<Page>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 For the Quarterly Period Ended September 30, 2001
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period From ______________ to _____________
Commission File Number 33-59960
SITHE/INDEPENDENCE FUNDING CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 13-3677475
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
335 MADISON AVENUE, NEW YORK, NY 10017
-------------------------------- -----
(Address of principal executive offices) (Zip code)
(212)-351-0000
--------------
(Registrant's telephone number, including area code)
SITHE/INDEPENDENCE POWER PARTNERS, L.P.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0468704
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
335 MADISON AVENUE, NEW YORK, NY 10017
-------------------------------- -----
(Address of principal executive offices) (Zip code)
(212)-351-0000
--------------
(Registrant's telephone number, including area code)
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 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.
[X] Yes [ ] No
<Page>
SITHE/INDEPENDENCE POWER PARTNERS, L.P.
SITHE/INDEPENDENCE FUNDING CORPORATION
<Table>
<Caption>
PAGE NO.
--------
PART I FINANCIAL INFORMATION
SITHE/INDEPENDENCE POWER PARTNERS, L.P.
(a Delaware Limited Partnership)
Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 2001 (Unaudited)
and December 31, 2000....................................................................... 3
Condensed Consolidated Statements of Operations for the Three and Nine Months
Ended September 30, 2001 and 2000 (Unaudited)............................................... 4
Condensed Consolidated Statement of Partners' Capital (Deficiency) for the Nine
Months Ended September 30, 2001 (Unaudited)................................................. 5
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2001 and 2000 (Unaudited)............................................... 6
Notes to Condensed Consolidated Financial Statements (Unaudited).............................. 7
Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................................... 13
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................... 17
Signatures ................................................................................... 18
</Table>
- 2 -
<Page>
SITHE/INDEPENDENCE POWER PARTNERS, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 8,832 $ 2,116
Restricted cash and cash equivalents 95,883 52,287
Restricted investments 18,257 24,173
Accounts receivable - trade 33,844 52,463
Fuel inventory and other current assets 7,688 7,079
Current portion of transmission constraint contract derivative asset 10,073 0
Current portion of financial swap derivative asset 548 0
--------- ---------
TOTAL CURRENT ASSETS 175,125 138,118
PROPERTY, PLANT AND EQUIPMENT, AT COST:
Land 4,862 5,010
Electric and steam generating facilities 745,718 777,444
--------- ---------
750,580 782,454
Accumulated depreciation (126,058) (116,680)
--------- ---------
624,522 665,774
DEBT ISSUANCE COSTS 5,644 6,297
OTHER ASSETS 4,945 14,070
TRANSMISSION CONSTRAINT CONTRACT DERIVATIVE ASSET 154,091 0
--------- ---------
TOTAL ASSETS $ 964,327 $ 824,259
========= =========
LIABILITIES AND PARTNERS' CAPITAL (DEFICIENCY)
CURRENT LIABILITIES:
Trade payables $ 29,679 $ 30,461
Accrued interest 21,039 154
Current portion of long-term debt 31,595 32,431
Current portion of transmission constraint contract derivative obligation 19,262 0
--------- ---------
TOTAL CURRENT LIABILITIES 101,575 63,046
LONG-TERM DEBT:
7.90% secured notes due 2002 15,379 30,759
8.50% secured bonds due 2007 150,839 150,839
9.00% secured bonds due 2013 408,609 408,609
Subordinated debt 419,282 0
--------- ---------
994,109 590,207
OTHER LIABILITIES 1,126 7,512
TRANSMISSION CONSTRAINT CONTRACT DERIVATIVE OBLIGATION 155,589 0
FINANCIAL SWAP DERIVATIVE OBLIGATION 13,818 0
COMMITMENTS AND CONTINGENCIES
PARTNERS' CAPITAL (DEFICIENCY) (301,890) 163,494
--------- ---------
TOTAL LIABILITIES AND PARTNERS' CAPITAL (DEFICIENCY) $ 964,327 $ 824,259
========= =========
</Table>
See notes to condensed consolidated financial statements
- 3 -
<Page>
SITHE/INDEPENDENCE POWER PARTNERS, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
2001 2000 2001 2000
--------- --------- --------- ---------
REVENUE $ 46,204 $ 121,816 $ 275,355 $ 315,002
COST OF SALES:
Fuel 26,183 57,087 146,307 157,898
Operations and maintenance 11,926 10,987 36,914 33,733
Depreciation 4,941 5,000 14,851 14,999
Loss on project restructuring 0 0 428,675 0
--------- --------- --------- ---------
43,050 73,074 626,747 206,630
OPERATING INCOME (LOSS) 3,154 48,742 (351,392) 108,372
NON-OPERATING INCOME (EXPENSE):
Interest expense (21,425) (14,323) (50,013) (43,517)
Interest and other income, net 1,254 1,639 4,559 3,983
--------- --------- --------- ---------
NET INCOME (LOSS) $ (17,017) $ 36,058 $(396,846) $ 68,838
========= ========= ========= =========
</Table>
See notes to condensed consolidated financial statements
- 4 -
<Page>
SITHE/INDEPENDENCE POWER PARTNERS, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
CONDENSED CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL (DEFICIENCY) (UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
TOTAL
PARTNERS'
GENERAL LIMITED CAPITAL
PARTNER PARTNERS (DEFICIENCY)
--------- --------- ------------
BALANCE, JANUARY 1, 2001 $ 1,435 $ 162,059 $ 163,494
Net income (loss) and total
comprehensive income (loss) (419,058) 22,212 (396,846)
