10-Q 1 ssfc3rd01.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2001 Commission File No. 33-95538 SALTON SEA FUNDING CORPORATION (Exact name of registrant as specified in its charter) 47-0790493 (IRS Employer Identification No.) Salton Sea Brine Processing L.P. California 33-0601721 Salton Sea Power Generation L.P. California 33-0567411 Fish Lake Power LLC Delaware 33-0453364 Vulcan Power Company Nevada 95-3992087 CalEnergy Operating Corporation Delaware 33-0268085 Salton Sea Royalty LLC Delaware 47-0790492 VPC Geothermal LLC Delaware 91-1244270 San Felipe Energy Company California 33-0315787 Conejo Energy Company California 33-0268500 Niguel Energy Company California 33-0268502 Vulcan/BN Geothermal Power Company Nevada 33-3992087 Leathers, L.P. California 33-0305342 Del Ranch, L.P. California 33-0278290 Elmore, L.P. California 33-0278294 Salton Sea Power L.L.C. Delaware 47-0810713 CalEnergy Minerals LLC Delaware 47-0810718 CE Turbo LLC Delaware 47-0812159 CE Salton Sea Inc. Delaware 47-0810711 Salton Sea Minerals Corp. Delaware 47-0811261 (Exact name of Registrants (State or other (I.R.S. Employer as specified in their charters) jurisdiction of Identification No.) incorporation or organization) 302 S. 36th Street, Suite 400-A, Omaha, NE 68131 (Address of principal executive offices and Zip Code of Salton Sea Funding Corporation) Salton Sea Funding Corporation's telephone number, including area code: (402) 231-1641 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 All common stock of Salton Sea Funding Corporation is indirectly held by Magma Power Company. 100 shares of Common Stock were outstanding on November 14, 2001. SALTON SEA FUNDING CORPORATION Form 10-Q September 30, 2001 _____________ C O N T E N T S PART I: FINANCIAL INFORMATION Item 1. Financial Statements Page SALTON SEA FUNDING CORPORATION Independent Accountants' Report 4 Balance Sheets, September 30, 2001 and December 31, 2000 5 Statements of Operations for the Three and Nine Months Ended September 30, 2001 and 2000 6 Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2000 7 Notes to Financial Statements 8 SALTON SEA GUARANTORS Independent Accountants' Report 11 Combined Balance Sheets, September 30, 2001 and December 31, 2000 12 Combined Statements of Operations for the Three and Nine Months Ended September 30, 2001 and 2000 13 Combined Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2000 14 Notes to Combined Financial Statements 15 PARTNERSHIP GUARANTORS Independent Accountants' Report 18 Combined Balance Sheets, September 30, 2001 and December 31, 2000 19 Combined Statements of Operations for the Three and Nine Months Ended September 30, 2001 and 2000 20 Combined Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2000 21 Notes to Combined Financial Statements 22 SALTON SEA ROYALTY LLC Independent Accountants' Report 26 Balance Sheets, September 30, 2001 and December 31, 2000 27 Statements of Operations for the Three and Nine Months Ended September 30, 2001 and 2000 28 Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2000 29 Notes to Financial Statements 30 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 33 PART II: OTHER INFORMATION Item 1. Legal Proceedings 44 Item 2. Changes in Securities 44 Item 3. Defaults on Senior Securities 44 Item 4. Submission of Matters to a Vote of Security Holders 44 Item 5. Other Information 44 Item 6. Exhibits and Reports on Form 8-K 44 Signatures 45 INDEPENDENT ACCOUNTANTS' REPORT Board of Directors and Stockholder Salton Sea Funding Corporation Omaha, Nebraska We have reviewed the accompanying balance sheet of the Salton Sea Funding Corporation as of September 30, 2001, and the related statements of operations for the three-month and nine-month periods ended September 30, 2001 and 2000, and the related statements of cash flows for the nine-month periods ended September 30, 2001 and 2000. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to such financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the balance sheet of the Salton Sea Funding Corporation as of December 31, 2000, and the related statements of operations, stockholder's equity, and cash flows for the year then ended (not presented herein); and in our report dated January 18, 2001 (March 27, 2001 as to Note 4), we expressed an unqualified opinion on those financial statements. In our opinion, the information set forth in the accompanying balance sheet as of December 31, 2000 is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived. DELOITTE & TOUCHE LLP Omaha, Nebraska October 26, 2001 SALTON SEA FUNDING CORPORATION BALANCE SHEETS (Dollars in Thousands, Except per Share Amounts) September 30, December 31, 2001 2000 (unaudited) ASSETS Cash $ 46,404 $ 8,467 Prepaid expenses and other assets 13,963 3,563 Current portion of secured project notes from Guarantors 26,116 23,658 __________ __________ Total current assets 86,483 35,688 Secured project notes from Guarantors 505,962 520,250 Investment in 1% of net assets of Guarantors 9,476 9,437 __________ __________ $ 601,921 $ 565,375 ========== ========== LIABILITIES AND STOCKHOLDER'S EQUITY Liabilities: Accrued liabilities $ 13,513 $ 3,479 Due to affiliates 43,033 4,753 Current portion of long term debt 26,116 23,658 __________ __________ Total current liabilities 82,662 31,890 Senior secured notes and bonds 505,962 520,250 __________ __________ Total liabilities 588,624 552,140 Commitments and contingencies (Note 3) Stockholder's equity: Common stock--authorized 1,000 shares, par value $.01 per share; issued and outstanding 100 shares --- --- Additional paid-in capital 5,366 5,366 Retained earnings 7,931 7,869 __________ __________ Total stockholder's equity 13,297 13,235 __________ __________ $ 601,921 $ 565,375 ========== ========== The accompanying notes are an integral part of these financial statements. SALTON SEA FUNDING CORPORATION STATEMENTS OF OPERATIONS (Dollars in Thousands) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 Revenues: Interest income $ 10,753 $ 10,702 $ 31,489 $ 32,421 Equity in earnings of Guarantors 22 279 39 335 ________ _________ _________ _________ Total revenues 10,775 10,981 31,528 32,756 ________ _________ _________ _________ Expenses: General and administrative expenses 283 234 746 711 Interest expense 10,183 10,434 30,676 31,831 _________ _________ _________ _________ Total expenses 10,466 10,668 31,422 32,542 _________ _________ _________ _________ Income before income taxes 309 313 106 214 Provision for income taxes 128 129 44 88 _________ _________ _________ _________ Net income $ 181 $ 184 $ 62 $ 126 ========= ========= ========= =========
The accompanying notes are an integral part of these financial statements. SALTON SEA FUNDING CORPORATION STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited) Nine Months Ended September 30, 2001 2000 Cash flows from operating activities: Net income $ 62 $ 126 Adjustments to reconcile net income to net cash flow from operating activities: Equity in earnings of Guarantors (39) (335) Changes in assets and liabilities: Prepaid expenses and other assets (10,400) (10,474) Accrued liabilities 10,034 10,266 ___________ ____________ Net cash flows from operating activities (343) (417) Cash flows from investing activities: Principal repayments of secured project notes from Guarantors 11,830 22,552 ___________ ____________ Net cash flows from investing activities 11,830 22,552 Cash flows from financing activities: Increase in due to affiliates 38,280 22,266 Repayment of senior secured notes and bonds (11,830) (22,552) ___________ ____________ Net cash flows from financing activities 26,450 (286) ___________ ____________ Net change in cash 37,937 21,849 Cash at beginning of period 8,467 2,086 ___________ ____________ Cash at end of period $ 46,404 $ 23,935 ============ ============ The accompanying notes are an integral part of these financial statements. SALTON SEA FUNDING CORPORATION NOTES TO FINANCIAL STATEMENTS (Unaudited) 1. General: In the opinion of management of the Salton Sea Funding Corporation (the "Funding Corporation"), the accompanying unaudited financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position as of September 30, 2001 and the results of operations for the three and nine months ended September 30, 2001 and 2000 and cash flows for the nine months ended September 30, 2001 and 2000. The results of operations for the nine months ended September 30, 2001 and 2000 are not necessarily indicative of the results to be expected for the full year. The unaudited financial statements should be read in conjunction with the financial statements included in the Funding Corporation's annual report on Form 10-K for the year ended December 31, 2000. 2. Accounting Pronouncements: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) 133, "Accounting for Derivative Instruments and Hedging Activities", which was delayed by SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of FASB No. 133" and amended by SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities". SFAS 133 requires an entity to recognize all of its derivatives as either assets or liabilities in its statement of financial position and measure those instruments at fair value. The Funding Corporation implemented the new standards on January 1, 2001. The initial adoption of SFAS 133 did not have a material impact on the Funding Corporation's financial position, results of operations or any impact on its cash flows. In June 2001, FASB approved the issuance of SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". These standards, issued in July 2001, establish accounting and reporting for business combinations. SFAS No. 141 requires all business combinations entered into subsequent to June 30, 2001 to be accounted for using the purchase method of accounting. SFAS No. 142 provides that goodwill and other intangible assets with indefinite lives will not be amortized, but will be tested for impairment on an annual basis. These standards are effective for the Funding Corporation beginning on January 1, 2002. The Funding Corporation has not quantified the impact resulting from the adoption of these standards. In July 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). This standard addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and the related asset retirement costs. SFAS 143 is effective for the Company's fiscal year beginning January 1, 2003. Management is in the process of evaluating the impact this standard will have on the Company's consolidated financial statements. In August 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" (SFAS 144). The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for the Company's fiscal year beginning January 1, 2002. Management is in the process of evaluating the impact this standard will have on the Guarantors' consolidated financial statements. 