-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QrgFvo6ov4/wtyZvUIPqA0hnwH+Ni03zWMk+7ehpHui+uAconJxAsbwU8sMLlCfI rMybNArNdu8r0oPbABuW7w== 0000892569-02-000715.txt : 20020415 0000892569-02-000715.hdr.sgml : 20020415 ACCESSION NUMBER: 0000892569-02-000715 CONFORMED SUBMISSION TYPE: 10-12G/A PUBLIC DOCUMENT COUNT: 6 FILED AS OF DATE: 20020403 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMMONWEALTH ENERGY CORP CENTRAL INDEX KEY: 0001156443 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 330769555 FILING VALUES: FORM TYPE: 10-12G/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-33069 FILM NUMBER: 02601297 MAIL ADDRESS: STREET 1: 15901 RED HILL AVENUE STREET 2: SUITE 100 CITY: TUSTIN STATE: CA ZIP: 92780 10-12G/A 1 a80144a2e10-12ga.txt FORM 10 AMENDMENT #2 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10 A ------------------------ GENERAL FORM FOR REGISTRATION OF SECURITIES PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMONWEALTH ENERGY CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 33-0769555 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
15901 RED HILL AVENUE, SUITE 100, TUSTIN, CALIFORNIA 92780 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (714) 258-0470 SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH TO BE SO REGISTERED EACH CLASS TO BE REGISTERED NONE NONE
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK (TITLE OF CLASS) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TABLE OF CONTENTS
PAGE ---- Item 1. Business.................................................... 1 Item 2. Financial Information....................................... 8 Item 3. Properties.................................................. 18 Item 4. Security Ownership of Certain Beneficial Owners and Management................................................ 18 Item 5. Directors and Executive Officers............................ 20 Item 6. Executive Compensation...................................... 22 Item 7. Certain Relationships and Related Transactions.............. 27 Item 8. Legal Proceedings........................................... 27 Item 9. Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters.................... 29 Item 10. Recent Sales of Unregistered Securities..................... 29 Item 11. Description of Registrant's Securities to be Registered..... 31 Item 12. Indemnification of Officers and Directors................... 31 Item 13. Financial Statements and Supplementary Data................. 31 Item 14. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures................................. 31 Item 15. Financial Statements and Exhibits........................... 32
i ITEM 1. BUSINESS A. Background and Overview. We were incorporated on August 15, 1997. Since then our primary business has been the sale of retail electric power to residential and small commercial customers in the newly deregulated California electricity market. We began providing electric service as one of more than 300 licensed Electric Service Providers ("ESPs") in the state and aggregated customers via an internal call center. As our customer base grew, we began developing software to better manage our back office customer service functions associated with servicing electricity accounts. We also began to provide service to larger commercial, industrial and governmental customers. Once we had established a foothold in California, we expanded our retail electricity services to end users in Pennsylvania, specifically into the Pennsylvania Electric Company territory ("PECO"). We established a new tradename, "electricAmerica," in Pennsylvania and began aggregating residential, commercial, industrial and governmental customers via our call center. Currently, we sell electric power to approximately 56,000 retail end-use customers in California and approximately 32,000 retail end-use customers in Pennsylvania. A portion of the electric power we sell is delivered to our retail and commercial end-use customers by the incumbent utility distribution companies ("UDCs") and electric distribution companies ("EDCs"). All of these companies serve as the incumbent utility in their jurisdiction and measure electric power usage and bill customers on our behalf but have different names dependent upon their respective jurisdiction. Three UDCs in California and one EDC in Pennsylvania conduct these activities on our behalf. The remaining portion of our electric power is sold to large wholesale customers by our own energy trading department. The price of electricity can fluctuate significantly. In an attempt to manage this risk, we enter into longer term wholesale power purchase agreements which allows us to purchase fixed daily quantities of electricity at fixed prices. During certain times and market conditions, such as when the supply of electricity is scarce, the price of electricity on the wholesale level increases and allows us to resell the electricity that we purchased, in excess of that needed to supply retail and commercial end-user customers, at higher prices to wholesale customers, as occurred in the California marketplace during the summer of 2000 through the winter of 2001. Because of a number of circumstances existing at the time, including weather, market design and conditions and scarcity of supply, we were able to sell electricity into the wholesale market during this period for amounts far in excess of the price at which we purchased the electricity. This allowed us to obtain unusually high revenues and margins for this period; we do not expect this trend to continue and expect that California's response to the energy crisis of the summer of 2000 through the winter of 2001 will prevent these conditions from recurring in the future. Most electricity markets function in a similar manner in that the incumbent utility is the entity that owns the physical wires that transport electricity to each user's location. The utility company is paid a fee for use of its wires. In addition to this basic service, some states allow the utility company to take on additional responsibilities, such as reading meters, generating bills to customers, collecting bills, taking requests for service changes or problems, etc., while in other jurisdictions the utility is not allowed to, or chooses not to, perform these services. In California and Pennsylvania, the utility companies currently assist us with the preparation, mailing and collection of our bills to end use customers. In addition, the utility companies are invoicing and collecting the charges and fees associated with those services as well as the right to use the distribution network. The California marketplace has evolved from a market driven, minute by minute trading forum, (operated by the now bankrupt California Power Exchange), to a system which requires parties to obtain more of their power through the use of forward contracts, or advance purchases and to clear those transactions through the market oversight body called the California Independent System Operator ("CAISO"). The CAISO is responsible for ensuring system reliability and that all electricity put into the grid has a corresponding exit from the grid. This matching of power transactions is done in a constant sequence of 15 minute increments. The Pennsylvania marketplace is governed by a similar structure called the PJM 1 interconnection ("PJM"). The PJM is responsible for matching all power transactions among market participants and ensuring system reliability. California has recently passed legislation that requires the California State Public Utilities Commission to suspend direct access. On March 21, 2002, the CPUC ruled to hold the effective date for suspension of direct access as September 20, 2001. The suspension of direct access means that retail electric suppliers, such as our company, will not be allowed to actively seek new customers to enroll for our services. The ruling came in connection with legislation entitled ABX-1, which amended the California Water Code section 801110, to allow for this suspension. This ruling allows us to keep our current customer base intact and only impacts our ESP business in California, not other states. The ruling does, however, prohibit us from signing up new customers for an, as yet, undetermined amount of time. This may affect our ability to continue to increase revenues in the State of California relating to our ESP business operations in this jurisdiction. Prior to the inception of electricity deregulation in 1998, the retail electric service industry was controlled almost exclusively by utilities. Presently, eight states and Washington, D.C. offer deregulated retail electric service, while fourteen states are transitioning to deregulated status. Our opportunities for expansion may increase as more states and territories deregulate. As in other industries that have deregulated, competition in the electric service industry is intended to provide consumers with a choice of multiple suppliers that is expected to promote product differentiation, lowered costs and enhanced services. To obtain these features, customers may switch electric service from their utility to an alternative supplier. The majority of our operating margins have come from the resale of electricity purchased under a contract with Calpine Power Services Company that expires in June 2002. This contract may not be renewed on terms as favorable to us as those contained in the current contract. During fiscal 2001, this contract accounted for 60% of the total energy supplied by us and from which 83% of our revenue was derived. To mitigate the risk of relying solely on our ESP business, we have expended a great deal of effort to diversify our business activities during the past twelve months. In this report we have attempted to describe the changes we are making to be able to have a diversified energy company that allows us to take advantage of other opportunities afforded by the energy marketplace in all of North America. However, none of these activities have yet contributed materially to our income or losses. As an electric service provider we are dependent on serving and expanding into deregulated electric service markets. We also have been pursuing other business opportunities in regulated and deregulated electric service markets. Our experience in the energy markets has led us to increase our breadth of service offerings, leverage our existing energy expertise and pursue a diversification strategy that includes: - Establishment of a trading desk to better manage and schedule our energy load, and our wholesale power purchases and sales; - Sale of energy-efficient products and services to retail customers through our own call center and direct sales force; - Management and fulfillment of utility back office functions for energy retailers, generators, utilities, municipalities and cooperatives; - Energy management programs, including energy curtailment, distributed generation and alternative power generation for commercial, industrial and governmental electric service customers; - Procurement of government sponsored energy-related grants to augment our research and development efforts; - Creation of separate, energy-focused profit centers, such as our call center; and - Investments in energy-related ventures synergetic with our plans. 2 Commonwealth Energy Corporation has three wholly-owned subsidiaries: electricAmerica, Inc., Utilihost, Inc. and electric.com, Inc. Each of these subsidiaries is incorporated in the State of Delaware, but as yet, none of them is operational. B. Products and Services. To date our business activities are comprised primarily of providing retail electricity services and, beginning in fiscal 2001, wholesale power procurement and sales. We are broadening the scope of the energy related services we provide to include energy efficient products, managed back office services, energy management programs, energy research and development and load aggregation. However, none of these services have yet begun to contribute materially to our income or losses or developed to the point of being a separate business segment. 1. Retail Electricity We offer electric "product" and service to customers on month-to-month or longer-term service contracts. The difference between the customers' list price for energy and the sum of our wholesale electricity purchase cost and ancillary costs provide us a gross profit/loss margin. We provide a value proposition to customers by pricing electric products below, or delivering a more environmentally friendly (not derived from fossil-fuel sources) product than, our competitors. We are licensed in California by the California Public Utilities Commission as an Electric Service Provider (License #1092); in Pennsylvania by the Pennsylvania Public Utility Commission as an Electric Generation Supplier (License #A-110117); in New Jersey by the New Jersey Board of Public Utilities as an Electric Generation Supplier (License #ESL-0046); in Ohio by the Public Utilities Commission of Ohio as a Certified Electric Supplier (License #01-074); in Texas as a Retail Energy Provider (RE Certificate #10029) and we are in the license approval process in Michigan as an Alternative Electric Supplier. We are also licensed as a Power Marketer by the Federal Energy Regulatory Commission ("FERC"). These licenses permit us to sell electrical power to commercial, industrial, governmental and residential customers. To procure commodity supply for our retail electric service sales, we purchase electricity under a mix of long-term and short-term wholesale contracts and, prior to fiscal 2001, by spot purchases in regional power exchanges. The mix of energy purchased under contracts and energy purchased on the spot market was 15.6% and 84.3%, respectively, for fiscal 1999 and 51.6% and 48.4%, respectively, for fiscal 2000. Our spot purchases during fiscal 2001 and the current year are minimal in markets in which we participate. In California, we currently provide customers with environmentally friendly power purchased under our contract with Calpine Power Services Company. In Pennsylvania, we provide customers with a 50% environmentally friendly power product derived from multiple sources, purchased via two long-term bilateral contracts and a variety of short-term contracts with wholesale power providers. Electricity sales to retail and commercial end-users in fiscal 2001 contributed $103.5 million in revenues, or 56.5% of total sales. The electricity distribution infrastructure utilized by utility companies prior to deregulation of the energy industry remains the only current method of distribution to the end-use customer. We use this established electricity network for the delivery of energy to our customers. We do not own or operate these lines, but we and our customers pay the utility companies that own the lines ancillary fees for use of this distribution network. These fees are collected by the respective independent system operator ("ISO") or regional transmission organization ("RTO") for a specific region or state, and typically run 5% to 10% of prevailing retail electricity market prices. The ISO or RTO insure that proper electricity reserve margins are in place at all times, as electricity must have supply and demand in near perfect balance to insure reliable service. 2. Wholesale Power Procurement and Sales Due to the variable electricity usage patterns of our customers, frequently we are left with excess electricity, which we are committed to purchase, and which must be resold, since it cannot be stored. We use our best efforts to sell this excess electricity in the wholesale electricity market. Conversely, increased usage by our customers may require us to purchase additional electricity to cover increased demand. 3 We have established a trading desk that buys and sells our electricity in regional markets. Excess energy is sold to wholesale entities short on supply, while additional energy is procured from time to time when required to supply our customers' usage. These purchases and sales are regulated by FERC and reports are made on a regular basis to the U.S. Department of Energy. Typically, electricity is more expensive during peak hours -- that is, when demand and usage are highest. Weather, generation capacity, transmission, distribution and other market issues are significant factors in determining our wholesale procurement and sale strategies. Because electricity is a "real-time" commodity (as soon as it is produced, it must be delivered into the grid to meet the demand by the end user) and cannot be stored, effective management of our electricity supply and demand is crucial to wholesale and retail market profitability. Wholesale power sales, which commenced in fiscal 2001 contributed $79.3 million in revenues, or 43.3% of total sales. The following segments have not yet materially contributed to our revenue: 3. Energy Efficient and Emergency Preparedness Products We developed and utilize our own inside sales force to sell energy efficient and emergency preparedness products to customers by telephone. Energy conservation and home safety are important issues to customers and selling them energy management controllers, compact fluorescent lamps, natural gas shut-off valves and other such devices has been a natural extension of our business, although sales of these products account for less than one percent of our total revenues. These products are targeted to residential, commercial, industrial and governmental customers. We fulfill orders for products and ship most of these products through our warehouse, but some are fulfilled and delivered from the manufacturers or distributors. In either case, we collect payment from our customers and are compensated for order processing and procurement, but in the case of orders fulfilled and shipped by the manufacturers or distributors, we do not retain payment for shipping costs. All deliveries of products are made only after payment by check or credit card from our customers. Energy Efficient and Emergency Preparedness Products sales in fiscal 2001 contributed $.5 million in revenues, or 0.2% of total sales in fiscal 2001. 