10-Q 1 ssfc1st02.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2002 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, 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) 341-4500 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 May [14], 2002. SALTON SEA FUNDING CORPORATION Form 10-Q March 31, 2002 ------------- 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, March 31, 2002 and December 31, 2001 5 Statements of Operations for the Three Months Ended March 31, 2002 and 2001 6 Statements of Cash Flows for the Three Months Ended March 31, 2002 and 2001 7 Notes to Financial Statements 8 SALTON SEA GUARANTORS Independent Accountants' Report 10 Combined Balance Sheets, March 31, 2002 and December 31, 2001 11 Combined Statements of Operations for the Three Months Ended March 31, 2002 and 2001 12 Combined Statements of Cash Flows for the Three Months Ended March 31, 2002 and 2001 13 Notes to Combined Financial Statements 14 PARTNERSHIP GUARANTORS Independent Accountants' Report 17 Combined Balance Sheets, March 31, 2002 and December 31, 2001 18 Combined Statements of Operations for the Three Months Ended March 31, 2002 and 2001 19 Combined Statements of Cash Flows for the Three Months Ended March 31, 2002 and 2001 20 Notes to Combined Financial Statements 21 SALTON SEA ROYALTY LLC Independent Accountants' Report 25 Balance Sheets, March 31, 2002 and December 31, 2001 26 Statements of Operations for the Three Months Ended March 31, 2002 and 2001 27 Statements of Cash Flows for the Three Months Ended March 31, 2002 and 2001 28 Notes to Financial Statements 29 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 31 PART II: OTHER INFORMATION Item 1. Legal Proceedings 39 Item 2. Changes in Securities 39 Item 3. Defaults on Senior Securities 39 Item 4. Submission of Matters to a Vote of Security Holders 39 Item 5. Other Information 39 Item 6. Exhibits and Reports on Form 8-K 39 Signatures 40 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 (the "Company") as of March 31, 2002, and the related statements of operations and cash flows for the three-month periods ended March 31, 2002 and 2001. 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 Salton Sea Funding Corporation as of December 31, 2001, 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 17, 2002 (March 1, 2002 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, 2001 is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived. DELOITTE & TOUCHE LLP Omaha, Nebraska April 26, 2002 SALTON SEA FUNDING CORPORATION BALANCE SHEETS (Dollars in Thousands, Except per Share Amounts) March 31, December 31, 2002 2001 (unaudited) ASSETS Cash $ 99,220 $ 4,361 Restricted cash 2,956 2,949 Accrued interest receivable and other assets 13,296 3,351 Current portion of secured project notes from Guarantors 28,572 28,572 Total current assets 144,044 39,233 Secured project notes from Guarantors 491,678 491,678 Investment in 1% of net assets of Guarantors 9,662 9,669 $ 645,384 $ 540,580 ========== ========== LIABILITIES AND STOCKHOLDER'S EQUITY Liabilities: Accrued interest $ 13,159 $ 3,333 Due to affiliates 98,884 3,899 Current portion of long term debt 28,572 28,572 Total current liabilities 140,615 35,804 Senior secured notes and bonds 491,678 491,678 Total liabilities 632,293 527,482 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 7,725 7,732 ---------- ---------- Total stockholder's equity 13,091 13,098 ---------- ---------- $ 645,384 $ 540,580 ========== ========== 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 March 31, 2002 2001 Revenues: Interest income $ 10,047 $ 10,329 Equity in earnings (loss) of Guarantors (7) 190 Total revenues 10,040 10,519 --------- -------- Expenses: General and administrative expenses 227 289 Interest expense 9,825 10,263 --------- -------- Total expenses 10,052 10,552 --------- -------- Loss before income taxes (12) (33) Income tax benefit (5) (14) Loss before cumulative effect of accounting change (7) (19) Cumulative effect of accounting change, net of tax --- (100) --------- -------- Net loss $ (7) $ (119) ========= ========= The accompanying notes are an integral part of these financial statements. SALTON SEA FUNDING CORPORATION STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited) Three Months Ended March 31, 2002 2001 Cash flows from operating activities: Net loss $ (7) $ (119) Adjustments to reconcile net loss to net cash flow from operating activities: Equity in (earnings) loss of Guarantors 7 (20) Changes in assets and liabilities: Prepaid expenses and other assets (9,945) (10,328) Accrued liabilities 9,826 10,263 Net cash flows from operating activities (119) (204) Cash flows from financing activities: Increase (decrease) in due to affiliates 94,985 (5,102) Restricted cash (7) --- Net cash flows from financing activities 94,978 (5,102) ---------- ---------- Net change in cash 94,859 (5,306) Cash at the beginning of period 4,361 8,467 Cash at the end of period $ 99,220 $ 3,161 ========== ========== Supplemental disclosures: Interest paid $ --- $ --- ========== ========== The accompanying notes are an integral part of these financial statements. SALTON SEA FUNDING CORPORATION NOTES TO FINANCIAL STATEMENTS --------------------- 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 March 31, 2002 and the results of operations for the three-months ended March 31, 2002 and 2001 and cash flows for the three-months ended March 31, 2002 and 2001. The results of operations for the three-months ended March 31, 2002 and 2001 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, 2001. Certain prior year amounts have been reclassified to conform with current year classifications. 2. Accounting Pronouncements: On January 1, 2002, the Funding Corporation adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which dictates the accounting for acquired goodwill and other intangible assets. SFAS No. 142 requires that amortization of goodwill and indefinite-lived intangible assets be discontinued and that entities disclose net income for prior periods adjusted to exclude such amortization and related income tax effects, as well as a reconciliation from the originally reported net income to the adjusted net income. The Funding Corporation's related amortization consists solely of its share of the goodwill amortization at the Guarantors, which has no income tax effect. Following is a reconciliation of net loss as originally reported for the quarters ended March 31, 2002 and 2001, to adjusted net loss (in thousands): Three months ended March 31, 2002 2001 Reported net loss..........................$ (7) $ (119) Goodwill amortization...................... --- 14 Adjusted net loss..........................$ (7) $ (105) In October 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets. There was no financial statement impact as a result of the Funding Corporation's adoption of SFAS No. 144 on January 1, 2002. 