3. Contingency: Southern California Edison ("Edison"), a wholly-owned subsidiary of Edison International, is a public utility primarily engaged in the business of supplying electric energy to retail customers in Central and Southern California, excluding Los Angeles. The Funding Corporation is aware that there have been public announcements that Edison's financial condition has deteriorated as a result of reduced liquidity. Edison's senior unsecured debt obligations are currently rated Caa2 by Moody's and D by S&P. Edison failed to pay approximately $119 million due under the Power Purchase Agreements for power delivered in November and December 2000 and January, February and March 2001, although the Power Purchase Agreements provide for billing and payment on a schedule where payments would have normally been received in early January, February, March, April and May 2001. On February 21, 2001, certain Guarantors filed a lawsuit against Edison in California's Imperial County Superior Court seeking a court order requiring Edison to make the required payments under the Power Purchase Agreements. The lawsuit also requested, among other things, that the court order permit these Guarantors to suspend deliveries of power to Edison and to permit the Guarantors to sell such power to other purchasers in California. On March 22, 2001, the Superior Court granted Guarantors' Motion for Summary Adjudication and a Declaratory Judgment ordering that: 1) under the Power Purchase Agreements, Guarantors have the right to temporarily suspend deliveries of capacity and energy to Edison, 2) Guarantors are entitled to resell the energy and capacity to other purchasers and 3) the interim suspension of deliveries to Edison shall not in any respect result in the modifications or termination of the Power Purchase Agreements and the Power Purchase Agreements shall in all respects continue in full force and effect other than the temporary suspension of deliveries to Edison. As a result of the March 22, 2001 Declaratory Judgment, the Guarantors' suspended deliveries of energy to Edison and entered into a transaction agreement with El Paso Merchant Energy, L.P. ("EPME") in which the Imperial Valley projects' available power was sold to EPME based on percentages of the Dow Jones SP-15 Index. On June 18, 2001, the Superior Court terminated the Imperial Valley projects right to resell power pursuant to the Declaratory Judgment. On June 20, 2001, the Guarantors entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). The Settlement Agreements require that Edison make a series of payments to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). The first payment of approximately $11.6 million, which represented 10% of the stipulated amounts, was received June 22, 2001. A second partial payment of 10% is payable within 5 days following the occurrence of Events to restore Edison to creditworthiness (the "Effective Date"). The final payment, representing the remaining stipulated amounts, shall be paid on the 5th business day after Edison receives proceeds from the financing resulting from the occurrence of Events to restore Edison to creditworthiness. In addition to these payments, Edison is required to make monthly interest payments calculated at a rate of 7% per annum on the outstanding stipulated amounts. The Settlement Agreements also provides a revised energy pricing structure, whereby Edison elects to pay the Imperial Valley Projects a fixed energy price of 5.37 cents/kilowatt hour in lieu of the Commission-approved SRAC Methodology under the Power Purchase Agreements, commencing on the first day of the month following the Effective Date and expiring five years from such date. All other contract terms remain unchanged. As a result of the aforementioned Settlement Agreements, the Guarantors resumed power sales to Edison on June 22, 2001. Energy payments are currently calculated using the SRAC formulas set forth in the Power Purchase Agreements until the fixed rate period begins. On October 2, 2001 the California Public Utilities Commission (PUC) and Edison reached a settlement in the Filed Rate Doctrine lawsuit Edison filed in Federal Court against the PUC. By its own terms, the settlement is intended to restore Edison to creditworthiness so that it is able to resume procuring the electricity needed by its customers; limit ratepayers' costs of paying off the debt; and maintain the state's role in regulating the investor owned utility by enabling Edison to pay down its back debts over a reasonable period of time. As a result of such settlement the Guarantors believe the conditions to the Effective Date under the Settlement Agreements have been satisfied. Edison disputes such conditions have been satisfied. The Guarantors are vigorously pursing enforcement of their rights under the Settlement Agreements. As a result of Edison's failure to make the payments due under the Power Purchase Agreements and the recent downgrades of Edison's credit ratings, Moody's downgraded the ratings for the Salton Sea Funding Securities to Caa2 (negative outlook) and S&P downgraded the ratings for the Salton Sea Funding Securities to BBB- and placed the Salton Sea Funding Securities on "credit watch negative". Following the execution of the Settlement Agreements, Moody's placed the Salton Sea Funding Securities on "credit watch positive". The Guarantors' are contractually entitled to receive payments under the Power Purchase Agreements. However, due to the uncertainties associated with Edison's financial condition and failure to pay contractual obligations, the Guarantors have established an allowance for doubtful accounts of approximately $90 million on September 30, 2001. INDEPENDENT ACCOUNTANTS' REPORT Board of Directors and Stockholder Magma Power Company Omaha, Nebraska We have reviewed the accompanying combined balance sheet of the Salton Sea Guarantors as of September 30, 2001, and the related combined statements of operations for the three-month and nine-month periods ended September 30, 2001 and 2000, and the related combined statements of cash flows for the nine-month periods ended September 30, 2001 and 2000. These financial statements are the responsibility of the Salton Sea Guarantors' management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to such combined financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the combined balance sheet of the Salton Sea Guarantors as of December 31, 2000, and the related combined statements of operations, Guarantors' equity, and cash flows for the year then ended (not presented herein); and in our report dated January 18, 2001 (March 27, 2001 as to Note 6), we expressed an unqualified opinion on those combined financial statements. In our opinion, the information set forth in the accompanying combined balance sheet as of December 31, 2000 is fairly stated, in all material respects, in relation to the combined balance sheet from which it has been derived. DELOITTE & TOUCHE LLP Omaha, Nebraska October 26, 2001 SALTON SEA GUARANTORS COMBINED BALANCE SHEETS (Dollars in Thousands) September 30, December 31, 2001 2000 (unaudited) ASSETS Accounts receivable, net of allowance of $29,189 and $0, respectively (Note 4) $ 28,829 $ 24,396 Prepaid expenses and other assets 5,733 8,699 __________ _________ Total current assets 34,562 33,095 Restricted cash --- 17 Property, plant, contracts and equipment, net 561,228 566,577 Excess of cost over fair value of net assets acquired, net 44,596 45,574 __________ _________ $ 640,386 $ 645,263 ========== ========= LIABILITIES AND GUARANTORS' EQUITY Liabilities: Accounts payable $ 408 $ 5 Accrued liabilities 16,161 10,826 Current portion of long term debt 18,902 17,319 __________ _________ Total current liabilities 35,471 28,150 Due to affiliates 17,603 18,720 Senior secured project note 256,656 266,898 __________ __________ Total liabilities 309,730 313,768 Commitment and contingencies (Note 4) Total Guarantors' equity 330,656 331,495 __________ _________ $ 640,386 $ 645,263 ========== ========= The accompanying notes are an integral part of these financial statements. SALTON SEA GUARANTORS COMBINED STATEMENTS OF OPERATIONS (Dollars in Thousands) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 _________ _________ _________ _________ Revenues: Sales of electricity $ 22,853 $ 32,375 $ 77,847 $ 59,873 Interest and other income 652 119 1,629 332 _________ _________ _________ _________ Total revenues 23,505 32,494 79,476 60,205 _________ _________ _________ _________ Expenses: Operating, general and administration 15,438 11,288 43,004 23,852 Depreciation and amortization 4,372 4,751 13,382 13,072 Interest expense 5,574 5,745 16,878 17,376 Less capitalized interest --- (1,988) (1,692) (8,124) _________ _________ _________ _________ Total expenses 25,384 19,796 71,572 46,176 _________ _________ _________ _________ Income (loss) before cumulative effect of accounting change (1,879) 12,698 7,904 14,029 Cumulative effect of accounting change --- --- (8,743) --- _________ _________ _________ _________ Net income (loss) $ (1,879) $ 12,698 $ (839) $ 14,029 ========= ========= ========= =========
The accompanying notes are an integral part of these financial statements. SALTON SEA GUARANTORS COMBINED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited)
Nine Months Ended September 30, 2001 2000 Cash flows from operating activities: Net income (loss) $ (839) $ 14,029 Adjustments to reconcile net income (loss) to net cash flows from operating activities: Depreciation and amortization 13,382 13,072 Cumulative effect of change in accounting principle 8,743 --- Changes in assets and liabilities: Accounts receivable (4,433) (10,694) Prepaid expenses and other assets (5,777) 2,533 Accounts payable and accrued liabilities 5,738 4,985 _______________ _____________ Net cash flows from operating activities 16,814 23,925 _______________ _____________ Cash flows from investing activities: Capital expenditures (7,055) (17,522) Decrease in restricted cash 17 2,526 _______________ _____________ Net cash flows from investing activities (7,038) (14,996) _______________ _____________ Cash flows from financing activities: Increase (decrease) in due to affiliates (1,117) 298 Contributions from _________ 50 --- Repayment of senior secured project note (8,659) (9,227) Net cash flows from financing activities (9,776) (8,929) _______________ _____________ Net change in cash --- --- Cash at beginning of period --- --- Cash at end of period $ --- $ --- =============== =============
The accompanying notes are an integral part of these financial statements. SALTON SEA GUARANTORS NOTES TO COMBINED FINANCIAL STATEMENTS (Unaudited) 1. General: In the opinion of management of the Salton Sea Guarantors (the "Guarantors"), the accompanying unaudited financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position as of September 30, 2001 and the results of operations for the three and nine months ended September 30, 2001 and 2000 and cash flows for the nine months ended September 30, 2001 and 2000. The results of operations for the nine months ended September 30, 2001 and 2000 are not necessarily indicative of the results to be expected for the full year. The unaudited financial statements shall be read in conjunction with the financial statements included in the Funding Corporation's annual report on Form 10-K for the year ended December 31, 2000. Certain prior year amounts have been reclassified in order to conform with current year classifications. 2. Accounting Policy Change: The Guarantors have changed their policy of accounting for major maintenance, overhaul and well workover costs. These costs, which have historically been accounted for using deferral methods, are now being expensed as incurred. The new policy went into effect January 1, 2001 and the Guarantors have recorded a cumulative effect of this change of $8.7 million. 