4. Managed Back Office Services We established a wholly-owned subsidiary, UtiliHost, Inc., which was organized to manage the customer-related back office processes for commodity trading partners. The core technology which will support UtiliHost is software that originally was developed by us to better manage electric service customers internally. TACT(TM) (Trans-Action Control Technology) and TRIUMPH(TM) (Total Resource Internet Utility Management Power Host) are proprietary software products which are available for use by UtiliHost to provide services and manage back office processes for clients. TACT acts as a data translator between trading partner transactions, while TRIUMPH is a comprehensive, modular software package that calculates and manages back office processes such as customer enrollment, forecasting, metering, ancillary products, billing, accounts receivable, customer service and settlement. We have commenced our marketing efforts for UtiliHost(TM) through a mix of direct mail, print media and Internet advertising, primarily in deregulated energy markets. On August 30, 2001, we signed a two-year joint venture agreement with a generator to service the electricity needs of a large California commercial account. This agreement provides for approximately $50,000 in revenue per month for UtiliHost services beginning in September 2001. Prior to this contract, UtiliHost had not generated any revenues. 5. Energy Management Programs Energy management programs consist of energy curtailment programs and distributed generation programs. Energy curtailment programs permit short-term curtailment or cessation of electric service at the discretion of the distributing company under certain circumstances, as specified in the service contract. These programs provide a financial benefit as an incentive to our customers to lower electrical usage, while we benefit by avoiding the purchase of expensive power from other suppliers. The resulting savings are ultimately shared between the customer and us. Our sales department markets these programs to commercial, industrial and governmental entities seeking to save energy costs by decreasing their energy usage during peak periods. The availability of curtailment programs is dependent upon the initiatives set by the ISO and/or the local 4 distribution company. We are presently not involved in any energy curtailment programs, however, we plan to offer the service in the future if ISO's and/or local distribution companies continue these programs. Distributed generation programs provide customers with on site electrical power generation, which improves reliability while also equipping them with a cost-effective source for seasonal or peak demand power. When certain industrial manufacturing processes are interrupted by a power outage, the results can be disastrous. Millions of dollars in materials, labor and time may be lost. Our sales department, along with outside consultants and associated vendors, formulate a custom energy solution for clients that have uninterruptable power requirements. 6. Energy Research and Development We were recently selected by the California Energy Commission to manage more than $11 million in research and development funds for development of renewable energy technologies. Launched in 1998, PIER (Public Interest Energy Research) funds various electricity-related research, development and demonstration projects. Our proposal, entitled "Biogas/PV Micro-Grid Renewable Resource Program," was the only private company proposal selected for the award. This project commences December 1, 2001, and runs for four years. Phase One of this project will include assessing regional electricity needs, renewable resources and power grid capabilities in at least two areas in California. Our focus will be on developing a method of blending biogas and solar resources to meet California's energy needs. Phase Two of this project will include a waste collection and generation option addressing ground water contamination developed for the California Dairy Industry and various Photovoltaic (solar) systems. We are committed to invest $3.5 million in matching funds in the development project if Phase Two is implemented. We have not incurred any significant costs related to this program. 7. Load Aggregation We are currently discussing with several generators and utilities a comprehensive solution for cities and major commercial and industrial customers to meet their energy demand. We will assist cities to become municipal utilities by providing them all required energy procurement, energy management, customer service and back-room services. We will do the same for major commercial and industrial customers to meet their electricity demand requirements. This program allows us a diversified approach to aggregating customers. To date, we have not entered into any contracts to provide load aggregation services. 8. ACT As we diversify our business and revenue streams, we have decided to establish separate divisions within our company that have profit and loss responsibility. Our call center, now called Advanced Client Technologies ("ACT"), outsources services to third party energy-related firms, and provides us with inbound, outbound and customer service functions for electricAmerica. A new division of our company, ACT specializes in aggregating electric service residential and small commercial customers, selling energy efficient and emergency preparedness products and handling inbound customer service inquiries. Call monitoring, third party verification and call reporting are also provided. In addition to maintaining our own customer aggregation and service needs, ACT's market focus has been on clients seeking to aggregate energy customers in deregulated markets. We currently have no third party contracts for ACT's services. 9. Summit Energy Ventures, L.L.C. In July 2001 Commonwealth made the initial capital contribution of $15 million into Summit Energy Ventures, LLC ("Summit"). To date this represents our entire capital contribution to Summit. When the Board approved this investment it did so to be able to have our funds work on our behalf and to gain access to the merger and acquisition and financial skills of Mr. Strasser. This decision was made to bring value to Commonwealth and to our shareholders while insuring Commonwealth had total control of the funds and the decisions to invest. Commonwealth owns 100% of the Preferred Membership Interest of Summit and as of February 27, 2002, 60% of the Common Membership Interest. Steven Strasser owns the other 40% of the Common Membership Interest. Summit was established at the request of Commonwealth solely to act on behalf of 5 Commonwealth to gain ownership in and develop significant business relationships with companies in the Energy Efficient Products and Services market. Commonwealth was introduced to Mr. Strasser by the senior partners at a major energy law firm. The rights and privileges of the Commonwealth Preferred Membership and Interest are as follows. Our Company receives in priority the following distribution, if any, of funds distributed by Summit: (1(st)) all amounts equal to the capital invested by Commonwealth in Summit, (2(nd)) an amount equal to 10% annual return on all funds invested by Commonwealth, and (3(rd)) the balance, if any, is split 60/40 between Commonwealth and Mr. Strasser. Commonwealth as the preferred member has other rights that the common members do not, including; (i) Commonwealth has the right of first refusal in the event of any issuance's of new members interests, (ii) we have the right to purchase any of the investments acquired by Summit at any time during the agreement on terms mutually agreeable to both the Investment Manager and us, and (iii) we have the right of first refusal for any sale of an investment by Summit. We receive all of our initial invested capital and an annual 10% preferred return before Mr. Strasser participates in any of the profits. Commonwealth through the Investment Committee, approves any of the investment criteria, and we make all of the investment decisions. No investment may be considered and no capital may be invested without the explicit written consent of Commonwealth Investment Committee. Steven Strasser is the president and sole shareholder in Northwest Power Management (NPM), the Investment Manager of Summit. NPM has the responsibility of identifying suitable companies. They then present individual companies that they have selected to the Commonwealth Investment Committee that provides their approval/disapproval. If approval is received, NPM then begins the due diligence investigation process. Once the preliminary due diligence is completed the findings are again presented to the Investment Committee. At that time, the Investment Committee provides its approval or disapproval to enter into formal negotiations with the company on the specific terms established by the Investment Committee. If these terms are met, the Investment Committee will provide their final approval to fund the investment. Once the investment is complete, it is the responsibility of NPM to manage the investment until such time as a disposition decision is made. At that time if we choose to do so, we may buy out Summit's interest in a specific investment. We pay to NPM, as the Investment Manager, an initial and semi-annual management fee. In August 2001, we paid NPM the initial management fee of $450,000 based on three percent (3%) of the initial capital contribution. In February 2002, we paid NPM a semi-annual management fee of $350,000 in accordance with the terms of the amended LLC agreement. C. Marketing. Our business prospects depend upon our ability to identify and enter favorable energy markets and to achieve sufficient customer scale to create a profitable operating cost structure. Currently, we are: - Selectively entering retail energy markets that have rate structures, market rules, consumer demographics, energy consumption patterns, access to favorable electricity supply and risk management profiles that are designed to enable us to provide savings and flexibility to our customers at an acceptable margin. - Capitalizing on the brand recognition of "electric" through our web site at www.electric.com and through our inbound toll-free number, 1-800-ELECTRIC. - Taking advantage of the increasing consumer acceptance of online commerce, both directly through our web sites (www.electricamerica.com and www.electric.com) and through traditional channels. - Developing strategic marketing alliances with established power suppliers to offer competitive electric products and services to, and management of, aggregations of customers. - Cross-selling additional products and services to our customers, such as energy efficiency and emergency-preparedness products. 6 - Positioning UtiliHost as a means for clients to outsource their electricity customer service management. D. Competition. We face competition in the electricity service business from a small number of energy retailers vying for residential and commercial customers, and from the incumbent utilities. According to the California Public Utilities Commission ("CPUC"), over 300 companies were licensed to market electricity on a retail basis at the beginning of the deregulated California electricity market. According to the CPUC, we are one of approximately sixteen companies that remains in the business in California. We face similar competition in Pennsylvania. We face competition in selling energy efficient and emergency preparedness products from many sources, including traditional hardware retailers and online energy product retailers. We face competition in managing back office services from application service providers, outsourcing vendors, utility billing vendors and large enterprise-wide software and systems integrators. E. Employees. We currently employ approximately 160 people; 156 at the Tustin, California offices, and four at our Cherry Hill, New Jersey office. We are not a party to any collective bargaining agreement or labor union contract, nor have we been subjected to any strikes or employment disruptions in our brief history. Management believes that we enjoy a good relationship with our employees. F. Governmental Regulation. To market electric power in a given area, we are required to register with the appropriate state public utilities commission, maintain a Power Marketer certificate from FERC, and comply with applicable and regulatory requirements. The regulatory requirements with which we must comply relate to the complex inter-relationship of the regulatory framework of deregulation of the electric industry in each of the jurisdictions in which we conduct business. This interrelationship is between the state statutes and regulations which implement the structure of deregulation in any given state with the regulatory oversight agency, typically the State Public Utility Commission, which enforces the state statutes and regulations. Both of these regulatory agencies have the ability in their separate capacity to make orders, rulings or initiate proceedings which may alter or change the regulatory structure which impacts the applicable rule structure for any given jurisdiction. States will require that we be registered with, and comply with, the protocols of an ISO or RTO for scheduling and moving electricity on the transmission system. Some states require that power marketers must also meet a renewable energy portfolio standard where a portion of the electricity they sell must be generated by renewable energy resources. In some states, registration as a retail electric provider simply requires that we obtain and maintain a certificate or license to do business in the state. We have been granted the necessary FERC permit, and have applied for all relevant state license and certificates required in our initial target markets. G. Forward-Looking Statements. This report statement includes forward-looking statements. All statements other than statements of historical facts contained in this documents are forward-looking statements. Forward-looking statements include, but are not limited to, statements relating to expansion opportunities for the subsidiary companies, extension of Commonwealth's business model to new markets and industries, demand in the market for UtiliHost services, completion of acquisitions of certain assets, and growth or retail energy operations and demand for retail energy outsourcing and back office solutions. When used in this document, the words "anticipate," "believe," "estimate," "expects," "intend," "may," "project," "plan," "should," and similar expressions are intended to be among the statements that identify forward-looking statements. Although Commonwealth believes that its expectations reflected in these forward-looking statements are based on reasonable assumptions, such statements involve risks and uncertainties and no assurances can be given that 7 actual results will be consistent with these forward looking statements. In particular, the following items may affect our future: - The California State Legislature, the Governor's Office and the California Public Utilities Commission may enact and enforce legislation that could adversely affect our operations in California. - We are required to obtain and maintain licenses from the states in which we sell electricity. - In certain states, competitive restructuring of retail marketing may prevent us from selling electricity. - We are completely dependant upon a limited number of third parties that we do not control to generate and supply to us electricity and their failure or delay in entering into or performing their contracts with us will have a material adverse effect on our operations and financial condition. - We are completely dependent upon a limited number of utilities that we do not control for the transmission and distribution of the electricity we sell to our customers and their failure or delay in entering into or performing their contracts with us will have a material adverse effect on our operations and financial condition. ITEM 2. FINANCIAL INFORMATION A. Selected Financial Data. The following table summarizes certain selected financial data for Commonwealth Energy Corporation. Our statement of operations data for the period August 15, 1997 (date of incorporation) through July 31, 1998 and each of the three years in the period ended July 31, 2001 and our balance sheet data at July 31, 1998, 1999, 2000 and 2001 set forth below are derived from audited consolidated financial statements of the Company. The consolidated financial statements as of July 31, 2000 and 2001 and for each of the three years in the period ended July 31, 2001 and the independent auditor's report thereon, are included elsewhere herein. Our statement of operations data for the six months ended January 31, 2001 and 2002 and the balance sheet data at January 31, 2002 set forth below are derived from unaudited consolidated financial statements.