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. Due to reduced liquidity, Edison failed to pay approximately $119 million owed under the power purchase agreements with certain Guarantors (Imperial Valley Projects, excluding the Salton Sea V and Turbo Projects) for power delivered in the fourth quarter 2000 and the first quarter 2001. Due to Edison's failure to pay contractual obligations, the Guarantors had established an allowance for doubtful accounts of approximately $21.0 million as of December 31, 2001. On June 20, 2001, the Guarantors' (excluding Salton Sea V and CE Turbo) entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). On June 22, 2001 Edison made an initial $11.6 million payment to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). On November 30, 2001, the Settlement Agreements were amended to reflect when Edison would be required to make the final payment on past due amounts. The final payment of approximately $104.6 million, representing the remaining stipulated amounts, was received March 1, 2002. Following the receipt of Edison's final payment of past due balances, the Guarantors released the remaining allowance for doubtful accounts. As a result of uncertainties related to Edison, the letter of credit that supports the debt service reserve fund at the Funding Corporation has not been extended beyond its current July 2004 expiration date, and as such cash distributions are not available to CE Generation until the Funding Corporation debt service reserve fund of approximately $67.6 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. In January 2001, the California Power Exchange ("PX") declared bankruptcy. As a result, the Salton Sea V and Turbo Projects have not received payment for power sold under the Transaction Agreements during December 2000 and January 2001 of approximately $3.8 million. The Guarantors have established an allowance for doubtful accounts for the full amount of this receivable. Edison has failed to pay approximately $2.8 million of capacity bonus payments for the months from October 2001 through March 2002. On December 10, 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 capacity bonus payments under the Power Purchase Agreements. The Project entities will vigorously pursue collection of the capacity bonus payments. However, due to Edison's failure to pay the contractual obligations, the Imperial Valley Projects have established an allowance for doubtful accounts of approximately $.8 million. 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 March 31, 2002, and the related combined statements of operations and cash flows for the three-month periods ended March 31, 2002 and 2001. 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, 2001, 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 17, 2002 (March 1, 2002 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, 2001 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 April 26, 2002 SALTON SEA GUARANTORS COMBINED BALANCE SHEETS (Dollars in Thousands) March 31, December 31, 2002 2001 (unaudited) ASSETS Accounts receivable, net of allowance of $3,268 and $9,829, respectively $ 11,205 $ 36,647 Prepaid expenses and other assets 5,989 5,314 Total current assets 17,194 41,961 Due from affiliates 2,465 --- Property, plant, contracts and equipment, net 542,042 543,719 Excess of cost over fair value of net assets acquired, net 44,270 44,270 --------- ---------- $ 605,971 $ 629,950 ======== ========= LIABILITIES AND GUARANTORS' EQUITY Liabilities: Accounts payable $ 980 $ 2,862 Accrued liabilities 6,920 9,414 Accrued interest 6,719 1,721 Current portion of long term debt 20,487 20,487 Total current liabilities 35,106 34,484 Due to affiliates --- 27,109 Senior secured project note 246,412 246,412 --------- ---------- Total liabilities 281,518 308,005 Commitment and contingencies (Note 3) Total Guarantors' equity 324,453 321,945 --------- ---------- $ 605,971 $ 629,950 ========= ========== 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 March 31, 2002 2001 Revenues: Sales of electricity $ 23,405 $ 32,130 Interest and other income 430 --- Total revenues 23,835 32,130 -------------- ------------- Expenses: Operating, general and administration 11,890 13,357 Depreciation and amortization 4,275 4,370 Interest expense 5,162 5,490 Less capitalized interest --- (1,692) Total expenses 21,327 21,525 Income before cumulative effect of accounting change 2,508 10,605 Cumulative effect of accounting change --- (8,743) -------------- ------------- Net income $ 2,508 $ 1,862 ============== ============= The accompanying notes are an integral part of these financial statements. SALTON SEA GUARANTORS COMBINED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited) Three Months Ended March 31, 2002 2001 Cash flows from operating activities: Net income $ 2,508 $ 1,862 Adjustments to reconcile net income to net cash flows from operating activities: Cumulative effect of change in accounting principle --- 8,743 Depreciation and amortization 4,275 4,370 Changes in assets and liabilities: Accounts receivable 25,442 (18,292) Prepaid expenses and other assets (675) 774 Accounts payable and accrued liabilities 622 7,037 -------- --------- Net cash flows from operating activities 32,172 4,494 -------- --------- Cash flows from investing activities: Capital expenditures (2,598) (2,676) Decrease in restricted cash --- 17 -------- ---------- Net cash flows from investing activities (2,598) (2,659) -------- ---------- Cash flows from financing activities: Decrease in due to affiliates (29,574) (1,835) -------- Net cash flows from financing activities (29,574) (1,835) -------- 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 -------------------- 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 March 31, 2002 and the results of operations for the three months ended March 31, 2002 and 2001 and cash flows for the three months ended March 31, 2002 and 2001. The results of operations for the three months ended March 31, 2002 and 2001 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, 2001. Certain prior year amounts have been reclassified in order to conform with current year classification. 2. Accounting Pronouncements: On January 1, 2002, the Guarantors adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which dictates the accounting for acquired goodwill and other intangible assets. SFAS No. 142 requires that amortization of goodwill and indefinite-lived intangible assets be discontinued and that entities disclose net income for prior periods adjusted to exclude such amortization and related income tax effects, as well as a reconciliation from the originally reported net income to the adjusted net income. The Guarantor's related amortization consists solely of goodwill amortization. Following is a reconciliation of net income as originally reported for the quarters ended March 31, 2002 and 2001, to adjusted net income (in thousands): Three months ended March 31, 2002 2001 Reported net income................$ 2,508 $ 1,862 Goodwill amortization............... --- 326 Adjusted net income.................$ 2,508 $ 2,188 The Guarantors' acquired intangible assets consists of power purchase contracts (the "contracts") with a cost of $7.9 million and accumulated amortization of $2.9 million at March 31, 2002, and are included in property, plant, contracts and equipment in the accompanying combined balance sheet. Amortization expense on the contracts was $.08 million for the three months ended March 31, 2002. The Guarantors expect amortization expense on the contracts to be $.2 million for the remainder of fiscal 2002 and $.3 million for each of the five succeeding fiscal years. In accordance with the new standard, the Guarantors are continuing to evaluate the other provisions of the standard including the determination of reporting units, the allocation of corporate assets and liabilities, including goodwill, and the impairment testing of goodwill. In August 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". 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 No. 143 is effective for the Guarantors' fiscal year beginning January 1, 2003. The Guarantors have not quantified the impact resulting from the adoption of this standard. In October 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets. There was no financial statement impact as a result of the Guarantors' adoption of SFAS No. 144 on January 1, 2002. 