10-Q 1 cegen10q093003.txt CE GENERATION, LLC - FORM 10-Q - 9/30/2003 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 September 30, 2003 Commission File No. 333-89521 CE GENERATION, LLC ------------------ (Exact name of registrant as specified in its charter) Delaware 47-0818523 --------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 302 South 36th Street, Suite 400 Omaha, Nebraska 68131 --------------- ----- (Address of principal executive offices) (Zip Code) (402) 341-4500 -------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: N/A Securities registered pursuant to Section 12(g) of the Act: N/A 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] The members' equity accounts are held 50% by MidAmerican Energy Holdings Company and 50% by TransAlta USA Inc. as of October 31, 2003. 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............................................11 Item 3. Quantitative and Qualitative Disclosures About Market Risk.........17 Item 4. Controls and Procedures............................................17 PART II - OTHER INFORMATION Item 1. Legal Proceedings..................................................18 Item 2. Changes in Securities and Use of Proceeds..........................18 Item 3. Defaults Upon Senior Securities....................................18 Item 4. Submission of Matters to a Vote of Security Holders................18 Item 5. Other Information..................................................18 Item 6. Exhibits and Reports on Form 8-K...................................18 SIGNATURES....................................................................19 EXHIBIT INDEX.................................................................20 -2- PART I - FINANCIAL INFORMATION Item 1. Financial Statements. INDEPENDENT ACCOUNTANTS' REPORT Board of Directors and Members CE Generation, LLC We have reviewed the accompanying consolidated balance sheet of CE Generation, LLC and subsidiaries (the "Company") as of September 30, 2003, and the related consolidated statements of operations and other comprehensive income for the three-month and nine-month periods ended September 30, 2003 and 2002, and of cash flows for the nine-month periods ended September 30, 2003 and 2002. These interim financial statements are the responsibility of the Company's management. We conducted our reviews 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 and 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 reviews, we are not aware of any material modifications that should be made to such consolidated interim 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 consolidated balance sheet of CE Generation, LLC and subsidiaries as of December 31, 2002, and the related consolidated statements of operations and other comprehensive income, 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 12) we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2002 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. As discussed in Note 2 to the consolidated financial statements, in 2003 the Company changed its accounting policy for asset retirement obligations. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Omaha, Nebraska November 3, 2003 -3- CE GENERATION, LLC AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands)

The accompanying notes are an integral part of these financial statements. -4- CE GENERATION, LLC AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME (In thousands)

The accompanying notes are an integral part of these financial statements. -5- CE GENERATION, LLC AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)

The accompanying notes are an integral part of these financial statements. -6- CE GENERATION, LLC AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. General In the opinion of the management of CE Generation, LLC ("CE Generation" or the "Company") the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position as of September 30, 2003, and the results of operations for the three-month and nine-month periods ended September 30, 2003 and 2002, and of cash flows for the nine-month periods ended September 30, 2003 and 2002. The results of operations for the three-month and nine-month periods ended September 30, 2003 are not necessarily indicative of the results to be expected for the full year. The unaudited consolidated financial statements and notes thereto should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2002. Certain amounts in the prior year financial statements and supporting note disclosures have been reclassified in order to conform to the current year presentation. Such reclassifications did not impact previously reported net income or members' equity. 2. New Accounting Pronouncements Effective January 1, 2003, the Company adopted Statement of Financial Accounting Standards 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 was recognized as a cumulative effect of a change in accounting principle of $2.5 million, net of tax of $1.6 million, as of January 1, 2003. The Company identified legal retirement obligations related to landfill and plant abandonment costs, measured the obligations using an expected cash flow approach and recorded those liabilities pursuant to SFAS 143 as of January 1, 2003. The following liabilities reflect amounts as if this statement had been applied during all periods (in thousands): September 30, December 31, 2003 2002 --------------- --------------- (Proforma) Plant abandonment.................... $3,969 $3,798 Landfill abandonment................. $3,914 $3,663 Following is a reconciliation of net income as originally reported for the three-month and nine-month periods September 30, 2003 and 2002, to adjusted net income as if this statement had been applied to all periods (in thousands):

