<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 September 30, 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,
155,969,984 shares outstanding as of November 10, 1999.
Page 1 of 39
<PAGE>
DYNEGY INC.
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
PART I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets:
September 30, 1999 and December 31, 1998.............................. 3
Condensed Consolidated Statements of Operations:
For the three months ended September 30, 1999 and 1998................ 4
Condensed Consolidated Statements of Operations:
For the nine months ended September 30, 1999 and 1998................. 5
Condensed Consolidated Statements of Cash Flows:
For the nine months ended September 30, 1999 and 1998................. 6
Notes to Condensed Consolidated Financial Statements..................... 7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................. 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 35
Item 2. Not Applicable................................................... -
Item 3. Not Applicable................................................... -
Item 4. Submission of Matters to a Vote of Security Holders.............. 37
Item 5. Not Applicable................................................... -
Item 6. Exhibits and Reports on Form 8-K................................. 38
Page 2 of 39
<PAGE>
DYNEGY INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SEPTEMBER 30, December 31,
1999 1998
--------------------- ---------------------
(unaudited)
ASSETS
Current Assets:
<S> <C> <C>
Cash and cash equivalents $ 28,337 $ 28,367
Accounts receivable, net 1,898,888 1,563,558
Accounts receivable, affiliates 53,920 60,180
Inventories 296,268 149,901
Assets from risk management activities 414,574 219,105
Prepayments and other assets 51,975 96,130
---------- ----------
2,743,962 2,117,241
---------- ----------
Property, Plant and Equipment 2,741,274 2,446,878
Less: accumulated depreciation (598,048) (514,771)
---------- ----------
2,143,226 1,932,107
---------- ----------
Other Assets:
Investments in unconsolidated affiliates 570,651 502,613
Assets from risk management activities 400,684 135,100
Other assets 555,937 577,176
---------- ----------
$6,414,460 $5,264,237
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $1,673,569 $1,370,902
Accounts payable, affiliates 184,851 113,827
Accrued liabilities 231,748 290,381
Liabilities from risk management activities 373,294 251,213
---------- ----------
2,463,462 2,026,323
Long-Term Debt 1,356,351 962,239
Other Liabilities:
Non-Recourse Debt 60,093 84,651
Liabilities from risk management activities 314,611 40,747
Deferred income taxes 313,652 317,537
Other long-term liabilities 447,436 504,677
---------- ----------
4,955,605 3,936,174
---------- ----------
Company Obligated Preferred Securities of Subsidiary Trust 200,000 200,000
Commitments and Contingencies (Note 6)
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 September 30, 1999 and
December 31, 1998 75,418 75,418
Common stock, $0.01 par value, 400,000,000 shares authorized;
155,671,613 shares issued at September 30, 1999 and
153,298,220 shares issued at December 31, 1998 1,557 1,533
Additional paid-in capital 965,464 935,183
Retained earnings 234,001 133,340
Less: treasury stock, at cost; 1,200,700 shares at September 30, 1999 and
1,200,700 shares at December 31, 1998 (17,585) (17,411)
---------- ----------
1,258,855 1,128,063
---------- ----------
$6,414,460 $5,264,237
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
Page 3 of 39
<PAGE>
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------------------------
1999 1998
-------------------- -------------------
<S> <C> <C>
Revenues $4,584,929 $4,586,515
Cost of sales 4,426,115 4,480,530
---------- ----------
Operating margin 158,814 105,985
Depreciation and amortization 33,235 30,837
General and administrative expenses 53,495 49,017
---------- ----------
Operating income 72,084 26,131
Equity in earnings of unconsolidated affiliates 31,858 37,147
Other income 8,414 28,735
Interest expense (22,039) (21,185)
Other expenses (10,725) (2,931)
Minority interest in income of a subsidiary (4,158) (4,158)
---------- ----------
Income before income taxes 75,434 63,739
Income tax provision 24,742 20,094
---------- ----------
Net Income $ 50,692 $ 43,645
========== ==========
Net Income Per Share:
Net income $ 50,692 $ 43,645
Less: preferred stock dividends 98 98
---------- ----------
Net income applicable to common stockholders $ 50,594 $ 43,547
========== ==========
Basic earnings per share $ 0.33 $ 0.29
========== ==========
Diluted earnings per share $ 0.30 $ 0.27
========== ==========
Basic shares outstanding 154,937 151,731
========== ==========
Diluted shares outstanding 171,446 162,917
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
Page 4 of 39
<PAGE>
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------------------
1999 1998
-------------------- --------------------
<S> <C> <C>
Revenues $10,790,659 $11,180,298
Cost of sales 10,386,021 10,869,409
----------- -----------
Operating margin 404,638 310,889
Depreciation and amortization 96,273 83,353
Severance charge --- 9,644
General and administrative expenses 150,128 136,000
----------- -----------
Operating income 158,237 81,892
Equity in earnings of unconsolidated affiliates 60,145 68,003
Other income 29,781 38,579
Interest expense (59,459) (55,281)
Other expenses (18,603) (5,526)
Minority interest in income of a subsidiary (12,474) (12,474)
----------- -----------
Income before income taxes 157,627 115,193
Income tax provision 50,888 35,768
----------- -----------
Net Income $ 106,739 $ 79,425
=========== ===========
Net Income Per Share:
Net income $ 106,739 $ 79,425
Less: preferred stock dividends 292 292
----------- -----------
Net income applicable to common stockholders $ 106,447 $ 79,133
=========== ===========
Basic earnings per share $0.69 $0.52
=========== ===========
Diluted earnings per share $0.64 $0.48
=========== ===========
Basic shares outstanding 153,885 151,534
=========== ===========
Diluted shares outstanding 166,719 163,670
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements
Page 5 of 39
<PAGE>
DYNEGY INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------------------------------------
1999 1998
----------------------- ------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 106,739 $ 79,425
Items not affecting cash flows from operating activities:
Depreciation and amortization 82,486 80,146
Equity in earnings of affiliates, net of cash distributions (18,571) (25,790)
Risk management activities (65,079) (11,500)
Deferred income taxes 47,243 35,768
Gain on asset sales (8,935) (31,173)
Other 13,053 9,036
Changes in assets and liabilities resulting from operating activities:
Accounts receivable (366,706) (41,891)
Inventories (122,106) (28,478)
Prepayments and other assets 74,438 13,363
Accounts payable 354,784 91,364
Accrued liabilities 25,123 (22,056)
Other, net (25,711) (7,226)
--------- ---------
Net cash provided by operating activities 96,758 140,988
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (279,852) (176,773)
Investment in unconsolidated affiliates, net (79,190) (75,901)
Proceeds from asset sales 16,650 48,152
Other, net (42,398) (11,444)
--------- ---------
Net cash used in investing activities (384,790) (215,966)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term borrowings 397,488 171,984
Repayments of long-term borrowings (13,655) (447,874)
Net proceeds from commercial paper and money market lines of credit (109,397) 357,878
Other, net 13,566 (18,661)
--------- ---------
Net cash provided by financing activities 288,002 63,327
--------- ---------
Net change in cash and cash equivalents (30) (11,651)
Cash and cash equivalents, beginning of period 28,367 23,047
--------- ---------
Cash and cash equivalents, end of period $ 28,337 $ 11,396
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
Page 6 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
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 - BUSINESS COMBINATION
On June 14, 1999, Dynegy and Illinova Corporation ("Illinova") announced the
execution of definitive agreements for the merger of Illinova and Dynegy. Terms
of the merger agreement call for each entity to continue to exist, retaining
their respective historical assets and liabilities. However, rather than being
independent, publicly traded companies, they will instead be subsidiaries of a
newly established parent company ("Energy Convergence"), which will be named
Dynegy Inc.
The merger is expected to close during the first quarter of 2000. Conditions
precedent to closing that remain outstanding include:
. Receipt of approvals or compliance exemptions from the Illinois Commerce
Commission under Illinois law and the Securities and Exchange Commission
under the Public Utility Holding Company Act of 1935,
. The sale of the Clinton nuclear facility by Illinova and the receipt of
approval by the Nuclear Regulatory Commission and other regulatory agencies,
and
. Disposition or restructuring of interests held by Dynegy in certain power
generation facilities pursuant to PURPA requirements.
Significant milestones recently achieved related to conditions precedent to
close included:
. Approval of the proposed merger by shareholders of both Dynegy and Illinova,
. Approval of the proposed merger by the Federal Energy Regulatory Commission
under the Federal Power Act,
. Receipt of approval from the Federal Trade Commission and the Antitrust
Division of the Department of Justice under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, and
. Completed negotiations and obtained the debt facility required to fund the
cash component of the acquisition price
In the combination, Dynegy shareholders, other than Chevron U.S.A. Inc.
