<PAGE>
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 March 31, 1999
[_] 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: 1-11156
DYNEGY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3248415
(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: Common stock, $.01 par value per share,
152,864,662 shares outstanding as of May 12, 1999.
Page 1 of 27
<PAGE>
DYNEGY INC.
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets:
March 31, 1999 and December 31, 1998................... 3
Condensed Consolidated Statements of Operations:
For the three months ended March 31, 1999 and 1998..... 4
Condensed Consolidated Statements of Cash Flows:
For the three months ended March 31, 1999 and 1998..... 5
Notes to Condensed Consolidated Financial Statements...... 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............. 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................ 24
Item 2. Not Applicable................................... -
Item 3. Not Applicable................................... -
Item 4. Not Applicable................................... -
Item 5. Not Applicable................................... -
Item 6. Exhibits and Reports on Form 8-K................. 26
Page 2 of 27
<PAGE>
DYNEGY INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31, December 31,
1999 1998
--------------------- ---------------------
(unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 12,084 $ 28,367
Accounts receivable, net 1,320,169 1,563,558
Accounts receivable, affiliates 55,973 60,180
Inventories 123,920 149,901
Assets from risk management activities 261,394 219,105
Prepayments and other assets 119,262 96,130
---------- ----------
1,892,802 2,117,241
---------- ----------
Property, Plant and Equipment 2,513,593 2,446,878
Less: accumulated depreciation (547,334) (514,771)
---------- ----------
1,966,259 1,932,107
---------- ----------
Other Assets:
Investments in unconsolidated affiliates 511,608 502,613
Assets from risk management activities 353,503 135,100
Other assets 544,820 577,176
---------- ----------
$5,268,992 $5,264,237
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $1,083,310 $1,370,902
Accounts payable, affiliates 117,202 113,827
Accrued liabilities 478,854 290,381
Liabilities from risk management activities 284,322 251,213
---------- ----------
1,963,688 2,026,323
Long-Term Debt 968,117 1,046,890
Other Liabilities:
Liabilities from risk management activities 259,877 40,747
Deferred income taxes 272,091 317,537
Other long-term liabilities 443,620 504,677
---------- ----------
3,907,393 3,936,174
---------- ----------
COMPANY OBLIGATED PREFERRED SECURITIES OF SUBSIDIARY TRUST 200,000 200,000
Commitments and Contingencies (NOTE 5)
Stockholders' Equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized: 8,000,000
shares designated as Series A Participating Preferred Stock,
7,815,363 shares issued and outstanding at March 31, 1999 and
December 31, 1998 75,418 75,418
Common stock, $0.01 par value, 400,000,000 shares authorized;
154,086,298 shares issued at March 31, 1999 and 153,298,220
shares issued at December 31, 1998 1,542 1,533
Additional paid-in capital 942,831 935,183
Retained earnings 159,393 133,340
Less: treasury stock, at cost: 1,200,700 shares at March 31, 1999 and
1,200,700 shares at December 31, 1998 (17,585) (17,411)
---------- ----------
1,161,599 1,128,063
---------- ----------
$5,268,992 $5,264,237
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
Page 3 of 27
<PAGE>
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS,
EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------------------------
1999 1998
-------------------- --------------------
<S> <C> <C>
Revenues $3,044,973 $3,315,569
Cost of sales 2,924,896 3,218,580
---------- ----------
Operating margin 120,077 96,989
Depreciation and amortization 31,288 25,532
General and administrative expenses 49,542 42,606
Severance charge --- 9,644
---------- ----------
Operating income 39,247 19,207
Equity in earnings of unconsolidated affiliates 15,063 15,755
Other income 13,918 2,968
Interest expense (19,234) (16,005)
Minority interest in income of a subsidiary (4,158) (4,158)
Other expenses (4,153) (1,356)
---------- ----------
Income before income taxes 40,683 16,411
Income tax provision (benefit) 12,612 4,072
---------- ----------
Net Income $ 28,071 $ 12,339
========== ==========
Net Income Per Share:
Net income $ 28,071 $ 12,339
Less: preferred stock dividends (96) (96)
---------- ----------
Net income applicable to common stockholders $ 27,975 $ 12,243
========== ==========
Basic earnings per share $0.18 $0.08
========== ==========
Diluted earnings per share $0.17 $0.07
========== ==========
Basic shares outstanding 152,492 151,533
========== ==========
Diluted shares outstanding 164,487 166,282
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
Page 4 of 27
<PAGE>
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------------------------
1999 1998
----------------------- ------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 28,071 $ 12,339
Items not affecting cash flows from operating activities:
Depreciation and amortization 29,316 24,229
Equity in earnings of affiliates, net of cash distributions (9,593) (2,744)
Risk management activities (8,424) (21,635)
Deferred income taxes 14,568 4,072
Other (2,519) 4,593
Changes in assets and liabilities resulting from operating activities:
Accounts receivable 189,963 213,817
Inventories 35,314 48,169
Prepayments and other assets 28,494 (2,255)
Accounts payable (288,038) (63,120)
Accrued liabilities (20,852) (27,007)
Other, net (8,059) (8,875)
--------- ---------
Net cash provided by (used in) operating activities (11,759) 181,583
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (99,918) (40,465)
Investment in unconsolidated affiliates, net (1,418) (18,231)
Proceeds from asset sales 16,650 ---
Other, net (39,060) 6,200
--------- ---------
Net cash (used in) provided by investing activities (123,746) (52,496)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term borrowings --- ---
Repayments of long-term borrowings (6,319) (129,550)
Net proceeds from commercial paper and money market lines of credit 127,072 26,500
Other, net (1,531) (11,814)
--------- ---------
Net cash used in financing activities 119,222 (114,864)
--------- ---------
Net change in cash and cash equivalents (16,283) 14,223
Cash and cash equivalents, beginning of period 28,367 23,047
--------- ---------
Cash and cash equivalents, end of period $ 12,084 $ 37,270
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
Page 5 of 27
<PAGE>
DNYEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended March 31, 1999 and 1998
(unaudited)
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 Company's Annual Report
on Form 10-K for the year ended December 31, 1998, filed with the SEC.
The financial statements include all material adjustments, which, in the opinion
of management, were necessary for a fair presentation of the results for the
interim periods. Other than recognition of the previously disclosed severance
charge and the adoption of EITF 98-10, such adjustments consist only of normal
recurring adjustments. Interim period results are not necessarily indicative of
the results for the full year. The preparation of the consolidated financial
statements in conformity with generally accepted accounting principles requires
management to develop estimates and make assumptions that affect reported
financial position and results of operations and that impact the nature and
extent of disclosure, if any, of contingent assets and liabilities. Actual
results could differ from those estimates.
NOTE 2 - ACCOUNTING POLICY CHANGE
Effective January 1, 1999, the Company adopted the provisions of Emerging Issues
Task Force Issue No. 98-10, "Accounting for Energy Trading and Risk Management
Activities" ("EITF 98-10") pursuant to the implementation requirements stated
therein. The resulting effect of adoption of the provisions of EITF 98-10 was to
alter the Company's comprehensive method of accounting for energy-related
contracts, as defined in that statement. The cumulative effect of this change in
accounting principle was not expected to be material to the estimated annual
1999 results of operations. The pro forma effect on prior periods of the
adoption of the provisions of EITF 98-10 was not determinable.
Previously, only North American fixed-price natural gas transactions were
measured at fair value, net of future servicing costs and reserves as estimated
by the Company. The Company now accounts for all energy trading activities at
fair value as of the balance sheet date and recognizes currently the net gains
or losses resulting from the revaluation of these contracts to market in its
results of operations. As a result, substantially all of the operations of the
Company's world-wide gas marketing, power marketing, and crude marketing
operations are now accounted for under a mark-to-market accounting methodology.
Generally, revenue recognition for the Company's natural gas liquids processing,
fractionation, transportation and marketing activities, as well as its power
generation businesses, remain on an accrual-based accounting methodology. Sales
and purchases by these businesses are not trading operations, as defined in the
statement, and therefore not subject to the provisions of EITF 98-10.
The Company continues to analyze the effects of adoption of the rules
promulgated by Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("Statement No. 133"). Provisions in
Statement No. 133 will affect the accounting and disclosure of contractual
arrangements and operations of the Company. The transition rules under Statement
No. 133 provide for early adoption as of the beginning of any fiscal quarter
subsequent to June 15, 1998. Dynegy intends to adopt the provisions of Statement
No. 133 within the timeframe and in accordance with the requirements provided by
that statement.
Management believes the adoption of the provisions of EITF 98-10 and Statement
No. 133 may affect the variability of future periodic results reported by
Dynegy, as well as its competitors, as market conditions and resulting
valuations change from time to time. Such earnings variability, if any, will
likely result principally from valuation issues arising from imbalances between
supply and demand created by illiquidity in certain commodity markets resulting
from, among other things, a lack of mature trading and price discovery
mechanisms, transmission and/or transportation constraints resulting from
regulation or other issues in certain markets and the need for a representative
number of market participants maintaining the financial liquidity and other
resources necessary to compete effectively. Management will monitor exposure to
these and other market and business risks and will adjust valuation factors
accordingly as indicated by changing circumstances.
