Item 13 - "Certain Relationships and Related Transactions".
OPERATIONS AND MAINTENANCE
Operations And Maintenance Agreements
Each of the Cottage Grove and Whitewater Facilities is operated by Westinghouse Operating Services Company, Inc. ("Westinghouse Services") pursuant to a seven-year operations and maintenance agreement (an "O&M Agreement" and collectively, the "O&M Agreements"). Under each O&M Agreement, Westinghouse Services was required to provide certain services during the pre-operational phase of the related Facility as well as services following commercial operation. As compensation for its services, Westinghouse Services is reimbursed under each O&M Agreement on a monthly basis for certain approved costs incurred in connection with operating the related Facility. In addition, Westinghouse Services (i) received a fixed monthly fee during the pre-operational phase of such Facility and (ii) will receive an annual management fee of $350,000 (subject to adjustment each year based on specified indices published by the United States Bureau of Labor Statistics) during the operational years of such Facility. The Partnerships contract directly with certain subcontractors for materials and services which are outside the scope of Westinghouse Service's obligations under the O&M Agreements, including major maintenance of the Facilities. Westinghouse Services is also subject to an annual performance bonus or penalty payment depending on each Facility's availability relative to certain performance criteria reflecting aspects of similar criteria contained in such Facility's Power Purchase Agreement. Furthermore, Westinghouse Services is subject to a penalty payment depending upon each Facility's ability to produce an uninterrupted supply of thermal energy.
On March 16, 1999, each Partnership exercised an option under its O&M Agreement to terminate the O&M Agreement with Westinghouse Services effective April 15, 1999. In connection with the exercise of such option, Cottage Grove and Whitewater each will make a payment to Westinghouse Services pursuant to its O&M Agreement in an amount approximately equal to $320,000. Each O&M Agreement will be replaced with a similar agreement, in all material respects identical to the applicable O&M Agreement, executed with LSP-Whitewater I, Inc. and LSP-Cottage Grove, Inc. respectively, each of which is an indirect subsidiary of Cogentrix Energy.
Parts Agreements
Cottage Grove and Whitewater each have a parts agreement (a "Parts Agreement" and collectively, the "Parts Agreements") with Westinghouse Electric. Under each Parts Agreement, Westinghouse Electric provides a spare set of certain major combustion turbine parts (including combustors, fuel nozzles, transitions, turbine blades and vanes and various other items), and repairs or replaces specified parts during certain scheduled and unscheduled outages of the related Facility. Pursuant to each Parts Agreement, which expires at the earlier of (i) completion of the first scheduled major inspection of the applicable Facility and (ii) 15 years after provisional acceptance of the related Facility, Westinghouse Electric is paid an annual fee of $976,833 (subject to adjustment each year based on specified indices published by the United States Bureau of Labor Statistics) for 12 years. In addition, Westinghouse Electric provides certain Westinghouse Electric parts at a discount from the list price for the life of the related Facility and repairs certain parts at cost plus a certain percentage markup for the duration of the financing of such Facility.
GREENHOUSE
Whitewater has entered into an operational services agreement (the "Greenhouse Operational Services Agreement") with FloriCulture, an affiliate of Whitewater, which operates the Greenhouse for the benefit of Whitewater.
Under the terms of the Greenhouse Operational Services Agreement, FloriCulture is required to provide all the services necessary to produce, market, and sell horticultural products and to operate and maintain the Greenhouse. As compensation for its services, FloriCulture is reimbursed on a monthly basis for its approved costs in connection with conducting the Greenhouse business and operating the Greenhouse, and will receive an annual management fee equal to 12% of Whitewater's net profit from the operation of the Greenhouse. The term of the Greenhouse Operational Services Agreement will expire on May 31, 2022.
SALE OF CAPACITY AND ELECTRICITY
Cottage Grove
Cottage Grove, as seller, and NSP, as purchaser, have entered into the Cottage Grove Power Purchase Agreement. Under and subject to the terms of the Cottage Grove Power Purchase Agreement, NSP is obligated to purchase all electric capacity made available to it and all associated energy which NSP chooses to dispatch from the Cottage Grove Facility beginning on the Cottage Grove Commercial Operations Date and extending for 30 years thereafter.
Payments by NSP to Cottage Grove under the Cottage Grove Power Purchase Agreement consist of (i) capacity payments and (ii) energy payments. The capacity payments made by NSP are based on the Facility's tested capacity and availability, and have three components: one rate component based on a fixed schedule and two rate components that escalate in accordance with changes in published indices. NSP is required to make capacity payments to Cottage Grove on a monthly basis for electric capacity made available to NSP, regardless of the level of dispatch. Capacity payments from NSP are subject to adjustment on the basis of performance-based factors which reflect the Cottage Grove Facility's semi-annually tested capacity and its rolling 12-month average for availability and on-peak availability. Capacity payments are also adjusted for transmission losses or gains relative to a reference plant (the "Capacity Loss Factor").
Under the Cottage Grove Power Purchase Agreement, NSP has full dispatch discretion over energy delivered by the Cottage Grove Facility subject to certain agreed dispatch parameters. This offers NSP the flexibility to call upon the Cottage Grove Facility to deliver energy when it is the lowest cost unused variable energy source available to NSP. There is no contractual minimum amount of energy that NSP must purchase from Cottage Grove.
Energy payments for energy delivered by the Cottage Grove Facility vary in accordance with a published monthly spot natural gas index or, in case of dispatch in excess of 16 hours per day, with the Cottage Grove Facility's actual fuel costs. The prices that Cottage Grove pays for natural gas pursuant to its gas supply contracts vary in accordance with the same monthly spot natural gas index as the related variable energy rate contained in the Cottage Grove Power Purchase Agreement or, in some circumstances, in accordance with daily spot prices for natural gas. While the gas pricing and gas transportation escalation rates under Cottage Grove's gas supply and transportation agreements are designed to generally track corresponding revenues derived under the Cottage Grove Power Purchase Agreement, there can be no assurance that such pricing components will match corresponding revenue streams under all operating and escalation environments.
Following the 10th anniversary of the Cottage Grove Commercial Operations Date, if NSP fails to obtain or is denied authorization by any governmental authority having jurisdiction over NSP's retail rates and charges, granting it the right to recover from its customers any payments made to Cottage Grove under the Cottage Grove Power Purchase Agreement, any such disallowance will be monitored in a tracking account and the unpaid balance in the tracking account shall accrue interest at 8.7% per annum. Within 30 days after Cottage Grove's First Mortgage Bonds have been fully retired, NSP may begin reducing payments to Cottage Grove to (i) ensure the payments are in-line with Minnesota Public Utility Commission rates and (ii) begin amortizing the balance in the tracking account. Should NSP exercise its right to reduce payments, the maximum reduction is 75% of the capacity payment otherwise due for the period.
Whitewater
Whitewater, as seller, and WEPCO, as Power Purchaser, have entered into the Whitewater Power Purchase Agreement. Under and subject to the terms of the Whitewater Power Purchase Agreement, WEPCO is obligated to purchase the electric capacity made available to it up to 236.5 megawatts and associated energy which WEPCO chooses to dispatch from the Whitewater Facility beginning on the Whitewater Commercial Operations Date and extending for 25 years thereafter.
Payments by WEPCO to Whitewater under the Whitewater Power Purchase Agreement consist of (i) capacity payments and (ii) energy payments. The capacity payments made by WEPCO are based on the Whitewater Facility's tested capacity and availability and
have three rate components: a rate component based on a fixed schedule, a fixed operation and maintenance rate component escalating in accordance with changes in a published index, and a fixed gas transport rate component escalating in a similar manner. WEPCO is required to make capacity payments to Whitewater on a monthly basis for electric generating capacity made available to WEPCO, regardless of the amount of electric energy actually dispatched. Capacity payments from WEPCO are subject to adjustment on the basis of performance-based factors which reflect the Whitewater Facility's semi-annually tested capacity, and average and peak availability factors for the preceding contract year.
Under the Whitewater Power Purchase Agreement, WEPCO has full dispatch discretion over energy to be delivered by the Whitewater Facility subject to certain agreed dispatch parameters. This offers WEPCO the flexibility to call upon the Whitewater Facility to deliver energy when it is the lowest cost unused variable energy source available to WEPCO. There is no contractual minimum amount of energy that WEPCO must purchase from Whitewater.
Energy payments for energy delivered by the Whitewater Facility vary in accordance with a published monthly spot natural gas index or with the Whitewater Facility's actual fuel costs. The prices that Whitewater pays for natural gas pursuant to its gas supply contracts vary in accordance with the same monthly spot natural gas index as the related variable energy rate contained in the Whitewater Power Purchase Agreement or, in some circumstances, in accordance with daily spot prices for natural gas. While the gas pricing and gas transportation escalation rates under Whitewater's gas supply and transportation agreements are designed to generally track corresponding revenues derived under the Whitewater Power Purchase Agreement, there can be no assurance that such pricing components will match corresponding revenue streams under all operating and escalation environments.
The Partnership and WEPCO disagreed on the interpretation of certain provisions in the Whitewater Power Purchase Agreement with respect to the methodology to be used to determine Committed Capacity of the Whitewater Facility, as defined. Effective on February 26, 1998, the Partnership and WEPCO entered into a settlement letter and the Fifth Amendment to the Power Purchase Agreement to resolve various differences in interpretation of the Whitewater Power Purchase Agreement to their mutual satisfaction. Whitewater does not believe that the settlement will have a material impact on the Partnership's results of operations or financial position.
Subject to certain limitations, the capacity payments from WEPCO may be reduced to the extent that WEPCO's senior debt instruments are downgraded by any two of Standard & Poor's Corporation, Moody's Investors Services, Inc. and Duff & Phelps as a result of WEPCO's long term power purchase obligations under the Whitewater Power Purchase Agreement. So long as Whitewater's First Mortgage Bonds are outstanding, the reduction may not exceed the level necessary to cause Whitewater's debt service coverage ratio to be less than 1.4 in any month, with such ratio calculated on a rolling average of the four fiscal quarters immediately preceding the proposed adjustment. After Whitewater's First Mortgage Bonds have been repaid, the reduction may not exceed 50% of Whitewater's revenues minus expenses. The amount of the reductions precluded by application of the above limitations will be monitored in a tracking account and the unpaid balance in the tracking account shall accrue interest at the base or prime lending rate set from time to time by The Chase Manhattan Bank, N.A. or its successor. Accrued tracking account obligations are to be repaid when possible, subject to the limitations described above, or may be applied to WEPCO's purchase of the Whitewater Facility at the expiration of the Whitewater Power Purchase Agreement.
