- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-K
<Table>
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
</Table>
COMMISSION FILE NUMBER 333-50828
CEDAR BRAKES I, L.L.C.
(Exact Name of Registrant as Specified in its Charter)
<Table>
DELAWARE 76-0613738
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
EL PASO BUILDING
1001 LOUISIANA STREET
HOUSTON, TEXAS 77002
(Address of Principal Executive Offices) (Zip Code)
</Table>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(713) 420-2600
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: None
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
STATE THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES
OF THE REGISTRANT: None
As of March 24, 2003, 100 percent of the membership interest of Cedar
Brakes I, L.L.C. is owned directly by Mesquite Investors, L.L.C. Such membership
interest is not publicly traded and therefore has no separate, quantifiable
market value.
DOCUMENTS INCORPORATED BY REFERENCE: None
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CEDAR BRAKES I, L.L.C.
TABLE OF CONTENTS
<Table>
<Caption>
CAPTION PAGE
------- ----
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 2
Item 3. Legal Proceedings........................................... 2
Item 4. Submission of Matters to a Vote of Security Holders......... 2
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 3
Item 6. Selected Financial Data..................................... 3
Item 7. Management's Discussion and Analysis of Financial Condition
and Results
of Operations............................................. 3
Cautionary Statement for Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform Act
of 1995..................................................... 11
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 12
Item 8. Financial Statements and Supplementary Data................. 14
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial
Disclosure................................................ 27
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 27
Item 11. Executive Compensation...................................... 27
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 27
Item 13. Certain Relationships and Related Transactions.............. 27
Item 14. Controls and Procedures..................................... 27
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 28
Signatures............................................................. 30
</Table>
- ---------------
Below is a list of terms that are common to our industry and used throughout
this document:
KWh = Kilowatt hours MWh = megawatt hours
When we refer to "us", "we", "our", "ours", or "Cedar Brakes" we are describing
Cedar Brakes I, L.L.C.
When we refer to "El Paso," we are describing El Paso Corporation.
PART I
ITEM 1. BUSINESS
We are a single member Delaware limited liability company formed on March
3, 2000. We are a wholly owned subsidiary of Mesquite Investors, L.L.C., an
entity which is indirectly owned by Limestone Electron Trust and a subsidiary of
El Paso Corporation. We are classified as a public utility subject to regulation
by the Federal Energy Regulatory Commission under the Federal Power Act. We
began operations on September 27, 2000 when we acquired a long-term power
purchase agreement to sell electric energy and provide electric capacity to
Public Service Electric and Gas Company.
Our sole business is the wholesale sale of electric energy and electric
capacity to Public Service Electric, our sole customer, under a power purchase
agreement that expires in 2013. We receive the electric energy we sell and the
electric capacity we provide under a power services agreement with our
affiliate, El Paso Merchant Energy, L.P., a subsidiary of El Paso. Performance
under this agreement by El Paso Merchant is guaranteed by El Paso. We have no
employees and El Paso Merchant carries out all of our administrative activities
under an administrative services agreement. Our material assets consist of our
power purchase agreement with Public Service Electric, receivables generated
under that agreement and cash held from the collection of those receivables. We
were created solely to carry out the terms of our material agreements and repay
our debt obligations with the cash generated from the execution of these
agreements. For a detailed discussion of our significant agreements, see Item 8,
Financial Statements and Supplementary Data, Note 5.
Our principal executive offices are located at 1001 Louisiana Street,
Houston, Texas 77002. Our telephone number is (713) 420-2600.
MANAGERS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to our limited liability company agreement, our company is managed
by a committee comprised of five managers. Three of these managers are appointed
by Mesquite Investors, L.L.C., our parent company, and two managers are
independent.
We utilize the employees of and management services provided by El Paso
Merchant pursuant to the administrative services agreement. We reimburse El Paso
Merchant for reasonable general and administrative expenses, and other
reasonable expenses, incurred on our behalf. The following table sets forth
information regarding our executive officers and managers.
<Table>
<Caption>
NAME AGE POSITION
- ---- --- --------
Robert W. Baker........................... 46 President
John L. Harrison.......................... 44 Senior Vice President, Chief Financial
Officer, Treasurer and Class A Manager
Bryan E. Seas............................. 42 Vice President and Controller
John J. O'Rourke.......................... 48 Vice President, Managing Director and Class
A Manager
Kurt Regulski............................. 45 Class A Manager
Orlando Figueroa.......................... 42 Class B Manager
Henry C. Mustin........................... 70 Class B Manager
</Table>
Robert W. Baker has served as our President since February 2003. He has
also served as Executive Vice President of El Paso and President of El Paso
Global Power since January 2003. He was Senior Vice President and Deputy General
Counsel of El Paso from December 2001 to January 2003. Prior to that time, he
held various positions with El Paso since 1996.
John L. Harrison has served as our Senior Vice President, Chief Financial
Officer and Treasurer since our formation. He has served as a Class A Manager
since September 2000. He has served as Senior Vice President, Chief Financial
Officer and Treasurer of El Paso Merchant since 2001. Prior to that period, he
1
served as Vice President and Senior Managing Director of El Paso Merchant since
2000. Prior to that, he held various positions with El Paso Merchant since 1996.
Bryan E. Seas has served as our Vice President and Controller since
September 2002. Prior to that period, he served as Director of Corporate
Accounting for El Paso since January 2000. He was Director of Accounting for
Southern Natural Gas Company since October, 1999. Prior to that, he held various
positions with Sonat Inc. since 1993.
John J. O'Rourke is a Class A Manager of the Management Committee and has
served as our Vice President and Managing Director since 2001. He is also Vice
President and Managing Director of El Paso Merchant Energy North America
Company. Prior to joining El Paso in May 2000, Mr. O'Rourke was a Director of
Business Management for FPL Energy since 1992.
Kurt Regulski has served as a Class A Manager since September 2000. Mr.
Regulski has also served in various positions with El Paso Merchant from 1999 to
our formation. He was a Director for Sonat Power Marketing since 1997. Prior to
that period, he was a Manager with Sonat Power Marketing.
Orlando Figueroa has served as Class B Manager since February 2003. He has
been Vice President -- Corporate Governance of Lord Securities Corporation, a
firm specializing in providing service to structured finance transactions, since
March 2002. In his position with Lord, he serves as an officer, manager, member
and/or director of several special purpose entities. Prior to his employment
with Lord, Mr. Figueroa held the position of Director of Corporate Services for
Loeb & Loeb L.L.P. from 1995-2002 and Supervisor of Corporate Services with
Moses & Singer L.L.P. from 1985 to 1995.
Vice Admiral Henry C. Mustin (USN, Retired) has served as our Class B
Manager since September 2000. He is the Chairman of the Board of his own
consulting company since 1992 and serves as director on a number of boards and
committees.
Our Class A Managers serve until resignation or until their respective
successors are elected and qualified. Our officers serve until removal or
resignation. Our Class B Managers serve until their successors are elected and
qualified.
Our Class A Managers and our officers are also officers or employees of El
Paso or its affiliates. Since our daily operations are managed by employees of
El Paso Merchant pursuant to the administrative services agreement, we have no
employees. We do not expect that our managers and officers will face a conflict
regarding the allocation of their time between our interests and the other
business interests of El Paso and its affiliates.
ITEM 2. PROPERTIES
None.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
2
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
None.
ITEM 6. SELECTED FINANCIAL DATA
<Table>
<Caption>
FOR THE YEAR ENDED
DECEMBER 31,
------------------------------
2002 2001 2000(2)
-------- -------- --------
(IN THOUSANDS)
Operating Results Data:
Operating revenues................................. $ 58,007 $ 56,816 $ 14,638
Income (loss) from continuing operations before
cumulative effect of accounting change.......... 7,729 (38,988) (3,132)
Cumulative effect of accounting change(1).......... -- 89,368 --
Net income (loss).................................. 7,729 50,380 (3,132)
</Table>
<Table>
<Caption>
AS OF DECEMBER 31,
------------------------------
2002 2001 2000
-------- -------- --------
(IN THOUSANDS)
Financial Position Data:
Total assets....................................... $370,469 $395,411 $316,118
Long-term debt, less current maturities............ 296,870 304,742 310,600
Member's capital................................... 53,778 47,249 (3,131)
</Table>
- ---------------
(1) Represents the adoption of Statement of Financial Accounting Standards No.
133 on January 1, 2001.
(2) Represents the period from our inception, March 3, 2000, to December 31,
2000.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
GENERAL
Our sole business is to sell electric energy and provide electric capacity
to Public Service Electric and Gas Company, a New Jersey corporation, under a
power purchase agreement that we entered into with Public Service Electric on
March 21, 2000. We began operating under this power purchase agreement on
September 27, 2000. We have no material assets other than this agreement and
amounts generated by this agreement, including deposits we are required to
maintain. We have no material obligations other than those under our bonds, our
power services agreement and administrative services agreement with El Paso
Merchant Energy, L.P., our affiliate. We have no employees and rely on El Paso
Merchant to carry out our obligations under these agreements.
RECENT DEVELOPMENTS
DOWNGRADE OF OUR BONDS
On November 27, 2002, Moody's Investors Service downgraded its ratings on
our senior secured bonds to "Ba2" from "Baa3". On December 2, 2002, Standard &
Poor's Ratings Services lowered its ratings on our bonds to "BB-" from "BBB-".
On February 10, 2003, Standard and Poor's further downgraded its ratings on our
bonds to "B". On February 12, 2003, Moody's further downgraded its ratings on
our bonds to "Caa1". In January 2003, Fitch Ratings downgraded its ratings on
our bonds to "BB+" from "BBB" and, on February 14, 2003, Fitch cut its ratings
further to "B". The downgrades by all of the rating agencies are the result of
previous actions taken by the rating agencies on the credit ratings of El Paso,
which guarantees El Paso
3
Merchant's performance under our power services and administrative services
agreements. All of the rating agencies maintain a negative outlook on our credit
ratings, indicating the possibility of further downgrades.