3. Contingency: A. Southern California Edison 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. Due to reduced liquidity, Edison failed to pay approximately $42.3 million owed under the power purchase agreements with certain Guarantors (excluding the Salton Sea V Project) for power delivered in the fourth quarter 2000 and the first quarter 2001. Due to Edison's failure to pay contractual obligations, the Guarantors had established an allowance for doubtful accounts of approximately $6.8 million as of December 31, 2001. On June 20, 2001, the Guarantors' (excluding the Salton Sea V Project) entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). On June 22, 2001 Edison made an initial $4.1 million payment to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). On November 30, 2001, the Settlement Agreements were amended to reflect when Edison would be required to make the final payment on past due amounts. The final payment of approximately $36.9 million, representing the remaining stipulated amounts, was received March 1, 2002. Following the receipt of Edison's final payment of past due balances, the Guarantors released the remaining allowance for doubtful accounts. As a result of uncertainties related to Edison, the letter of credit that supports the debt service reserve fund at Salton Sea Funding Corporation has not been extended beyond its current July 2004 expiration date, and as such, cash distributions are not available to CE Generation until the Salton Sea Funding Corporation debt service reserve fund of approximately $67.6 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. In January 2001, the California Power Exchange ("PX") declared bankruptcy. As a result, the Salton Sea V Project has not received payment for power sold under the Transaction Agreements during December 2000 and January 2001 of approximately $3.0 million. The Guarantors have established an allowance for doubtful accounts for the full amount of this receivable. Edison has failed to pay approximately $.7 million of capacity bonus payments for the months from October 2001 through March 2002. On December 10, 2001 certain Guarantors (except the Salton Sea V Project) filed a lawsuit against Edison in California's Imperial County Superior Court seeking a court order requiring Edison to make the required capacity bonus payments under the Power Purchase Agreements. The Guarantors will vigorously pursue collection of the capacity bonus payments. However, due to Edison's failure to pay these contractual obligations, the Guarantors have established an allowance for doubtful accounts of approximately $.2 million. B. Environmental Liabilities The Guarantors are subject to numerous legislative and regulatory environmental protection requirements involving air and water pollution, waste management, hazardous chemical use, noise abatement, and land use aesthetics. State and federal environmental laws and regulations currently have, and future modifications may have, the effect of (i) increasing the lead time for the construction of new facilities, (ii) significantly increasing the total cost of new facilities, (iii) requiring modification of the Guarantors' existing facilities, (iv) increasing the risk of delay on construction projects, (v) increasing the Guarantors' cost of waste disposal and (vi) reducing the reliability of service provided by the Guarantors and the amount of energy available from the Guarantors' facilities. Any of such items could have a substantial impact on amounts required to be expended by the Guarantors in the future. 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 March 31, 2002 and December 31, 2001, the environmental liabilities recorded on the balance sheet were not material. 4. Change in Accounting Policy Effective January 1, 2001, the Guarantors changed their accounting policy for overhaul and well workover costs. These costs, had historically been accounted for using the deferral method, and are now expensed as incurred. The Guarantors have recorded a cumulative effect of this change of approximately $8.7 million in the three months ended March 31, 2001. 5. Related Party Transactions On September 29, 2000, Salton Sea Power L.L.C. ("Salton Sea Power") entered into an agreement to sell all available power from the Salton Sea V Project to El Paso Merchant Energy Company ("EPME"). Under the terms of the agreement, EPME purchased and sold available power on behalf of Salton Sea Power, into the California ISO markets. The purchase price for the available power shall be equivalent to the value actually received by EPME for the sale of such power, including renewable premiums. On January 17, 2001, Salton Sea Power entered into a Transaction Agreement to sell available power from the Salton Sea V Project to EPME. Under the terms of the agreement, at the option of Salton Sea Power, EPME purchased all available power from the Salton Sea V Project based on day ahead price quotes received from EPME. On March 27, 2001 and May 1, 2001, Salton Sea Power entered into a Transaction Agreement to sell available power to EPME based on percentages of the Dow Jones SP-15 Index. Pursuant to these agreements, sales to EPME from the Guarantors totaled $2.0 million and $14.0 million for the three months ended March 31, 2002 and 2001, respectively. As of March 31, 2002 and December 31, 2001, accounts receivable from EPME were $1.4 million and $11.8 million, respectively. 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 March 31, 2002, and the related combined statements of operations and cash flows for the three-month periods ended March 31, 2002 and 2001. 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, 2001, 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 17, 2002 (March 1, 2002 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, 2001 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 April 26, 2002 PARTNERSHIP GUARANTORS COMBINED BALANCE SHEETS (Dollars in Thousands)
March 31, December 31, 2002 2001 (unaudited) ASSETS Cash $ 2,676 $ - Accounts receivable, net of allowance of $1,399 and $14,925, respectively 11,776 59,384 Prepaid expenses and other assets 18,735 19,358 Total current liabilities 33,187 78,742 Restricted cash 14,269 21,282 Property, plant, contracts and equipment, net 640,038 633,574 Management fee 69,739 70,806 Due from affiliates 56,158 13,072 Excess of cost over fair value of net assets acquired, net 120,866 120,866 ------------ ------------- $ 934,257 $ 938,342 ============ ============= LIABILITIES AND GUARANTORS' EQUITY Liabilities: Accounts payable $ 2,024 $ 5,480 Accrued liabilities 11,784 12,853 Accrued interest 6,299 1,605 Current portion of long term debt 4,625 4,625 Total current liabilities 24,732 24,563 Senior secured project notes 244,117 244,117 Deferred income taxes 100,743 102,083 ------------ ------------- Total liabilities 369,592 370,763 Commitments and contingencies (Note 3) Guarantors' equity: Common stock 3 3 Additional paid-in capital 387,663 387,663 Retained earnings 176,999 179,913 ------------ ------------- Total Guarantors' equity 564,665 567,579 ------------ ------------- $ 934,257 $ 938,342 ============ ============= The accompanying notes are an integral part of these financial statements.
PARTNERSHIP GUARANTORS COMBINED STATEMENTS OF OPERATIONS (Dollars in Thousands) (Unaudited)