Page 6 of 27
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended March 31, 1999 and 1998
(unaudited)
NOTE 3 -- 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
the Series A Convertible Participating Preferred Stock, options outstanding and
a warrant.
NOTE 4 -- UNCONSOLIDATED AFFILIATES
At March 31, 1999, Dynegy's investment in unconsolidated affiliates accounted
for by the equity method included: a 25 percent participating preferred stock
interest in Accord Energy Limited, a United Kingdom limited company; an
approximate 23 percent interest in Venice Energy Services Company, L.L.C.; a
38.75 percent partnership interest in Gulf Coast Fractionators; a 25 percent
interest in Midstream Barge Company, L.L.C.; a 49 percent partnership interest
in West Texas LPG Pipeline, Limited Partnership; interests ranging from eight to
50 percent in fifteen partnerships, each formed to build (or buy), own and
operate cogeneration power generation facilities; 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. Also at March 31, 1999, the Company had two cost-
basis investments: Indeck North American Power Fund, L.P. and Indeck North
American Power Partners, L.P. Summarized unaudited combined income statement
information for the unconsolidated affiliates accounted for by the equity method
is presented in the table below:
<TABLE>
<CAPTION>
Three-Months Ended March 31,
---------------------------------------------------------
1999 1998
---------------------------------------------------------
Equity Equity
Total Share Total Share
----------- ---------- ---------- ----------
($ in thousands)
<S> <C> <C> <C> <C>
Revenues (1) $237,304 $93,670 $200,048 $83,778
======== ======= ======== =======
Operating margin (1) $ 85,762 $34,098 $ 81,527 $32,620
======== ======= ======== =======
Net income (1) $ 23,733 $10,247 $ 31,540 $11,261
======== ======= ======== =======
</TABLE>
______________________
(1) The interim financial data for both periods presented is exclusive of
amounts attributable to the Company's investment in Accord as such
information was unavailable for the current period or is incompatible with
current presentation.
NOTE 5 -- COMMITMENTS AND CONTINGENCIES
On April 17, 1997, Pacific Gas and Electric Company ("PG&E") filed a lawsuit in
the Superior Court of the State of California, City and County of San Francisco,
against Destec Energy, Inc., Destec Holdings, Inc. and Destec Operating Company
(wholly-owned subsidiaries of the Company now known respectively as Dynegy Power
Corp., Dynegy Power Holdings, Inc. and Dynegy Operating Company) as well as
against San Joaquin CoGen Limited ("San Joaquin" or the "Partnership") and its
general partners (collectively the "Dynegy Defendants"). Dynegy Power Corp. and
its affiliates now own all of the partnership interests in the Partnership as a
result of the purchase of the interests of the two outside partners in the
Partnership. In the lawsuit, PG&E asserts claims and alleges unspecified damages
for fraud, negligent misrepresentation, unfair business practices, breach of
contract and breach of the implied covenant of good faith and fair dealing.
PG&E alleges that due to the insufficient use of steam by San Joaquin's steam
host, the Partnership did not
Page 7 of 27
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended March 31, 1999 and 1998
(unaudited)
qualify as a cogenerator pursuant to the California Public Utilities Code
("CPUC") Section 218.5, and thus was not entitled under CPUC Section 454.4 to
the discount the Partnership received under gas transportation agreements
entered into between PG&E and San Joaquin in 1989, 1991, 1993 and 1995. All of
PG&E's claims in this suit arise out of the Partnership's alleged failure to
comply with CPUC Section 218.5. The defendants filed a response to the suit on
May 15, 1997. On October 20, 1997, PG&E named Libbey-Owens-Ford ("LOF"), the
Partnership's steam host, as an additional defendant in the action. On February
23, 1998, PG&E served its Second Amended Complaint on all defendants. On March
30, 1998, the defendants filed their response to PG&E's Second Amended
Complaint, denying PG&E's allegations and alleging certain counterclaims against
PG&E. By Order dated July 20, 1998, the court dismissed certain of defendants'
counterclaims against PG&E, and abated certain others, pending resolution by the
CPUC. The trial date is currently December 13, 1999. The Partnership has
previously advised the FERC of PG&E's claims, and stated that it would submit
any appropriate filings upon completion of its investigation. If the facility
was found not to have satisfied the California cogeneration facility standards,
there is a strong likelihood that it would also fail to satisfy the more
stringent federal standards. In accordance with the terms of a Protective Order
entered into by the parties at the commencement of the litigation, PG&E has
notified San Joaquin that it may make a FERC filing seeking damages from San
Joaquin and decertification of its status as a qualifying facility under the
federal standards. Under FERC precedent, if the San Joaquin facility were found
not to have been a qualifying facility, San Joaquin could be required to refund
to PG&E payments it received pursuant to the Power Purchase Agreement in excess
of PG&E's short-term energy costs during the period of non-compliance, plus
interest. In the event the court or FERC were to determine that San Joaquin is
liable to PG&E under the Gas Transportation Agreement or Power Purchase
Agreement due to LOF's failure to use sufficient quantities of steam, San
Joaquin notified LOF that it would seek to recover such amounts from LOF under
the terms of the Steam Purchase Agreement between San Joaquin and LOF. The
parties engaged in settlement discussions, which resulted in the execution of a
Termination and Settlement Agreement between PG&E and the Dynegy Defendants on
March 9, 1999 (the "Settlement Agreement"). The Settlement Agreement provides
for, upon the receipt of CPUC approval, a dismissal with prejudice of PG&E's
claims against the Dynegy Defendants, a release by PG&E of all claims relative
to FERC matters and a termination of the San Joaquin power purchase agreement as
of December 31, 1999, whereupon the San Joaquin facility will continue to
operate as a merchant plant. The Dynegy Defendants will seek to recover from LOF
any losses resulting from the settlement with PG&E. However, if the settlement
is not ultimately concluded, the Dynegy Defendants will seek to recover from LOF
any losses or amounts for which it may be found liable. Further, the Company's
subsidiaries intend to continue to vigorously defend this action. In the opinion
of management, the ultimate resolution of this lawsuit will not have a material
adverse effect on the Company's financial position or results of operations. On
April 15, 1999, the Dynegy Defendants filed suit against LOF in the Superior
Court of the State of California, County of San Francisco seeking to recover
damages the Dynegy Defendants have or will suffer as a result of LOF's failure
to purchase steam from the San Joaquin facility in quantities required by the
Steam Purchase Contract executed by San Joaquin and LOF. The lawsuit states
claims against LOF for breach of contract, breach of implied covenant of good
faith and fair dealing, fraud in the inducement/intentional misrepresentation,
negligent misrepresentation, fraudulent concealment and non-disclosure,
interference with contract and indemnity. On April 28, 1999, LOF filed a
procedural opposition to the lawsuit essentially challenging venue in San
Francisco County. LOF has not filed its answer as of May 12, 1999.
On March 24, 1995, Southern California Gas Company ("SOCAL") filed a lawsuit in
the Superior Court of the State of California for the County of Los Angeles,
against Destec Energy, Inc., Destec Holdings and Destec Gas Services, Inc. (now
known respectively as Dynegy Power Corp., Dynegy Holdings, Inc. and Dynegy Gas
Services, Inc.), wholly-owned direct and indirect subsidiaries of the Company
(collectively, the "Defendants"), as well as against Chalk Cliff Limited and
McKittrick Limited (collectively, the "Partnerships"). The Company owns an
indirect 50 percent limited partnership interest in McKittrick Limited, and
Chalk Cliff Limited is now wholly-owned by subsidiaries of the Company through
the purchase of the interests of Dominion Energy, Inc. All general partners of
the Partnerships are also named defendants. The lawsuit alleged breach of
contract against the Partnerships and their respective general partners, and
interference and conspiracy to interfere with contracts against the Defendants.
The breach of contract claims arose out of the "transport-or-pay" provisions of
the gas transportation service agreements between the Partnerships and SOCAL.