-7- The plant abandonment obligation had not been recorded prior to January 1, 2003. The landfill abandonment obligation had a previously recorded liability of $1.5 million at December 31, 2002. 3. Intangible Assets The following table summarizes the acquired intangible assets, which are included in properties, plants, contracts and equipment, net, on the balance sheet, as of September 30, 2003 and December 31, 2002 (in thousands):

Amortization expense on acquired intangible assets was $4.6 million and $14.1 million for the three-month and nine-month periods ended September 30, 2003, respectively, and $4.6 million and $13.7 million for the three-month and nine-month periods ended September 30, 2002, respectively. CE Generation expects amortization expense on acquired intangible assets to be $18.7 million for 2003 and $15.8 million for each of the five succeeding fiscal years. 4. Commitments and Contingencies Edison and the California Power Exchange ---------------------------------------- Due to reduced liquidity, Southern California Edison ("Edison") had failed to pay approximately $119 million owed under the power Purchase Agreements with the projects indirectly owned by the Company located in the Imperial Valley (the "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 Imperial Valley Projects (excluding the Salton Sea V and CE Turbo Projects) had established an allowance for doubtful accounts of approximately $21 million as of December 31, 2001. Pursuant to a settlement agreement, the final payment by Edison for past due balances was received March 1, 2002. Following the receipt of Edison's payment of past due balances, the Imperial Valley Projects 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, the Imperial Valley Projects (excluding the Salton Sea I, Salton Sea V and CE Turbo Projects) 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 these contractual obligations, the Imperial Valley Projects established an allowance for doubtful accounts of approximately $2.7 million as of December 31, 2002. In connection with the June 11, 2003 settlement discussed below, the receivables associated with this allowance were written off during 2003. On March 25, 2002, Salton Sea II's 10 megawatt ("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 failed to recognize the uncontrollable force event and as such did not pay amounts otherwise due and owing and 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 amounts and to rescind such deration. -8- On June 11, 2003, the Imperial Valley Projects (excluding the Salton Sea I, Salton Sea V and CE Turbo projects) entered into a settlement agreement with Edison. The settlement, which relates to the capacity bonus payment and Salton Sea II uncontrollable force event disputes, provides for an $800,000 settlement payment from Edison, payment of amounts previously withheld for the Unit II deration and the recission of such deration. The amounts previously withheld for the Unit II deration were received in the second quarter of 2003. The $800,000 settlement payment is contingent upon approval by the California Public Utilities Commission. On July 10, 2003, Salton Sea IV's 34 MW turbine went out of service due to an uncontrollable force event. Such uncontrollable force event ended, and Salton Sea IV returned to service on September 17, 2003. Edison failed to recognize the uncontrollable force event and as such has not paid amounts otherwise due and owing under the Salton Sea IV Power Purchase Agreement totaling $1.7 million. On September 19, 2003 and October 17, 2003, Salton Sea Power Generation, L.P., with Fish Lake Power Company, owner of Salton Sea IV served notices of error Edison for such unpaid amounts. As a result, the Company established reserve of $1.4 million for capacity payments as of September 30, 2003. As a result of uncertainties related to Edison, the letter of credit that supported the debt service reserve fund at Salton Sea Funding Corporation had not been extended beyond its then existing July 2004 expiration date, and as such cash distributions were not available to CE Generation until the Salton Sea Funding Corporation debt service reserve fund of approximately $65.4 million had been funded or the letter of credit had been extended beyond its July 2004 expiration date or replaced. At December 31, 2002, the fund had a cash balance of $46.3 million. In May 2003, the previous $65.4 million Salton Sea Funding Corporation debt service reserve letter of credit was replaced by a $32.7 million TransAlta USA Inc. ("TransAlta"), a wholly owned subsidiary of TransAlta Corporation, letter of credit which expires on May 30, 2004, and a $32.7 million MidAmerican Energy Holdings Company ("MidAmerican") letter of credit which expires on June 6, 2006. These new Salton Sea Funding Corporation debt service reserve letters of credit permitted the cash, which was previously restricted, to be included in funds distributed to CE Generation on May 29, 2003. During the second quarter of 2003, CE Generation distributed a total of $65.0 million to MidAmerican and TransAlta. 