In the event that at any time WEPCO is denied rate recovery from its customers of any payment to be made to Whitewater under the Whitewater Power Purchase Agreement by an applicable regulatory authority, WEPCO's payments to Whitewater may be correspondingly reduced, subject to certain limitations. While Whitewater's First Mortgage Bonds are outstanding, the capacity payments may be reduced by the annual regulatory disallowance provided that the reduction may not cause Whitewater's debt service coverage ratio to be less than 1.4 in any month calculated on a rolling average of the four fiscal quarters preceding the proposed adjustment. After Whitewater's First Mortgage Bonds are repaid, reductions may not exceed 50% of Whitewater's revenues minus expenses. The amount of the reductions precluded by these restrictions is monitored in a tracking account with repayment subject to the same provisions as for bond downgrading adjustments discussed above.
QUALIFYING FACILITY STATUS
The Cottage Grove Facility and the Whitewater Facility are each certified as a QF under PURPA and the regulations of the Federal Energy Regulatory Commission ("FERC") promulgated thereunder. While loss of QF status does not result in a default under either Power Purchase Agreement, it can result in a reduction in payments under the Cottage Grove Power Purchase Agreement to the lower of FERC approved rates or the contract rates, or under the Whitewater Power Purchase Agreement to the lower of FERC approved rates or rates reflecting a five percent discount from the capacity component of the contract rates. Under its respective Power Purchase Agreement, each Partnership may regain full contract rates if it regains QF status that has been lost. In addition, a loss of QF status
will cause the rates and certain organizational and financial affairs of the affected Partnership to become subject to regulation by the FERC, possibly result in both Partnerships to become regulated under the Public Utility Holding Company Act of 1935, as amended ("PUHCA"), and to the extent not preempted by the Federal Power Act, as amended ("FPA"), to become subject to the jurisdiction of the applicable state public utility commission.
THERMAL ENERGY SALES
Cottage Grove
Cottage Grove has a steam supply agreement, as amended, with 3M (the "3M Thermal Energy Agreement"), which provides for Cottage Grove to supply the steam requirements of 3M's manufacturing plant in Cottage Grove, Minnesota. The Cottage Grove Facility is capable of delivering up to 190,000 pounds of steam per hour through its cogeneration process and, alternatively, up to 160,000 pounds of steam per hour in the aggregate through two auxiliary steam generators (the "Auxiliary Boilers") which are used when NSP has not dispatched the Facility or when the cogeneration process is otherwise unavailable. The term of the 3M Thermal Energy Agreement extends for an initial period of 30 years from the date upon which the first deliveries of steam were made, which term may be extended upon terms and conditions mutually satisfactory to Cottage Grove and 3M.
The 3M Thermal Energy Agreement obligates Cottage Grove to supply all of 3M's steam requirements up to a maximum of 664 million pounds of steam annually at a rate not to exceed 190,000 pounds per hour when the Cottage Grove Facility's cogeneration process is operating and 160,000 pounds per hour when the steam is generated by the Auxiliary Boilers (the "Maximum 3M Purchase Amount"). For the first ten years after Cottage Grove commences steam delivery to 3M, 3M must take and use, at a minimum, the amount of steam necessary to maintain the Cottage Grove Facility's status as a QF (the "Minimum 3M Purchase Amount"). Thereafter, if 3M takes less than the Minimum 3M Purchase Amount, Cottage Grove may reduce the Maximum 3M Purchase Amount and sell steam in excess of such reduction to other steam purchasers. In the event Cottage Grove delivers steam which does not conform to the specifications in the 3M Thermal Energy Agreement, Cottage Grove must discontinue such delivery (unless otherwise requested by 3M) and, at its own expense, take prompt action to correct such non-conformance. The 3M Thermal Energy Agreement also provides that 3M is obligated to return the condensate to the Cottage Grove Facility, supply a quantity of cooling and potable water sufficient to satisfy the requirements of the Cottage Grove Facility and, to the extent consistent with certain governmental permits and regulations, accept the Cottage Grove Facility's wastewater and sanitary wastewater into 3M's existing discharge systems. 3M has the right to reduce the water supply to the Facility in the event that it cannot satisfy both its own and Cottage Grove's requirements; however, Cottage Grove has drilled a back-up well as a reserve in the event of any shortfalls in water supply from 3M.
Cottage Grove is obligated to supply steam to 3M on a non-interruptible basis, except during periods of force majeure, emergency conditions affecting the Cottage Grove Facility and periods when 3M is unable to accept steam due to repair or maintenance of its manufacturing plant. In the event of any failure to supply steam to 3M, other than as a result of force majeure or the acts or omissions of 3M, Cottage Grove must reimburse 3M for its incremental costs.
Whitewater
University of Wisconsin-Whitewater -- Whitewater has a steam supply agreement with the Department of Administration of the State of Wisconsin ("DOA"), which provides for Whitewater to supply the steam requirements of UWW (the "UWW Thermal Energy Agreement"). The initial term of the UWW Thermal Energy Agreement expires June 30, 2005 (the "UWW Initial Term"). The DOA has the option to extend the UWW Initial Term for up to four extension periods of four years each.
The UWW Thermal Energy Agreement obligates Whitewater to supply all of UWW's steam requirements up to a maximum of 350 million pounds of steam annually at a rate not to exceed 100,000 pounds per hour (the "Maximum UWW Purchase Amount"). The DOA may also request, and Whitewater must use reasonable efforts to supply, steam in excess of the Maximum UWW Purchase Amount. The DOA is not obligated to take any minimum annual or hourly quantity of steam. In the event Whitewater delivers steam that does not conform to the specifications set forth in the UWW Thermal Energy Agreement, Whitewater must discontinue such delivery (unless otherwise requested by the DOA) and, at its own cost, take prompt action to correct such non-conformance.
Whitewater has agreed to reimburse the DOA for costs up to $500,000 incurred to repair and recondition one of UWW's existing steam boilers for use as a back-up boiler and to modify the operations of the UWW heating plant where its boilers are located. As of December 31, 1998, Whitewater has reimbursed the DOA approximately $280,000 for the repair of UWW's steam boiler. Whitewater has also agreed to pay the annual costs to maintain the back up boiler in a standby mode.
Whitewater is obligated to supply steam to UWW on a non-interruptible basis, except during periods of force majeure, emergency conditions affecting the Whitewater Facility and periods when UWW is unable to accept steam due to necessary repair or maintenance to the UWW steam piping system. In the event of any failure to supply UWW, other than as a result of force majeure or the acts or omissions of UWW, Whitewater must reimburse UWW for its incremental costs.
Greenhouse -- Under the terms of the Greenhouse Operational Services Agreement with FloriCulture, Whitewater will supply the hot water requirements of the Greenhouse. See "Operations and Maintenance; Greenhouse".
GAS SUPPLY
Each of Cottage Grove and Whitewater has entered into gas supply contracts with substantially identical terms, with the exception of the volume of gas required to be delivered under the contracts. This difference is primarily a result of varying contractual requirements in the Power Purchase Agreements. Specifically, each Partnership has entered into (i) a gas sales contract with Dynegy, as amended (the "Dynegy Gas Supply Contracts"), and (ii) a gas sales contract with Aquila, as amended (the "Aquila Gas Supply Contracts," and together with the Dynegy Gas Supply Contracts, the "Gas Supply Contracts") to collectively service 100% of the expected gas requirements of its Facility.
The Aquila Gas Supply Contracts and the Dynegy Gas Supply Contracts each provide for the sale of up to 17,060 MMBtu per day of gas to Cottage Grove and up to 11,855 MMBtu per day of gas to Whitewater. Under the Gas Supply Contracts, except during periods of force majeure or default by a Partnership, Dynegy and Aquila (together, the "Gas Suppliers") are required to supply on a firm basis to the point of demarcation between the field zone and the market zone of Northern Natural (the "Demarcation Point"), all gas properly nominated by each Partnership. If a Gas Supplier fails to deliver properly nominated gas to the Demarcation Point for any reason other than force majeure or a Partnership's failure to pay for past deliveries, Cottage Grove or Whitewater, as the case may be, has the right to buy replacement gas (or fuel oil) from other sources and charge the applicable Gas Supplier for the direct increased cost (including transportation charges), if any, of using such gas or fuel oil.
Under the Gas Supply Contracts, there are three categories of gas, Tier I Gas, Tier II Gas, and Tier III Gas. Tier I Gas is "baseload" gas, nominated prior to the commencement of each month at a set volume for such month. Tier II Gas is "TOK-swing" gas, nominated prior to the commencement of each month at a set volume with the ability to reduce daily volumes to reflect daily swings in gas needs at the Facilities. Tier III Gas is "spot-swing" gas, nominated on a monthly basis (in the case of Aquila) and daily basis (in the case of both Dynegy and Aquila) to fulfill daily swings in Facility requirements not met by Tier I Gas and/or Tier II Gas.
The price for Tier I Gas is equal to a published price for first-of-the-month spot natural gas delivered to Northern Natural in Texas, Oklahoma and Kansas (the "TOK Price"), plus a percentage fee. The price for Tier II Gas is equal to the TOK Price plus a reservation fee payable on all Tier II volumes nominated, regardless of whether such volumes are actually purchased by such Partnership. The price for Tier III Gas is calculated on a daily cost basis, which could vary above or below the first-of-the-month TOK Price. The TOK Price, or, in some circumstances, actual fuel cost is used as the basis for the price payable for variable energy under the Power Purchase Agreements.