Three Months Ended March 31, 2002 2001 Revenues: Sales of electricity $ 22,199 $ 23,494 Interest and other income 536 35 Total revenues 22,735 23,529 --------- Expenses: Operating, general and administration 18,286 14,394 Depreciation and amortization 6,787 5,081 Interest expense 4,754 4,793 Less capitalized interest (2,838) (4,733) --------- Total expenses 26,989 19,535 --------- Income (loss) before income taxes (4,254) 3,994 Provision for income tax expense (benefit) (1,340) 1,378 Income (loss) before cumulative effect of accounting change (2,914) 2,616 Cumulative effect of accounting change, net of tax --- (8,254) ------------- ------------- Net loss $ (2,914) $ (5,638) ============= ==============
The accompanying notes are an integral part of these financial statements. PARTNERSHIP GUARANTORS COMBINED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited) Three Months Ended March 31, 2002 2001 Cash flows from operating activities: Net loss $ (2,914) $ (5,638) Adjustments to reconcile net loss to net cash flow from operating activities: Cumulative effect of change in accounting principle, net of tax --- 8,254 Depreciation and amortization 6,787 5,081 Deferred income taxes (1,340) 1,378 Changes in assets and liabilities: Accounts receivable 47,608 (21,111) Prepaid expenses and other assets 623 (4,016) Accounts payable and accrued liabilities 169 11,639 ---------- ---------- Net cash flows from operating activities 50,933 (4,413) ---------- ---------- Cash flows from investing activities: Capital expenditures (12,542) (6,299) Decrease in restricted cash 7,013 106 Management fee 358 819 ---------- ---------- Net cash flows from investing activities (5,171) (5,374) ---------- ---------- Cash flows from financing activities: Decrease (increase) in due from affiliates (43,086) 9,787 ---------- ---------- Net cash flows from financing activities (43,086) 9,787 ---------- ---------- Net change in cash 2,676 --- Cash at beginning of period --- --- ---------- ---------- Cash at end of period $ 2,676 $ --- ========== ========== The accompanying notes are an integral part of these financial statements. PARTNERSHIP GUARANTORS NOTES TO COMBINED FINANCIAL STATEMENTS -------------------- 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 March 31, 2002 and the results of operations for the three-months ended March 31, 2002 and 2001 and cash flows for the three-months ended March 31, 2002 and 2001. The results of operations for the three-months ended March 31, 2002 and 2001 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, 2001. 2. Accounting Pronouncements: On January 1, 2002, the Guarantors adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which dictates the accounting for acquired goodwill and other intangible assets. SFAS No. 142 requires that amortization of goodwill and indefinite-lived intangible assets be discontinued and that entities disclose net income for prior periods adjusted to exclude such amortization and related income tax effects, as well as a reconciliation from the originally reported net income to the adjusted net income. The Guarantors' related amortization consists solely of goodwill amortization, which has no income tax effect. Following is a reconciliation of net loss as originally reported for the quarters ended March 31, 2002 and 2001, to adjusted net loss (in thousands): Three months ended March 31, 2002 2001 Reported net loss...........................$(2,914) $(5,638) Goodwill amortization....................... --- 891 Adjusted net loss...........................$(2,914) $(4,747) The following table summarizes the acquired intangible assets as of March 31, 2002 (in thousands): Gross Carrying Accumulated Amount Amortization Amortized Intangible Assets: Power Purchase Contracts $ 123,002 $ 95,716 Patented Technology 46,290 13,938 ------------- ------------- Total $ 169,292 $ 109,654 ============= ============= Amortization expense on acquired intangible assets was $.9 million for the three months ended March 31, 2002. The Guarantors expect amortization expense on acquired intangible assets to be $2.6 million for the remainder of fiscal 2002 and $3.5 million for each of the five succeeding fiscal years. In accordance with the new standard, the Guarantors are continuing to evaluate the other provisions of the standard including the determination of reporting units, the allocation of corporate assets and liabilities, including goodwill, and the impairment testing of goodwill. In August 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". 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 No. 143 is effective for the Guarantors' fiscal year beginning January 1, 2003. The Guarantors have not quantified the impact resulting from the adoption of this standard. In October 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets. There was no financial statement impact as a result of the Guarantors' adoption of SFAS No. 144 on January 1, 2002. 3. Contingency: A. Southern California Edison 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. Due to reduced liquidity, Edison failed to pay approximately $76.9 million owed under the power purchase agreements with certain Guarantors (excluding the Turbo Project) for power delivered in the fourth quarter 2000 and the first quarter 2001. Due to Edison's failure to pay contractual obligations, the Guarantors had established an allowance for doubtful accounts of approximately $14.1 million as of December 31, 2001. On June 20, 2001, the Guarantors' (excluding the Turbo Project) entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). On June 22, 2001 Edison made an initial $7.5 million payment to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). On November 30, 2001, the Settlement Agreements were amended to reflect when Edison would be required to make the final payment on past due amounts. The final payment of approximately $67.7 million, representing the remaining stipulated amounts, was received March 1, 2002. Following the receipt of Edison's final payment of past due balances, the Guarantors released the remaining allowance for doubtful accounts. As a result of uncertainties related to Edison, the letter of credit that supports the debt service reserve fund at Salton Sea Funding Corporation has not been extended beyond its current July 2004 expiration date, and as such cash distributions are not available to CE Generation until the Salton Sea Funding Corporation debt service reserve fund of approximately $67.6 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. In January 2001, the California Power Exchange ("PX") declared bankruptcy. As a result, the Turbo Project has not received payment for power sold under the Transaction Agreements during December 2000 and January 2001 of approximately $.8 million. The Guarantors have established an allowance for doubtful accounts for the full amount of this receivable. Edison has failed to pay approximately $2.0 million of capacity bonus payments for the months from October 2001 through March 2002. On December 10, 2001 certain Guarantors (excluding the Turbo Project) filed a lawsuit against Edison in California's Imperial County Superior Court seeking a court order requiring Edison to make the required capacity bonus payments under the Power Purchase Agreements. The Guarantors will vigorously pursue collection of the capacity bonus payments. However, due to Edison's failure to pay these contractual obligations, the Guarantors have established an allowance for doubtful accounts of approximately $.6 million. B. Minerals 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 $29.6 million under the EPC Contract Letter of Credit on July 20, 2001. The liquidated damages have been accounted for as a reduction of the capitalized costs of the project. 