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 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 resulted in a total payment of $12.1 million from Stone & Webster in the second quarter 2003 and the arbitration was dismissed. The settlement was recorded as a $4.5 million reduction of incremental capital expenditures and a $7.6 million reduction of incremental operating expenses related to legal, other expenses and equipment write-offs. On November 25, 2002, Vulcan/BN Geothermal Power Company, Del Ranch, L.P., and CE Turbo, LLC entered into a settlement agreement with Stone & Webster related to 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 CE Turbo Project. The settlement agreement resulted in a $3.5 million payment from Stone & Webster which was recorded as a reduction of incremental capital expenditures. -9- Other Commitments and Contingencies ----------------------------------- CE Generation's geothermal and cogeneration facilities are Qualifying Facilities ("QF") under the Public Utility Regulatory Policies Act of 1978 ("PURPA") and their contracts for the sale of electricity are subject to regulations thereunder. In order to promote open competition in the industry, legislation has been proposed in the U.S. Congress that calls for either a repeal of PURPA on a prospective basis or the significant restructuring of the regulations governing the electric industry, including sections of PURPA. Current federal legislative proposals would not abrogate, amend, or modify existing contracts with electric utilities. The ultimate outcome of any proposed legislation is unknown at this time. The Power Resources Project, a 200 net MW natural gas-fired cogeneration project owned by Power Resources Ltd. ("Power Resources"), an indirect wholly-owned subsidiary of CE Generation, was a QF under PURPA and sold electricity to TXU Generation Company LP pursuant to a 15-year negotiated power purchase agreement ("the Power Resources PPA"), which provided for capacity and energy payments. Capacity and energy payments in 2003 were $3.7 million per month and 3.6 cents per kilowatt hour, respectively. The Power Resources PPA expired September 30, 2003. The Power Resources Project sold steam to ALON USA, LP ("ALON") under a 15-year agreement that also expired September 30, 2003. On August 5, 2003, Power Resources entered into a Tolling Agreement with ONEOK Energy Marketing and Trading Company, L.P. ("ONEOK"). Under the terms of the agreement, Power Resources sells its electricity and capacity to ONEOK for $1.75 per kilowatt-month plus a variable operating and maintenance fee of $.50 per MW hour ("MWh"). In addition, ONEOK pays annual turbine start-up costs in an amount equal to the greater of (i) $3,643 per turbine start-up, (ii) $939,986 or (iii) $140 per hour of operation during the year. The agreement commenced October 1, 2003 and expires December 31, 2005. On May 20, 2003, Salton Sea Power entered into a Power Sales Agreement (the "Riverside Power Sales Agreement") with the City of Riverside, California ("Riverside"). Under the terms of the agreement, Salton Sea Power sells up to 20 MW of energy generated from Salton Sea V to Riverside at $61 per MWh. Sales under the agreement commenced June 1, 2003 and will terminate May 31, 2013. Minerals LLC ("Minerals") contracted with Zachry Construction Corporation ("Zachry") under a time and materials contract to do a maximum of $1.32 million work for the Zinc Recovery Project. Zachry has invoiced Minerals for $4.7 million of work under this contract. Minerals has been unable to substantiate Zachry's invoices. Zachry filed a demand for arbitration with the American Arbitration Association (the "AAA") on August 19, 2003 for collection of its claimed outstanding invoices. Although the AAA has selected an arbitration panel, neither the AAA nor the panel has scheduled any hearings on this matter to date. Minerals anticipates that the evidentiary hearing on this matter will not likely occur prior to the summer of 2004. 5. Related Party Transactions On January 29, 2003, TransAlta purchased El Paso Merchant Energy North American Company's ("EPME") 50% interest in CE Generation. Pursuant to a Transaction Agreement dated January 29, 2003, Salton Sea Power and CE Turbo began selling power to a subsidiary of TransAlta on February 12, 2003 based on percentages of the Dow Jones SP-15 Index. The Transaction Agreement shall continue until the earlier of (a) 30 days following a written notice of termination after October 1, 2003 or (b) any other termination date mutually agreed to by the parties. No such notice of termination has been given by either party. Sales under this agreement totaled $2.9 million and $8.0 million during the three-month and nine-month periods ended September 30, 2003, respectively. Sales to EPME totaled $1.1 million and $4.6 million during the three-month and nine-month periods ended September 30, 2002, respectively. -10- 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 CE Generation, LLC ("CE Generation" or the "Company"), during the periods included in the accompanying financial statements. This discussion should be read in conjunction with the Company's historical financial statements and the notes to those statements. The Company's actual results in the future could differ significantly from the historical results. FORWARD-LOOKING STATEMENTS From time to time, CE Generation may make forward-looking statements within the meaning of the federal securities laws that involve judgments, assumptions and other uncertainties beyond the control of the Company or any of its subsidiaries individually. 