10-Q 1 was5176.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 Or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________________ to _______________________ Commission File No. 0-13510 ZOND-PANAERO WINDSYSTEM PARTNERS I, A CALIFORNIA LIMITED PARTNERSHIP State or other jurisdiction of incorporation or organization: California I.R.S. Employer Identification No: 77-0035358 Address of principal executive offices: 1221 Lamar Street, Suite 1600, Houston, Texas Zip Code: 77010 Registrant's telephone number, including area code: (713) 345-3582 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 ZOND-PANAERO WINDSYSTEM PARTNERS I, A CALIFORNIA LIMITED PARTNERSHIP For the three and six months ended June 30, 2004 TABLE OF CONTENTS PART I FINANCIAL INFORMATION Item 1. Condensed Financial Statements Condensed Balance Sheets at June 30, 2004 (Unaudited) and December 31, 2003. Unaudited Condensed Statements of Operations for the six months ended June 30, 2004 and June 30, 2003. Unaudited Condensed Statements of Operations for the three months ended June 30, 2004 and June 30, 2003. Unaudited Condensed Statements of Changes in Partners' Deficit for the six months ended June 30, 2004 and the year ended December 31, 2003. Unaudited Condensed Statements of Cash Flows for the six months ended June 30, 2004 and June 30, 2003. Notes to Unaudited Condensed Financial Statements. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk Item 4. Controls and Procedures PART II OTHER INFORMATION Item 1. Legal Proceedings Item 3. Defaults Upon Senior Securities Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K 2 ZOND-PANAERO WINDSYSTEM PARTNERS I, A CALIFORNIA LIMITED PARTNERSHIP CONDENSED BALANCE SHEETS (Dollars in thousands)

3 ZOND-PANAERO WINDSYSTEM PARTNERS I, A CALIFORNIA LIMITED PARTNERSHIP UNAUDITED CONDENSED STATEMENT OF OPERATIONS (Dollars in thousands, except per Unit value, which is in whole dollars)

4 ZOND-PANAERO WINDSYSTEM PARTNERS I, A CALIFORNIA LIMITED PARTNERSHIP UNAUDITED CONDENSED STATEMENT OF OPERATIONS (Dollars in thousands, except per Unit value, which is in whole dollars)

5 ZOND-PANAERO WINDSYSTEM PARTNERS I, A CALIFORNIA LIMITED PARTNERSHIP UNAUDITED CONDENSED STATEMENT OF CHANGES IN PARTNERS' DEFICIT (Dollars in thousands)

6 ZOND-PANAERO WINDSYSTEM PARTNERS I, A CALIFORNIA LIMITED PARTNERSHIP UNAUDITED CONDENSED STATEMENT OF CASH FLOWS (Dollars in thousands)

7 ZOND-PANAERO WINDSYSTEM PARTNERS I, A CALIFORNIA LIMITED PARTNERSHIP NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION The Condensed financial statements included herein for the quarterly periods ended June 30, 2004 and 2003 have been prepared by Zond-PanAero Windsystem Partners I, a California Limited Partnership (the "Partnership") without audit pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, these statements reflect all adjustments (consisting only of normal recurring entries), which are, in the opinion of the Partnership, necessary for a fair presentation of the financial results for the interim periods. Certain information and notes normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Partnership believes that the disclosures are adequate to make the information presented not misleading. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ended December 31, 2004. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NOTE 2 - THE PARTNERSHIP Introduction The Partnership was formed on June 29, 1984 to purchase, own and operate a system of 300 Vestas Energy A/S Model V-15 wind turbine electric generators (the "Turbines"). The Turbines, together with certain infrastructural improvements (the "Infrastructural Improvements") which are owned by Mesa Wind Developers ("Mesa"), a joint venture between Enron Wind Systems, Inc. ("EWSI") and an affiliate of PanAero Corporation ("PanAero"), form an integrated electric power generating facility (the "Windsystem") with a rated capacity of 19.5 megawatts in the San Gorgonio Pass area of the San Bernardino Mountains near Palm Springs, California (the "Operating Site"). EWSI is a developer and operator of commercial wind-powered electric generating facilities and PanAero is a wind resources development company. On January 3, 1997, EWSI's parent, Zond Corporation, became a wholly-owned subsidiary of Enron Renewable Energy Corp., which is wholly-owned by Enron Corp. ("Enron"). In May 1997, the name Zond Corporation was changed to Enron Wind Corp. ("EWC"). The general partner (the "General Partner") of the Partnership is Zond Windsystems Management LLC ("ZWM"), a California limited liability company wholly-owned by Enron Wind Systems, LLC ("EWS"). See "Bankruptcy and Mergers" regarding certain affiliated mergers and name changes affecting ZWM, EWS and EWC. The business of the Partnership and the respective rights of its partners, including the Partnership's limited partners (the "Limited Partners"), are 8 governed by the First Amended and Restated Certificate and Agreement of Limited Partnership of Zond-PanAero Windsystem Partners I, a California Limited Partnership, entered into on November 29, 1984, as amended (the "Partnership Agreement"). The Partnership Agreement states that the Partnership will terminate on December 31, 