("Chevron"), NOVA Gas Services (U.S.) Inc. ("NOVA") and BG Holdings, Inc., may
elect to exchange each Dynegy share for 0.69 of a share of Energy Convergence
Class A common stock, based on a fixed exchange ratio, or elect to receive
$16.50 per share in cash consideration, subject to proration. NOVA and BG
Holdings, Inc. have agreed to elect cash and thereby reduce their respective
ownership in Dynegy as part of this combination. Therefore, instead of receiving
Energy Convergence Class A common stock in exchange for their respective shares
of Dynegy common stock, NOVA and the parent of BG Holdings, Inc. will each
receive a combination of cash, subject to proration, and shares of Energy
Convergence Series A preferred stock. Chevron will receive shares of Energy
Convergence Class B common stock in exchange for all of its shares of Dynegy
common stock and Series A Preferred Stock, respectively. Additionally, as part
of the combination, Chevron will purchase between $200 million and $240 million
of additional Energy Convergence Class B common stock. Each share of Illinova
common
Page 7 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
stock will be converted into one share of Energy Convergence common
stock. After the combination, former Dynegy shareholders will own approximately
51 percent of the outstanding shares of Energy Convergence stock.
Approximately 60 percent of the consideration received by existing Dynegy
shareholders will be in the form of Energy Convergence stock and 40 percent will
be cash. In aggregate, the cash portion of the consideration will approximate
$1.06 billion. The amount of cash available will be insufficient to completely
satisfy cash elections and the cash portion of the consideration will be
prorated to shareholders electing to receive cash. The proration will impact
Dynegy shareholders in the following manner. For each 100 shares of Dynegy
common stock for which an election is made to receive cash, the shareholder will
receive cash consideration with respect to no less than 64 shares of Dynegy
common stock and no more than 83 shares of Dynegy common stock.
Energy Convergence plans to finance the cash component of the merger initially
with borrowings under a debt facility, the potential issuance of public debt and
the issuance of between $200 million and $240 million of Class B common stock to
Chevron. After the closing of the merger, Energy Convergence anticipates
repaying or refinancing a significant portion of the debt facility with proceeds
from an offering of equity securities, additional public debt issuances,
proceeds from potential asset sales and cash flow from operations.
Dynegy will account for the merger as a purchase of Illinova. This accounting
treatment is based on various factors present in the merger, including the
majority ownership (and voting control) of Dynegy's shareholders following the
merger, the role of Dynegy's management following the merger (including the
service of C.L. Watson as Chairman and Chief Executive Officer) and the
influence of Chevron because of the size of its ownership interest and its
rights under the shareholder agreement, articles of incorporation and bylaws. As
a result, the consolidated financial statements of Energy Convergence after the
merger will reflect the assets and liabilities of Dynegy at historical book
values and the assets and liabilities of Illinova at fair values as of the close
date.
Illinova is the holding company for: Illinois Power Company, an electric and
natural gas utility that serves approximately 650,000 customers over a 15,000
square-mile area of Illinois; Illinova Generating, Inc., which invests in,
develops and operates independent power projects worldwide; and Illinova Energy
Partners, Inc., which markets energy and energy-related services in the United
States and Canada. At December 31, 1998, Illinova had approximately $6.8 billion
in assets and 1998 revenues of $2.4 billion.
NOTE 3 - 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 each 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.
Page 8 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
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 Financial Accounting Standards
Board recently deferred implementation of the provisions of Statement No. 133 to
fiscal periods beginning after September 15, 2000. 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 trading
portfolio 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.
NOTE 4 -- EARNINGS PER SHARE
Basic earnings per share represents the amount of earnings for the period
available to each share of common stock outstanding during the period. Diluted
earnings per share represents the amount of earnings for the period available to
each share of common stock outstanding during the period plus each share that
would have been outstanding assuming the issuance of common shares for all
dilutive potential common shares outstanding during the period. Differences
between basic and diluted shares outstanding in all periods are attributed to
the Series A Convertible Participating Preferred Stock, options outstanding and
a warrant.
NOTE 5 -- UNCONSOLIDATED AFFILIATES
At September 30, 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 39 percent partnership
interest in West Texas LPG Pipeline, Limited Partnership; interests ranging from
eight to 50 percent in fourteen partnerships, each formed to build (or buy), own
and operate 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 September 30, 1999, the Company had three
cost-basis investments: Indeck North American Power Fund, L.P., Indeck North
American Power Partners, L.P and Altra Energy Technologies, Inc. Summarized
unaudited combined income statement information for the unconsolidated
affiliates accounted for by the equity method is presented in the table below:
<TABLE>
<CAPTION>
=============================================================================================
NINE-MONTHS ENDED SEPTEMBER 30,
-----------------------------------------------------
1999 1998
------------------------ -----------------------
EQUITY EQUITY
TOTAL SHARE TOTAL SHARE
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
($ IN THOUSANDS)
Revenues (1) $739,162 $276,296 $661,683 $276,614
======== ======== ======== ========
Operating margin (1) $256,553 $ 96,611 $293,121 $122,219
======== ======== ======== ========
Net income (1) $ 98,786 $ 42,446 $142,365 $ 54,503
======== ======== ======== ========
=============================================================================================
</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.
Page 9 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
NOTE 6--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 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 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 February 14,
2000. 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. Upon termination of the power
purchase agreement, Dynegy will repay project debt of approximately $26 million.
By Order dated October 7, 1999, the CPUC approved the Settlement Agreement. The
CPUC approval became final on November 8, 1999. 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. The suit has been removed to the United States District Court for the
Northern District of California. Following removal, LOF filed a motion to
dismiss/stay based on the contention that the issue of QF compliance is
essential to the disposition of the suit and
Page 10 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
that the FERC is vested with the exclusive jurisdiction to address QF
compliance. The hearing on the motion was held on August 30, 1999. The District
Court took the matter under advisement and has yet to issue its ruling.
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"). Chalk Cliff Limited
and McKittrick Limited are now wholly-owned by subsidiaries of the Company:
Chalk Cliff Limited through the purchase of the interests of Dominion Energy,
Inc., and McKittrick Limited through the purchase of the interests of UtilCo
Group, Inc. and certain affiliates. 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 September 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
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 and will vigorously defend against SOCAL's claims. The parties engaged in
settlement discussions, which resulted in the execution of a Settlement
Agreement between SOCAL and all defendants in the pending litigation on August
25, 1999, (the "Settlement Agreement"). The Settlement Agreement provides for,
upon the receipt of CPUC approval, the dismissal of the pending litigation, the
termination of underlying gas transmission service contracts, and Dynegy's
payment of settlement consideration. In connection with the execution of the
Settlement Agreement, the lenders have agreed to forebear foreclosure
proceedings in respect to the projects pending CPUC approval of the Settlement
Agreement.
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
Page 11 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
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 hearing on the motions to
dismiss was held in July 1999. On August 20, 1999, the District Court again
dismissed MID's antitrust claims against PG&E and Destec, this time without
leave to amend the complaint. As a result of the dismissal of the antitrust
claims, the District Court also dismissed the pendant state law claims. MID has
appealed the District Court's dismissal of its suit to the Ninth Circuit Court
of Appeal. Following dismissal of its federal court suit, MID filed suit in
California state court asserting its breach of contract claims against Destec
and its tortious interference with contract claims against PG&E. 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.
On July 30, 1999, The Dow Chemical Company ("Dow") filed a lawsuit in the United
States District Court for the District of Delaware against Dynegy Power
Corporation ("DPC"), a wholly-owned subsidiary of the Company. Dow seeks
contribution from DPC in connection with claims against Dow asserted by The AES
Corporation ("AES") in a lawsuit filed on November 30, 1998 in the United States
District Court for the Southern District of Texas. AES asserts various federal
and Texas securities laws claims, and Texas claims for fraud and civil
conspiracy, arising out of AES' September 1997 purchase of stock of Destec
Engineering, a subsidiary of DPC (at that time Destec Power Corp). Specifically,
AES alleges that Destec Power made certain misrepresentations about the expected
profits that Destec Engineering would earn in connection with the construction
of the Elsta power plant in The Netherlands, and the anticipated completion date
of the Elsta plant. AES alleges that Dow is liable because it "controlled" or
had the power to control the management of Destec Power. AES does not assert any
claims against Destec Power or any other Dynegy entity. Dow is vigorously
defending against AES' claims. In response to a motion to transfer filed by Dow,
the United States District Court for the Southern District of Texas transferred
the suit to the United States District Court for Delaware. In the suit filed by
Dow, Dow seeks to recover from DPC any amounts it must pay AES. The Court has
yet to set the filing date for DPS' answer to Dow's claims. In the opinion of
management, the ultimate resolution of this lawsuit will not have a material
adverse effect on the Company's financial position.
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 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 7 -- CAPITAL STOCK
At September 30, 1999, employee stock options aggregating 6.0 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 3.3
million options during that two-year period, at exercise prices ranging from
$2.03 to $24.06. Other options currently granted under the Company's option
plans will fully vest periodically and become exercisable through the year 2004
at prices ranging from $2.03 to $24.06. 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,
Page 12 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
the Company has established two 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 September 30, 1999.
In order to supplement its stock repurchase program and to facilitate the
orderly distribution of shares arising from the exercise of stock options, the
Company may at times enter into forward purchase agreements on its common stock.