POTENTIAL CHANGES IN MESQUITE INVESTORS' OWNERSHIP
Chaparral Investors, L.L.C. is the parent of Mesquite Investors, our sole
member. At December 31, 2002, Chaparral was owned approximately 20 percent by a
wholly owned subsidiary of El Paso and 80 percent by Limestone Electron Trust,
an unaffiliated third party. In March 2003, El Paso contributed $1 billion to
Limestone in exchange for a non-controlling interest which increased El Paso's
effective ownership in Chaparral to approximately 90 percent. Also in March
2003, El Paso notified Limestone that it would exercise its rights to purchase
all of the outstanding third party equity in Limestone on May 31, 2003. If El
Paso acquires the remaining Limestone equity interest in Chaparral, we would
become a wholly owned, indirect subsidiary of El Paso.
DOWNGRADE OF EL PASO CORPORATION'S CREDIT RATINGS
On February 7, 2003 Standard and Poor's downgraded El Paso's senior
unsecured debt to a rating of "B". On February 11, 2003, Moody's downgraded El
Paso's senior unsecured debt ratings to "Caa1". Both rating agencies maintain a
negative outlook on El Paso's credit ratings, indicating the possibility of
further ratings downgrades. El Paso is the parent of El Paso Merchant. The
credit rating downgrades of El Paso may impact El Paso Merchant's ability to
perform under the provisions of the power services and administrative services
agreements.
EL PASO CORPORATION ANNOUNCES EXIT OF ENERGY TRADING ACTIVITIES
El Paso's credit downgrades in the third and fourth quarter and the
deterioration of the energy trading environment led to its decision in November
2002 to exit the energy trading business and pursue an orderly liquidation of
its trading portfolio. El Paso anticipates this liquidation may occur through
2004. If El Paso seeks to assign its obligations under the power services and
administrative services agreements to another party, our indenture requires the
consent of the bondholders to any such assignment. El Paso has guaranteed to us
the punctual performance of all of El Paso Merchant's obligations under the
power services and administrative services agreements. We are in the process of
evaluating what impact, if any, this announcement will have on these agreements.
If El Paso Merchant ceases to perform its obligations under its agreements with
us and El Paso fails to meet its obligations under the guaranty, there can be no
assurance that we will be able to make payments of principal and interest on our
debt. In such event, we would be able to seek a replacement power provider and
administrative services provider and to pursue our remedies under the agreements
with El Paso Merchant and the guaranty issued by El Paso.
EL PASO PROXY CONTEST
On February 18, 2003, Selim Zilkha, a stockholder of El Paso, announced his
intention to initiate a proxy solicitation to replace El Paso's entire board of
directors with his own nominees and on March 11, 2003, Mr. Zilkha filed his
preliminary proxy statement to that effect with the SEC. This proxy contest may
be highly disruptive and may negatively impact El Paso's ability to achieve the
stated objectives of its 2003 Operational and Financial Plan. In addition, El
Paso may have difficulty attracting and retaining key personnel until such proxy
contest is resolved. Therefore, this proxy contest, whether or not successful,
could have a material adverse effect on El Paso's liquidity and financial
condition, which, in turn, could adversely affect our liquidity and financial
condition.
GENERAL
POWER CONTRACT RESTRUCTURINGS
Our sole business is to sell electric energy and provide electric capacity
to Public Service Electric under our power purchase agreement with them. We were
formed in March 2000, but did not begin operations until September 27, 2000 when
we acquired a power purchase agreement from our affiliate, Newark Bay
4
Cogeneration Partnership L.P. This power purchase agreement was acquired as part
of the process of what has become known in the power industry as a "power
contract restructuring." Many domestic power plants have long-term power sales
contracts with regulated utilities that were entered into under the Public
Utility Regulatory Policies Act of 1978 (PURPA). The power sold to the utility
under these PURPA contracts is required to be delivered from a specified power
generation plant at power prices that are usually significantly higher than the
cost of power in the wholesale power market. The cost of generating power at
these PURPA power plants is typically higher than the cost that would be
incurred by obtaining the power in the wholesale power market, principally
because the PURPA power plants are less efficient than newer power generation
facilities.
In a power contract restructuring, the PURPA power purchase agreement is
amended so that the power sold to the utility does not have to be provided from
the specific power plant. Because we are able to buy lower cost power in the
wholesale power market, we have the ability to reduce the cost paid by the
utility, thereby inducing the utility to enter into the power contract
restructuring transaction. Following the contract restructuring, the power plant
operates on a merchant basis, which means that it is no longer dedicated to one
buyer and will operate only when power prices are high enough to make operations
economical. Prior to a power contract restructuring, the power plant and its
related PURPA power purchase agreement are accounted for at their historical
cost, which is either the cost of construction or, if acquired, the acquisition
cost. Revenues and expenses prior to restructuring are, in most cases, accounted
for on an accrual basis as power is generated and sold to the utility. As part
of the restructuring, any existing related fuel supply and steam agreements are
generally amended or terminated, the value of the remaining merchant plant is
evaluated for possible impairment and the restructured power purchase agreements
are adjusted to their estimated fair value. The restructured power agreement can
then be sold or we can enter into an offsetting power services agreement. In
cases when we enter into a power services agreement, we use the restructured
power purchase agreement and the power services agreement, along with the
fixed-price spread between these contracts as collateral to obtain financing.
The offsetting power services agreement requires the power supplier, which can
be an affiliate or third-party, to provide long-term fixed price power in
amounts sufficient for us to meet our obligations under the restructured power
agreement.
Under the original power purchase agreement, Newark Bay sold generating
capacity and associated energy from the Newark Bay facility to Public Service
Electric and the Newark Bay facility was required to be a qualifying facility
under PURPA. Newark Bay and Public Service Electric sought to amend the original
power purchase agreement in order to achieve a number of benefits, including the
elimination of the requirement that the capacity and energy sold under the
original power purchase agreement be sourced only from the Newark Bay facility.
The elimination of this requirement benefited us because now we can buy energy
from any source connected to the Pennsylvania-New Jersey-Maryland (PJM) market,
and the cost of energy sourced in this manner may be less expensive than the
cost to produce such energy at the Newark Bay facility. The benefits of the
amended power purchase agreement also include significantly more flexibility in
scheduling energy deliveries, including a greater degree of daily delivery
flexibility. From the perspective of Public Service Electric, our ability to
source lower cost power in the market allowed us to provide Public Service
Electric with a substantial reduction in the price of the energy and capacity
rates under the amended power purchase agreement compared to the prices under
the original power purchase agreement.
We purchased the original power purchase agreement from Newark Bay on
September 27, 2000, for $289.8 million. We simultaneously amended the original
power purchase agreement and began operating under the restructured power
purchase agreement on September 27, 2000. In order to meet our energy delivery
and electric capacity commitments under the power purchase agreement, we entered
into a power services agreement with El Paso Merchant. The power services
agreement has the same term as the power purchase agreement and we purchase
energy at an established price and at quantities sufficient to meet our
obligations to Public Service Electric.
In September 2000, we issued 8 1/2% Series A senior secured bonds, due
2014, with an aggregate principal amount of $310.6 million. We completed an
exchange of the Series A bonds for registered 8 1/2% Series B senior secured
bonds, due 2014, in May 2001. The terms of the Series B bonds and the Series A
bonds are substantially the same in all material respects, except that the
Series B bonds are registered with the Securities
5
and Exchange Commission. Scheduled payments of principal and interest on the
bonds are expected to be paid from the positive margin created between the sales
of electric energy and capacity to Public Service Electric and purchases of
electric energy and capacity from El Paso Merchant.
The power purchase agreement was initially accounted for as an intangible
asset, which we amortized ratably as we recognized revenues under the agreement.
Beginning January 1, 2001, our power purchase agreement and our power services
agreement were accounted for as derivative instruments under the provisions of
Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended. As a result, the
power purchase agreement and the power services agreement were recorded on our
balance sheet at their estimated fair values, with changes in those estimated
fair values recorded in our statement of operations. The difference between the
fair value and the unamortized cost of these agreements on January 1, 2001, was
$89.4 million, and was recorded as a cumulative effect of an accounting change
in our statement of operations.
The power purchase and power services agreements are reflected as assets or
liabilities on our balance sheets and had estimated fair values as follows:
<Table>
<Caption>
AS OF
DECEMBER 31,
--------------- INCREASE
2002 2001 (DECREASE)
------ ------ ----------
(IN MILLIONS)
Power purchase agreement, asset........................... $298.9 $354.8 $(55.9)
Power services agreement -- affiliate, asset
(liability)............................................. 27.7 (27.6) 55.3
------ ------ ------
$326.6 $327.2 $ (0.6)
====== ====== ======
</Table>
The estimated fair value of these agreements is calculated based on
expected cash receipts and payments under the agreements compared to the
estimated future market prices of power. These estimated market prices for power
consider a combination of available market data and pricing information supplied
by a third party. The differences between market and contractual prices are then
discounted using discount rates that consider the counterparty credit risk and
current and anticipated market conditions as reflected in the United States
treasury rate. We make adjustments to this discount rate when we believe that
market changes in the rates result in changes in fair values that can be
realized.
Our estimates of future power prices are based on the forward pricing curve
of the appropriate power delivery and receipt points in the applicable power
market. This forward pricing curve is derived from a combination of actual
prices observed in the applicable market and pricing information supplied by a
third party. The timing of cash receipts and payments are based on the expected
timing of electric energy and electric capacity delivered under these
agreements.
The net decrease in fair value of $.6 million for the year ended December
31, 2002 is reflected as an increase in operating expenses in our statement of
operations. The decrease in fair value of the power purchase agreement is
attributable primarily to an increase in the estimated market prices of power
and 2002 settlements offset by a decrease in the discount rate due to a decrease
in long term interest rates that occurred during the first six months of 2002.
The increase in the power services agreement is due primarily to an increase in
estimated market prices of power, partly offset by an increase in the discount
rate used to estimate fair value for this agreement, resulting from the decline
in the credit ratings of El Paso as discussed previously, and 2002 settlements.