2005, unless earlier terminated in accordance with the provisions of the Partnership Agreement. The Windsystem, which became operational in November 1984, was constructed by Mesa Construction Company ("MCC"), a joint venture between an affiliate of EWSI and an affiliate of PanAero. The Partnership paid MCC a total of $48.9 million for the purchase, construction and installation of the Turbines, comprised of $22.4 million in cash and $26.5 million in the form of eighteen-year, 13% notes payable in equal semi-annual installments of principal and interest totaling $1.9 million (the "Purchase Notes"). As of the date of filing of this report, the Partnership is in default of the Purchase Notes. See Notes 3 and 4 below. Bankruptcy and Mergers Commencing on December 2, 2001, and periodically thereafter, Enron and certain of its subsidiaries filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code"). On February 20, 2002, EWC and EWSI each filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. Additionally, two California limited liability companies formed on February 19, 2002 for the purposes of merging with EWC and EWSI in anticipation of the sale of Enron's wind business also filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. EWC merged with and into one of such limited liability companies on April 19, 2002 and the surviving limited liability company changed its name to Enron Wind LLC ("EW"). EWSI merged with and into the other limited liability company, also on April 19, 2002, and the surviving limited liability company changed its name to Enron Wind Systems, LLC. On April 12, 2002, Zond Windsystems Management Corporation ("ZWMC"), the general partner of the Partnership at such time, merged with and into a third California limited liability company, formed on March 12, 2002, and the surviving limited liability company changed its name to Zond Windsystems Management LLC. On May 3, 2002, Zond Construction Corp. merged with and into a fourth California limited liability company, formed on March 21, 2002, and the surviving limited liability company changed its name to Zond Construction LLC ("ZC"). Neither ZWM nor ZC has filed for bankruptcy. Substituted Limited Partner PanAero Management Corporation ("PAMC"), a California corporation wholly-owned by PanAero, formerly served as a general partner of the Partnership (together with ZWMC, the "Former General Partners"). In June 1988, the Partnership solicited a vote by proxy of the Limited Partners to remove PAMC as a general partner. Pursuant to that vote, PAMC was converted to a substituted limited partner. Although the term "Substituted Limited Partner" is defined in the Partnership Agreement as any individual, partnership, corporation, trust or other entity admitted to the Partnership as a Limited Partner pursuant to transfer provisions under the Partnership Agreement, the term substituted limited partner is used in the accompanying Condensed Balance Sheets at June 30, 2004 (Unaudited) and December 31, 2003 and the Unaudited Condensed Statements of Changes in Partners' Deficit for June 30, 2004 and December 31, 2003 only in reference to the substituted limited partner interest created by the removal of PAMC as a general partner. Under an Agreement of Settlement and Mutual Releases 9 (the "Settlement Agreement") executed on June 26, 2000, PAMC agreed to transfer its substituted limited partner interest in the Partnership to ZWMC. Sale to General Electric On April 10, 2002, Enron, EWC and certain of its subsidiaries, including EWSI, entered into an Amended and Restated Purchase and Sale Agreement in which such entities agreed to sell in an asset sale (the "GE Sale") their wind turbine manufacturing, operation and maintenance and construction businesses to General Electric Company, acting through its GE power systems business ("GEPS"). The GE Sale was consummated on May 10, 2002. EW and its subsidiaries retained their existing wind power projects including the indirect ownership of the general partnership interest in the Partnership. However, effective as of the sale, substantially all of the employees who had been involved in the management of the Partnership transferred to GEPS. Following the sale to GEPS, new management was appointed to manage and operate the Partnership, and ZWM's principal executive offices were moved to 1400 Smith Street, Houston, Texas 77002 and subsequently were moved to 1221 Lamar Street, Suite 1600, Houston, Texas 77010. Eric D. Gadd was appointed President and Chief Executive Officer of ZWM on September 26, 2002. Mary Cilia was appointed Chief Financial Officer and Treasurer of ZWM on May 3, 2004. New Management and Financial Reports Until its appointment, the new management of the Partnership had no material involvement with the business and operations of the Partnership. In the process of reviewing the Partnership's books and records and through conversations with prior management, it appeared to new management that the Partnership had attempted, but failed, to file with the SEC certain Partnership Securities Exchange Act of 1934 ("Exchange Act") reports for certain time periods preceding the Enron bankruptcy. The submissions of such reports into the EDGAR filing system