These forward purchase agreements would be settled on a net basis in shares of
Dynegy common stock, or in cash at Dynegy's election. To the extent that the
market price of Dynegy common stock on a settlement date is higher (lower) than
the forward purchase price, the net differential is received (paid) by Dynegy.
Dynegy has entered into an agreement with a financial institution to assist in
the execution of this plan. To date, the Company has not executed any forward
purchase agreements for its own common stock.
NOTE 8 -- SEGMENT INFORMATION
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
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 three- and nine-month periods ended September 30, 1999 and
1998 is presented below.
Page 13 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
==============================================================================================================================
DYNEGY'S SEGMENT DATA FOR THE QUARTER ENDED SEPTEMBER 30, 1999
WHOLESALE GAS
AND POWER LIQUIDS ELIMINATION TOTAL
-------------------------------------------------------------------------
<S> <C> <C> <C> <C>
($ IN THOUSANDS)
Unaffiliated revenues:
Domestic $2,585,033 $1,400,520 $ --- $3,985,553
Canadian 324,764 93,400 --- 418,164
United Kingdom 181,212 --- --- 181,212
---------- ---------- ----------- ----------
3,091,009 1,493,920 --- 4,584,929
---------- ---------- ----------- ----------
Intersegment revenues:
Domestic 111,763 50,976 (162,739) ---
Canadian 21,483 17,483 (38,966) ---
United Kingdom --- --- --- ---
---------- ---------- ----------- ----------
133,246 68,459 (201,705) ---
---------- ---------- ----------- ----------
Total revenues 3,224,255 1,562,379 (201,705) 4,584,929
---------- ---------- ----------- ----------
Operating margin 75,460 83,354 --- 158,814
Depreciation and amortization (9,796) (23,439) --- (33,235)
Interest expense (12,422) (9,617) --- (22,039)
Interest and other income 4,140 4,274 --- 8,414
Equity earnings of unconsolidated affiliates 25,574 6,284 --- 31,858
Income tax (provision) benefit (14,453) (10,289) --- (24,742)
Net income $ 26,776 $ 23,916 $ --- $ 50,692
Identifiable assets:
Domestic $3,436,313 $2,510,394 $ --- $5,946,707
Canadian 313,621 39,044 --- 352,665
United Kingdom 115,088 --- --- 115,088
Investment in unconsolidated affiliates 404,964 165,687 --- 570,651
Capital expenditures 110,288 34,124 --- 144,412
==============================================================================================================================
</TABLE>
Page 14 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
==============================================================================================================================
DYNEGY'S SEGMENT DATA FOR THE QUARTER ENDED SEPTEMBER 30, 1998
WHOLESALE GAS
AND POWER LIQUIDS ELIMINATION TOTAL
-------------------------------------------------------------------------
<S> <C> <C> <C> <C>
($ IN THOUSANDS)
Unaffiliated revenues:
Domestic $3,356,459 $ 748,531 $ --- $4,104,990
Canadian 261,312 80,264 --- 341,576
United Kingdom 139,949 --- --- 139,949
---------- ---------- ----------- ----------
3,757,720 828,795 --- 4,586,515
---------- ---------- ----------- ----------
Intersegment revenues:
Domestic 68,278 16,866 (85,144) ---
Canadian 263 --- (263) ---
United Kingdom --- --- --- ---
---------- ---------- ----------- ----------
68,541 16,866 (85,407) ---
---------- ---------- ----------- ----------
Total revenues 3,826,261 845,661 (85,407) 4,586,515
---------- ---------- ----------- ----------
Operating margin 61,630 44,355 --- 105,985
Depreciation and amortization (5,220) (25,617) --- (30,837)
Interest expense (6,982) (14,203) --- (21,185)
Interest and other income 1,909 26,826 --- 28,735
Equity earnings of unconsolidated affiliates 33,451 3,696 --- 37,147
Income tax (provision) benefit (15,912) (4,182) --- (20,094)
Net income $ 36,564 $ 7,081 $ --- $ 43,645
Identifiable assets:
Domestic $2,514,283 $2,266,830 $ --- $4,781,113
Canadian 298,607 22,988 --- 321,595
United Kingdom 74,027 --- --- 74,027
Investment in unconsolidated affiliates 373,980 157,373 --- 531,353
Capital expenditures 78,917 11,489 --- 90,406
==============================================================================================================================
</TABLE>
Page 15 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
==============================================================================================================================
DYNEGY'S SEGMENT DATA FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
WHOLESALE GAS
AND POWER LIQUIDS ELIMINATION TOTAL
-------------------------------------------------------------------------
<S> <C> <C> <C> <C>
($ IN THOUSANDS)
Unaffiliated revenues:
Domestic $5,855,757 $3,060,975 $ --- $ 8,916,732
Canadian 982,822 203,342 --- 1,186,164
United Kingdom 687,763 --- --- 687,763
---------- ---------- ----------- -----------
7,526,342 3,264,317 --- 10,790,659
---------- ---------- ----------- -----------
Intersegment revenues:
Domestic 238,847 151,639 (390,486) ---
Canadian 42,766 17,483 (60,249) ---
United Kingdom --- --- --- ---
---------- ---------- ----------- -----------
281,613 169,122 (450,735) ---
---------- ---------- ----------- -----------
Total revenues 7,807,955 3,433,439 (450,735) 10,790,659
---------- ---------- ----------- -----------
Operating margin 216,492 188,146 --- 404,638
Depreciation and amortization (27,180) (69,093) --- (96,273)
Interest expense (30,995) (28,464) --- (59,459)
Interest and other income 23,096 6,685 --- 29,781
Equity earnings of unconsolidated affiliates 48,084 12,061 --- 60,145
Income tax (provision) benefit (44,122) (6,766) --- (50,888)
Net income $ 74,907 $ 31,832 $ --- $ 106,739
Identifiable assets:
Domestic $3,436,313 $2,510,394 $ --- $ 5,946,707
Canadian 313,621 39,044 --- 352,665
United Kingdom 115,088 --- --- 115,088
Investment in unconsolidated affiliates 404,964 165,687 --- 570,651
Capital expenditures 289,476 69,566 --- 359,042
==============================================================================================================================
</TABLE>
Page 16 of 39
<PAGE>
DYNEGY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Interim Periods Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
==============================================================================================================================
DYNEGY'S SEGMENT DATA FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
WHOLESALE GAS
AND POWER LIQUIDS ELIMINATION TOTAL
-------------------------------------------------------------------------
<S> <C> <C> <C> <C>
($ IN THOUSANDS)
Unaffiliated revenues:
Domestic $7,406,843 $2,380,930 $ --- $ 9,787,773
Canadian 734,195 240,792 --- 974,987
United Kingdom 417,538 --- --- 417,538
---------- ---------- ----------- -----------
8,558,576 2,621,722 --- 11,180,298
---------- ---------- ----------- -----------
Intersegment revenues:
Domestic 111,109 194,095 (305,204) ---
Canadian 5,290 --- (5,290) ---
United Kingdom --- --- --- ---
---------- ---------- ----------- -----------
116,399 194,095 (310,494) ---
---------- ---------- ----------- -----------
Total revenues 8,674,975 2,815,817 (310,494) 11,180,298
---------- ---------- ----------- -----------
Operating margin 169,834 141,055 --- 310,889
Depreciation and amortization (17,996) (65,357) --- (83,353)
Interest expense (18,064) (37,217) --- (55,281)
Interest and other income 5,320 33,259 --- 38,579
Equity earnings of unconsolidated affiliates 54,944 13,059 --- 68,003
Income tax (provision) benefit (36,347) 579 --- (35,768)
Net income $ 70,061 $ 9,364 $ --- $ 79,425
Identifiable assets:
Domestic $2,514,283 $2,266,830 $ --- $ 4,781,113
Canadian 298,607 22,988 --- 321,595
United Kingdom 74,027 --- --- 74,027
Investment in unconsolidated affiliates 373,980 157,373 --- 531,353
Capital expenditures 161,484 91,190 --- 252,674
==============================================================================================================================
</TABLE>
Page 17 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 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
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 deregulation of the
domestic electric power industry. Effective March 1, 1995, Clearinghouse and
Trident NGL Holding, Inc., a fully integrated natural gas liquids company,
merged and the combined entity was renamed NGC Corporation. 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 and
developer. 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 reportable segments:
the Wholesale Gas and Power and Liquids segments. The Wholesale Gas and Power
segment is actively engaged in 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 18 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
. Fluctuations in energy commodity prices which could not or have not been
properly hedged or that 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.
In addition, as it relates to the proposed Illinova combination, there can be no
assurance that:
. The combination will be ultimately consummated or that the terms and
conditions of the merger, as currently contemplated, will ultimately be
executed;
. We have correctly identified and assessed all of the factors affecting
Illinova's or Dynegy's businesses;
. The available information with respect to these factors on which we have
based our analysis is complete or correct;
. Our analysis is correct; or
. Our strategies, which are based in part on this analysis, will be successful.
