10-Q 1 saltonseafunding10q33103.txt SALTON SEA FUNDING CORPORATION - 3-31-2003 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, 2003 Commission File No. 33-95538 SALTON SEA FUNDING CORPORATION ------------------------------ (Exact name of registrant as specified in its charter) Delaware 47-0790493 -------- ------------------- (State of Incorporation) (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 95-2636765 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 95-3992087 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 302 S. 36th Street, Suite 400, Omaha, Nebraska 68131 ---------------------------------------------- ---------- (Address of principal executive offices of (Zip Code of Salton Sea Funding Corporation) 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x] All common stock of Salton Sea Funding Corporation is indirectly held by Magma Power Company. As of May 12, 2003, 100 shares of common stock were outstanding. TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Item 1. Financial Statements................................................3 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..............................................26 Item 3. Quantitative and Qualitative Disclosures About Market Risk.........31 Item 4. Controls and Procedures............................................31 PART II - OTHER INFORMATION Item 1. Legal Proceedings..................................................32 Item 2. Changes in Securities and Use of Proceeds..........................32 Item 3. Defaults Upon Senior Securities....................................32 Item 4. Submission of Matters to a Vote of Security Holders................32 Item 5. Other Information..................................................32 Item 6. Exhibits and Reports on Form 8-K...................................32 SIGNATURES....................................................................33 CERTIFICATIONS................................................................34 EXHIBIT INDEX.................................................................36 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. INDEPENDENT ACCOUNTANTS' REPORT Board of Directors and Stockholder Salton Sea Funding Corporation Omaha, Nebraska We have reviewed the accompanying balance sheet of Salton Sea Funding Corporation (the Company) as of March 31, 2003, and the related statements of operations and cash flows for the three-month periods ended March 31, 2003 and 2002. 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, 2002, 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 24, 2003 (January 29, 2003 as to Note 6), 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, 2002 is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Omaha, Nebraska May 8, 2003 -3- SALTON SEA FUNDING CORPORATION BALANCE SHEETS (In thousands, except per share amounts)
AS OF ----------------------- MARCH 31, DECEMBER 31, 2003 2002 --------- ------------ (UNAUDITED) ASSETS Current assets: Cash ........................................................... $ 23,236 $ 19,583 Restricted cash ................................................ 46,448 46,293 Accrued interest receivable and other current assets ........... 12,466 3,228 Current portion secured project notes from Guarantors .......... 28,086 28,086 -------- -------- Total current assets ......................................... 110,236 97,190 -------- -------- Secured project notes from Guarantors ............................ 463,592 463,592 Investment in 1% of net assets of Guarantors ..................... 9,688 9,721 -------- -------- TOTAL ASSETS ..................................................... $583,516 $570,503 ======== ======== LIABILITIES AND STOCKHOLDER'S EQUITY Current liabilities: Accrued interest ............................................... $ 12,453 $ 3,156 Current portion of long-term debt .............................. 28,086 28,086 -------- -------- Total current liabilities .................................... 40,539 31,242 -------- -------- Due to affiliates ................................................ 65,912 62,251 Senior secured notes and bonds ................................... 463,592 463,592 -------- -------- Total liabilities .............................................. 570,043 557,085 -------- -------- 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 ..................................... 5,911 5,811 Retained earnings .............................................. 7,562 7,607 -------- -------- Total stockholder's equity ................................... 13,473 13,418 -------- -------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY ....................... $583,516 $570,503 ======== ========
The accompanying notes are an integral part of these financial statements. -4- SALTON SEA FUNDING CORPORATION STATEMENTS OF OPERATIONS (In thousands) THREE MONTHS ENDED MARCH 31, ------------------- 2003 2002 ------- -------- (UNAUDITED) REVENUE: Interest income ......................... $ 9,469 $ 10,047 Equity in loss of Guarantors ............ (133) (7) ------- -------- Total revenue ......................... 9,336 10,040 ------- -------- COSTS AND EXPENSES: General and administrative expenses ..... 115 227 Interest expense ........................ 9,297 9,825 ------- -------- Total costs and expenses .............. 9,412 10,052 ------- -------- LOSS BEFORE INCOME TAXES .................. (76) (12) Benefit for income taxes ................ (31) (5) ------- -------- NET LOSS .................................. $ (45) $ (7) ======= ======== The accompanying notes are an integral part of these financial statements. -5- SALTON SEA FUNDING CORPORATION STATEMENTS OF CASH FLOWS (In thousands)
THREE MONTHS ENDED MARCH 31, --------------------- 2003 2002 -------- -------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ....................................................................... $ (45) $ (7) Adjustments to reconcile net loss to net cash flows from operating activities: Equity in loss of Guarantors ............................................... 133 7 Changes in assets and liabilities: Accrued interest receivable and other current assets ..................... (9,238) (9,945) Accrued interest ......................................................... 9,297 9,826 -------- -------- Net cash flows from operating activities ............................... 147 (119) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase in restricted cash .................................................. (155) (7) Due to affiliates ............................................................ 3,661 94,985 -------- -------- Net cash flows from financing activities ................................... 3,506 94,978 -------- -------- NET CHANGE IN CASH ............................................................. 3,653 94,859 Cash at the beginning of period ................................................ 19,583 4,361 -------- -------- CASH AT THE END OF PERIOD ...................................................... $ 23,236 $ 99,220 ======== ========
