-Peak Market Power Prices:
Cinergy $ 37.02 $ 36.21 $ 39.24 $ 32.43
TVA 35.72 45.65 38.99 37.59
PJM 48.82 39.24 45.23 36.59
CALPX SP 15 45.02 150.11 147.26 89.52
</Table>
(1) Three and nine-month periods ended September 30, 2000 results include a
one-time pre-tax gain of $83 million ($58 million after-tax) on the
disposition of Dynegy's non-operating interest in Accord Energy Ltd.
("Accord"), a U.K. gas marketing joint venture. The nine-month period
ended September 30, 2000 also includes a pre-tax non-recurring gain on
the sale of certain qualifying facilities of $52 million ($34 million
after-tax) and a reasonable allocation of pre-tax non-recurring charges
aggregating $68 million ($44 million after-tax).
(2) Recurring net income consists of segment reported net income adjusted
for identified non-recurring items described in (1) above for 2000 and
for the cumulative effect of change in accounting principle in the
nine-month period ended September 30, 2001.
25
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DMT reported recurring segment net income of $263 million for the
three-month period ended September 30, 2001, compared with recurring net income
of $142 million in the 2000 quarter. The third quarter 2000 recurring net income
excludes the $58 million after-tax gain on the disposition of Dynegy's
non-operating interest in Accord. Dynegy's recurring results of operations
period-to-period were influenced by the following:
- Increased generation due to development and acquisition of assets;
- Increased customer origination;
- Improved margins on domestic, Canadian and European marketing activities;
- Expansion of DynegyDIRECT, the Company's electronic commerce portal launched
late in 2000, offset by
- Unfavorable variance in other items due to the Accord disposition and
settlements creating gains in the third quarter of 2000;
- Increased depreciation and amortization expenses reflecting continued
expansion of the Company's asset base; and
- Increased general and administrative expenses reflecting the impact of higher
variable compensation costs and increased capital and overhead costs required
to support a larger, more diverse base of operations.
Total physical MW hours sold in the third quarter of 2001 increased to
90.5 million MW hours compared to 48.7 million MW hours in the third quarter of
2000. Total natural gas volumes sold in North America in the third quarter of
2001 totaled 11.0 billion cubic feet per day compared to 9.8 billion cubic feet
per day during last year's third quarter. The increased volumes in both power
and gas were a result of improved market liquidity, greater sales volumes on
DynegyDIRECT, greater market origination and incremental gas marketing in
Canada.
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DMT reported recurring segment net income of $513 million for the
nine-month period ended September 30, 2001, compared with recurring net income
of $263 million in the same 2000 period. The 2001 period recurring net income
excludes the cumulative effect of a change in accounting principle, while the
2000 period recurring net income excludes a one-time after-tax gain of $58
million on the disposition of Dynegy's non-operating interest in Accord, a
non-recurring after-tax gain of $34 million relating to the sale of certain
qualifying facilities and an after-tax charge of $7 million related to merger
costs. Recurring results of operations period-to-period were influenced by the
same factors impacting quarterly results.
Total physical MW hours sold during the nine-month period ended
September 30, 2001 aggregated 212.6 million MW hours compared to 95.9 million MW
hours during the 2000 period. Total North American natural gas volumes sold
increased to 10.7 billion cubic feet per day from 9.5 billion cubic feet per day
during last year's nine-month period ended September 30, 2000.