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.
The Wholesale Gas and Power segment includes 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. 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. Historically, fuel costs,
principally natural gas, represented the primary variable cost impacting the
financial performance of the Company's investment in power generating
facilities. Operating margins at these facilities were relatively insensitive to
commodity price fluctuations since most purchase and sales contracts contained
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, the Company's investment strategy, which emphasizes growth of
merchant generation capacity, is significantly altering the makeup of its
generation asset portfolio. The growth of merchant generation capacity as a
percentage of total available capacity increases the Company's exposure to
commodity price risk. The financial performance and cash flow derived from
merchant generation capacity is impacted, either favorably or unfavorably, by
changes in and the relationship between natural gas and electricity prices. The
Company actively manages the price risks described above and may, at times, have
a bias in the market, within established guidelines, resulting from management
of its portfolio.
Page 19 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
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
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 have historically been
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. Dynegy believes that prospective
seasonal fluctuations in demand and market prices for natural gas will reduce
over time as industry-wide gas-fired merchant generation capacity expands in the
United States. 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.
Page 20 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
The Company maintains a commercial paper program for amounts up to $800 million,
as supported by its corporate credit agreements. At September 30, 1999,
approximately $429 million of commercial paper was outstanding.
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 2000. Both
agreements provide funding for working capital, letters of credit and other
general corporate expenditures. At September 30, 1999, letters of credit and
borrowings under the corporate credit agreements aggregated $35.5 million and,
after consideration of the outstanding money market and commercial paper,
aggregate unused borrowing capacity under the corporate credit agreements
approximated $335.5 million.
OTHER AGREEMENTS. The terms, interest rates and principal balances outstanding
under certain other credit agreements and sources of capital consisting of: five
separate series of outstanding public notes; the Canadian Credit Facility;
certain non-recourse debt; and the Company Obligated Preferred Securities of a
Subsidiary Trust, have not changed materially from disclosures contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 1998, and
the Company's June 30, 1999 Quarterly Report on Form 10-Q.
OTHER MATTERS
ILLINOVA MERGER. On June 14, 1999, Dynegy and Illinova Corporation ("Illinova")
announced the execution of definitive agreements for the merger of Illinova and
Dynegy. Conditions precedent to closing include:
. Receipt of approvals or compliance exemptions from the Illinois Commerce
Commission under Illinois law and the Securities and Exchange Commission
under the Public Utility Holding Company Act of 1935,
. The sale of the Clinton nuclear facility by Illinova and the receipt of
approval by the Nuclear Regulatory Commission and other regulatory agencies,
and
. Disposition or restructuring of interests held by Dynegy in certain power
generation facilities pursuant to PURPA requirements.
Significant milestones recently achieved related to conditions precedent to
close included:
. Approval of the proposed merger by shareholders of both Dynegy and Illinova,
. Approval of the proposed merger by the Federal Energy Regulatory Commission
under the Federal Power Act,
. Receipt of approval from the Federal Trade Commission and the Antitrust
Division of the Department of Justice under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, and
. Completed negotiations and obtained the debt facility required to fund the
cash component of the acquisition price
The merger will be accounted for under the purchase method of accounting and
Dynegy will be the acquiror for accounting purposes. The merger is expected to
close during the first quarter of 2000.
Management believes the combination of Illinova and Dynegy presents an
opportunity to create a leading provider of energy services and products. The
combination will bring together a strong, innovative utility company owning
strategically located generation assets and operations, electric transmission
and retail distribution capabilities with one of the leading North American
energy marketers and independent power producers. These two companies have
diverse but complementary operations, providing qualitative and quantitative
expansion of Dynegy's electric generation capacity, while enhancing Dynegy's
access to dependable cash flow and an improved platform for further expansion.
Therefore, it is expected that the combined company will be well positioned to
be successful in the increasingly competitive energy marketplace. Dynegy expects
the merger to enhance shareholder value more than either company could do on its
own.
Factors considered in evaluating the benefits of the merger included:
Page 21 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
. The merger will improve public float thereby enhancing the
Company's access to equity capital at attractive cost;
. The merger will provide the liquidity needed to allow certain Dynegy
shareholders to reduce the size of their investment in Dynegy;
. The merger is expected to provide continuing shareholders, who desire to
invest in a full-service provider of energy products and services, an
investment vehicle having the flexibility and resources required to respond
to the numerous opportunities in the energy industry;
. The merger will add an additional 6,498 gross megawatts of electricity
generating capacity to Dynegy's current capacity of 7,832 gross megawatts per
year (both figures include current capacity as well as capacity under
construction). This additional capacity is in the Midwestern United States
and is expected to allow Dynegy to sell more electricity for its own account
on better terms throughout the North American market;
. The merger is expected to provide Dynegy with a larger platform in the
electricity trading market from which it can expand its marketing operations.
This larger platform is expected to provide the linchpin for Dynegy's
strategy to be at the forefront of the restructuring of the power industry
and the convergence of the gas and electricity industries;
. The addition of Illinova's traditional utility business is expected to
provide a stable base of cash flow from which the combined company will be
able to leverage its business strategy; and
. The merger is expected to be accretive to the earnings per share of the
Dynegy shareholders.
Energy Convergence will finance the cash component of the merger with borrowings
under a debt facility and the issuance of between $200 million and $240 million
of Class B common stock to Chevron. The resulting increase in total indebtedness
of the combined companies after the merger could have a negative impact on the
credit ratings of Energy Convergence, Dynegy and Illinois Power until such time
as financial leverage is reduced. However, after the closing of the merger,
Energy Convergence anticipates repaying or refinancing a significant portion of
the debt facility with proceeds from an offering of equity securities,
additional public debt issuances, proceeds from potential asset sales and cash
flow from operations. Management of Dynegy, Illinova and Energy Convergence
believe the combined companies will have investment grade credit ratings, ready
access to debt and equity capital at reasonable rates and sufficient trade
credit to operate their businesses efficiently. However, management is unable to
predict with certainty when or whether the capital structure of Energy
Convergence will become less leveraged.
COMPLAINT AGAINST ILLINOIS POWER COMPANY. On November 3, 1999, the U.S.
Environmental Protection Agency ("EPA") issued a Notice of Violation ("NOV")
against Illinois Power Company ("Illinois Power") and, with the Department of
Justice ("DOJ"), filed a Complaint against Illinois Power in the U.S. District
Court for the Southern District of Illinois, No. 99C833. Similar notices and
lawsuits have been filed against a number of other utilities. Both the NOV and
Complaint allege violations of the Clean Air Act and regulations thereunder.
More specifically, both allege, based on the same events, that certain equipment
repairs, replacements and maintenance activities at Illinois Power's three
Baldwin Station generating units constituted "major modifications" under either
or both the Prevention of Significant Deterioration and the New Source
Performance Standards regulations. When non-exempt "major modifications" occur,
the Clean Air Act and related regulations generally require that generating
facilities meet more stringent emissions standards.
The regulations under the Clean Air Act provide certain exemptions to the
definition of "major modifications," particularly an exemption for routine
repair, replacement or maintenance. Illinova has analyzed each of the activities
covered by the EPA's allegations and believes each activity represents prudent
practice regularly performed throughout the utility industry as necessary to
maintain the operational efficiency and safety of equipment. As such, Illinova
believes that each of these activities is covered by the exemption for routine
repair, replacement and maintenance and that the EPA is changing, or attempting
to change through enforcement actions, the intent and meaning of its
regulations.
Illinova also believes that, even if some of the activities in question were
found not to qualify for the routine exemption, there were no increases either
in annual emissions or in the maximum hourly emissions achievable at any of the
units caused by any of the activities. The regulations provide an exemption for
increased hours of operation or production rate and for increases in emissions
resulting from demand growth.
Page 22 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
Although none of Illinois Power's other facilities are covered in the Complaint
and NOV, the EPA has officially requested information concerning activities at
Illinois Power's Vermilion, Wood River and Hennepin Plants. It is possible that
the EPA will eventually commence enforcement actions against those plants as
well.
The EPA has the authority to seek penalties for the alleged violations in
question at the rate of up to $27,500 per day for each violation. The EPA also
will be seeking installation of "best available control technology" ("BACT") (or
equivalent) at the Baldwin Station and possibly at the other three plants as
well. Illinova's estimates of the cost to install BACT are only preliminary at
this time. However, a significant portion of the cost of the BACT is already
included in Illinova's capital budget in connection with previously planned
pollution control upgrades. Such pollution control upgrades were previously
disclosed to Dynegy during due diligence.
Illinova believes that the EPA's and DOJ's claims are totally without merit, and
that there is no likely outcome that would have a material adverse effect on
Illinova's operations or its financial performance. The Company has no reason to
believe that Illinova's current assessment of the EPA's and DOJ's claims against
Illinois Power is incorrect. Consequently, based on information currently
available relating to this issue, management of both Dynegy and Illinova do not
envision that the Complaint or NOV will alter the closing date of the proposed
merger.