SOCAL sought damages from the Partnerships for past damages and anticipatory
breach damages in an amount equal to approximately $31,000,000. On October 24,
1997, the
Page 8 of 27
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended March 31, 1999 and 1998
(unaudited)
Court granted SOCAL's Motion for Summary Judgment relating to the breach of
contract causes of action against the Partnerships and their respective general
partners, and requested that SOCAL submit a proposed order consistent with that
ruling for the Court's signature. On November 21, 1997, the Partnerships filed
for voluntary Chapter 11 bankruptcy protection in the Eastern District of
California. Normal business operations by the Partnerships continued throughout
the course of these reorganization proceedings. On January 12, 1998, the Court
entered a Final Order that (a) severed out the Partnerships due to their Chapter
11 bankruptcy filings, (b) included a finding of contract liability against the
Defendants, (c) dismissed the tortious interference claims against the
Defendants, and (d) assessed damages in an aggregate amount of approximately
$31,000,000. On the same day, the Defendants filed their Notice of Appeal, and
posted a security bond with the Second Appellate District in Los Angeles based
on the lack of allegations made or proven by SOCAL which support holding those
entities liable in contract. On March 11, 1998, the Partnerships and their
respective general partners filed Notices of Appeal with respect to certain
findings of fact in the Court's January 12, 1998 Final Order that were adverse
to those defendants. On or about April 15, 1998, the Court entered a final
judgment against the Partnerships themselves in recognition of the lifting of
the automatic stay against those entities by the Bankruptcy Court. The
Partnerships filed their appeal of that final judgment on June 4, 1998. On
October 21, 1998, the Bankruptcy Court dismissed the voluntary bankruptcy
filings of the Partnerships and their respective lenders thereafter notified
each of the Partnerships of the occurrences of an Event of Default under the
Partnerships' respective credit agreements due to the existence of the SOCAL
judgment against them, and have instituted foreclosure proceedings as to the
projects. Additionally, receivers were named by the lenders and approved by the
Court for each of the projects. In early December 1998, the defendants filed
their opening appellate briefs in the appeal of the Court's final judgment. On
February 23, 1999, the Court granted a motion by SOCAL to amend the Court's
final judgment to include a finding that Dynegy Power Corp. is the alter ego of
the Partnerships and their respective general partners. Dynegy Power Corp. has
appealed the Court's ruling, and will vigorously defend SOCAL's claims. On April
13, 1999, the Court granted a motion by SOCAL to amend the final judgment to
include a finding that Destec Energy, Inc. is the alter ego of the Partnerships
and their respective general partners. The Court's order named Dynegy as the
successor to Destec Energy, Inc. Dynegy has appealed the Court's ruling.
The PG&E and SOCAL litigations represent pre-acquisition contingencies acquired
by the Company in the Destec Acquisition. In a related matter, Chalk Cliff and
San Joaquin have each guaranteed the obligations of the other partnership,
represented by the project financing loans used to construct the power
generation facilities owned by the respective Partnerships. In the opinion of
management, the election by the lender of its option under the terms of such
arrangements would not have a material adverse effect on the Company's financial
position or results of operations.
On August 3, 1998, Modesto Irrigation District ("MID") filed a lawsuit against
PG&E and 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, CA.
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 restating its breach of contract claim against Destec. PG&E and
Destec have filed motions to dismiss MID's revised federal and state antitrust
claims. The motions to dismiss are scheduled for hearing in July, 1999. Dynegy
believes the allegations made by MID are meritless 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.
The Company assumed liability for various claims and litigation in connection
with the Chevron Combination, the Trident Combination, the Destec Acquisition
and in connection with the acquisition of certain gas processing and gathering
facilities from Mesa Operating Limited Partnership. The Company believes, based
on its review of these matters and consultation with outside legal counsel, that
the ultimate resolution of such items will not have a material adverse effect on
the Company's financial position or results of operations. Further, the Company
is subject to various legal proceedings and
Page 9 of 27
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended March 31, 1999 and 1998
(unaudited)
claims, which arise in the normal course of business. 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 6 -- CAPITAL STOCK
At March 31, 1999, employee stock options aggregating 4.8 million shares were
exercisable at prices ranging from $2.03 to $21.63 per share. Employee stock
option grants made from 1994 to 1998 will become exercisable during 1999 and
2000, respectively, resulting in the potential exercise of approximately 8.7
million options during that two-year period, at exercise prices ranging from
$2.03 to $21.63. Other options currently granted under the Company's option
plans will fully vest periodically and become exercisable through the year 2005
at prices ranging from $2.03 to $21.63. Grants made under the Company's option
plans may be canceled under certain circumstances as provided in the plans.
While the Company cannot predict the timing or the number of shares which may be
issued upon the exercise of option grants by individual employees, the Company
is pursuing a variety of alternatives to help assure an orderly distribution of
shares which may become available to the market.
In May 1997, the Board of Directors approved a stock repurchase program that
allows the Company to repurchase, from time to time, up to 1.6 million shares of
common stock in open market transactions. The timing and number of shares
ultimately repurchased will depend upon market conditions and consideration of
alternative investments. Pursuant to this program, the Company has acquired
1,200,700 shares at a total cost of $17.6 million, or $14.65 per share on a
weighted average cost basis, through March 31, 1999.
NOTE 7 -- SEGMENT INFORMATION
The Company has adopted Financial Accounting Standard No. 131, "Disclosures
about Segments of an Enterprise and Related Information" and has restated its
segment disclosures for all reporting periods. Dynegy's operations are divided
into two reportable segments: Wholesale Gas and Power and Liquids. The Wholesale
Gas and Power segment is actively engaged in value creation through marketing
and trading of natural gas, power and coal and the generation of electricity
principally under the name Dynegy Marketing and Trade. The Liquids segment
consists of the North American mid-stream liquids operations, as well as the
international liquefied petroleum gas transportation and natural gas liquids
marketing operations located in Houston and London, and certain other
businesses. The North American mid-stream liquids operations are actively
engaged in the gathering and processing of natural gas and the transportation,
fractionation, storage and marketing of NGLs. This segment operates principally
under the name Dynegy Mid-Stream Services. Generally, Dynegy accounts for
intercompany transactions at prevailing market rates. Operating segment
information for the quarters ended March 31, 1999 and 1998 is presented below.
Page 10 of 27
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended March 31, 1999 and 1998
(unaudited)
<TABLE>
<CAPTION>
DYNEGY'S SEGMENT DATA FOR THE QUARTER ENDED MARCH 31, 1999
Wholesale Gas and
Power Liquids Elimination Total
------------------------ ------------ ------------ -----------
($ in thousands)
<S> <C> <C> <C> <C>
Unaffiliated revenues:
Domestic $1,630,795 $ 698,579 $ --- $2,329,374
Canadian 321,013 43,560 --- 364,573
United Kingdom 351,026 --- --- 351,026
---------- ---------- ----------- ----------
2,302,834 742,139 --- 3,044,973
---------- ---------- ----------- ----------
Intersegment revenues
Domestic 51,752 42,253 (94,005) ---
Canadian 11,293 --- (11,293) ---
United Kingdom --- --- --- ---
---------- ---------- ----------- ----------
63,045 42,253 (105,298) ---
---------- ---------- ----------- ----------
Total revenues 2,365,879 784,392 (105,298) 3,044,973
---------- ---------- ----------- ----------
Operating margin 70,106 49,971 --- 120,077
Depreciation and amortization (8,561) (22,727) --- (31,288)
Interest expense (9,569) (9,665) --- (19,234)
Interest and other income 12,473 1,445 --- 13,918
Equity earnings of unconsolidated affiliates 12,637 2,426 --- 15,063
Income tax (provision) benefit (15,524) 2,912 --- (12,612)
Net income 26,498 1,573 --- 28,071
Identifiable assets:
Domestic $2,851,176 $2,047,501 $ --- $4,898,677
Canadian 253,927 42,458 --- 296,385
United Kingdom 119,323 --- --- 119,323
Investment in unconsolidated affiliates 351,199 160,409 --- 511,608
Capital expenditures 80,431 20,905 --- 101,336
</TABLE>
Page 11 of 27
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended March 31, 1999 and 1998
(unaudited)
<TABLE>
<CAPTION>
DYNEGY'S SEGMENT DATE FOR THE QUARTER ENDED MARCH 31, 1998
Wholesale Gas and
Power Liquids Elimination Total
------------------- ----------- ----------- ------------
($ in thousands)
<S> <C> <C> <C> <C>
Unaffiliated revenues:
Domestic $1,983,052 $ 847,306 $ --- $2,830,358
Canadian 231,543 80,264 --- 311,807
United Kingdom 173,404 --- --- 173,404
---------- ---------- ----------- ----------
2,387,999 927,570 --- 3,315,569
---------- ---------- ----------- ----------
Intersegment revenues
Domestic 27,659 100,369 (128,028) ---
Canadian --- --- --- ---
United Kingdom --- --- --- ---
---------- ---------- ----------- ----------
27,659 100,369 (128,028) ---
---------- ---------- ----------- ----------
Total revenues 2,415,658 1,027,939 (128,028) 3,315,569
---------- ---------- ----------- ----------
Operating margin 39,225 57,764 --- 96,989
Depreciation and amortization (5,728) (19,804) --- (25,532)
Interest expense (5,202) (10,803) --- (16,005)
Interest and other income 2,031 937 --- 2,968
Equity earnings of unconsolidated affiliate 10,600 5,155 --- 15,755
Income tax (provision) benefit (4,482) 410 --- (4,072)
Net income 7,632 4,707 --- 12,339
Identifiable assets:
Domestic $1,978,231 $2,092,195 $ --- $4,070,426
Canadian 291,972 43,972 --- 335,944
United Kingdom 76,757 --- --- 76,757
Investment in unconsolidated affiliates 342,951 159,662 --- 502,613
Capital expenditures 21,730 36,966 --- 58,696
</TABLE>
Page 12 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
The following discussion and analysis should be read in conjunction with the
unaudited condensed consolidated financial statements of Dynegy Inc. included
elsewhere herein and with the Company's Annual Report on Form 10-K for the year
ended December 31, 1998.