Under the Gas Supply Contracts, the Partnerships are subject to an annual minimum take requirement for Tier I Gas equal to 40% of the annualized maximum quantity. Under the Dynegy Gas Supply Contracts, one-half of Tier II Gas quantities delivered may be applied to reduce the minimum take requirement. The Partnerships may satisfy the minimum take requirements by delivering gas to the Facilities, taking gas into storage or by remarketing gas to third parties. In the event of two consecutive annual minimum take shortfalls, Aquila has the right to reduce the volumes deliverable under the applicable Aquila Gas Supply Contract. On a monthly basis, Whitewater and Cottage Grove are required to take all Tier I Gas nominated for such month, make other arrangements for the disposition thereof, or pay certain penalties.
The primary term of each Gas Supply Contract is 20 years beginning with the Commercial Operations Date of the respective Facility. Following the end of the primary term, the Dynegy Gas Supply Contracts may be extended at the applicable Partnership's option for an additional five-year term. The Aquila Gas Supply Contracts extend beyond the primary term on a year-to-year basis, unless affirmatively terminated by one of the parties thereto.
The Gas Supply Contracts may be terminated prior to expiration in the event the corresponding Power Purchase Agreement is terminated without replacement or upon the occurrence of certain events of default. Events of default include bankruptcy or insolvency proceedings, legal process against the contract itself, false representations or warranties, unexcused failure to deliver gas, continued failure to pay for gas after suspension of deliveries by the applicable Gas Supplier or any other continued material breach.
GAS TRANSPORTATION
Cottage Grove
Cottage Grove has various gas transportation agreements with Northern Natural (collectively, the "Cottage Grove Northern Transportation Agreements") pursuant to an agreement among Cottage Grove, Northern Natural and Peoples (the "Cottage Grove Letter Agreement"). The Cottage Grove Letter Agreement and the Cottage Grove Northern Transportation Agreements (the "Cottage Grove Northern Agreements") have a term of 20 years, subject to a 10-year option to renew by Cottage Grove, and set forth the terms and conditions under which Northern Natural agrees to transport on both a firm and interruptible basis the gas purchased by Cottage Grove pursuant to the Cottage Grove Gas Supply Contracts. Under the Cottage Grove Northern Agreements, gas is transported from Northern Natural's field zone to the Demarcation Point on an interruptible basis, and from the Demarcation Point to the interconnection of the facilities of Northern Natural and Peoples (the "Cottage Grove TBS") on a firm basis. Subject to certain restrictions (including minimum and maximum injection and withdrawal rates), the Cottage Grove Northern Agreements also provide firm storage service at Northern Natural's gas storage facility in the market zone of an aggregate volume of gas sufficient to supply the Cottage Grove Facility for approximately 29 days.
Cottage Grove also has an agreement with Peoples that provides for the transportation from the Cottage Grove TBS to the Cottage Grove Facility of 29,120 MMBtu per day on a firm basis and excess gas required by the Cottage Grove Facility on an interruptible basis (the "Peoples Agreement", and together with the Cottage Grove Northern Agreements, the "Cottage Grove Transportation Agreements").
Under the Cottage Grove Letter Agreement, Peoples has agreed to release to Cottage Grove 34,120 MMBtu/day of firm capacity it currently holds on Northern Natural's system for gas transportation under the Cottage Grove Transportation Agreements from the Demarcation Point to the Cottage Grove TBS. Northern Natural has agreed to construct, maintain and own at its expense the Cottage Grove TBS and other facilities necessary to effectuate the services described above. In order to secure its payment obligations under the Cottage Grove Letter Agreement, if the rating on the Senior Secured Bonds falls below investment grade, Cottage Grove will be required to obtain a guarantee or a letter of credit from an investment grade entity.
The Peoples Agreement provided for the construction of an approximately one mile long pipeline at Peoples' expense from the Cottage Grove TBS to the Cottage Grove Facility. The agreement designates Peoples as Cottage Grove's agent with respect to nominations on Northern Natural's system and requires Peoples to deliver gas, if available, to Cottage Grove in case of a failure of any of Cottage Grove's supplies under the Cottage Grove Gas Supply Contracts. In addition, the Peoples Agreement provides various balancing services which augment the balancing rights held by Cottage Grove under the Cottage Grove Northern Agreements. For up to 20 days of each "heating period" (i.e., an interval beginning December 1 and extending to the end of the following February) Peoples has the option to retain the gas destined for the Cottage Grove Facility for its own use, subject to proper notice and the reimbursement of Cottage Grove for replacement fuel costs. In consideration for such option, Cottage Grove receives a monthly payment of $116,480 during the heating period. In addition, on any day during each heating period on which Cottage Grove nominates a quantity of gas and transportation from the Gas Suppliers and Northern Natural less than 29,120 MMBtu, Peoples may require Cottage Grove to nominate and deliver to Peoples the difference between the quantities actually nominated and 29,120 MMBtu, subject to compliance with Northern Natural's tariffs, agreement between Peoples and NSP and payment to Cottage Grove of its actual cost of gas and gas transportation with respect to such differential quantities.
Whitewater
Whitewater has various gas transportation agreements with Northern Natural (collectively, the "Whitewater Northern Agreements"). The Whitewater Northern Agreements have a term of 20 years, with a 10-year option to renew by Whitewater, and set forth the terms and conditions under which Northern Natural agrees to transport, on both a firm and interruptible basis, the gas purchased by Whitewater pursuant to the Whitewater Gas Supply Contracts. Under the Whitewater Northern Agreements, gas will be transported from Northern Natural's field zone to the Demarcation Point on an interruptible basis, and from the Demarcation Point to the interconnection of the facilities of Northern Natural and WNG (the "Whitewater TBS") on a firm basis. Subject to certain restrictions (including the minimum and maximum injection and withdrawal rates), the Whitewater Northern Agreements also provide for firm storage service at Northern Natural's gas storage facility in the market zone of an aggregate volume of gas sufficient to supply the Whitewater Facility for approximately 21 days. Finally, the Whitewater Northern Agreements provide for interruptible storage service at Northern Natural's gas storage facility in the market area, subject to its availability.
Under the Whitewater Northern Agreements, Northern Natural agrees to provide 30,400 MMBtu/day of firm capacity for the transportation of gas from the Demarcation Point to the Whitewater TBS. Northern Natural has also agreed to construct, maintain and own the Whitewater TBS and other facilities necessary to effectuate the services described above. As a contribution toward the cost of these facilities, Whitewater has made a payment to Northern Natural of $2,500,000. In order to secure its payment obligations under the Whitewater Northern Agreements, if the rating on the Senior Secured Bonds falls below investment grade, Whitewater will be required to obtain a guarantee or a letter of credit from an investment grade entity.
Whitewater also has an agreement with WNG which provides for the transportation of all gas required by the Whitewater Facility from the Whitewater TBS to the Whitewater Facility (the "WNG Agreement", and together with the Whitewater Northern Agreements, the "Whitewater Transportation Agreements"). The WNG Agreement provided for the construction of an approximately five mile long pipeline from the Whitewater TBS to the Whitewater site. Whitewater paid approximately $1,328,000 for the construction of the pipeline. The WNG Agreement extends for an initial term of 25 years (with two optional five-year extensions), and provides for the firm transport of the daily and hourly gas requirements of the Whitewater Facility.
Whitewater has an agreement, as amended, with Wisconsin Power & Light Company ("WP&L") which provides WP&L with the ability to purchase a portion of Whitewater's daily gas supply and interstate transportation capacity in return for the payment of a monthly fee to Whitewater and reimbursement of Whitewater's incremental costs (the "WP&L Agreement"). The WP&L Agreement permits WP&L to purchase from Whitewater up to 15,000 MMBtu/day of gas and up to 10,400 MMBtu/day of interstate transportation capacity, not to exceed in the aggregate 508,000 MMBtu/year of combined gas and transportation capacity. In consideration therefor, WP&L pays Whitewater a monthly fee of $58,500 and the incremental costs incurred for replacement gas or fuel oil, including transportation. The term of the WP&L Agreement commenced in 1997 and continues for three years, with an option in favor of WP&L to extend the term for an additional three years.
DEPENDENCE ON THIRD PARTIES
Each Partnership is highly dependent on a single utility for purchases of electric generating capacity and energy from its respective Facility, a single operator to perform the operation and maintenance of its respective Facility and, in the case of the Cottage Grove Facility, a single steam purchaser for purchases of thermal energy. In addition, each Partnership has contracted with only two gas companies, Aquila and Dynegy, to supply the gas requirements of the Facilities, and has contracted with a single interstate gas transporter, Northern Natural, to transport gas. Any material breach by any one of these parties of their respective obligations to either Partnership could affect the ability of the applicable Partnership to make payments under its First Mortgage Bonds and consequently Funding's ability to make payments on the Senior Secured Bonds. In addition, bankruptcy or insolvency of certain other parties or defaults by such parties relative to their contractual or regulatory obligations could adversely affect the ability of a Partnership to make payments to Funding with respect to such Partnership's First Mortgage Bonds and consequently Funding's ability to make payments on the Senior Secured Bonds. If a project agreement were to be terminated due to a breach of such project agreement, the affected Partnership's ability to enter into a substitute agreement having substantially equivalent terms and conditions, or with an equally creditworthy third party, is uncertain.
THE INDEPENDENT POWER MARKET
Utilities in the United States have been the predominant producers of electric power intended primarily for sale to third parties since the early 1900s; however, the enactment of PURPA removed certain regulatory constraints relating to the production and sale of electric energy by certain non-utility power producers and required electric utilities to buy electricity from certain types of non-utility power producers under certain conditions, thereby encouraging companies other than electric utilities to enter the electric power production market. As a result, a market for electric power produced by independent power producers unaffiliated with utilities such as the Partnerships has developed in the United States since the enactment of PURPA.
The Energy Policy Act of 1992 (the "Policy Act") expands certain exemptions previously available only under PURPA and provides for the ability of independent power producers to compete in a non-regulated fashion without having to qualify as QFs under PURPA. In addition, over the last several years, various state utility commissions have opened the electrical generation and sales market to competition not only from QFs but to non-QF independent power producers and competitive proposals from other utilities and power marketers. These developments have generally required that independent power projects must now be viewed as "least-cost" with such a showing being demonstrated through a competitive procurement process, such as those which resulted in the selection of the Cottage Grove Facility and Whitewater Facility.