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 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 the letter of credit. Therefore, Minerals LLC asked for a judgment in excess of approximately $20 million. The arbitration is scheduled for June 2002. C. Environmental Liabilities The Guarantors are subject to numerous legislative and regulatory environmental protection requirements involving air and water pollution, waste management, hazardous chemical use, noise abatement, and land use aesthetics. State and federal environmental laws and regulations currently have, and future modifications may have, the effect of (i) increasing the lead time for the construction of new facilities, (ii) significantly increasing the total cost of new facilities, (iii) requiring modification of the Guarantors' existing facilities, (iv) increasing the risk of delay on construction projects, (v) increasing the Guarantors' cost of waste disposal and (vi) reducing the reliability of service provided by the Guarantors and the amount of energy available from the Guarantors' facilities. Any of such items could have a substantial impact on amounts required to be expended by the Guarantors in the future. 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 March 31, 2002 and December 31, 2001, the environmental liabilities recorded on the balance sheet were not material. 4. Change in Accounting Policy Effective January 1, 2001, the Guarantors changed their accounting policy for overhaul and well workover costs. These costs, had historically been accounted for using the deferral method, and are now expensed as incurred. The Guarantors have recorded a cumulative effect of this change of approximately $8.3 million, net of tax in the three months ended March 31, 2001. 5. Related Party Transactions On September 29, 2000, CE Turbo LLC ("CE Turbo") entered into an agreement to sell all available power from the Turbo Project to EPME. Under the terms of the agreement, EPME purchased and sold available power on behalf of CE Turbo, into the California ISO markets. The purchase price for the available power shall be equivalent to the value actually received by EPME for the sale of such power, including renewable premiums. On January 17, 2001, the CE Turbo Project entered into a Transaction Agreement to sell available power from the Turbo Project to EPME. Under the terms of the agreement, at the option of CE Turbo, EPME purchased all available power from the Turbo Project based on day ahead price quotes received from EPME. On March 27, 2001 and May 1, 2001, CE Turbo entered into a Transaction Agreement to sell available power to EPME based on percentages of the Dow Jones SP-15 Index. Pursuant to these agreements, sales to EPME from the Company totaled $.4 million and $2.9 million for the three months ended March 31, 2002 and 2001, respectively. As of March 31, 2002 and December 31, 2001, accounts receivable from EPME were $.2 million and $2.4 million, respectively. 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 March 31, 2002, and the related statements of operations and cash flows for the three-month periods ended March 31, 2002 and 2001. 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, 2001, and the related statements of operations, equity, and cash flows for the year then ended (not presented herein); and in our report dated January 17, 2002 (March 1, 2002 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, 2001 is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived. DELOITTE & TOUCHE LLP Omaha, Nebraska April 26, 2002 SALTON SEA ROYALTY LLC BALANCE SHEETS (Dollars in Thousands, Except per Share Amounts) March 31, December 31, 2002 2001 (unaudited) ASSETS Prepaid expenses and other assets $ 26 $ 31 Total current assets 26 31 Royalty stream, net 14,651 14,865 Excess of cost over fair value of net assets acquired, net 30,464 30,464 Due from affiliates 36,530 33,940 $ 81,671 $ 79,300 ========== ========== LIABILITIES AND EQUITY Liabilities: Accrued interest $ 113 $ 29 Current portion of long term debt 3,460 3,460 Total current liabilities 3,573 3,489 Senior secured project note 1,147 1,147 ---------- ---------- Total liabilities 4,720 4,636 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 75,390 73,103 ---------- ---------- Total equity 76,951 74,664 ---------- ---------- $ 81,671 $ 79,300 ========== ========== The accompanying notes are an integral part of these financial statements. SALTON SEA ROYALTY LLC STATEMENTS OF OPERATIONS (Dollars in Thousands) (Unaudited) Three Months Ended March 31, 2002 2001 Revenues: Royalty income $ 3,682 $ 3,463 Expenses: Operating, general and administrative expenses 1,092 879 Amortization 214 487 Interest expense 89 177 --------- ---------- Total expenses 1,395 1,543 --------- ---------- Net income $ 2,287 $ 1,920 ========= ========== The accompanying notes are an integral part of these financial statements. SALTON SEA ROYALTY LLC STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited) Three Months Ended March 31, 2002 2001 Cash flows from operating activities: Net income $ 2,287 $ 1,920 Adjustments to reconcile net income to net cash flow from operating activities: Amortization 214 487 Changes in assets and liabilities: Prepaid expenses and other assets 5 13 Accrued liabilities and deferred income taxes 84 164 Net cash flows from operating activities 2,590 2,584 Net cash flows from financing activities: Increase in due from affiliates (2,590) (2,584) --------- --------- Net cash flows from financing activities (2,590) (2,584) 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 -------------------- 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 March 31, 2001 and the results of operations for the three months ended March 31, 2002 and 2001 and cash flows for the three months ended March 31, 2002 and 2001. The results of operations for the three months ended March 31, 2002 and 2001 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, 2001. 2. Accounting Pronouncements: On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which dictates the accounting for acquired goodwill and other intangible assets. SFAS No. 142 requires that amortization of goodwill and indefinite-lived intangible assets be discontinued and that entities disclose net income for prior periods adjusted to exclude such amortization and related income tax effects, as well as a reconciliation from the originally reported net income to the adjusted net income. The Company's amortization consists solely of goodwill amortization. Following is a reconciliation of net income as originally reported for the quarters ended March 31, 2002 and 2001, to adjusted net income (in thousands): Three months ended March 31, 2002 2001 Reported net income.....................$ 2,287 $ 1,920 Goodwill amortization................... --- 227 Adjusted net income.....................$ 2,287 $ 2,147 The Company's acquired intangible assets consist of the royalty stream with a cost of $60.7 million and accumulated amortization of $46 million at March 31, 2002. Amortization expense on the royalty stream was $0.2 million for the three months ended March 31, 2002. The Company expects amortization expense on the royalty stream to be $0.6 million for the remainder of fiscal 2002 and $0.9 million for each of the five succeeding fiscal years. In accordance with the new standard, the Company is continuing to evaluate the other provisions of the standard including the determination of reporting units, the allocation of corporate assets and liabilities, including goodwill, and the impairment testing of goodwill. In August 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". 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 No.143 is effective for the Company's fiscal year beginning January 1, 2003. The Company has not quantified the impact resulting from the adoption of this standard. In October 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets. There was no financial statement impact as a result of the Company's adoption of SFAS No. 144 on January 1, 2002. 