The accompanying notes are an integral part of these financial statements. -6- SALTON SEA FUNDING CORPORATION NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL In the opinion of management of 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, 2003 and the results of operations and cash flows for the three-month periods ended March 31, 2003 and 2002. The results of operations for the three-month period ended March 31, 2003 are not necessarily indicative of the results to be expected for the full year. The unaudited financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto included in the Funding Corporation's annual report on Form 10-K for the year ended December 31, 2002. Certain amounts in the prior year financial statements have been reclassified in order to conform to current year presentation. Such reclassifications did not impact previously reported net income (loss) or retained earnings. 2. NEW ACCOUNTING PRONOUNCEMENTS Effective January 1, 2003, the Funding Corporation adopted SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). This statement provides accounting and disclosure requirements for retirement obligations associated with long-lived assets. The cumulative effect of initially applying this statement did not have a material effect on the Funding Corporation's financial position, results of operations or cash flows. 3. CONTINGENCY Due to reduced liquidity, Southern California Edison ("Edison") had failed to pay approximately $119 million owed under the power purchase agreements with certain Guarantors (Imperial Valley Projects, excluding the Salton Sea V and CE 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. Pursuant to a settlement agreement the final payment of past due amounts by Edison 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. Edison has disputed a portion of the settlement agreement and has failed to pay approximately $3.9 million of capacity bonus payments for the months from October 2001 through May 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. Due to Edison's failure to pay the contractual obligations, certain Guarantors established an allowance for doubtful accounts of approximately $3.1 million and $2.7 million as of March 31, 2003 and December 31, 2002, respectively. On March 25, 2002, Salton Sea II's 10 MW turbine went out of service due to an uncontrollable force event. Such uncontrollable force event ended and Salton Sea II returned to service on December 17, 2002. Edison has failed to recognize the uncontrollable force event and, as such, has not paid amounts otherwise due and owing, and has improperly derated Salton Sea II from 15 MW to 12.5 MW under the Salton Sea II power purchase agreement. On January 29, 2003, Salton Sea Power Generation L.P., owner of Salton Sea II, served a complaint on Edison for such unpaid amount and to rescind such deration. -7- 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 LLC ("CE Generation") until the Funding Corporation debt service reserve fund of approximately $65.4 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. The fund had a cash balance of $46.4 million and $46.3 million as of March 31, 2003 and December 31, 2002, respectively. 4. RELATED PARTY TRANSACTIONS On January 29, 2003, TransAlta USA, Inc. ("TransAlta"), a wholly owned subsidiary of TransAlta Corporation, purchased El Paso's Merchant Energy's 50% interest in CE Generation. Pursuant to a Transaction Agreement dated January 29, 2003, CE Turbo and Salton Sea Power began selling available power to TransAlta on February 12, 2003 based on percentages of the Dow Jones SP-15 Index. Such agreement will expire on October 15, 2003. Sales to TransAlta from the Partnership and Salton Sea Guarantors totaled $2.3 million for the three months ended March 31, 2003. The accounts receivable balance at March 31, 2003 was $2.3 million. At December 31, 2002 accounts receivable from El Paso Merchant Energy were $1.4 million. -8- 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, 2003, and the related combined statements of operations and cash flows for the three-month periods ended March 31, 2003 and 2002. 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, 2002, 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 24, 2003 (January 29, 2003 as to Note 7), 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, 2002 is fairly stated, in all material respects, in relation to the combined balance sheet from which it has been derived. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Omaha, Nebraska May 8, 2003 -9- SALTON SEA GUARANTORS COMBINED BALANCE SHEETS (In thousands)
AS OF ------------------------ MARCH 31, DECEMBER 31, 2003 2002 --------- ------------ (UNAUDITED) ASSETS Current assets: Accounts receivable, net ................................. $ 16,932 $ 20,524 Prepaid expenses and other current assets ................ 4,659 5,283 -------- -------- Total current assets ................................... 21,591 25,807 -------- -------- Properties, plants, contracts and equipment, net ........... 534,407 535,220 Excess of cost over fair value of net assets acquired ...... 23,252 23,252 -------- -------- TOTAL ASSETS ............................................... $579,250 $584,279 ======== ======== LIABILITIES AND GUARANTORS' EQUITY Current liabilities: Accounts payable ......................................... $ 1,810 $ 328 Accrued interest ......................................... 6,219 1,593 Other accrued liabilities ................................ 14,141 12,304 Current portion of long-term debt ........................ 22,765 22,765 -------- -------- Total current liabilities .............................. 44,935 36,990 -------- -------- Due to affiliates .......................................... 29,122 35,665 Senior secured project note ................................ 223,654 223,654 -------- -------- Total liabilities ........................................ 297,711 296,309 -------- -------- Commitments and contingencies (Notes 4 and 5) Guarantors' equity ......................................... 281,539 287,970 -------- -------- TOTAL LIABILITIES AND GUARANTORS' EQUITY ................... $579,250 $584,279 ======== ========
The accompanying notes are an integral part of these financial statements. -10- SALTON SEA GUARANTORS COMBINED STATEMENTS OF OPERATIONS (In thousands) THREE MONTHS ENDED MARCH 31, -------------------- 2003 2002 -------- ------- (UNAUDITED) REVENUE: Operating revenue ....................................... $ 18,124 $23,405 Interest and other income (loss), net ................... (162) 430 -------- ------- Total revenue ......................................... 17,962 23,835 -------- ------- COSTS AND EXPENSES: Royalty, operating, general and administrative expense .. 14,724 11,890 Depreciation and amortization ........................... 4,893 4,275 Interest expense ........................................ 4,776 5,162 -------- ------- Total costs and expenses .............................. 24,393 21,327 -------- ------- NET INCOME (LOSS) ......................................... $ (6,431) $ 2,508 ======== ======= The accompanying notes are an integral part of these financial statements. -11- SALTON SEA GUARANTORS COMBINED STATEMENTS OF CASH FLOWS (In thousands) THREE MONTHS ENDED MARCH 31, ---------------------- 2003 2002 -------- -------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) .................................. $ (6,431) $ 2,508 Adjustments to reconcile net income (loss) to net cash flows from operating activities: Depreciation and amortization .................... 