26
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
<Table>
<Caption>
=========================================================================================================================
DYNEGY MIDSTREAM SERVICES
=======================================================================================================================
--------------------------------- --------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------- --------------------------------
2001 2000 2001 2000
--------------------------------- --------------------------------
($ IN MILLIONS, EXCEPT AVERAGE COMMODITY PRICES)
Operating Margin $ 63 $ 60 $ 217 $ 188
Earnings from Unconsolidated Investments 3 7 9 18
------ ------ ------ ------
SUBTOTAL - FINANCIAL CONTRIBUTION 66 67 226 206
Depreciation and Amortization(1) (21) (20) (61) (84)
General and Administrative Expenses (15) (14) (45) (45)
Other Items(1) 1 (5) (7) (40)
------ ------ ------ ------
EARNINGS BEFORE INTEREST AND TAXES 31 28 113 37
Interest Expense (12) (14) (42) (18)
------ ------ ------ ------
PRE-TAX EARNINGS 19 14 71 19
Income Tax Provision 7 6 26 6
------ ------ ------ ------
NET INCOME $ 12 $ 8 $ 45 $ 13
====== ====== ====== ======
RECURRING NET INCOME(2) $ 12 $ 8 $ 45 $ 48
====== ====== ====== ======
OPERATING STATISTICS:
Natural Gas Liquids Processed (MBbls/d-Gross):
Field Plants 56.3 55.1 56.0 62.4
Straddle Plants 26.1 34.2 25.5 37.4
------ ------ ------ ------
82.4 89.3 81.5 99.8
====== ====== ====== ======
Fractionation Volumes (MBbls/d) 241.6 253.1 230.4 240.3
Natural Gas Liquids Sold (MBbls/d) 550.4 520.8 562.0 562.3
Average Commodity Prices:
Natural Gas - Henry Hub (First of the
Month) ($/MMBtu) $ 2.92 $ 4.26 $ 4.87 $ 3.41
Crude Oil - Cushing ($/Bbl) 26.64 30.52 27.85 27.29
Natural Gas Liquids ($/Gal) 0.39 0.56 0.50 0.53
(1) Nine-month period ended September 30, 2000 results include a reasonable allocation of pre-tax non-recurring
charges aggregating $68 million ($44 million after-tax).
(2) Recurring net income reflect the allocation of the items described in (1) above.
=======================================================================================================================
</Table>
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DMS reported recurring net income of $12 million in the third quarter
of 2001 compared with recurring net income of $8 million in the third quarter of
2000. The following influenced recurring results of operations period-to-period:
- Higher price realization;
- Decreased interest expense in 2001 due to timing of interest expense
allocation; and
- Decreased earnings from unconsolidated affiliates due to fee-based gas
processing contracts.
Aggregate domestic NGL processing volumes totaled 82.4 thousand gross
barrels per day in the third quarter of 2001 compared to 89.3 thousand gross
barrels per day during the same period in 2000.
27
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
This decrease was primarily due to reduced straddle volumes resulting from lower
fractionation spreads compared to the third quarter of 2000. The continued
active management of price risk associated with DMS' field processing plants and
greater gas price realization in field plants mitigated the financial impact of
reduced processing volumes. NGL marketing volumes were higher period-over-period
reflecting increased chemical demand in the third quarter of 2001.
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DMS reported recurring net income of $45 million in the nine-month
period ended September 30, 2001 compared with recurring net income of $48
million in the same 2000 period. After adjusting for earnings recognized from
the Mid-Continent assets disposed of in 2000, recurring net income for the
nine-month period ended September 30, 2001 increased $2 million
period-over-period. Recurring net income for the 2000 period excludes an
aggregate non-recurring after-tax charge of $35 million relating to the sale and
impairment of certain assets and allocated merger costs. Recurring results of
operations period-to-period were influenced by the following:
- The sale of the Mid-Continent liquids assets in March 2000; and
- Increased interest expense in 2001, due to timing of interest expense
allocation; offset by
- Higher price realization in 2001;
- Beneficial restructuring of contracts in 2001; and
- Stronger wholesale marketing operations in 2001.
Aggregate domestic NGL processing volumes totaled 81.5 thousand gross
barrels per day in the nine-month period ended September 30, 2001 compared to a
normalized average of 96.0 thousand gross barrels per day during the same 2000
period. The normalized volumes reflect the sale of the Mid-Continent assets in
March 2000. Fractionation volumes decreased principally as a result of reduced
processing volume through the Company's straddle plants. Such plants were
shut-in during most of 2001 due to greatly reduced fractionation spreads
resulting from the unhinging of the relationship between natural gas and liquids
prices. The continued active management of price risk associated with DMS' field
processing plants and greater price realization in field plants mitigated the
financial impact of reduced processing volumes. NGL marketing volumes were lower
period-to-period reflecting a decrease in demand during the second quarter of
2001 offset by greater commercialization of the Company's NGL business through
DynegyDIRECT.