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. Due to reduced liquidity, Edison failed to pay approximately $119 million owed under the power purchase agreements with certain Guarantors (Imperial Valley Projects, excluding the Salton Sea V and Turbo Projects) for power delivered in the fourth quarter 2000 and the first quarter 2001. Due to Edison's failure to pay contractual obligations, the Guarantors had established an allowance for doubtful accounts of approximately $21.0 million as of December 31, 2001. On June 20, 2001, the Guarantors' (excluding the Salton Sea V and Turbo Projects) entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). On June 22, 2001 Edison made an initial $11.6 million payment to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). On November 30, 2001, the Settlement Agreements were amended to reflect when Edison would be required to make the final payment on past due amounts. The final payment of approximately $104.6 million, representing the remaining stipulated amounts, was received March 1, 2002. Following the receipt of Edison's final payment of past due balances, the Guarantors released the remaining allowance for doubtful accounts. As a result of uncertainties related to Edison, the letter of credit that supports the debt service reserve fund at Salton Sea Funding Corporation has not been extended beyond its current July 2004 expiration date, and as such cash distributions are not available to CE Generation until the Salton Sea Funding Corporation debt service reserve fund of approximately $67.6 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. In January 2001, the California Power Exchange ("PX") declared bankruptcy. As a result, the Salton Sea V and Turbo Projects have not received payment for power sold under the Transaction Agreements during December 2000 and January 2001 of approximately $3.8 million. The Guarantors have established an allowance for doubtful accounts for the full amount of this receivable. Edison has failed to pay approximately $2.8 million of capacity bonus payments for the months from October 2001 through March 2002. On December 10, 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 capacity bonus payments under the Power Purchase Agreements. The Guarantors will vigorously pursue collection of the capacity bonus payments. However, due to Edison's failure to pay these contractual obligations, the Guarantors have established an allowance for doubtful accounts of $.8 million. THE SALTON SEA FUNDING CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS --------------------------------- Forward-Looking Statements 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 geothermal resources, uncertainties relating to 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. Critical Accounting Policies The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Note 2 to the Consolidated Financial Statements in the Annual Report on Form 10-K describes the significant accounting policies and methods used in the preparation of the Consolidated Financial Statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, impairment of long-lived assets and contingent liabilities. Actual results could differ from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the Consolidated Financial Statements. Allowance for Doubtful Accounts The allowance for doubtful accounts is based on the Company's assessment of the collectibility of specific customer accounts and the aging of the accounts receivable. If there is a deterioration of a major customer's credit worthiness or actual defaults are higher than the Company's historical experience, estimates of the recoverability of amounts due could be adversely affected. Impairment of Long-Lived Assets The Guarantors' long-lived assets consist primarily of property, plant and equipment, goodwill and intangible assets that were acquired in business acquisitions. The Guarantors believe the useful lives we assigned to these assets, which range from 3 to 40 years, are reasonable. The Guarantors evaluate the long-lived assets for impairment when events or changes in circumstances indicate, in management's judgment, that the carrying value of such assets may not be recoverable. These computations utilized judgments and assumptions inherent in management's estimate of undiscounted future cash flows to determine recoverability of an asset. If the Guarantors assumptions about these assets change as a result of events or circumstances, and the Guarantors believe the assets may have declined in value, then the Guarantors may record impairment charges, resulting in lower profits. Contingent Liabilities The Guarantors are subject to the possibility of various loss contingencies arising in the ordinary course of business. The Guarantors consider the likelihood of the loss or impairment of an asset or the incurrence of a liability as well as the ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss contingency is accrued when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. The Guarantors regularly evaluate current information available to determine whether such accruals should be adjusted. 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"), 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. Revenues: The Salton Sea Guarantors' sales of electricity decreased to $23.4 million for the three months ended March 31, 2002 from $32.1 million for the same period in 2001, a 27.2% decrease. Sales of electricity for the three months ended March 31, 2002 included the impact of a $6.8 million reduction in the allowance for doubtful accounts. Sales of electricity for the three months ended March 31, 2001 included the impact of a $12.5 million increase in the allowance for doubtful accounts. Excluding the impact of the adjustments related to the allowance for doubtful accounts, sales of electricity decreased $28 million or 62% to $16.6 million for the three months ended March 31, 2002 from $44.6 million for the three months March 31, 2001. This decrease was primarily due to lower rates in 2002, partially offset by outages in 2001, which were more extensive compared to 2002. The following data includes the aggregate capacity and electricity production of the Salton Sea Guarantors: Three Months Ended March 31, 2002 2001 Overall capacity factor 89.3% 84.1% Capacity (NMW) (average) 168.4 168.4 kWh produced (in thousands) 324,800 305,800 The overall capacity factor for the Salton Sea Guarantors increased for the three months ended March 31, 2002 compared to the same period in 2001 primarily due to outage timing. The Partnership Guarantors' sales of electricity decreased to $22.2 million for the three months ended March 31, 2002 from $23.5 million for the same period in 2001, a 5.5% decrease. Sales of electricity for the three months ended March 31, 2002 included the impact of $14.1 million reduction in the allowance for doubtful accounts. Sales of electricity for the three months ended March 31, 2001 included the impact of a $28.9 million increase in the allowance for doubtful accounts. Excluding the impact of the adjustments related to the allowance for doubtful accounts, sales of electricity decreased $44.3 million or 85% to $8.1 million for the three months ended March 31, 2002 from $52.4 million for the three months March 31, 2001. This decrease was due to lower rates and decreased production from scheduled overhauls. The following data includes the aggregate capacity and electricity