4,893 4,275 Changes in assets and liabilities: Accounts receivable, net ....................... 3,592 25,442 Prepaid expenses and other current assets ...... 624 (675) Accounts payable and accrued liabilities ....... 7,945 622 -------- -------- Net cash flows from operating activities ..... 10,623 32,172 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES - Capital expenditures ............................... (4,080) (2,598) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES - Due to affiliates .................................. (6,543) (29,574) -------- -------- NET CHANGE IN CASH ................................... -- -- Cash at the beginning of period ...................... -- -- -------- -------- CASH AT THE END OF PERIOD ............................ $ -- $ -- ======== ======== The accompanying notes are an integral part of these financial statements. -12- SALTON SEA GUARANTORS NOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL In the opinion of management of 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, 2003 and the results of operations and cash flows for the three-month periods ended March 31, 2003 and 2002. The results of operations for the three months ended March 31, 2003 are not necessarily indicative of the results to be expected for the full year. The unaudited financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto included in the Guarantors' annual report on Form 10-K for the year ended December 31, 2002. Certain amounts in the prior year financial statements have been reclassified in order to conform to current year presentation. Such reclassifications did not impact previously reported net income (loss) or Guarantors' equity. 2. NEW ACCOUNTING PRONOUNCEMENTS Effective January 1, 2003, the Guarantors adopted SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). This statement provides accounting and disclosure requirements for retirement obligations associated with long-lived assets. The cumulative effect of initially applying this statement did not have a material effect on the Guarantors' financial position, results of operations or cash flows. 3. INTANGIBLE ASSETS The Guarantors' acquired intangible assets consist of power purchase contracts (the "contracts") with a cost of $33.4 million and accumulated amortization of $9.1million and $8.8 million at March 31, 2003 and December 31, 2002, respectively. Amortization expense on the contracts was $0.3 million for the three-month periods ended March 31, 2003 and 2002. The Guarantors' expect amortization expense on the contracts to be $0.9 million for the remaining nine months of 2003 and $1.2 million for each of the four succeeding fiscal years. 4. CONTINGENCIES Due to reduced liquidity, Southern California Edison ("Edison") had failed to pay approximately $42.3 million owed under the power purchase agreements with certain Guarantors (Imperial Valley Projects, 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. Pursuant to a settlement agreement the final payment of past due amounts by Edison 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. Edison has disputed a portion of the settlement agreement and has failed to pay approximately $1.1 million of capacity bonus payments for the months from October 2001 through May 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. Due to Edison's failure to pay the contractual obligations, certain Guarantors established an allowance for doubtful accounts of approximately $0.9 million and $0.8 million as of March 31, 2003 and December 31, 2002, respectively. -13- On March 25, 2002, Salton Sea II's 10 MW turbine went out of service due to an uncontrollable force event. Such uncontrollable force event ended and Salton Sea II returned to service on December 17, 2002. Edison has failed to recognize the uncontrollable force event and, as such, has not paid amounts otherwise due and owing, and has improperly derated Salton Sea II from 15 MW to 12.5 MW under the Salton Sea II power purchase agreement. On January 29, 2003, Salton Sea Power Generation L.P., owner of Salton Sea II served a complaint on Edison for such unpaid amount and to rescind such deration. 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 LLC ("CE Generation") until the Funding Corporation debt service reserve fund of approximately $65.4 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. The fund had a cash balance of $46.4 million and $46.3 million as of March 31, 2003 and December 31, 2002, respectively. Stone & Webster --------------- The Salton Sea V Project was constructed by Stone & Webster, Inc. (formerly Stone & Webster Engineering Corporation), a wholly-owned subsidiary of the Shaw Group ("Stone & Webster"), pursuant to a date certain, fixed-price, turnkey engineering, procure, construct and manage contract (the "Salton Sea V Project EPC Contract"). On March 7, 2002, Salton Sea Power L.L.C. ("Salton Sea Power"), the owner of the Salton Sea V Project, filed a Demand for Arbitration against Stone & Webster for breach of contract and breach of warranty arising from deficiencies in Stone & Webster's design, engineering, construction and procurement of equipment for the Salton Sea V Project pursuant to the Salton Sea V Project EPC Contract. The demand for arbitration did not include a stated claim amount. On April 25, 2003, Salton Sea Power entered into a settlement agreement with Stone & Webster. The Settlement Agreement will result in a total payment of $12.1 million from Stone & Webster in the second quarter of 2003 and the arbitration will be dismissed. 5. RELATED PARTY TRANSACTIONS On January 29, 2003, TransAlta USA Inc. ("TransAlta"), a wholly owned subsidiary of TransAlta Corporation, purchased El Paso Merchant Energy North American Company's 50% interest in CE Generation. Pursuant to a Transaction Agreement dated January 29, 2003, Salton Sea Power began selling available power to TransAlta on February 12, 2003 based on percentages of the Dow Jones SP-15 Index. Such agreement will expire on October 15, 2003. Sales to TransAlta from the Guarantors totaled $1.8 million for the three months ended March 31, 2003. The accounts receivable balance at March 31, 2003 was $1.8 million. At December 31, 2002 accounts receivable from El Paso Merchant Energy were $1.1 million. -14- 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, 2003, and the related combined statements of operations and cash flows for the three-month periods ended March 31, 2003 and 2002. 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, 2002, 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 24, 2003 (January 29, 2003 as to Note 9), 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, 2002 is fairly stated, in all material respects, in relation to the combined balance sheet from which it has been derived. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Omaha, Nebraska May 8, 2003 -15- PARTNERSHIP GUARANTORS COMBINED BALANCE SHEETS (In thousands)