3. Accounting Pronouncements: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) 133, "Accounting for Derivative Instruments and Hedging Activities", which was delayed by SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of FASB No. 133" and amended by SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities". SFAS 133 requires an entity to recognize all of its derivatives as either assets or liabilities in its statement of financial position and measure those instruments at fair value. The Guarantors implemented the new standards on January 1, 2001. The initial adoption of SFAS 133 did not have a material impact on the Guarantors' financial position, results of operations or any impact on their cash flows. In June 2001, FASB approved the issuance of SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". These standards, issued in July 2001, establish accounting and reporting for business combinations. SFAS No. 141 requires all business combinations entered into subsequent to June 30, 2001 to be accounted for using the purchase method of accounting. SFAS No. 142 provides that goodwill and other intangible assets with indefinite lives will not be amortized, but will be tested for impairment on an annual basis. These standards are effective for the Guarantors beginning on January 1, 2002. The Guarantors have not quantified the impact resulting from the adoption of these standards. In July 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). This standard addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and the related asset retirement costs. SFAS 143 is effective for the Guarantor's fiscal year beginning January 1, 2003. Management is in the process of evaluating the impact this standard will have on the Guarantors' consolidated financial statements. In August 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" (SFAS 144). The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for the Guarantors' fiscal year beginning January 1, 2002. Management is in the process of evaluating the impact this standard will have on the Guarantors' consolidated financial statements. 4. Contingency: Southern California Edison ("Edison"), a wholly-owned subsidiary of Edison International, is a public utility primarily engaged in the business of supplying electric energy to retail customers in Central and Southern California, excluding Los Angeles. The Guarantors are aware that there have been public announcements that Edison's financial condition has deteriorated as a result of reduced liquidity. Edison's senior unsecured debt obligations are currently rated Caa2 by Moody's and D by S&P. Edison failed to pay approximately $42.3 million to the Guarantors due under the Power Purchase Agreements for power delivered in November and December 2000 and January, February and March 2001, although the Power Purchase Agreements provide for billing and payment on a schedule where payments would have normally been received in early January, February, March, April and May 2001. On February 21, 2001, certain Guarantors filed a lawsuit against Edison in California's Imperial County Superior Court seeking a court order requiring Edison to make the required payments under the Power Purchase Agreements. The lawsuit also requested, among other things, that the court order permit the Guarantors to suspend deliveries of power to Edison and to permit the Guarantors to sell such power to other purchasers in California. On March 22, 2001, the Superior Court granted Guarantors' Motion for Summary Adjudication and a Declaratory Judgment ordering that: 1) under the Power Purchase Agreements, Guarantors have the right to temporarily suspend deliveries of capacity and energy to Edison, 2) Guarantors are entitled to resell the energy and capacity to other purchasers and 3) the interim suspension of deliveries to Edison shall not in any respect result in the modifications or termination of the Power Purchase Agreements and the Power Purchase Agreements shall in all respects continue in full force and effect other than the temporary suspension of deliveries to Edison. As a result of the March 22, 2001 Declaratory Judgment, the Guarantors' suspended deliveries of energy to Edison and entered into a transaction agreement with El Paso Merchant Energy, L.P. ("EPME") in which the Imperial Valley projects' available power was sold to EPME based on percentages of the Dow Jones SP-15 Index. On June 18, 2001, the Superior Court terminated the Imperial Valley projects right to resell power pursuant to the Declaratory Judgment. On June 20, 2001, the Guarantors entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). The Settlement Agreements require that Edison make a series of payments to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). The first payment of approximately $11.6 million, which represented 10% of the stipulated amounts, was received June 22, 2001. A second partial payment of 10% is payable within 5 days following the occurrence of Events to restore Edison to creditworthiness (the "Effective Date"). The final payment, representing the remaining stipulated amounts, shall be paid on the 5th business day after Edison receives proceeds from the financing resulting from the occurrence of Events to restore Edison to creditworthiness. In addition to these payments, Edison is required to make monthly interest payments calculated at a rate of 7% per annum on the outstanding stipulated amounts. The Settlement Agreements also provides a revised energy pricing structure, whereby Edison elects to pay the Imperial Valley Projects a fixed energy price of 5.37 cents/kilowatt hour in lieu of the Commission-approved SRAC Methodology under the Power Purchase Agreements, commencing on the first day of the month following the Effective Date and expiring five years from such date. All other contract terms remain unchanged. As a result of the aforementioned Settlement Agreements, the Guarantors resumed power sales to Edison on June 22, 2001. Energy payments are currently calculated using the SRAC formulas set forth in the Power Purchase Agreements until the fixed rate period begins. On October 2, 2001 the California Public Utilities Commission (PUC) and Edison reached a settlement in the Filed Rate Doctrine lawsuit Edison filed in Federal Court against the PUC. By its own terms, the settlement is intended to restore Edison to creditworthiness so that it is able to resume procuring the electricity needed by its customers; limit ratepayers' costs of paying off the debt; and maintain the state's role in regulating the investor owned utility by enabling Edison to pay down its back debts over a reasonable period of time. As a result of such settlement the Guarantors believe the conditions to the Effective Date under the Settlement Agreements have been satisfied. Edison disputes such conditions have been satisfied. The Guarantors are vigorously pursing enforcement of their rights under the Settlement Agreements. As a result of Edison's failure to make the payments due under the Power Purchase Agreements and the recent downgrades of Edison's credit ratings, Moody's has downgraded the ratings for the Salton Sea Funding Securities to Caa2 (negative outlook) and S&P has downgraded the ratings for the Salton Sea Funding Securities to BBB- and has placed the Salton Sea Funding Securities on "credit watch negative". Following the execution of the Settlement Agreements, Moody's placed the Salton Sea Funding Securities on "credit watch positive". The Guarantors are contractually entitled to receive payments due under the Power Purchase Agreements. However, due to the uncertainties associated with Edison's financial condition and failure to pay, the Guarantors have established an allowance for doubtful accounts of approximately $29.2 million at September 30, 2001. The allowance for doubtful accounts has been recorded as a reduction of net sales in the statement of operations. INDEPENDENT ACCOUNTANTS' REPORT Board of Directors and Stockholder Magma Power Company Omaha, Nebraska We have reviewed the accompanying combined balance sheet of the Partnership Guarantors as of September 30, 2001, the related combined statements of operations for the three-month and nine-month periods ended September 30, 2001 and 2000, and the related combined statements of cash flows for the nine-month periods ended September 20, 2001 and 2000. These financial statements are the responsibility of the Partnership Guarantors' management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to such combined financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the combined balance sheet of the Partnership Guarantors as of December 31, 2000, and the related combined statements of operations, Guarantors' equity and cash flows for the year then ended (not presented herein); and in our report dated January 18, 2001 (March 27, 2001 as to Note 8A), we expressed an unqualified opinion on those combined financial statements. In our opinion, the information set forth in the accompanying combined balance sheet as of December 31, 2000 is fairly stated, in all material respects, in relation to the combined balance sheet from which it has been derived. DELOITTE & TOUCHE LLP Omaha, Nebraska October 26, 2001 PARTNERSHIP GUARANTORS COMBINED BALANCE SHEETS (Dollars in Thousands) September 30, December 31, 2001 2000 (unaudited) ASSETS Accounts receivable, net of allowance of $60,802 and $0, respectively (Note 4) $ 42,326 $ 28,319 Prepaid expenses and other assets 19,538 26,661 _________ _________ Total current liabilities 61,864 54,980 Restricted cash 29,657 106 Due from affiliates 25,224 35,066 Property, plant, contracts and equipment, net 468,365 470,804 Construction in progress 150,134 165,460 Management fee 69,305 70,855 Excess of cost over fair value of net assets acquired, net 121,757 124,430 _________ _________ $ 926,306 $ 921,701 =========== ========= LIABILITIES AND GUARANTORS' EQUITY Liabilities: Accounts payable $ 2,738 $ 101 Accrued liabilities 23,934 17,722 Current portion of long term debt 3,267 1,907 _________ _________ Total current liabilities 29,939 19,730 Senior secured project notes 246,429 248,743 Deferred income taxes 100,599 101,734 _________ _________ Total liabilities 376,967 370,207 Commitments and contingencies (Note 4) Guarantors' equity: Common stock 3 3 Additional paid-in capital 387,663 387,663 Retained earnings 161,673 163,828 _________ _________ Total Guarantors' equity 549,339 551,494 _________ _________ $ 926,306 $ 921,701 ========= ========= The accompanying notes are an integral part of these financial statements. PARTNERSHIP GUARANTORS COMBINED STATEMENTS OF OPERATIONS (Dollars in Thousands) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 _________ _________ _________ _________ Revenues: Sales of electricity $ 20,782 $ 35,063 $ 64,352 $ 65,080 Interest and other income 1,702 1,783 2,642 2,884 _________ _________ _________ _________ Total revenues 22,484 36,846 66,994 67,964 _________ _________ _________ _________ Expenses: Operating, general and administration 8,974 12,119 35,646 29,427 Depreciation and amortization 5,877 4,966 17,895 14,459 Interest expense 4,857 4,984 14,479 15,124 Less capitalized interest (2,855) (4,855) (10,338) (14,684) _________ _________ _________ _________ Total expenses 16,853 17,214 57,682 44,326 _________ _________ _________ _________ Income before income taxes 5,631 19,632 9,312 23,638 Provision for income taxes 1,944 6,477 3,213 7,799 _________ _________ _________ _________ Income before cumulative effect of accounting change 3,687 13,155 6,099 15,839 Cumulative effect of accounting change, net of tax --- --- (8,254) --- Net income (loss) $ 3,687 $ 13,155 $ (2,155) $ 15,839 ========== ========= ========== ==========
The accompanying notes are an integral part of these financial statements. PARTNERSHIP GUARANTORS COMBINED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited)