During the latter half of 2002, long term treasury rates continued to
decline. We did not adjust our discount rate for this decline in treasury rates
since this decrease, combined with the significant uncertainties in the capital
markets, did not result in an increased fair value that we believe could have
been realized in the market. As of December 31, 2002 and December 31, 2001, the
discount rates used to calculate the fair value of the power purchase agreement
were 6.44 percent and 7.70 percent and the discount rates used to calculate the
fair value of the power services agreement were 15.35 percent and 7.63 percent.
6
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
For the year ended December 31, 2002, we had net income of $7.7 million
compared to net income of $50.4 million for the year ended December 31, 2001.
The 2001 amount includes income of $89.4 million as a result of our adoption of
SFAS No. 133 on January 1, 2001. Excluding this item, our net loss would have
been $39.0 million. During the year ended December 31, 2002, we generated
operating revenues of $58.0 million from the sale of approximately 790,000
megawatt hours of electric energy and from providing electric capacity to Public
Service Electric, compared to revenues of $56.8 million from the sale of
approximately 789,000 megawatt hours of electric energy and from providing
electric capacity for the same period in 2001.
Operating expenses decreased from $69.7 million for the year ended December
31, 2001 to $24.1 million for the year ended December 31, 2002. This decrease
was primarily the result of a decrease in the expense associated with the
changes in the fair value of our power agreements to $0.6 million in 2002 from
$46.0 million in 2001. This decrease was primarily due to a significant decline
in the long-term interest rates from the time the initial fair value of the
agreements were estimated, offset by an increase in the estimated market prices
of power as well as by 2002 settlements. Additionally, the fair value of our
power services agreement increased due primarily to the increase in estimated
market prices of power partially offset by an increase in the discount rate due
to the decline in the credit ratings of El Paso, as previously discussed.
In December 2001, we changed our discount rates used to value these power
agreements to reflect the specific risk associated with each agreement. Prior to
December 2001, we utilized fixed discount rates. This change in estimate in 2001
resulted in a decrease in the fair value of the power agreements in our 2001
statement of operations of approximately $31.8 million.
Our operating expenses also include fees incurred under our administrative
services agreement with El Paso Merchant. Interest and debt expense was $26.5
million for the year ended December 31, 2002 and $27.0 million for the year
ended December 31, 2001. The decrease in interest and debt expense is primarily
attributed to a decrease in the principal amount outstanding on our bonds.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO PERIOD ENDED DECEMBER 31, 2000
We were formed in March 2000, but did not begin operations until September
27, 2000, when we acquired the power purchase agreement from Newark Bay
Cogeneration Partnership, L.P. Accordingly, our results of operations for the
year ended December 31, 2000 are not comparable with the same period in 2001.
For the period from September 27, 2000 to December 31, 2000, our net loss was
$3.1 million. During that period, we generated revenues of $14.6 million from
the sale of approximately 207,000 megawatt hours of electric energy and from
providing electric capacity to Public Service Electric. Operating expenses
totaled $10.7 million, primarily from payments to El Paso Merchant for purchases
of power and for the amortization of the power purchase agreement. This
amortization ceased on January 1, 2001 when we began accounting for our power
purchase agreement at fair value as a derivative instrument. Interest and debt
expense for the 2000 period was $7.1 million.
For the year ended December 31, 2001, our net income was $50.4 million.
During the year, we generated revenues of $56.8 million from the sales of
electric energy and from providing electric capacity to Public Service Electric.
Operating expenses totaled $69.7 million, including $23.5 million in expenses
related to power purchased from El Paso Merchant and $46.0 million of non-cash
losses as a result of changes in the fair values of our power purchase and power
services agreements, both of which are reflected on our December 31, 2001
balance sheet at their fair values. Our operating expenses also include fees to
El Paso Merchant under our administrative services agreement. The annual fee to
El Paso Merchant under this agreement is $0.1 million. These fees accrue
annually, but are due and payable only to the extent that we have sufficient
cash after paying obligations under our bond indenture. Interest and debt
expense for the year ended December 31, 2001, was $27.0 million.
7
CRITICAL ACCOUNTING POLICY
Our most critical accounting policy that impacts our financial statements
from period to period pertains to our accounting for derivative instruments. Our
power purchase and power services agreements qualify as derivative instruments
and must be recorded at their estimated fair values on our balance sheets.
Changes in the estimated fair values of these agreements are reported in our
statement of operations as change in fair value of power agreements. The fair
values of these agreements are calculated based on expected cash receipts and
payments under the agreements compared to the estimated future market prices of
power. The estimated market prices for power consider a combination of available
market data and pricing information supplied by a third party. The differences
between market and contractual prices are then discounted using discount rates
that consider an appropriate risk-free rate, adjusted for counterparty credit
risk and current and anticipated market conditions. We make adjustments to these
discount rates when we believe that market changes in the rates result in
changes in fair values that can be realized. Changes in these values in the
future, which could be positive or negative, will occur as our estimates of each
of these variables change and as additional market data becomes available, and
these changes could be material from period to period. However, the pricing
under our power agreements is fixed over their term and, as a result, despite
short-term fluctuations in market factors, our long-term reported results will
be more reflective of the terms of these agreements. If significant future
changes in interest rates or counterparty credit risks occur, it will have a
significant impact on our financial position and results of operations.
For additional information concerning the impact to our power purchase and
power services agreements, and therefore, on our financial statements, that
could result from changes in discount rates and commodity prices, see Item 7A,
Quantitative and Qualitative Disclosures About Market Risk.
Under the power purchase agreement, electricity rates are set annually in
accordance with a schedule to the power purchase agreement. The following table
sets forth the amount of annual energy deliveries, the rates at which we
purchase electricity from El Paso Merchant and the rates we receive when we sell
electricity to Public Service Electric:
<Table>
<Caption>
CONTRACT RATE CONTRACT RATE
($ PER MWH) ($ PER MWH)
PAYABLE BY PUBLIC PAYABLE BY US TO
MAXIMUM ANNUAL SERVICE ELECTRIC TO US EL PASO MERCHANT
ENERGY DELIVERIES UNDER POWER PURCHASE UNDER POWER
CONTRACT YEAR QUANTITY (MWH) AGREEMENT SERVICES AGREEMENT
- ------------- ------------------- ----------------------- ------------------
2003.............................. 811,229 $74.64 $28.56
2004.............................. 855,779 75.44 27.94
2005.............................. 855,779 76.96 28.07
2006.............................. 855,779 78.74 28.26
2007.............................. 855,779 80.34 28.26
2008.............................. 855,779 82.13 28.80
2009.............................. 855,779 83.88 29.08
2010.............................. 855,779 85.76 29.36
2011.............................. 855,779 87.67 29.64
2012.............................. 855,779 89.63 29.64
2013(1)........................... 570,519 92.43 33.75
</Table>
- ---------------
(1) Through August 31, 2013.
The maximum amount of the annual energy payments for any year can be
readily determined. Payments to us under the power purchase agreement are
determined by multiplying the contract rate by the amount of energy delivered.
Our results of operations in the future will depend primarily on revenues
from the sale of electric energy and electric capacity and the level of our
expenses. There can be no assurance that we can find alternative buyers for the
electric energy and electric capacity purchased from El Paso Merchant in the
event of the
8
termination of the power purchase agreement, the loss of which would accordingly
have a material affect on our business.
We believe, based solely upon our review of information contained in Public
Service Electric's filings with the SEC and the credit ratings assigned to
Public Service Electric's senior unsecured debt by Standard and Poor's, Moody's
and Fitch, that Public Service Electric has adequate financial resources to
fulfill its payment obligations to us under the terms of the power purchase
agreement.
RELATED PARTY TRANSACTIONS
Our material related party agreements include an administrative services
agreement and a power services agreement both with El Paso Merchant, our
affiliate. Both agreements were entered into on terms that we believe were based
on market rates at the dates they were negotiated. However, market rates can and
do change and there is no guarantee that the rates we originally agreed to in
these contracts will be indicative of market rates in the future.
LIQUIDITY AND CAPITAL RESOURCES
CASH FROM OPERATING ACTIVITIES
Net cash provided by operating activities was approximately $8.7 million
for the year ended December 31, 2002 compared to $14.1 million for the same
period in 2001. The decrease was primarily due to changes in working capital
items, partially offset by increases in electricity sales in 2002.
CASH FROM FINANCING ACTIVITIES
Net cash used in financing activities was approximately $6.8 million for
the year ended December 31, 2002 and consisted primarily of a $5.9 million
principal payment on our long-term debt made on February 15, 2002, and a $1.2
million distribution to our sole member.
In September 2000, we issued 8 1/2% Series A senior secured bonds with an
aggregate principal amount of $310.6 million. In May 2001, we completed an offer
to exchange the Series A bonds with 8 1/2% Series B senior secured bonds due on
February 15, 2014.
Other than the obligations to repay our bonds, we have no significant
capital requirements, either in the short or long term. We believe that cash
flows from operations will be sufficient to satisfy our cash and liquidity
requirements, including the payment of interest and principal on our bonds and
the payment of our operating expenses, although we cannot assure you that this
will be the case.
Our primary sources of liquidity are the payments to be made by Public
Service Electric under the power purchase agreement, shortfall payments and
excess amounts, if any, required to be paid to us by El Paso Merchant under the
power services agreement and guaranteed by El Paso Corporation under its
performance guaranty, and amounts on deposit in the liquidity account or
acceptable credit support provided in place of cash deposits (see discussion of
the liquidity account in Item 8, Financial Statements and Supplementary Data,
Note 4). We are prohibited by our bond indenture from incurring additional
indebtedness. We would, therefore, be unable to make up any shortfalls in cash
through additional borrowings to pay amounts due under the bonds. All scheduled
payments of principal and interest on the bonds have been calculated to be paid
solely from the margin created between sales of electric energy and electric
capacity to Public Service Electric and purchases of electric energy and
electric capacity from El Paso Merchant, each for the full amount of the
required energy deliveries.
Pursuant to the power purchase agreement, we have the right to schedule and
deliver the annual energy deliveries for each year. If El Paso Merchant fails to
deliver the required energy deliveries, then El Paso Merchant must pay to us an
energy shortfall liquidated damage payment, which will enable us to meet our
payments of principal and interest on the bonds.