AS OF ------------------------ MARCH 31, DECEMBER 31, 2003 2002 --------- ------------ (UNAUDITED) ASSETS Current assets: Accounts receivable, net ................................. $ 13,511 $ 14,330 Prepaid expenses and other current assets ................ 19,003 19,516 -------- -------- Total current assets ................................... 32,514 33,846 -------- -------- Restricted cash ............................................ 132 1 Properties, plants, contracts and equipment, net ........... 667,687 664,722 Management fee ............................................. 67,621 68,679 Due from affiliates ........................................ 91,240 82,083 Excess of fair value over net assets acquired .............. 120,866 120,866 -------- -------- TOTAL ASSETS ............................................... $980,060 $970,197 ======== ======== LIABILITIES AND GUARANTORS' EQUITY Current liabilities: Accounts payable ......................................... $ 3,506 $ 2,903 Accrued interest ......................................... 6,182 1,576 Other accrued liabilities ................................ 17,043 15,464 Current portion of long-term debt ........................ 5,017 5,017 -------- -------- Total current liabilities .................................. 31,748 24,960 -------- -------- Senior secured project note ................................ 239,099 239,099 Deferred income taxes ...................................... 106,753 104,850 -------- -------- Total liabilities ........................................ 377,600 368,909 -------- -------- Commitments and contingencies (Notes 4 and 5) Guarantors' equity: Common stock ............................................. 3 3 Additional paid-in capital ............................... 442,225 432,200 Retained earnings ........................................ 160,232 169,085 -------- -------- Total guarantors' equity ............................... 602,460 601,288 -------- -------- TOTAL LIABILITIES AND GUARANTORS' EQUITY ................... $980,060 $970,197 ======== ========
The accompanying notes are an integral part of these financial statements. -16- PARTNERSHIP GUARANTORS COMBINED STATEMENTS OF OPERATIONS (In thousands) THREE MONTHS ENDED MARCH 31, --------------------- 2003 2002 -------- -------- (UNAUDITED) REVENUE: Operating revenue ..................................... $ 19,723 $ 22,199 Interest and other income (loss), net ................. (131) 536 -------- -------- Total revenue ....................................... 19,592 22,735 -------- -------- COSTS AND EXPENSES: Royalty, operating, general and administrative costs .. 24,199 18,286 Depreciation and amortization ......................... 5,633 6,787 Interest expense ...................................... 4,664 4,754 Capitalized interest .................................. -- (2,838) -------- -------- Total costs and expenses ............................ 34,496 26,989 -------- -------- LOSS BEFORE INCOME TAXES ................................ (14,904) (4,254) Benefit for income taxes ................................ (6,051) (1,340) -------- -------- NET LOSS ................................................ $ (8,853) $ (2,914) ======== ======== The accompanying notes are an integral part of these financial statements. -17- PARTNERSHIP GUARANTORS COMBINED STATEMENTS OF CASH FLOWS (In thousands)
THREE MONTHS ENDED MARCH 31, -------------------- 2003 2002 -------- -------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ................................................. $ (8,853) $ (2,914) Adjustments to reconcile net loss to net cash flows from operating activities: Depreciation and amortization .......................... 5,633 6,787 Deferred income taxes .................................. 1,903 (1,340) Changes in assets and liabilities: Accounts receivable, net ............................. 819 47,608 Prepaid expenses and other current assets ............ 513 623 Accounts payable and accrued liabilities ............. 6,788 169 -------- -------- Net cash flows from operating activities ........... 6,803 50,933 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures pertaining to operating projects .... (6,582) (6,191) Construction ............................................. (1,098) (6,351) Decrease (increase) in restricted cash ................... (131) 7,013 Management fee ........................................... 350 358 -------- -------- Net cash flows from investing activities ............... (7,461) (5,171) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Due from affiliates ...................................... (9,367) (43,086) Equity contribution ...................................... 10,025 -- -------- -------- Net cash flows from financing activities ............... 658 (43,086) -------- -------- NET CHANGE IN CASH ......................................... -- 2,676 Cash at beginning of period ................................ -- -- -------- -------- CASH AT THE END OF PERIOD .................................. $ -- $ 2,676 ======== ========
The accompanying notes are an integral part of these financial statements. -18- PARTNERSHIP GUARANTORS NOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL In the opinion of management of Partnership 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, 2003 and the results of operations and cash flows for the three-month periods ended March 31, 2003 and 2002. The results of operations for the three-month period ended March 31, 2003 are not necessarily indicative of the results to be expected for the full year. The unaudited financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto included in the Guarantors' annual report on Form 10-K for the year ended December 31, 2002. Certain amounts in the prior year financial statements have been reclassified in order to conform to current year presentation. Such reclassifications did not impact previously reported net income (loss) or retained earnings. 2. NEW ACCOUNTING PRONOUNCEMENTS Effective January 1, 2003, the Guarantors adopted SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). This statement provides accounting and disclosure requirements for retirement obligations associated with long-lived assets. The cumulative effect of initially applying this statement did not have a material effect on the Guarantors' financial position, results of operations or cash flows. 3. INTANGIBLE ASSETS The following table summarizes the acquired intangible assets as of March 31, 2003 and December 31, 2002 (in thousands):
MARCH 31, 2003 DECEMBER 31, 2002 ---------------------------- ---------------------------- GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED AMOUNT AMORTIZATION AMOUNT AMORTIZATION Amortized Intangible Assets: Power Purchase Contracts ..... $123,002 $ 97,286 $123,002 $ 96,894 Patented Technology .......... 46,290 15,867 46,290 15,385 -------- -------- -------- -------- Total ...................... $169,292 $113,153 $169,292 $112,279 ======== ======== ======== ========