production of the Partnership Guarantors: Three Months Ended March 31, 2002 2001 Overall capacity factor 89.3% 101.3% Capacity (NMW) (average) 158 158 kWh produced (in thousands) 306,000 345,700 The overall capacity factor for the Partnership Guarantors decreased for the three months ended March 31, 2002 compared to the same period in 2001 due to scheduled overhauls in 2002. Edison's Average Avoided Cost of Energy was 2.9 cents per kilowatt-hour and 15.2 cents per kilowatt-hour for the three months ended March 31, 2002 and 2001, respectively. Estimates of Edison's future Avoided Cost of Energy vary substantially from year to year. As a result of the Settlement Agreements, Edison has elected to pay the Guarantors (except Salton Sea Projects IV and V and the Turbo Project) a fixed energy price in lieu of Edison's Average Avoided Cost of Energy. The fixed energy price was 3.25 cents/per kilowatt-hour in the first quarter 2002 and is scheduled to increase to 5.37 cents/per kilowatt hour effective May 1, 2002 through April 30, 2007. The Royalty Guarantor revenue increased to $3.7 million for the three months ended March 31, 2002 from $3.5 million for the same period last year. The increase relates to additional royalties recognized on the past due interest payments from Edison. Operating Expenses: The Salton Sea Guarantors' operating expenses, which include royalty, operating, and general and administrative expenses, decreased to $11.9 million for the three months ended March 31, 2002 from $13.4 for the same period in 2001. The decrease was due to lower royalty expenses resulting from lower revenues and lower brine disposal costs. The Partnership Guarantors' operating expenses, which include royalty, operating, and general and administrative expenses, increased to $18.3 million for the three months ended March 31, 2002 from $14.4 million for the same period in 2001. The increase was due to overhaul costs in 2002. The Royalty Guarantors' operating expenses increased to $1.1 million for the three months ended March 31, 2002 from $0.9 million for the same period in 2001. This increase was due to higher royalty costs resulting from higher revenue. Depreciation and Amortization: The Salton Sea Guarantors' depreciation and amortization decreased to $4.3 million for the three months ended March 31, 2002 from $4.4 million for the same period of 2001, due to the discontinuation of goodwill amortization in 2002. The Partnership Guarantors' depreciation and amortization increased to $6.8 million for the three months ended March 31, 2002 from $5.1 million for the same period in 2001. The increase was due primarily to the upgraded brine handling system, partially offset by the discontinuation of goodwill amortization in 2002 of $0.9 million. The Royalty Guarantors' amortization decreased to $0.2 million for the three months ended March 31, 2002 compared to $0.5 million for the same period of 2001. The decrease was due primarily to the discontinuation of goodwill amortization in 2002 of $0.2 million. Interest Expense: The Salton Sea Guarantors' interest expense net of capitalized amounts, increased to $5.2 million for the three months ended March 31, 2002 from $3.8 million for the same period in 2001. The increase was due to lower capitalized interest on the minerals extraction process partially offset by reduced indebtedness. The Partnership Guarantors' interest expense, net of capitalized amounts, increased to $1.9 million for the three months ended March 31, 2002 from $0.1 million for the same period in 2001. The increase was due to reduced capitalized interest on the minerals extraction process. The Royalty Guarantors' interest expense decreased to $0.1 million for the three months ended March 31, 2002 from $0.2 million from the same period in 2001. The decrease was due to reduced indebtedness. Income Tax Provision: The Partnership Guarantors income tax provision decreased to a benefit of $1.3 million for the three months ended March 31, 2002 from an expense of $1.4 million for the same period in 2001. This decrease was primarily due to a lower pre-tax income. Income taxes will be paid by the parent of the Guarantors from distributions to the parent company by the Guarantors, which occur after operating expenses and debt service. Cumulative Effect of Accounting Policy Change: On January 1, 2001, the Guarantors changed their policy of accounting for the overhaul and well workover costs. These costs, which have historically been accounted for using the deferral method, are expensed as incurred. The Salton Sea Guarantors recorded a cumulative effect of $8.7 million. The Partnership Guarantors recorded a cumulative effect of $8.3 million, net of tax. Net Income: The Salton Sea Funding Corporation's net loss for the three months ended March 31, 2002 was not significant compared to a loss of $0.1 million for the same period in 2001. The net loss primarily represents interest income and expense, net of applicable tax, and the Salton Sea Funding Corporation's 1% equity in earnings (losses) of the Guarantors. The Salton Sea Guarantors' net income increased to $2.5 million for the three months ended March 31, 2002 compared to $1.9 million for the same period of 2001. The Partnership Guarantors' net loss decreased to $2.9 million for the three months ended March 31, 2002 compared to $5.6 million for the same period of 2001. The Royalty Guarantors' net income increased to $2.3 million for the three months ended March 31, 2002 compared to $1.9 million for the same period of 2001. Related Party Transactions On September 29, 2000, Salton Sea Power L.L.C. ("Salton Sea Power") and CE Turbo LLC ("CE Turbo") entered into an agreement to sell all available power from the Salton Sea V Project and Turbo Project to EPME. Under the terms of the agreement, EPME purchased and sold available power on behalf of Salton Sea Power and CE Turbo, into the California ISO markets. The purchase price for the available power shall be equivalent to the value actually received by EPME for the sale of such power, including renewable premiums. On January 17, 2001, Salton Sea Power and CE Turbo entered into a Transaction Agreement to sell available power from the Salton Sea V Project and Turbo Project to EPME. Under the terms of the agreement, at the option of Salton Sea Power and CE Turbo, EPME purchased all available power from the Salton Sea V Project and Turbo Project based on day ahead price quotes received from EPME. On March 27, 2001 and May 1, 2001, the Imperial Valley Projects entered into a Transaction Agreement to sell available power to EPME based on percentages of the Dow Jones SP-15 Index. On June 28, 2001, the Imperial Valley Projects (excluding the Salton Sea V Project and Turbo Project) ceased selling available power to EPME and resumed power sales to Edison. Pursuant to these agreements, sales to EPME from the Company totaled $2.4 million and $16.9 million for the three months ended March 31, 2002 and 2001, respectively. As of March 31, 2002 and December 31, 2001, accounts receivable from EPME were $1.6 million and $14.2 million, respectively. Liquidity and Capital Resources The Salton Sea Guarantors' cash flows from operating activities increased to $32.2 million for the three months ended March 31, 2002 from $4.5 million for the same period in 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 Project revenue and interest earned on funds on deposit. The increase was primarily due to the receipt of past due balances from Edison. The Partnership Guarantors' cash flows from operating activities increased to $50.9 million for the three months ended March 31, 2002 from from a net cash use of $4.4 