Nine Months Ended September 30, 2001 2000 Cash flows from operating activities: Net income (loss) $ (2,155) $ 15,839 Adjustments to reconcile net income (loss) to net cash flow from operating activities: Depreciation and amortization 17,895 14,459 Cumulative effect of change in accounting principle, net of tax 8,254 --- Deferred income taxes 3,213 7,799 Changes in assets and liabilities: Accounts receivable (14,007) (7,304) Prepaid expenses and other assets (5,481) (4,843) Accounts payable and accrued liabilities 8,849 5,098 ______________ _____________ Net cash flows from operating activities 16,568 31,048 ______________ _____________ Cash flows from investing activities: Capital expenditures (11,394) (11,887) Capital expenditures-construction (14,322) (96,314) Receipt of liquidated damages 29,648 --- Decrease (increase) in restricted cash (29,551) 55,468 Management fee 163 (1,537) ______________ _____________ Net cash flows from investing activities (25,456) (54,270) ______________ _____________ Cash flows from financing activities: Repayments of senior secured project notes (954) (8,562) Decrease in due from affiliates 9,842 31,784 ______________ _____________ Net cash flows from financing activities 8,888 23,222 ______________ _____________ Net change in cash --- --- Cash at beginning of period --- --- ______________ _____________ Cash at end of period $ --- $ --- ============== =============
The accompanying notes are an integral part of these financial statements. PARTNERSHIP GUARANTORS NOTES TO COMBINED FINANCIAL STATEMENTS (Unaudited) 1. General: In the opinion of management of the Partnership Guarantors (the "Guarantors"), the accompanying unaudited combined financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position as of September 30, 2001 and the results of operations for the three and nine months ended September 30, 2001 and 2000 and cash flows for the nine months ended September 30, 2001 and 2000. The results of operations for the nine months ended September 30, 2001 and 2000 are not necessarily indicative of the results to be expected for the full year. The unaudited financial statements shall be read in conjunction with the financial statements included in the Funding Corporation's annual report on Form 10-K for the year ended December 31, 2000. Certain prior year amounts have been reclassified in order to conform with current year classifications. 2. Accounting Policy Change: The Guarantors have changed their policy of accounting for major maintenance, overhaul and well workover costs. These costs, which have historically been accounted for using deferral methods, will be expensed as incurred. The new policy went into effect January 1, 2001 and the Guarantors have recorded a cumulative effect of $8.3 million, net of tax. 3. Accounting Pronouncements: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) 133, "Accounting for Derivative Instruments and Hedging Activities", which was delayed by SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of FASB No. 133" and amended by SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities". SFAS 133 requires an entity to recognize all of its derivatives as either assets or liabilities in its statement of financial position and measure those instruments at fair value. The Guarantors implemented the new standards on January 1, 2001. The initial adoption of SFAS 133 did not have a material impact on the Guarantors' financial position, results of operations or any impact on their cash flows. In June 2001, FASB approved the issuance of SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". These standards, issued in July 2001, establish accounting and reporting for business combinations. SFAS No. 141 requires all business combinations entered into subsequent to June 30, 2001 to be accounted for using the purchase method of accounting. SFAS No. 142 provides that goodwill and other intangible assets with indefinite lives will not be amortized, but will be tested for impairment on an annual basis. These standards are effective for the Guarantors beginning on January 1, 2002. The Guarantors have not quantified the impact resulting from the adoption of these standards. In July 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). This standard addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and the related asset retirement costs. SFAS 143 is effective for the Guarantor's fiscal year beginning January 1, 2003. Management is in the process of evaluating the impact this standard will have on the Guarantors' consolidated financial statements. In August 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" (SFAS 144). The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for the Guarantors' fiscal year beginning January 1, 2002. Management is in the process of evaluating the impact this standard will have on the Guarantors' consolidated financial statements. 4. Contingency: Southern California Edison ("Edison"), a wholly-owned subsidiary of Edison International, is a public utility primarily engaged in the business of supplying electric energy to retail customers in Central and Southern California, excluding Los Angeles. The Funding Corporation is aware that there have been public announcements that Edison's financial condition has deteriorated as a result of reduced liquidity. Edison's senior unsecured debt obligations are currently rated Caa2 by Moody's and D by S&P. Edison failed to pay approximately $76.9 million due under the Power Purchase Agreements for power delivered in November and December 2000 and January, February and March 2001, although the Power Purchase Agreements provide for billing and payment on a schedule where payments would have normally been received in early January, February, March, April and May 2001. On February 21, 2001, certain Guarantors filed a lawsuit against Edison in California's Imperial County Superior Court seeking a court order requiring Edison to make the required payments under the Power Purchase Agreements. The lawsuit also requested, among other things, that the court order permit these Guarantors to suspend deliveries of power to Edison and to permit the Guarantors to sell such power to other purchasers in California. On March 22, 2001, the Superior Court granted Guarantors' Motion for Summary Adjudication and a Declaratory Judgment ordering that: 1) under the Power Purchase Agreements, Guarantors have the right to temporarily suspend deliveries of capacity and energy to Edison, 2) Guarantors are entitled to resell the energy and capacity to other purchasers and 3) the interim suspension of deliveries to Edison shall not in any respect result in the modifications or termination of the Power Purchase Agreements and the Power Purchase Agreements shall in all respects continue in full force and effect other than the temporary suspension of deliveries to Edison. As a result of the March 22, 2001 Declaratory Judgment, the Guarantors' suspended deliveries of energy to Edison and entered into a transaction agreement with El Paso Merchant Energy, L.P. ("EPME") in which the Imperial Valley projects' available power was sold to EPME based on percentages of the Dow Jones SP-15 Index. On June 18, 2001, the Superior Court terminated the Imperial Valley projects right to resell power pursuant to the Declaratory Judgment. On June 20, 2001, the Guarantors entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). The Settlement Agreements require that Edison make a series of payments to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). The first payment of approximately $11.6 million, which represented 10% of the stipulated amounts, was received June 22, 2001. A second partial payment of 10% is payable within 5 days following the occurrence of Events to restore Edison to creditworthiness (the "Effective Date"). The final payment, representing the remaining stipulated amounts, shall be paid on the 5th business day after Edison receives proceeds from the financing resulting from the occurrence of Events to restore Edison to creditworthiness. In addition to these payments, Edison is required to make monthly interest payments calculated at a rate of 7% per annum on the outstanding stipulated amounts. The Settlement Agreements also provides a revised energy pricing structure, whereby Edison elects to pay the Imperial Valley Projects a fixed energy price of 5.37 cents/kilowatt hour in lieu of the Commission-approved SRAC Methodology under the Power Purchase Agreements, commencing on the first day of the month following the Effective Date and expiring five years from such date. All other contract terms remain unchanged. As a result of the aforementioned Settlement Agreements, the Guarantors resumed power sales to Edison on June 22, 2001. Energy payments are currently calculated using the SRAC formulas set forth in the Power Purchase Agreements until the fixed rate period begins. On October 2, 2001 the California Public Utilities Commission (PUC) and Edison reached a settlement in the Filed Rate Doctrine lawsuit Edison filed in Federal Court against the PUC. By its own terms, the settlement is intended to restore Edison to creditworthiness so that it is able to resume procuring the electricity needed by its customers; limit ratepayers' costs of paying off the debt; and maintain the state's role in regulating the investor owned utility by enabling Edison to pay down its back debts over a reasonable period of time. As a result of such settlement the Guarantors believe the conditions to the Effective Date under the Settlement Agreements have been satisfied. Edison disputes such conditions have been satisfied. The Guarantors are vigorously pursing enforcement of their rights under the Settlement Agreements. As a result of Edison's failure to make the payments due under the Power Purchase Agreements and the recent downgrades of Edison's credit ratings, Moody's downgraded the ratings for the Salton Sea Funding Securities to Caa2 (negative outlook) and S&P has downgraded the ratings for the Salton Sea Funding Securities to BBB- and placed the Salton Sea Funding Securities on "credit watch negative". Following the execution of the Settlement Agreements, Moody's placed the Salton Sea Funding Securities on "credit watch positive". The Guarantors are contractually entitled to receive payment under the Power Purchase Agreements and Settlement Agreements. However, due to the uncertainties associated with Edison's financial condition and failure to pay contractual obligations, the Guarantors have established an allowance for doubtful accounts of approximately $60.8 million on September 30, 2001. The allowance for doubtful accounts has been recorded as a reduction of net sales in the statement of operations. CalEnergy Minerals LLC, a Partnership Guarantor ("Minerals LLC") owns the rights to proprietary processes for the extraction of zinc from elements in solution in the geothermal brine and fluids utilized at the Guarantor's Imperial Valley plants. A pilot plant has successfully produced commercial quality zinc at the Guarantor's Imperial Valley Project. The Guarantor's affiliates intend to sequentially develop facilities for the extraction of manganese, silver, gold, lead, boron, lithium and other products as they further develop the extraction technology. Minerals LLC is constructing the Zinc Recovery Project which will recover zinc from the geothermal brine (the "Zinc Recovery Project"). Facilities are being installed near the Guarantors sites to extract a zinc chloride solution from the geothermal brine through an ion exchange process. This solution will be transported to a central processing plant where zinc ingots will be produced through solvent extraction, electrowinning and casting processes. The Zinc Recovery Project is designed to have a capacity of approximately 30,000 metric tones per year and is scheduled to commence commercial operations in 2002. In September 1999, Minerals LLC entered into a sales agreement whereby all high grade zinc produced by the Zinc Recovery Project will be sold to Cominco, Ltd. The initial term of the agreement expires in December 2005. The Zinc Recovery Project was being constructed by Kvaerner U.S. Inc. ("Kvaerner") pursuant to a date certain, fixed-price, turnkey engineering, procure, construct and manage contract (the "Zinc Recovery Project EPC Contract"). On