were not accepted although prior management apparently believed the filings were made successfully. These reports consist of the Partnership's Form 10-K for the year ended December 31, 1999, the Partnership's Forms 10-Q for each of the three quarters of 2000, the Partnership's Form 10-K for the year ended December 31, 2000, and the Partnership's Forms 10-Q for the first and second quarters of 2001 (collectively, the "Historical Reports"). These reports appear to have been prepared by prior management of the Partnership and audited or reviewed, as the case may be, by Arthur Andersen LLP. The Partnership has copies of the EDGARized version of each of such reports as well as most of the cover sheets reflecting the attempted EDGAR submissions. In response to correspondence from the Partnership requesting guidance regarding the filing of the Historical Reports, the Partnership received a letter from the SEC dated June 16, 2004 that, among other things, stated that the Partnership should promptly file its remaining delinquent Forms 10-K and Forms 10-Q. The Partnership is currently reviewing copies of the Historical Reports. To date, the Partnership has not filed any of the Historical Reports with the SEC. During 2003, current management of the Partnership reviewed the current and historical financial information available to it, but was unable to prepare quarterly and annual reports that complied with Exchange Act requirements because the Partnership had not been able to retain an independent auditor. At that time, management believed that the fact that EWS is a debtor-in-possession under Chapter 11 of the Bankruptcy Code and the fact that it and ZWM are indirect wholly owned subsidiaries of Enron would make it extraordinarily difficult for the Partnership to find an independent auditor to replace Arthur Andersen LLP. In 2003, the Partnership decided to file quarterly and annual operating reports on Form 8-K disclosing unaudited financial and business information about the Partnership on a quarterly basis until the Partnership was 10 able to retain an independent auditor and recommence filing periodic reports on Forms 10-K and 10-Q. On November 5, 2003, the Partnership filed a Form 8-K with the SEC disclosing the foregoing information. Thereafter, using Form 8-K, the Partnership filed operating reports with unaudited financial and business information for the fiscal years ended December 31, 2001, 2002 and 2003, and for the fiscal quarters ended March 31, 2003, June 30, 2003 and September 30, 2003. By filing these operating reports, the Partnership publicly disclosed more recent financial and business information. However, the operating reports contained unaudited financial statements and were not in compliance with the requirements of the Exchange Act. In addition, the operating reports did not cover all periods for which the Partnership failed to file periodic reports. On January 28, 2004, the Partnership retained Hein & Associates LLP as its independent accountant. On May 10, 2004, the Partnership filed with the SEC the Partnership's comprehensive Form 10-K for the fiscal years ended December 31, 2001, 2002 and 2003 and the Partnership's Forms 10-Q for each of the first three quarters of 2003. On May 14, 2004, the Partnership timely filed with the SEC the Partnership's Form 10-Q for the first quarter of 2004. Operation and Maintenance Services EWS manages the Windsystem pursuant to a windsystem management agreement with the Partnership executed on July 27, 1988 (the "Management Agreement"). The Management Agreement terminates by its terms on December 31, 2004. Prior to May 10, 2002, Enron Wind Maintenance LLC, an affiliate of EWS, provided operations and maintenance services for the Windsystem. On May 10, 2002, in connection with the GE Sale, EWS contracted with GE Wind Energy, LLC to perform certain operations and maintenance services relating to the Windsystem for a period of one year ending on May 10, 2003. In April 2003, EWS entered into an agreement (the "O&M Agreement") with SeaWest Asset Management Services, LLC ("SeaWest") to provide certain operation and maintenance services relating to the Windsystem for a 5-year period ending on May 10, 2008. If EWS terminates the O&M Agreement prior to the end of its stated term, EWS may be required to pay certain agreed demobilization fees to SeaWest. If EWS is required to pay such fees, EWS may attempt to seek recovery from the Partnership of some, or all, of the amount of such fees pursuant to the terms of the Management Agreement. Management currently estimates that the amount of the demobilization fee, if any, for which EWS would seek recovery from the Partnership would not be in excess of approximately $100,000 at December 31, 2004, with the amount of such demobilization fee declining as of May 10 of each subsequent year until contract expiration. Substantial Transactions and Operating Agreements The accompanying unaudited condensed financial statements include substantial transactions with related parties. These transactions are further described in Notes 4 and 5. A summary of the major operating agreements entered into by the Partnership, directly or indirectly, is set forth below: (1) The Partnership