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 CE Generation's 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 of the Company to differ materially from any expected future results or performance, expressed or implied, by the forward-looking statements. In connection with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, CE Generation has 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. The Company does not 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 Company's Consolidated Financial Statements included in the Company's 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 Consolidated Financial Statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, impairment of long-lived assets and contingent liabilities. Actual results could differ from these estimates. For additional discussion of the Company's critical accounting policies, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. RESULTS OF OPERATIONS FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002 Operating revenue increased $1.5 million or 1.1% to $142.8 million for the three-month period ended September 30, 2003 from $141.3 million for the same period in 2002. The increase reflects $3.3 million of higher revenue at the company's gas facilities due to $5.6 million of increased energy rates partially offset by $2.3 million in lower revenue from decreased production as a result of curtailment and maintenance and $1.8 million of lower revenue due to decreased production related to an uncontrollable force event at the Salton Sea Unit IV Project partially offset by higher rates at the geothermal projects located in the Imperial Valley in California (the "Imperial Valley Projects"). -11- Interest and other income decreased $1.6 million to $0.7 million for the three-month period ended September 30, 2003 from $2.3 million for the same period in 2002 due to interest earned on past due Southern California Edison ("Edison") amounts in 2002. Fuel expenses increased $1.7 million to $32.1 million for the three-month period ended September 30, 2003 from $30.4 million for the same period in 2002. The increase was primarily due to higher natural gas prices at the Company's gas facilities, partially offset by increased utility curtailment in 2003. Plant operating expenses, which include operating, maintenance, resource and other plant operating expenses, increased $2.4 million to $33.4 million for the three-month period ended September 30, 2003 from $31.0 million for the same period in 2002. The increase was primarily due to an uncontrollable force event at the Salton Sea Unit IV Project and timing of other maintenance activities. General and administrative expenses decreased $1.0 million to $1.1 million for the three-month period ended September 30, 2003 from $2.1 million for the same period in 2002. These costs include administrative services including executive, financial, legal, tax and other corporate functions. The decrease in 2003 was primarily due to a reduction in legal costs related to disputes with Edison. Depreciation and amortization increased $1.8 million to $21.8 million for the three month period ended September 30, 2003 from $20.0 million for the same period in 2002. The increase was primarily due to a change in salvage values used at the Salton Sea Projects. Interest expense decreased $1.8 million to $17.2 million for the three-month period ended September 30, 2003 from $19.0 million for the same period in 2002. The decrease is due to lower outstanding debt balances. The provision for income taxes decreased $2.0 million to $9.0 million for the three-month period ended September 30, 2003 from $11.0 million for the same period in 2002. The effective tax rate was 23.7% and 26.7% in 2003 and 2002, respectively. The lower effective tax rate is due to greater depletion benefits in 2003. RESULTS OF OPERATIONS FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002 Operating revenue increased $7.0 million or 1.8% to $388.2 million for the nine-month period ended September 30, 2003 from $381.2 million for the same period in 2002. The increase reflects $26.0 million due to higher rates at the Imperial Valley Projects and $15.6 million due to increased energy rates at the Company's gas facilities in 2003, partially offset by the $21.0 million adjustment to the Edison provision at the Imperial Valley Projects in the first quarter of 2002 and $13.6 million in lower revenue from decreased production, at both the Imperial Valley Projects and the gas facilities, as a result of curtailment and