June 14, 2001, Minerals LLC issued notices of default, termination and demand for payment of damages to Kvaerner under the Zinc Recovery Project EPC Contract due to failure to meet performance obligations. As a result of Kvaerner's failure to pay monetary obligations under the Zinc Recovery EPC Contract, the Guarantors drew $29.7 million under the EPC Contract Letter of Credit on July 20, 2001. The Guarantors have entered into a time and materials reimbursable engineer, procure and construction management contract with AMEC E&C Services, Inc. to complete the Zinc Recovery Project. On July 11, 2001, Kvaerner filed an Amended Demand For Arbitration against Minerals LLC characterizing the nature of the dispute as concerns regarding change orders and performance penalties. Kvaerner did not state the amount of its claim. On August 7, 2001, Minerals LLC filed an Answering Statement and Counterclaim against Kvaerner. Minerals LLC denied all material allegations in Kvaerner's Amended Demand for Arbitration, and asserted a counterclaim against Kvaerner for breach of contract and specific performance. Minerals LLC alleged that its total estimated damage for Kvaerner's breach of contract are in excess of approximately $60.0 million; however, Minerals LLC has offset approximately $42.5 million of these damages by exercising its rights under the EPC Contract to claim the retainage and by drawing on a letter of credit. Therefore, Minerals LLC asked for a judgment in excess of approximately $20.0 million. The arbitration is scheduled for June 2002. INDEPENDENT ACCOUNTANTS' REPORT Board of Directors and Stockholder Magma Power Company Omaha, Nebraska We have reviewed the accompanying balance sheet of the Salton Sea Royalty LLC as of September 30, 2001, and the related statements of operations for the three-month and nine-month periods ended September 30, 2001 and 2000, and the related statements of cash flows for the nine-month periods ended September 30, 2001 and 2000. These financial statements are the responsibility of the Salton Sea Royalty LLC's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to such financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the balance sheet of the Salton Sea Royalty LLC as of December 31, 2000, and the related statements of operations, equity, and cash flows for the year then ended (not presented herein); and in our report dated January 18, 2001 (March 27, 2001 as to Note 5), we expressed an unqualified opinion on those financial statements. In our opinion, the information set forth in the accompanying balance sheet as of December 31, 2000 is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived. DELOITTE & TOUCHE LLP Omaha, Nebraska October 26, 2001 SALTON SEA ROYALTY LLC BALANCE SHEETS (Dollars in Thousands, Except per Share Amounts) September 30, December 31, 2001 2000 (unaudited) ASSETS Prepaid expenses and other assets $ 44 $ 82 __________ __________ Total current assets 44 82 Royalty stream, net 14,938 15,719 Excess of cost over fair value of net assets acquired, net 30,691 31,372 Due from affiliates 28,890 26,497 __________ __________ $ 74,563 $ 73,670 ========== ========== LIABILITIES AND EQUITY Liabilities: Accrued liabilities $ 168 $ 57 Current portion of long term debt 3,947 4,434 __________ __________ Total current liabilities 4,115 4,491 Senior secured project note 2,877 4,607 __________ __________ Total liabilities 6,992 9,098 Commitment and contingencies (Note 3) Equity: Common stock, par value $.01 per share; 100 share authorized, issued and outstanding --- --- Additional paid-in capital 1,561 1,561 Retained earnings 66,010 63,011 __________ __________ Total equity 67,571 64,572 __________ __________ $ 74,563 $ 73,670 ========== ========== The accompanying notes are an integral part of these financial statements. SALTON SEA ROYALTY LLC COMBINED STATEMENTS OF OPERATIONS (Dollars in Thousands) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 _________ _________ _________ _________ Revenues: Royalty income $ 759 $ 3,816 $ 6,598 $ 8,083 Expenses: Operating, general and administrative expenses 126 1,099 1,655 2,272 Amortization of royalty stream and goodwill 487 491 1,462 1,474 Interest expense 139 206 482 748 _________ _________ _________ _________ Total expenses 752 1,796 3,599 4,494 _________ _________ _________ _________ Net income $ 7 $ 2,020 $ 2,999 $ 3,589 ========= ========= ========= =========
The accompanying notes are an integral part of these financial statements. SALTON SEA ROYALTY LLC STATEMENT OF CASH FLOWS (Dollars in Thousands) (Unaudited) Nine Months Ended September 30, 2001 2000 Cash flows from operating activities: Net income $ 2,999 $ 3,589 Adjustments to reconcile net income to net cash flow from operating activities: Amortization of royalty stream and goodwill 1,462 1,474 Changes in assets and liabilities: Prepaid expenses and other assets 38 115 Accrued liabilities 111 141 ____________ ___________ Net cash flows from operating activities 4,610 5,319 Net cash flows from financing activities: Increase in due from affiliates (2,393) (558) Repayment of senior secured project note (2,217) (4,761) ____________ ___________ Net cash flows from financing activities (4,610) (5,319) Net change in cash --- --- Cash at beginning of period --- --- ____________ ___________ Cash at end of period $ --- $ --- ============ =========== The accompanying notes are an integral part of these financial statements. SALTON SEA ROYALTY LLC NOTES TO FINANCIAL STATEMENTS (Unaudited) 1. General: In the opinion of management of the Salton Sea Royalty LLC (the "Company"), the accompanying unaudited financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position as of September 30, 2001 and the results of operations for the three and nine months ended September 30, 2001 and 2000 and cash flows for the nine months ended September 30, 2001 and 2000. The results of operations for the nine months ended September 30, 2001 and 2000 are not necessarily indicative of the results to be expected for the full year. The unaudited financial statements shall be read in conjunction with the financial statements included in the Funding Corporation's annual report on Form 10-K for the year ended December 31, 2000. 2. Accounting Pronouncements: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) 133, "Accounting for Derivative Instruments and Hedging Activities", which was delayed by SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of FASB No. 133" and amended by SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities". SFAS 133 requires an entity to recognize all of its derivatives as either assets or liabilities in its statement of financial position and measure those instruments at fair value. The Guarantors implemented the new standards on January 1, 2001. The initial adoption of SFAS 133 did not have a material impact on the Guarantors' financial position, results of operations or any impact on their cash flows. In June 2001, FASB approved the issuance of SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". These standards, issued in July 2001, establish accounting and reporting for business combinations. SFAS No. 141 requires all business combinations entered into subsequent to June 30, 2001 to be accounted for using the purchase method of accounting. SFAS No. 142 provides that goodwill and other intangible assets with indefinite lives will not be amortized, but will be tested for impairment on an annual basis. These standards are effective for the Company beginning on January 1, 2002. The Company has not quantified the impact resulting from the adoption of these standards. In July 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (SFAS 143). This standard addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and the related asset retirement costs. SFAS 143 is effective for the Company's fiscal year beginning January 1, 2003. Management is in the process of evaluating the impact this standard will have on the Company's consolidated financial statements. In August 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" (SFAS 144). The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for the Company's fiscal year beginning January 1, 2002. Management is in the process of evaluating the impact this standard will have on the Company's consolidated financial statements. 3. Contingency: Southern California Edison ("Edison"), a wholly-owned subsidiary of Edison International, is a public utility primarily engaged in the business of supplying electric energy to retail customers in Central and Southern California, excluding Los Angeles. The Funding Corporation is aware that there have been public announcements that Edison's financial condition has deteriorated as a result of reduced liquidity. Edison's senior unsecured debt obligations are currently rated Caa2 by Moody's and D by S&P. Edison failed to pay approximately $119 million to the Guarantors due under the Power Purchase Agreements for power delivered in November and December 2000 and January, February and March 2001, although the Power Purchase Agreements provide for billing and payment on a schedule where payments would have normally been received in early January, February, March, April and May 2001. On February 21, 2001, certain Guarantors filed a lawsuit against Edison in California's Imperial County Superior Court seeking a court order requiring Edison to make the required payments under the Power Purchase Agreements. The lawsuit also requested, among other things, that the court order permit the Guarantors to suspend deliveries of power to Edison and to permit the Guarantors to sell such power to other purchasers in California. On March 22, 2001, the Superior Court granted Guarantors' Motion for Summary Adjudication and a Declaratory Judgment ordering that: 1) under the Power Purchase Agreements, Guarantors have the right to temporarily suspend deliveries of capacity and energy to Edison, 2) Guarantors are entitled to resell the energy and capacity to other purchasers and 3) the interim suspension of deliveries to Edison shall not in any respect result in the modifications or termination of the Power Purchase Agreements and the Power Purchase Agreements shall in all respects continue in full force and effect other than the temporary suspension of deliveries to Edison. As a result of the March 22, 2001 Declaratory Judgment, the Guarantors' suspended deliveries of energy to Edison and entered into a transaction agreement with El Paso Merchant Energy, L.P. ("EPME") in which the Imperial Valley projects' available power was sold to EPME based on percentages of the Dow Jones SP-15 Index. On June 18, 2001, the Superior Court terminated the Imperial Valley projects right to resell power pursuant to the Declaratory Judgment. On June 20, 2001, the Guarantors entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). The Settlement Agreements require that Edison make a series of payments to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). The first payment of approximately $11.6 million, which represented 10% of the stipulated amounts, was received June 22, 2001. A second partial payment of 10% is payable within 5 days following the occurrence of Events to restore Edison to creditworthiness (the "Effective Date"). The final payment, representing the remaining stipulated amounts, shall be paid on the 5th business day after Edison receives proceeds from the financing resulting from the occurrence of Events to restore Edison to creditworthiness. In addition to these payments, Edison is required to make monthly interest payments calculated at a rate of 7% per annum on the outstanding stipulated amounts. The Settlement Agreements also provides a revised energy pricing structure, whereby Edison