Capital contribution 35 8,216 8,251
Distributions to partners (768) (76,021) (76,789)
--------- --------- ---------
BALANCE, SEPTEMBER 30, 2001 $(418,356) $ 116,466 $(301,890)
========= ========= =========
</Table>
See notes to condensed consolidated financial statements
- 5 -
<Page>
SITHE/INDEPENDENCE POWER PARTNERS, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
NINE MONTHS
ENDED SEPTEMBER 30,
-------------------------
2001 2000
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(396,846) $ 68,838
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation 14,851 14,999
Loss on project restructuring 428,675 0
Unrealized loss on derivatives 23,957 0
Gain on sale of property, plant and equipment (173) 0
Unrealized (gain) loss on marketable securities (421) 421
Amortization of deferred financing costs 653 690
Changes in operating assets and liabilities:
Accounts receivable - trade 18,619 (8,866)
Fuel inventory and other current assets (609) (5,138)
Other assets (268) (5,285)
Trade payables (782) 685
Accrued interest payable 20,885 13,838
Other liabilities (1,526) 2,272
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 107,015 82,454
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of fixed assets 28,112 0
Capital expenditures (1,686) (78)
Restricted funds (37,259) (44,875)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (10,833) (44,953)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distributions to partners (76,789) (31,635)
Principal payments on secured notes (16,216) (9,648)
Capital contribution 3,539 0
--------- ---------
NET CASH USED IN FINANCING ACTIVITIES (89,466) (41,283)
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 6,716 (3,782)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,116 6,076
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 8,832 $ 2,294
========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments:
Interest $ 28,475 $ 28,989
SUPPLEMENTAL NON-CASH FINANCING ACTIVITIES
Advances to affiliates contributed to Partners' Capital 4,712 --
</Table>
See notes to condensed consolidated financial statements
- 6 -
<Page>
SITHE/INDEPENDENCE POWER PARTNERS, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. THE PARTNERSHIP
Sithe/Independence Power Partners, L.P. (the "Partnership") was formed in
November 1990 for a term of 50 years to develop, construct and own a natural
gas-fired cogeneration facility having capacity of approximately 1,000 megawatts
("MW") located in the Town of Scriba, County of Oswego, New York (the
"Project"). The Project began commercial operation for financial reporting
purposes on December 29, 1994. The Partnership is a Delaware limited partnership
formed by Sithe/Independence, Inc. (the "General Partner"), its sole general
partner. The General Partner is an indirect wholly-owned subsidiary of Sithe
Energies, Inc. ("Sithe Energies"). Prior to June 29, 2001, the limited partners
of the Partnership were Sithe Energies and certain of its direct and indirect
wholly-owned subsidiaries (the "Limited Partners"). On June 29, 2001 one of the
Limited Partners sold its 40% ownership interest in the Partnership to Oswego
Cogen Company, LLC ("Oswego Cogen"), an indirect, wholly-owned subsidiary of
Enron Corp. Accordingly, as of September 30, 2001, the Partnership is owned 60%
by Sithe Energies (directly and indirectly through its wholly-owned
subsidiaries) and 40% by Oswego Cogen.
Through June 30, 2001, the majority of the Project's capacity was sold to
Consolidated Edison Company of New York, Inc. ("Con Edison") with the remainder
of the capacity sold to Alcan Aluminum Corporation ("Alcan") and into the
electric energy market administered by the New York Independent System Operator,
Inc. (the "NYISO" or "ISO Administered Market"). The majority of the electric
energy generated by the Project was sold into the ISO Administered Market, with
the remainder of the generation sold to Niagara Mohawk Power Corporation
("Niagara Mohawk") and Alcan. Effective July 1, 2001, while the majority of the
Project's capacity will continue to be sold to Con Edison, and up to 44 MW of
the Project's capacity and associated energy will continue to be sold to Alcan,
as discussed in Note 4, the Partnership has entered into tolling arrangements
with Dynegy Power Marketing, Inc. ("DPM"), under which DPM will pay the
Partnership tolling fees for the right to supply natural gas to the Project to
be converted to electric energy.
2. BASIS OF PRESENTATION
The accompanying condensed consolidated balance sheets at September 30,
2001 and December 31, 2000 and the condensed consolidated statements of
operations for the three and nine months ended September 30, 2001 and 2000 and
cash flows for the nine months ended September 30, 2001 and 2000 should be read
in conjunction with the audited consolidated financial statements included in
the Annual Report on Form 10-K for the year ended December 31, 2000 for the
Partnership and its wholly-owned subsidiary, Sithe/Independence Funding
Corporation ("Sithe Funding").
The results of operations for the three and nine months ended September
30, 2001 are not necessarily indicative of the results to be expected for the
full year. The unaudited financial information at September 30, 2001 and for the
three and nine months ended September 30, 2001 and 2000 contains all
adjustments, consisting only of normal recurring adjustments, which management
considers necessary for a fair presentation of the financial position and
operating results for such periods.