REGULATION
General
The Partnerships are required to comply with numerous Federal, state and local statutory and regulatory standards and obtain and maintain numerous permits and approvals relating to energy, the environment and other laws required for the operation of the Facilities. The permits and regulatory approvals that have been issued to the Partnerships contain certain conditions. There can be no assurance that either Facility will continue to operate in accordance with the conditions established by the permits or approvals or that the Partnerships or third parties will be able to obtain any outstanding permits required for the operation of the Facilities. Laws and regulations affecting Funding, the Partnerships and the Facilities may change during the period in which the Senior Secured Bonds are scheduled to be outstanding, and such changes could adversely affect Funding or the Partnerships. For example, changes in laws or regulations (including but not limited to environmental laws and regulations) could impose more stringent or comprehensive requirements on the operation or maintenance of the Facilities, resulting in increased compliance costs or the reduction of certain benefits currently available to the Partnerships, or could expose Funding or the Partnerships to liabilities for previous actions taken in compliance with all laws in effect at the time or for actions taken by or conditions caused by unrelated third parties.
PURPA
PURPA and the regulations promulgated thereunder by FERC provide an electric generating facility with rate and regulatory incentives if the facility is a QF. Under PURPA, a topping-cycle cogeneration facility is a QF if (i) the facility sequentially produces both electricity and a useful thermal energy output during any calendar year (and the first 12 months of operation) which constitutes at least five percent of its total energy output and which is used for industrial, commercial, heating or cooling purposes, (ii) during any calendar year (and the first 12 months of operation) the sum of the useful power output of the facility plus one-half of its useful thermal energy output equals or exceeds 42.5 percent of the total energy input of natural gas and oil, or, in the event that the facility's useful thermal energy output is less than 15 percent of the facility's total energy output, such sum equals or exceeds 45 percent of such total energy input and (iii) the facility is not owned by a person primarily engaged in the generation or sale of electric energy (other than from QFs, other types of exempt facilities and power marketers) or more than 50 percent owned by an electric utility, electric utility holding company, or a wholly or partially owned subsidiary of an electric utility or an electric utility holding company. PURPA and the regulations promulgated thereunder exempt QFs from PUHCA, most provisions of the FPA and certain state laws relating to rates, and the financial and organizational regulation of electric utilities.
The Partnerships expect the Facilities to continue to meet all of the criteria required for designation as QFs under PURPA. If either Facility were to fail to meet such criteria, the related Partnership may become subject to regulation under PUHCA, the FPA and state utility laws. Furthermore, as a result of the loss of QF status on one Facility, and the possible creation of a holding company, the other Facility may lose its QF status due to a violation of PURPA's ownership restrictions.
PUHCA
PUHCA provides that any corporation, partnership or other entity, or organized group of persons which owns, controls or holds with power to vote 10 percent or more of the outstanding voting securities, or controlling influence over the management, of a "public utility company" or a company which is a "holding company" of a "public utility company" is subject to registration with the United States Securities and Exchange Commission (the "Commission") and regulation under PUHCA, unless eligible for an exemption or unless a Commission order declaring it not to be a holding company is issued. PUHCA requires registration for a holding company of a public utility company, and requires a public utility holding company to limit its utility operations to a single integrated utility system and to divest any other operations not functionally related to the operation of the utility system. In addition, a public utility company which is a subsidiary of a registered holding company under PUHCA is subject to financial, organizational and rate regulation, including approval by the Commission of its financing transactions.
The Policy Act contains amendments to PUHCA which may allow the Partnerships to operate their businesses without becoming subject to PUHCA in the event that either Facility loses its status as a QF. Under the Policy Act, a company engaged exclusively in the business of owning and/or operating one or more facilities used for the generation of electric energy exclusively for sale at wholesale may be exempted from PUHCA. In order to qualify for such an exemption, a company must apply to the FERC for a determination of eligibility, pursuant to implementing rules promulgated by the FERC. Both Whitewater and Cottage Grove were granted exempt wholesale generator status by the FERC on October 17, 1996. Notwithstanding this exemption, in the event that QF status is revoked, the applicable Partnership would be subject to regulation under the FPA and the capacity and energy rates, as described below, would have to be approved by FERC.
FPA
Under the FPA, the FERC has exclusive rate-making jurisdiction over wholesale sales of electricity and transmission in interstate commerce. These rates may be based on a cost-of-service approach or a market-based approach. If a Facility were to lose its QF status, the rates set forth in each of the Power Purchase Agreements would have to be filed with FERC and would be subject to review and acceptance by the FERC under the FPA. The Whitewater Power Purchase Agreement provides for a reduction in capacity payment rates in such event to the lower of a five percent discount from the contract rates, or FERC approved rates. The Cottage Grove Power Purchase Agreement provides for Cottage Grove to receive the lower of FERC approved rates or the contract rates.
The FPA, and the FERC's authority thereunder, also subject public utilities to various other requirements, including accounting and record-keeping requirements, FERC approval requirements applicable to activities such as selling, leasing or otherwise disposing of certain facilities, FERC approval requirements for mergers, consolidations, acquisitions, the issuance of securities and assumption of liabilities, and certain restrictions regarding interlocking directorates. Upon a loss of QF status, the affected Partnership would become subject to such requirements and although it could make application for specific waivers, there is no assurance such application would be approved.
State Regulation
If the Whitewater Facility loses its QF status, it would, absent a successful request for exemption, become subject to a wide range of Wisconsin statutes and regulations applicable to Wisconsin public utilities, including the requirement of the approval by the Wisconsin Public Service Commission (the "Wisconsin PSC") for the issuance of securities and the need to file periodic detailed information on financial and organizational matters.
The rates charged to Whitewater under the WNG Agreement are subject to approval by the Wisconsin PSC. The criteria for approval by the Wisconsin PSC is related to its determination that such rates are compensatory. If the rates are determined by the Wisconsin PSC to be non-compensatory, and the Wisconsin PSC requires WNG to increase the rates, Whitewater shall be subject to such increased rates.
Wisconsin law prohibits the granting or transfer of any licenses, permits and franchises to own or operate equipment to produce light, heat or power to any foreign corporation. Local counsel does not believe that the Wisconsin law applies to Whitewater. However, if it is determined that this prohibition does apply, Whitewater's Certificate of Public Convenience and Necessity ("CPCN") could be determined to be invalid. If this were to occur, Whitewater's ability to repay the Whitewater First Mortgage Bonds, and Funding's ability to repay the Senior Secured Bonds, could be materially delayed or impaired.
Gas Supply And Transportation
The gas transportation agreements serving each Facility are subject in various respects to the regulatory authority of governmental entities having jurisdiction, including but not limited to (i) for Cottage Grove, the Minnesota Environmental Quality Board ("MEQB"), the Minnesota Department of Natural Resources, the Minnesota Public Utilities Commission and the FERC and (ii) for Whitewater, the Wisconsin Department of Natural Resources, the Wisconsin PSC and the FERC.
There can be no assurance that changes in regulatory rules or oversight by such agencies would not adversely affect the economics of Cottage Grove and Whitewater or their access to gas supplies. Similarly, modifications to tariff provisions could result in a disallowance of any price discounts existing under the transportation agreements.
ENVIRONMENTAL MATTERS
The construction and operation of power projects are subject to extensive environmental protection and land use regulation in the United States. Those regulations applicable to the Partnerships primarily involve the discharge of emissions into the water and air and the use of water, but can also include wetlands preservation, endangered species, waste disposal and noise regulation. These laws and regulations often require a lengthy and complex process of obtaining and renewing licenses, permits and approvals from federal, state and local agencies. If such laws and regulations are changed and the Facilities are not grandfathered, extensive modifications to power project technologies and the Facilities could be required.
Although a number of major environmental statutes are scheduled for reauthorization, the Partnerships expect that environmental regulations will continue to become more stringent as environmental regulations previously passed become implemented. Accordingly, the Partnerships plan to continue a strong emphasis on implementation of environmental standards and procedures at the Facilities to minimize the environmental impact of energy generation.
CLEAN AIR ACT. In late 1990, Congress passed the Clean Air Act Amendments of 1990 (the "1990 Amendments") which affect existing facilities as well as new project development. The original Clean Air Act of 1970 set guidelines for emissions standards for major pollutants from newly-built sources. The Facilities perform at levels better than federal performance standards mandated for such facilities under the Clean Air Act. The 1990 Amendments attempt to reduce emissions from existing sources -- particularly large older facilities that were exempted from certain regulations under the original Clean Air Act.
The 1990 Amendments create a marketable commodity called a sulfur dioxide ("SO(2)") "allowance." All non-exempt facilities over 25 megawatts that emit SO(2), including independent power plants, must obtain allowances in order to operate after 1999. Each allowance gives the owner the right to emit one ton of SO(2). The Facilities have determined their need for allowances and have accounted for these requirements in their operating budgets and financial forecasts.
The 1990 Amendments also require states to impose annual operating permit fees. Such fees are not expected to significantly increase the costs at the Facilities.
The 1990 Amendments also contain other provisions that could affect the Facilities. Provisions dealing with geographical areas the EPA has designated as in "nonattainment" with national ambient air quality standards require that existing sources of air pollutants in a nonattainment area be retrofit with reasonably available control technology ("RACT") for all pollutants for which an area is designated nonattainment. The technology currently installed at the Facilities should uniformly meet or exceed RACT for those pollutants.
The 1990 Amendments also provide an extensive new operating permit program for existing sources called the Title V permitting program. Because the Facilities were permitted under the Prevention of Significant Deterioration New Source Review Process, the permitting impact to the Partnerships under the 1990 Amendments at the Facilities is expected to be minimal. The costs of applying for and obtaining operating air permits are not anticipated to be significant.
The hazardous air pollutant provisions of the 1990 Amendments presently exclude electric steam generating facilities, such as the Facilities. Three studies of the emissions from such facilities are, however, in progress. Until all of these studies are completed and Congress either amends the Clean Air Act further or the EPA promulgates regulations, the federal hazardous air pollutants emissions restrictions, which will be applied to the Facilities and other electric steam generating facilities, will remain uncertain.