CAPITAL ASSET PROGRAM. The Company is engaged in a continuous capital asset
expansion program consistent with its business plan and energy convergence
strategies. The emphasis of this capital asset program is on the acquisition or
construction of strategically located power generation assets. Consistent with
this strategy and as a result of the long lead time required by industry
manufacturers, the Company has executed or is currently negotiating purchase
orders to acquire in excess of thirty state-of-the-art gas-fired turbines,
representing a capital commitment of approximately $1 billion. Delivery of the
manufactured turbines will occur ratably beginning in 1999 and ending in early
2003. Commitments under these purchase orders are generally payable consistent
with the delivery schedule. The purchase orders include milestone requirements
by the manufacturer and provide Dynegy with the ability to cancel each discrete
purchase order commitment in exchange for a fee, which escalates over time. The
capital asset program is subject to periodic review and revision, and the actual
number of projects and aggregate cost for such projects will be dependent on
various factors including available capital resources, market conditions,
legislative actions, load growth, changes in materials, supplies and labor costs
and the identification of partners in order to spread investment risk.
CONSTRUCTION PROJECT. In October 1999, the Company announced that it had
achieved all of the necessary approvals to begin construction on its Heard
County Power Project, a 500-megawatt natural gas-fired, simple-cycle peaking
facility located in Franklin in Heard County, Georgia. A Dynegy subsidiary will
design and construct the generating facility, as agent for a third party, and
Dynegy is obligated to guarantee approximately 90 percent of the actual cost of
the project during the construction phase. It is anticipated that Dynegy will
subsequently lease the completed facility from that third party for an initial
term of five years. Under certain circumstances, the Company maintains an option
to purchase the facility from the third party and it may participate in the
outright sale of the asset.
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 23 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
===================================================================================================
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------------ --------------
<S> <C> <C>
Natural Gas (Trillion Cubic Feet) 5.305 4.179
Electricity (Million Megawatt Hours) 28.564 1.835
Natural Gas Liquids (Million Barrels) 12.502 6.397
Crude Oil (Million Barrels) 14.525 18.800
Interest Rate Swaps (in thousands of US Dollars) $ 65,726 $ 69,332
Weighted Average Fixed Interest Rate Paid on
Swaps 8.085 8.067
U.K. Pound Sterling (in thousands of US Dollars) $ 91,210 $ 69,254
Average U.K. Pound Sterling Contract Rate (in $ 1.6086 $ 1.6143
US Dollars)
Canadian Dollar (in thousands of US Dollars) $340,688 $268,307
Average Canadian Dollar Contract Rate (in US $ 0.6757 $ 0.6710
Dollars)
=================================================================================================
</TABLE>
Dynegy measures entity-wide market risk in its financial trading and risk-
management portfolios using value at risk. The quantification of market risk
using value at risk provides a consistent measure of risk across diverse energy
markets and products with different risk factors to set the overall corporate
risk tolerance, determine risk targets, and position limits. The use of these
methodologies requires a number of key assumptions including the selection of a
confidence level and the holding period to liquidation. Dynegy relies on value
at risk to determine the maximum potential reduction in the trading portfolio
value allowed within a given probability over a defined period. Because of
limitations to value at risk, Dynegy uses other means to monitor market risk in
the trading portfolios. In addition to value at risk, Dynegy performs regular
stress and scenario analysis to measure extreme losses due to exceptional
events. The value at risk and stress testing results are reviewed to determine
the maximum allowable reduction in the total equity of the commodity portfolios.
Additional measures are used to determine the treatment of risks outside the
value at risk methodologies, such as market volatility, liquidity, event and
correlation risk. Dynegy estimates value at risk using a JP Morgan
RiskMetrics(TM) approach assuming a one-day holding period and a 95 percent
confidence level. At September 30, 1999, the value at risk for Dynegy's trading
and risk-management portfolios approximated $3 million and the average of such
value during the nine-month period ended September 30, 1999 was estimated at $4
million.
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 3.3 million options during that two-year period, at
exercise prices ranging from $2.03 to $24.06. Other options currently granted
under the Company's option plans will fully vest periodically and become
exercisable through the year 2004 at prices ranging from $2.03 to $24.06. Grants
made under the Company's option plans may be canceled under certain
circumstances as provided in the plans.
In order to supplement its stock repurchase program and to facilitate the
orderly distribution of shares arising from the exercise of stock options, the
Company may at times enter into forward purchase agreements on its common stock.
These forward purchase agreements would be settled on a net basis in shares of
Dynegy common stock, or in cash at Dynegy's election. Dynegy has entered into an
agreement with a financial institution to assist in the execution of this plan.
To date, the Company has not executed any forward purchase agreements for its
own common stock.
Management believes that an orderly distribution of shares, which may become
available to the market, will be achieved through execution of alternatives
available from a combination of its stock repurchase plan and forward purchase
agreement program.
YEAR 2000 ISSUES. The Company is nearing completion of its readiness activities
for 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
Page 24 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
have a material adverse effect on Company operations and its financial position.
The Company believes that its competitors face similar risks.
Dynegy has completed all phases of the Year 2000 program relative to computer
systems and technology infrastructure that are essential to the Company's
business. All critical business applications have been assessed, tested and
remediated. The Company's technical infrastructure, including all aspects of
networking, computing and communications capabilities have also been tested and
remediated as required. Furthermore, the embedded systems program for Dynegy's
plants and pipeline assets is essentially complete. During the fourth quarter,
the Year 2000 Program will continue working with critical third parties to
mitigate risk of business interruptions. Contingency plans to provide
operational alternatives required as a result of unforeseen or undetected Year
2000 issues impacting plant and pipeline assets have been completed. Likewise,
for business processes and critical computer systems, business continuity plans
have been developed which include detailed workaround procedures in the event of
a Year 2000-related disruption. Dynegy's Supply Chain Management program has
communicated with hundreds of external entities that could have an impact on the
Company's ability to continue conducting business into 2000. Many of Dynegy's
customers are inquiring about the Company' Year 2000 readiness, and Dynegy is
openly sharing information with them.
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 SEC requires that public companies forecast the most reasonably 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
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 $6 and
$8 million. Approximately $2 million of this amount was expended during 1998
related to this project and an additional $3 million was expended through third
quarter 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.
Page 25 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
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 and equity sales, if required. Further, the Company believes
that it maintains the financial flexibility to consummate the Illinova merger in
accordance with the merger terms and financing plan currently contemplated.
Page 26 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 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 and subsegments
for the three- and nine-month periods ended September 30, 1999 and 1998,
respectively.
<TABLE>
<CAPTION>
Wholesale Gas and Power Liquids
----------------------------------------------------------------------------
Three Months Ended September 30, Three Months Ended September 30,
----------------------------------------------------------------------------
1999 1998 1999 1998
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating Margin:
Power Marketing and Generation $ 43,091 $ 35,961 $ --- $ ---
Natural Gas Marketing 32,369 25,669 --- ---
Upstream Operations --- --- 43,111 19,219
Downstream Operations --- --- 37,197 21,740
Crude Oil Operations --- --- 3,046 3,396
Equity Investments 25,574 33,451 6,284 3,696
-------- -------- -------- --------
SUBTOTAL - FINANCIAL CONTRIBUTION 101,034 95,081 89,638 48,051
Depreciation (9,796) (5,220) (23,439) (25,617)
General and Administrative Expenses (35,656) (28,858) (17,839) (20,159)
Other Items (1) 148 (157) (2,459) 25,961
-------- -------- -------- --------
EARNINGS BEFORE INTEREST AND TAXES $ 55,730 $ 60,846 $ 45,901 $ 28,236
======== ======== ======== ========
OPERATING STATISTICS:
Natural Gas Marketing (Bcf/d) -
U.S. Sales Volumes 6.1 5.8 --- ---
Canadian Sales Volumes 2.4 2.3 --- ---
U.K. Sales Volumes 1.0 0.8 --- ---
-------- -------- -------- --------
9.5 8.9 --- ---
======== ======== ======== ========
Electric Power Marketing - Million Megawatt Hours Sold 22.7 51.4 --- ---
Power Generation (Million Megawatt Hours Generated) -
Gross 7.9 4.1 --- ---
Net 4.4 2.6 --- ---
Natural Gas Liquids Processed (MBbls/d - Gross) -
Field Plants --- --- 83.6 93.5
Straddle Plants --- --- 45.7 24.1
-------- -------- -------- --------
--- --- 129.3 117.6
======== ======== ======== ========
Natural Gas Gathering and Transmission (Bcf/d) --- --- 0.2 0.3
Barrels Received for Fractionation (MBbls/d) --- --- 230.8 203.5
NGL Marketing - Sales Volumes (MBbls/d) --- --- 402.6 385.7
LPG Sales Volumes (MBbls/d) --- --- 96.4 84.8
Crude Oil Marketing - Sales Volumes (MBbls/d) --- --- 252.1 263.1
===================================================================================================================================
</TABLE>
(1) The Liquids Segment includes the $26.3 million pre-tax gain on the sale of
Ozark Gas Transmission in the third quarter of 1998.