- 7 -
<Page>
3. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations", SFAS No. 142, "Goodwill and Other Intangible Assets", and SFAS
No. 143, "Accounting for Asset Retirement Obligations". In August 2001, the
FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets". SFAS No. 141 prohibits the use of the pooling-of-interest
method for business combinations initiated after June 30, 2001 and also
applies to all business combinations accounted for by the purchase method
that are completed after June 30, 2001. There are also transition provisions
that apply to business combinations completed before July 1, 2001, that were
accounted for by the purchase method. The adoption of SFAS No. 141 did not
have an impact on the Partnership's results of operations or financial
position. SFAS No. 142 is effective for fiscal years beginning after December
15, 2001 as to all goodwill and other intangible assets recognized in an
entity's statement of financial position at that date, regardless of when
those assets were initially recognized. SFAS No. 143 requires that asset
retirement obligations be reported at fair value in the period incurred for
fiscal years beginning after June 15, 2002 and recognized as expenses in
subsequent periods. SFAS No. 144 is effective for fiscal years beginning
after December 15, 2001 and requires one accounting model to be used for
long-lived assets to be disposed of by sale, whether previously held and used
or newly acquired. SFAS No. 144 retains the previous recognition and
measurement standards for impairment losses. The Partnership is currently
evaluating the provisions of SFAS Nos. 142, 143 and 144, which it has not yet
adopted.
Effective January 1, 2001, the Partnership adopted SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133, as
amended and interpreted, establishes accounting and reporting standards
requiring that all derivatives, including certain derivative instruments
embedded in other contracts be recorded in the balance sheet as either an asset
or liability measured at their fair value. When specific hedge accounting
criteria are not met, SFAS No. 133 requires that changes in a derivative's fair
value be recognized currently in earnings. If a derivative is designated as a
fair-value hedge, the changes in the fair value of the derivative and the hedged
item will be recognized in earnings. If the derivative is designated as a
cash-flow hedge, changes in the fair value of the derivative will be recorded in
other comprehensive income and will be recognized in the income statement when
the hedged item affects earnings. SFAS No. 133 requires that an entity formally
document, designate and perform ongoing assessments of the effectiveness of
transactions that receive hedge accounting. The impact of the Partnership's
adoption of SFAS No. 133 as of January 1, 2001 was not material. As of September
30, 2001, the Partnership had three derivatives, a Transmission Congestion
Contract ("TCC") discussed below, and a multi-agreement financial swap and a gas
supply agreement, which are part of the tolling arrangements discussed in Note
4. None of these derivatives are designated as hedges under SFAS No. 133.
- 8 -
<Page>
Effective with the September 1, 2000 consummation of the Amended and
Restated Energy Purchase Agreement between the Partnership and Con Edison (the
"Amended EPA"), all the electric energy generated by the Project is sold at the
point where the Project delivers energy to the NYISO (the "Independence Bus").
The Partnership has a 20 year Transmission Services Agreement through November
14, 2014 with Niagara Mohawk (the "TSA"), under which Niagara Mohawk is
obligated to transmit 853 MW from the Independence Bus to the point of
interconnection between Niagara Mohawk's transmission system and Con Edison's
transmission system (the "Pleasant Valley Bus"). As a result of the Amended EPA,
the Partnership no longer transmits power under the TSA, and effective September
1, 2000, the Partnership converted its grandfathered physical transmission
rights under the TSA to a financial TCC under the NYISO's open access
transmission tariff. Under the TCC, the Partnership receives from, or pays to
the NYISO, the product of (i) the positive or negative difference, respectively,
between the locational based marginal price ("LBMP") per MWH at the Pleasant
Valley Bus and the Independence Bus for each hour that is due to congestion, and
(ii) 853 MW. The Partnership continues to pay Niagara Mohawk under the TSA,
which must remain in place as part of the TCC.
Ongoing discussions and interpretations of SFAS No. 133 by the FASB
could alter the definition of derivative instruments. The Partnership has
implemented SFAS No. 133 based upon current rules and guidance, and any
changes in these rules and guidance could impact the Partnership's subsequent
reported operating results. Recent interpretations and deliberations of the
FASB's Derivatives Implementation Group due to uncertainties as to whether
contracts such as the TCC are derivatives caused the Partnership to
reevaluate the TCC and conclude that it is derivative. As of and for the nine
months ended September 30, 2001, to record the TCC at fair value, the
Partnership recognized a current asset of $10.1 million, a long-term asset of
$154.1 million, a current liability of $19.3 million, a long-term obligation
of $155.6 million and a charge to income of $10.7 million reflected as a
reduction of revenue on the Partnership's Statement of Operations.
4. PROJECT RESTRUCTURING
On June 29, 2001, the Partnership (i) amended its long-term gas supply
agreement with Enron North America Corp., as successor in interest by merger to
Enron Power Services, Inc. ("Enron"); (ii) transferred its obligations under
five of its seven gas transportation arrangements to Enron, which has agreed to
assume such obligations; and (iii) entered into a tolling arrangement with DPM
that commenced on July 1, 2001. Also on June 29, 2001, Sithe Energies, through
an indirect, wholly owned subsidiary, sold a forty percent limited partnership
interest in the Partnership to Oswego Cogen.