sells the electricity produced by the Turbines to Southern California Edison Company ("SCE"), pursuant to a power purchase and sales agreement (the "Power Agreement"). The Power Agreement was originally entered into between SCE and PanAero in April 1982 and covers an aggregate of 29.9 megawatts of generating capacity. PanAero assigned the Power 11 Agreement to Mesa in July 1984. Mesa subsequently assigned the portion of the Power Agreement that covers the aggregate rated capacity of the Turbines (19.5 megawatts), to the Partnership until December 31, 2004. The remaining 10.4 megawatts of generating capacity available under the Power Agreement was assigned by Mesa to Zond-PanAero Windsystem Partners II, a California Limited Partnership ("ZPII"), whose general partner is an affiliate of the General Partner. SCE purchases electricity produced by the Turbines at a price equal to the greater of 89% of SCE's "Cost of Energy" (as defined in the Power Agreement) or a fixed minimum price of $.102 per kilowatt hour ("kWh"), with the limitation that when 89% of SCE's Cost of Energy exceeds $.20 kWh, the price per kWh paid by SCE will be limited to $.20 per kWh plus 70% of the difference between 89% of SCE's Cost of Energy and $.20 per kWh. During both of the six months ended June 30, 2003 and June 30, 2004, the Partnership earned $.102 per kWh of electricity delivered to SCE. Absent an extension of rights under the Power Agreement, the Partnership will not have the ability to sell power subsequent to December 31, 2004. See Note 3 for additional information. (2) Since July 1988, the Partnership has contracted with EWS (or its predecessor) for the operation and maintenance of the Turbines and the performance of certain ancillary management services, such as collection of revenues from SCE and the administration and payment of all Partnership expenses. Under the provisions of the Management Agreement, the Partnership pays a management fee of 2% of "Gross Operating Proceeds", which are defined as all gross receipts from the sale of electricity generated by the Turbines and all amounts paid in lieu of receipts from the sale of electricity, including, without limitation, any proceeds of systems performance or wind resource insurance, casualty loss and business interruption insurance paid in reimbursement of lost revenues and warranty payments in reimbursement of lost revenues. Under the Management Agreement, EWS is entitled to be reimbursed for 115% of the maintenance costs, including labor and material costs that it incurs in the performance of services, including services performed by third parties. See Note 5 for additional information. (3) The Operating Site is situated on two adjoining parcels of land, consisting of approximately 440 acres, located in the San Gorgonio Pass area of the San Bernardino Mountains, approximately 16 miles northwest of Palm Springs, California. The Partnership uses the Infrastructural Improvements and a portion of the Operating Site pursuant to a 20-year easement granted by Mesa under the terms of a Wind Park Easement Agreement dated as of September 7, 1984, as amended (the "Wind Park Easement Agreement"). Mesa has rights to develop wind energy resources at the Operating Site, which includes the Infrastructural Improvements, under a right-of-way grant (the "Right-of-Way Grant") from the United States Bureau of Land Management ("BLM"). The primary term of the Right-of-Way Grant expired on January 26, 2003. On December 19, 2002, the Right-of-Way Grant was extended for a ten-year period commencing on January 27, 2003; however, the Wind Park Easement Agreement terminates on December 31, 2004. See Note 3 for additional information. EWSI, PanAero, and their affiliates have developed and sold additional wind turbines on the Operating Site to ZPII, and Mesa has granted a similar easement to ZPII. Under the Wind Park Easement Agreement, Mesa charges the Partnership rental fees in an amount equal to the greater of 5% of Gross Operating Proceeds or the Partnership's pro rata share (with the other producers of electric energy from wind power on the Operating Site) of the payments due the BLM under the Right-of-Way Grant. Effective January 1, 1996, the BLM changed 12 the annual rental payment due under the Right-of-Way Grant to a flat rent of $79,000. Rental payments may be adjusted by the BLM annually to reflect any change in the fair rental value of the Operating Site, which could result in revised easement payments by the Partnership to Mesa. Cash Distributions The Partnership distributes cash in accordance with the terms of the Partnership Agreement. Due to less-than-projected operating results, the Partnership has not distributed any cash to the General Partner, Limited Partners, Dean Witter Reynolds Inc. as a special limited partner, the Former General Partners or the substituted limited partners during any fiscal year other than 1985, in which the Partnership distributed an aggregate of approximately $158,000 to the Limited Partners and $2,000 to the Former General Partners. Under the Purchase Notes, the Partnership cannot make cash distributions to its partners unless certain cash reserve balances are maintained, no events of default