Amortization expense on acquired intangible assets was $0.9 million for the three-month periods ended March 31, 2003 and 2002. The Guarantors expect amortization expense on acquired intangible assets to be $2.6 million for the nine months remaining in 2003 and $3.5 million for each of the four succeeding fiscal years. 4. CONTINGENCY Due to reduced liquidity, Southern California Edison ("Edison") failed to pay approximately $76.9 million owed under the power purchase agreements with certain Guarantors (excluding CE 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. -19- Pursuant to a settlement agreement the final payment of past due amounts by Edison 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. Edison has disputed a portion of the settlement agreement and has failed to pay approximately $2.7 million of capacity bonus payments for the months from October 2001 through May 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. Due to Edison's failure to pay the contractual obligations, certain Guarantors have established an allowance for doubtful accounts of approximately $2.2 million and $1.9 million as of March 31, 2003 and December 31, 2002, respectively. 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 LLC ("CE Generation") until the Funding Corporation debt service reserve fund of approximately $65.4 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. The fund had a cash balance of $46.4 million and $46.3 million as of March 31, 2003 and December 31, 2002, respectively. 5. RELATED PARTY TRANSACTIONS On January 29, 2003, TransAlta USA, Inc. ("TransAlta"), a wholly owned subsidiary of TransAlta Corporation, purchased El Paso Merchant Energy North American Company's 50% interest in CE Generation. Pursuant to a Transaction Agreement dated January 29, 2003, CE Turbo LLC began selling available power to TransAlta on February 12, 2003 based on percentages of the Dow Jones SP-15 Index. Such agreement will expire on October 15, 2003. Sales to TransAlta from the Guarantors totaled $0.5 million for the three months ended March 31, 2003. The accounts receivable balance at March 31, 2003 was $0.5 million. During the three months ended March 31, 2003, the Guarantors received approximately $10.0 million in contributions from MidAmerican Energy Holdings Company, one of its partners, to be used for capital expenditures. At December 31, 2002 accounts receivable from El Paso Merchant Energy were $0.3 million. -20- 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, 2003, and the related statements of operations and cash flows for the three-month periods ended March 31, 2003 and 2002. 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, 2002, and the related statements of operations, members' equity, and cash flows for the year then ended (not presented herein); and in our report dated January 24, 2003 (January 29, 2003 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, 2002 is fairly stated, in all material respects, in relation to the balance sheet from which it has been derived. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Omaha, Nebraska May 8, 2003 -21- SALTON SEA ROYALTY LLC BALANCE SHEETS (In thousands, except per share amounts)
AS OF ----------------------- MARCH 31, DECEMBER 31, 2003 2002 -------- ------------ (UNAUDITED) ASSETS Prepaid expenses and other current assets .............. $ 11 $ 13 Royalty stream, net .................................... 13,798 14,011 Excess of cost over fair value of net assets acquired .. 30,464 30,464 Due from affiliates .................................... 41,742 39,501 ------- ------- TOTAL ASSETS ........................................... $86,015 $83,989 ======= ======= LIABILITIES AND MEMBERS' EQUITY Current liabilities: Accrued interest .................................... $ 28 $ 7 Current portion of long-term debt ................... 304 304 ------- ------- Total current liabilities ......................... 332 311 Senior secured project note ............................ 843 843 ------- ------- Total liabilities ................................... 1,175 1,154 ------- ------- Commitments and contingencies (Note 4) Members' equity: Common stock, par value $.01 per share; 100 shares authorized, issued and outstanding ..... -- -- Additional paid-in capital .......................... 1,561 1,561 Retained earnings ................................... 83,279 81,274 ------- ------- Total members' equity ............................. 84,840 82,835 ------- ------- TOTAL LIABILITIES AND MEMBERS' EQUITY .................. $86,015 $83,989 ======= =======
The accompanying notes are an integral part of these financial statements. -22- SALTON SEA ROYALTY LLC STATEMENTS OF OPERATIONS (In thousands) THREE MONTHS ENDED MARCH 31, ------------------ 2003 2002 -------- ------ (UNAUDITED) REVENUE - ROYALTY INCOME ................................... $3,039 $3,682 COSTS AND EXPENSES: Royalty, operating, general and administrative expenses .. 798 1,092 Amortization of royalty stream ........................... 213 214 Interest expense ......................................... 23 89 ------ ------ Total costs and expenses ............................... 1,034 1,395 ------ ------ NET INCOME ................................................. $2,005 $2,287 ====== ====== The accompanying notes are an integral part of these financial statements. -23- SALTON SEA ROYALTY LLC STATEMENTS OF CASH FLOWS (In thousands)
THREE MONTHS ENDED MARCH 31, -------------------- 2003 2002 ------- ------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net income ..................................................................... $ 2,005 $ 2,287 Adjustments to reconcile net income to net cash flows from operating activities: Amortization of royalty stream and goodwill .................................. 213 214 Changes in assets and liabilities: Prepaid expenses and other current assets .................................. 2 5 Accrued interest ........................................................... 21 84 ------- ------- Net cash flows form operating activities ................................. 2,241 2,590 ------- ------- NET CASH FLOWS FROM FINANCING ACTIVITIES: Due from affiliates ............................................................ (2,241) (2,590) ------- ------- NET CHANGE IN CASH ............................................................... -- -- Cash at beginning of period ...................................................... -- -- ------- ------- CASH AT THE END OF PERIOD ........................................................ $ -- $ -- ======= =======
The accompanying notes are an integral part of these financial statements. -24- SALTON SEA ROYALTY NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL In the opinion of management of 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, 2003 and the results of operations and cash flows for the three-month periods ended March 31, 2003 and 2002. The results of operations for the three-month period ended March 31, 2003 are not necessarily indicative of the results to be expected for the full year. The unaudited financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2002. Certain amounts in the prior year financial statements have been reclassified in order to conform to current year presentation. Such reclassifications did not impact previously reported net income or retained earnings. 2. NEW ACCOUNTING PRONOUNCEMENTS Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). This statement provides accounting and disclosure requirements for retirement obligations associated with long-lived assets. The cumulative effect of initially applying this statement did not have a material effect on the Company's financial position, results of operations or cash flows. 