GAS SUPPLY AGREEMENT AMENDMENT
Prior to the June 29, 2001 amendment to the Partnership's long-term gas
supply agreement, the Partnership recognized fuel expense for gas consumed at
its plant based on pricing provided for in the Project's 20-year gas supply
agreement with Enron. Pursuant to such agreement, the price for the first
116,000 MMBtu's of natural gas per day ("Tier I gas") was fixed for the first
five years of the agreement and thereafter fluctuated with pricing based on a
pre-determined multiple of Con Edison's actual avoided energy price (which,
effective January 17, 2000, was determined by reference to the LBMP in the ISO
Administered Market for energy at the Pleasant Valley Bus) as well as certain
other payments made by Con Edison to the project. Up to an additional 76,291
MMBtu's of gas consumed per day by the Project ("Tier II gas") was priced based
on the pre-determined multiple applied to Niagara Mohawk's "energy only" rate
which was determined by the real time price at the Independence Bus in the ISO
Administered Market.
Enron maintained a notional tracking account to account for differences
between the contract price and spot gas prices, except that there was no such
tracking with respect to the Tier I gas during the first five years of the
contract. The tracking account was increased if the
- 9 -
<Page>
then current spot gas price was greater than the contract price and was
decreased if the then current spot gas price was lower that the contract price.
Interest was accrued on the tracking account at 1% over prime.
As a result of the amendment to the gas supply agreement, the Partnership
and Enron agreed to terminate the Partnership's obligation to purchase natural
gas from Enron and the tracking account balance of $419.3 million was fixed and
converted to a secured subordinated loan (the "Tracking Account Loan") resulting
in a $419.3 million charge, recorded as a loss on project restructuring on the
Partnership's condensed consolidated statement of operations. The Tracking
Account Loan is subordinate to the Partnership's secured notes and bonds (the
"Securities") and to certain payments due to Con Edison under the Amended EPA.
The Tracking Account Loan bears interest at an annual rate of 7%, which is
payable semi-annually, beginning December 1, 2001 from cash distributable to
the partners under the indenture pursuant to which the Securities were issued.
The Tracking Account Loan will be repaid in 40 semi-annual principal payments
commencing June 1, 2015.
GAS TRANSPORTATION AGREEMENTS
The Partnership had previously entered into long-term gas transportation
agreements with seven pipeline companies in order to transport, on a firm basis,
the natural gas purchased pursuant to the Partnership's then existing
obligations under the gas supply agreement. In connection with the cancellation
of the Partnership's fuel purchase obligations, Enron has assumed and agreed to
perform all of the Partnership's future obligations for all but two of these gas
transportation arrangements. The Partnership will continue to pay fixed demand
charges under contracts with Niagara Mohawk and Empire State Pipeline.
TOLLING ARRANGEMENTS
The Partnership has entered into tolling arrangements for the Project with
DPM and its affiliates which commenced on July 1, 2001 and run through 2014.
Under the tolling arrangement (the "Tolling Agreement"), DPM will pay the
Partnership a monthly tolling fee for the right (1) to supply natural gas to the
Project, (2) to request the Partnership to run the Project as needed to convert
such natural gas to electrical energy within certain efficiency parameters and
(3) to receive such electrical energy at an electrical transmission delivery
point at the Project. Approximately sixty percent of the output of the Project
is covered by the Tolling Agreement. DPM is responsible for payment of all
natural gas commodity and transportation costs associated with the natural gas
necessary to generate electric energy under the Tolling Agreement, except for
demand charges due Niagara Mohawk and Empire State Pipeline, which remain the
obligation of the Partnership. In addition to the monthly tolling fee, DPM will
be required to pay the Partnership variable payments designed to reimburse the
Partnership for its costs of operating and maintaining the Project. If the
Project is not available, the Partnership will have the right to meet its
contractual obligations under the Tolling Agreement by supplying electric energy
from other sources. If the Project is not available and the Partnership does not
supply replacement energy, the monthly tolling fee will be subject to an
availability adjustment. However, the Project will not be responsible to DPM for
any damages resulting from the Project's failure to deliver electric energy
under the Tolling Agreement. DPM does not have a direct right to terminate the
Tolling Agreement due to the unavailability of the Project.
In addition, the Partnership has entered into a multi-agreement financial
swap with DPM (collectively, the "Financial Swap Agreement") with respect to
375 MW of the Projects energy. To hedge its exposure under the Financial Swap
Agreement, using natural gas supplied by Dynegy Canada Marketing and Trade
("DCMT"), the Partnership will generate electricity from forty percent of the
Project and sell such electricity to the NYISO. DPM will pay the Partnership
(i) a monthly fixed payment under the financial swap and (ii) a payment
designed to cover the Partnership's costs of generating electric energy
(including amounts paid under the gas
- 10 -
<Page>
supply agreement with DCMT described below) from the Project's reserved
capability. The Partnership will pay to DPM amounts equal to amounts received
from the NYISO for the sales of energy associated with the reserved forty
percent of the Project. In connection with the Financial Swap Agreement,
affiliates of the General and Limited Partners will be obligated to provide a
credit support reserve in the form of cash, letters of credit or corporate
guarantees. The monthly fixed payments are subject to reduction if the
Project is not available at a time DPM calls on the Financial Swap Agreement.