28
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
<Table>
<Caption>
=======================================================================================================================
TRANSMISSION AND DISTRIBUTION
=======================================================================================================================
--------------------------------- --------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------- --------------------------------
2001 2000 2001 2000
--------------------------------- --------------------------------
($ IN MILLIONS)
Operating Margin $ 125 $ 129 $ 331 $ 329
Depreciation and Amortization(1) (41) (40) (124) (116)
General and Administrative Expenses (16) (17) (47) (56)
Other Items(1) 1 1 24 1
------ ------ ------- -------
EARNINGS BEFORE INTEREST AND TAXES 69 73 184 158
Interest Expense (29) (33) (93) (109)
------ ------ ------- -------
PRE-TAX EARNINGS 40 40 91 49
Income Tax Provision 14 13 34 15
------ ------ ------- -------
NET INCOME $ 26 $ 27 $ 57 $ 34
====== ====== ======= =======
RECURRING NET INCOME(2) $ 26 $ 27 $ 57 $ 35
====== ====== ======= =======
OPERATING STATISTICS:
Electricity Sales in KWH (Millions):
Residential 1,681 1,593 4,160 3,870
Commercial 1,194 1,204 3,308 3,257
Commercial - distribution(3) 5 --- 39 ---
Industrial 1,645 2,432 4,754 6,844
Industrial - distribution(3) 677 --- 1,937 ---
Other 96 94 285 274
------ ------ ------- -------
Sales to Ultimate Customers 5,298 5,323 14,483 14,245
Interchange 1 1 2 51
------ ------ ------- -------
Total Electric Sales 5,299 5,324 14,485 14,296
====== ====== ======= =======
Gas Sales in Therms (Millions):
Residential 20 21 225 204
Commercial 12 12 99 88
Industrial 13 13 52 54
------ ------ ------- -------
Sales to Ultimate Customers 45 46 376 346
Transportation of Customer-Owned Gas 49 56 185 195
Interdepartmental Sales 11 5 17 18
------ ------ ------- -------
Total Gas Sales 105 107 578 559
====== ====== ======= =======
(1) Nine-month period ended September 30, 2000 results include a reasonable allocation of pre-tax non-recurring
charges aggregating $68 million ($44 million after-tax).
(2) Recurring net income consists of segment reported net income adjusted for identified non-recurring items
described in (1) above.
(3) Includes sales statistics for delivery service customers supplied by an alternative retail energy supplier.
=======================================================================================================================
</Table>
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
The Transmission and Distribution segment reported recurring net income
of $26 million in the third quarter of 2001 compared to $27 million in the third
quarter of 2000. Operating results reflect reduced industrial volumes partially
offset by improved efficiencies and increased residential volumes due to higher
weather-driven demand.
29
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
The Transmission and Distribution segment reported recurring net income
of $57 million in the nine-month period ended September 30, 2001 compared to $35
million in the same 2000 period. Results of operations period-to-period were
influenced by the same factors impacting quarterly results in addition to an
insurance settlement which occurred in 2001.
<Table>
<Caption>
========================================================================================================================
DYNEGY GLOBAL COMMUNICATIONS
========================================================================================================================
---------------------------------- ---------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------- ---------------------------------
2001 2000 2001 2000
---------------------------------- ---------------------------------
($ IN MILLIONS)
Operating Margin $ (6) $ --- $(18) $ ---
Earnings from Unconsolidated Investments 5 --- 19 ---
---- ----- ---- -----
SUBTOTAL - FINANCIAL CONTRIBUTION (1) --- 1 ---
Depreciation and Amortization (5) --- (15) ---
General and Administrative Expenses (18) --- (58) ---
Other Items 3 --- 3 ---
---- ----- ---- -----
LOSS BEFORE INTEREST AND TAXES (21) --- (69) ---
Interest Expense (2) --- (5) ---
---- ----- ---- -----
PRE-TAX LOSS (23) --- (74) ---
Income Tax Benefit (8) --- (28) ---
---- ----- ---- -----
NET LOSS $(15) $ --- $(46) $ ---
==== ===== ==== =====
RECURRING NET LOSS $(15) $ --- $(46) $ ---
==== ===== ==== =====
========================================================================================================================
</Table>
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DGC's segment results reflect a $15 million quarterly loss in the
three-month period ended September 30, 2001 resulting from start-up costs
associated with expansion of the Company's global communications business.
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
DGC's segment results reflect a $46 million loss in the nine-month
period ended September 30, 2001 resulting from start-up costs associated with
expansion of the Company's global communications business and decreasing demand
during a downturn in the industry sector.
CASH FLOW DISCLOSURES
OPERATING CASH FLOW. Cash flow from operating activities totaled $640
million for the nine-month period ended September 30, 2001, compared to $374
million reported in the same 2000 period. Changes in operating cash flow reflect
favorable variances in net income, cash flow from risk-management activities and
changes in accounts receivable offset by the difference in timing in accounts
payable and cash received from equity investments (principally WCP). Changes in
other working capital accounts, which include prepayments and other current
assets and accrued liabilities, reflect expenditures or recognition of
liabilities for settlements of certain litigation, insurance costs, certain
deposits, salaries, taxes other than on income, certain deferred revenue
accounts and other similar items. Fluctuations in these accounts,
period-to-period, reflect changes in the timing of payments or recognition of
liabilities and are not directly impacted by seasonal factors.