PERIOD FROM SIX MONTHS ENDED AUGUST 15, YEARS ENDED JULY 31, JANUARY 31, 1997 THROUGH ------------------------------ ----------------- JULY 31, 1998 1999 2000 2001 2001 2002 ------------- -------- -------- -------- ------- ------- (AMOUNTS IN THOUSANDS EXCEPT PER SHARE INFORMATION) (UNAUDITED) STATEMENT OF OPERATIONS DATA: Net revenue................... $ 1,387 $ 39,124 $ 99,624 $183,264 $95,765 $54,377 Direct energy costs........... 3,735 38,729 86,732 76,615 35,778 43,069 ------- -------- -------- -------- ------- ------- Gross (negative) margin....... (2,348) 395 12,892 106,649 59,987 11,308 Other costs and expenses(1)... 5,928 18,940 22,037 25,861 9,304 11,199 ------- -------- -------- -------- ------- ------- Income (loss) from operations.................. (8,276) (18,545) (9,145) 80,788 50,683 109 Interest income, net.......... 19 123 499 1,593 259 620 ------- -------- -------- -------- ------- ------- Income (loss) before income taxes....................... (8,257) (18,422) (8,646) 82,381 50,942 729 Provision for income taxes.... -- -- -- 21,852 11,318 292 ------- -------- -------- -------- ------- ------- Net income (loss)(2)(3)....... $(8,257) $(18,422) $ (8,646) $ 60,529 $39,624 $ 437 ======= ======== ======== ======== ======= ======= Net income (loss) per common share(4): Basic....................... $ (.96) $ (.84) $ (.30) $ 2.06 $ 1.35 $ .02 ======= ======== ======== ======== ======= ======= Diluted..................... $ (.96) $ (.84) $ (.30) $ 1.77 $ 1.16 $ .01 ======= ======== ======== ======== ======= ======= Weighted-average shares outstanding(4): Basic....................... 12,561 26,625 33,519 29,385 29,373 27,607 ======= ======== ======== ======== ======= ======= Diluted..................... 12,561 26,625 33,519 34,152 34,185 32,028 ======= ======== ======== ======== ======= =======
8
AT JULY 31, ------------------------------------- AT JANUARY 31, 1998 1999 2000 2001 2002 ------ ------- ------- -------- -------------- (UNAUDITED) BALANCE SHEET DATA: Working capital........................... $1,896 $12,428 $12,803 $ 50,184 $43,628 Total assets.............................. 7,205 27,858 41,590 107,016 98,849 Long-term debt............................ -- -- -- -- -- Shareholders' equity...................... 3,131 19,900 24,236 86,037 84,006
- --------------- (1) Includes stock-based compensation costs as follows:
AMOUNT -------------- (IN THOUSANDS) Period from August 15, 1997 through July 31, 1998........... $ 464 Year ended July 31, 1999.................................... 5,718 Year ended July 31, 2000.................................... 445 Year ended July 31, 2001.................................... 1,080 Six months ended January 31, 2001 (unaudited)............... -- Six months ended January 31, 2002 (unaudited)............... --
(2) No cash dividends have been paid on our common stock. (3) Our convertible preferred stock provides for cumulative dividends, which accrue at an annual rate of 10% and are payable at the discretion of our Board of Directors. Such dividends have been accrued as follows:
AMOUNT -------------- (IN THOUSANDS) Period from August 15, 1997 through July 31, 1998........... $64 Year ended July 31, 1999.................................... 84 Year ended July 31, 2000.................................... 84 Year ended July 31, 2001.................................... 81 Six months ended January 31, 2001 (unaudited)............... 42 Six months ended January 31, 2002 (unaudited)............... 36
(4) Per share information and weighted average shares outstanding for the period from August 15, 1997 through July 31, 1998, for the years ended July 31, 1999 and 2000 and for the six months ended January 31, 2001 have been restated to reflect the resolution of the status of our common stock issued to our founder as more fully described in Notes 1 and 11 of the Notes to Consolidated Financial Statements included elsewhere herein. B. Management's Discussion and Analysis of Financial Condition and Results of Operations. Our primary business to date has been the sale of electric power to retail and commercial end-users in California and, beginning January 2000, in Pennsylvania and the sale of electric power to wholesale customers in California and Pennsylvania. We are licensed by the FERC as a power marketer and by the California, Pennsylvania, New Jersey, Texas and Ohio Public Utilities Commissions as an electric services or electric generation supplier. We plan to enter new deregulated electric power markets in the future. We are in the licensing process in Michigan. As of January 31, 2002, we delivered electricity to approximately 90,600 customers in California and Pennsylvania. The growth of this business depends upon the deregulated status of each state, the availability of cost-effective energy purchases to us and the acquisition of retail or commercial customers by us. We do not have our own electricity generation facilities. The power we sell to our customers is purchased from generators. During fiscal 2000, in both California and Pennsylvania, we purchased electricity both under long-term contracts and in the spot market. By the end of fiscal 2001, substantially all of our electricity was purchased under long-term contracts. 9 CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates in the Company's consolidated financial statements relate to independent system operator costs, the allowance for doubtful accounts and unbilled receivables and legal claims. Actual results could differ from those estimates. Our net revenue from sales of electric power is recognized as the power is delivered to the Company's customers. Net revenue represents proceeds from energy sales to the following class of customers: Retail and commercial end users, and Wholesale. Direct energy costs include electric power purchased, independent system operator fees and scheduling coordination fees. The actual independent system (ISO) operator costs are not finalized until a settlement process by the ISO is performed of each days activities of all grid participants. Prior to the completion of settlement, we estimate and accrue for these costs based on preliminary settlement information. Selling and marketing expenses include salaries of sales and marketing personnel and promotional and advertising costs. General and administrative expenses include salaries for corporate support personnel, rent expenses, insurance expenses, bad debt expenses, depreciation expenses and other costs of the corporate office. As a result of market conditions in California during fiscal 2001, the credit worthiness of several participants in the marketplace with whom we conduct business has deteriorated significantly. The resulting impact on the Company has been a holdback of $3,696,854 in amounts due to us from the Automated Power Exchange (APX) related to November 2000, January 2001 and August 2001 activity. The APX has informed us that the holdbacks were made, in part because PG&E and PX, which have declared bankruptcy, did not make their scheduled payments to the APX. We have established an allowance of $2,327,171 for doubtful accounts related to the APX holdbacks based upon our estimates of the amounts that will ultimately be collected from the APX. In addition, PG&E has withheld payments of approximately $1,104,000 from their remittances to us. Although we have filed a Proof of Claim in PG&E's bankruptcy proceedings to recover these amounts, we have established an allowance for doubtful accounts in the amount of these withholdings. In addition to these specific allowances, we provide for estimated doubtful accounts on our energy sales. The Company's customers are billed monthly at various dates throughout the month. Unbilled receivables represent the amount of electric power delivered to customers at the end of a period, but not yet billed. Unbilled receivables from sales in California are estimated by the Company as the number of kilowatt hours delivered times 95% of the individual Utility Purchased Energy cost as published by each individual utility for residential customers. Unbilled receivables from sales in Pennsylvania are estimated in the same manner, except using the average current customer sales price per kilowatt hour. From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We accrue for estimated losses on such matters in accordance with Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies." RESULTS OF OPERATIONS SIX MONTHS ENDED JANUARY 31, 2002 COMPARED TO SIX MONTHS ENDED JANUARY 31, 2001 Retail Energy Sales Electricity sales to retail and commercial end-users decreased by $26.1 million, or 40.4% from $64.5 million for the six months ended January 31, 2001 to $38.5 million for the six months ended January 31, 2002. California electricity retail sales which decreased $28.4 million were offset by an increase in Pennsylvania electricity retail sales of $2.4 million. The average retail price per kWh in California for the six months ended January 31, 2001 was $.178 compared to $.085 for the six months ended January 31, 2002. Total kilowatt hours of electricity billed in California for the six months ended January 31, 2002 was 303.6 million compared to 311.4 million for the six months ended January 31, 2001. The average retail price 10 per kWh in Pennsylvania for the six months ended January 31, 2002 was $.056 compared to $.048 for the six months ended January 31, 2001. Total kilowatt hours of electricity billed in Pennsylvania for the six months ended January 31, 2002 was 217.5 million compared to 166.1 million in the prior year. At January 31, 2002, we had 90,000 customers compared to 95,000 customers at January 31, 2001. Wholesale energy sales The $13.8 million wholesale sales revenue for the six months ended January 31, 2002, consisted of California sales of $5.4 million and Pennsylvania sales of $8.4 million. Our major California wholesales customers were California Department of Water Resources and Sempra Energy. California wholesale energy sales decreased from $28.8 million for the six months ended January 31, 2001 to $5.4 million for the six months ended January 31, 2002. The wholesale price per kWh decreased from $.159 for the six months ended January 31, 2001 to $.024 for the six months ended January 31, 2002. Total wholesale kilowatt hours sold in California for the six months ended January 31, 2002 was 228.8 million compared to 180.9 million for the six months ended January 31, 2001. Pennsylvania wholesale energy sales increased from $.1 million for the six months ended January 31, 2001 to $8.4 million for the six months ended January 31, 2002. The wholesale price per kWh decreased from $.033 for the six months ended January 31, 2001 to $.026 for the six months ended January 31, 2002. Total wholesale kilowatt hours sold in Pennsylvania for the six months ended January 31, 2002 was 318.2 million compared to 2.9 million for the six months ended January 31, 2001. Green power credit Green power credit revenue decreased from $2.3 million for the six months ended January 31, 2001 to $2.1 million for the six months ended January 31, 2002. The decrease is due to a small increase in the customer base that was eligible for green power credits during the six months ended January 31, 2002 offset by the reserve of the January 2002 green power credit revenue. The January 2002 green power credit revenue was fully reserved because the legislative action to extend the program past December 31, 2001 has not been approved and the Company does not know if the subsidy will be continued. Direct energy costs Direct energy costs increased to $43.0 million for the six months ended January 31, 2002, an increase of $7.3 million, or 20.4%, from $35.8 million for the six months ended January 31, 2001. California direct energy costs decreased from $25.6 million during the six months ended January 31, 2001 to $17.4 million for the six months ended January 31, 2002. Pennsylvania direct energy costs increased from $9.8 million for the six months ended January 31, 2001 to $25.6 million during the six months ended January 31, 2002. The decrease in California direct energy costs was the result of lower energy purchase price and scheduling costs. Our California average energy purchase price decreased from $.054 per kWh during the six months ending January 31, 2001 to $.032 per kWh for the six months ended January 31, 2002. California scheduling costs were reduced $4.6 million by using one scheduler during the six months ended January 31, 2002 compared to three schedulers during the six months ended January 31, 2001. Scheduling costs were reduced by the final settlement of California ISO costs for $2.4 million below prior period estimates. Pennsylvania direct energy costs increased due to purchases of 542.7 million kWhs of electricity during the six months ended January 31, 2002 compared to purchases of 234.8 million kWhs during the six months ended January 31, 2001. Pennsylvania energy purchase price decreased from $.045 per kWh during the six months ended January 31, 2001 to $.038 per kWh for the six months ended January 31, 2002. Pennsylvania scheduling costs increased $2.6 million as a result of scheduling more kWh across the transmission and distribution system during the six months ended January 31, 2002 compared to the six months ended January 31, 2001. Direct energy costs, as a percent of net revenues, increased from 37.4% for the six months ended January 31, 2001 to 79.2% for the six months ended January 31, 2002. This increase was primarily the result of decreased sales prices in the California wholesale market. 