However, the Partnership's exposure to damages under the Financial Swap
Agreement (beyond the reductions in the monthly fixed payments) resulting
from market energy prices at times that the Project is not available is
limited over the life of the Financial Swap Agreement to the amount of the
credit support reserve. If the credit support reserve is called upon, the
Partnership is not obligated to replenish the reserve. The Financial Swap
Agreement contains restrictions on the start and stop times and durations of
the individual financial swaps designed to mirror the operational
requirements of the Project. The Financial Swap Agreement will be in place
through 2014.
Pursuant to a gas supply agreement between the Partnership and DCMT (the
"Gas Supply Agreement"), the Partnership will purchase from DCMT at a defined
index price, all natural gas required to operate forty percent of the Project.
The pricing under the Gas Supply Agreement is structured so that payments for
natural gas associated with operation of the reserved capability are covered by
the payments from DPM under the Financial Swap Agreement. In addition, if DCMT
fails to deliver natural gas to the Project at any time that the Partnership is
intending to operate the Project to sell electric energy to the NYISO to cover
its exposure under the Financial Swap Agreement, DCMT is obligated to reimburse
the Partnership at the NYISO market price for the amount of such electric
energy.
Under SFAS No. 133, as amended and interpreted, the Partnership accounts
for the Financial Swap Agreement and the Gas Supply Agreement as derivatives
which are not designated as hedges. However, the Partnership believes that
together, the Tolling Agreement, the Financial Swap Agreement and the Gas Supply
Agreement eliminate the financial risks associated with the purchase of natural
gas to operate the Project on a full-time, base load basis as well as
eliminating the variable market prices associated with the marketing of power
into the NYISO. The Partnership estimates that the Financial Swap Agreement and
Gas Supply Agreement derivatives each had a zero fair value as of July 1, 2001.
As of and for the three months ended September 30, 2001, to record the Financial
Swap Agreement at fair value, the Partnership recognized a current asset of $.5
million, a long-term obligation of $13.8 million and a charge to income of $13.3
million reflected as a reduction of revenue on the Partnership's Statement of
Operations. Since natural gas purchased by the Partnership under the Gas Supply
Agreement is at current market price, this derivative had a zero fair value at
September 30, 2001.
The Partnership, DPM, and Dynegy Marketing and Trade ("DMT") have entered
into an energy management agreement (the "Energy Management Agreement"), whereby
DMT is responsible for all bidding and scheduling of gas under the Gas Supply
Agreement and the Tolling Agreement, and DPM is responsible for all bidding and
scheduling of electric purchases and sales under the Tolling Agreement and
resulting from the Financial Swap Agreement. Dynegy Holdings Inc., the parent of
DPM, DCMT and DMT, guarantees certain obligations of DPM, DCMT and DMT under the
Tolling Agreement, the Financial Swap Agreement, the Gas Supply Agreement and
the Energy Management Agreement pursuant to four separate Guaranty Agreements.
OTHER
During the second quarter of 2001, the Partnership recognized a $9.4
million loss on project restructuring to write-off prepaid equalization fees
that were included in other assets. The $9.4 million balance of prepaid
equalization fees represented the difference between the six annual $3.0
million equalization payments made to Niagara Mohawk between December 31,
1995 and December 31, 2000 and the amortization of such fees over the 22 year
term of the Alcan
- 11 -
<Page>
Energy Sales Contract. The Partnership is no longer obligated to make the four
remaining annual equalization fee payments to Niagara Mohawk.
5. COMMITMENTS AND CONTINGENCIES
LITIGATION AND CLAIMS
On March 29, 1995, the Partnership filed a petition with the Federal
Energy Regulatory Commission (the "FERC") alleging Niagara Mohawk has been
overcharging for the transmission of electricity in violation of the FERC policy
by calculating transmission losses on an incremental basis. The Partnership
believes that transmission losses should be calculated on an average basis. The
Partnership had been recording its transmission expense at the disputed, higher
rate. The Partnership requested that the FERC order Niagara Mohawk to
recalculate the transmission losses beginning in October 1994, when it began
wheeling power from the Project. In September 1996, the FERC issued an order
dismissing the Partnership's complaint and requiring Niagara Mohawk to provide
the Partnership with information regarding the calculation of transmission
losses. In October 1996, the Partnership filed a request for rehearing of the
FERC's order which was denied by the FERC. In December 1997, the Partnership
filed a petition for review of the FERC orders in the United States Court of
Appeals. On January 29, 1999, the Court of Appeals found the FERC had not
engaged in reasoned decision-making or reached conclusions supported by the
record in the underlying proceeding, and therefore remanded the case to the FERC
for further proceedings. On June 28, 2001, the Partnership entered into a
settlement agreement (the "Settlement") with Niagara Mohawk which superceded a
previous, partial settlement agreement (the "PSA") dated February 23, 2001.
Under the terms of the Settlement, $2.3 million paid by Niagara Mohawk to the
Partnership under the PSA on March 2, 2001 now represents full settlement of all
claims for transmission loss overcharges. The terms of the Settlement also
stipulate that the TSA between Niagara Mohawk and the Partnership be amended to
provide that the currently effective firm transmission rate be fixed at $1.76
per kw/month and the currently effective contract demand of 853 MW be fixed for
the period commencing on July 2, 1999 and ending December 31, 2005. The $2.3
million was recognized as revenue in the first quarter of 2001.