The annual energy deliveries may be scheduled and delivered at any time
during the calendar year (subject to meeting the minimum energy deliveries
requirements, prior notification provisions and maximum
9
delivery rate limits). Although our revenues, determined on an annual basis,
should remain stable, our monthly revenues may vary. We receive our last monthly
payment from Public Service Electric for each year on January 31 of the
following calendar year. Interest payments on our bonds are made semi-annually,
on February 15 and August 15 of each year, and principal payments are made
annually on February 15 of each year, beginning in 2002.
Assuming that we schedule and deliver all of the annual energy deliveries
each year, the minimum debt service coverage ratio for any year is expected to
be 1.03 to 1.00 and the average debt service coverage ratio for any year is
expected to be 1.03 to 1.00. The following table sets forth on an annual basis
expected cash available for debt service and debt service for the bonds
commencing in the year 2003.
<Table>
<Caption>
EXPECTED CASH AVAILABLE DEBT
YEAR FOR DEBT SERVICE(1) SERVICE(2)
- ---- ----------------------- ----------
(IN MILLIONS)
2003.................................................. $ 37.4 $ 36.3
2004.................................................. 40.8 39.6
2005.................................................. 42.1 40.9
2006.................................................. 43.6 42.3
2007.................................................. 45.0 43.7
2008.................................................. 46.2 44.9
2009.................................................. 47.6 46.2
2010.................................................. 49.1 47.7
2011.................................................. 50.7 49.0
2012.................................................. 52.3 50.7
2013.................................................. 35.0 34.0
------ ------
Totals........................................... $489.8 $475.3
====== ======
</Table>
- ---------------
(1) Determined from February 1 to January 31 of the following year. The
information presented in the table regarding cash available for debt service
is based upon the assumptions that the full amount of the annual energy
deliveries are scheduled and delivered each year and the energy deliveries
are purchased at the rates set forth in the power services agreement and
sold at the rates set forth in the power purchase agreement.
(2) Determined from February 16 to February 15 of the following year. The
information presented in the table regarding debt service is based upon a
principal amount of $310.6 million and an interest rate of 8.50%.
Our projection of a minimum debt service coverage ratio of 1.03 to 1.00 is
also based upon the assumption that El Paso Merchant will make the liquidated
damage payments that would be required in the event that it is unable to fulfill
its obligations under the power services agreement. El Paso Merchant may be
required to pay us excess amounts in the event that they fail to deliver the
minimum energy deliveries, schedule energy deliveries or deliver energy at the
contractually specified delivery point. If, for example, El Paso Merchant has
not delivered any of the energy scheduled for delivery that month, it will be
required to pay us an amount determined by reference to Public Service
Electric's cost of replacement energy for that month. If El Paso Merchant or El
Paso is unable to pay these excess amounts, we may be unable to pay
corresponding amounts that we are required to pay Public Service Electric under
the power purchase agreement.
Further, if El Paso Merchant does not schedule and deliver the annual
energy deliveries to us in any year, it will be required to pay to us shortfall
payments. These shortfall payments are calculated so that they are equivalent to
the shortfall between our expected revenues under the power purchase agreement
assuming the full delivery of the annual energy deliveries and the actual amount
of energy deliveries made during that year. If El Paso Merchant or El Paso is
unable to pay shortfall payments, we may be unable to make payments on the
bonds.
10
We have funded a liquidity account with a trustee in an amount equal to the
liquidity reserve required balance (which is equal to our next semi-annual
interest payment). The purpose of the liquidity account is to provide the
trustee with cash if we do not have sufficient funds in the collections account
to make a principal or interest payment. The trustee will be able to withdraw
amounts from the liquidity account to make such payments to the extent that
funds are in the liquidity account. We have the right from time to time to
withdraw all or a portion of the cash on deposit in our liquidity account if we
replace it with acceptable credit support.
DISTRIBUTIONS AND DEBT SERVICE
Pursuant to the bond indenture, payments to our bondholders are given
priority over payments to our member. Under our bond indenture, cash
distributions may be made to our member on February 15 of each year, for all
excess cash, provided that no event of default or defaults have occurred and the
debt coverage ratio calculated as of that date, for the most recently ended six
month period, equals or exceeds 1.03 to 1.00. We expect that all excess cash
flow (after the payment of debt service, operating expenses and deposits to the
liquidity account) will be distributed annually to our member, as permitted by
our bond indenture.
During the six months ended January 31, 2002, we generated funds of
approximately $15.7 million available for debt service from the sale of electric
energy and electric capacity. Interest for this period was approximately $13.2
million, providing an interest coverage ratio of 1.19. Including the
proportionate principal payments for the same periods of approximately $2.1
million, the debt service coverage ratio was 1.03. During the year ended
December 31, 2002, we generated funds of approximately $34.8 million available
for debt service from the sale of electric energy and electric capacity.
Interest for the period was approximately $26.0 million, providing an interest
coverage ratio of 1.34. Including the proportionate principal payments for the
same period of approximately $7.6 million, the debt service coverage ratio was
1.04. In accordance with the terms of our bond indenture, a distribution of $1.2
million was paid to our member during February 2002.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
This report contains or incorporates by reference forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Where any forward-looking statement includes a statement of the
assumptions or bases underlying the forward-looking statement, we caution that,
while we believe these assumptions or bases to be reasonable and to be made in
good faith, assumed facts or bases almost always vary from the actual results,
and the differences between assumed facts or bases and actual results can be
material, depending on the circumstances. Where, in any forward-looking
statement, we or our management express an expectation or belief as to future
results, that expectation or belief is expressed in good faith and is believed
to have a reasonable basis. We cannot assure you, however, that the statement of
expectation or belief will result or be achieved or accomplished. The words
"believe," "expect," "estimate," "anticipate" and similar expressions will
generally identify forward-looking statements. All of our forward-looking
statements, whether written or oral, are expressly qualified by these cautionary
statements and any other cautionary statements that may accompany such
forward-looking statements. In addition, we disclaim any obligation to update
any forward-looking statements to reflect events or circumstances after the date
of this report.
11
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The fair value of our debt is exposed to changing interest rates and
underlying credit risks. The table below shows the carrying value and average
interest rates of our long-term debt by expected maturity date. The fair value
of our long-term debt was estimated based on quoted market prices for the same
or similar issues.
On November 27, 2002, Moody's Investors Service downgraded its ratings on
our bonds to "Ba2" from "Baa3". On December 2, 2002, Standard and Poor's Ratings
Services lowered its ratings on our bonds to "BB-" from "BBB-". On January 10,
2003, Standard and Poor's further downgraded its ratings on our bonds to "B" and
on February 12, 2003, Moody's further downgraded its ratings on our bonds to
"Caa1". In January 2003, Fitch Ratings downgraded its ratings on our bonds to
"BB+" from "BBB" and, on February 14, 2003, Fitch cut its ratings to "B". The
downgrade by all of the rating agencies is the result of previous actions taken
by the rating agencies on the credit ratings of El Paso, which guarantees El
Paso Merchant's performance under our power services and administrative services
agreements. All of the rating agencies maintain a negative outlook on our credit
ratings, indicating the possibility of further downgrades. Further downgrades of
El Paso's credit ratings could indirectly have a negative impact on the fair
value of our long-term debt.
<Table>
<Caption>
DECEMBER 31, 2002
---------------------------------------------------------------------------------
EXPECTED MATURITY DATE OF CARRYING VALUE DECEMBER 31, 2001
---------------------------------------------------------------------- -------------------
FAIR CARRYING FAIR
2003 2004 2005 2006 2007 THEREAFTER TOTAL VALUE VALUE VALUE
------ ------- ------- ------- ------- ---------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
LIABILITIES:
Long-term debt, including
current portion -- fixed
rate.................... $7,872 $11,026 $15,254 $17,868 $20,803 $231,919 $304,742 $228,597 $310,600 $336,965
Average interest
rate.............. 8.5% 8.5% 8.5% 8.5% 8.5% 8.5%
</Table>
Our power agreements are also sensitive to interest rate fluctuations since
the anticipated cash flows from these agreements are discounted at a United
States Treasury rate, adjusted for credit risk, to arrive at their fair value.
Changes in these rates impact our fair value estimates. The sensitivity of the
fair value of our power agreements to changes in interest rates are as follows:
<Table>
<Caption>
1% INCREASE 1% DECREASE
------------------- -------------------
FAIR FAIR INCREASE FAIR INCREASE
VALUE VALUE (DECREASE) VALUE (DECREASE)
------ ------ ---------- ------ ----------
(IN MILLIONS)
Power purchase agreement...................... $298.9 $284.4 $ (14.5) $314.6 $15.7
Power services agreement...................... 27.7 26.5 (1.2) 28.9 1.2
------ ------ ------- ------ -----
Total............................... $326.6 $310.9 $ (15.7) $343.5 $16.9
====== ====== ======= ====== =====
</Table>
COMMODITY PRICE RISK
Our power purchase agreement and our power services agreement meet the
definition of a derivative under the provisions of SFAS No. 133, as amended, and
are carried at estimated fair value. The fair value of these agreements at
December 31, 2002 was estimated considering the expected estimated cash receipts
and payments under these agreements using contractual prices under the
agreements compared to anticipated future power prices discounted at a
risk-adjusted rate commensurate with the term of each agreement and the credit
risk of the counterparty. Our estimates of the timing of cash receipts and
payments are based on the anticipated timing of electric energy and electric
capacity delivered under the agreements. These estimates also consider the
minimum and maximum energy delivery requirements under those agreements.
Estimates of the future prices of power consider the forward pricing curve of
the appropriate power delivery and receipt points, and this curve is derived
from the actual prices observed in the market and pricing information supplied
by a third party. Changes in future prices impact the fair value of these
agreements.