11 Selling and marketing expenses Selling and marketing expenses decreased $.2 million, or 10.9%, from $2.0 million for the six months ended January 31, 2001 to $1.8 million for the six months ended January 31, 2002. The decrease is primarily a result of a decrease in contact center activities as the Company reduced its activities for the solicitation of new customers. Contact center salary costs decreased by $.3 million which was offset by an increase in marketing consultants of $.1 million. General and administrative expenses General and administrative expenses increased $2.1 million, or 28.9% from $7.3 million for the six months ended January 31, 2001, to $9.4 million for the six months ended January 31, 2002. This is primarily the result of increased legal expenses of $.9 million, the continued development activities on our billing system of $.3 million, management fees for Summit Energy Ventures of $.2 million, and Pennsylvania gross receipt taxes of $.4 million. The increase in legal expenses is primarily related to increased litigation defense costs and legal fees for filing our registration statement and reports with the Securities and Exchange Commission. Additionally, Summit Energy Venture management fees of $.2 million, not incurred in the prior year, are related to the formation of Summit in July 2002. Interest income Interest income increased to $.8 million for the six months ended January 31, 2002, an increase of $.1 million or 20.8%, from $.7 million for the six months ended January 31, 2001. The increase is attributable to an increase in our short term investments from the cash provided from operations during the second six months of fiscal 2001, partially offset by lower yields on short-term investments during the six months ended January 31, 2002. Interest expense Interest expense decreased to $.2 million for the six months ended January 31, 2002, a decrease of $.2 million or 52.2%, from $.4 million for the six months ended January 31, 2001. The decrease is attributable to lower borrowings under our revolving line of credit and a decline in the average interest rate for the six months ended January 31, 2001. Provision for income taxes The provision for income taxes decreased to $.3 million for the six months ended January 31, 2002, a decrease of $11.0 million from $11.3 for the six months ended January 31, 2001. We reported income of $.7 million before income taxes for the six months ended January 31, 2002 compared to income before income taxes of $50.9 million for the six months ended January 31, 2001. The provision for income tax as a percentage of income before income taxes was 40% and 22.2% for the six months ended January 31, 2002 and 2001, respectively. This increase in rate was due to the reversal of the valuation allowance on deferred tax assets of $10.3 million during the six months ended January 31, 2001. Net income Net income decreased to $.4 million for the six months ended January 31, 2002, a decrease of $39.2 million from the $39.6 million net income for the six months ended January 31, 2001. This decrease in net income is primarily attributable to a $48.7 million decrease in gross margin and an increase in general and administrative expenses of $2.1 million, offset in part by a decrease in selling and marketing expenses of $.2 million, a decrease in the provision for income taxes of $11.0 million and increase in net interest income of $.4 million. 12 YEAR ENDED JULY 31, 2001 COMPARED TO YEAR ENDED JULY 31, 2000 Retail energy sales Electricity sales to retail and commercial end-users increased by $12.7 million, or 14.5%, from $87.3 million for fiscal 2000 to $100.0 million for fiscal 2001. California electricity retail sales which decreased $4.1 million were offset by an increase in Pennsylvania electricity retail sales of $16.8 million. The average retail price per kWh in California during fiscal 2001 was $.145 compared to $.0501 during fiscal 2000. Total kilowatt hours of electricity billed in California during 2001 was 563.4 million compared to 1.7 billion billed in the prior year. The year-to-year reduction in kilowatt hours billed resulted from the termination of commercial and industrial customers that were returned to incumbent utilities during June and July 2000 because these customers were requiring us to purchase large quantities of electricity on the spot market which, in turn, gave us severe credit issues. The increased Pennsylvania retail sales were attributable to having a full year of electricity sales in fiscal 2001 compared to seven months of sales in the comparable period of 2000. The average retail price per kWh in Pennsylvania during 2001 was $.052 compared to $.0475 during fiscal 2000. Total kilowatt hours of electricity billed in Pennsylvania during 2001 was 378.6 million compared to 3.2 million in the prior year. At July 31, 2001, we had approximately 88,000 customers compared to approximately 81,000 customers at July 31, 2000. Wholesale energy sales Wholesale electricity sales commenced during fiscal 2001. The $79.3 million wholesale sales revenue consisted of California sales of $70.7 million and Pennsylvania sales of $8.6 million. Our major California wholesales customer during 2001 was the State of California Department of Water Resources and Power. Our other significant wholesale customers included Sempra Energy and San Diego Gas and Electric. The California supply and demand conditions that drove up the wholesale electricity prices during 2001 began moving toward equilibrium in the fourth quarter as wholesale prices began to abate. We expect to see lower prices and wholesale electricity sales as a percent of total sales much lower during fiscal 2002 than existed in fiscal 2001. Green power credit Green power credit revenue decreased by $8.3 million, or 67.7%, from $12.3 million for fiscal 2000 to $4.0 million for fiscal 2001. The green power credits decreased due to a rate reduction from $.015 to $.01 per kWh in June 2000 and reduced sales of electricity subject to the credit caused by the reduction of customers during June and July 2000. Direct energy costs Direct energy costs declined to $76.6 million for fiscal 2001, a decrease of $10.1 million, or 11.7%, from $86.7 million for fiscal 2000. This decrease is a result of $40.8 million lower costs in California partially offset by increased costs in Pennsylvania. Increased costs in Pennsylvania are due to having only seven months of costs totaling $3.4 million for fiscal 2000 compared to a full year of costs totaling $34 million for fiscal 2001. In Pennsylvania, for the seven months in fiscal 2000 that we operated there, our average monthly purchase of electricity was 8.8 million kWh increasing to 55.3 million kWh monthly for fiscal 2001, as we established our customer base. Decreased costs in California during fiscal 2001, as compared to the prior year, are due to reduced requirements for the purchase of electricity due to the customers we terminated in June and July 2000. Many of the customers that we terminated used the majority of their energy during peak hours which required us to purchase electricity in the spot market during the portions of the day when it was most expensive, often at a price in excess of our selling price. These customer terminations brought our electricity supply requirements in California to supply our customers at or below the quantity of electricity that we had secured under our long-term purchase contract and reduced the average amount we paid for electricity by approximately $.01 per kWh in fiscal 2001 as compared to fiscal 2000. Direct energy costs, as a percent of net revenues, decreased from 87.1% fiscal 2000 to 41.8% for fiscal 2001. 13 Selling and marketing expenses Selling and marketing expenses decreased $2.6 million, or 42.1%, from $6.2 million for fiscal 2000 to $3.6 million for fiscal 2001. This decrease is primarily a result of a decrease in promotional activities as the Company reduced its activities for the solicitation of new customers. Advertising costs decreased $1.9 million and telemarketing payroll decreased $.4 million due the reduction of personnel in that department. General and administrative expenses General and administrative expenses increased $5.8 million, or 37.7%, from $15.4 million for fiscal 2000 to $21.2 million for fiscal 2001. This is primarily the result of increased legal expenses of $5.3 million and bad debt expenses of $1.3 million compared to fiscal 2000. The increase in legal expenses is primarily related to the settlement with our founder of $4.8 million, and the increase in bad debt expense is related to the Company providing for amounts due from PG&E and PX, which have declared bankruptcy. These increases were partially offset by a decrease in customer termination cost of $.7 million incurred in fiscal 2000, where no further expenses were required in fiscal 2001. Stock-based compensation charges Stock-based compensation charges increased from $.4 million for fiscal 2000 to $1.1 million for fiscal 2001. The stock-based compensation charges for fiscal 2001 all resulted from performance-based stock options granted to our Chairman and CEO. Interest income, net Interest income grew to $1.6 million for fiscal 2001, an increase of $1.1 million or 220%, from $.5 million for fiscal 2000. The increase is attributable to the increase in cash flow available for investments provided from operations, offset in part by a $.6 million increase in interest expense due to borrowings which were outstanding on our line of credit during fiscal 2001. Provision for income taxes The provision for income taxes increased to $21.9 million during fiscal 2001 compared to no provision for income taxes for fiscal 2000 for which period we reported a loss before income taxes. The income tax rate for fiscal 2001 was 26.6% which is below the expected income tax rate primarily due to a reversal of the valuation allowance on our deferred tax asset in the amount of $13.6 million. Net income Net income increased to $60.5 million for fiscal 2001, an increase of $69.2 million, or 800.1%, from the $8.6 million loss for fiscal 2000. This increase in net income is primarily attributable to a $93.8 million increase in gross margin, offset in part by the provision for income taxes of $21.9 million. The key driver of the $93.8 million increase in gross margin was the significant increase in California electricity prices. California revenues rose substantially while the average cost per kWh of the electricity that we sold was lower than in the prior year. Because we were able to acquire electricity in California during fiscal 2001 under a fixed price electricity procurement contract, which extends through June 2002, the higher prices at which we were able to recall the electricity significantly increased our gross margin. During the fourth quarter of fiscal 2001, electricity prices and our gross margin significantly declined in California as compared to the first three quarters of fiscal 2001. We expect to see in fiscal 2002 electricity prices closer to historical levels than the prior year. YEAR ENDED JULY 31, 2000 COMPARED TO YEAR ENDED JULY 31, 1999 Net revenue Net revenues increased by $60.5 million, or 154.6%, from $39.1 million in fiscal 1999 to $99.6 million in fiscal 2000. California energy sales represented $57.7 million of the increase, while Pennsylvania sales, which 14 commenced in January 2000, accounted for $2.8 million of the increase. California electricity price increases that began in May 2000 contributed to an estimated $15.0 million of the increase in California energy sales. The green power credits received increased $8.8 million to $12.3 million for fiscal 2000 compared to $3.5 million in fiscal 1999 due to increased electricity sales subject to the credit. The remainder of the sales increase resulted from new customers. At July 31, 2000, the Company had approximately 81,000 customers compared to approximately 52,000 customers at July 31, 1999. Direct energy costs Direct energy costs grew to $86.7 million in fiscal 2000, an increase of $48.0 million, or 124.0%, from $38.7 million in fiscal 1999. This increase was due to a higher level of energy purchases in fiscal 2000 as compared to fiscal 1999 due to our increased customer base. Direct energy costs, as a percent of net revenues, decreased from 99.0% in fiscal 1999 to 87.1% in fiscal 2000. This decrease in the energy cost percentage was driven by the higher California retail prices during the latter part of fiscal 2000, an increase of higher margin residential customers and improved energy procurement methods. These favorable components were partially offset by higher costs of electricity purchases in the wholesale market for quantities in excess of our fixed price contract. Selling and marketing expenses Selling and marketing expenses increased $4.2 million, or 205%, from $2.0 million for fiscal 1999 to $6.2 million for fiscal 2000. This increase is due to higher costs associated with increased promotional and telemarketing activities as we changed our customer base from industrial to residential customers. General and administrative expenses General and administrative expenses increased $4.2 million, or 37.5%, from $11.2 million for fiscal 1999 to $15.4 million for fiscal 2000. Approximately $1.9 million of the increase is due to development and maintenance of our internal information technology systems. The remaining increase is due primarily to $.7 million of commercial and industrial customer termination costs and $1.2 million in increased costs related to severance arrangements with former officers. Stock-based compensation charges Stock-based compensation charges decreased by $5.3 million, or 92.2%, from $5.7 million for fiscal 1999 to $.4 million for fiscal 2000. The decrease was due to fewer fully vested options being granted in fiscal 2000, which also had a lower average difference between the fair value of the our common stock at date of grant and the option exercise prices. Interest income, net Interest income, net, grew to $.5 million in fiscal 2000, an increase of $.4 million, from fiscal 1999. The increase is attributable to having a full year's impact on investment income of capital raised in fiscal 1999. Net loss Net loss declined to $8.6 million in fiscal 2000, a decrease of $9.8 million, or 53.1%, from $18.4 million in fiscal 1999. This decrease in net loss is primarily attributable to a $12.5 million increase in gross margin offset in part by a $3.1 million increase in other costs and expenses. LIQUIDITY AND CAPITAL RESOURCES Through July 31, 2000, most of our capital was raised through a series of private placements for the sale of common stock which provided an aggregate of $51.1 million of net proceeds, of which $41.3 million was used to support our operating activities which were unprofitable through July 31, 2000. We began profitable operations during the three months ended October 31, 2000. 