CAPITAL EXPENDITURES AND INVESTING ACTIVITIES. Capital expenditures of
$1.5 billion and $514 million in the nine-month periods ended September 30, 2001
and 2000, respectively, related to the aforementioned acquisition of the Central
Hudson power generation facilities in the Northeast in 2001 and to the
construction of power generation assets, betterments
30
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
of existing facilities related to the Transmission and Distribution segment
and investments associated with technology infrastructure in both periods.
Business acquisitions for the nine-month period ended September 30, 2001
included acquisition costs related to the purchase of iaxis Ltd, while the
2000 period included the acquisition of Illinova. Proceeds from asset sales in
2001 included the sale of the Central Hudson facilities in May 2001 for $920
million pursuant to the previously mentioned leveraged lease transaction in
addition to disposals of certain non-strategic Canadian assets and
investments. The non-strategic assets disposed of in 2000 principally related
to the sale of certain qualifying facilities and liquids assets for which the
Company received cash inflows of approximately $847 million.
FINANCING ACTIVITIES. In March 2001, Holdings issued $500 million of
6.875 percent Senior Notes due April 1, 2011. The net proceeds of
approximately $496 million from the sale were used to repay commercial paper.
Interest is payable on the Senior Notes on April 1 and October 1 of each
year, beginning October 1, 2001. Additionally, during the second quarter of
2001, IP received proceeds of $187 million from the issuance of variable rate
pollution control bonds. Contemporaneously, the Company retired and repaid
pollution control bonds with a comparatively higher rate.
In the first quarter of 2000, Chevron purchased shares of Class B
Common Stock for $200 million. Proceeds from this sale were used to partially
finance the cash portion of the Illinova acquisition.
UNCERTAINTY OF FORWARD-LOOKING STATEMENTS AND INFORMATION
Dynegy's reports, filings and other public announcements often include
statements reflecting assumptions, expectations, projections, intentions or
beliefs about future events. These statements are intended as "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995. You can
identify these statements by the fact that they do not relate strictly to
historical or current facts. They use words such as "anticipate," "estimate,"
"project," "forecast," "may," "will," "should," "expect" and other words of
similar meaning. In particular, these include, but are not limited to,
statements relating to the following:
- Projected operating or financial results;
- Expectations regarding capital expenditures, dividends and other payments;
- Pending or recent acquisitions, including the anticipated closing date,
expected cost savings or synergies and the accretive or dilutive impact of
an acquisition on earnings;
- Expectations regarding transaction volume and liquidity in wholesale energy
markets in North America and Europe;
- Beliefs or assumptions about the outlook for deregulation of retail and
wholesale energy markets in the U.S. and Europe and anticipated business
developments in such markets;
- The Company's ability to effectively compete for market share with industry
participants;
- Beliefs regarding the outcome of legal and administrative proceedings;
- The expected commencement date for commercial operations for new power
plants; and
- Anticipated developments with respect to demand for broadband services and
applications and the Company's strategic plans in connection therewith.
Any or all of Dynegy's forward-looking statements may turn out to be wrong. They
can be affected by inaccurate assumptions or by known or unknown risks and
uncertainties, including the following:
- The timing and extent of changes in commodity prices for energy,
particularly natural gas, electricity and NGLs, or communications products
or services;
- The timing and extent of deregulation of energy markets in the U.S. and
Europe and the rules and regulations adopted on a transitional basis in
such markets;
- The condition of the capital markets generally, which will be affected by
interest rates, foreign currency fluctuations and general economic
conditions, as well as Dynegy's ability to maintain its investment grade
credit ratings;
- The effectiveness of Dynegy's risk-management policies and procedures and
the ability of Dynegy's trading counterparties to satisfy their financial
commitments;
- The liquidity and competitiveness of wholesale trading markets for energy
commodities, including the impact of electronic or online trading in these
markets;
- Operational factors affecting the start up or ongoing commercial operations
of Dynegy's power generation or midstream natural gas facilities, including
catastrophic weather related damage, unscheduled outages or repairs,
unanticipated changes in fuel costs or availability of fuel emission
credits, the unavailability of gas transportation, the unavailability of
electric transmission service or workforce issues;
31
<Page>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
- Uncertainties regarding the development of, and competition within, the
market for broadband services in the U.S. and Europe, including risks
relating to competing technologies and standards, regulation, capital costs
and the timing and amount of customer demand for high bandwidth
applications;
- Cost and other effects of legal and administrative proceedings,
settlements, investigations and claims, including environmental liabilities
that may not be covered by indemnity or insurance;
- Other U.S. or European regulatory or legislative developments that affect
the demand for energy generally, increase the environmental compliance cost
for Dynegy's power generation or midstream gas facilities or impose
liabilities on the owners of such facilities; and
- General political conditions, including any extended period of war or
conflict involving the United States or Europe.