GENERAL
COMPANY PROFILE. Dynegy is a leading provider of energy products and services in
North America and the United Kingdom. Products marketed by the Company's
wholesale operations include natural gas, electricity, coal, natural gas
liquids, crude oil, liquid petroleum gas and related services. The Company's
wholesale marketing operations are supported by ownership or control of an
extensive asset base and transportation network that includes unregulated power
generation, gas and liquids storage capacity, gas, power and liquids
transportation capacity and gas gathering, processing and fractionation assets.
The critical mass achieved through the combination of a large scale energy
marketing operation with strategically located assets which augment the
marketing efforts affords the Company the ability to offer innovative, value-
creating energy solutions to its customers.
From inception of operations in 1984 until 1990, Natural Gas Clearinghouse
("Clearinghouse") limited its activities primarily to natural gas marketing.
Starting in 1990, Clearinghouse began expanding its core business operations
through acquisitions and strategic alliances resulting in the formation of a
mid-stream energy asset business and establishing energy marketing operations in
both Canada and the United Kingdom. The Company initiated electric power
marketing operations in February 1994 in order to exploit opportunities created
by the deregulation of the domestic electric power industry. Effective March 1,
1995, Clearinghouse and Holding, a fully integrated natural gas liquids company,
merged and the combined entity was renamed NGC Corporation, Inc. On August 31,
1996, NGC completed a strategic combination with Chevron whereby substantially
all of Chevron's mid-stream assets were merged with NGC. Effective July 1, 1997,
NGC acquired Destec Energy, Inc., a leading independent power producer. During
1998, the Company changed its name to Dynegy Inc. in order to reflect its
evolution from a natural gas marketing company to an energy services company
capable of meeting the growing demands and diverse challenges of the dynamic
energy market of the 21st Century.
BUSINESS SEGMENTS. Dynegy's operations are divided into two segments: the
Wholesale Gas and Power and Liquids segments. The Wholesale Gas and Power
segment is actively engaged in value creation through marketing and trading of
natural gas, power and coal and the generation of electricity principally under
the name Dynegy Marketing and Trade. The Liquids segment consists of the North
American mid-stream liquids operations, as well as the international liquefied
petroleum gas transportation and natural gas liquids marketing operations
located in Houston and London, and certain other businesses. The North American
mid-stream liquids operations are actively engaged in the gathering and
processing of natural gas and the transportation, fractionation, storage and
marketing of NGLs. The Liquids segment operates principally under the name
Dynegy Mid-Stream Services.
UNCERTAINTY OF FORWARD-LOOKING STATEMENTS AND INFORMATION. This Form 10-Q
contains various forward-looking statements, within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, and information that are based on management's beliefs as well as
assumptions made by and information currently available to management. When used
in this document, words such as "anticipate", "estimate", "project", "forecast"
and "expect" reflect forward-looking statements. Although the Company believes
that the expectations reflected in such forward-looking statements are
reasonable; it can give no assurance that such expectations will prove to have
been correct. Such statements are subject to certain risks, uncertainties and
assumptions. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results may vary
materially from those anticipated, estimated, projected or expected. Among the
key risk factors that may have a direct bearing on Dynegy's results of
operations and financial condition are:
. Competitive practices in the industries in which Dynegy competes;
. Fluctuations in commodity prices for natural gas, electricity, natural gas
liquids, crude oil or coal;
Page 13 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
. Fluctuations in energy commodity prices which could not or have not been
properly hedged or which are inconsistent with Dynegy's open position in its
energy marketing activities;
. Operational and systems risks;
. Environmental liabilities which are not covered by indemnity or insurance;
. Software, hardware or third-party failures resulting from Year 2000 issues;
. General economic and capital market conditions, including fluctuations in
interest rates; and
. The impact of current and future laws and governmental regulations
(particularly environmental regulations) affecting the energy industry in
general, and Dynegy's operations in particular.
IMPACT OF PRICE FLUCTUATIONS. Dynegy's operating results are impacted by
commodity price, interest rate and foreign exchange rate fluctuations. The
Company routinely enters into financial instrument contracts to hedge purchase
and sale commitments, fuel requirements and inventories in its natural gas,
natural gas liquids, crude oil, electricity and coal businesses in order to
minimize the risk of market fluctuations. As a result of marketplace liquidity
and other factors, the Company may, at times, be unable to fully hedge its
portfolio for certain market risks. Dynegy also monitors its exposure to
fluctuations in interest rates and foreign currency exchange rates and may
execute swaps, forward-exchange contracts or other financial instruments to
manage these exposures.
Operating margins in the Wholesale Gas and Power segment include the integrated
component businesses: wholesale gas marketing, wholesale power marketing and
power generation. Operating margins earned by wholesale gas and power marketing,
exclusive of risk-management activities, are relatively insensitive to commodity
price fluctuations since most of the purchase and sales contracts do not contain
fixed-price provisions. Generally, prices contained in these contracts are tied
to a current spot or index price and, therefore, adjust directionally with
changes in overall market conditions. However, market price fluctuations for
natural gas and electricity can have a significant impact on the operating
margin derived from risk-management activities in these businesses. Dynegy
generally attempts to balance its fixed-price physical and financial purchase
and sales commitments in terms of contract volumes, and the timing of
performance and delivery obligations. However, the Company may, at times, have a
bias in the market, within established guidelines, resulting from management of
its portfolio. To the extent a net open position exists, fluctuating commodity
market prices can impact Dynegy's financial position or results of operations,
either favorably or unfavorably. The net open positions are actively managed,
and the impact of changing prices on the Company's financial condition at a
point in time is not necessarily indicative of the impact of price movements
throughout the year. Fuel costs, principally natural gas, represent the primary
variable cost impacting margins at the Company's power generating facilities.
Historically, operating margins have been relatively insensitive to commodity
price fluctuations since most of this business's purchase and sales contracts
contain variable power sales contract features tied to a current spot or index
natural gas price, allowing revenues to adjust directionally with changes in
natural gas prices. However, as the Company's investment in merchant generation
capacity expands, changes in and the relationship between, natural gas and
electricity prices may impact the financial performance and cash flow related to
its portfolio of merchant power generation assets.
Operating margins associated with the Liquids segment's natural gas gathering,
processing and fractionation activities are very sensitive to changes in natural
gas liquids prices and the availability of inlet volumes. The impact from
changes in natural gas liquids prices results principally from the nature of
contractual terms under which natural gas is processed and products are sold. In
addition, certain of the Liquids Businesses' processing plant assets are
impacted by changes in, and the relationship between, natural gas and natural
gas liquids prices which, in turn influences the volumes of gas processed.
Commodity price fluctuations may also affect the operating margins derived from
the Company's natural gas liquid and crude oil marketing businesses. Based upon
current levels of natural gas processing activities and industry fundamentals,
the estimated impact on annual operating margins of each one-cent movement in
the annual average price of natural gas liquids approximates $8 to $10 million.
The availability of inlet volumes directly affects the utilization and
profitability of the segment's businesses throughout the Liquids Value Chain.
The acquisition of inlet volumes is highly competitive and the availability of
such volumes to industry-wide participants is also impacted by price
variability. Unilateral decisions made by producers to shut-in production or
otherwise curtail workovers, reduce well maintenance activities and/or delay or
Page 14 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
cancel drilling activities, as a result of depressed commodity prices or other
factors, negatively affects production available to the entire mid-stream
industry. Because such decisions are based upon the pricing environment at any
particular time, management cannot predict with precision the impact that such
decisions may have on its business.
Seasonality. Dynegy's revenue and operating margin are subject to fluctuations
during the year, primarily due to the impact certain seasonal factors have on
sales volumes and the prices of natural gas, electricity and natural gas
liquids. Natural gas sales volumes and operating margin are typically higher in
the winter months than in the summer months, reflecting increased demand due to
greater heating requirements and, typically, higher natural gas prices.
Conversely, power marketing operations are typically impacted by higher demand
and commodity price volatility during the summer cooling season. Consistent with
power marketing, the Company's electricity generating facilities generally
experience peak demand during the summer cooling season, particularly for
merchant plant generating facilities. The Liquids businesses are also subject to
seasonal factors; however, such factors typically have a greater impact on sales
prices than on sales volumes. Natural gas liquids prices typically increase
during the winter season due to greater heating requirements. The Company's
wholesale propane business is seasonally weighted in terms of volume and price,
consistent with the trend in the Company's natural gas operations, as a result
of greater demand for crop-drying and space-heating requirements in the fall and
winter months.
Effect of Inflation. Although Dynegy's operations are affected by general
economic trends, management does not believe inflation has had a material effect
on the Company's results of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business strategy has historically focused on acquisitions or
construction of core operating facilities in order to capture significant
synergies existing among these types of assets and Dynegy's natural gas, power
and natural gas liquids marketing businesses. The Company's energy convergence
strategies are 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 (a.k.a.,
"Merchant Leverage Effect"). For the foreseeable future, the Company's primary
focus will be the acquisition and/or construction of power generating assets
that will enable the Company to fully realize the Merchant Leverage Effect of
commercialization of these generating assets.
Dynegy has historically relied upon operating cash flow and borrowings from a
combination of commercial paper issuances, money market lines of credit,
corporate credit agreements and various public debt issuances for its liquidity
and capital resource requirements. The following briefly describes the terms of
these arrangements.