15 Cash flow used in operations for the six months ended January 31, 2002 was $3.7 million, a decrease of $51.5 million compared with cash provided by operations for the six months ended January 31, 2001 of $47.8 million. Net income for the six months ended January 31, 2002 of $.4 million, compared to a net profit of $39.6 million for the six months ended January 31, 2001, was the primary reason for this decrease which primarily resulted from California's lower wholesale prices. In addition, during the six months ended January 31, 2002, there was a decrease in energy receivables of $1.9 million also due to the lower wholesale prices in California, a decrease in accounts payable of $1.6 million, a decrease in accrued expenses of $4.2 million due to legal settlement with our former CEO, and a decrease in deposits, prepaids and other assets of $1.0 million. Investing activities for six months ended January 31, 2002 include purchases of property and equipment of $1.1 million, an increase of $.9 million compared to the six months ended January 31, 2001 and investments through Summit Energy of $4.9 million. Cash flow provided by financing activities for the six months ended January 31, 2002 was $1.9 million, compared to cash used of $2.5 million for the six months ended January 31, 2001. The increase of $4.4 million is due primarily to the $2.4 million repurchase of common stock during the six months ended January 31, 2002 and a decrease in borrowings under our line of credit of $.3 million. In addition, during the six months ended January 31, 2001 we were required to increase our restricted cash to fund letters of credit of $1.7 which was not required during the six months ended January 31, 2002. Cash flow from operations for fiscal 2001 was $61.8 million an increase of $76.9 million compared with cash used from operations in fiscal 2000 of $15.0 million. Net profit for fiscal 2001 of $60.5 million, compared to a net loss of $8.6 million for fiscal 2000, was the primary reason for this increase. California's higher retail and wholesale prices were the key influences on our profitability. Investing activities for fiscal 2001 include only purchases of property and equipment of $1.1 million, a decrease of $.6 million compared to fiscal 2000. Cash used in financing activities for fiscal 2001 was $23.8 million, compared to cash provided of $14.7 million for fiscal 2000. The change of $38.4 million is attributable to the following: $15.0 million investment in Summit Energy Ventures which is classified as restricted cash; absence of sales of common stock during fiscal 2001, which provided $12.1 million during fiscal 2000; an increase in restricted cash of $4.8 million for letters of credit required by energy suppliers to support increased purchases of electricity in fiscal 2001 and $5.3 million provided in fiscal 2000 from borrowings under our credit facility. Cash flow used in operations for fiscal 2000 was $15.0 million, a decrease in cash used of $5.2 million compared to fiscal 1999. The major components of cash used in operations in fiscal 2000 were the net loss of $8.6 million and an increase in billed and unbilled accounts receivable of $13.2 million. The higher California electricity prices in the fourth quarter of fiscal 2000 drove sales higher resulting in higher accounts receivables. During fiscal 2000, we used cash of $1.8 million for investing activities, a decrease of $.7 million compared with the prior year. Investing activities during fiscal 2000 consisted only of purchases of property and equipment. Financing activities in fiscal 2000 were comprised of three components. Net cash proceeds from the sale of common stock were $12.1 million. This compares with $28.3 million in net capital raised in fiscal 1999 from the sale of common stock. We also borrowed $5.3 million under a $15 million credit facility that was entered into with Coast Business Credit in June 2000. The credit facility with Coast Business Credit carried a loan origination fee of $300,000 and required the issuance to Coast Business Credit of a warrant to purchase 100,000 shares of our common stock at an exercise price of $5.50 per share. The loan has a maturity date of June 30, 2002, subject to automatic renewal and early termination, and bears interest at the prime rate plus 1.75% per annum, calculated on the basis of a 360-day year. The borrowings from the credit facility were used primarily to pay for California electricity purchases, the price of which had increased significantly during the fourth quarter of fiscal 2000. There was also an increase of $2.7 million in restricted cash during fiscal 2000 required for additional collateral to support additional energy purchases both in California and Pennsylvania. The most significant trend that has contributed to the decrease in our liquidity and capital resources during the six months ended January 31, 2002 was the significant decrease in energy prices to consumers and 16 in the wholesale energy markets in California. During fiscal 2001, our liquidity and capital resources increased as a result of the significant increase in energy prices to consumers and in the wholesale energy markets in California. We believe that consumer energy prices have leveled off and will remain at their current level for the foreseeable future. The wholesale energy market has also stabilized after significant fluctuations during fiscal 2000 and fiscal 2001. Based upon current market conditions, we believe we should be able to enter into new contracts to purchase electricity at approximately the currently contracted rate upon the expiration of our current contract in June 2002. Therefore, based on these factors, we believe that our liquidity and capital resources will not be adversely affected in the coming year. As a result of market conditions in California during fiscal 2001, the credit worthiness of several participants in the marketplace with whom we conduct business has deteriorated significantly. The resulting impact on the Company has been a holdback of $3,696,854 in amounts due to us from the Automated Power Exchange (APX) relating to November 2000 and January 2001 activity. The APX has informed us that the holdbacks were made, in part, because PG&E and PX, which have declared bankruptcy, did not make their scheduled payments to the APX. We have established an allowance of $2,327,171 for doubtful accounts related to the APX holdbacks based upon our estimates of the amounts that will ultimately be collected from the APX. In addition, PG&E has withheld payments of approximately $1,104,000 from their remittances to us. Although we have filed a proof of claim in PG&E's bankruptcy proceedings to recover these amounts, we have established an allowance for doubtful accounts in the amount of these withholdings. On September 20, 2002, the CPUC issued a ruling suspending "direct access" pursuant to legislation by the California state legislature requiring the CPUC to suspend "direct access" in California. The suspension of "direct access" means that retail electricity suppliers, such as the Company, will not be allowed to actively seek customers. This ruling permits the Company to keep its current customer base, but prohibits the Company from signing up new non direct access customers for an undetermined period of time. During June through September 2001, we entered into new long-term electric service agreements with several large commercial and industrial customers in California. The contracts were all completed prior to the September 20, 2001, CPUC ruling to suspend "direct access." Based on the historical consumption data of these commercial and industrial customers, we expect these new contracts to add approximately 600 million kWhs annually at sales contract rates in the aggregate of $.089 per kWh. Delivery to these customers began in October 2001 and all the new customer meters were on-line by January 2002. In the event that the CPUC should retroactively invoke the suspension of direct access, all of these contracts would be void and the customers returned to their respective UDC. Revenues related to these contracts was $.7 million for the six months ended January 31, 2002. We are actively seeking relief from this ruling. There is no assurance that any legislative or legal appeal will give us relief from the state's suspension of direct access. As of January 31, 2002, $15 million in cash was invested in Summit Energy Ventures. Under certain circumstances, we may, at our discretion, invest an additional $10 million in Summit. If this additional cash were invested with Summit, it would reduce the amount of cash that would otherwise be used for our growth initiatives. The initial $15 million credit facility that the Company obtained on June 29, 2000 was restructured on August 10, 2001. This restructuring provided the Company with more flexibility than the original agreement. The new line shortened the maturity date to June 30, 2002, compared to June 30, 2003. If we decide to evaluate alternative lenders and can find a lender with more favorable terms, we can make the change twelve months earlier without incurring a one percent pre-payment penalty. It also provides us with an opportunity to eliminate the .5% renewal fee. We reduced the limit of the credit facility from $15 million to $10 million to decrease the minimum interest charges. By reducing the credit facility limit, the minimum interest charge is calculated on $3.5 million (35% of $10 million) compared with the initial agreement's $5.2 million (35% of $15 million). The interest rate charged remains the same at prime plus 1.75%. The cost to amend the original agreement was $20,000. On January 4, 2002, the Board of Directors of the Company approved a $10 million stock repurchase program. Under this program, the Company may purchase up to $10 million of its common stock, options and 17 warrants from time to time over an 18 month period, in open market or privately negotiated, subject to market conditions and other factors. As of January 31, 2002, the Company has minimum contractual obligation as follows:
FOR THE SIX MONTHS FOR THE YEARS ENDING JULY 31, ENDED ----------------------------------- TOTAL JULY 31, 2002 2003 2004 2005 ----------- ------------- ----------- ----------- ------- Electricity purchase contracts..... $83,485,800 $30,773,820 $32,565,300 $20,146,680 $ -- Notes payable under line of credit........................... 3,578,753 3,578,753 -- -- -- Operating leases................... 1,475,072 422,700 652,949 371,835 27,588 ----------- ----------- ----------- ----------- ------- $88,539,625 $34,775,273 $33,218,249 $20,518,515 $27,588 =========== =========== =========== =========== =======
The Company is in negotiations to secure new California energy purchase contracts comparable to the existing contract which expires June 2002. Based upon current market conditions, we believe we should be able to enter into new contracts to purchase electricity at approximately the currently contracted rate. We expect that our existing funds, our existing line of credit and our cash flow from operations will be sufficient to fund our operations and meet our capital requirements for the next 12 months. C. Inflation. Inflation has not been a material factor in either revenue or operating expenses during our existence. D. Quantitative and Qualitative Disclosures About Market Risk. We do not have or use any derivative instruments as of January 31, 2002 nor do we have any plans to enter into such derivative instruments. We generally invest cash equivalents in high-quality credit instruments consisting primarily of high yielding money market funds, bankers acceptance notes and government agency securities with maturities of 90 days or less. We do not expect any material loss from our cash equivalents and, therefore, believe that our potential interest rate exposure is not material. We do not currently invoice customers in any currency other than the United States dollar. In addition, we do not currently incur significant expenses denominated in foreign currencies. Therefore, we believe that we are not currently subject to significant risk as a result of currency fluctuations. An electricity price change of per $.01 kWh, has an estimated annual impact on our net revenue of: California............................................. $18.1 million Pennsylvania........................................... $11.0 million
ITEM 3. PROPERTIES Our principal executive office is located in Tustin, California. This facility houses our administrative operations. The Company leases approximately 33,104 square feet of office space at these premises pursuant to a lease that expires on April 14, 2004. We lease additional office space for our operations in Cherry Hill, New Jersey. This additional space consists of 1,210 square feet pursuant to a three-year lease executed on August 25, 1999. We believe that our leased property is in good condition, is well maintained and is adequate for our current and immediately foreseeable operating needs. ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information with respect to beneficial ownership of our Series A Convertible Preferred Stock and Common Stock as of September 30, 2001 for: - each person known by us to beneficially own more than 5% of our Series A Convertible Preferred Stock or 5% of our common stock; 18 - each executive officer named in the Summary Compensation Table set forth in Item 6 -- "Executive Compensation"; - each of our directors; and - all of our executive officers and directors as a group. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and includes voting or investment power with respect to the securities. Unless otherwise indicated, the address for those listed below is c/o Commonwealth Energy Corporation, 15901 Red Hill Avenue, Suite 100, Tustin, California 92780. Except as indicated by footnote, and subject to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them. In preparing the table below, we have relied upon information supplied by such persons and our stock records. The number of shares of common stock outstanding used in calculating the percentage for each listed person includes the shares of common stock underlying options held by such persons that are exercisable within 60 days of January 31, 2002, but excludes shares of common stock underlying options held by any other person. Percentage of beneficial ownership is based on 27,323,071 shares of common stock and 775,000 shares of Series A Convertible Preferred Stock outstanding as of January 31, 2002.