12
The sensitivity of the fair value of our power agreements to changes in
commodity prices is as follows:
<Table>
<Caption>
10% INCREASE 10% DECREASE
------------------- -------------------
FAIR FAIR INCREASE FAIR INCREASE
VALUE VALUE (DECREASE) VALUE (DECREASE)
------ ------ ---------- ------ ----------
(IN MILLIONS)
Power purchase agreement...................... $298.9 $275.8 $(23.1) $322.0 $23.1
Power services agreement...................... 27.7 30.4 2.7 25.0 (2.7)
------ ------ ------ ------ -----
Total............................... $326.6 $306.2 $(20.4) $347.0 $20.4
====== ====== ====== ====== =====
</Table>
13
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CEDAR BRAKES I, L.L.C.
STATEMENTS OF OPERATIONS
<Table>
<Caption>
PERIOD FROM
INCEPTION
(MARCH 3, 2000)
YEAR ENDED DECEMBER 31, TO
--------------------------- DECEMBER 31,
2002 2001 2000
------------ ------------ ---------------
(IN THOUSANDS)
Operating revenues
Electricity sales.................................. $58,007 $ 56,816 $14,638
------- -------- -------
Operating expenses
Electricity purchases -- affiliate................. 23,133 23,456 4,766
Change in fair value of power agreements........... 573 46,038 --
Administrative fees -- affiliate................... 100 100 26
Amortization of power purchase agreement........... -- -- 5,937
Other.............................................. 328 125 --
------- -------- -------
24,134 69,719 10,729
------- -------- -------
Operating income (loss).............................. 33,873 (12,903) 3,909
------- -------- -------
Other (income) expense
Interest income.................................... (400) (874) (14)
Interest and debt expense.......................... 26,544 26,959 7,055
------- -------- -------
26,144 26,085 7,041
------- -------- -------
Income (loss) before cumulative effect of accounting
change............................................. 7,729 (38,988) (3,132)
Cumulative effect of accounting change............... -- 89,368 --
------- -------- -------
Net income (loss).................................... $ 7,729 $ 50,380 $(3,132)
======= ======== =======
</Table>
See accompanying notes.
14
CEDAR BRAKES I, L.L.C.
BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31, DECEMBER 31,
2002 2001
------------ ------------
(IN THOUSANDS)
ASSETS
Current assets
Cash and cash equivalents................................. $ 24,710 $ 22,804
Accounts receivable -- Public Service Electric and Gas
Company................................................ 2,188 40
Power purchase agreement.................................. 30,817 36,026
Power services agreement -- affiliate..................... 4,973 --
-------- --------
Total current assets.............................. 62,688 58,870
Power purchase agreement.................................... 268,153 318,794
Power services agreement -- affiliate....................... 22,707 --
Restricted cash............................................. 12,952 13,201
Deferred financing costs, net............................... 3,969 4,546
-------- --------
Total assets...................................... $370,469 $395,411
======== ========
LIABILITIES AND MEMBER'S CAPITAL
Current liabilities
Accounts payable
Trade.................................................. $ 126 $ --
Affiliate.............................................. 2,109 65
Accrued interest payable.................................. 9,714 9,900
Power services agreement -- affiliate..................... -- 2,607
Current maturities of long-term debt...................... 7,872 5,858
-------- --------
Total current liabilities......................... 19,821 18,430
Power services agreement -- affiliate....................... -- 24,990
Long-term debt, less current maturities..................... 296,870 304,742
Commitments and contingencies
Member's capital............................................ 53,778 47,249
-------- --------
Total liabilities and member's capital............ $370,469 $395,411
======== ========
</Table>
See accompanying notes.
15
CEDAR BRAKES I, L.L.C.
STATEMENTS OF CASH FLOWS
<Table>
<Caption>
PERIOD FROM
INCEPTION
YEAR ENDED DECEMBER 31, (MARCH 3, 2000)
--------------------------- TO DECEMBER 31,
2002 2001 2000
------------ ------------ -----------------
(IN THOUSANDS)
Cash flows from operating activities
Net income (loss)................................. $ 7,729 $ 50,380 $ (3,132)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities
Cumulative effect of accounting change......... -- (89,368) --
Change in fair value of power agreements....... 573 46,038 --
Amortization of power purchase agreement....... -- -- 5,937
Amortization of deferred financing costs....... 577 514 161
Working capital changes
Accounts receivable -- Public Service
Electric and Gas Company.................. (2,148) 5,232 (5,272)
Accounts payable -- trade and affiliate...... 2,170 (1,690) 1,755
Accrued interest payable..................... (186) 3,006 6,894
------- -------- --------
Net cash provided by operating
activities.............................. 8,715 14,112 6,343
------- -------- --------
Cash flows from investing activities
Purchase of power purchase agreement.............. -- -- (289,830)
------- -------- --------
Net cash used in investing activities..... -- -- (289,830)
------- -------- --------
Cash flows from financing activities
Net proceeds from issuance of long-term debt...... -- -- 305,379
Initial capital contribution...................... -- -- 1
Principal payments on long-term debt.............. (5,858) -- --
Distribution to member............................ (1,200) -- --
Change in restricted cash......................... 249 -- (13,201)
------- -------- --------
Net cash (used in) provided by financing
activities.............................. (6,809) -- 292,179
------- -------- --------
Change in cash and cash equivalents................. 1,906 14,112 8,692
Cash and cash equivalents
Beginning of period............................... 22,804 8,692 --
------- -------- --------
End of period..................................... $24,710 $ 22,804 $ 8,692
======= ======== ========
Supplemental disclosure of cash flow information
Cash paid for interest............................ $26,153 $ 23,394 $ --
======= ======== ========
</Table>
See accompanying notes.
16
CEDAR BRAKES I, L.L.C.
STATEMENTS OF MEMBER'S CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001 AND
THE PERIOD FROM INCEPTION (MARCH 3, 2000) TO DECEMBER 31, 2000
<Table>
<Caption>
(IN THOUSANDS)
Initial capital contribution on March 3, 2000............... $ 1
Net loss for the period from inception (March 3, 2000) to
December 31, 2000......................................... (3,132)
-------
Balance, December 31, 2000.................................. (3,131)
Net income for the year ended December 31, 2001............. 50,380
-------
Balance, December 31, 2001.................................. 47,249
Distribution to member...................................... (1,200)
Net income for the year ended December 31, 2002............. 7,729
-------
Balance, December 31, 2002.................................. $53,778
=======
</Table>
See accompanying notes.
17
CEDAR BRAKES I, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS
1. ORGANIZATION AND NATURE OF OPERATIONS
We are a Delaware limited liability company organized in March 2000 under
the terms of a limited liability company agreement. We are a wholly owned
subsidiary of Mesquite Investors, L.L.C., an entity which is indirectly owned by
the Limestone Electron Trust and a subsidiary of El Paso Corporation. El Paso
Chaparral Management, L.P., a wholly owned indirect subsidiary of El Paso,
manages the operations of Mesquite Investors. Our sole business is to sell
electric energy and provide electric capacity to Public Service Electric and Gas
Company, a New Jersey corporation, under a power purchase agreement that we
entered into with Public Service Electric on March 21, 2000. We began operating
under this power purchase agreement on September 27, 2000 when the Newark Bay
Cogeneration Partnership L.P. power purchase agreement, which had an aggregate
book value of $289.8 million, was sold to us. We do not have any employees and
all of our operations are carried out by our affiliate, El Paso Merchant Energy,
L.P., a subsidiary of El Paso, under an administrative services agreement (see
Note 6). We purchase the electric capacity and electric energy necessary to meet
our obligations under a power services agreement with El Paso Merchant (see
Notes 5 and 6).
POTENTIAL CHANGES IN MESQUITE INVESTORS' OWNERSHIP
Chaparral Investors, L.L.C. is the parent of Mesquite Investors, our sole
member. At December 31, 2002, Chaparral was owned approximately 20 percent by a
wholly owned subsidiary of El Paso and 80 percent by Limestone Electron Trust,
an unaffiliated third party. In March 2003, El Paso contributed $1 billion to
Limestone in exchange for a non-controlling interest which increased El Paso's
effective ownership in Chaparral to approximately 90 percent. Also in March
2003, El Paso notified Limestone that it would exercise its rights to purchase
all of the outstanding third party equity in Limestone on May 31, 2003. If El
Paso acquires the remaining Limestone equity interest in Chaparral, we would
become a wholly owned, indirect subsidiary of El Paso.
2. LIMITED LIABILITY COMPANY
As a limited liability company, our member is not personally obligated for
our debt, obligations or other liabilities simply because they are our member.
These debts, obligations and other liabilities are solely ours. In accordance
with the terms of our limited liability company agreement, our member may
determine the date of our dissolution.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Our financial statements are prepared on the accrual basis of accounting in
accordance with accounting principles generally accepted in the United States of
America.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires us to
make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses and disclosure of contingent assets and
liabilities that exist at the date of the financial statements. Actual results
may differ from those estimates.
CASH AND CASH EQUIVALENTS
We consider short-term investments purchased with an original maturity of
three months or less to be cash equivalents.
18
CEDAR BRAKES I, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
RESTRICTED CASH
As required by our bond indenture (see Note 4), we established a restricted
cash fund from the proceeds of our bond issuance equal to the amount of a
semi-annual interest payment. We must maintain this fund through the maturity
date of the bonds. As of December 31, 2002 and 2001, we had restricted cash of
$13.0 million and $13.2 million.
CASH DISTRIBUTIONS
Under our bond indenture and our limited liability company agreement, cash
distributions may be made to our member annually starting February 15, 2002 for
all excess cash, provided that no event of default has occurred, and the debt
coverage ratio calculated as of that date for the most recently ended six month
period equals or exceeds 1.03 to 1.00. We made no cash distributions in 2001 or
2000. A cash distribution of $1.2 million was made to our member on February 15,
2002.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We review collectibility of our accounts receivable on a regular basis,
primarily under the specific identification method. At December 31, 2002 and
2001, no allowance for doubtful accounts was recorded.
DEFERRED FINANCING COSTS
Our deferred financing costs represent the cost to issue our bonds and are
amortized using the effective interest method over the term of the bonds.