The Settlement also supercedes the PSA and fully settles a previous
complaint filed with the FERC by the Partnership seeking reimbursement of
approximately $63.0 million for overcharges by Niagara Mohawk for the
construction and upgrade of Niagara Mohawk's transmission system (the
"Interconnection Facilities") for the purpose of connecting the Project to the
Interconnection Facilities. Under the PSA, on March 2, 2001 Niagara Mohawk paid
the Partnership $15.1 million to purchase the assets defined as the
Interconnection Facilities under the PSA with a book value of $13.0 million,
resulting in a $2.1 million gain which was included in interest and other income
for the first quarter of 2001. The Settlement changed the purchase price and the
definition of the assets included in the Interconnection Facilities, and on
August 1, 2001 Niagara Mohawk paid an additional $13.0 million to the
Partnership for the Interconnection Facilities. As a result, during the second
quarter of 2001, the Partnership reversed $1.9 of the $2.1 million gain
recognized in the first quarter resulting in a net $.2 million gain from the
sale of the Interconnection Facilities for the nine months ended September 30,
2001, representing the difference between the $28.1 million proceeds received
from Niagara Mohawk under the Settlement, and the net book value of the
Interconnection Facility assets of $27.9 million. The Settlement, together with
the related amendments to the TSA and the Interconnection Agreement, have been
submitted to the FERC for approval. Although FERC approval of the Settlement is
still pending as of the date hereof, the Partnership anticipates that the FERC
will ultimately approve the Settlement.
- 12 -
<Page>
SITHE/INDEPENDENCE POWER PARTNERS, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
As more fully discussed in Note 4 to the Condensed Consolidated Financial
Statements, the Partnership has entered into tolling arrangements with Dynegy
Power Marketing, Inc. ("DPM") and its affiliates which commenced on July 1, 2001
and run through 2014.
Under SFAS No. 133, as amended and interpreted, the Partnership accounts
for the Financial Swap Agreement and the Gas Supply Agreement as derivatives
which are not designated as hedges, with the change in the estimated fair value
of these derivatives impacting reported earnings from period to period. However,
the Partnership believes that together, the Tolling Agreement, the Financial
Swap Agreement and the Gas Supply Agreement eliminate the financial risks
associated with the purchase of natural gas to operate the Project on a
full-time, base load basis as well as eliminating the variable market prices
associated with the marketing of power into the NYISO. The Partnership also
accounts for the TCC as a derivative which is not designated as a hedge, and
changes in the estimated fair value of the TCC will also affect reported
earnings from period to period.
Revenue for the third quarter of 2001 of $46.2 million was $75.6 million
(62%) less than the corresponding period of last year. Of this decrease, $49.2
million was primarily attributable to the fact that the Partnership operated the
Project under tolling arrangements with DPM in the third quarter of 2001 versus
the comparable period of last year, when the majority of the Project's output
was sold to Con Edison, Niagara Mohawk and the NYISO with the energy rates based
on locational based marginal prices as determined by the NYISO, $13.1 million
was due to the change in estimated fair value of the TCC and $13.3 million was
due to the change in estimated fair value of the Financial Swap Agreement.
Cost of sales for the third quarter of 2001 of $43.0 million was $30.0
million (41%) less than the corresponding period of last year. The commencement
of the tolling arrangement with DPM and the project restructuring transaction
(discussed below) resulted in an amendment to the gas supply agreement with
Enron which eliminated the Partnership's obligation to purchase natural gas from
Enron and transferred to Enron its obligations under five of the seven fuel
transportation agreements. The effect of the project restructuring and the
commencement of the tolling arrangements with DPM resulted in an approximate
$30.9 million reduction in fuel expense. Operations and maintenance expense for
the third quarter of 2001 was approximately $.9 million higher than in the
corresponding period of last year due primarily to higher expense for scheduled
equipment maintenance.
Interest expense for the third quarter of 2001 of $21.4 million was $7.1
million (50%) higher than the corresponding period of last year due to
recognition of $7.4 million of interest expense on the $419.3 million
subordinated Enron tracking account loan (discussed below), offset by $.3
million of lower interest expense due to a lower outstanding principal amount of
the Securities.
Interest and other income, net for the third quarter of 2001 of $1.3
million consists of $1.0 million of interest income and $.3 million of
unrealized gains on the Partnership's restricted investments.
- 13 -
<Page>
Revenue for the nine months ended September 30, 2001 of $275.4 million was
$39.6 million (13%) lower than the corresponding period of last year. This
decrease consisted of $49.2 million from the commencement of tolling
arrangements with DPM effective July 1, 2001, $13.3 million from the change
in estimated fair value of the Financial Swap Agreement and $10.7 million
from the change in estimated fair value of the TCC, partially offset by $13.3
million of higher realized TCC revenue, as the TCC was in effect for the
entire nine months ended September 30, 2001 and only one month in the
corresponding period of last year, $17.4 million of higher revenue in the
first six months of 2001 primarily due to higher energy rates and higher net
generation and $2.3 million for the final settlement of a dispute with
Niagara Mohawk regarding transmission loss overcharges.