3. ROYALTY STREAM The Royalty Company's policy is to provide amortization expense beginning upon the commencement of revenue production over the estimated remaining useful life of the identifiable assets. The royalty streams have been assigned values separately for each of (1) the remaining portion of the fixed price periods of the Projects' power sales agreements and (2) the 20-year avoided cost periods of the Projects' power sales agreements and are amortized separately over such periods using the straight line method. The royalty stream has a cost of $60.5 million and accumulated amortization $46.7 million and $46.5 million as of March 31, 2003 and December 31, 2002, respectively. Royalty stream amortization expense was $0.2 million for the three-month periods ended March 31, 2003 and 2002 and is expected to be $0.6 million for the remaining nine months of 2003 and $0.8 million for each of the four succeeding four fiscal years. 4. CONTINGENCY Due to reduced liquidity, Southern California Edison ("Edison") failed to pay approximately $119 million owed under the power purchase agreements with certain Guarantors Partnership 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. The final payment of past due amounts by Edison 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 LLC until Salton Sea Funding Corporation debt service reserve fund -25- of approximately $65.4 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. The fund had a cash balance of $46.4 million and $46.3 million as of March 31, 2003 and December 31, 2002, respectively. 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 financial condition and results of operations of Salton Sea Funding Corporation (the "Funding Corporation") and the Salton Sea Guarantors, the Partnership Guarantors, and Salton Sea Royalty LLC (the "Royalty Guarantors", or collectively the "Guarantors"), during the periods included in the accompanying statements of operations. This discussion should be read in conjunction with the Funding Corporation's and the Guarantors' historical financial statements and the notes to those statements. Actual results in the future could differ significantly from the historical results. FORWARD-LOOKING STATEMENTS From time to time, the Funding Corporation and the Guarantors may make forward-looking statements within the meaning of the federal securities laws that involve judgments, assumptions and other uncertainties beyond their control. These forward-looking statements may include, among others, statements concerning revenue and cost trends, cost recovery, cost reduction strategies and anticipated outcomes, pricing strategies, changes in the utility industry, planned capital expenditures, financing needs and availability, statements of the Funding Corporation's or the Guarantors' expectations, beliefs, future plans and strategies, anticipated events or trends and similar comments concerning matters that are not historical facts. These types of forward-looking 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 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 Private Securities Litigation Reform Act of 1995, the Funding Corporation and the Guarantors have identified important factors that could cause actual results to differ materially from those expectations, including weather effects on revenues and other operating uncertainties, uncertainties relating to economic and political conditions and uncertainties regarding the impact of regulations, changes in government policy and competition. Neither the Funding Corporation nor the Guarantors assume any 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 Funding Corporation's and the Guarantors' financial statements included in their annual report on Form 10-K for the year ended December 31, 2002 describes the significant accounting policies and methods used in the preparation of the financial statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts and impairment of long-lived assets. Actual results could differ from these estimates. For additional discussion of the Funding Corporation's and Guarantors' critical accounting policies, see "Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Funding Corporation's and the Guarantors' Annual Report on Form 10-K for the year ended December 31, 2002. NEW ACCOUNTING PRONOUNCEMENTS Effective January 1, 2003, the Funding Corporation and the Guarantors adopted SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). This statement provides accounting and disclosure requirements for retirement obligations associated with long-lived assets. The cumulative effect of initially applying this statement did not have a material effect on the Funding Corporation's or the Guarantors' financial position, results of operations or cash flows. -26- RESULTS OF OPERATIONS FOR THE PERIOD ENDED MARCH 31, 2003 AND 2002 For purposes of consistency in financial presentation, plant capacity factors for the Salton Sea I, Salton Sea II, Salton Sea III, Salton Sea IV and Salton Sea V plants are based on nominal capacity amounts of 10, 20, 50, 40 and 49 net mega-watts ("NMW"), respectively and for the Vulcan, Elmore, Leathers, Del Ranch, and CE Turbo plants are based on capacity amounts of 34, 38, 38, 38 and 10 NMW, respectively. Each plant possesses an operating margin, which allows for production in excess of the amounts listed above. Utilization of this operating margin is based upon a variety of factors and can be expected to vary throughout the year under normal operating conditions. The following operating data represents the aggregate capacity and electricity production of Salton Sea I, Salton Sea II, Salton Sea III, Salton Sea IV and Salton Sea V: PERIOD ENDED MARCH 31, ----------------------- 2003 2002 -------- -------- Overall capacity factor........... 71.6% 89.3% Capacity NMW (weighted average)... 168.4 168.4 MWh produced...................... 260,600 324,800 The overall capacity factor for the Salton Sea Guarantor decreased for the three months ended March 31, 2003 compared to the same period in 2002 primarily due to the timing of scheduled outages which are typically scheduled from January through May. The following operating data represents the aggregate capacity and electricity production of Vulcan, Elmore, Leathers, Del Ranch and CE Turbo: PERIOD ENDED MARCH 31, ------------------------- 2003 2002 -------- ---------- Overall capacity factor.......... 101.9% 89.3% Capacity NMW (weighted average).. 158.0 158.0 MWh produced..................... 