Amortization of deferred financing costs was approximately $0.6 million in 2002,
$0.5 million in 2001 and $0.2 million in 2000 and is included in our statements
of operations as interest and debt expense. Accumulated amortization of deferred
financing costs was approximately $1.3 million as of December 31, 2002 and $0.7
million as of December 31, 2001.
INCOME TAXES
Since we are a limited liability company, income taxes accrue to our
member. As a result, we have not reflected a provision for income taxes in our
financial statements.
REVENUE RECOGNITION
We recognize revenue when we deliver electric energy and provide electric
capacity. Revenue is based on the quantity of electricity delivered at rates
specified in our power purchase agreement.
ACCOUNTING FOR POWER PURCHASE AND POWER SERVICES AGREEMENTS
We record our power purchase and power services agreements on our balance
sheets at their estimated fair values in accordance with Statement of Financial
Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended. We estimate the fair value of our power purchase
agreement with Public Service Electric and our power services agreement with El
Paso Merchant, our affiliate, based on an estimate of the cash receipts and
payments under these agreements using anticipated future power prices compared
to the contractual prices under these agreements, discounted at a rate that is
based upon the 10-year United States Treasury rate, adjusted for the credit risk
of each counterparty. We make adjustments to this discount rate when we believe
that market changes in the rates result in changes in fair values that can be
realized. In December 2001, we revised our discount rates to reflect the
specific risk associated with Public Service Electric and El Paso Merchant.
Prior to this change, we utilized fixed discount rates that approximated the
risk associated with each counterparty. We believe the risk adjusted rates
provide a better indication of fair value versus the rates used prior to the
change. This change in accounting estimate resulted in an additional decrease in
the fair value of our power agreements of approximately $31.8 million and is
19
CEDAR BRAKES I, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
reflected in operating expenses in our 2001 statement of operations. See Note 5
for additional information on the power purchase and power services agreements.
In June 2002, we revised our power purchase agreement discount rate as a
result of revised counterparty credit spreads and significant declines in the
10-year United States Treasury rate from the time the initial fair value of the
agreement was estimated. During the latter half of 2002, long-term treasury
rates continued to decline. We did not adjust our discount rate for this decline
in treasury rates since this decrease, combined with the significant
uncertainties in the capital markets, did not result in an increased fair value
that we believe could have been realized in the market.
Additionally, during 2002, El Paso's credit risk increased as their senior
unsecured debt was downgraded by the rating agencies (see Note 6). Prior to the
fourth quarter, we did not adjust the discount rate used to value the power
services agreement for this change in credit risk as the estimated fair value
resulted in a liability and we did not believe that the decrease in our
liability to El Paso Merchant, resulting from an increase in the discount rate,
would be realized. In the fourth quarter, changes in estimated power prices
resulted in an increase in the fair value such that the estimated fair value of
the power services agreement resulted in an asset. Accordingly, we adjusted the
discount rate used to determine the fair value of this agreement, to reflect El
Paso's increased credit spread, in the fourth quarter. The discount rate used to
calculate the fair value of the power purchase agreement was 6.44 percent at
December 31, 2002 and 7.70 percent at December 31, 2001 and the rate used to
calculate the fair value of the power services agreement was 15.35 percent at
December 31, 2002 and 7.63 percent at December 31, 2001.
Our estimates of the timing of cash receipts and payments are based on the
anticipated timing of electric energy and electric capacity delivered under
these agreements. These estimates also consider the minimum and maximum energy
delivery requirements under our agreements. Estimates of the future prices of
power are based on the forward pricing curve of the appropriate power delivery
and receipt points, and this curve is derived from actual prices observed in the
market and pricing information supplied by a third party. Changes in these
values in the future, which could be positive or negative, will occur as our
estimates of each of these variables change and as additional market data
becomes available, and these changes could be material from period to period.
However, the pricing of our power agreements is fixed over their term and, as a
result, despite short-term fluctuations in market factors, our long term
reported results will be more reflective of the terms of these agreements. If
significant future changes in interest rates or counterparty credit risks occur,
it will have a significant impact on our financial position and results of
operations.
4. LONG-TERM DEBT
In September 2000, we issued 8 1/2% Series A senior secured bonds with an
aggregate principal amount of $310.6 million. The bonds mature on February 15,
2014, with principal paid annually on each February 15 beginning in 2002.
Interest payments are due semiannually on each February 15 and August 15
beginning in 2001. The effective interest rate of our bonds was 8.69% at
December 31, 2002 and 2001. The bonds are collateralized by all of our assets.
In May 2001, we completed an offer to exchange the Series A bonds with
8 1/2% Series B senior secured bonds due 2014. The terms of the Series B bonds
and the Series A bonds are substantially the same in all material respects,
except that the Series B bonds are registered with the Securities and Exchange
Commission.
We may redeem all or any portion of outstanding bonds from the holders at
any time at a redemption price equal to the principal amount plus accrued and
unpaid interest to the redemption date, plus a make-whole premium, if any. The
make-whole premium is equal to the discounted present value of all principal and
interest payments scheduled to become due after the redemption date less the
unpaid principal amount of the bonds, provided that the make-whole premium is
not less than zero.
20
CEDAR BRAKES I, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
Obligations under our bonds are non-recourse to our member or any of its
affiliates.
The following are aggregate maturities of the principal amounts of our
long-term debt for each of the next five years and in total thereafter:
<Table>
<Caption>
(IN THOUSANDS)
2003........................................................ $ 7,872
2004........................................................ 11,026
2005........................................................ 15,254
2006........................................................ 17,868
2007........................................................ 20,803
Thereafter.................................................. 231,919
--------
Total long-term debt, including current
maturities...................................... $304,742
========
</Table>
As required by our bond indenture, we established three separate cash
accounts from the proceeds of our bond issuance: a collections account, a
liquidity account and a damages and indemnity account. The collections account
was established to receive all payments that we are entitled to receive,
including revenues from electric energy and electric capacity sales to Public
Service Electric under the power purchase agreement. The liquidity account was
established to pay interest and principal due on the bonds in the event
sufficient funds are not available in the collections account to make the
interest and principal payments. We are required to maintain in the liquidity
account a cash balance equal to the maximum amount of interest that will be due
on any single subsequent interest payment date. The damages and indemnity
account was established to receive all payments from El Paso Merchant under the
terms of the power services agreement (see Note 5) and El Paso under the terms
of the El Paso performance guaranty (see Note 6). These cash accounts are
required to be maintained for the life of the bond indenture. The balance in the
liquidity account is reported as restricted cash on our balance sheets.
5. POWER AGREEMENTS
POWER PURCHASE AGREEMENT
We have a power purchase agreement with Public Service Electric that
extends through August 2013. Under this agreement, we are required to arrange
for 123 megawatts per day of capacity to be made available to Public Service
Electric, and we are required to sell and deliver electric energy to Public
Service Electric at established prices and at any delivery point within the
Pennsylvania-New Jersey-Maryland Power system. The prices under the agreement
are specified on an annual basis and escalate each year over the contract term.
For 2000, the price was $70.74 per megawatt hour, for 2001, the price was $72.17
per megawatt hour and, for 2002, the price was $73.53 per megawatt hour and
increases annually thereafter to $92.43 per megawatt hour in 2013. The amount of
energy delivered under this agreement is subject to an annual minimum and
maximum requirement. We must deliver a minimum of 394,000 megawatt hours
annually, with 40,000 megawatt hours required in each of the months of June
through September during the on-peak hours. The remainder of the minimum
requirements must be met during the other months in the year. During any one
year, total deliveries cannot exceed the specified maximum amounts, which range
from 788,954 megawatt hours to 855,779 megawatt hours over the life of the
contract.
If we fail to deliver all or part of the scheduled energy or fail to
schedule sufficient deliveries to meet the minimum energy delivery requirements
for reasons within our control, Public Service Electric's payment to us may be
reduced by a credit, if any, for energy purchased by Public Service Electric
over the prices stated in our power purchase agreement. No credits were applied
during the periods ended December 31, 2002, 2001 or 2000.
21
CEDAR BRAKES I, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
If we fail to provide all or part of the required electric capacity for
reasons within our control, Public Service Electric must use reasonable efforts
to purchase replacement capacity in the amount of the shortfall. We must
reimburse Public Service Electric for all costs associated with the replacement
capacity. If Public Service Electric is unable to replace this capacity
shortfall, Public Service Electric's payment to us will be reduced by a credit
as specified in the power purchase agreement. Generally, the credit would equal
the deficiency charge, if any, payable by Public Service Electric as a direct
result of our failure to provide the required electric capacity. No credits were
applied during the periods ended December 31, 2002, 2001 or 2000.
POWER SERVICES AGREEMENT
In order to meet our electric energy delivery and electric capacity
commitments under the power purchase agreement, we entered into a power services
agreement with El Paso Merchant. The power services agreement has the same term
as the power purchase agreement. Under this agreement, we purchase energy at an
established price and at quantities sufficient to meet our obligations to Public
Service Electric. The price under the power services agreement was $23.03 per
megawatt hour in 2000, $29.71 per megawatt hour in 2001 and $29.30 per megawatt
hour in 2002. Beyond 2002, these prices escalate each year to $33.75 per
megawatt hour in 2013.
Under the power services agreement, El Paso Merchant must schedule and
deliver to us during each year both the minimum hourly energy deliveries and the
full amount of energy deliveries that we are obligated to deliver under our
power purchase agreement with Public Service Electric and El Paso Merchant must
also make available to us capacity credits equal to the capacity we are required
to provide under our power purchase agreement with Public Service Electric. If
El Paso Merchant fails to deliver all or part of the scheduled energy to us for
any reason within their control, our payment to them will be reduced by a credit
calculated in the same manner as the credit to Public Service Electric described
above. No credits were taken during the periods ended December 31, 2002, 2001 or
2000.
The power services agreement also provides that El Paso Merchant deliver
sufficient amounts of electric capacity to meet our capacity requirements under
the power purchase agreement. If El Paso Merchant fails to provide all or part
of the capacity, for any reason within their control, our payment to them will
be reduced by a credit calculated in the same manner as our payment to Public
Service Electric if we fail to provide capacity under the power purchase
agreement. El Paso Merchant's performance under this agreement has been
guaranteed by El Paso under a performance guaranty (see Note 6). No credits were
taken during the periods ended December 31, 2002, 2001, or 2000.