PERCENT TITLE OF CLASS NAME AMOUNT OF CLASS -------------- ------------------------ --------- -------- Series A Convertible Preferred Stock.... Robert Perkins 25,000 3.23% Joseph P. Saline 0(10) * Common Stock............................ Ian B. Carter 2,400,000(1) 8.09% Robert Perkins 327,000(2) 1.19% Richard Paulsen 450,000(3) 1.62% John Barthrop 300,000(4) 1.09% James Oliver 250,000(5) * Brad Gates 100,000(6) * Junona Jonas 50,000(7) * Series A Convertible Preferred Stock.... Directors and Executive Officers as a Group 25,000 3.23% Common Stock............................ Directors and Executive Officers as a Group 3,877,000(8) 12.53%(9)
- --------------- * Represents less than one percent. (1) Includes an option to purchase 2,350,000 shares that may be exercised as shares within 60 days of January 31, 2002. (2) Includes an option to purchase 150,000 shares that may be exercised as shares within 60 days of January 31, 2002. (3) Includes an option to purchase 450,000 shares that may be exercised as shares within 60 days of January 31, 2002. (4) Includes an option to purchase 298,000 shares that may be exercised as shares within 60 days of January 31, 2002. (5) Includes an option to purchase 250,000 shares that may be exercised as shares within 60 days of January 31, 2002. (6) Includes an option to purchase 100,000 shares that may be exercised as shares within 60 days of January 31, 2002. (7) Includes an option to purchase 50,000 shares that may be exercised as shares within 60 days of January 31, 2002. 19 (8) This figure is based on the current number of shares of Common Stock that each director and executive officer of the Company owns plus the number of shares of Common Stock that each director and executive officer has the right to obtain within 60 days from January 31, 2002. (9) This percentage was derived by dividing the figure obtained in footnote (8) above by the total number of shares of Common Stock outstanding as of November 30, 2001 plus the number of shares of Common Stock that each director and executive officer has the right to obtain within 60 days from January 31, 2002. (10)Mr. Saline has filed a claim for certain preferred shareholder rights which differ from the rights set forth in the Certificate of Determination. The Company has returned his original investment of $25,000 wherein he claims to have purchased 50,000 shares. See Item 8 -- Legal Proceedings. ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS In November 2000 at the annual meeting of shareholders, the shareholders adopted a Bylaw amendment changing the number of authorized directors to five. The November 2000 vote to adopt a fixed number of five directors was adopted by the affirmative votes of a narrow majority of the outstanding shares entitled to vote as required by Sections 211, 212 and 152 of the California Corporations Code. That majority was 14,989,333, out of approximately 29.3 million shares. The proper number of shares outstanding in November 2000 was approximately 29.3 million. This number was derived by eliminating from the record any reference to 4.72 million shares of Fred Bloom's Common Stock that were subsequently stipulated on August 10, 2001 to be void. That stipulation was accepted by the Superior Court having jurisdiction over our litigation (see Item 8 -- Legal Proceedings). "Void" means "void ab initio"; or having never been issued. Therefore, the 4.72 million shares were void from the beginning and could never be counted in determining any vote. In addition, in calculating whether the shareholders achieved an affirmative majority of 29.3 million shares, Mr. Bloom's 1.2 million "accommodation shares" were not counted as outstanding shares entitled to vote because by contract (the Accommodation Agreement between the Company and Mr. Bloom, which has been honored by both parties) Mr. Bloom had given up that right for all purposes. As a matter of contract, these shares could not be voted by anyone. A. Identification of Directors. Our directors and their ages as of January 31, 2002 are as follows:
NAME AGE POSITION ---- --- -------- Ian B. Carter.................................. 63 Chairman of the Board Craig G. Goodman............................... 52 Director Robert C. Perkins.............................. 62 Director Junona A. Jonas................................ 58 Director Joseph P. Saline, Jr........................... 60 Director
The directors of the Company serve as such until the next annual meeting of the shareholders of the Company or until their successors are elected and qualified. IAN B. CARTER -- CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER Mr. Carter has been a member of the Board since January 1999 and Chief Executive Officer since January 2000. For four months prior to that, he acted as Interim President. From June 1986 through September 1999, Mr. Carter spent 14 years with Coldwell Banker Commercial Brokerage, as an investment specialist. Prior to that, he spent four years as a Systems Engineer and Salesman with IBM. Mr. Carter spent almost seven years in the United States Army serving in Vietnam, Europe and the Pentagon. Mr. Carter received his Bachelor of Science (BS) degree in Engineering from the United States Military Academy at West Point, New York and his Master in Business Administration (MBA) in finance from the University of Southern California. 20 CRAIG G. GOODMAN -- DIRECTOR From 1997 to the present Mr. Goodman has served as the Chief Executive Officer of the National Energy Marketers Association, a national non-profit association representing a regionally diverse cross-section of wholesale and retail marketers of natural gas, electricity and energy-related products, services, information and technology. Mr. Goodman is admitted to the bars of the states of Texas and Florida, as well as Washington, D.C. and the U.S. Supreme Court. Mr. Goodman received his bachelor's degree in economics with honors from the University of Maryland and a juris doctorate degree with a concentration in international corporate law and economics from the University of Miami School of Law. ROBERT C. PERKINS -- DIRECTOR Mr. Perkins has been a member of the Board since January 1999. For the past 30 years, Mr. Perkins has served as Chairman and CEO of Hospital Management Services providing financial and management consulting to hospitals and similar institutions. Mr. Perkins received his Bachelor of Science degree in accounting from Bob Jones University. JUNONA A. JONAS -- DIRECTOR Ms. Jonas has been a member of the Board since January 2001. She brings experience from a career with PG&E that spanned from 1978 through 1999 during which time she served as the first President and COO of PG&E's retail energy services subsidiary, Vantus Energy Corporation, and subsequently served as Vice President, Gas and Electricity Supply at PG&E. Ms. Jonas also served as past President and COO of utility.com. She currently serves as the General Manager of Alameda Power and Telecom. Ms. Jonas has a Bachelors degree from Santa Clara University and a Masters degree from Stanford and Cal State University Hayward. JOSEPH P. SALINE, JR. -- DIRECTOR Mr. Saline has been a member of the Board since January 2001. Mr. Saline is currently an Operations Manager at Litton Industries in their Integrated Systems Division, and also serves on the board of directors of InterBill Inc. in Rohnert Park, California. Mr. Saline retired as a Colonel in the United States Air Force Reserve. He received a Bachelors degree from the University of Detroit and a Masters degree from Purdue University. B. Identification of Executive Officers. Our executive officers and their ages as of January 31, 2002 are as follows:
NAME AGE POSITION ---- --- -------- Ian B. Carter............................ 63 Chief Executive Officer Richard L. Paulsen....................... 53 Chief Operating Officer James L. Oliver.......................... 53 Chief Financial Officer John A. Barthrop......................... 58 General Counsel and Secretary
RICHARD L. PAULSEN -- CHIEF OPERATING OFFICER Mr. Paulsen has been the Chief Operating Officer since May 2000. Mr. Paulsen previously served as the CEO and President of Olicon Imaging Systems, Inc., a national supplier of diagnostic imaging products and services. Prior to that, Mr. Paulsen worked at Wieden and Kennedy, Inc. an advertising agency, as Executive Vice President and Chief Operating Officer. From 1978 to 1986, he started and financed the firm of Basic Computer Systems, Inc., a national supplier of application software and systems. Mr. Paulsen graduated from Loyola University with a Bachelor of Science degree in mathematics. 21 JAMES L. OLIVER -- CHIEF FINANCIAL OFFICER Mr. Oliver has been the Chief Financial Officer of the Company since November 1999. Mr. Oliver spent seven years with Emerson Electric Co. as Chief Financial Officer for two operating units. Prior to that, Mr. Oliver served as CFO for a business unit of Smithkline Beckman, as head of strategic and financial planning for an operating unit of Dresser Industries. He has consulted for a variety of companies including Snapple, the Stanley garage door opener business and the private equity firm of former U.S. Secretary of the Treasury, William E. Simon. Mr. Oliver received his Bachelor of Science degree in accounting and finance from the University of Southern California. JOHN A. BARTHROP -- GENERAL COUNSEL Mr. Barthrop has been our General Counsel since May 1999, and has over 30 years of experience practicing law and counseling businesses. Prior to accepting a position with us, he was a principal member of the business and litigation law firm of Smith, Sinek & Barthrop. He owned and operated his own law firm in Orange, California for over 15 years. He was General Counsel and Assistant to the President for Newman Properties, a national real estate development company, responsible for negotiating phased retail development projects in the Western states. He was also Associate General Counsel for the Beneficial Standard, a conglomerate involved in insurance, finance and real estate . Mr. Barthrop obtained a Bachelor of Science degree from the University of Washington and a Juris Doctorate from University of California, Hastings College of Law, and is licensed to practice before the State Courts and the U.S. District Courts. C. Family Relationships. There are no family relationships among directors, executive officers or persons nominated or chosen by the Company to become directors or executive officers. ITEM 6. EXECUTIVE COMPENSATION The following table sets forth for each of the past three fiscal years, all compensation received for services rendered in all capacities by all persons serving as chief executive officer and each of the other current most highly compensated executive officers of our company.