347,900 306,000 The overall capacity factor for the Partnership Guarantor increased for the three months ended March 31, 2003 compared to the same period in 2002 primarily due to the timing of scheduled outages which are typically scheduled from January through May. Southern California Edison's ("Edison") Average Avoided Cost of Energy was 6.2 cents per kilowatt-hour and 2.9 cents per kilowatt-hour for the three months ended March 31, 2003 and 2002, respectively. Estimates of Edison's future Avoided Cost of Energy vary substantially from year to year. During 2002, as a result of certain settlement agreements, Edison 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 increased to 5.37 cents per kilowatt hour effective May 1, 2002 through April 30, 2007. The Salton Sea Guarantors' operating revenue decreased $5.3 million, or 22.6%, to $18.1 million for the three months ended March 31, 2003 from $23.4 million for the same period in 2002. The decrease was primarily due to the impact of a $6.8 million adjustment to the Edison provision in 2002 and lower production due to more overhauls in 2003, offset by higher rates in 2003. The Salton Sea Guarantors' interest and other income (loss) decreased $0.6 million to a net loss of $0.2 million for the three months ended March 31, 2003 from a net income of $0.4 million for the same period in 2002. The decrease was due to interest earned on the past due balances from Edison in 2002. -27- The Partnership Guarantors' operating revenue decreased $2.5 million, or 11.3%, to $19.7 million for the three months ended March 31, 2003 from $22.2 million for the same period in 2002. The decrease was primarily due to the impact of a $14.1 million adjustment to the Edison provision in 2002 partially offset by higher rates and, to a lesser degree, higher production in 2003. The Partnership Guarantors' interest and other income (loss) decreased $0.6 million to a net loss of $0.1 million for the three months ended March 31, 2003 from a net income of $0.5 million for the same period in 2002. The decrease was due to lower interest income due to interest earned on the past due balances from Edison in 2002. The Royalty Guarantors' revenue decreased $0.7 million, or 18.9%, to $3.0 million for the three months ended March 31, 2003 from $3.7 million for the same period in 2002. The decrease was the result of lower energy revenue at the Partnership Projects resulting in lower royalty income. The Salton Sea Guarantors' operating expenses, which include royalty, operating, general and administrative expenses, increased $2.8 million, or 23.5%, to $14.7 million for the three months ended March 31, 2003, from $11.9 million for the same period in 2002 primarily due to the timing of overhauls and higher pipe repair costs, partially offset by lower royalty expense. The Partnership Guarantors' operating expenses, which include royalty, operating, general and administrative expenses, increased $5.9 million, or 32.2%, to $24.2 million for the three months ended March 31, 2003, from $18.3 million for the same period in 2002. The increase in expenses was primarily due to operating expenses at the zinc recovery plant, which began limited production in December 2002, partially offset by lower royalty expense. The Royalty Guarantors' operating expenses, which include royalty, operating, general and administrative expenses, decreased $0.3 million to $0.8 million for the three months ended March 31, 2003 from $1.1 million for the same period in 2002. The decrease was primarily due to lower royalty expense. The Salton Sea Guarantors' depreciation and amortization increased $0.6 million to $4.9 million for the three months ended March 31, 2003 from $4.3 million for the same period in 2002. The increase was due to a change in salvage value assumptions and higher depreciable asset balances. The Partnership Guarantors' depreciation and amortization decreased $1.2 million to $5.6 million for the three months ended March 31, 2003 from $6.8 million for the same period in 2002. The decrease was due to the write off of an abandoned project during 2002 partially offset by a change in salvage value assumptions and higher depreciable asset balances. The Salton Sea Guarantors' interest expense decreased $0.4 million to $4.8 million for the three months ended March 31, 2003 from $5.2 million for the same period in 2002. The decrease was due to reduced indebtedness. The Partnership Guarantors' interest expense, net of capitalized amounts, increased $2.8 million to $4.7 million for the three months ended March 31, 2003 from $1.9 million for the same period in 2002. The increase was due to the discontinuance of capitalizing interest on the minerals extraction process, as the zinc recovery plant began limited production in December 2002, partially offset by reduced indebtedness. The Salton Sea Guarantors are substantially 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' benefit for income taxes, increased to $6.1 million for the three months ended March 31, 2003 from $1.3 million for the same period in 2002. The increase was due to higher pre-tax loss. The effective tax rate was 40.6% and 31.5% in 2003 and 2002, respectively. The changes from year to year in the effective rate are due primarily to the generation of energy tax credits, the resolution of certain tax issues, primarily related to depletion, and depletion deductions. Income taxes will be paid by the parent of the Guarantors from distributions to the parent company by the Guarantors, which occur after payment of operating expenses and debt service. -28- The Royalty Guarantors are substantially comprised of partnerships. Income taxes are the responsibility of the partners and Royalty Guarantors have no obligation to provide funds to the partners for payment of any tax liabilities. Accordingly, the Royalty Guarantors have no tax obligations. The Funding Corporation's net losses were not significant for the three months ended March 31, 2003 and 2002. The net loss primarily represents interest income and expense, net of applicable tax, and the Funding Corporation's 1% equity in earnings of the Guarantors. LIQUIDITY AND CAPITAL RESOURCES The Salton Sea Guarantors' cash flows from operating activities decreased to $10.6 million for the three months ended March 31, 2003 from $32.2 million for the same period in 2002. The 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 decrease was primarily due to the receipt of past due balances from Edison in 2002. The Partnership Guarantors' cash flows from operating activities decreased to $6.8 million for the three months ended March 31, 2003 from a source of $50.9 million for the same period in 2002. The 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 decrease was primarily due to the receipt of past due balances from Edison in 2002. The Royalty Guarantors' cash flow from operations decreased to $2.2 million for the three months ended March 31, 2003 from $2.6 million for the same period in 2002. The Royalty Guarantors' only source of revenue is royalties received pursuant to resource lease agreements with the Partnership Projects. Due to reduced liquidity, Edison had 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. Pursuant to a settlement agreement the final payment of the past due amounts by Edison 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. Edison has failed to pay approximately $3.9 million of capacity bonus payments for the months from October 2001 through May 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. Due to Edison's failure to pay the contractual obligations, the Imperial Valley Projects have established an allowance for doubtful accounts of approximately $3.1 million as of March 31, 2003. On March 25, 2002, Salton Sea II's 10 MW turbine went out of service due to an uncontrollable force event. Such uncontrollable force event ended, and Salton Sea II returned to service, on December 17, 2002. Edison has failed to recognize the uncontrollable force event and as such has not paid amounts otherwise due and owing and has improperly derated Salton Sea II from 15 MW to 12.5 MW, under the Salton Sea II Power Purchase Agreement. On January 29, 2003, Salton Sea Power Generation, L.P. served a complaint on Edison for such unpaid amounts and to rescind such deration. 