In July 1997, the EPA promulgated more restrictive ambient air quality standards for ozone and particulate matter: less than 25 microns in diameter -- PM-2.5. These new standards will likely increase the number of nonattainment areas for both ozone and PM-2.5. If the Facilities are in these new nonattainment areas, further emission reduction requirements could result in the installation of additional control technology.
In addition, the Ozone Transport Assessment Group ("OTAG"), composed of state and local air regulatory officials from the 37 eastern states, has recommended additional NO(x) emission reductions that go beyond current federal standards. These recommendations include reductions from utility and industrial boilers. In the fall of 1998, the EPA adopted regulations requiring revisions to state implementation plans ("SIPs"). These regulations implement some of the OTAG's recommendations and go beyond some of the OTAG's recommendations for reductions in NO(x) emissions. The Facilities are not expected to be subject to these regulations.
The 1990 Amendments expand the enforcement authority of the federal government by increasing the range of civil and criminal penalties for violations of the Clean Air Act, enhancing administrative civil penalties, and adding a citizen suit provision. These enforcement provisions also include enhanced monitoring, recordkeeping and reporting requirements for existing and new facilities. On February 13, 1997, the EPA issued a regulation providing for the use of "any credible evidence or information" in lieu of, or in addition to, the test methods prescribed by regulation to determine the compliance status of permitted sources of air pollution. This
rule may effectively make emission limits previously established for many air pollution sources, including the Facilities, more stringent.
The Kyoto Protocol regarding greenhouse gas emissions and global warming was signed by the U.S., committing to significant reductions in greenhouse gas emissions. The U.S. Senate must ratify the agreement for the protocol to take effect. The Clinton Administration has proposed a package of legislative and administrative policies to curb greenhouse gases, none of which are affected by the need for Senate ratification. Management believes that none of these policies will have a material effect on the results of operations or financial position of the Partnerships. Future initiatives on this issue and the effects on the Partnerships are unknown at this time.
CLEAN WATER ACT. The Facilities are subject to a variety of state and federal regulations governing existing and potential water/wastewater and stormwater discharges from the Facilities. Generally, federal regulations promulgated through the Clean Water Act govern overall water/wastewater and stormwater discharges through National Pollutant Discharge Elimination System permits. Under current provisions of the Clean Water Act, existing permits must be renewed every five years, at which time permit limits are under extensive review and can be modified to account for more stringent regulations. In addition, the permits have re-opener clauses which can be used to modify a permit at anytime. The Facilities have either recently gone through permit renewal or will be renewed within the next few years. Based upon recent renewals, the Partnerships do not anticipate more stringent monitoring requirements for the Facilities.
The Whitewater site boundary is situated approximately one quarter of a mile away from a landfill under which groundwater contamination has been discovered. To the extent that such contamination has reached or reaches the Whitewater Facility site, there is a possibility that Whitewater would be responsible for the costs of remediating such contamination from off-site sources that is subsequently identified at the site.
EMERGENCY PLANNING AND COMMUNITY RIGHT-TO-KNOW ACT. In April of 1997, the EPA expanded the list of industry groups required to report the Toxic Release Inventory under Section 313 of the Emergency Planning and Community Right-to-Know Act to include electric utilities. If oil is burned at all, the Facilities will be required to complete a toxic chemical inventory release form for each listed toxic chemical manufactured, processed or otherwise used in excess of threshold levels for the 1998 reporting year. The purpose of this requirement is to inform the EPA, states, localities and the public about releases of toxic chemicals to the air, water and land that can pose a threat to the community.
COMPETITION
The demand for power in the United States traditionally has been met by utility construction of large-scale electric generation projects under rate-base regulation. PURPA removed certain regulatory constraints relating to the production and sale of electric energy by eligible non-utilities and required electric utilities to buy electricity from various types of non-utility power producers under certain conditions, thereby encouraging companies other than electric utilities to enter the electric power production market. Concurrently, there has been a decline in the construction of large generating plants by electric utilities. In addition to independent power producers, subsidiaries of fuel supply companies, engineering companies, equipment manufacturers and other industrial companies, as well as subsidiaries of a number of regulated utilities, have entered the power market. Because the Partnerships have long-term contracts to sell electric generating capacity and energy from the Facilities, it is not expected that competitive forces will have a significant effect on the businesses of the Partnerships. Nevertheless, each of the Power Purchase Agreements permits the purchasing utility to schedule the respective Facility for dispatch on an economic basis, which takes into account the variable cost of electricity to be delivered by the Facility compared to the variable cost of electricity available to the purchasing utility from other sources. Accordingly, competitive forces may have some effect on the dispatch levels of the Facilities.
The FERC and numerous state utility regulatory commissions have continued to pursue proceedings to deregulate the generation and sale of electricity. In several states, including Wisconsin and Minnesota, commissions have initiated proceedings to examine or develop methods for making the retail sale of electricity competitive. These proceedings remain at early stages in Wisconsin and Minnesota, and the potential impact of these proceedings on the Partnerships is unknown at this time.
EMPLOYEES
Funding and the Partnerships have no employees and do not anticipate having any employees in the future. Each Partnership and each General Partner has a management services agreement which provides for Cogentrix Energy to perform management services for each Partnership and each General Partner. See Part III, Item 13 - "Certain Relationships and Related Transactions". In addition, each of the Cottage Grove and Whitewater Facilities has been operated to date by Westinghouse Services pursuant to the O&M Agreements. Cogentrix Energy has recently caused each Partnership to exercise its option under its O&M Agreement to terminate the O&M Agreement with Westinghouse Services effective April 15, 1999. The O&M Agreements will be replaced with similar agreements executed with indirect subsidiaries of Cogentrix Energy. See Part I, Item 1 - "Operations and Maintenance".
PART I/ITEM 2. PROPERTIES
COTTAGE GROVE
Cottage Grove owns a 13 acre tract of land located in the City of Cottage Grove, Washington County, Minnesota, on which the Cottage Grove Facility was constructed.
WHITEWATER
Whitewater owns a 35 acre tract of land located in the City of Whitewater, Wisconsin on which the Whitewater Facility and the substation for the Facility were constructed (the "Whitewater Site"). Whitewater also owns a 93 acre tract of land, adjacent to the Whitewater Site and located in the City of Whitewater, Wisconsin, on which the Greenhouse was constructed.
PART I/ITEM 3. LEGAL PROCEEDINGS
Funding, Whitewater and Cottage Grove experience routine litigation in the normal course of business. Management is of the opinion that none of this routine litigation will have a material adverse impact on the financial position or results of operations of Funding, Whitewater or Cottage Grove.
PART I/ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II/ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public market for Funding's common stock. Funding has 100 issued and outstanding shares of common stock, $0.01 par value per share, 50 of which shares are owned by each Partnership. All of the equity interests in the Partnerships are held by the partners of the Partnerships and, therefore, there is no established public market for the equity interests in the Partnerships.
PART II/ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data have been taken from the audited financial statements of Funding, Cottage Grove and Whitewater. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" under Part II, Item 7 and the financial statements and related notes included under Part II, Item 8.
Funding was organized on June 23, 1995, and the Partnerships were formed on December 14, 1993. Since their formation in 1993 through September 18, 1997 and October 1, 1997 for Whitewater and Cottage Grove, respectively, the Partnerships were developing and constructing their respective Facilities and had recognized no operating revenues or expenses.
STATEMENT OF INCOME DATA (dollars in thousands):
BALANCE SHEET DATA (dollars in thousands):
PART II/ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Whitewater Facility commenced commercial operations on September 18, 1997, and the Cottage Grove Facility commenced commercial operations on October 1, 1997. The Whitewater and Cottage Grove Power Purchase Agreements described in Part I/Item 1 - "Sale of Capacity and Electricity" meet the criteria of a "sales-type" capital lease as described in Statement of Financial Accounting Standards (SFAS) No. 13, "Accounting for Leases". Cottage Grove and Whitewater each recognized a gain on sales-type capital lease for the difference between the estimated fair market value and the historical cost of the Facilities as of the commencement of the respective Power Purchase Agreement terms (commencement of commercial operations). The Partnerships each recorded a net investment in lease that reflects the present value of future minimum lease payments. Future minimum lease payments represent the amount of capacity payments due from the utilities under the Power Purchase Agreements in excess of fixed operating costs (i.e. executory costs). The difference between the undiscounted future minimum lease payments due from the utilities and the net investment in lease represents unearned income. This unearned income will be recognized as lease revenue over the term of the Power Purchase Agreements using the effective interest rate method. The Partnerships will also recognize service revenue related to the reimbursement of costs incurred in operating the Facilities and providing electricity and thermal energy. The amount of service revenue recognized by each Partnership will be directly related to the level of dispatch of the Facilities by the utility and to a lesser extent the level of thermal energy required by the steam hosts.
RESULTS OF OPERATIONS - 1998
Whitewater
The Whitewater Power Purchase Agreement term commenced September 18, 1997. Prior to September 18, 1997, Whitewater recognized no revenues or expenses.
Revenues for the year ended December 31, 1998 were approximately $51.3 million as compared to $13.3 million for the year ended December 31, 1997. The increase is attributable to the Whitewater Facility being in operation for a full 12 months for the year ended December 31, 1998, as compared to only approximately 3 months in the year ended December 31, 1997. Revenues at December 31, 1998 and 1997 consisted primarily of lease revenue of approximately $23.4 million and $6.6 million respectively, and service revenue of approximately $25.0 million and $5.9 million, respectively.
Operating expenses were approximately $29.3 million for the year ended December 31, 1998 as compared to approximately $7.7 million for the year ended December 31, 1997 . The increase is attributable to the Whitewater Facility being in operation for a full 12 months for the year ended December 31, 1998, as compared to only approximately 3 months in the year ended December 31, 1997. Operating expenses at December 31, 1998 and 1997 consisted primarily of cost of services related to operating the Facility of approximately $27.5 million and $6.9 million, respectively. Operating expenses also included approximately $1.8 million and $0.8 million of expenses related to operating the Greenhouse for the years ended December 31, 1998 and 1997, respectively.