LONG TERM COMPENSATION --------------------------------------------- ANNUAL COMPENSATION AWARDS PAYOUTS ---------------------------------------- ---------- -------------------------------- (a) (b) (c) (d) (e) (g) (h) OTHER (f) SECURITIES (i) ANNUAL RESTRICTED UNDERLYING ALL OTHER NAME AND PRINCIPAL FISCAL COMPEN- STOCK OPTIONS/ LTIP COMPEN- POSITION YEAR SALARY BONUS SATION(2) AWARD(S) SARS(4) PAYOUTS SATION ------------------ ------ -------- -------- --------- ---------- ---------- ------- --------- Ian Carter,.................. 2001 $313,336 $100,000 $15,600 -- 300,000 $ -- $ -- Chief Executive Officer 2000 211,932 -- 7,800 -- 3,300,000(3) -- -- 1999 -- -- -- -- 200,000 -- -- Frederick Bloom,............. 2001 -- -- -- -- -- -- 92,138(1) Former Chief 2000 184,899 50,000 -- -- -- -- 40,373(1) Executive Officer 1999 168,250 25,000 -- -- -- -- -- Richard Paulsen,............. 2001 248,326 50,000 4,155 -- 900,000 -- -- Chief Operating Officer 2000 36,250 -- -- -- -- -- -- John Barthrop,............... 2001 150,971 40,000 4,800 -- 500,000 -- -- General Counsel 2000 101,552 -- -- -- -- -- -- 1999 21,154 -- -- -- 50,000 -- -- James L. Oliver,............. 2001 140,526 40,000 4,800 -- 500,000 -- -- Chief Financial Officer 2000 76,058 -- 2,800 -- -- -- --
- --------------- (1) Represents severance payments made in conjunction with the employee's resignation and severance agreement effective June 1, 2000. (2) Represents auto allowance paid. 22 (3) Includes an option to purchase 2,600,000 shares pursuant to performance criteria in his employment contract. (4) This column represents options and are not to be confused with shares. Once earned these options may be exercised as stock at the designated option price. The compensation table above excludes $1,080,000 of stock-based compensation charged to operations in fiscal 2001 related to Mr. Carter's performance-based stock options granted. The difference between the exercise price of these stock options and the estimated fair value of the Company's common stock as estimated by the Company's management for financial reporting purposes is recorded as stock-based compensation charges. We currently have in place our 1999 Equity Incentive Plan, pursuant to which 7,000,000 shares of common stock are reserved for issuance, to provide incentive compensation to our employees. Directors are eligible for the Company's 1999 Equity Incentive Plan if they are both Directors and employees. At this time, Ian Carter is the Company's only employee Director and is therefore the only Director that qualifies to participate in the tax benefits under this plan. The following table sets forth information concerning nonqualified stock options granted our 1999 Equity Incentive Plan to the executive officers during the fiscal year ended July 31, 2001.
POTENTIAL REALIZABLE VALUE AT % OF TOTAL ASSUMED ANNUAL RATES OF STOCK # OF SECURITIES OPTIONS PRICE APPRECIATION FOR OPTION UNDERLYING GRANTED TERM OPTIONS TO EMPLOYEE IN EXERCISE EXPIRATION ------------------------------ NAME GRANTED FISCAL YEAR PRICE(1) DATE 5% 10% ---- --------------- -------------- -------- ---------- ------------- ------------- Ian Carter........... 300,000 10.2% $2.50 01/01/10 $ 471,671 $1,195,307 Richard Paulsen...... 900,000 30.5% 2.75 11/01/07 1,007,574 2,348,075 John Barthrop........ 500,000 16.9% 2.75 11/01/07 559,763 1,304,486 James L. Oliver...... 500,000 16.9% 2.75 11/01/07 559,763 1,304,486
- --------------- (1)All stock options were granted with exercise prices determined by the Board of Directors or Compensation Committee to be the fair market value of the underlying shares of Common Stock at the date of grant of the stock option. No trading market existed for the underlying stock at the date of grant of the stock options summarized in this table. The following table sets forth information concerning the aggregate stock options exercised by and granted to the executive officers during the fiscal year ended July 31, 2001.
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS SHARES AT JULY 31, 2001 AT JULY 31, 2001 ACQUIRED ON VALUE ------------------------- ------------------------- NAME AND PRINCIPAL POSITION EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE - --------------------------- ----------- ----------- ------------------------- ------------------------- Ian B. Carter, Chief Executive Officer...... -- $ -- 1,950,000/1,650,000 $1,497,500/907,500 Richard Paulsen, Chief Operating Officer...... -- -- 225,000/775,000 67,500/232,500 John Barthrop, General Counsel.............. 2,000 2,002 173,500/375,000 159,000/112,500 James L. Oliver, Chief Financial Officer...... -- -- 125,000/375,000 37,500/112,500
(A) COMPENSATION COMMITTEE INTERLOCKS Executive compensation is determined by a Compensation Committee elected by our Board of Directors. The Compensation Committee is currently comprised of: Robert Perkins, Craig Goodman and Ian Carter. The Compensation Committee meets periodically or on an as needed basis and decides compensation structure and amounts on the basis of comparable executive compensation structures and amounts as 23 established by a peer group of companies, our performance and other factors as may be determined to be useful in making such determination by the Compensation Committee. Except for Mr. Carter, none of the Compensation Committee members are or has been an officer or employee of Commonwealth Energy Corporation. Mr. Carter recuses himself on compensation issues relating to himself. No member of the Compensation Committee is or has been a director or member of the compensation committee of another entity, one of whose executive officers serves or has served on our Compensation Committee. In addition, no member of the Compensation Committee is or has been a member of a compensation committee of another entity, one of whose executive officers is or has been a member of our Board of Directors. The Compensation Committee was formed by the Board in September 1999, and both Mr. Perkins and Mr. Carter were appointed to the Compensation Committee in December 1999. Mr. Goodman was appointed in January 2002 and replaced Mr. Gates (a former board member) on the Compensation Committee. (B) EMPLOYMENT AGREEMENTS Ian B. Carter. Mr. Carter serves as Chairman and Chief Executive Officer of the Company pursuant to an employment agreement originally entered into on January 1, 2000, as amended and restated on November 1, 2000. The agreement provides for Mr. Carter's employment through January 31, 2005. Mr. Carter received a base salary of $275,000 for the first twelve months of his employment and will receive a salary according to the following schedule, subject to possible increases which the Board of Directors may grant from time to time: $325,000 for the second twelve months, $375,000 for the third twelve months, $425,000 for the fourth twelve months and $500,000 for the fifth twelve months. In addition, Mr. Carter is entitled to receive a bonus of $100,000 and any additional discretionary cash bonus based on the Company's results of operation. Under his employment agreement, Mr. Carter is eligible to earn options to purchase, in the aggregate, up to 4,500,000 shares of the Company's common stock at an exercise price of $2.50 per share, expiring on January 1, 2010. The option includes the rights to purchase 700,000 shares upon the execution of his employment agreement, with 300,000 vested immediately and an additional 100,000 vest each January 1 from 2001 through 2004. As of January 4, 2002, 500,000 of such automatically vest options had vested. An additional option covering 2,300,000 shares were granted upon execution and is performance-based, vesting upon the occurrence of certain events as specified on page F-17 of the Notes to the Consolidated Financial Statements. As of January 4, 2002, 1,250,000 of such performance-based options had vested. Mr. Carter's employment agreement further provides for the granting of up to 300,000 additional options each January from 2001 through 2004 upon meeting or exceeding the Company's financial performance objectives as set forth in its business plans for years 2000 through 2004. The Company met said performance goal in 2000 and exceeded it by at least 10% in 2001, earning Mr. Carter the right to purchase 100,000 and 300,000 shares in January 2001 and January 2002, respectively. Prior to entering into, and separate from, his employment agreement, Mr. Carter had received 200,000 vested options. As of January 2002 Mr. Carter holds, in the aggregate options exercisable to purchase up to 2,350,000 shares of the Company's common stock. If during the term of the agreement, Mr. Carter is terminated, leaves, or is replaced as a result of: (i) all or substantially all of the assets of the Company or more than fifty percent (50%) of the issued and outstanding voting shares of the Company being acquired by any one person or entity not then affiliated with the Company; (ii) control of the Company being taken over by a group of shareholders when no significant change of ownership has taken place; or (iii) a merger, acquisition, strategic alliance or any other event that could bring substantial capital into the Company, the Company will pay Mr. Carter an amount equal to eight times the annual base salary due him plus the amount of taxes payable by Mr. Carter under I.R.S. Code sec. 280G. In such events, Mr. Carter has the right to require the Company to repurchase all of his stock and all stock options referenced in his agreement, whether earned or unearned, at a value two (2) times the then aggregate price value of the Company's stock. The Company may terminate Mr. Carter's employment upon the occurrence of any of the following: Mr. Carter's death, total disability, or for cause. "Total disability" is deemed to have occurred if Mr. Carter is incapacitated for 120 consecutive calendar days or for 150 calendar days (whether or not consecutive) in any 180 calendar day period. Upon a termination for death or total disability, the Company will continue to pay Mr. Carter for a period of one year thereafter or until expiration of the term of the agreement, whichever 24 occurs first, his then current base salary and bonus. "For cause" is limited to a conviction, entry of plea of guilty or nolo contendere for any felony that would materially and adversely interfere with his ability to perform his services of his employment. In the event of a termination for cause, Mr. Carter is entitled to receive all compensation and benefits payable to him through the date of termination. Mr. Carter may only terminate his employment "for cause," which is limited to either (i) the sale of all or substantially all of the Company's assets to a person unaffiliated with the Company or the occurrence of a change of control without Mr. Carter's consent or (ii) the Company's material breach of the agreement. In the case of a termination described in (i) above, Mr. Carter is entitled to receive a payment equal to eight times his then current base salary. In the case of termination under (ii) above, Mr. Carter is entitled to receive a payment equal to the monetary value of all of the compensation and benefits payable to him for the remainder of the term. If at the expiration of the term, the Company has met or exceeded the projections set forth in the business plan, and the Company does not offer to extend Mr. Carter's employment on terms no less favorable than those stated in the agreement, the Company will pay Mr. Carter a sum of $100,000 for a period of ten years. Mr. Carter will consult to the Company during that period and be Vice-Chairman of the Board. Richard L. Paulsen. Mr. Paulsen serves as Chief Operating Officer of the Company pursuant to an employment agreement entered into on November 1, 2000. The agreement provides for Mr. Paulsen's employment through December 31, 2004. Mr. Paulsen will receive a base salary according to the following schedule, subject to increases which the CEO and the Compensation Committee may grant from time to time: $275,000 for the first twelve months of his employment, $325,000 for the second twelve months, $375,000 for the third twelve months and $425,000 per annum thereafter. Mr. Paulsen will be entitled to an annual cash bonus of $75,000 for calendar years 2001 and 2002, and $100,000 thereafter based upon the number of meters then under contract. If during the term of the agreement there is a Change in Control, then the Company will pay Mr. Paulsen a cash bonus equal to the sum of eight times his then annual base salary plus the amount of taxes payable by him under I.R.S. Code sec. 280G. A "Change in Control" is generally defined as any of the following: (i) any person acquires 50% or more of (A) the outstanding shares of Common Stock of the Company or (B) the combined voting power of the Company's then-outstanding securities entitled to vote generally in the election of Directors; (ii) during any period of not more than two consecutive years, the incumbent Directors cease for any reason to constitute at least a majority of the Board of Directors; or (iii) a merger or consolidation resulting in the holders of voting securities of the Company outstanding immediately prior thereto failing to continue to represent at least 50% of the combined voting power of the voting securities of the Company, or the Company's sale or disposition of all or substantially all of the Company's assets or any transaction; (iv) the Company is subject to a hostile takeover in the form of a proxy fight; or (v) any other means that allows the Company to be controlled by a material change in the Board of Directors. In such events, Mr. Paulsen has the right to require the Company to repurchase all of his stock and all stock options referenced in his agreement, whether earned or unearned, at a value two (2) times the then aggregate price value of the Company's stock, not to exceed $10.00 per share. The agreement will terminate upon the occurrence of any of the following: Mr. Paulsen's death, "total disability" (as defined above), material breach of the agreement or fiduciary duty by Mr. Paulsen or written notice of Mr. Paulsen's decision to terminate his employment. If Mr. Paulsen's employment is terminated in any of the manners described above, he will be entitled to receive the base salary and benefits earned through the date of termination. If Mr. Paulsen's employment is terminated for any other reason, then he will be entitled to receive (i) his base salary and benefits earned through the date of termination and (ii) an amount equal to one and one-half times his then current annual base salary. James L. Oliver. Mr. Oliver serves as Chief Financial Officer of the Company pursuant to an employment agreement entered into on November 1, 2000. The agreement provides for Mr. Oliver's employment through December 31, 2004. 