maintenance, in 2003. Interest and other income decreased $5.2 million to $2.0 million for the nine-month period ended September 30, 2003 from $7.2 million for the same period in 2002 due to the interest earned in 2002 on past due Edison amounts, Salton Sea II Project business interruption revenue and the sale of Saranac emission credits in 2002. Fuel expenses increased $6.1 million to $95.8 million for the nine-month period ended September 30, 2003 from $89.7 million for the same period in 2002. The increase was primarily due to higher natural gas prices at the Company's gas facilities. Plant operating expenses, which include operating, maintenance, resource and other plant operating expenses, increased $1.7 million to $98.4 million for the nine-month period ended September 30, 2003 from $96.7 million for the same period in 2002. The increase was primarily due to the Salton Sea Unit IV repairs partially offset by settlement of a warranty claim with Stone & Webster, Inc. ("Stone & Webster"). General and administrative expenses decreased $1.7 million to $3.2 million for the nine-month period ended September 30, 2003 from $4.9 million for the same period in 2002. These costs include administrative services including -12- executive, financial, legal, tax and other corporate functions. The decrease in 2003 was due to a reduction in legal costs related to disputes with Edison. Depreciation and amortization increased $2.2 million to $64.6 million for the nine-month period ended September 30, 2003 from $62.4 million for the same period in 2002. The increase was primarily due to a change in salvage values used at the Salton Sea Projects. Interest expense decreased $5.0 million to $53.1 million for the nine-month period ended September 30, 2003 from $58.1 million for the same period in 2002. The decrease is due to lower outstanding debt balances. The provision for income taxes decreased $1.3 million to $18.1 million for the nine-month period ended September 30, 2003 from $19.4 million for the same period in 2002. The effective tax rate was 24.1% and 25.3% in 2003 and 2002, respectively. The lower effective tax rate is due to greater depletion benefits in 2003. The cumulative effect of a change in accounting principle in 2003 reflects the Company's adoption of Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143") as of January 1, 2003. The cumulative effect of initially applying this statement was recognized as a cumulative effect of a change in accounting principle of $2.5 million, net of tax of $1.6 million, as of January 1, 2003. If CE Generation had adopted the policy as of January 1, 2002, income before cumulative effect of change in accounting principle would have been $0.5 million lower for the nine-month period ended September 30, 2002 on a proforma basis. LIQUIDITY AND CAPITAL RESOURCES Each of CE Generation's direct or indirect subsidiaries is organized as a legal entity separate and apart from CE Generation and its other subsidiaries. Pursuant to separate project financing agreements, the assets of each subsidiary (excluding PRL (beginning September 30, 2003) and Yuma) are pledged or encumbered to support or otherwise provide the security for their own project or subsidiary debt. It should not be assumed that any asset of any subsidiary of CE Generation will be available to satisfy the obligations of CE Generation or any of its other subsidiaries; provided, however, that unrestricted cash or other assets which are available for distribution may, subject to applicable law and the terms of financing arrangements for such parties, be advanced, loaned, paid as dividends or otherwise distributed or contributed to CE Generation or affiliates thereof. "Subsidiary" means all of CE Generation's direct or indirect subsidiaries (1) owning direct or indirect interests in the Imperial Valley Projects (including the Salton Sea Projects and the Partnership Projects), or (2) owning direct interests in the subsidiaries that own interests in the foregoing projects, the Saranac Project, a 240 net megawatt ("MW") natural gas-fired cogeneration facility owned by Saranac Energy Company, Inc., an indirect wholly-owned subsidiary of CE Generation, and the Power Resources Project, a 200 net MW natural gas-fired cogeneration project owned by Power Resources Ltd. ("Power Resources"), an indirect wholly-owned subsidiary of CE Generation. CE Generation generated cash flows from operations of $134.5 million for the nine-month period ended September 30, 2003 compared with $157.7 million for the same period in 2002. The decrease was primarily due to the receipt of past due balances from Edison in 2002 and changes in working capital in 2003. Cash flow used in investing activities was $13.8 million for the nine-month period ended September 30, 2003 and included a $4.5 million reduction due to recoveries from the Stone & Webster settlement. Cash used was $26.6 million for the nine-month period ended September 30, 2002. Capital expenditures are the primary component of investing activities. Cash flow used in financing activities was $71.8 million for the nine-month period ended September 30, 2003 compared with $100.9 million for the same period in 2002. The changes in cash flows from financing activities primarily reflect the funding of debt service reserve accounts and distributions to owners. -13- Due to reduced liquidity, Edison failed to pay approximately $119 million owed under the Power Purchase Agreements with the 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 Imperial Valley Projects (excluding the Salton Sea V and CE Turbo Projects) had established an allowance for doubtful accounts of approximately $21 million as of December 31, 2001. 