Commercial Paper and Money Market Lines of Credit. The Company uses commercial
paper proceeds and borrowings under uncommitted money market lines of credit for
general corporate purposes, including short-term working capital requirements.
The Company maintains a commercial paper program for amounts up to $800 million,
as supported by its corporate credit agreements. At March 31, 1999,
approximately $636 million of commercial paper was outstanding and $30 million
was outstanding under existing money market lines of credit.
Corporate Credit Agreements. Dynegy's corporate credit agreements are comprised
of a $400 million, five-year revolving credit agreement maturing in May 2003,
and a $400 million, 364-day revolving credit agreement maturing in May 1999.
Both agreements provide funding for working capital, letters of credit and other
general corporate expenditures. The Company maintains an additional $240
million, 364-day revolving credit agreement having a current maturity date of
December 17, 1999. This facility also provides funding for general corporate
purposes. At March 31, 1999, letters of credit and borrowings under the
corporate credit agreements aggregated $4.9 million and, after consideration of
the outstanding commercial paper, aggregate unused borrowing capacity under the
corporate credit agreements approximated $369 million.
Page 15 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
Canadian Credit Facility. In November 1998, an indirect wholly-owned Canadian
subsidiary of the Company entered into a $60 million, two-year revolving credit
facility maturing in November 2000. Borrowings under this agreement may be used
for general corporate purposes. At March 31, 1999, $40 million was outstanding
under this agreement.
Public Debt. The Company has three separate public debt issues aggregating $500
million, which mature in 2005, 2018 and 2026, respectively. Net proceeds derived
from these issues were used to reduce outstanding borrowings under credit
arrangements existing at the date of each respective issuance.
Development Project Financing. The consolidated long-term debt balance includes
three notes aggregating $96.8 million having recourse only to the assets of
three power generation projects. Each of the three notes represents a fifteen-
year term loan obligation payable in semi-annual installments of principal plus
accrued interest.
Company Obligated Preferred Securities of Subsidiary Trust. In May 1997, NGC
Corporation Capital Trust I ("Trust"), a wholly owned subsidiary of Dynegy,
issued in a private transaction $200 million aggregate liquidation amount of
8.316% Subordinated Capital Income Securities (referred to herein as
"Securities") representing preferred undivided beneficial interests in the
assets of the Trust. The Trust invested the proceeds from the issuance of the
Trust Securities in an equivalent amount of 8.316% Subordinated Debentures
("Subordinated Debentures") of the Company. The sole assets of the Trust are the
Subordinated Debentures. Following the issuance of the Securities, the Trust
completed an exchange offer through which all of the outstanding Securities were
exchanged by the holders thereof for registered securities having substantially
the same rights and obligations.
OTHER MATTERS
Stockholder Divestiture. In August 1998, the Company announced that NOVA had
given notice of its intent to divest its 25.4 percent stake in Dynegy,
representing approximately 38.8 million common shares. Chevron and BG each also
currently own 25.4 percent of the outstanding common shares of Dynegy and
maintain certain preferential rights to purchase the common shares to be
divested by NOVA pursuant to the shareholder's agreement between BG, Chevron and
NOVA dated May 22, 1996. The uncertainty surrounding the change in ownership has
temporarily reduced the Company's financial flexibility by limiting its access
to certain capital market sectors. As a result, the Company's ability to finance
the full execution of its business strategy, as discussed more fully in the
Company's Form 10-K, may be diminished if resolution of NOVA's divestiture is
prolonged or is concluded in a manner which negatively impacts Dynegy's stock
price. Dynegy's management and Board of Directors are actively pursuing
alternatives to resolve this issue in a timely manner. Management believes that
the ultimate resolution of this issue will not have a material adverse impact on
its operations or financial condition.
Quantitative and Qualitative Market Risk Disclosures. The Company is exposed to
certain market risks inherent in the Company's financial instruments, which
arise from transactions entered into in the normal course of business. The
Company routinely enters into financial instrument contracts to hedge purchase
and sale commitments, fuel requirements and inventories in its natural gas,
natural gas liquids, crude oil, electricity and coal businesses in order to
minimize the risk of market fluctuations. Dynegy also monitors its exposure to
fluctuations in interest rates and foreign currency exchange rates and may
execute swaps, forward-exchange contracts or other financial instruments to
hedge and manage these exposures. The absolute notional contract amounts
associated with commodity risk-management, interest rate and forward exchange
contracts, respectively, were as follows:
Page 16 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
----------------------------------
<S> <C> <C>
Natural Gas (Trillion Cubic Feet) 4.842 4.179
Electricity (Million Megawatt Hours) 3.308 1.835
Natural Gas Liquids (Million Barrels) 8.828 6.397
Crude Oil (Million Barrels) 20.487 18.800
Interest Rate Swaps (in thousands of US Dollars) $ 68,754 $ 69,332
Weighted Average Fixed Interest Rate Paid on
Swaps 8.073 8.067
U.K. Pound Sterling (in thousands of US Dollars) $ 59,963 $ 69,254
Average U.K. Pound Sterling Contract Rate (in
US Dollars) $ 1.6033 $ 1.6143
Canadian Dollar (in thousands of US Dollars) $218,942 $268,307
Average Canadian Dollar Contract Rate (in US
Dollars) $ 0.6701 $ 0.6710
</TABLE>
Stock Options. Employee stock option grants made from 1994 to 1998 will become
exercisable during 1999 and 2000, respectively, resulting in the potential
exercise of approximately 8.7 million options during that two-year period, at
exercise prices ranging from $2.03 to $21.63. Other options currently granted
under the Company's option plans will fully vest periodically and become
exercisable through the year 2005 at prices ranging from $2.03 to $21.63. Grants
made under the Company's option plans may be canceled under certain
circumstances as provided in the plans. While the Company cannot predict the
timing or the number of shares which may be issued upon the exercise of option
grants by individual employees, the Company is pursuing a variety of
alternatives to help assure an orderly distribution of shares which may become
available to the market.
Year 2000 Issues. The Company is continuing its analysis of the "Year 2000"
issue, which arises from the use by certain computer hardware and software
applications of two digits rather than four to define an applicable year. Such
hardware and software may be incapable of appropriately recognizing the year
2000, the result of which could be system failures or miscalculations leading to
disruptions in the Company's activities and operations. If the Company and/or
its significant customers or suppliers fail to timely make necessary
modifications and conversions, the Year 2000 issue could have a material adverse
effect on Company operations and its financial position. The Company believes
that its competitors face similar risks.
Dynegy has established a corporate-wide project team to identify and rectify
non-compliant hardware and software within its infrastructure. The Company has
completed its inventory of corporate-wide imbedded systems issues as well as its
inventory of corporate hardware and software applications. The Company is
substantially complete with its inventorying of hardware and software
infrastructure at remote locations. A final risk assessment, testing and
remediation activity is ongoing on all of the Company's core systems and
business applications at both corporate and field locations. It is expected that
all core systems and business applications will be Year 2000 ready by September
1999. In addition, the Company is focusing assessment efforts to determine that
major customers and suppliers are also Year 2000 ready. The project team is also
formulating contingency plans to address alternatives for the Company should
Year 2000 issues disrupt operations. As part of the plan, the Company is
developing contingency plans that address essential aspects of the Year 2000
problem. The contingencies identified include:
. Satisfactory remediation of all core systems and business applications is
not executed by December 31, 1999;
. System modifications and conversions instituted by significant customers or
suppliers fail to satisfactorily remediate Year 2000 issues by December 31,
1999; and
Page 17 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
. Year 2000 issues remain unidentified by Dynegy, its industry partners or
ancillary service providers, which disrupt operations of the Company.
Dynegy's contingency plans are being designed to minimize any disruptions or
other adverse effects resulting from Year 2000 incompatibilities regarding core
systems and business applications and to facilitate the early identification and
remediation of system problems that manifest themselves after December 31, 1999.
In addition to software and hardware issues directly affecting commercial
operations of the Company, the contingency plan addresses, for example, loss of
electricity, telecommunications, building access, security and other factors.
Nevertheless, there can be no absolute assurance that there will not be a
material adverse effect on the Company if its efforts are delayed or are
ineffective, if material issues remain unidentified or if third party entities
do not convert or replace hardware and software applications in a timely manner
and in a way that is compatible with the Company's hardware and software
infrastructure.
The Securities and Exchange Commission requires that public companies forecast
the most reasonable likely worst-case Year 2000 scenario. In doing so, the
Company assumed that its Year 2000 plan is ineffective. In reviewing a worst-
case scenario, the Company contemplated issues that, although considered highly
unlikely, must be contemplated in such a review. Issues contemplated in this
review included total failure of financial and operational systems, total loss
of supplies from third parties, total loss of transportation, storage and
similar operational capabilities and widespread extended loss of utilities,
building access and other similar items. Under this scenario, the Company would
face substantial claims by third parties and loss of revenue and cash flow
resulting from, among other things, service interruptions, the inability to meet
contractual obligations and the inability to invoice or pay third parties timely
and accurately. Further, such a disruption could affect the operational
integrity of certain commercial assets, the result of which could have
operational, safety and environmental implications. The Company is not able to
quantify the financial effect of the worst case scenario described above and
will continue to actively monitor business conditions with the aim of assessing
and quantifying material adverse effects, if any, that result or may result from
the Year 2000 issue.