On June 28, 2001, the Partnership entered into a settlement agreement (the
"Settlement") with Niagara Mohawk, which superceded a previous, partial
settlement agreement (the "PSA") dated February 23, 2001. Under the terms of the
Settlement, $2.3 million paid by Niagara Mohawk to the Partnership under the PSA
on March 2, 2001 now represents full settlement of all claims for transmission
loss overcharges. The terms of the Settlement also stipulate that the TSA
between Niagara Mohawk and the Partnership be amended to provide that the
currently effective firm transmission rate be fixed at $1.76 per kw/month and
the currently effective contract demand of 853 MW be fixed for the period
commencing on July 2, 1999 and ending December 31, 2005.
Cost of sales, exclusive of the loss on project restructuring, for the
nine months ended September 30, 2001 of $198.1 million was $8.6 million(4%)
lower than the corresponding period of last year. Fuel expense for the nine
months ended September 30, 2001 was $11.5 million lower than the corresponding
period of last year due to the commencement of the tolling arrangement and the
project restructuring transaction discussed below. This decrease in cost of
sales was partially offset by an increase in operations and maintenance expense
primarily related to higher equipment maintenance costs associated with
scheduled equipment maintenance and a contractual price increase under the
Partnership's long-term equipment maintenance contract.
On June 29, 2001, the Partnership entered into a series of transactions
which included (i) an amendment to the Partnership's long-term gas supply
agreement with Enron which effectively terminated the Partnership's obligation
to purchase natural gas from Enron, (ii) the transfer of its obligations under
five of its seven gas transportation arrangements to Enron, (iii) a tolling
arrangement with Dynegy Power Marketing, Inc. which commenced on July 1, 2001
and (iv) the sale of a 40% limited partnership interest in the Partnership to
Oswego Cogen Company, LLC, an indirect wholly-owned subsidiary of Enron Corp.
As a result of the amendment to the gas supply agreement, the Partnership
and Enron agreed to terminate the Partnership's obligation to purchase natural
gas from Enron and the tracking account balance of $419.3 million was fixed and
converted to a secured subordinated loan (the "Tracking Account Loan") resulting
in a $419.3 million charge, recorded as a loss on project restructuring on the
Partnership's condensed consolidated statement of operations. The Tracking
Account Loan is subordinate to the Securities and to certain payments due to Con
Edison under the Amended EPA.
The Partnership recognized an additional $9.4 million loss on project
restructuring to write-off prepaid equalization fees that were included in other
assets. The $9.4 million balance of prepaid equalization fees represented the
difference between the six annual $3.0 million equalization payments made to
Niagara Mohawk between December 31, 1995 and December 31, 2000 and the
amortization of such fees over the 22 year term of the Alcan Energy Sales
Contract. The Partnership is no longer obligated to make the four remaining
annual equalization fee payments to Niagara Mohawk.
- 14 -
<Page>
Interest expense for the nine months ended September 30, 2001 of $50.0
million was $6.5 million (15%) higher than in the corresponding period of
last year due to the recognition of $7.4 million of interest expense on the
Tracking Account Loan offset by $.9 million of lower interest expense
relating to lower outstanding amounts of the Partnership's secured notes and
bonds.
Interest and other income, net for the nine months ended September 30,
2001 of $4.6 million consisted primarily of interest income ($3.7 million),
unrealized gains on the Partnership's restricted investments ($.6 million) and a
net gain on the sale of the Interconnection Facilities to Niagara Mohawk in
accordance with the terms of the Settlement ($.2 million) discussed below.
The Settlement also supercedes the PSA and fully settles a previous
complaint filed with the FERC by the Partnership seeking reimbursement of
approximately $63.0 million for overcharges by Niagara Mohawk for the
construction and upgrade of Niagara Mohawk's transmission system (the
"Interconnection Facilities") for the purpose of connecting the Project to the
Interconnection Facilities. Under the PSA, on March 2, 2001 Niagara Mohawk paid
the Partnership $15.1 million to purchase the assets defined as the
Interconnection Facilities under the PSA with a book value of $13.0 million,
resulting in a $2.1 million gain which was included in interest and other income
for the first quarter of 2001. The Settlement changed the purchase price and the
definition of the assets included in the Interconnection Facilities, and on
August 1, 2001 Niagara Mohawk paid an additional $13.0 million to the
Partnership for the Interconnection Facilities. As a result, during the second
quarter of 2001, the Partnership reversed $1.9 of the $2.1 million gain
recognized in the first quarter resulting in a net $.2 million gain from the
sale of the Interconnection Facilities for the nine months ended September 30,
2001, representing the difference between the $28.1 million proceeds received
from Niagara Mohawk under the Settlement, and the net book value of the
Interconnection Facility assets of $27.9 million.