elects to pay the Imperial Valley Projects a fixed energy price of 5.37 cents/kilowatt hour in lieu of the Commission-approved SRAC Methodology under the Power Purchase Agreements, commencing on the first day of the month following the Effective Date and expiring five years from such date. All other contract terms remain unchanged. As a result of the aforementioned Settlement Agreements, the Guarantors resumed power sales to Edison on June 22, 2001. Energy payments are currently calculated using the SRAC formulas set forth in the Power Purchase Agreements until the fixed rate period begins. On October 2, 2001 the California Public Utilities Commission (PUC) and Edison reached a settlement in the Filed Rate Doctrine lawsuit Edison filed in Federal Court against the PUC. By its own terms, the settlement is intended to restore Edison to creditworthiness so that it is able to resume procuring the electricity needed by its customers; limit ratepayers' costs of paying off the debt; and maintain the state's role in regulating the investor owned utility by enabling Edison to pay down its back debts over a reasonable period of time. As a result of such settlement the Guarantors believe the conditions to the Effective Date under the Settlement Agreements have been satisfied. Edison disputes such conditions have been satisfied. The Guarantors are vigorously pursing enforcement of their rights under the Settlement Agreements. As a result of Edison's failure to make the payments due under the Power Purchase Agreements and the recent downgrades of Edison's credit ratings, Moody's has downgraded the ratings for the Salton Sea Funding Securities to Caa2 (negative outlook) and S&P has downgraded the ratings for the Salton Sea Funding Securities to BBB- and has placed the Salton Sea Funding Securities on "credit watch negative". Following the execution of the Settlement Agreements, Moody's placed the Salton Sea Funding Securities on "credit watch positive". The Guarantors' are contractually entitled to receive payments under the Power Purchase Agreements and Settlement Agreements. However, due to the uncertainties associated with Edison's financial condition and failures to pay contractual obligations, the Guarantors have established an allowance for doubtful accounts of approximately $90 million on September 30, 2001. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following is management's discussion and analysis of certain significant factors which have affected the Salton Sea Funding Corporation's (the "Funding Corporation") and the Salton Sea Guarantors, the Partnership Guarantors and the Salton Sea Royalty LLC's (collectively, the "Guarantors") financial condition and results of operations during the periods included in the accompanying statements of operations. Business Funding Corporation was organized for the sole purpose of acting as issuer of senior secured notes and bonds (the "Securities"). The Securities are payable from the proceeds of payments made of principal and interest on the senior secured project notes by the Guarantors to the Funding Corporation. The Securities are guaranteed on a joint and several basis by the Guarantors. The guarantees of the Partnership Guarantors and Salton Sea Royalty LLC are limited to available cash flow. The Funding Corporation does not conduct any operations apart from the Securities. Power Purchase Agreements The Vulcan, Leathers, Del Ranch and Elmore partnerships (collectively, the "Partnership Projects") sell all electricity generated by the respective plants pursuant to four long-term SO4 Agreements between the projects and Southern California Edison Company ("Edison"). These SO4 Agreements provide for capacity payments, capacity bonus payments and energy payments. Edison is contractually obligated to make fixed annual capacity payments to the projects and, to the extent that capacity factors exceed certain benchmarks, is required to make capacity bonus payments. The price for capacity and capacity bonus payments is fixed for the life of the SO4 Agreements and the capacity payments are significantly higher in the months of June through September. The price for energy sold is based on the cost that Edison avoids by purchasing energy from the Partnership Projects instead of obtaining the energy from other sources (avoided cost of energy) for energy delivered pursuant to their respective SO4 Agreements. The Salton Sea I Project sells electricity to Edison pursuant to a 30-year negotiated power purchase agreement, as amended (the "Salton Sea I PPA"), which provides for capacity and energy payments. The energy payment is calculated using a base price, which is subject to quarterly adjustments based on a basket of indices. The time period weighted average energy payment for Salton Sea I was 5.9 cents per kWh during the nine months ended September 30, 2001. As the Salton Sea I PPA is not an SO4 Agreement, the energy payments do not revert to Edison's avoided cost of energy. The Salton Sea II and Salton Sea III Projects sells electricity to Edison pursuant to 30-year modified SO4 Agreements that provide for capacity payments, capacity bonus payments and energy payments. The price for contract capacity and contract capacity bonus payments is fixed for the life of the modified SO4 Agreements. The energy payments for the first ten year period, which expired on April 4, 2000 for Salton Sea II and expired on February 13, 1999 for Salton Sea III, were levelized at a time period weighted average of 10.6 cents per kWh and 9.8 cents per kWh for Salton Sea II and Salton Sea III, respectively. Thereafter, the price for energy is Edison's avoided cost of energy. For Salton Sea II only, Edison is entitled to receive, at no cost, 5% of all energy delivered in excess of 80% of contract capacity through March 31, 2004. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ The Salton Sea IV Project sells electricity to Edison pursuant to a modified SO4 Agreement which provides for contract capacity payments on 34 MW of capacity at two different rates based on the respective contract capacities deemed attributable to the original Salton Sea PPA option (20 MW) and to the original Fish Lake Power Purchase Agreement ("PPA") (14 MW). The capacity payment price for the 20 MW portion adjusts quarterly based upon specified indices and the capacity payment price for the 14 MW portion is a fixed levelized rate. The energy payment (for deliveries up to a rate of 39.6 MW) is at a fixed price for 55.6% of the total energy delivered by Salton Sea IV and is based on an energy payment schedule for 44.4% of the total energy delivered by Salton Sea IV. The contract has a 30-year term but Edison is not required to purchase the 20 MW of capacity and energy originally attributable to the Salton Sea I PPA option after September 30, 2017, the original termination date of the Salton Sea I PPA. Edison's average avoided cost of energy was 8.9 cents per kWh and 4.6 per kWh for the nine months ended September 30, 2001 and 2000, respectively. Estimates of Edison's future avoided cost of energy vary substantially from year to year. The Company cannot predict the likely level of avoided cost of energy prices under the SO4 Agreements and the modified SO4 Agreements. The Salton Sea V project, which commenced operations in the third quarter of 2000, will sell approximately one-third of its net output to a zinc facility, which is owned by a subsidiary of MidAmerican and is expected to commence commercial operations in 2002. The remainder of the Salton Sea V output is sold through other market transactions. The CE Turbo project, which commenced commercial operation in the third quarter of 2000, sells its output through market transactions. The CE Turbo project may sell its output to a zinc facility, which is owned by a subsidiary of MidAmerican and is expected to commence commercial operations in 2002. The remainder of the CE Turbo Project output is sold through other market transactions. As a result of legal proceedings with Edison, on March 22, 2001 the Partnership Projects and Salton Sea I, Salton Sea II, Salton Sea III and Salton Sea IV suspended power sales to Edison. On March 27, 2001 and May 1, 2001, the Partnership projects, including the CE Turbo project, and Salton Sea Projects entered into a transaction agreement to sell available power to EPME based on percentages of the Dow Jones SP-15 Index. On June 20, 2001 the Partnership and Salton Sea Projects (excluding Salton Sea Unit V and CE Turbo) entered into Agreements Addressing Payment and Pricing Issues with Edison and, as a result, resumed power sales to Edison on June 22, 2001. See discussion in Liquidity and Capital Resources, page 38. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Results of Operations The following data includes the aggregate capacity and electricity production of Salton Sea Units I, II, III, IV and V:
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 Overall capacity factor 79.9% 77.6% 79.9% 67.5% Capacity (NMW) (weighted average) 168.4 168.4 168.4 138.5 kWh produced (in thousands) 297,200 288,400 881,900 614,400
The overall capacity factor for the Salton Sea Projects increased for the three and nine months ended September 30, 2001 compared to the same periods in 2000 primarily due to timing of overhauls and other maintenance. The capacity increased due to the start up of Salton Sea Unit V in the third quarter of 2000. The following data includes the aggregate capacity and electricity production of the Partnership Projects:
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 Overall capacity factor 105.9% 103.7% 102.2% 95.5% Capacity (NMW) (weighted average) 158 154.6 158 150.2 kWh produced (in thousands) 369,600 353,900 1,058,200 943,100
The overall capacity factor for the Partnership Projects increased for the three months and nine months ended September 30, 2001 compared to the same periods in 2000 due to timing of overhauls and other maintenance. The capacity increased due to the start up of CE Turbo in the third quarter of 2000. Revenues: The Salton Sea Guarantors' sales of electricity decreased to $22,853 for the three months ended September 30, 2001 from $32,375 for the same period in 2000, a 29.4% decrease. For the nine months ended September 30, 2001, sales of electricity increased to $77,847 from $59,873 in 2000, a 30.0% increase. Due to uncertainties associated with Edison's financial condition and failure to pay, the Salton Sea Guarantors have established an allowance for doubtful accounts of approximately $29.2 million. The decrease in the quarter was primarily due to the increased allowance for doubtful accounts and lower avoided cost rates. The year to date increase was primarily due to higher avoided cost rates in 2001, the start up of Unit V in the third quarter of 2000 and scheduled overhauls in 2000, which were more extensive compared to 2001 partially offset by the allowance for doubtful accounts. The Salton Sea Guarantors' interest and other income increased to $652 for the three months ended September 30, 2001 from $119 for the same period in 2000. For the nine months ended September 30, 2001, interest and other income increased to $1,629 from $332 in 2000. The increase was due to a payment of interest income by Edison as part of a settlement agreement. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Revenues: (continued) The Partnership Guarantors' sales of electricity decreased to $20,782 for the three months ended September 30, 2001 from $35,063 for the same period in 2000, a 40.7% decrease. For the nine months ended September 30, 2001, sales of electricity decreased to $64,352 from $65,080 in 2000, a 1.1% decrease. Due to uncertainties associated with Edison's financial conditions and failure to pay, the Partnership Guarantors have established an allowance for doubtful accounts of approximately $60.8 million. The decrease in the quarter was primarily due to the increased allowance for doubtful accounts and lower avoided cost rates. The year to date decrease was primarily due to the allowance for doubtful accounts, partially offset by higher production and higher avoided cost rates in 2001. The Royalty Guarantor revenue decreased to $759 for the three months ended September 30, 2001 from $3,816 for the same period last year. For the nine months ended September 30, 2001 royalty revenue decreased to $6,598 from $8,083 in 2000. These decreases were due primarily to lower energy revenue from the Partnership Projects. Operating Expenses: The Salton Sea Guarantors' operating expenses, which include royalty, operating, and general and administrative expenses, increased to $15,438, for the three months ended September 30, 2001 from $11,288 for the same period in 2000. For the nine months ended September 30, 2001, operating expense increased to $43,004 from $23,852 in 2000. The increases were due to higher brine disposal costs and the start up of Unit V in the third quarter of 2000. The year to date increase was also due to higher royalty expenses resulting from higher revenues. The Partnership Guarantors' operating expenses, which include royalty, operating, and general and administrative expenses, decreased to $8,974 for the three months ended September 30, 2001 from $12,119 for the same period in 2000. The decrease in costs in the third quarter was due to a decrease in royalty expense resulting from lower revenues. For the nine month period ended September 30, 2001, operating expenses increased to $35,646 from $29,427 in 2000. The increase for the nine months was due to the start up of CE Turbo in the third quarter of 2000 and higher brine disposal costs. For the three months ended September 30, 2001 the Royalty Guarantors' operating expenses decreased to $126 from $1,099 for the same period in 2000. The decrease was due to lower royalty costs resulting from lower energy revenue. For the nine months ended September 30, 2001, operating expenses decreased to $1,655 from $2,272 in 2000. This decrease was due to lower royalty costs resulting from lower energy revenue. Depreciation and Amortization: The Salton Sea Guarantors' depreciation and amortization decreased to $4,372 for the three months ended, September 30 2001 from $4,751 for the same period of 2000, a 8.0% decrease. For the nine months ended September 30, 2001, depreciation and amortization increased to $13,382 from $13,072 in 2000, a 2.4% increase. The increase was due primarily to the start up of Unit V in the third quarter of 2000. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Depreciation and Amortization: (continued) The Partnership Guarantors' depreciation and amortization increased to $5,877 for the three months ended September 30, 2001 from $4,966 for the same period in 2000. For the nine months ended September 30, 2001 depreciation and amortization increased to $17,895 from $14,459 in 2000. The increases were due primarily to the upgraded brine handling system and the start up of CE Turbo in the third quarter of 2000. The Royalty Guarantors' amortization was $487 for the three months ended September 30, 2001 compared to $491 for the same period of 2000. For the nine months ended September 30, 2001, amortization was $1,462 compared to $1,474 in 2000. Interest Expense: The Salton Sea Guarantors' interest expense, net of capitalized interest, increased to $5,574 for the three months ended September 30, 2001 from $3,757 for the same period in 2000. For the nine months ended September 30, 2001, interest expense, net of capitalized interest, increased to $15,186 from $9,252 in 2000. The increases were due to the discontinuance of capitalizing interest on the minerals extraction process partially offset by reduced indebtedness. The Partnership Guarantors' interest expense, net of capitalized interest, increased to $2,002 for the three months ended September 30, 2001 from $129 for the same period in 2000. For the nine months ended September 30, 2001, interest expense, net of capitalized interest, increased to $4,141 from $440 in 2000. The increases were due to the discontinuance of capitalizing interest on the minerals extraction process partially offset by reduced indebtedness. The Royalty Guarantors' interest expense decreased to $139 for the three months ended September 30, 2001 from $206 from the same period in 2000. For the nine months ended September 30, 2001, interest expense decreased to $482 from $748 in 2000. The decreases were due to reduced indebtedness. Income Tax Provision: The Salton Sea Guarantors are comprised of partnerships. Income taxes are the responsibility of the partners and Salton Sea Guarantors have no obligation to provide funds to the partners for payment of any tax liabilities. Accordingly, the Salton Sea Guarantors have no tax obligations. The Partnership Guarantors income tax benefit was $1,944 for the three months ended September 30, 2001 compared to a provision of $6,477 for the same period in 2000. For the nine months ended September 30, 2001, the income tax provision decreased to $3,213 from $7,799 in 2000. These decreases were primarily due to a lower pre-tax income. Income taxes will be paid by the parent of the Partnership Guarantors from distributions to the parent company by the Partnership Guarantors which occur after operating expenses and debt service. The Royalty Guarantor is a partnership. Income taxes are the responsibility of the partners and Royalty Guarantor has no obligation to provide funds to the partners for payment of any tax liabilities. Accordingly, the Royalty Guarantor has no tax obligations. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Cumulative Effect of Accounting Policy Change: The Guarantors have changed their policy of accounting for major maintenance, overhaul and well workover costs. These costs, which have historically been accounted for using deferral methods, will be expensed as incurred. The new policy went into effect January 1, 2001 and the Salton Sea Guarantors have recorded a cumulative effect of this change of $8.7 million. The Partnership Guarantors have recorded a cumulative effect of this change of $8.3 million, net of tax. Net Income (Loss): The Salton Sea Funding Corporation's net income for the three months ended September 30, 2001 was $181 compared to a net income of $184 for the same period in 2000. For the nine months ended September 30, 2001 the net income was $62 compared to $126 in 2000. The net income primarily represents interest income and expense, net of applicable tax, and the Salton Sea Funding Corporation's 1% equity in earnings of the Guarantors. The Salton Sea Guarantors had a net loss of $1,879 for the three months ended September 30, 2001 compared to net income of $12,698 for the same period of 2000. For the nine months ended September 30, 2001, the net loss was $839 compared to net income of $14,029 in 2000. The Partnership Guarantors had a net income of $3,687 for the three months ended September 30, 2001 compared to net income of $13,155 for the same period of 2000. For the nine months ended September 30, 2001, the Partnership Guarantors' had a net loss of $2,155 compared to net income of $15,839 in 2000. The Royalty Guarantor's net income decreased to $7 for the three months ended September 30, 2001 compared to $2,020 for the same period of 2000. For the nine months ended September 30, 2001, net income decreased to $2,999 from $3,589 in 2000. Liquidity and Capital Resources: Prior to March 22, 2001 and after June 22, 2001, the operating Salton Sea Guarantors' only source of revenue is payments received pursuant to long term power sales agreements with Edison, other than Salton Sea V revenue and interest earned on funds on deposit. Prior to March 22, 2001 and after June 22, 2001, the operating Partnership Guarantors' primary source of revenue is payments received pursuant to long term power sales agreements with Edison, other than CE Turbo and interest earned on funds on deposit. The Royalty Guarantor's only source of revenue is Royalties received pursuant to resource lease and service agreements with the Partnership Projects. If Edison pays the projects, these payments, for each of the Guarantors, are expected to be sufficient to fund operating and maintenance expenses, payments of interest and principal on the Salton Sea Funding Securities, projected capital expenditures and debt service reserve fund requirements. Edison, a wholly-owned subsidiary of Edison International, is a public utility primarily engaged in the business of supplying electric energy to retail customers in Central and Southern California, excluding Los Angeles. The Funding Corporation is aware that there have been public announcements that Edison's financial condition has deteriorated as a result of reduced liquidity. Edison's senior unsecured debt obligations are currently rated Caa2 by Moody's and D by S&P. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Liquidity and Capital Resources: (continued) Edison failed to pay approximately $119 million due under the Power Purchase Agreements for power delivered in November and December 2000 and January, February and March 2001, although the Power Purchase Agreements provide for billing and payment on a schedule where payments would have normally been received in early January, February, March, April and May 2001. On February 21, 2001, certain Guarantors filed a lawsuit against Edison in California's Imperial County Superior Court seeking a court order requiring Edison to make the required payments under the Power Purchase Agreements. The lawsuit also requested, among other things, that the court order permit the Guarantors to suspend deliveries of power to Edison and to permit the Guarantors to sell such power to other purchasers in California. On March 22, 2001, the Superior Court granted Guarantors' Motion for Summary Adjudication and a Declaratory Judgment ordering that: 1) under the Power Purchase Agreements, Guarantors have the right to temporarily suspend deliveries of capacity and energy to Edison, 2) Guarantors are entitled to resell the energy and capacity to other purchasers and 3) the interim suspension of deliveries to Edison shall not in any respect result in the modifications or termination of the Power Purchase Agreements and the Power Purchase Agreements shall in all respects continue in full force and effect other than the temporary suspension of deliveries to Edison. As a result of the March 22, 2001 Declaratory Judgment, the Guarantors' suspended deliveries of energy to Edison and entered into a transaction agreement with El Paso Merchant Energy, L.P. ("EPME") in which the Imperial Valley projects' available power was sold to EPME based on percentages of the Dow Jones SP-15 Index. On June 18, 2001, the Superior Court terminated the Imperial Valley projects right to resell power pursuant to the Declaratory Judgment. On June 20, 2001, the Guarantors entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). The Settlement Agreements require that Edison make a series of payments to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). The first payment of approximately $11.6 million, which represented 10% of the stipulated amounts, was received June 22, 2001. A second partial payment of 10% is payable within 5 days following the occurrence of Events to restore Edison to creditworthiness (the "Effective Date"). The final payment, representing the remaining stipulated amounts, shall be paid on the 5th business day after Edison receives proceeds from the financing resulting from the occurrence of Events to restore Edison to creditworthiness. In addition to these payments, Edison is required to make monthly interest payments calculated at a rate of 7% per annum on the outstanding stipulated amounts. The Settlement Agreements also provides a revised energy pricing structure, whereby Edison elects to pay the Imperial Valley Projects a fixed energy price of 5.37 cents/kilowatt hour in lieu of the Commission-approved SRAC Methodology under the Power Purchase Agreements, commencing on the first day of the month following the Effective Date and expiring five years from such date. All other contract terms remain unchanged. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Liquidity and Capital Resources: (continued) As a result of the aforementioned Settlement Agreements, the Guarantors resumed power sales to Edison on June 22, 2001. Energy payments are currently calculated using the SRAC formulas set forth in the Power Purchase Agreements until the fixed rate period begins. On October 2, 2001 the California Public Utilities Commission (PUC) and Edison reached a settlement in the Filed Rate Doctrine lawsuit Edison filed in Federal Court against the PUC. By its own terms, the settlement is intended to restore Edison to creditworthiness so that it is able to resume procuring the electricity needed by its customers; limit ratepayers' costs of paying off the debt; and maintain the state's role in regulating the investor owned utility by enabling Edison to pay down its back debts over a reasonable period of time. As a result of such settlement the Guarantors believe the conditions to the Effective Date under the Settlement Agreements have been satisfied. Edison disputes such conditions have been satisfied. The Guarantors are vigorously pursing enforcement of their rights under the Settlement Agreements. As a result of Edison's failure to make the payments due under the Power Purchase Agreements and the downgrades of Edison's credit ratings, Moody's downgraded the ratings for the Salton Sea Funding Securities to Caa2 (negative outlook) and S&P downgraded the ratings for the Salton Sea Funding Securities to BBB- and placed the Salton Sea Funding Securities on "credit watch negative". Following the execution of the Settlement Agreements, Moody's placed the Salton Sea Funding Securities on "credit watch positive". CalEnergy Minerals LLC, a Partnership Guarantor ("Minerals LLC") owns the rights to proprietary processes for the extraction of zinc from elements in solution in the geothermal brine and fluids utilized at the company's Imperial Valley plants. A pilot plant has successfully produced commercial quality zinc at the Company's Imperial Valley Project. The Company's affiliates intend to sequentially develop facilities for the extraction of manganese, silver, gold, lead, boron, lithium and other products as they further develop the extraction technology. Minerals LLC is constructing the Zinc Recovery Project which will recover zinc from the geothermal brine (the "Zinc Recovery Project"). Facilities are being installed near the Guarantors sites to extract a zinc chloride solution from the geothermal brine through an ion exchange process. This solution will be transported to a central processing plant where zinc ingots will be produced through solvent extraction, electrowinning and casting processes. The Zinc Recovery Project is designed to have a capacity of approximately 30,000 metric tonnes per year and is scheduled to commence commercial operations in 2002. In September 1999, Minerals LLC entered into a sales agreement whereby all high grade zinc produced by the Zinc Recovery Project will be sold to Cominco, Ltd. The initial term of the agreement expires in December 2005. The Zinc Recovery Project was being constructed by Kvaerner U.S. Inc. ("Kvaerner") pursuant to a date certain, fixed-price, turnkey engineering, procure, construct and manage contract (the "Zinc Recovery Project EPC Contract"). On June 14, 2001, Minerals LLC issued notices of default, termination and demand for payment of damages to Kvaerner under the Zinc Recovery Project EPC Contract due to failure to meet performance obligations. As a result of Kvaerner's failure to pay monetary obligations under the Zinc Recovery EPC Contract, the Guarantors drew $29.7 million under the EPC Contract Letter THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Liquidity and Capital Resources: (continued) of Credit on July 20, 2001. The Guarantors have entered into a time and materials reimbursable engineer, procure and construction management contract with AMEC E&C Services, Inc. to complete the Zinc Recovery Project. On July 11, 2001, Kvaerner filed an Amended Demand For Arbitration against Minerals LLC characterizing the nature of the dispute as concerns regarding change orders and performance penalties. Kvaerner did not state the amount of its claim. On August 7, 2001, Minerals LLC filed an Answering Statement and Counterclaim against Kvaerner. Minerals LLC denied all material allegations in Kvaerner's Amended Demand for Arbitration, and asserted a counterclaim against Kvaerner for breach of contract and specific performance. Minerals LLC alleged that its total estimated damage for Kvaerner's breach of contract are in excess of approximately $60.0 million; however, Minerals LLC has offset approximately $42.5 million of these damages by exercising its rights under the EPC Contract to claim the retainage and by drawing on a letter of credit. Therefore, Minerals LLC asked for a judgment in excess of approximately $20.0 million. The arbitration is scheduled for June 2002. Certain information included in this report contains forward-looking statements made pursuant to the Private Securities Litigation Reform Act of 1995 ("Reform Act"). Such statements are based on current expectations and involve a number of known and unknown risks and uncertainties that could cause the actual results and performance of the Company to differ materially from any expected future results or performance, expressed or implied, by the forward-looking statements. In connection with the safe harbor provisions of the Reform Act, the Company has identified important factors that could cause actual results to differ materially from such expectations, including development and construction uncertainty, operating uncertainty, acquisition uncertainty, uncertainties relating to doing business outside of the United States, uncertainties relating to geothermal resources, uncertainties relating to domestic and international economic and political conditions and uncertainties regarding the impact of regulations, changes in government policy, industry deregulation and competition. Reference is made to all of the Company's SEC filings, incorporated herein by reference, for a description of such factors. The Company assumes no responsibility to update forward-looking information contained herein. Accounting Pronouncements: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) 133, "Accounting for Derivative Instruments and Hedging Activities", which was delayed by SFAS 137 "Accounting for Derivative Instruments and Hedging Activities - Deferral of Effective Date of FASB No. 133" and amended by SFAS 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities". SFAS 133 requires an entity to recognize all of its derivatives as either assets or liabilities in its statement of financial position and measure those instruments at fair value. The Guarantors implemented the new standards on January 1, 2001. The initial adoption of SFAS 133 did not have a material impact on the Guarantors' financial position, results of operations or any impact on their cash flows THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Accounting Pronouncements: (continued) In June 2001, FASB approved the issuance of SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets". These standards, issued in July 2001, establish accounting and reporting for business combinations. SFAS No. 141 requires all business combinations entered into subsequent to June 30, 2001 to be accounted for using the purchase method of accounting. SFAS No. 142 provides that goodwill and other intangible assets with indefinite lives will not be amortized, but will be tested for impairment on an annual basis. These standards are effective for the Funding Corporation beginning on January 1, 2002. The Funding Corporation has not quantified the impact resulting from the adoption of these standards. In July 2001, FASB issued SFAS No.143, "Accounting for Asset Retirement Obligations" (SFAS 143). This standard addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and the related asset retirement costs. SFAS 143 is effective for the Company's fiscal year beginning January 1, 2003. Management is in the process of evaluating the impact this standard will have on the Company's consolidated financial statements. In August 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" (SFAS 144). The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for the Company's fiscal year beginning January 1, 2002. Management is in the process of evaluating the impact this standard will have on the Company's consolidated financial statements. Environmental Liabilities: The Company may be exposed to environmental costs in the ordinary course of business. Expenditures for ongoing compliance with environmental regulations that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments indicate that remediation efforts are probable and the costs can be reasonably estimated. Estimates of the liability are based upon currently available facts, existing technology and presently enacted laws and regulations taking into consideration the likely effects of inflation and other social and economic factors, and include estimates of associated legal costs. These amounts also consider prior experience in remediating sites, other companies' clean-up experience and data released by the Environmental Protection Agency or other organizations. These estimated liabilities are subject to revision in future periods based on actual costs or new circumstances, and are included in the accompanying balance sheets at their undiscounted amounts. As of September 30, 2001 and December 31, 2000, the environmental liabilities recorded on the balance sheet were not material. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ Qualitative and Quantitative Disclosures About Market Risk There have been no significant changes in the Salton Sea Funding Corporation's market risk for the nine months ended September 30, 2001. For additional information see the Company's Annual Report on Form 10-K for the year ended December 31, 2000. Inflation Inflation has not had a significant impact on the Guarantors' operating revenue and costs. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in thousands, except per kwh data) _________________________________ SALTON SEA FUNDING CORPORATION PART II - OTHER INFORMATION Item 1 - Legal proceedings. Neither the Salton Sea Funding Corporation nor the Guarantors are parties to any material legal matters except as noted in footnote 3 of the Salton Sea Funding Corporation financial statements. Item 2 - Changes in Securities. Not applicable. Item 3 - Default on Senior Securities. Not applicable. Item 4 - Submission of Matters to a Vote of Security Holders. Not applicable. Item 5 - Other Information. Not applicable. Item 6 - Exhibits and Reports on Form 8-K. (a) Exhibits: None (b) Reports on Form 8-K: None SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Omaha, State of Nebraska, on this 14th day of November 2001. SALTON SEA FUNDING CORPORATION Date: November 14, 2001 /s/ Joseph M. Lillo By: Joseph M. Lillo Vice President and Controller