Results of the review conducted to date indicate that the Company is unlikely to
be burdened by a material event resulting from the Company's untimely resolution
of Year 2000 issues. The potential costs and uncertainties associated with this
review are dependent upon a number of factors, including legacy software and
hardware configurations, planned information technology infrastructure
enhancements and the availability of trained personnel. Aggregate current cost
estimates for the entire Year 2000 project are projected to range between $8 and
$10.5 million. Approximately $2 million of this amount was expended during 1998
related to this project and an additional $1 million was expended during the
first quarter of 1999. These cost estimates include costs for identification and
remediation of Year 2000 issues. Such cost estimates are based on current
available information and are subject to revision, either upward or downward, as
the project matures and additional information becomes available.
CONCLUSION
The Company continues to believe that it will be able to meet all foreseeable
cash requirements, including working capital, capital expenditures and debt
service, from operating cash flow, supplemented by borrowings under its various
credit facilities, if required.
Page 18 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
RESULTS OF OPERATIONS
Provided below is a tabular presentation of certain domestic and international
operating and financial statistics for the Company's segments for the three-
month periods ended March 31, 1999 and 1998, respectively.
<TABLE>
<CAPTION>
Wholesale Gas and Power Liquids
----------------------------- -----------------------
1999 1998 1999 1998
------------- ----------- ---------- --------
<S> <C> <C> <C> <C>
Operating Margin:
Power Marketing and Generation $ 37,432 $ 7,080 $ --- $ ---
Natural Gas Marketing 32,674 32,145 --- ---
Upstream Operations --- --- 18,340 31,852
Downstream Operations --- --- 26,987 23,203
Crude Oil Operations --- --- 4,644 2,709
Equity Investments 12,638 10,599 2,425 5,156
-------- -------- -------- --------
SUBTOTAL - FINANCIAL CONTRIBUTION 82,744 49,824 52,396 62,920
Depreciation (8,561) (5,728) (22,727) (19,804)
General and Administrative Expenses (1) (31,539) (27,306) (18,003) (24,944)
Other Items (2) 10,653 1,876 (888) (264)
-------- -------- -------- --------
EARNINGS BEFORE INTEREST AND TAXES $ 53,297 $ 18,666 $ 10,778 $ 17,908
======== ======== ======== ========
OPERATING STATISTICS:
Natural Gas Marketing (Bcf/d) -
U.S. Sales Volumes 7.0 6.5 --- ---
Canadian Sales Volumes 2.3 2.1 --- ---
U.K. Sales Volumes 1.6 0.7 --- ---
-------- -------- -------- --------
10.9 9.3 --- ---
======== ======== ======== ========
Electric Power Marketing - Million Megawatt Hours Sold 13.1 25.0 --- ---
Power Generation (Million Megawatt Hours Generated) -
Gross 3.6 3.3 --- ---
Net 2.4 2.1 --- ---
Natural Gas Liquids Processed (MBbls/d - Gross) -
Field Plants --- --- 88.5 86.7
Straddle Plants --- --- 28.6 40.8
-------- -------- -------- --------
--- --- 117.1 127.5
======== ======== ======== ========
Natural Gas Gathering and Transmission (MMcf/d) --- --- 0.2 0.4
Fractionation - Barrels Received for Fractionation --- --- 161.3 202.0
NGL Marketing - Sales Volumes (MBbls/d) --- --- 462.0 431.7
LPG Sales Volumes (MBbls/d) --- --- 77.4 59.6
Crude Oil Marketing - Sales Volumes (MBbls/d) --- --- 153.0 195.2
</TABLE>
(1) Includes the segment's share of the $9.6 million pre-tax severance charge
recognized in the first quarter of 1998.
(2) The Wholesale Gas and Power segment includes the $8.9 million pre-tax gain
on sale of an investment, which was effective January 1, 1999, for
accounting purposes.
Page 19 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
THREE-MONTH PERIODS ENDED MARCH 31, 1999 AND 1998
For the quarter ended March 31, 1999, Dynegy realized net income of $28.1
million, or $0.17 per share compared with first quarter 1998 net income of $12.3
million, or $0.07 per share. Current period results include an after-tax benefit
of approximately $5.8 million, or $0.03 per share, related to the sale of an
investment. First quarter 1998 results include an after-tax charge of $6.3
million, or $0.04 per share, attributed to a severance charge resulting
principally from the restructuring of the Company's natural gas liquids
business. Normalized earnings, which exclude the aforementioned non-recurring
items, totaled $22.3 million, or $0.14 per share, in 1999 as opposed to $18.6
million, or $0.11 per share, in 1998. In general, the improved earnings period-
to-period result from the continued exploitation of the significant leverage
available through integration of wholesale gas and power marketing, trading and
arbitrage opportunities with ownership, or control, and optimization of
generation assets. The execution of the Merchant Leverage Effect more than
offset the negative impact imposed on the 1999 results by depressed natural gas
liquids prices.
Consolidated operating margin for the first quarter of 1999 totaled $120.1
million as compared to $97.0 million for the corresponding 1998 period. The 1999
quarterly consolidated operating margin was significantly higher than in the
prior period principally as a result of significantly improved operating margins
period-to-period in the power marketing and generation businesses partially
offset by lower margins in the Liquids segment. Consolidated operating margins
in both quarters were unfavorably impacted by commodity price variability from
historic norms. The mild winters during both 1999 and 1998 depressed demand for
natural gas resulting in reduced commodity price variability. These factors
limited natural gas and power trading opportunities, negatively impacting
operating margins in both periods. The precipitous drop in crude oil prices
during the latter half of 1998 continued during most of the first quarter of
1999. Natural gas liquids prices, which move in reasonable correlation with
crude prices, also dropped precipitously during that period. Principally as a
result of the downward movement in energy commodity prices, wellhead production
was shut-in and drilling for new production by the petroleum industry was
curtailed. These factors combined to produce extremely unfavorable market
conditions for the Company's upstream liquids operations during the 1999
quarter. Natural gas liquids and crude oil commodity prices began strengthening
near the end of the quarter. Assuming such price recovery is sustained, market
pressure on the Liquids segment will ease as wellhead production increases over
time and market commodity prices return to more profitable levels.
Normalized operating income increased $10.4 million period-to-period reflecting
the aforementioned increase in consolidated operating margin offset by increases
in depreciation and amortization and general and administrative expenses. The
increase in depreciation and amortization expense period-to-period resulted
principally from investment in depreciable assets associated with the expansion
of the power generation business as well as information technology
infrastructure improvements. The increased level of general and administrative
expenses period-to-period principally reflects the incremental costs associated
with a larger, more diverse base of operations, non-capitalizable consulting and
other costs required to support technology infrastructure improvements and, to a
lesser degree, expenses related to identifying and resolving Year 2000 issues.
Incremental to Dynegy's consolidated operating income was the Company's equity
share in the earnings of its unconsolidated affiliates, which contributed in
excess of $15 million to both 1999 and 1998 pre-tax quarterly earnings. As with
operating margin, the Company's investments in power generation benefited from
the execution of the Merchant Leverage Effect. However, the Company's
investments in ventures involved in businesses related to the natural gas
liquids industry were negatively impacted by lack of demand, lower production
and throughput volumes and depressed commodity prices. The following table
provides a summary of equity earnings by investment for the comparable periods.
Page 20 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
<TABLE>
<CAPTION>
For the Three Months Ended March 31,
---------------------------------------
1999 1998
---------------- ---------------
<S> <C> <C>
WHOLESALE GAS AND POWER:
Accord $ 4,500 $ 4,500
Power Generation Equity Investments (in
aggregate) 8,620 7,154
Retail Alliances (in aggregate) (649) (1,050)
Other, net 167 (5)
------- --------
TOTAL WHOLESALE GAS AND POWER 12,638 10,599
------- --------
LIQUIDS BUSINESSES:
Gulf Coast Fractionators 870 1,189
West Texas LPG Pipeline Limited Partnership 872 1,717
Venice Energy Services Company, L.L.C. 294 1,763
Other, net 389 487
------- --------
TOTAL LIQUIDS BUSINESSES 2,425 5,156
------- --------
$15,063 $ 15,755
======= ========
</TABLE>
Interest expense totaled $19.2 million for the three-months ended March 31,
1999, compared with $16.0 million for the comparable 1998 period. The higher
interest expense period-to-period is principally attributed to higher average
outstanding principal amounts resulting primarily from the acquisition of
interests in certain power generating facilities, construction costs associated
with power generation projects, construction costs associated with the Louisiana
fractionator and the acquisition of a Canadian gas processing facility.
Accumulated distributions associated with the Guaranteed Preferred Beneficial
Interests in Subordinated Deferrable Interest Debentures totaled $4.2 million
for each quarter ended March 31, 1999 and 1998, respectively.
Other income and expenses, net for the three-month period ended March 31, 1999,
included the $8.9 million gain on the sale of an investment. For the quarter
ended March 31, 1998, other income and expenses, net, was not material.