Many of these factors will be important in determining Dynegy's actual
future results. Consequently, no forward-looking statement can be guaranteed.
Dynegy's actual future results may vary materially from those expressed or
implied in any forward-looking statements.
All of Dynegy's forward-looking statements, whether written or oral,
are expressly qualified by these cautionary statements and any other cautionary
statements that may accompany such forward-looking statements. In addition,
Dynegy disclaims any obligation to update any forward-looking statements to
reflect events or circumstances after the date of this report.
32
<Page>
DYNEGY INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2001 AND 2000
The Company is exposed to certain market risks indigenous to its
industry or inherent in transactions entered into in the normal course of
business. In executing risk-management strategies intended to mitigate these
market risks, the Company routinely utilizes various types of financial
instruments. The absolute notional contract amounts associated with commodity
risk-management, interest rate and forward exchange contracts were as follows at
the dates indicated:
<Table>
<Caption>
=======================================================================================================
ABSOLUTE NOTIONAL CONTRACT AMOUNTS
=======================================================================================================
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
Natural Gas (Trillion Cubic Feet) 13.687 7.709
Electricity (Million MW Hours) 63.922 162.321
NGLs (Million Barrels) 11.573 9.899
Weather Derivatives (Thousands of Heating Degree Days) 64.000 427.423
U.K. Pound Sterling (In millions of U.S. Dollars) $ 141 $ 15
Average U.K. Pound Sterling Contract Rate (U.S. Dollars) $ 1.4321 $ 1.4658
Eurodollars (In millions of U.S. Dollars) $ 41.50 $ 36.00
Average Eurodollar Contract Rate (U.S. Dollars) $ 0.9140 $ 1.0200
Canadian Dollar (In millions of U.S. Dollars) $ 1,719 $ 738
Average Canadian Dollar Contract Rate (U.S. Dollars) $ 0.6482 $ 0.6768
=======================================================================================================
</Table>
Dynegy measures entity-wide market risk in its financial trading and
risk-management portfolios using Value at Risk. The quantification of market
risk using Value at Risk provides a consistent measure of risk across diverse
energy markets and products with different risk factors to set the overall
corporate risk tolerance, determine risk targets, and position limits. The use
of this methodology requires a number of key assumptions including the selection
of a confidence level and the holding period to liquidation. Dynegy relies on
Value at Risk to determine the maximum potential reduction in the trading
portfolio value allowed within a given probability over a defined period.
Because of limitations to Value at Risk, Dynegy uses other means to monitor
market risk in the trading portfolios. In addition to Value at Risk, Dynegy
performs regular stress and scenario analyses to measure extreme losses due to
exceptional events. The Value at Risk and stress testing results are reviewed to
determine the maximum allowable reduction in the total equity of the commodity
portfolios. Additional measures are used to determine the treatment of risks
outside the Value at Risk methodologies, such as market volatility, liquidity,
event and correlation risk. Dynegy estimates Value at Risk using a JP Morgan
RiskMetrics-TM- approach assuming a one-day holding period and a 95 percent
confidence level. At September 30, 2001, the Value at Risk for Dynegy's trading
and risk-management portfolios approximated $15.7 million and the average of
such value during the quarter ended September 30, 2001 was estimated at $11.8
million.
33
<Page>
DYNEGY INC.
PART II. OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
See Part I, Item 1, Condensed Consolidated Financial Statements, Note 7,
which is incorporated herein by reference.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) There are no instruments or documents required to be included as
exhibits to this Form 10-Q.
(b) No form 8-Ks, Commission File No. 1-15659, were filed during the third
quarter of 2001.
34
<Page>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNEGY INC.
Date: October 30, 2001 By: /s/ Michael R. Mott
---------------------------------------
Michael R. Mott,
Senior Vice President and Controller
(Duly Authorized Officer and Principal
Accounting Officer)
35