Page 27 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
Wholesale Gas and Power Liquids
--------------------------------------------------------------------------
Nine Months Ended September 30, Nine Months Ended September 30,
--------------------------------------------------------------------------
1999 1998 1999 1998
--------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating Margin:
Power Marketing and Generation $129,502 $ 80,319 $ --- $ ---
Natural Gas Marketing 86,872 89,515 --- ---
Upstream Operations --- --- 92,715 70,720
Downstream Operations --- --- 84,887 61,464
Crude Oil Operations --- --- 10,662 8,871
Equity Investments 48,084 54,948 12,061 13,055
-------- -------- -------- --------
SUBTOTAL - FINANCIAL CONTRIBUTION 264,458 224,782 200,325 154,110
Depreciation (27,180) (17,996) (69,093) (65,357)
General and Administrative Expenses (1) (97,581) (81,290) (52,547) (64,354)
Other Items (2) (3) 18,324 3,070 (7,146) 29,983
-------- -------- -------- --------
EARNINGS BEFORE INTEREST AND TAXES $158,021 $128,566 $ 71,539 $ 54,382
======== ======== ======== ========
OPERATING STATISTICS:
Natural Gas Marketing (Bcf/d) -
U.S. Sales Volumes 6.4 5.8 --- ---
Canadian Sales Volumes 2.2 2.2 --- ---
U.K. Sales Volumes 1.2 0.7 --- ---
-------- -------- -------- --------
9.8 8.7 --- ---
======== ======== ======== ========
Electric Power Marketing - Million Megawatt Hours Sold 50.5 102.9 --- ---
Power Generation (Million Megawatt Hours Generated) -
Gross 15.7 10.9 --- ---
Net 9.5 7.0 --- ---
Natural Gas Liquids Processed (MBbls/d - Gross) -
Field Plants --- --- 86.4 88.5
Straddle Plants --- --- 35.9 32.2
-------- -------- -------- --------
--- --- 122.3 120.7
======== ======== ======== ========
Natural Gas Gathering and Transmission (Bcf/d) --- --- 0.2 0.3
Barrels Received for Fractionation (MBbls/d) --- --- 205.9 196.1
NGL Marketing - Sales Volumes (MBbls/d) --- --- 427.7 398.5
LPG Sales Volumes (MBbls/d) --- --- 82.9 64.5
Crude Oil Marketing - Sales Volumes (MBbls/d) --- --- 204.6 246.8
===================================================================================================================================
</TABLE>
(1) Includes each 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.
(3) The Liquids Segment includes the $26.3 million pre-tax gain on the sale of
the Ozark Gas Transmission System in the third quarter of 1998.
THREE-MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
For the quarter ended September 30, 1999, Dynegy realized net income of $50.7
million, or $0.30 per share, compared with third quarter 1998 net income of
$43.6 million, or $0.27 per share. The 1998 quarter included a one-time gain of
$17.1 million, or $0.11 per share, related to a gain on sale of the Ozark Gas
Transmission System resulting in recurring earnings for that period of $26.5
million, or $0.16 per share. In general, the 88 percent increase in recurring
earnings period-to-period
Page 28 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
reflects a solid performance by the Wholesale Gas and Power segment and
substantially improved results in the Liquids segment reflecting a general
strengthening in market conditions and continued achievement of previously
disclosed cost-reduction and revenue-enhancement targets.
Consolidated operating margin for the third quarter of 1999 totaled $158.8
million compared to $106.0 million for the same 1998 period, reflecting improved
margins in both business segments. The Wholesale Gas and Power segment
contributed $75.5 million to the 1999 consolidated operating margin, compared to
$61.6 million reported in third quarter 1998 and the Liquids segment contributed
$83.3 million compared to $44.4 million in the prior period. In general, mild
weather was prevalent throughout North America during most of the 1999 third
quarter, which reduced demand for electricity and limited power price volatility
and trading opportunities during the peak summer power demand season. Despite
the market conditions in 1999, margin improved quarter over quarter due
principally to improved results in the United Kingdom, increased origination in
North America and additional power generation capacity available in the mid-west
market. Natural gas liquids and crude oil commodity prices improved an average
of $0.16 per gallon and $8.10 per barrel period to period. This dramatic
improvement in market prices coupled with the completion of the Liquids
segment's three-year initiative to reduce operating costs and generate
incremental revenue enhancements positively impacted these businesses.
Operating income increased $46 million, or 176 percent, 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, higher
variable compensation costs 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
approximately $32 million and $37 million to pre-tax quarterly earnings in the
1999 and 1998 periods, respectively. Cooler weather in the western United States
depressed demand for electricity reducing quarter over quarter returns from
power generation investments in Southern California. The decrease in earnings in
these investments was due in part to lower ancillary fees and in part to lower
volume sales. Losses in the retail gas alliance investments during the 1999
period principally reflect an aggressive advertising campaign occurring in the
southeast as deregulation of electricity markets in that region accelerated and
competition for customers increased. Pursuant to the timing of the deregulation
plan in this region, advertising costs are not expected to be as significant a
component of alliance operating results beginning in the fourth quarter of 1999.
The company's investments in ventures involved in businesses related to the
natural gas liquids industry increased as market conditions have improved for
this segment. The following table provides a summary of equity earnings by
investment for the comparable periods.
Page 29 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
============================================================================================
FOR THE THREE-MONTHS ENDED
SEPTEMBER 30,
---------------------------------------
1999 1998
---------------------------------------
<S> <C> <C>
WHOLESALE GAS AND POWER:
Accord $ 6,020 $ 4,500
Power Generation Equity Investments (in aggregate) 22,033 29,755
Retail Gas Alliances (in aggregate) (2,477) (804)
Other, net (2) ---
------- -------
TOTAL WHOLESALE GAS AND POWER 25,574 33,451
------- -------
LIQUIDS BUSINESSES:
Gulf Coast Fractionators 939 1,031
West Texas LPG Pipeline Limited Partnership 1,805 1,528
Venice Energy Services Company, L.L.C. 3,306 760
Other, net 234 377
------- -------
TOTAL LIQUIDS BUSINESSES 6,284 3,696
------- -------
$31,858 $37,147
======= =======
============================================================================================
</TABLE>
Interest expense totaled $22.0 million for the quarter ended September 30, 1999,
compared to $21.2 million for the equivalent 1998 period. An increase in
principal outstanding period-to-period was offset by lower average interest
costs and increased capitalization of interest on construction projects.
Accumulated distributions associated with the Company Obligated Preferred
Securities of a Subsidiary Trust totaled $4.2 million for each quarter ended
September 30, 1999 and 1998, respectively.
Other income and expenses, net reflected a charge of $2.3 million in the quarter
ended September 30, 1999 compared with income of $25.8 million in the 1998
period. The 1998 period included a pretax gain of $26.3 million related to the
sale of Ozark Gas Transmission System. The remaining amounts consisted of
interest income, minority interests in consolidated subsidiaries and certain
other non-recurring income and expense items in both periods.
The Company reported an income tax provision of $24.7 million for the three-
month period ended September 30, 1999, compared to an income tax provision of
$20.1 million for the 1998 period. The effective rates approximated 33 and 32
percent in 1999 and 1998, respectively. The differences between the
aforementioned effective rates and the statutory rate of 35 percent for both
periods results principally from permanent differences arising from the
amortization of certain intangibles and debt premiums, permanent differences
from the effect of certain foreign equity investments and state income taxes.
WHOLESALE GAS AND POWER SEGMENT
The Wholesale Gas and Power segment had earnings before interest and taxes
("EBIT") of $55.7 million for the three-month period ended September 30, 1999,
compared with $60.8 million in the 1998 quarter. Results period-to-period were
influenced by:
. lower demand for electricity in 1999, particularly in the southern California
market, and
. less price volatility in the North American power markets in 1999, which
reduced trading opportunities,
. increased advertising costs by our retail alliances, and
. increased depreciation and general and administrative expenses reflecting the
capital and overhead costs required to support the larger, more diverse base
of operations, partially offset by
Page 30 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
. increased gas and power marketing origination in 1999,
. the initiation of commercial operations of a power generation plant in the
mid-west market, and
. favorable market movements in the United Kingdom
Total natural gas volumes sold increased to 9.5 billion cubic feet per day from
8.9 billion cubic feet per day during last year's third quarter, principally as
a result of increased volumes sold to the retail alliances and to fuel gas-fired
generation in the U.S. Total megawatt hours produced and sold during the 1999
quarter aggregated 27.1 million megawatt hours compared to 54.0 million megawatt
hours during the 1998 period. The 26.9 million megawatt reduction period over
period is principally a reflection of the trading volume which occurred as a
result of the volatility in electricity markets during the 1998 period.
LIQUIDS SEGMENT
The Liquids segment had normalized EBIT of $45.9 million for the three-month
period ended September 30, 1999, compared to $1.9 million for the 1998 quarter.