exist, and certain ratio tests are met. The Partnership has not met these criteria since 1985. The Partnership did not make cash distributions to its partners during the six month periods ended June 30, 2003 or June 30, 2004. NOTE 3 - GOING CONCERN The following matters raise substantial doubt about the Partnership's ability to continue as a going concern: 1. As discussed in Note 4 below, the Partnership has not had sufficient cash flows from operations to make scheduled payments of principal and interest on the outstanding Purchase Notes. Accordingly, the Partnership is in default of the Purchase Notes. Upon notice of default, MCC has a right to foreclose against its security interests in the assets of the Partnership. As of the date of filing of this report, MCC has not notified the Partnership of its intent to foreclose on its security interests. Any such foreclosure by MCC on its security interests in the assets of the Partnership would have a material adverse effect on the Partnership. 2. The Partnership's assignment of rights under the Power Agreement expires on December 31, 2004 and the Power Agreement expires in June 2005. Additionally, the Wind Park Easement Agreement expires on December 31, 2004. The Partnership will have no ability to sell the power it generates after December 31, 2004 without an extension of the assignment of rights under the Power Agreement and an extension of the Wind Park Easement Agreement. Additionally, if the Partnership were to obtain an extension of its assignment of rights under the Power Agreement, it could only be effective until June 2005, unless the Power Agreement were extended beyond that date or some other arrangements were made. 3. The Partnership's operation and maintenance service provider was provided notice from SCE that beginning April 13, 2004 the amount of electricity that the Windsystem could generate and deliver to SCE was being curtailed by approximately 75%. A representative from SCE explained that the curtailment action was being taken due to the re-routing of power as a result of the construction of a new power line. SCE substantially curtailed the Partnership's electrical production from the Windsystem beginning April 13, 2004 and continuing through May 17, 2004 (the "SCE Curtailment"). Historically, the second quarter of the year has been a relatively high production quarter. The SCE Curtailment resulted in lower production and correspondingly lower cash flows for the Partnership than would have been expected based upon past results. See Note 7. After making payments related to 13 ongoing operations, the Partnership was unable to make payments of accrued interest on the Purchase Notes which are currently in default. NOTE 4 - PURCHASE NOTES Under an agreement reached in April 1989, MCC reduced the interest rate on the Purchase Notes from 13% to 11% per annum effective in January 1990. The Partnership secured its payment obligations under the Purchase Notes by granting MCC security interests in the Turbines and other intangible collateral including the rights, title and interests of the Partnership under several of the Partnership's major operating agreements. As of June 30, 2004, the principal has been fully repaid but there remains $4.3 million of interest in arrears on the Purchase Notes. The Partnership's cash flows have been insufficient to make scheduled payments associated with the Purchase Notes. Under the terms of the Purchase Notes, payments made by the Partnership are applied towards principal and then towards accrued and unpaid interest. The Purchase Notes matured on December 31, 2002. As a result, all outstanding principal and unpaid interest on the Purchase Notes was due at that time. The Partnership's non-payment of interest in arrears on the Purchase Notes gives MCC the right to foreclose against its security interests in the assets of the Partnership. MCC has not notified the Partnership of its intent to foreclose on its security interests. NOTE 5 - AMOUNTS PAYABLE TO RELATED PARTIES, NET In addition to the Purchase Notes (See Note 4 above), the Partnership had amounts payable to Mesa (See Note 2 above) and EWS, respectively as of June 30, 2004. Amounts payable to Mesa include easement fees and other miscellaneous expenses related to Windsystem operations. Amounts payable to EWS include management fees and other miscellaneous expenses related to Windsystem operations. Such amounts are unsecured and non-interest bearing. The Partnership has the following related party transactions and relationships: (1) Mesa assigned easement rights to a portion of the Operating Site and granted rights to use the Infrastructural Improvements to the Partnership under the Wind Park Easement Agreement (See Note 2 above). The Partnership incurred $0.03 million in easement fees during the second quarter of 2004 as compared to $0.04 million during the second quarter of 2003, pursuant to the Wind Park Easement Agreement. (2) The Partnership contracted with EWSI to operate and maintain the Turbines and to perform certain management and administrative services under the Management Agreement (See Note 2 above). The Partnership incurred expenses of $0.2 million during the second quarter of 2004 as compared to $0.3 million during the second quarter of 2003 pursuant to the Management Agreement. In 1988, Mesa assigned $581,000 of receivables from the Partnership to each of its two general partners, EWSI and an affiliate of PanAero. EWSI subsequently forgave its $581,000 of receivables from the Partnership. This forgiveness was treated as a capital contribution in the accompanying financial statements. 