The Company reported an income tax provision of $12.6 million for the three-
month period ended March 31, 1999, representing an effective rate of 31 percent.
This compared to an income tax provision of $4.1 million and an effective rate
of 25 percent in the comparable 1998 period. Differences between the
aforementioned effective rates and the statutory rate of 35 percent in each
period results principally from permanent differences attributable to
amortization of certain intangibles and debt premiums, permanent differences
arising from the effect of certain foreign equity investments and state income
taxes.
WHOLESALE GAS AND POWER SEGMENT
The Wholesale Gas and Power segment had normalized earnings before interest and
taxes ("EBIT") of $44.4 million for the three-month period ended March 31, 1999,
compared with $21.4 million in the 1998 quarter. As discussed previously, the
increase in 1999 quarterly EBIT over 1998 EBIT was achieved without favorable
commodity price conditions in either quarter. Aggregate operating margin and
equity earnings reported by this segment totaled $82.7 million for the 1999
quarter, compared to $49.8 million in 1998. The material increase in financial
contribution by this segment period-to-period results from, among other things,
expansion of the Company's investment in power generation, the impetus placed by
this segment on quality of operating margins over the quantity of sales volumes
and the continuing integration of the segment's operations through execution of
the Merchant Leverage Effect. Depreciation and general and administrative
expenses both increased significantly period-to-period reflecting the capital
and overhead costs required to support the larger, more diverse base of
operations.
Page 21 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
Power marketing and generation operations generated operating margin and equity
earnings for the quarter ended March 31, 1999, of $46.2 million compared to
$14.2 million in 1998. The dramatic growth in financial contribution from these
operations reflects the value extraction derived from integration of power
marketing with owned or controlled generation capacity.
Worldwide gas marketing operations generated operating margin and equity
earnings for the quarter ended March 31, 1999 of $36.5 million compared to $35.6
million in 1998. As previously discussed, market conditions in 1999 and 1998
were influenced by unseasonably warm weather in the winter months that
eliminated any significant volatility in commodity prices. Worldwide sales
volumes totaled 10.9 Bcf/d in 1999 compared to 9.3 Bcf/d in 1998. The growth in
sales volumes period-to-period was primarily in the U.K. reflecting the
expansion of Dynegy's presence in that country as well as the expansion of
business opportunities available as the UK's gas market continues its
privatization. The growth in US volumes is attributed to sales made to its
retail affiliates as well as expanded asset management arrangements.
LIQUIDS SEGMENT
The Liquids segment had normalized EBIT of $10.8 million for the three-month
period ended March 31, 1999, compared to $24.8 million for the 1998 quarter. As
discussed previously, this segment was negatively impacted by unfavorable market
conditions during the 1999 quarter. NGL prices averaged $0.06 per gallon lower
in 1999 as compared to the same period a year ago. Crude oil prices were 24
percent lower period-to-period averaging $10.39 per barrel in the 1999 quarter
as compared to $13.75 in the 1998 quarter. The initiatives undertaken by this
segment beginning in the fourth quarter of 1997 and executed throughout 1998
allowed the businesses to improve operating efficiencies, reduce costs and
mitigate exposure to asset impairments resulting from the commodity price
variability. However, benefits derived from these initiatives could not overcome
the significant negative impact resulting from the depressed commodity price
environment.
Aggregate domestic natural gas liquids processing volumes totaled 117.1 thousand
gross barrels per day in 1999 compared to an average 127.5 thousand gross
barrels per day during 1998. The lower volumes in 1999 reflect the economic
decisions made during the period to reduce production at its straddle processing
plants principally as a result of the relationship of natural gas and NGL
commodity prices. In addition, commodity price induced production curtailments
in producing regions throughout the US reduced available throughput at the
Company's natural gas processing facilities. Fractionation volumes and crude
marketing volumes were both lower period-to-period principally as a result of
the impact lower commodity prices had on available throughput. Natural gas
liquids marketing volumes increased period-to-period as the Company aggressively
marketed inventoried volumes.
OPERATING CASH FLOW
Cash flow from operating activities (before working capital changes) totaled
$51.4 million in the quarter ended March 31, 1999, compared to $20.9 million in
the comparable 1998 period reflecting the improved operating results previously
discussed herein. However, the Company reported a use of operating cash of $11.8
million in the 1999 quarter principally as a result of the timing of trade
accounts payable distributions, which negatively impacted cash flow from
operations in the current period. Changes in operating cash flow reflect the
operating results plus management of working capital, particularly trade
accounts receivable, trade accounts payable and discretionary inventory
management period-to-period. Changes in other working capital accounts, which
include prepayments, other current assets and accrued liabilities, reflect
expenditures or recognition of liabilities for insurance costs, certain
deposits, salaries, taxes other than on income, certain deferred revenue
accounts and other similar items. Fluctuations in these accounts, period-to-
period, reflect changes in the timing of payments or recognition of liabilities
and are not directly impacted by seasonal factors.
Page 22 of 27
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended March 31, 1999 and 1998
CAPITAL EXPENDITURES AND INVESTING ACTIVITIES
During the quarter ended March 31, 1999, the Company spent $140.3 million,
principally related to the acquisition or construction of power generation
assets, maintenance capital improvements at existing facilities and capital
investment associated with technology infrastructure improvements. The Company
also received proceeds of $16.7 million principally related to the
aforementioned sale of an investment. During the quarter ended March 31, 1998,
the Company spent a net $52.5 million, principally on the acquisition of a 50
percent interest in the Long Beach Generating Facility, construction costs
associated with the previously disclosed Lake Charles fractionation facility and
on expenditures for capital improvements at existing facilities.
DIVIDEND REQUIREMENTS AND STOCK REPURCHASES
Dynegy declares quarterly dividends on its outstanding common stock at the
discretion of its Board of Directors. The holders of the Series A Preferred
Stock are entitled to receive dividends or distributions equal per share in
amount and kind to any dividend or distribution payable on shares of the
Company's common stock, when and as the same are declared by the Company's Board
of Directors. The Company paid approximately $2.0 million in cash dividends and
distributions during each of the quarters ended March 31, 1999 and 1998,
respectively.
In May 1997, the Board of Directors approved a stock repurchase program that
allows the Company to repurchase, from time to time, up to 1.6 million shares of
common stock in open-market transactions. The timing and number of shares
ultimately repurchased will depend upon market conditions and consideration of
alternative investments. The Company acquired no shares under this plan during
the three-month period ended March 31, 1999. For the three-month period ended
March 31, 1998, the Company acquired 152,800 shares of its common stock in open-
market transactions for an aggregate cost of $2.3 million, or $14.93 per share
on a weighted average cost basis.
Page 23 of 27
<PAGE>
DYNEGY INC.
PART II. OTHER INFORMATION
Item 1 - Legal Proceedings
On April 17, 1997, Pacific Gas and Electric Company ("PG&E") filed a lawsuit in
the Superior Court of the State of California, City and County of San Francisco,
against Destec Energy, Inc., Destec Holdings, Inc. and Destec Operating Company
(wholly-owned subsidiaries of the Company now known respectively as Dynegy Power
Corp., Dynegy Power Holdings, Inc. and Dynegy Operating Company) as well as
against San Joaquin CoGen Limited ("San Joaquin" or the "Partnership") and its
general partners (collectively the "Dynegy Defendants"). Dynegy Power Corp. and
its affiliates now own all of the partnership interests in the Partnership as a
result of the purchase of the interests of the two outside partners in the
Partnership. In the lawsuit, PG&E asserts claims and alleges unspecified damages
for fraud, negligent misrepresentation, unfair business practices, breach of
contract and breach of the implied covenant of good faith and fair dealing.
PG&E alleges that due to the insufficient use of steam by San Joaquin's steam
host, the Partnership did not qualify as a cogenerator pursuant to the
California Public Utilities Code ("CPUC") Section 218.5, and thus was not
entitled under CPUC Section 454.4 to the discount the Partnership received under
gas transportation agreements entered into between PG&E and San Joaquin in 1989,
1991, 1993 and 1995. All of PG&E's claims in this suit arise out of the
Partnership's alleged failure to comply with CPUC Section 218.5. The defendants
filed a response to the suit on May 15, 1997. On October 20, 1997, PG&E named
Libbey-Owens-Ford ("LOF"), the Partnership's steam host, as an additional
defendant in the action. On February 23, 1998, PG&E served its Second Amended
Complaint on all defendants. On March 30, 1998, the defendants filed their
response to PG&E's Second Amended Complaint, denying PG&E's allegations and
alleging certain counterclaims against PG&E. By Order dated July 20, 1998, the
court dismissed certain of defendants' counterclaims against PG&E, and abated
certain others, pending resolution by the CPUC. The trial date is currently
December 13, 1999. The Partnership has previously advised the FERC of PG&E's
claims, and stated that it would submit any appropriate filings upon completion
of its investigation. If the facility was found not to have satisfied the
California cogeneration facility standards, there is a strong likelihood that it
would also fail to satisfy the more stringent federal standards. In accordance
with the terms of a Protective Order entered into by the parties at the
commencement of the litigation, PG&E has notified San Joaquin that it may make a
FERC filing seeking damages from San Joaquin and decertification of its status
as a qualifying facility under the federal standards. Under FERC precedent, if
the San Joaquin facility were found not to have been a qualifying facility, San
Joaquin could be required to refund to PG&E payments it received pursuant to the
Power Purchase Agreement in excess of PG&E's short-term energy costs during the
period of non-compliance, plus interest. In the event the court or FERC were to
determine that San Joaquin is liable to PG&E under the Gas Transportation
Agreement or Power Purchase Agreement due to LOF's failure to use sufficient
quantities of steam, San Joaquin notified LOF that it would seek to recover such
amounts from LOF under the terms of the Steam Purchase Agreement between San
Joaquin and LOF. The parties engaged in settlement discussions, which resulted
in the execution of a Termination and Settlement Agreement between PG&E and the
Dynegy Defendants on March 9, 1999 (the "Settlement Agreement"). The Settlement
Agreement provides for, upon the receipt of CPUC approval, a dismissal with
prejudice of PG&E's claims against the Dynegy Defendants, a release by PG&E of
all claims relative to FERC matters and a termination of the San Joaquin power
purchase agreement as of December 31, 1999, whereupon the San Joaquin facility
will continue to operate as a merchant plant. The Dynegy Defendants will seek to
recover from LOF any losses resulting from the settlement with PG&E. However, if
the settlement is not ultimately concluded, the Dynegy Defendants will seek to
recover from LOF any losses or amounts for which it may be found liable.