LIQUIDITY AND CAPITAL RESOURCES
Financing for the Project consisted of a loan to the Partnership by Sithe
Funding of the proceeds of its issuance of $717.2 million of the Securities and
$60 million of capital contributions by the Partners. In addition, under a
credit facility obtained by the Partners, one or more letters of credit may be
issued in connection with their obligations pursuant to certain Project
contracts, and, as of September 30, 2001, letters of credit aggregating $2.2
million were outstanding in connection with such obligations. Also, the
Partnership has secured the Project's debt service reserve obligations with a
letter of credit in the amount of $50 million. As of September 30, 2001, the
Partnership had restricted funds and investments aggregating $114.1 million,
including the Project's cumulative cash debt service reserve and major overhaul
reserve of $33.0 million and $6.0 million, respectively. In addition, these
restricted funds included $11.4 million that was utilized for October 2001
operating expenses, $42.9 million reserved for the December 2001 debt service
payment and the balance available for transfer to the Partnership distribution
account. Funds in the Partnership distribution account are available as
additional operating and debt service reserves until such time as certain
coverage ratios are achieved. To secure the Partnership's obligation to pay any
amounts drawn under the debt service letter of credit, the letter of credit
provider has been assigned a security interest and lien on all of the collateral
in which the holders of the Securities have been assigned a security interest
and lien. The $419.3 million Tracking Account Loan bears interest at 7%, which
is payable semi-annually, beginning December 1, 2001 from cash distributable to
the partners in accordance with the terms of the Securities. The Tracking
Account Loan will be repaid in 40 semi-annual principal payments commencing on
June 1, 2015.
- 15 -
<Page>
The Partnership is precluded from making distributions to Partners unless
project reserve accounts are funded to specified levels and unless the required
debt service coverage ratio is met. During the first nine months of 2001, the
Partnership made distributions to its Partners in the amount of $76.8 million.
The Partnership believes that funds available from cash on hand,
restricted funds, operations and the debt service letter of credit will be more
than sufficient to liquidate Partnership obligations as they come due and pay
scheduled debt service.
FORWARD-LOOKING STATEMENTS
Certain statements included in this Quarterly Report on Form 10-Q are
forward-looking statements as defined in Section 21E of the Securities
Exchange Act of 1934. The words "anticipate", "believe", "expect",
"estimated" and similar expressions generally identify forward-looking
statements. While the Partnership believes in the veracity of all statements
made herein, forward-looking statements are necessarily based upon a number
of estimates and assumptions that, while considered reasonable by the
Partnership, are inherently subject to significant business, economic and
competitive uncertainties and contingencies, the continued performance of
counterparties to derivative contracts and gas supply agreements, the demand
for and price of electricity and changes in government regulations and the
continuing deregulation of the electric energy industry. These uncertainties
and contingencies could cause the Partnership's actual results to differ
materially from those expressed in any forward-looking statements made by, or
on behalf of, the Partnership.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Partnership uses the sensitivity analysis methodology to disclose the
quantitative information for interest rate and commodity price risks. The
sensitivity analysis estimates the potential loss of fair value from market risk
sensitive instruments due to a 10% unfavorable change in interest rates and
commodity prices.
INTEREST RATE RISK
The Partnership has investments in financial instruments subject to
interest rate risk consisting of $95.9 million of restricted cash and cash
equivalents and $18.3 million of restricted investments. In the case of
restricted cash and cash equivalents, due to the short duration of these
financial instruments, a 10% immediate change in interest rates would not have a
material effect on the Partnership's financial condition. In the case of
restricted investments, the resulting potential decrease in fair value from a
10% immediate change in interest rates would be approximately $.2 million.
The Partnership's outstanding long-term debt at September 30, 2001 bears
interest at fixed rates and therefore the Partnership's results of operations
would not be affected by changes in interest rates as they apply to borrowings.
COMMODITY PRICE RISK
The Partnership is subject to commodity price risk on the fair value of
the TCC from changes in the differential between the LBMP at the Pleasant Valley
Bus and the Independence Bus due to congestion. The Partnership estimates that a
10% decrease in this differential would decrease the estimate fair value of the
TCC assets by approximately $16.4 million.
The Partnership is also subject to commodity price risk on the fair value
of the Financial Swap Agreement from changes in the spread between prices of
natural gas and electricity. The Partnership estimates that a 10% decrease in
this price spread would decrease the estimated fair value of the Financial Swap
Agreement current asset by approximately $.1 million.
- 16 -
<Page>
PART II -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibit No. Description of Exhibit
----------- ----------------------
No Exhibits were filed during the quarter covered by this report.
(b) Reports on Form 8-K:
No report on Form 8-K was filed during the quarter covered by
this report.
- 17 -
<Page>
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.
Sithe/Independence Funding Corporation
--------------------------------------
(REGISTRANT)
November 14, 2001 /s/ Thomas M. Boehlert
--------------------------------------
THOMAS M. BOEHLERT
CHIEF FINANCIAL OFFICER AND
SENIOR VICE PRESIDENT
(PRINCIPAL FINANCIAL AND
ACCOUNTING OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, the
co-registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Sithe/Independence Power Partners, L.P.
---------------------------------------
(REGISTRANT)
By: Sithe/Independence, Inc.
------------------------
GENERAL PARTNER
November 14, 2001 /s/ Thomas M. Boehlert
----------------------------------
THOMAS M. BOEHLERT
CHIEF FINANCIAL OFFICER AND
SENIOR VICE PRESIDENT
(PRINCIPAL FINANCIAL AND
ACCOUNTING OFFICER)
- 18 -