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 Salton Sea Funding Corporation debt service reserve -29- fund of approximately $65.4 million has been funded or the letter of credit has been extended beyond its July 2004 expiration date or replaced. The fund had a cash balance of $46.4 million and $46.3 million as of March 31, 2003 and December 31, 2002, respectively. The Salton Sea V Project was constructed by Stone & Webster, Inc. (formerly Stone & Webster Engineering Corporation), a wholly-owned subsidiary of the Shaw Group ("Stone & Webster"), pursuant to a date certain, fixed-price, turnkey engineering, procure, construct and manage contract (the "Salton Sea V Project EPC Contract"). On March 7, 2002, Salton Sea Power L.L.C. ("Salton Sea Power"), the owner of the Salton Sea V Project, filed a Demand for Arbitration against Stone & Webster for breach of contract and breach of warranty arising from deficiencies in Stone & Webster's design, engineering, construction and procurement of equipment for the Salton Sea V Project pursuant to the Salton Sea V Project EPC Contract. On April 25, 2003, Salton Sea Power entered into a settlement agreement with Stone & Webster. The Settlement Agreement will result in a $12.1 million payment from Stone & Webster and the arbitration will be dismissed. The Salton Sea Guarantors' cash flow used in investing activities increased to $4.1 million for the three months ended March 31, 2003 from $2.6 million for the same period in 2002. Capital expenditures are the primary component of investing activities. The Partnership Guarantors' cash flow used in investing activities increased to $7.5 million for the three months ended March 31, 2003 from $5.2 million for the same period in 2002. Capital expenditures are the primary component of investing activities. Minerals LLC constructed the Zinc Recovery Project, which is recovering zinc from the geothermal brine (the "Zinc Recovery Project"). Facilities have been 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 is being transported to a central processing plant where zinc ingots are being 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. Limited production began during December 2002 and full production is expected by late-2003. 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 capital costs, excluding interest during construction, of the Zinc Recovery Project are approximately $153.4 million, net of payments for liquidated damages, through March 31, 2003. The Zinc Recovery Project anticipates incurring $14.5 million in capital expenditures during the remainder of 2003 to optimize production. The Funding Corporation's net cash flows from financing activities decreased to $3.5 million for the three months ended March 31, 2003 from $95.0 million for the same period in 2002 primarily due to reduced borrowings from affiliates. Salton Sea Guarantors' net cash flows used in financing activities decreased to $6.5 million from $29.6 million for the same period in 2002. Partnership Guarantors' net cash flows from financing activities increased to $0.7 million for the three months ended March 31, 2003 from a net cash use of $43.1 million for the same period in 2002 primarily due to an equity contribution received in 2003. The changes in net cash flows from financing activities are primarily the result of the funding of the debt service reserve fund. These receipts were deposited into cash accounts at the Funding Corporation and are recorded as amounts due to the Salton Sea and Partnership Guarantors. RELATED PARTY TRANSACTIONS On January 29, 2003, TransAlta USA, Inc. ("TransAlta"), a wholly owned subsidiary of TransAlta Corporation, purchased El Paso Merchant Energy North American Company's 50% interest in CE Generation. Pursuant to a Transaction Agreement dated January 29, 2003, Salton Sea Power and CE Turbo and began selling available power to TransAlta, on February 12, 2003, based on percentages of the Dow Jones SP-15 Index. Such agreement will expire on October 15, 2003. Sales to TransAlta from the Guarantors totaled $2.3 million for the three months ended March 31, 2003. The accounts receivable balance at March 31, 2003 was $2.3 million -30- 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, 2002. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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, 2002. ITEM 4. CONTROLS AND PROCEDURES. Salton Sea Funding Corporation's chief executive officer and chief financial officer have established "disclosure controls and procedures" (as defined in Rule 13a-14(c) and Rule 15d-14(c) of the Securities and Exchange Act of 1934) to ensure that material information of the companies and their subsidiaries is made known to them by others within the respective companies. Under their supervision, an evaluation of the disclosure controls and procedures was performed within 90 days prior to the filing of this quarterly report. Based on that evaluation, the above-mentioned officers have concluded that, as of the date of the evaluation, the disclosure controls and procedures were operating effectively. Additionally, the above-mentioned officers find that there have been no significant changes in internal controls, or in other factors that could significantly affect internal controls, subsequent to the date of that evaluation. -31- PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. In addition to the proceedings described in Note 3 in the notes to the consolidated financial statements, the Funding Corporation and its subsidiaries are currently parties to various minor items of litigation or arbitration, none of which, if determined adversely, would have a material adverse effect on the Funding Corporation. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. Not applicable. ITEM 3. DEFAULTS UPON 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: The exhibits listed on the accompanying Exhibit Index are filed as part of this Quarterly Report. (B) REPORTS ON FORM 8-K: None. -32- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SALTON SEA FUNDING CORPORATION (Registrant) Date: May 12, 2003 /s/ Wayne F. Irmiter ------------------------------ Wayne F. Irmiter Vice President & Controller -33- SECTION 302 CERTIFICATION FOR FORM 10-Q CERTIFICATIONS I, Edward J. Heinrich, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Salton Sea Funding Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 12, 2003 /s/ Edward J. Heinrich ---------------------- Edward J. Heinrich President (chief executive officer) -34- SECTION 302 CERTIFICATION FOR FORM 10-Q CERTIFICATIONS -------------- I, Wayne F. Irmiter, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Salton Sea Funding Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 12, 2003 /s/ Wayne F. Irmiter -------------------- Wayne F. Irmiter Vice President and Controller (chief accounting officer) -35- EXHIBIT INDEX Exhibit No. ----------- 99.1 Chief Executive Officer's Certificate Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Chief Accounting Officer's Certificate Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -36-