Whitewater recognized a gain on sales-type capital lease described above of approximately $97.0 million during the year ended December 31, 1997. This gain represented the difference between the estimated fair market value of the Facility of approximately $261.7 million and the historical cost of the Facility of approximately $164.7 million.
Interest expense of approximately $14.1 million for the year ended December 31, 1998 and $4.0 million for the year ended December 31, 1997, consisted primarily of interest expense on the First Mortgage Bonds. The increase in interest expense between years is attributable to the Partnership recognizing a full year of interest expense on the bonds for the year ended December 31, 1998 as compared to only approximately 3 months in the year ended December 31, 1997. Interest incurred prior to the commercial operations date, which included the construction phase of the Whitewater Facility, and amortization of deferred financing costs were capitalized as part of construction in process.
Interest income increased to approximately $1.0 million for the year ended December 31, 1998 as compared to $0.4 million for the year ended December 31, 1997. The increase is attributable to the Partnership recognizing a full year of interest income on short-term investments for the year ended December 31, 1998 as compared to only approximately 3 months in the year ended December 31, 1997. Interest income earned during the construction phase of the Whitewater Facility and prior to the commercial operations date
was netted against construction in process. The trust indenture restricts the investment of available funds to high quality, short-term financial investments.
Cottage Grove
The Cottage Grove Power Purchase Agreement term commenced October 1, 1997. Prior to October 1, 1997, Cottage Grove recognized no revenues or expenses.
Revenues for the year ended December 31, 1998 were approximately $44.8 million as compared to $10.7 million for the year ended December 31, 1997. The increase is attributable to the Cottage Grove Facility being in operation for a full 12 months for the year ended December 31, 1998, as compared to only 3 months in the year ended December 31, 1997. Revenues in 1998 and 1997 consisted primarily of lease revenue of approximately $21.1 million and $5.3 million respectively, and service revenue of approximately $19.7 million and $4.9 million, respectively.
Operating expenses of approximately $25.1 million for the year ended December 31, 1998 and $5.9 million for the year ended December 31, 1997 consisted of cost of services related to operating the Facility. The increase in operating expenses is attributable to the Cottage Grove Facility being in operation for a full 12 months for the year ended December 31, 1998, as compared to only 3 months in the year ended December 31, 1997.
Cottage Grove recognized a gain on sales-type capital lease described above of approximately $87.1 million during the year ended December 31, 1997. This gain represented the difference between the estimated fair market value of the Facility of approximately $233.6 million and the historical cost of the Facility of approximately $146.5 million.
Interest expense of approximately $12.3 million for the year ended December 31, 1998 and $3.1 million for the year ended December 31, 1997, consisted primarily of interest expense on the First Mortgage Bonds. The increase in interest expense between years is attributable to the Partnership recognizing a full year of interest expense on the bonds for the year ended December 31, 1998 as compared to only 3 months in the year ended December 31, 1997. Interest incurred prior to the commercial operations date, which included the construction phase of the Cottage Grove Facility, and amortization of deferred financing costs were capitalized as part of construction in process.
Interest income increased to approximately $1.1 million for the year ended December 31, 1998 as compared to $0.4 million for the year ended December 31, 1997. The increase is attributable to the Partnership recognizing a full year of interest income on short-term investments for the year ended December 31, 1998 as compared to only approximately 3 months in the year ended December 31, 1997. Interest income earned during the construction phase of the Cottage Grove Facility and prior to the commercial operations date was netted against construction in process. The trust indenture restricts the investment of available funds to high quality, short-term financial investments.
FACILITY CONSTRUCTION
Cottage Grove
The Partnership has a $107 million turnkey construction contract (inclusive of executed change orders) with Westinghouse Electric. Westinghouse Electric had committed to complete the construction and start-up of the Cottage Grove Facility to specified performance levels by May 31, 1997 and was required under the contract to reimburse the Partnership for extension fees paid under the Cottage Grove Power Purchase Agreement, and to pay certain liquidated damages in the event of a delay. During 1997, Westinghouse Electric was required to pay $1,333,000 and $5,073,000 of reimbursable extension fees and delay liquidated damages, respectively, to Cottage Grove. The Partnership recorded a receivable from Westinghouse Electric of $3,012,000 at December 31, 1997, which was comprised of reimbursable extension fees of $267,000 and delay liquidated damages of $2,745,000. This receivable was collected during the year ended December 31, 1998. The construction and start-up of the Cottage Grove Facility were substantially complete and commercial operations commenced on October 1, 1997.
Effective September 30, 1997, the Partnership and the Contractor, with the concurrence of R.W. Beck, the independent engineer, agreed to a Construction Contract change order. Under the change order, certain nonmaterial modifications were made to the Cottage Grove Construction Contract and certain guarantees were deferred until final completion, which allowed the Contractor to achieve substantial completion and the Partnership to commence commercial operations. In addition, the Contractor committed to certain future modifications in the Facility's construction, extension of certain warranty periods and certain financial concessions. As of
December 31, 1998, the Partnership had retained construction contract payments (in the form of cash and an irrevocable letter of credit) totaling approximately $10,886,000.
Whitewater
The Partnership has a $115 million turnkey construction contract (inclusive of executed change orders) with Westinghouse Electric. Westinghouse Electric had committed to complete the construction and start-up of the Whitewater Facility to specified performance levels by May 31, 1997 and was required under the contract to reimburse the Partnership for extension fees paid under the Whitewater Power Purchase Agreement, and to pay certain liquidated damages in the event of a delay. During 1997, Westinghouse Electric was required to pay $110,000 and $4,539,000 of reimbursable extension fees and delay liquidated damages, respectively, to Whitewater. The Partnership recorded a receivable from Westinghouse Electric of $2,195,000 at December 31, 1997, which was comprised of reimbursable extension fees of $35,000 and delay liquidated damages of $2,160,000. This receivable was collected during the year ended December 31, 1998. The construction and start-up of the Whitewater Facility were substantially complete and commercial operations commenced on September 18, 1997.
Effective September 18, 1997, the Partnership and the Contractor, with the concurrence of R.W. Beck, the independent engineer, agreed to a Construction Contract change order. Under the change order, certain nonmaterial modifications were made to the Whitewater Construction Contract and certain guarantees were deferred until final completion, which allowed the Contractor to achieve substantial completion and the Partnership to commence commercial operations. In addition, the Contractor committed to certain future modifications in the Facility's construction, extension of certain warranty periods and certain financial concessions. As of December 31, 1998, the Partnership had retained construction contract payments (in the form of cash and an irrevocable letter of credit) totaling approximately $11,174,000.
LIQUIDITY AND CAPITAL RESOURCES
Whitewater
The principal components of operating cash flow for the year ended December 31, 1998 were net income of $8.9 million and a $0.7 million adjustment for depreciation and amortization of debt issuance and financing costs, which were partially offset by amortization of unearned lease income, net of minimum lease payments received of $1.0 million and a net $1.1 million use of cash reflecting changes in other working capital assets and liabilities. Cash flow provided by operating activities of $7.5 million and $7.5 million of escrow funds released, as well as a portion of the cash on hand at the beginning of the period of $6.6 million, was primarily used to make partner distributions of $14.4 million, purchase property, plant and equipment of $0.3 million and lend $6.9 million to an affiliate.
The principal components of operating cash flow for the period ended December 31, 1997 were net income of $99.0 million and a $0.2 million adjustment for depreciation and amortization of debt issuance and financing costs, which were partially offset by amortization of unearned lease income, net of minimum lease payments received of $0.3 million, a gain of $97.0 million on sales-type capital lease, and a net of $3.9 million use of cash reflecting changes in other working capital assets and liabilities. Cash flow in operating activities of $2.0 million was funded with net proceeds of $0.9 million from the sale of land and a net $42.6 million of investments drawn by the Partnership. Payments of $33.8 million on construction in process were funded with the excess cash provided from the investment draws.
Cottage Grove
The principal components of operating cash flow for the year ended December 31, 1998 were net income of $8.5 million, a $0.3 million adjustment for amortization of debt issuance and financing costs and a net $0.9 million of cash provided by changes in other working capital assets and liabilities, which were partially offset by amortization of unearned lease income, net of minimum lease payments received of $1.5 million. Cash flow provided by operating activities of $8.2 million and a release of escrow funds of $3.6 million, as well as a portion of the cash on hand at the beginning of the period of $7.9 million, was primarily used to make partner distributions of $13.7 million and lend $6.0 million to an affiliate.
The principal components of operating cash flow for the period ended December 31, 1997 were net income of $89.2 million and a $0.1 million adjustment for amortization of debt issuance and financing costs, partially offset by amortization of unearned lease income, net of minimum lease payments received of $0.4 million, a gain of $87.1 million on sales-type capital lease, and a net $4.3 million use of cash reflecting changes in other working capital assets and liabilities. Cash flow used in operating activities of $2.5 million was funded with net proceeds of $36.0 million of investments drawn by the Partnership. Payments of $24.7 million on construction in process were funded with the excess cash provided from the investment draws.
The $332,000,000 of proceeds received by Funding from the sale of the Senior Secured Bonds were used by Funding to acquire (i) $155,000,000 of Cottage Grove First Mortgage Bonds and (ii) $177,000,000 of Whitewater First Mortgage Bonds. In addition to the proceeds of the First Mortgage Bonds, each Partnership received equity contributions from each of TPC Cottage Grove and TPC Whitewater in 1997, in the respective amounts of $18,167,000 for Cottage Grove and $20,556,000 for Whitewater (the "Equity Contribution Amounts"). The net proceeds from the sale of each Partnership's First Mortgage Bonds and the Equity Contribution Amounts together with other sources of funds available to such Partnership were used to: (i) finance the development, design, engineering, construction, testing, inspection and start-up of its Facility (ii) pay interest on each Partnership's First Mortgage Bonds during construction and (iii) maintain a debt service reserve fund as required by certain financing documents. During the year ended December 31, 1998, the Partnerships transferred the cash held in the debt service reserve fund to an affiliate of one of the limited partners, Cogentrix Energy, Inc. The required funds, currently equal to $6,043,000 and $6,900,000 for Cottage Grove and Whitewater, respectively, are included on the respective balance sheets as a Note Receivable from Affiliate. The receivables are backed by an irrevocable letter of credit issued on behalf of Cogentrix Energy, Inc.