6. RELATED PARTY TRANSACTIONS
POWER SERVICES AGREEMENT
El Paso Merchant provides electric energy and electric capacity to us under
the power services agreement as discussed above. Purchases under this agreement
were based on market rates at the time the agreement was negotiated and are
reflected in our statements of operations as electricity purchases -- affiliate.
Amounts owed under the agreement are included in accounts payable -- affiliate
on our balance sheets. See Note 5 for further discussion.
ADMINISTRATIVE SERVICES AGREEMENT
We have an administrative services agreement with El Paso Merchant to
provide project management, finance and accounting services to us for a fee of
$100,000 per year through 2013. In addition to the base fee, we are obligated to
reimburse El Paso Merchant for direct expenses other than project management,
finance and accounting services that may be incurred on our behalf. Fees and
expenses under this agreement are due and payable only to the extent that we
have sufficient cash after paying obligations under our bond indenture.
22
CEDAR BRAKES I, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
Our administrative fee expense is reflected as administrative fees -- affiliate
in our statements of operations. As of December 31, 2002 and 2001, approximately
$42,000 was payable to El Paso Merchant which is included in accounts
payable -- affiliate on our balance sheets.
EL PASO CORPORATION PERFORMANCE GUARANTY
El Paso, the parent company of El Paso Merchant, entered into a performance
guaranty with us on September 27, 2000, which expires after the expiration of El
Paso Merchant's obligations under the power services and administrative services
agreements. Under the performance guaranty, El Paso guarantees to us the
punctual performance of all of El Paso Merchant's obligations under the power
services and administrative services agreements.
On February 7, 2003, Standard and Poor's downgraded El Paso's senior
unsecured debt to a rating of "B" and on February 11, 2003, Moody's downgraded
El Paso's senior unsecured debt ratings to "Caa1". Both rating agencies maintain
a negative outlook on El Paso's credit ratings, indicating the possibility of
further ratings downgrades.
EL PASO CORPORATION ANNOUNCES EXIT OF ENERGY TRADING ACTIVITIES
El Paso's credit downgrades in the third and fourth quarter and the
deterioration of the energy trading environment led to its decision in November
2002 to exit the energy trading business and pursue an orderly liquidation of
its trading portfolio. El Paso anticipates this liquidation may occur through
2004. If El Paso seeks to assign its obligations under the power services and
administrative services agreements to another party, our indenture requires the
consent of the bondholders to any such assignment. El Paso has guaranteed to us
the punctual performance of all of El Paso Merchant's obligations under the
power services and administrative services agreements.
7. CONCENTRATION OF CREDIT RISK
Our cash and accounts receivable potentially subject us to credit risk. Our
cash accounts are held by major financial institutions. Our trade receivables
and revenues are from a single customer, Public Service Electric, who purchases
electric energy and electric capacity from us under a long-term power purchase
agreement. Public Service Electric's senior unsecured debt is rated "Baa1" by
Moody's, "BBB-" by Standard and Poor's, and "A-" by Fitch Ratings.
We purchase all of the electric energy and electric capacity that we
provide to Public Service Electric from our affiliate, El Paso Merchant, under a
power services agreement (see Notes 5 and 6). El Paso guarantees El Paso
Merchant's performance under this power service agreement. Recently, El Paso's
senior unsecured debt was downgraded by the rating agencies and it remains on
negative watch (see Note 6). If El Paso Merchant ceases to perform its
obligations under its agreement with us, and El Paso fails to meet its
obligations under the guaranty, there can be no assurance that we will be able
to make payments of principal and interest on our bonds. In such event, we would
be able to seek a replacement power provider and to pursue our remedies under
the contract with El Paso Merchant and the guaranty issued by El Paso.
8. FAIR VALUE OF FINANCIAL INSTRUMENTS
As of December 31, 2002 and 2001, the carrying amounts of our financial
instruments including cash, cash equivalents and trade receivables and payables
are representative of fair value because of their short-term
23
CEDAR BRAKES I, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
nature. The fair values of our derivative instruments are reflected on our
balance sheets. The following table reflects the carrying amount and estimated
fair value of our other financial instruments at December 31:
<Table>
<Caption>
2002 2001
----------------- -----------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ------ -------- ------
(IN MILLIONS)
Long-term debt............................................. $304.7 $228.6 $310.6 $337.0
</Table>
DOWNGRADE OF OUR BONDS
The fair value of our long-term debt has been estimated based on quoted
market prices for the same or similar issues. On October 4, 2002, Moody's
downgraded its ratings on our senior secured bonds to "Baa3" from "Baa2". On
November 27, 2002, Moody's further downgraded its ratings on our bonds to "Ba2".
On December 2, 2002, Standard & Poor's lowered its ratings on our bonds to "BB-"
from "BBB-". On February 10, 2003, Standard and Poor's further downgraded its
ratings on our bonds to "B". On February 12, 2003, Moody's further downgraded
its ratings on our bonds to "Caa1". In January 2003, Fitch downgraded its
ratings on our bonds to "BB+" from "BBB" and on February 14, 2003, Fitch cut its
rating further to "B". The downgrades by all of the rating agencies is the
result of previous actions taken by the rating agencies on the credit ratings of
El Paso, which guarantees El Paso Merchant's performance under our power
services and administrative services agreements. All of the rating agencies
maintain a negative outlook on our credit ratings, indicating the possibility of
further downgrades. These downgrades and further downgrades of El Paso's credit
ratings could indirectly have a negative impact on the fair value of our
long-term debt.
In May 2002, Standard and Poor's lowered the senior unsecured credit rating
of our only customer, Public Service Electric, from "BBB+" to "BBB-". Although
our credit rating is not directly related to the credit rating of Public Service
Electric, an indirect result of this downgrade was a reduction in the credit
rating of our bonds in June 2002 by Standard and Poor's from "BBB" to "BBB-".
Further downgrades of Public Service Electric could indirectly have a negative
impact on the fair value of our long-term debt.
24
CEDAR BRAKES I, L.L.C.
NOTES TO THE FINANCIAL STATEMENTS -- (CONTINUED)
9. SUPPLEMENTAL SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Financial information by quarter is summarized below:
<Table>
<Caption>
QUARTER ENDED
-----------------------------------------------
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------ ------- --------
(IN THOUSANDS)
2002
Operating revenues............................. $ 8,757 $17,345 $15,759 $16,146
Operating income............................... (10,219) 7,203 27,788(1) 9,101
Net income (loss).............................. (16,747) 538 21,264 2,674
</Table>
<Table>
<Caption>
QUARTER ENDED
-----------------------------------------------
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------ ------- --------
(IN THOUSANDS)
2001
Operating revenues............................. $ 9,796 $16,627 $15,634 $14,759
Operating income (loss)........................ (26,479)(2) 5,609 8,818 (851)
Income (loss) before cumulative effect of
accounting change........................... (33,051) (1,142) 2,541 (7,336)
Cumulative effect of accounting change......... -- -- -- 89,368
Net income (loss).............................. (33,051) (1,142) 2,541 82,032
</Table>
- ---------------
(1) Operating income includes the effects of a change in discount rates
resulting in a $24.1 million increase in the fair value of our power
agreements (see Note 3).
(2) Operating loss includes the effects of a $31.8 million change in accounting
estimate related to a change in discount rates (see Note 3).
25
REPORT OF INDEPENDENT ACCOUNTANTS
To the Member of Cedar Brakes I, L.L.C.:
In our opinion, the accompanying balance sheets and the related statements
of operations, of member's capital and of cash flows present fairly, in all
material respects, the financial position of Cedar Brakes I, L.L.C. at December
31, 2002 and 2001, and the results of its operations and its cash flows for the
years ended December 31, 2002 and 2001 and for the period from inception (March
3, 2000) to December 31, 2000, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Houston, Texas
March 27, 2003
26
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding our executive officers is presented in Item 1,
Business, of this Form 10-K under the caption "Managers and Executive Officers
of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
None.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
None.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 14. CONTROLS AND PROCEDURES
Evaluation of Controls and Procedures. Under the supervision and with the
participation of management, including our principal executive officer and
principal financial officer, we have evaluated the effectiveness of the design
and operation of our disclosure controls and procedures (Disclosure Controls)
and internal controls (Internal Controls) within 90 days of the filing date of
this annual report pursuant to Rules 13a-15 and 15d-15 under the Securities
Exchange Act of 1934 (Exchange Act).
Definition of Disclosure Controls and Internal Controls. Disclosure
Controls are our controls and other procedures that are designed to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified under the Exchange Act. Disclosure Controls include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by us in the reports that we file under the Exchange
Act is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure. Internal Controls are procedures
which are designed with the objective of providing reasonable assurance that (1)
our transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded and
reported, all to permit the preparation of our financial statements in
conformity with generally accepted accounting principles.
Limitations on the Effectiveness of Controls. Our management, including the
principal executive officer and principal financial officer, does not expect
that our Disclosure Controls and Internal Controls will prevent all error and
all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain
27
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Over time, controls may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
No Significant Changes in Internal Controls. We have sought to determine
whether there were any "significant deficiencies" or "material weaknesses" in
our Internal Controls, or whether the company had identified any acts of fraud
involving personnel who have a significant role in our Internal Controls. This
information was important both for the controls evaluation generally and because
the principal executive officer and principal financial officer are required to
disclose that information to our Board and our independent auditors and to
report on related matters in this section of the Annual Report. The principal
executive officer and principal financial officer note that, from the date of
the controls evaluation to the date of this Annual Report, there have been no
significant changes in Internal Controls or in other factors that could
significantly affect Internal Controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Effectiveness of Disclosure Controls. Based on the controls evaluation, our
principal executive officer and principal financial officer have concluded that,
subject to the limitations discussed above, the Disclosure Controls are
effective to ensure that material information relating to us is made known to
management, including the principal executive officer and principal financial
officer, particularly during the period when our periodic reports are being
prepared.