Improved natural gas liquids and crude oil prices, supplemented by targeted cost
reductions and revenue enhancements favorably impacted this segment's results
period-to-period. Sustained market price improvements have resulted in increased
gas processing, fractionation and trading opportunities. In addition, world
demand for natural gas liquids strengthened early in the quarter, particularly
in Europe and Asia enhancing revenues from global marketing operations. By the
end of the quarter, the foreign demand in the liquids markets had softened.
However, the Liquids segment was unable to fully realize the improved pricing
environment during the 1999 quarter as increases in wellhead production lagged
improvements in natural gas liquids prices. Producers have been reluctant or
slow to increase wellhead production of natural gas behind the Company's field
plants as they evaluated available sources of capital, re-evaluated previously
planned capital expenditure programs, analyzed reservoir production capabilities
and validated the sustainability of commodity price levels. A delay in increased
wellhead production, as influenced by this producer behavior, partially reduced
opportunities for further improvement in 1999 operating margins. Additionally,
forward sales of equity natural gas liquids production entered into during the
first quarter of 1999 will impede this segment's ability to fully leverage
opportunities during the fourth quarter of 1999 presented by the improved
commodity pricing environment.
Aggregate domestic natural gas liquids processing volumes totaled 129.3 thousand
gross barrels per day in 1999 compared to an average 117.6 thousand gross
barrels per day during 1998. The increase in processing volumes is a result of a
90 percent increase in straddle plant volumes, reflecting the improved pricing
relationship between natural gas and natural gas liquids, offset by an 11
percent decline in field processing volumes principally due to the producer
behavior described above. Fractionation volumes increased principally as a
result of successful marketing efforts, which increased available throughput
during the period. Natural gas liquids marketing volumes were substantially
higher period over period reflecting the improving world-wide demand in the
chemicals and wholesale markets. Crude oil marketing volumes reflected a slight
decline period over period.
NINE-MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
For the nine-months ended September 30, 1999, Dynegy realized net income of
$106.7 million, or $0.64 per share, on revenues of approximately $10.8 billion.
This compared with net income of $79.4 million, or $0.48 per share, on total
revenue of $11.2 billion reported in the same 1998 period. Both periods included
non-recurring adjustments that impacted reported results. The 1999 period
includes an after tax gain of $5.8 million, or $0.03 per share, related to a
sale of an investment. The 1998 period includes an after tax gain of $17.1
million related to the sale of the Ozark Gas Transmission System offset by a
$6.3 million after tax severance charge resulting in a net positive impact on
reported earnings per share of $0.07 per share. Cash flow provided by operating
activities totaled $96.8 million in 1999 compared to $141.0 million during the
1998 period.
Consolidated operating margin for the first nine month period ended September
30, 1999 totaled $404.6 million compared to $310.9 million in 1998, an increase
of 30 percent. The Wholesale Gas and Power segment's operating margin totaled
$216.4
Page 31 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
million, an improvement of $46.5 million or 27 percent over 1998 operating
margins principally reflecting growth in the power generation and marketing
businesses. The Liquids segment contributed an aggregate $188.3 million to the
consolidated operating margin, or $47.2 million more than reported in 1998.
Natural gas liquids prices improved $0.05 per gallon period over period while
crude prices improved $2.53 per barrel. The improved market conditions and
completion of cost reductions and revenue enhancements have favorably impacted
the Liquids segment. Operating income totaled $158.2 million for the nine-months
ended September 30, 1999, compared to $82.0 million in the comparable 1998
period, an improvement of 93 percent. The increase of $76.2 million reflects the
aforementioned increase in consolidated operating margin, which was partially
offset by the aggregate increase in depreciation and amortization and general
and administrative expenses. The increases in depreciation and amortization
expense and general and administrative expenses result principally from the same
reasons and circumstances that impacted these items during the three-months
ended September 30, 1999, described previously.
The Company's equity share in the earnings of its unconsolidated affiliates
contributed an aggregate $60.1 million to 1999 pretax year-to-date results,
compared to $68.0 million during the comparable 1998 period. The decrease in
equity earnings generally reflects lower earnings from the west coast power
generation investments and the increased losses in the retail gas alliances
incurred as a result of higher advertising costs. The following table provides a
summary of equity earnings by investment for the comparable periods.
<TABLE>
<CAPTION>
============================================================================================
FOR THE NINE-MONTHS ENDED
SEPTEMBER 30,
---------------------------------------
1999 1998
---------------------------------------
<S> <C> <C>
WHOLESALE GAS AND POWER:
Accord $15,020 $13,500
Power Generation Equity Investments (in aggregate) 38,198 43,882
Retail Gas Alliances (in aggregate) (5,565) (2,434)
Other, net 431 ---
------- -------
TOTAL WHOLESALE GAS AND POWER 48,084 54,948
------- -------
LIQUIDS BUSINESSES:
Gulf Coast Fractionators 2,063 3,111
West Texas LPG Pipeline Limited Partnership 3,946 5,104
Venice Energy Services Company, L.L.C. 4,875 3,686
Other, net 1,177 1,154
------- -------
TOTAL LIQUIDS BUSINESSES 12,061 13,055
------- -------
$60,145 $68,003
======= =======
============================================================================================
</TABLE>
Interest expense totaled $59.5 million for the nine-month period ended September
30, 1999, compared to $55.3 million for the same 1998 period. The increase of
$4.2 million is principally attributed to higher outstanding principal balances
resulting from the acquisition of interests in certain power generating
facilities, construction costs associated with power generation projects,
construction costs associated with the Lake Charles fractionator and the
acquisition of a Canadian gas processing facility. Distributions associated with
the Trust Securities totaled $12.5 million in 1999 and 1998.
Other income and expenses, net totaled $11.2 million for the first nine months
of 1999 and was $33.1 million in the nine-month period ended September 30, 1998.
The 1999 amount is primarily a result of the pre tax gain on sale of an
investment and the 1998 amount is primarily from the pre tax gain on sale of
Ozark Gas Transmission System and a gas processing facility.
The Company reported an income tax provision of $50.9 million for the nine-month
period ended September 30, 1999, representing an effective tax rate of 32
percent, compared to an income tax provision of $35.8 million and an effective
rate of 31 percent for the equivalent 1998 period. Differences between the
aforementioned effective rates and the statutory rate of 35
Page 32 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
percent for each of the nine-month periods ended September 30, 1999 and 1998,
respectively, result principally from the same factors impacting the effective
rates for the three-month periods ended September 30, 1999 and 1998, previously
discussed.
WHOLESALE GAS AND POWER
Normalized EBIT for the nine-month period ended September 30, 1999, totaled
$149.2 million compared with $131.3 million in the same 1998 period, an increase
of 14 percent period over period. Results realized in the two periods were
influenced by substantially the same factors that impacted the quarterly
results. Both periods were influenced by a lack of significant price volatility
in the North American natural gas markets.
Total natural gas volumes sold increased to 9.8 billion cubic feet per day from
8.7 billion cubic feet per day during the first nine months of last year,
principally as a result of the aforementioned increase in sales volumes to the
retail alliances and to fuel gas-fired generation in the U.S. Total megawatt
hours produced and sold during the 1999 quarter aggregated 60.0 million megawatt
hours compared to 109.9 million megawatt hours during the 1998 period. The
decrease in megawatt hours sold and produced period over period is principally a
reflection of the impetus placed by this segment on quality of operating margins
over the quantity of sales volumes and the trading volume which occurred as a
result of the volatility in electricity markets during prior period 1998.
LIQUIDS
The Liquids segment had normalized EBIT of $71.5 million for the nine-month
period ended September 30, 1999, compared to $35.0 million for the same period
in 1998. Substantially all of the financial improvement in this segment period-
to-period is a result of the 1999 third quarter results and is reflective of the
aforementioned commodity price improvements and the successful cost and revenue
enhancement initiatives.
Aggregate domestic natural gas liquids processing volumes totaled 122.3 thousand
gross barrels per day in 1999 essentially flat when compared to an average 120.7
thousand gross barrels per day during 1998. Fractionation volumes were slightly
higher reflecting the third quarter 1999 improvements and the addition of a full
year production at the Lake Charles fractionation facility. Natural gas liquids
marketing volumes increased period-to-period as the Company aggressively
marketed and traded volumes as commodity prices and world demand improved. Crude
oil marketing volumes were lower period to period.
OPERATING CASH FLOW
Cash flow from operating activities totaled $96.8 million for the nine-month
period ended September 30, 1999, compared to $141.0 million reported in the same
1998 period. Changes in operating cash flow reflect the operating results
previously discussed herein and changes in working capital, particularly trade
accounts receivables and payables and investment in discretionary inventory
volumes period-to-period. The decrease in operating cash flow period over period
is principally a result of origination activities in energy trading that will be
realized in cash in future periods and increased investment in inventory
principally reflecting the higher commodity prices period over 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.