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 Imperial Valley Projects 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, the Imperial Valley Projects (excluding the Salton Sea I, Salton Sea V, and CE Turbo Projects) 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 these contractual obligations, the Imperial Valley Projects established an allowance for doubtful accounts of approximately $2.7 million as of December 31, 2002. In connection with the June 11, 2003 settlement discussed below, the receivables associated with this allowance were written off during 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 failed to recognize the uncontrollable force event and as such did not pay amounts otherwise due and owing and 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 amounts and to rescind such deration. On June 11, 2003, the Imperial Valley Projects (excluding the Salton Sea I, Salton Sea V and CE Turbo Projects) entered into a settlement agreement with Edison. The settlement, which relates to the capacity bonus payment and Salton Sea II uncontrollable force event disputes, provides for an $800,000 settlement payment from Edison, payment of amounts previously withheld for the Unit II deration and the recission of such deration. The amounts previously withheld for the Unit II deration were received in the second quarter of 2003. The $800,000 settlement payment is contingent upon approval by the California Public Utilities Commission. On July 10, 2003, Salton Sea IV's 34 MW turbine went out of service due to an uncontrollable force event. Such uncontrollable force event ended, and Salton Sea IV returned to service on September 17, 2003. Edison failed to recognize the uncontrollable force event and as such has not paid amounts otherwise due and owing under the Salton Sea IV Power Purchase Agreement totaling $1.7 million. On September 19, 2003 and October 17, 2003, Salton Sea Power Generation, L.P., with Fish Lake Power Company, owner of Salton Sea IV served notices of error on Edison for such unpaid amounts. As a result, the Company has set up a reserve of $1.4 million for capacity payments as of September 30, 2003. As a result of uncertainties related to Edison, the letter of credit that supported the debt service reserve fund at Salton Sea Funding Corporation had not been extended beyond its then existing July 2004 expiration date, and as such cash distributions were not available to CE Generation until the Salton Sea Funding Corporation debt service reserve fund of approximately $65.4 million had been funded or the letter of credit had been extended beyond its July 2004 expiration date or replaced. At December 31, 2002, the fund had a cash balance of $46.3 million. In May 2003, the previous $65.4 million Salton Sea Funding Corporation debt service reserve letter of credit was replaced by a $32.7 million TransAlta USA Inc. ("TransAlta"), a wholly owned subsidiary of TransAlta Corporation, letter of credit which expires May 30, 2004 and a $32.7 million MidAmerican Energy Holdings Company ("MidAmerican") letter of credit which expires June 6, 2006. -14- These new Salton Sea Funding Corporation debt service reserve letters of credit permitted the cash, which was previously restricted, to be included in funds distributed to CE Generation on May 29, 2003. During the second quarter of 2003, CE Generation distributed a total of $65.0 million to MidAmerican and TransAlta. Stone & Webster --------------- The Salton Sea V Project was constructed by 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 resulted in a total payment of $12.1 million from Stone & Webster in the second quarter of 2003 and the arbitration was dismissed. The settlement was recorded as a $4.5 million reduction of incremental capital expenditures and a $7.6 million reduction of incremental operating expenses related to legal, other expenses and equipment write-offs. The CE Turbo Project was constructed by Stone & Webster, pursuant to a date certain, fixed-price, turnkey engineering, procure, construct and manage contract (the "CE Turbo Project EPC Contract"). On March 7, 2002, Vulcan/BN Geothermal Power Company, Del Ranch, L.P., and CE Turbo LLC, the owners of the CE Turbo 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 CE Turbo Project pursuant to the CE Turbo Project's EPC Contract. On November 25, 2002, Vulcan/BN Geothermal Power Company, Del Ranch, L.P., and CE Turbo, LLC entered into a settlement agreement with Stone & Webster related to 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 CE Turbo Project. The settlement agreement resulted in a $3.5 million payment from Stone & Webster which was recorded as a reduction of incremental capital expenditures. The Power Resources Project was a Qualifying Facility ("QF") under the Public Utility Regulatory