14 NOTE 6 - LITIGATION FERC Investigation In May 2003, the Federal Energy Regulatory Commission (the "FERC"), pursuant to FERC Docket No. EL03-47-000, began investigating whether the Windsystem and certain other power projects owned by Enron or its affiliates failed to meet the ownership criteria for qualifying facility ("QF") status under the Public Utility Regulatory Policies Act of 1978 ("PURPA"), following Enron's acquisition of Portland General Electric Company in 1997. Under PURPA, and the applicable FERC regulations, a power project is not a QF if more than 50% of the equity interest in the project is owned by an electric utility or electric utility holding company. The Partnership and the FERC Trial Staff have settled the issues under investigation and entered into a Consent Agreement dated March 10, 2004 (the "Consent Agreement"). Pursuant to the Consent Agreement, the Partnership and the FERC Trial Staff agreed that the Windsystem is a QF notwithstanding Enron's indirect equity interest in the Windsystem and the other contractual relationships between the Partnership and various affiliates of Enron. The FERC approved the Consent Agreement effective June 2, 2004. NOTE 7 - SUBSEQUENT EVENTS Purchase Notes The Partnership is in default of the Purchase Notes. MCC has not notified the Partnership of its intent to foreclose on its security interest. As of August 13, 2004, the total amount in default is $4.3 million, which is comprised entirely of interest in arrears. The terms of the Purchase Notes do not require that the Partnership pay additional interest on the accrued and unpaid interest due under the Purchase Notes. See Notes 3 and 4 for additional information. SCE Curtailment By letter dated June 22, 2004, Enron Wind LLC, on behalf of the sellers under the Power Agreement, issued for payment an invoice to SCE in the amount of approximately $750,000 to compensate the Partnership and ZP II for their estimated losses during the SCE Curtailment. During this period, SCE curtailed the Partnership's production of electric power by approximately 75%, resulting in the Partnership's inability to produce and sell a significant portion of electric power. Of the approximately $750,000 invoiced to SCE, approximately $482,000 represents lost revenue that otherwise would have been paid to the Partnership. To date, SCE has not responded to the demand for payment and none of the amount invoiced to SCE has yet been recorded as revenue for the Partnership. See Note 3. 15 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Going Concern The following matters raise substantial doubt about the Partnership's ability to continue as a going concern: 1. The Partnership has not had sufficient cash flows from operations to make scheduled payments of principal and interest on the outstanding Purchase Notes. Accordingly, the Partnership is in default of the Purchase Notes. Upon notice of default, MCC has a right to foreclose against its security interests in the assets of the Partnership. As of the date of filing of this report, MCC has not notified the Partnership of its intent to foreclose on its security interests. Any such foreclosure by MCC on its security interests in the assets of the Partnership would have a material adverse effect on the Partnership. 2. The Partnership's assignment of rights under the Power Agreement expires on December 31, 2004 and the Power Agreement expires in June 2005. Additionally, the Wind Park Easement Agreement expires on December 31, 2004. The Partnership will have no ability to sell the power it generates after December 31, 2004 without an extension of the assignment of rights under the Power Agreement and an extension of the Wind Park Easement Agreement. Additionally, if the Partnership were to obtain an extension of its assignment of rights under the Power Agreement, it could only be effective until June 2005, unless the Power Agreement were extended beyond that date or some other arrangements were made. 3. The Partnership's operation and maintenance service provider was provided notice from SCE that beginning April 13, 2004 the amount of electricity that the Windsystem could generate and deliver to SCE was being curtailed by approximately 75%. A representative from SCE explained that the curtailment action was being taken due to the re-routing of power as a result of the construction of a new power line. SCE substantially curtailed the Partnership's electrical production from the Windsystem during the period from April 13, 2004 through May 17, 2004 (the "SCE Curtailment"). Historically, the second quarter of the year has been a relatively high production quarter. The SCE Curtailment resulted in lower production and correspondingly lower cash flows for the Partnership than would have been expected based upon past results. After