As required by the financing documents, both Cottage Grove and Whitewater have set aside certain funds to pay for project cost overruns, including change orders to the Construction Contracts and any other reasonable contingencies, during construction and through final completion of the Facilities (the "Contingency Fund"). At December 31, 1998 and 1997, the balances of the Contingency Fund accounts were $1,433,000 and $1,426,000, respectively for Cottage Grove and $345,000 and $339,000, respectively for Whitewater.
In addition to funds received through the acquisition of the First Mortgage Bonds by Funding and through the Equity Contribution Amount, each Partnership may receive on its behalf certain letters of credit to be issued pursuant to a letter of credit facility. Each letter of credit facility provides for letters of credit in a face amount not to exceed $5,000,000 for Whitewater and $5,500,000 for Cottage Grove that may be drawn on by the respective Partnership from time to time. Such letters of credit will satisfy certain requirements of the Partnerships under various project agreements. Effective October 31, 1997, a $500,000 letter of credit was issued under the Cottage Grove letter of credit facility to secure certain obligations of Cottage Grove under the Cottage Grove Power Purchase Agreement.
In order to provide for the Partnerships' working capital needs, each Partnership has also entered into a working capital facility. Each working capital facility will provide for working capital loans in an aggregate principal amount not to exceed $3,000,000 for each Partnership. At December 31, 1998, no loans were outstanding under the working capital facilities.
The Partnerships expect that payments from the utilities under the Power Purchase Agreements will provide the substantial majority of the revenues of each of the Partnerships. Under and subject to the terms of the Power Purchase Agreements, each utility is obligated to purchase electric capacity made available to it and energy that it requests from the related Partnership. For additional information regarding NSP and WEPCO, reference is made to the respective Annual Reports filed on Form 10-K, the Quarterly Reports filed on Form 10-Q, proxy, and any other filings made by NSP and WEPCO with the Securities and Exchange Commission (the "Commission").
The Power Purchase Agreements are dispatchable contracts that provide the utilities with the ability to suspend or reduce purchases of electricity from the Facilities. The Power Purchase Agreements are structured such that the Partnership will continue to receive capacity payments during any period of dispatch. Each Partnership is dependent on capacity payments under its Power Purchase Agreement to meet its fixed obligations, including the payment of debt service under each Partnership's First Mortgage Bonds (which will be Funding's sole source of revenues for payment of debt service under the Senior Secured Bonds). Capacity payments by each of NSP and WEPCO are based on the tested capacity and availability of the Facilities and are unaffected by levels of dispatch. Each Facility's capacity is subject to semi-annual verification through testing. Capacity payments are subject to reduction if a Facility is operating at reduced or degraded capacity at the time of such test, although each Facility is permitted a retest subject to certain retest limitations. Also, capacity payments for each Facility are subject to rebate or reduction if the respective Facility does not maintain certain minimum levels of availability. Under the Cottage Grove Power Purchase Agreement, capacity payments are further adjusted by, among other things, the capacity loss factor, which is determined in accordance with procedures jointly agreed to by Cottage Grove and NSP. The Partnerships expect to achieve the minimum capacity and availability levels; however, any material shortfall in tested capacity or availability over a significant period could result in a shortage of funds to the Partnerships.
Each Partnership presently believes that funds available from cash and investments on hand, restricted funds, operations and letter of credit and working capital facilities will be more than sufficient to liquidate each partnership's obligations as they come due, pay 1999 project debt service and make required contributions to project reserve accounts.
As with any power generation facility, operation of the Facilities will involve certain risks, including the performance of a Facility below expected levels of output or efficiency, interruptions in fuel supply, pipeline disruptions, disruptions in the supply of thermal or electrical energy, power shut-downs due to the breakdown or failure of equipment or processes, violation of permit requirements (whether through operation, or change in law), operator error, labor disputes or catastrophic events such as fires, earthquakes, explosions, floods or other similar occurrences affecting a Facility or its power purchasers, thermal energy purchasers, fuel suppliers or fuel transporters. The occurrence of any of these events could significantly reduce or eliminate revenues generated by a Facility or significantly increase the expenses of that Facility, thereby impacting the ability of a Partnership to make payments of the amounts necessary to fund principal of and interest on its First Mortgage Bonds, and consequently Funding's ability to make payments of principal of and interest on the Senior Secured Bonds. Not all risks are insured and the proceeds of such insurance applicable to covered risks may not be adequate to cover a Facility's lost revenues or increased expenses. In addition, extended unavailability under the Power Purchase Agreements, which may result from one or more of such events, may entitle the respective Power Purchaser to terminate its Power Purchase Agreement.
IMPACT OF ENERGY PRICE CHANGES, INTEREST RATES AND INFLATION
The Partnerships have attempted to mitigate the risk of increases in fuel and transportation costs by providing contractually for matching increases in the energy payments the Partnerships receive from the utilities purchasing electricity generated by the Facilities. In addition, the Partnerships have hedged against the risk of fluctuations in interest rates by arranging fixed rate financing.
YEAR 2000 COMPLIANCE
The Year 2000 issue exists because many computer systems and applications, including those embedded in equipment and facilities, use two digit rather than four digit date fields to designate an applicable year. As a result, the systems and applications may not properly recognize the year 2000 or process data that includes such date, potentially causing data miscalculations or inaccuracies or operational malfunctions or failures. The Partnerships initiated assessments in 1998 to identify the issues required to be resolved to assure business critical systems successfully operate upon and beyond the turn of the century. The assessments include reviewing information technology and systems utilizing embedded technology. Plans for achieving Year 2000 compliance were finalized during 1998 and remediation work is underway. The Partnerships have identified the following systems and applications on which to focus its efforts to ensure Year 2000 compliance:
-- corporate applications, which include core business systems; -- embedded technology systems, which include the plants operating and control systems and -- business partner and vendor systems.
Non-compliance in the embedded technology systems or business partner and vendor systems could result in temporary shutdown of the facilities, and potential equipment damage.
Replacement of the core financial systems, which include corporate applications such as purchasing, accounts payable and general ledger, with Year 2000 compliant client-server software is virtually complete. The Partnerships expect to complete the updating of their human resources and internal payroll systems by June 30, 1999. The Partnerships do not expect any disruptions in corporate applications as a result of the Year 2000 issue.
Investigation, analysis, remediation and contingency planning for embedded technology such as plant operating control systems, telecommunications and facilities-based equipment at the facilities has been completed. The investigation and analysis have identified no significant Year 2000 issues. For those insignificant issues that have been identified as non-compliant, the Partnerships have established a remediation plan to address the areas of non-compliance. The remediation of these systems is expected to be completed by June 30, 1999.
The Partnerships are communicating with critical suppliers, vendors, joint venture partners and major customers verbally, in writing and through other representations made by the organizations to assess their compliance efforts and the Partnerships' exposure resulting from Year 2000 issues. Of major concern are the fuel suppliers and transporters, and the electric and steam customers. The Partnerships produce revenue by selling the power produced to major utilities. The Partnerships depend on fuel suppliers and transporters to deliver fuel to power the generating facilities. The Partnerships also rely on transmission and distribution facilities to deliver power to the electric and steam customers. At this time, based on the Partnerships' review of responses they have received, the Partnerships do not expect a major impact from non-compliant Year 2000 suppliers, vendors, joint venture partners or major customers. However, an incomplete or incorrect assessment of the Year 2000 issues by the suppliers and transporters, transmission and distribution facilities, as well as the utility customers, could adversely effect the Partnerships' financial results and operations.
The Partnerships have developed contingency plans for the critical systems. The Partnerships developed these plans to address the most likely worst case scenario, the inability of the plants to produce and distribute power. The contingency plans include turning back the date on all date critical systems at the plant to ensure the continuous operation of the generating facilities. These plans have been tested and appear to be adequate.
The Partnerships expect that the business critical systems will be Year 2000 compliant by June 30, 1999, and do not anticipate costs associated with the Year 2000 issue to have a material impact on the results of operations or financial position. Currently, the Partnerships have not entered into any material contracts with external contractors to complete the Year 2000 compliance projects. Cogentrix Energy has dedicated two headquarters level employees to oversee, develop and test systems to ensure Year 2000 readiness, including Year 2000 readiness at the Cottage Grove and Whitewater Facilities. Managers at each plant location are also responsible for various components of the Year 2000 testing. Despite management's current expectations, there can be no assurances that there will not be interruptions or other limitations of financial and operating systems functionality or that the Partnerships will not ultimately incur significant unplanned costs to avoid such interruptions or limitations.
PART II/ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See financial statements commencing at.
PART II/ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The registrant has previously reported the information required by this item in a report on Form 8-K filed on March 31, 1998.
PART III/ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS OF THE GENERAL PARTNERS
Each Partnership Agreement provides that all management functions of the respective Partnership are the responsibility of the General Partner, subject to certain conditions and limitations. All of the stock of each General Partner is owned by an indirect wholly-owned subsidiary of Cogentrix Energy. Certain officers of Cogentrix Energy concurrently serve as officers of the General Partner.
The following table sets forth the names and positions of the directors and executive officers of each General Partner. With the exception of Mr. Taiano, each of these individuals was elected or appointed to his position on March 20, 1998 when the change in control event described in Part I, Item 1 - "ORGANIZATION - Change in Control" occurred. Directors are elected annually and each elected director holds office until a successor is elected. Officers are chosen from time to time by vote of the board of directors.