million for the same period in 2001. The operating Partnership Guarantors' primary source of revenue is payments received pursuant to long term power sales agreements with Edison, other than Turbo Project and Zinc Recovery Project revenue and interest earned on funds on deposit. The increase was primarily due to the receipt of past due balances from Edison. The Royalty Guarantors' cash flow from operations was $2.6 million for the periods ended March 31, 2002 and 2001. The Royalty Guarantors' only source of revenue is royalties received pursuant to resource lease 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 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. Due to reduced liquidity, Edison failed to pay approximately $119 million owed under the power purchase agreements with certain Guarantors (Imperial Valley Projects, excluding the Salton Sea V and Turbo Projects) for power delivered in the fourth quarter 2000 and the first quarter 2001. Due to Edison's failure to pay contractual obligations, the Guarantors had established an allowance for doubtful accounts of approximately $21.0 million as of December 31, 2001. On June 20, 2001, the Guarantors' (excluding Salton Sea V and CE Turbo) entered into Agreements Addressing Renewable Energy Pricing and Payment Issues with Edison ("Settlement Agreements"). On June 22, 2001 Edison made an initial $11.6 million payment to repay the past due balances under the Power Purchase Agreements (the "stipulated amounts"). On November 30, 2001, the Settlement Agreements were amended to reflect when Edison would be required to make the final payment on past due amounts. The final payment of approximately $104.6 million, representing the remaining stipulated amounts, was received March 1, 2002. Following the receipt of Edison's final payment of past due balances, the Guarantors released the remaining allowance for doubtful accounts. As a result of uncertainties related to Edison, the letter of credit that supports the debt service reserve fund at Salton Sea Funding Corporation has not been extended beyond its current July 2004 expiration date, and as such cash distributions are not available to CE Generation until the Salton Sea Funding Corporation debt service reserve fund of approximately $67.6 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. In January 2001, the California Power Exchange ("PX") declared bankruptcy. As a result, the Salton Sea V and Turbo Projects have not received payment for power sold under the Transaction Agreements during December 2000 and January 2001 of approximately $3.8 million. The Guarantors have established an allowance for doubtful accounts for the full amount of this receivable. Edison has failed to pay approximately $2.8 million of capacity bonus payments for the months from October 2001 through March 2002. On December 10, 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 capacity bonus payments under the Power Purchase Agreements. The Guarantors will vigorously pursue collection of the capacity bonus payments. However, due to Edison's failure to pay the contractual obligations, the Imperial Valley Projects have established an allowance for doubtful accounts of approximately $.8 million. The Salton Sea Guarantors' cash flow used in investing activities decreased to $2.6 million for the three months ended March 31, 2002 from $2.7 million for the same period in 2001. Capital expenditures are the primary component of investing activities. The Partnership Guarantors' cash flow used in investing activities decreased to $5.2 million for the three months ended March 31, 2002 from $5.4 million for the same period in 2001. Capital expenditures are the primary component of investing activities. 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 sites of the Imperial Valley Projects 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. Total project costs of the Zinc Recovery Project are expected to be approximately $217.9 million, net of payments for liquidated damages, which is being funded by $140.5 million of debt and the balance from equity contributions. The Zinc Recovery Project has incurred $165.0 million, net of payments for liquidated damages received, of such costs through March 31, 2002. The Zinc Recovery Project was being constructed by 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 Partnership Guarantors drew $29.6 million under the EPC Contract Letter of Credit on July 20, 2001. The Partnership 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. Salton Sea Funding Corporation's net cash flows provided from financing activities increased to $95.0 million for the three months ended March 31, 2002 from a net cash use of $5.1 million for the same period in 2001. Salton Sea Guarantors' net cash flows used in financing activities increased to $29.6 million from $1.8 million for the same period in 2001. Partnership Guarantors' net cash use in financing activities increased to $43.1 million for the three months ended March 31, 2002 from a net cash provided of $9.8 million for the same period in 2001. The changes in net cash flows from financing activities are primarily the result of the receipt of the past due balances from Edison. These receipts were deposited into cash accounts at Salton Sea Funding Corporation and are recorded as amounts due to the Salton Sea and Partnership Guarantors. Environmental Liabilities The Guarantors are subject to numerous legislative and regulatory environmental protection requirements involving air and water pollution, waste management, hazardous chemical use, noise abatement and land use aesthetics. State and federal environmental laws and regulations currently have, and future modifications may have, the effect of (i) increasing the lead time for the construction of new facilities, (ii) significantly increasing the total cost of new facilities, (iii) requiring modification of the Guarantors' existing facilities, (iv) increasing the risk of delay on construction projects, (v) increasing the Guarantors' cost of waste disposal and (vi) reducing the reliability of service provided by the Guarantors and the amount of energy available from the Guarantors' facilities. Any of such items could have a substantial impact on amounts required to be expended by the Guarantors in the future. 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 March 31, 2002 and December 31, 2001, the Guarantors' environmental liabilities recorded on the balance sheet were not material. Inflation Inflation has not had a significant Impact on the Guarantors' cost structure. Quantitative and Qualitative Disclosure about Market Risk There have been no material changes in the market risk from the information provided in Item 7A. Quantitative and Qualitative Disclosures About Market Risk of the Funding Corporation's Annual Report on Form 10-K for the year ended December 31, 2001. Contractual Obligations and Commercial Commitments There have been no material changes in the contractual obligations and commercial commitments from the information provided in Item 7 of the Funding Corporation's Annual Report on Form 10-K for the year ended December 31, 2001. 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: Not applicable. (b) Reports on Form 8-K: Current Report filed March 4, 2002, reporting of receipt of past due payments from Southern California Edison. 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 and on behalf of the other registrants by the undersigned thereunto duly authorized, in the City of Omaha, State of Nebraska, on this 14th day of May 2002. SALTON SEA FUNDING CORPORATION Date: May 14, 2002 /s/ Paul J. Leighton By: Paul J. Leighton Secretary