CAPITAL EXPENDITURES AND INVESTING ACTIVITIES
During the nine-months ended September 30, 1999, the Company spent a net $385.0
million principally on power generation assets, including an interest in a power
generation partnership, and additional expenditures related to maintenance
capital improvements at existing facilities and capital investment associated
with technology infrastructure improvements. The
Page 33 of 39
<PAGE>
DYNEGY INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
For the Interim Periods Ended September 30, 1999 and 1998
Company received proceeds of $16.7 million in the first quarter principally
related to the sale of an investment. During the nine-months ended September 30,
1998, the Company spent a net $216.0 million, principally on the acquisition of
power generating assets, construction costs associated with the previously
disclosed Lake Charles fractionation facility and on expenditures for capital
improvements at existing facilities. Additionally, during the 1998 period, the
Company sold the Ozark Gas Transmission System and several discrete non-
strategic assets.
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 $6 million in cash dividends and
distributions during each nine-month period ended September 30, 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. No shares were acquired pursuant to this program during
1999. The Company acquired 456,800 shares of its stock through open-market
trades during the nine-month period ended September 30, 1998, at a total cost of
$6.1 million, or $13.34 per share on a weighted average cost basis.
Page 34 of 39
<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 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 February
14, 2000. 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. Upon termination of the power
purchase agreement, Dynegy will repay project debt of approximately $26 million.
By Order dated October 7, 1999, the CPUC approved the Settlement Agreement. The
CPUC approval became final on November 8, 1999. 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. The suit has been removed to the United States District Court for
the Northern District of California. Following removal, LOF filed a motion to
dismiss/stay based on the contention that the issue of QF compliance is
essential to the disposition of the suit and that the FERC is vested with the
exclusive jurisdiction to address QF compliance. The hearing on the motion was
held on August 30, 1999. The District Court took the matter under advisement
and has yet to issue its ruling.
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 35 of 39
<PAGE>
DYNEGY INC.
PART II. OTHER INFORMATION
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"). Chalk Cliff Limited and
McKittrick Limited are now wholly-owned by subsidiaries of the Company: Chalk
Cliff Limited through the purchase of the interests of Dominion Energy, Inc.,
and McKittrick Limited through the purchase of the interests of UtilCo Group,
Inc. and certain affiliates. 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
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 and will vigorously defend against SOCAL's claims. The parties engaged
in settlement discussions, which resulted in the execution of a Settlement
Agreement between SOCAL and all Defendants in the pending litigation on August
25, 1999 (the "Settlement Agreement"). The Settlement Agreement provides for,
upon the receipt of CPUC approval, the dismissal of the pending litigation, the
termination of underlying gas transmission service contracts, and Dynegy's
payment of settlement consideration. In connection with the execution of the
Settlement Agreement, the lenders have agreed to forebear foreclosure
proceedings in respect to the projects pending CPUC approval of the Settlement
Agreement.
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 hearing on the motions to dismiss was held in July 1999. On August
20, 1999, the District Court again dismissed MID's antitrust claims against PG&E
and Destec, this time without leave to amend the complaint. As a result of the
dismissal of the antitrust claims,
Page 36 of 39
<PAGE>
DYNEGY INC.
PART II. OTHER INFORMATION
the District Court also dismissed the pendant state law claims. MID has appealed
the District Court's dismissal of its suit to the Ninth Circuit Court of Appeal.
Following dismissal of its federal court suit, MID filed suit in California
state court asserting its breach of contract claims against Destec and its
tortious interference with contract claims against PG&E. 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.
On July 30, 1999, The Dow Chemical Company ("Dow") filed a lawsuit in the United
States District Court for the District of Delaware against Dynegy Power
Corporation ("DPC"), a wholly-owned subsidiary of the Company. Dow seeks
contribution from DPC in connection with claims against Dow asserted by The AES
Corporation ("AES") in a lawsuit filed on November 30, 1998 in the United States
District Court for the Southern District of Texas. AES asserts various federal
and Texas securities laws claims, and Texas claims for fraud and civil
conspiracy, arising out of AES' June 1997 purchase of stock of Destec
Engineering, a subsidiary of DPC (at that time Destec Power Corp).
Specifically, AES alleges that Destec Power made certain misrepresentations
about the expected profits that Destec Engineering would earn in connection with
the construction of the Elsta power plant in The Netherlands, and the
anticipated completion date of the Elsta plant. AES alleges that Dow is liable
because it "controlled" or had the power to control the management of Destec
Power. AES does not assert any claims against Destec Power or any other Dynegy
entity. Dow is vigorously defending against AES' claims. In response to a
motion to transfer filed by Dow, the United States District Court for the
Southern District of Texas transferred the suit to the United States District
Court for Delaware. In the suit filed by Dow, Dow seeks to recover from DPC any
amounts it must pay AES. The Court has yet to set the filing date for DPS'
answer to Dow's claims. In the opinion of management, the ultimate resolution
of this lawsuit will not have a material adverse effect on the Company's
financial position.
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 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 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting (the "Special Meeting") of the stockholders of the Company was
held on October 11, 1999. The purpose of the Special Meeting was to consider
and vote upon the following proposals:
1. To approve the adoption of the Agreement and Plan of Merger, dated June 14,
1999, by and among Illinova Corporation, Energy Convergence Holding Company,
Energy Convergence Acquisition Corporation, Dynegy Acquisition Corporation
and Dynegy Inc.; and
2. To approve the adoption of the Dynegy Inc. 2000 Long Term Incentive Plan.
The following votes were cast with respect to the approval of the adoption of
the Agreement and Plan of Merger, dated June 14, 1999, by and among Illinova
Corporation, Energy Convergence Holding Company, Energy Convergence Acquisition
Corporation, Dynegy Acquisition Corporation and Dynegy Inc.
For: 144,443,075
Against/Withheld: 141,719
Abstentions: 4,033
Broker non-votes: -0-
The following votes were cast with respect to the approval of the adoption of
the Dynegy Inc. 2000 Long Term Incentive Plan:
Page 37 of 39
<PAGE>
DYNEGY INC.
PART II. OTHER INFORMATION
For: 133,007,249
Against/Withheld: 11,520,574
Abstentions: 31,504
Broker non-votes: -0-
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) The following instruments and documents are included as exhibits to this
Form 10-Q.
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
4.1 Indenture dated as of September 26, 1996,
Restated as of March 23, 1998 (includes
amendments in the First through Fifth
Supplemental Indentures) among Dynegy Inc.
(formerly known as NGC Corporation) and The
First National Bank of Chicago, as Trustee (1)
4.2 Form of 6.875% Senior Note due 2002 (2)
4.3 Form of 7.450% Senior Note due 2006 (2)
- --------
(1) Incorporated by reference to exhibits to the Current Report on Form 8-K of
Dynegy Inc. dated June 14, 1999.
(2) Incorporated by reference to exhibits to the Current Report on Form 8-K of
Dynegy Inc. dated July 22, 1999.
(b) Current Report on Form 8-K, Commission File No. 1-11156, dated July 22,
1999, relating to the issuance and sale by Dynegy Inc. of $200,000,000
aggregate principal amount of 6.875% Senior Notes due July 15, 2002 and
$200,000,000 aggregate principal amount of 7.450% Senior Notes due July 15,
2006 in an underwritten public offering.
Current Report on Form 8-K, Commission File No. 1-11156, dated July
27, 1999, relating to the announcement of 1999 second-quarter results by
Dynegy Inc.
Page 38 of 39
<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: November 15, 1999 By: /s/ Bradley P. Farnsworth
----------------- ---------------------------------------
Bradley P. Farnsworth, Senior Vice
President and Controller
(Principal Accounting Officer)
Page 39 of 39
<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> JUL-01-1999 JUL-01-1998
<PERIOD-END> SEP-30-1999 SEP-30-1998
<CASH> 28,337 28,367
<SECURITIES> 0 0
<RECEIVABLES> 1,952,808 1,623,738
<ALLOWANCES> 0 0
<INVENTORY> 296,268 149,901
<CURRENT-ASSETS> 2,743,962 2,117,241
<PP&E> 2,741,274 2,446,878
<DEPRECIATION> (598,048) (514,771)
<TOTAL-ASSETS> 6,414,460 5,264,237
<CURRENT-LIABILITIES> (2,463,462) (2,026,323)
<BONDS> 0 0
0 0
(75,418) (75,418)
<COMMON> (1,557) (1,533)
<OTHER-SE> (1,181,880) (1,126,530)
<TOTAL-LIABILITY-AND-EQUITY> (6,414,460) (5,264,237)
<SALES> (4,584,929) (4,586,515)
<TOTAL-REVENUES> (4,584,929) (4,586,515)
<CGS> 4,426,115 4,480,530
<TOTAL-COSTS> 4,426,115 4,480,530
<OTHER-EXPENSES> 10,725 2,931
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 22,039 21,185
<INCOME-PRETAX> (75,434) (63,739)
<INCOME-TAX> 24,742 20,094
<INCOME-CONTINUING> (50,692) (43,645)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (50,692) (43,645)
<EPS-BASIC> 0.33 0.29
<EPS-DILUTED> 0.30 0.27
</TABLE>