Mark F. Miller is the President, Chief Operating Officer and a Director of Cogentrix Energy. Prior to joining Cogentrix Energy in May 1997, Mr. Miller was Vice President for Northrop Grumman in Bethpage, New York. He joined Northrop Grumman in 1982 and held successive positions in the material, law and contracts departments before being named Vice President, Contracts and Pricing at Northrop's B-2 Division in 1991. In 1993, he became Vice President Business Management at the B-2 Division. In 1994, Northrop acquired the Grumman Corporation and Mr. Miller was named Vice President Business Management for the newly formed Electronics and Systems Integration Division, a position he held until his move to Cogentrix Energy. From 1980 to 1982, he was an associate with the law firm of Dolack, Hansler.
James R. Pagano has been Group Senior Vice President - Development, Mergers & Acquisitions since February 1999. From May 1997 until then he was Group Senior Vice President - Chief Financial Officer of Cogentrix Energy, prior to which he was Senior Vice President - Project Finance since February 1995 and Vice President - Project Finance since Cogentrix Energy's formation. Previously, Mr. Pagano was Vice President - Project Finance of Cogentrix, Inc. since July 1993, Vice President - Legal and Finance from July 1992 to July 1993, and from January 1992 to July 1992, Mr. Pagano was Vice President and Assistant General Counsel of Cogentrix, Inc. Prior to joining Cogentrix, Inc. he was Vice President of The Deerpath Group, Inc., a financial advisory firm. From 1987 to 1990, Mr. Pagano was an associate with the law firm of Simpson Thacher & Bartlett.
James E. Lewis has been a Director of Cogentrix Energy since 1998, and was appointed Vice Chairman in March 1999. Prior to 1999, Mr. Lewis was Executive Vice President of Cogentrix Energy since November 1992. From 1991 to 1992, he was Senior Vice President of Operations responsible for the daily operations of Cogentrix Energy's facilities. From 1989 to 1991, Mr. Lewis was Vice President - Utility Operations. Mr. Lewis joined Cogentrix Energy in 1986. Mr. Lewis beneficially owns 45,120, or 16%, of the issued and outstanding shares of Cogentrix Energy.
Dennis W. Alexander has been Group Senior Vice President, General Counsel, Secretary and a Director of Cogentrix Energy since February 1994. Immediately prior to joining Cogentrix Energy, Mr. Alexander was Vice President/General Counsel of Wheelabrator Environmental Systems Inc., the waste-to-energy and cogeneration subsidiary of Wheelabrator Technologies Inc., an independent power and environmental services and products company, as well as Director, Environmental, Health and Safety Audit Program for Wheelabrator Technologies Inc. From 1988 to 1990, Mr. Alexander was Vice President/General Counsel - Operations of Wheelabrator Environmental Systems Inc. and from 1986 to 1988 was Vice President/General Counsel of Wheelabrator Energy Systems, a cogeneration project development subsidiary. From 1984 to 1986, he served as Group General Counsel for The Signal Company and from 1980 to 1984 as Division General Counsel of Wheelabrator-Frye Inc., each a diversified public company.
Richard L. Taiano serves as an independent director of each General Partner. Prior to his appointment, Mr. Taiano had no relationship to either General Partner or its affiliates. Mr. Taiano is an Assistant Vice President of Lord Securities and is responsible for daily cash management and accounting for the special purpose companies managed by the firm. Prior to joining Lord Securities in
1992, Mr. Taiano was with Goldman, Sachs & Co. where he started in 1987 and was an associate in the Controllers Department from 1987 to February, 1995, serving in the London, Tokyo, Hong Kong, and New York offices of the firm.
DIRECTORS AND EXECUTIVE OFFICERS OF FUNDING
The following table sets forth the names and positions of the individuals who are the directors and executive officers of Funding.
Directors are elected annually and each elected director holds office until a successor is elected. Officers will be chosen from time to time by vote of the board of directors.
Peter H. Sorensen serves as an independent director of Funding. Prior to his appointment, Mr. Sorensen had no relationship to Funding or its affiliates. Mr. Sorensen started with Lord Securities in April, 1986 and currently supervises the administration of the special purpose financing companies managed by the firm. As President of Lord Securities, he assists in the structuring of the related finance programs, oversees all legal and rating agency matters and works on the development of new business. Mr. Sorensen holds a B.S. in Business Administration from Barrington College, R.I.
For biographical information on each of the above listed persons other than Mr. Sorensen, see "-Directors and Executive Officers of the General Partners" above.
PART III/ITEM 11. EXECUTIVE COMPENSATION
None of the officers or directors of Funding or the General Partners has received or, it is anticipated, will receive compensation for their services from Funding or from the General Partners except that Lord Securities is paid a fee for providing the services of Mr. Taiano and Mr. Sorensen. The directors and executive officers of Cogentrix Energy are compensated by Cogentrix Energy and are not entitled to any direct compensation from the Partnerships. However, Cogentrix Energy is paid a management fee and is reimbursed for certain expenses by the Partnerships as described under Part III/Item 13 - "Certain Relationships and Related Transactions".
PART III/ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS & MANAGEMENT
The following information is given with respect to the partnership interests in LSP-Cottage Grove, L.P. held by persons who are beneficial owners of more than 5% of such interests.
The following information is given with respect to the partnership interests in LSP-Whitewater Limited Partnership held by persons who are beneficial owners of more than 5% of such interests.
Except as specifically provided or required by law, the limited partners of Cottage Grove and Whitewater may not participate in the management or control of the respective Partnerships. Thus, although each General Partner has a 1% interest in its Partnership, it has sole responsibility for the management of such Partnership. All of the outstanding capital stock of each of the General Partners is owned by an indirect subsidiary of Cogentrix Energy. See Part I/Item 1 - "ORGANIZATION - Change in Control" and Part III/Item 13 - "Certain Relationships and Related Transactions".
The following information is given with respect to the beneficial ownership of the outstanding capital stock of Funding.
PART III/ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Each Partnership believes that, taking into consideration all of their terms and conditions, the transactions with the related parties described below were at least as favorable to it as those which could have been obtained from unrelated parties in arms-length transactions.
COGENTRIX ENERGY. LS Power was the developer of the Facilities and until March 1998 (See Part I/Item 1. Business, Organization - Change in Control) provided certain management services to each Partnership and each General Partner pursuant to the MSA's. Since March 20, 1998, Cogentrix Energy has provided certain management services to each Partnership pursuant to the MSAs. Under the MSAs, Cogentrix Energy manages the business affairs of each Partnership and is responsible for supervising each Partnership's, and monitoring each counterparty's, compliance with all contracts to which each Partnership is a party. Under the MSAs, each Partnership currently pays Cogentrix Energy as compensation for its services a monthly management fee of approximately $54,000 which fees escalate annually pursuant to a rate of change in a consumer-price related index. Cogentrix Energy is also reimbursed for its reasonable and necessary expenses incurred in performing its services, including the salaries of its personnel to the extent related to services required under the MSAs. The amounts payable by each Partnership to Cogentrix Energy under the MSAs are designated as operating expenses under the depository agreements and therefore are paid prior to interest and principal on such Partnership's First Mortgage Bonds. For the year ended December 31, 1998 Cogentrix Energy received payments pursuant to the MSAs of approximately $970,000 in the aggregate.
The Partnerships each maintain a debt service reserve fund as required by certain financing documents. During the year ended December 31, 1998, the Partnerships transferred the cash held in the debt service reserve funds to Cogentrix Energy. The required funds, currently equal to $6,043,000 and $6,900,000 for Cottage Grove and Whitewater, respectively, are included on the respective balance sheets as a Note Receivable from Affiliate. The receivables are backed by irrevocable letters of credit.
FLORICULTURE. FloriCulture is a single purpose corporation formed to operate the Greenhouse for the benefit of Whitewater and is an indirect, wholly-owned subsidiary of Cogentrix Energy (See Part I/Item 1. Business, Organization - Change in Control). Whitewater and FloriCulture entered into the Greenhouse Operational Services Agreement in 1997, whereby FloriCulture is required to provide all the services necessary to produce, market, and sell horticultural products and to operate and maintain the Greenhouse. As compensation for its services, FloriCulture is reimbursed on a monthly basis for its approved costs in connection with conducting the Greenhouse business and operating the Greenhouse, and receives an annual management fee equal to 12% of Whitewater's net profit from the operation of the Greenhouse. The term of the Greenhouse Operational Services Agreement will expire on May 31, 2022. For the year ended December 31, 1998, FloriCulture earned a management fee pursuant to the Greenhouse Operational Services Agreement of approximately $26,000.
LSP-COTTAGE GROVE, INC. LSP-Cottage Grove, Inc. is the general partner of Cottage Grove and since March 20, 1998 has been a wholly-owned subsidiary of Cogentrix Energy (See Part I/Item 1., Business, Organizations - Change in Control). LSP-Cottage Grove, Inc. has no assets other than its general partnership interest in Cottage Grove. The officers of LSP-Cottage Grove, Inc. concurrently serve as officers of Cogentrix Energy but do not receive compensation in the former capacity. LSP-Cottage Grove, Inc. is a party to the MSA with Cogentrix Energy.
LSP-WHITEWATER I, INC. LSP-Whitewater I, Inc. is the general partner of Whitewater and since March 20, 1998 has been a wholly-owned subsidiary of Cogentrix Energy (See Part I/Item 1., Business, Organizations - Change in Control). LSP-Whitewater I, Inc. has no assets other than its general partnership interest in Whitewater. The officers of LSP-Whitewater I, Inc. concurrently serve as officers of Cogentrix Energy but do not receive compensation in the former capacity. LSP-Whitewater I, Inc. is a party to the MSA with Cogentrix Energy.
TPC COTTAGE GROVE & TPC WHITEWATER. TPC Cottage Grove and TPC Whitewater are both wholly-owned subsidiaries of Tomen and were formed for the sole purpose of holding a limited partnership interest in the related Partnership. During 1997, TPC
Cottage Grove and TPC Whitewater made capital contributions of $18,167,000 and $20,556,000 to Cottage Grove and Whitewater, respectively.
RELATIONSHIP OF FUNDING AND THE PARTNERSHIPS
Each Partnership owns 50% of the capital stock of Funding. Each Partnership has designated Funding as its agent for certain purposes including issuing the Senior Secured Bonds. Each Partnership has indemnified Funding against all claims arising in connection with Funding's performance of its obligations.
PART IV/ITEM 14.