making payments related to ongoing operations, the Partnership was unable to make payments of accrued interest on the Purchase Notes which are currently in default. Liquidity and Capital Resources The Partnership experienced a lack of liquidity throughout the second quarter of 2004, primarily due to an ongoing shortfall in revenues from operations in comparison to the costs and expenses of operations. The Purchase Notes matured on December 31, 2002, and all of the outstanding principal and accrued and unpaid interest under the Purchase Notes was due at that time. The Partnership has not generated sufficient cash flow to pay the accrued and unpaid interest on the Purchase Notes. As a result, interest payments on the Purchase Notes in the aggregate amount of $4.3 million, were in arrears at June 30, 2004. The Partnership's failure to pay on December 31, 2002 such outstanding principal and accrued interest in arrears on the Purchase Notes resulted in a default under the Purchase Notes, and such default is continuing with respect to the nonpayment of accrued interest. This continuing default gives MCC the right to 16 foreclose against the collateral of its loans as set forth in the Purchase Notes. As of June 30, 2004 and as of the filing of this report, MCC had not exercised its right to foreclosure under the Purchase Notes. See "Results of Operations for the Three Months Ended June 30, 2004 Compared to the Three Months Ended June 30, 2003". The Partnership's primary source of revenues and liquidity to fund operations of the Windsystem, repay debt, administer the Partnership, and make distributions to its partners is the production and sale of electricity from the Windsystem. The Partnership's sole customer is SCE. The price paid by SCE for the electricity is contractually defined under the Power Agreement. During the second quarter of 2004, the Partnership's production and revenues were less than expected due to the SCE Curtailment. As of June 30, 2004, the Partnership had no current or planned commitments for capital expenditures. Results of Operations for the Six Months Ended June 30, 2004 Compared to the Six Months Ended June 30, 2003. For the first six months of 2004, revenues from power sales were $1.9 million, and the Windsystem produced 18.3 million kWh of electricity for sale to SCE. This was a decrease of $0.5 million or 22% in revenue and a decrease of 5.0 million kWh of electricity produced or 21% as compared to the same period in 2003. This decrease was primarily due to the SCE Curtailment. Total costs and expenses in the first six months of 2004 and 2003 were $2.1 million. Interest expense decreased $0.05 million in the first half of 2004 as compared to the same period in 2003 due to lower average principal balances on the Purchase Notes outstanding during 2004. Property taxes increased $0.05 million in the first half of 2004 as compared to the same period in 2003 due to tax penalties related to prior periods being assessed in 2004. Maintenance expenses decreased $0.04 million in the first six months of 2004 due to a decrease in unscheduled maintenance as compared to the first six months of 2003. Insurance expenses decreased $0.05 million in the first six months of 2004 due to a decrease in premiums as compared to the same period in 2003. Other operating costs increased $0.09 million in the first six months of 2004 due to an increase in the use of outside consultants as compared to the same period in 2003. Overall, the Partnership reported a net loss of $0.2 million for the first six months of 2004, which is a decrease of $0.5 million as compared to the first six months of 2003. During the first six months of 2004, total partners' deficit increased by $0.2 million or 17% to $1.7 million from the first six months of 2003. Net loss per Unit was $197 for the first six months of 2004 compared with a net income per Unit of $239 for the first six months of 2003. Cash flows from operations decreased $2.3 million in the first six months of 2004 as compared to 2003. This decrease was primarily due to the payment of $1.5 million in interest on the Purchase Notes on January 16, 2004. Other factors contributing to the decrease included a net impact of unfavorable changes in working capital as well as reduced earnings in the first half of 2004 due primarily to the SCE Curtailment. Cash flows used in financing activities increased by $0.5 million due to principal payments made on the Purchase Notes during the six months ended June 30, 2004, while none were made during the six months ended June 30, 2003. 17 Results of Operations for the Three Months Ended June 30, 2004 Compared to the Three Months Ended June 30, 2003. For the three months ended June 30, 2004, revenues from power sales were $1.2 million, and the Windsystem produced 12.1 million kWh of electricity for sale to SCE for the second quarter of 2004. This was a decrease of $0.5 million or 27% in revenue and a decrease of 4.6 million kWh of electricity produced or 27% as compared to the same period in 2003. This decrease was primarily due to the SCE Curtailment. Costs and expenses for the second quarter of 2004 were $1.0 million. This was a decrease of $0.1 million or 11%, as compared to the second quarter of 2003. Overall, the Partnership reported net income of $0.3 million for the second quarter of 2004, which is a decrease of $0.4 million or 56% as compared to the second quarter of 2003. Net income per Unit was $237 for the second quarter of 2004 compared with a net income per Unit of $536 for the second quarter of 2003. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Partnership's management, with the participation of the General Partner's Chief Executive Officer and Chief Financial Officer has evaluated the disclosure requirements of Item 305 of Regulation S-K "Quantitative and Qualitative Disclosures about Market Risk,"and has concluded that the Partnership has no market risk sensitive instruments for which this disclosure is required. Item 4. CONTROLS AND PROCEDURES The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. This term means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. During 2003, the Partnership put into place procedures for gathering, analyzing, communicating to management, and disclosing the information the Partnership is required to disclose in the periodic reports required by the Exchange Act. In April of 2004, the Partnership formalized, in writing, its disclosure controls and procedures. The Partnership's management, with the participation of the General Partner's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Partnership's disclosure controls and procedures as of June 30, 2004. Based on these evaluations, the General Partner's Chief Executive Officer and Chief Financial Officer concluded that the Partnership's disclosure controls and procedures were effective as of June 30, 2004. 18 During the three months ended June 30, 2004, the Partnership made no change in its internal controls over financial reporting that materially affected, or is reasonably likely to materially affect, its internal controls over financial reporting. 19 PART II - OTHER INFORMATION Item 1. Legal proceedings. FERC Investigation In May 2003, the Federal Energy Regulatory Commission (the "FERC"), pursuant to FERC Docket No. EL03-47-000, began investigating whether the Windsystem and certain other power projects owned by Enron or its affiliates failed to meet the ownership criteria for qualifying facility ("QF") status under the Public Utility Regulatory Policies Act of 1978 ("PURPA") following Enron's acquisition of Portland General Electric Company in 1997. Under PURPA, and the applicable FERC regulations, a power project is not a QF if more than 50% of the equity interest in the project is owned by an electric utility or electric utility holding company. The Partnership and FERC Trial Staff have settled the issues under investigation and entered into a Consent Agreement dated March 10, 2004 (the "Consent Agreement"). Pursuant to the Consent Agreement, the Partnership and FERC Trial Staff agreed that the Windsystem is a QF notwithstanding Enron's indirect equity interest in the Windsystem and the other contractual relationships between the Partnership and various affiliates of Enron. The FERC approved the Consent Agreement effective June 2, 2004. Item 3. Defaults upon senior securities. The Partnership is in default of the Purchase Notes. As of August 13, 2004, the total amount in default is $4.3 million, which is comprised of unpaid interest in arrears. The outstanding principal balance of the Purchase Notes was paid by the Partnership in January of 2004. See Notes 3, 4 and 7 to the Financial Statements for additional information. Item 5. Other information. This report contains statements that are forward-looking within the meaning of Section 27(a) of the Securities Act of 1933 and Section 21(e) of the Exchange Act. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and that actual results could differ materially as a result of known and unknown risks and uncertainties, including general economic conditions, future trends, and other risks, uncertainties and factors disclosed in this operating report. 20 Item 6. Exhibits and reports of Form 8-K (a) Exhibits 31.1 Rule 13a-14(a) Certification of Eric D. Gadd 31.2 Rule 13a-14(a) Certification of Mary H. Cilia 32.1 Section 1350 Certification of Eric D. Gadd 32.2 Section 1350 Certification of Mary H. Cilia (b) Reports on Form 8-K None. 21 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. Zond-PanAero Windsystem Partners I, a Date: August 13, 2004 California Limited Partnership --------------- By: Zond Windsystems Management LLC, General Partner By: /s/ Eric D. Gadd ------------------------------- Eric D. Gadd Chief Executive Officer of Zond Windsystems Management LLC, The General Partner of Zond-PanAero Windsystem Partners I, a California Limited Partnership By: /s/ Mary H. Cilia ------------------------------- Mary H. Cilia Chief Financial Officer of Zond Windsystems Management LLC, the General Partner of Zond-PanAero Windsystem Partners I, a California Limited Partnership 22 Exhibit Index Number Description 31.1* Rule 13a-14(a) Certification of Eric D. Gadd 31.2* Rule 13a-14(a) Certification of Eric D. Gadd 32.1* Section 1350 Certification of Eric D. Gadd 32.2* Section 1350 Certification of Mary H. Cilia * Filed with this report 23

ZOND PANAERO WINDSYSTEM PARTNERS I 10-Q