Further, the Company's subsidiaries intend to continue to vigorously defend this
action. In the opinion of management, the ultimate resolution of this lawsuit
will not have a material adverse effect on the Company's financial position or
results of operations. On April 15, 1999, the Dynegy Defendants filed suit
against LOF in the Superior Court of the State of California, County of San
Francisco seeking to recover damages the Dynegy Defendants have or will suffer
as a result of LOF's failure to purchase steam from the San Joaquin facility in
quantities required by the Steam Purchase Contract executed by San Joaquin and
LOF. The lawsuit states claims against LOF for breach of contract, breach of
implied covenant of good faith and fair dealing, fraud in the
inducement/intentional misrepresentation, negligent misrepresentation,
fraudulent concealment and non-disclosure, interference with contract and
indemnity. On April 28, 1999, LOF filed a procedural opposition to the lawsuit
essentially challenging venue in San Francisco County. LOF has not filed its
answer as of May 12, 1999.
On March 24, 1995, Southern California Gas Company ("SOCAL") filed a lawsuit in
the Superior Court of the State of California for the County of Los Angeles,
against Destec Energy, Inc., Destec Holdings and Destec Gas Services, Inc. (now
Page 24 of 27
<PAGE>
known respectively as Dynegy Power Corp., Dynegy Holdings, Inc. and Dynegy Gas
Services, Inc.), wholly-owned direct and indirect subsidiaries of the Company
(collectively, the "Defendants"), as well as against Chalk Cliff Limited and
McKittrick Limited (collectively, the "Partnerships"). The Company owns an
indirect 50 percent limited partnership interest in McKittrick Limited, and
Chalk Cliff Limited is now wholly-owned by subsidiaries of the Company through
the purchase of the interests of Dominion Energy, Inc. All general partners of
the Partnerships are also named defendants. The lawsuit alleged breach of
contract against the Partnerships and their respective general partners, and
interference and conspiracy to interfere with contracts against the Defendants.
The breach of contract claims arose out of the "transport-or-pay" provisions of
the gas transportation service agreements between the Partnerships and SOCAL.
SOCAL sought damages from the Partnerships for past damages and anticipatory
breach damages in an amount equal to approximately $31,000,000. On October 24,
1997, the Court granted SOCAL's Motion for Summary Judgment relating to the
breach of contract causes of action against the Partnerships and their
respective general partners, and requested that SOCAL submit a proposed order
consistent with that ruling for the Court's signature. On November 21, 1997, the
Partnerships filed for voluntary Chapter 11 bankruptcy protection in the Eastern
District of California. Normal business operations by the Partnerships continued
throughout the course of these reorganization proceedings. On January 12, 1998,
the Court entered a Final Order that (a) severed out the Partnerships due to
their Chapter 11 bankruptcy filings, (b) included a finding of contract
liability against the Defendants, (c) dismissed the tortious interference claims
against the Defendants, and (d) assessed damages in an aggregate amount of
approximately $31,000,000. On the same day, the Defendants filed their Notice of
Appeal, and posted a security bond with the Second Appellate District in Los
Angeles based on the lack of allegations made or proven by SOCAL which support
holding those entities liable in contract. On March 11, 1998, the Partnerships
and their respective general partners filed Notices of Appeal with respect to
certain findings of fact in the Court's January 12, 1998 Final Order that were
adverse to those defendants. On or about April 15, 1998, the Court entered a
final judgment against the Partnerships themselves in recognition of the lifting
of the automatic stay against those entities by the Bankruptcy Court. The
Partnerships filed their appeal of that final judgment on June 4, 1998. On
October 21, 1998, the Bankruptcy Court dismissed the voluntary bankruptcy
filings of the Partnerships and their respective lenders thereafter notified
each of the Partnerships of the occurrences of an Event of Default under the
Partnerships' respective credit agreements due to the existence of the SOCAL
judgment against them, and have instituted foreclosure proceedings as to the
projects. Additionally, receivers were named by the lenders and approved by the
Court for each of the projects. In early December 1998, the defendants filed
their opening appellate briefs in the appeal of the Court's final judgment. On
February 23, 1999, the Court granted a motion by SOCAL to amend the Court's
final judgment to include a finding that Dynegy Power Corp. is the alter ego of
the Partnerships and their respective general partners. Dynegy Power Corp. has
appealed the Court's ruling, and will vigorously defend SOCAL's claims. On April
13, 1999, the Court granted a motion by SOCAL to amend the final judgment to
include a finding that Destec Energy, Inc. is the alter ego of the Partnerships
and their respective general partners. The Court's order named Dynegy as the
successor to Destec Energy, Inc. Dynegy has appealed the Court's ruling.
The PG&E and SOCAL litigations represent pre-acquisition contingencies acquired
by the Company in the Destec Acquisition. In a related matter, Chalk Cliff and
San Joaquin have each guaranteed the obligations of the other partnership,
represented by the project financing loans used to construct the power
generation facilities owned by the respective Partnerships. In the opinion of
management, the election by the lender of its option under the terms of such
arrangements would not have a material adverse effect on the Company's financial
position or results of operations.
On August 3, 1998, Modesto Irrigation District ("MID") filed a lawsuit against
PG&E and 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, CA.
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 restating its breach of contract claim against Destec. PG&E and
Destec have filed motions to dismiss MID's revised federal and state antitrust
claims. The motions to dismiss are scheduled for hearing in July, 1999. Dynegy
believes the allegations made by MID are meritless 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.
The Company assumed liability for various claims and litigation in connection
with the Chevron Combination, the Trident Combination, the Destec Acquisition
and in connection with the acquisition of certain gas processing and gathering
facilities from Mesa Operating Limited Partnership. The Company believes, based
on its review of these matters and
Page 25 of 27
<PAGE>
consultation with outside legal counsel, that the ultimate resolution of such
items will not have a material adverse effect on the Company's financial
position or results of operations. Further, the Company is subject to various
legal proceedings and claims, which arise in the normal course of business. 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.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
Exhibit 27 Financial Data Schedule
(b) No reports on Form 8-K were filed by the Company during the quarter-ended
March 31, 1999.
Page 26 of 27
<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 and thereunto duly authorized.
DYNEGY INC.
Date: May 14, 1999 By: /s/ BRADLEY P. FARNSWORTH
-----------------------------------------
Bradley P. Farnsworth, Vice President and
Controller (Principal Accounting Officer)
Page 27 of 27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> MAR-31-1999 MAR-31-1998
<CASH> 12,084 28,367
<SECURITIES> 0 0
<RECEIVABLES> 1,376,142 1,623,738
<ALLOWANCES> 0 0
<INVENTORY> 123,920 149,901
<CURRENT-ASSETS> 1,892,802 2,117,241
<PP&E> 2,513,593 2,446,878
<DEPRECIATION> (547,334) (514,771)
<TOTAL-ASSETS> 5,268,992 5,264,237
<CURRENT-LIABILITIES> (1,963,688) (2,026,323)
<BONDS> 0 0
0 0
(75,418) (75,418)
<COMMON> (1,542) (1,533)
<OTHER-SE> (1,160,057) (1,126,530)
<TOTAL-LIABILITY-AND-EQUITY> (5,268,992) (5,264,237)
<SALES> (3,044,973) (3,315,569)
<TOTAL-REVENUES> (3,044,973) (3,315,569)
<CGS> 2,924,896 3,218,580
<TOTAL-COSTS> 2,924,896 3,218,580
<OTHER-EXPENSES> 4,153 1,356
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 19,234 16,005
<INCOME-PRETAX> (40,683) (16,411)
<INCOME-TAX> 12,612 4,072
<INCOME-CONTINUING> (28,071) (12,339)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (28,071) (12,339)
<EPS-PRIMARY> 0.18 0.08
<EPS-DILUTED> 0.17 0.07
</TABLE>