Policies Act of 1978 ("PURPA") and sold electricity to TXU Generation Company LP pursuant to a 15 year negotiated power purchase agreement ("the Power Resources PPA"), which provided for capacity and energy payments. Capacity and energy payments, in 2003 were $3.7 million per month and 3.6 cents per kilowatt ("kW") hour, respectively. The Power Resources PPA expired September 30, 2003. The Power Resources Project sold steam to ALON USA, LP ("ALON") under a 15-year agreement that also expired September 30, 2003. On August 5, 2003, Power Resources Ltd. ("Power Resources") entered into a Tolling Agreement with ONEOK Energy Marketing and Trading Company, L.P. ("ONEOK"). Under the terms of the agreement, Power Resources sells its electricity and capacity to ONEOK for $1.75 per kW-month plus a variable operating and maintenance fee of $.50 per MW hour ("MWh"). In addition, ONEOK pays annual turbine start-up costs in an amount equal to the greater of (i) $3,643 per turbine start-up, (ii) $939,986 or (iii) $140 per hour of operation during the year. The agreement commenced October 1, 2003 and expires December 31, 2005. On May 20, 2003, Salton Sea Power entered into a Power Sales Agreement with the City of Riverside, California ("Riverside"). Under the terms of the agreement, Salton Sea Power sells up to 20 MW of energy generated from Salton Sea V to Riverside at $61 per MWh. Sales under the agreement commenced June 1, 2003 and will terminate May 31, 2013. Minerals LLC ("Minerals") contracted with Zachry Construction Corporation ("Zachry") under a time and materials contract to do a maximum of $1.32 million work for the Zinc Recovery Project. Zachry has invoiced Minerals for $4.7 million of work under this contract. Minerals has been unable to substantiate Zachry's invoices. Zachry filed a demand for arbitration with the American Arbitration Association (the "AAA") on August 19, 2003 for collection of its claimed outstanding invoices. Although the AAA has selected an arbitration panel, neither the AAA nor the panel has scheduled any hearings on this matter -15- to date. Minerals anticipates that the evidentiary hearing on this matter will not likely occur prior to the summer of 2004. RELATED PARTY TRANSACTIONS On January 29, 2003, TransAlta purchased El Paso Merchant Energy North American Company's ("EPME") 50% interest in CE Generation. Pursuant to a Transaction Agreement dated January 29, 2003, Salton Sea Power and CE Turbo LLC began selling power to a subsidiary of TransAlta on February 12, 2003 based on percentages of the Dow Jones SP-15 Index. The Transaction Agreement shall continue until the earlier of (a) 30 days following a written notice of termination after October 1, 2003 or (b) any other termination date mutually agreed to by the parties. No such notice of termination has been given by either party. Sales under this agreement totaled $2.9 million and $8.0 million during the three-month and nine-month periods September 30, 2003, respectively. Sales to EPME totaled $1.1 million and $4.6 million during the three-month and nine-month periods ended September 30, 2002, respectively. 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 Company's Annual Report on Form 10-K for the year ended December 31, 2002 other than as discussed in this "Liquidity and Capital Resources" section. -16- Item 3. Quantitative and Qualitative Disclosures About Market Risk. For quantitative and qualitative disclosures about market risk affecting CE Generation, see Item 7A "Qualitative and Quantitative Disclosures About Market Risk" of CE Generation's Annual Report on Form 10-K for the year ended December 31, 2002. Other than the Power Resources and Riverside contract changes, CE Generation's exposure to market risk has not changed materially since December 31, 2002. Item 4. Controls and Procedures. An evaluation was performed under the supervision and with the participation of the Company's management, including its chief executive officer and chief financial officer, regarding the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of September 30, 2003. Based on that evaluation, the Company's management, including the chief executive officer and chief financial officer, concluded that the Company's disclosure controls and procedures were effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls. -17- PART II - OTHER INFORMATION Item 1. Legal Proceedings. See Note 4 to the financial statements and discussion in management's discussion and analysis. 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. -18- 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. CE GENERATION, LLC ------------------ (Registrant) Date: November 6, 2003 /s/ Wayne F. Irmiter ---------------------------- Wayne F. Irmiter Vice President & Controller -19- EXHIBIT INDEX Exhibit No. Description of Exhibit ----------- ---------------------- 31.1 Chief Executive Officer's Certificate Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Chief Accounting Officer's Certificate Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Chief Executive Officer's Certificate Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Chief Accounting Officer's Certificate Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -20-

CE GENERATION LLC 10-Q