Officer Certifications. The certifications from the principal executive
officer and principal financial officer required under Sections 302 and 906 of
the Sarbanes-Oxley Act of 2002 have been included herein, or as Exhibits to this
Annual Report, as appropriate.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
1. Financial statements.
Our financial statements are included in Part II, Item 8 of this report:
<Table>
<Caption>
PAGE
----
Statements of Operations.................................... 15
Balance Sheets.............................................. 16
Statements of Cash Flows.................................... 17
Statements of Member's Capital.............................. 18
Notes to the Financial Statements........................... 19
Report of Independent Accountants........................... 27
</Table>
2. Financial statement schedules and supplementary information required to
be submitted.
None.
<Table>
3. Exhibit list............................................. 30
</Table>
(b) Reports on Form 8-K:
None.
28
CEDAR BRAKES I, L.L.C.
EXHIBIT LIST
DECEMBER 31, 2002
Each exhibit identified below is filed as a part of this report. Exhibits
not incorporated by reference to a prior filing are designated by an asterisk;
all exhibits not so designated are incorporated herein by reference to a prior
filing as indicated. Exhibits designated with a "+" constitute a management
contract or compensatory plan or arrangement required to be filed as an exhibit
to this report pursuant to Item 15(c) of Form 10-K.
<Table>
<Caption>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
3.A -- Certificate of Formation of Cedar Brakes I, L.L.C. dated as
of March 3, 2000 (Exhibit 3.1 to our Form S-4 filed November
28, 2000, Registration No. 333-50828).
3.B -- Amended and Restated Limited Liability Company Agreement of
Cedar Brakes I, L.L.C. dated September 11, 2000 (Exhibit 3.2
to our Form S-4 filed November 28, 2000, Registration No.
333-50828); Amendment No. 1, dated October 19, 2000, to the
Amended & Restated Limited Liability Company Agreement of
Cedar Brakes I, L.L.C. (Exhibit 3.3 to our Form S-4,
Registration No. 333-50828); Amendment No. 2, dated January
19, 2001, to the Amended and Restated Limited Liability
Company Agreement of Cedar Brakes I, L.L.C. (Exhibit 3.4 to
our Form S-4 filed November 28, 2000, Registration No.
333-50828).
4.A -- Indenture dated as of September 26, 2000 between Cedar
Brakes I, L.L.C. and Bankers Trust Company, as Trustee
(Exhibit 4.1 to our Form S-4 filed November 28, 2000,
Registration No. 333-50828); First Supplemental Indenture
dated as of November 20, 2000 between Cedar Brakes I, L.L.C.
and Bankers Trust Company, as Trustee (Exhibit 4.2 to our
Form S-4 filed November 28, 2000, Registration No.
333-50828); Second Supplemental Indenture dated as of
January 19, 2001, between Cedar Brakes I, L.L.C., and
Bankers Trust Company, as Trustee (Exhibit 4.2(a) to our
Form S-4 filed November 28, 2000, Registration No.
333-50828).
10.A -- Amended and Restated Power Purchase Agreement dated as of
March 21, 2000 between Cedar Brakes I, L.L.C. and Public
Service Electric and Gas Company (Exhibit 10.1 to our Form
S-4 filed November 28, 2000, Registration No. 333-50828).
10.B -- Power Services Agreement dated September 20, 2000 between
Cedar Brakes I, L.L.C. and El Paso Merchant Energy, L.P.
(Exhibit 10.2 to our Form S-4 filed November 28, 2000,
Registration No. 333-50828)
10.C -- Administrative Services Agreement dated as of September 20,
2000 between Cedar Brakes I, L.L.C. and El Paso Merchant
Energy, L.P. (Exhibit 10.3 to our Form S-4 filed November
28, 2000, Registration No. 333-50828)
10.D -- Guaranty dated as of September 20, 2000 from El Paso Energy
Corporation of the performance of El Paso Merchant Energy,
L.P. under the Power Services Agreement (Exhibit 10.2 to our
Form S-4 filed November 28, 2000, Registration No.
333-50828) and the Administrative Services Agreement
(Exhibit 10.3 to our Form S-4 filed November 28, 2000,
Registration No. 333-50828) (Exhibit 10.4 to our Form S-4
filed November 28, 2000, Registration No. 333-50828).
*99.A -- Certification of Principal Executive Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002. A signed original of this
written statement required by sec. 906 has been provided to
Cedar Brakes I, L.L.C. and will be retained by Cedar Brakes
I, L.L.C. and furnished to the Securities and Exchange
Commission or its staff upon request.
*99.B -- Certification of Chief Financial Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002. A signed original of this
written statement required by sec. 906 has been provided to
Cedar Brakes I, L.L.C. and will be retained by Cedar Brakes
I, L.L.C. and furnished to the Securities and Exchange
Commission or its staff upon request.
</Table>
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Houston, Texas, on March 31, 2003.
CEDAR BRAKES I, L.L.C.
By: /s/ JOHN L. HARRISON
------------------------------------
Name: John L. Harrison
Title: Senior Vice President,
Chief Financial Officer,
Treasurer and Class A
Manager
Pursuant to the requirements of the Securities Act of 1934, as amended,
this report has been signed by the following persons in the capacities and on
the dates indicated:
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ ROBERT W. BAKER President March 31, 2003
------------------------------------------------
Robert W. Baker
/s/ JOHN L. HARRISON Senior Vice President, Chief March 31, 2003
------------------------------------------------ Financial Officer, Treasurer and
John L. Harrison Class A Manager
(Principal Financial Officer)
/s/ BRYAN E. SEAS Vice President and Controller March 31, 2003
------------------------------------------------ (Principal Accounting Officer)
Bryan E. Seas
/s/ KURT REGULSKI Class A Manager March 31, 2003
------------------------------------------------
Kurt Regulski
/s/ JOHN J. O'ROURKE Class A Manager March 31, 2003
------------------------------------------------
John J. O'Rourke
</Table>
30
CERTIFICATION
I, Robert W. Baker, certify that:
1. I have reviewed this annual report on Form 10-K of Cedar Brakes I,
L.L.C.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
/s/ ROBERT W. BAKER
--------------------------------------
Robert W. Baker
President
(Principal Executive Officer)
Cedar Brakes I, L.L.C.
31
CERTIFICATION
I, John L. Harrison, certify that:
1. I have reviewed this annual report on Form 10-K of Cedar Brakes I,
L.L.C.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
/s/ JOHN L. HARRISON
--------------------------------------
John L. Harrison
Senior Vice President,
Chief Financial Officer
(Principal Financial Officer)
Cedar Brakes I, L.L.C.
32
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
3.A -- Certificate of Formation of Cedar Brakes I, L.L.C. dated as
of March 3, 2000 (Exhibit 3.1 to our Form S-4 filed November
28, 2000, Registration No. 333-50828).
3.B -- Amended and Restated Limited Liability Company Agreement of
Cedar Brakes I, L.L.C. dated September 11, 2000 (Exhibit 3.2
to our Form S-4 filed November 28, 2000, Registration No.
333-50828); Amendment No. 1, dated October 19, 2000, to the
Amended & Restated Limited Liability Company Agreement of
Cedar Brakes I, L.L.C. dated September 11, 2000 (Exhibit 3.3
to our Form S-4, Registration No. 333-50828); Amendment No.
2, dated January 19, 2001, to Amended and Restated Limited
Liability Company Agreement of Cedar Brakes I, L.L.C., dated
September 11, 2000 (Exhibit 3.4 to our Form S-4 filed
November 28, 2000, Registration No. 333-50828).
4.A -- Indenture dated as of September 26, 2000 between Cedar
Brakes I, L.L.C. and Bankers Trust Company, as Trustee
(Exhibit 4.1 to our Form S-4 filed November 28, 2000,
Registration No. 333-50828); First Supplemental Indenture
dated as of November 20, 2000 between Cedar Brakes I, L.L.C.
and Bankers Trust Company, as Trustee (Exhibit 4.2 to our
Form S-4 filed November 28, 2000, Registration No.
333-50828); Second Supplemental Indenture dated as of
January 19, 2001, between Cedar Brakes I, L.L.C., and
Bankers Trust Company, as Trustee (Exhibit 4.2(a) to our
Form S-4 filed November 28, 2000, Registration No.
333-50828).
10.A -- Amended and Restated Power Purchase Agreement dated as of
March 21, 2000 between Cedar Brakes I, L.L.C. and Public
Service Electric and Gas Company (Exhibit 10.1 to our Form
S-4 filed November 28, 2000, Registration No. 333-50828).
10.B -- Power Services Agreement dated September 20, 2000 between
Cedar Brakes I, L.L.C. and El Paso Merchant Energy, L.P.
(Exhibit 10.2 to our Form S-4 filed November 28, 2000,
Registration No. 333-50828)
10.C -- Administrative Services Agreement dated as of September 20,
2000 between Cedar Brakes I, L.L.C. and El Paso Merchant
Energy, L.P. (Exhibit 10.3 to our Form S-4 filed November
28, 2000, Registration No. 333-50828)
10.D -- Guaranty dated as of September 20, 2000 from El Paso Energy
Corporation of the performance of El Paso Merchant Energy,
L.P. under the Power Services Agreement (Exhibit 10.2 to our
Form S-4 filed November 28, 2000, Registration No.
333-50828) and the Administrative Services Agreement
(Exhibit 10.3 to our Form S-4, Registration No. 333-50828)
(Exhibit 10.4 to our Form S-4 filed November 28, 2000,
Registration No. 333-50828).
*99.A -- Certification of Principal Executive Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002. A signed original of this
written statement required by sec. 906 has been provided to
Cedar Brakes I, L.L.C. and will be retained by Cedar Brakes
II, L.L.C. and furnished to the Securities and Exchange
Commission or its staff upon request.
*99.B -- Certification of Chief Financial Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002. A signed original of this
written statement required by sec. 906 has been provided to
Cedar Brakes I, L.L.C. and will be retained by Cedar Brakes
I, L.L.C. and furnished to the Securities and Exchange
Commission or its staff upon request.
</Table>