25 Mr. Oliver will receive a base salary according to the following schedule, subject to increases which the CEO and the Compensation Committee may grant from time to time: $150,000 for the first twelve months of his employment, $180,000 for the second twelve months, $210,000 for the third twelve months and $240,000 per annum thereafter. Mr. Oliver will be paid an annual cash bonus of 30% of his then current annual salary provided that the Company has met or exceeded the projections in its annual business plan or as the Board of Directors deems appropriate. If during the term of the agreement there is a Change in Control (as defined above), then the Company will pay Mr. Oliver a cash bonus equal to the sum of four times Mr. Oliver's then current annual base salary plus the amount of taxes payable by Mr. Oliver under I.R.S. Code sec. 280G. In the event of a sale of assets or any change of control as defined therein, Mr. Oliver shall have the right to require the Company to repurchase all of his stock and stock options, then earned or to be earned, at two (2) times the then aggregate price value of the Company's stock not to exceed $10.00 per share. The agreement will terminate upon the occurrence of any of the following: Mr. Oliver's death, "total disability" (as defined above), material breach of the agreement or fiduciary duty by Mr. Oliver or written notice of Mr. Oliver's decision to terminate his employment. If Mr. Oliver's employment is terminated in any of the manners described above, he will be entitled to receive the base salary and benefits earned through the date of termination. If Mr. Oliver's employment is terminated for any other reason, then he will be entitled to receive (i) his base salary and benefits earned through the date of termination and (ii) an amount equal to one and one-half times his then current annual base salary. John A. Barthrop. Mr. Barthrop serves as Chief Legal Officer of the Company pursuant to an employment agreement dated November 1, 2000. The agreement provides for Mr. Barthrop's employment through December 31, 2004. Mr. Barthrop will receive a base salary according to the following schedule, subject to possible increases which the CEO and the Compensation Committee may grant from time to time: $160,000 for the first twelve months of his employment, $185,000 for the second twelve months, $210,000 for the third twelve months and $240,000 per annum thereafter. Mr. Barthrop will be paid an annual cash bonus of 30% of his then current annual salary provided that the Company has met or exceeded the projections in its annual business plan or as the Board of Directors deems appropriate. If during the term of the agreement there is a Change in Control (as defined above), then the Company will pay Mr. Barthrop a cash bonus equal to the sum of four times Mr. Barthrop's then current annual base salary plus the amount of taxes payable by Mr. Barthrop under I.R.S. Code sec. 280G. The agreement will terminate upon the occurrence of any of the following: Mr. Barthrop's death, "total disability" (as defined above), material breach of the agreement or fiduciary duty by Mr. Barthrop or written notice of Mr. Barthrop's decision to terminate his employment. If Mr. Barthrop's employment is terminated in any of the manners described above, he will be entitled to receive his base salary and benefits earned through the date of termination. If Mr. Barthrop's employment is terminated for any other reason, then he will be entitled to receive (i) the base salary and benefits earned through the date of termination and (ii) an amount equal to one and one-half times his then current annual base salary. Pursuant to the employment agreements dated November 1, 2000, Messrs. Paulsen, Barthrop and Oliver, have been granted an option to purchase an aggregate of 900,000, 500,000 and 500,000 shares, respectively, of the Company's Common Stock. The options will have a three-year vesting period and an exercise price of $2.75 a share. All of the options will expire on November 1, 2007. Pursuant to the previous employment agreement entered into on May 6, 1999 with John Barthrop, he received an option to purchase 50,000 shares of our Common Stock. (C) DIRECTORS' FEES Only non-employee (outside) directors are compensated for Board service. We do not have any standard arrangements for director compensation, rather each director may be offered a retainer amount and meeting 26 attendance fees based on such factors as length of service, industry experience, and service on committees of the Board. Directors who serve on Board committees are paid $300 for each committee meeting attended, the amount is increased to $500 for the Committee Chairperson. In connection with their election to our Board, Messrs. Perkins and Gates and Mrs. Jonas each receive compensation of $6,250 per quarter and an annual grant of options to purchase 50,000 shares of our common stock at an exercise price set by the Company from time to time. The option grants issued to Messrs. Perkins and Gates and Mrs. Jonas in fiscal 2001 have an exercise price of $2.75 per share. (D) CHANGE IN CONTROL AGREEMENTS We have entered into employment agreements with certain of our executive officers, which, among other things, provide for severance and other benefits if, during the term of the such agreements (i) all or substantially all of the assets of Commonwealth Energy Corporation or more than fifty percent (50%) of the issued and outstanding voting shares of the Commonwealth Energy Corporation are, in any transaction or series of transactions, acquired by any one person or entity not then affiliated with the Company, or (ii) control of Commonwealth Energy Corporation is taken over by a group of shareholders when no significant change of ownership has taken plan, or (iii) a liquidity event such as a merger, acquisition, strategic alliance or any other event that could bring substantial capital into the company and any of these events listed require that such officer be terminated, leave the company, be replaced or any other event that no longer allows or requires such officer to remain with the Company. Certain change in control rights include the right to require the Company to repurchase all of the employee's stock and stock options, earned or to be earned at two (2) times the aggregate price value of the Company's stock. ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. ITEM 8. LEGAL PROCEEDINGS From time to time, we have been and may be involved in litigation relating to claims arising out of our operations in the normal course of business. As of the date of this report, we are not a party to any legal proceedings, the adverse outcome of which, in management's opinion, individually or in the aggregate, would have a material adverse effect on our results of operations or financial position. We had sued Frederick M. Bloom, the founder and former Chairman and Chief Executive Officer of our company, in an action entitled Commonwealth Energy Corporation, et al. v. Bloom in Orange County Superior Court case number 00CC15507. The causes of actions included, inter alia, on behalf of both the Company and its subsidiary electricAmerica, Inc. against Mr. Bloom, fraud regarding issuance of Commonwealth shares, (the complaint specifies Mr. Bloom failed to pay the amount he stated he paid for the founder's shares), fraud in obtaining an employment agreement, fraud in obtaining severance agreement, corporate waste based on breach of fiduciary duty to us by his failure to exercise the due care and loyalty, and breach of fiduciary duty regarding signing and submitting information to the CPUC. Mr. Bloom filed a counterclaim against the Company alleging breach of fiduciary duty, declaratory relief, breach of contract, rescission of Accommodation Agreement, and for specific recovery of personal property. On August 10, 2001, we settled the claims and related counterclaims filed in the litigation. The material terms of the settlement provided that we pay Mr. Bloom $4,790,000 in unspecified damages, and an additional $2,400,000 to purchase 1,175,160 shares of our common stock claimed to be held by Mr. Bloom and his affiliates. The settlement agreement also confirmed the fact that the remaining 4,720,000 shares of our common stock claimed to be held by Mr. Bloom and his affiliates were void. As a material part of the settlement, Mr. Bloom also confirmed that his record ownership of and voting rights to a separate 1,200,000 shares had been forfeited and he agreed to release any claims under an Accommodation Agreement dated May 31, 2000 and agreed that he would have no future ownership in Commonwealth Energy Corporation. Finally, Mr. Bloom agreed not to compete with our business for two years in certain specified energy-related areas. 27 Joseph P. Saline, a member of our Board, has filed two lawsuits. On August 16, 2001, Mr. Saline filed a civil suit against us seeking the production of certain corporate records. We have provided Mr. Saline with documents he requested under the protection of a court order which prohibits him from disclosing those documents to other persons outside of our Board of Directors. On October 29, 2001, Mr. Saline filed a claim for certain preferred shareholder rights which differ from the rights set forth in the Certificate of Determination concerning preferred shares filed with the California State Department of Corporations. The Company has answered and filed a cross-action for declaratory relief. Mr. Saline obtained an interim court order allowing him to claim the right, as a preferred shareholder, to vote 704,000 shares at the Company's November 2001 annual shareholder meeting. The interim court order is being aggressively contested by the Company. Mr. Saline's claim is based in part on a contract he made with Mr. Bloom on behalf of Commonwealth, that does not conform to the recorded Certificate of Determination regarding the rights, privileges and restrictions of the preferred shares. This litigation is ongoing. We settled a contested matter with the CPUC relating to Mr. Bloom's failure to disclose in the CPUC's updated Energy Service Provider application signed by Mr. Bloom in 1998, of seven regulatory actions resulting in cease and desist sanctions filed against Mr. Bloom. For Mr. Bloom's failure to disclose these sanctions, the CPUC imposed a fine of $140,000. The CPUC also alleged that we, under the direction of Mr. Bloom, illegally supplemental billed approximately 20,200 customers in early 1999. While we contested this claim, we agreed, as part of the settlement, to return funds received from those customers who were billed, to pay an audit fee and to pay fines for 159 violations related to supplemental billing complaints that were documented by the Consumer Services Division ("CSD") of the CPUC. The total settlement amount of $256,500 was recorded as expense of $100,000 in fiscal 2000 and $156,500 in fiscal 2001, in our consolidated financial statements. We have agreed to cooperate fully with any state or federal regulatory or law enforcement agency, in any investigation of the activities of Mr. Bloom during the period he served as an officer of our company. The settlement terms require that if Mr. Bloom returns in any capacity whatsoever as a director, officer, or employee, of Commonwealth or any of its subsidiaries at any time, we must immediately file a formal application for re-registration with the CPUC under Code #394.1(a), disclosing the resumed relationship. The settlement was adopted by the CPUC on July 15, 2001. We settled a complaint filed by the Department of Corporations ("DOC") in an action entitled The People of the State of California v. Commonwealth Energy Corporation, Los Angeles Superior Court, case No. BC245014. The agreed judgment is in the form of an injunction and ancillary relief and was filed on February 13, 2001. The DOC's complaint was based upon activities that took place from September 1997 to October 1999, a period during which Mr. Bloom and other members of our former management were in charge of operations. The investigation that led to the complaint centered around the sale of our restricted securities. As part of the settlement, we agreed to cooperate with the Commissioner of Corporations and the DOC in connection with any further investigation arising out of the events described in the complaint, including any investigation of former officers, directors, or employees. We paid $150,000 in civil penalties as part of the DOC settlement in February, 2001. The Company has agreed to cooperate with the DOC in any future investigation it may conduct against Mr. Bloom or any other former members of management. On February 1, 2002, Joseph Saline, Kevin Biswell, Joseph O'Gundiji and Michael Doak filed a complaint in California Superior Court against us challenging the election of one of the Company's directors at the 2001 annual meeting of shareholders. Plaintiffs contend that Mr. Biswell should have been elected as the fifth member of the five-member board. We are defending against the complaint but have volunteered detailed information about the ballot counting process and results, including verification by PricewaterhouseCoopers, in order to speed the dispute process. Trial on the matter is scheduled to commence on April 8, 2002. No monetary damages are sought in this action. Thirteen former stock sales employees led by Mr. David James commenced a lawsuit against us on February 23, 2001 in Orange County Superior Court alleging that former management had agreed to issue additional deeply discounted stock options to them as additional compensation for stock sales but that we had not issued all of the stock options allegedly earned. Our books and related records reflect the right to issuance in the aggregate of stock options covering 1,221,000 shares of Common Stock to which we believe they are entitled. The plaintiffs have not identified the basis for the number of respective shares under option each 28 believes he or she is owed and we, therefore, cannot estimate the impact on our capital structure should they succeed in whole or in part in their lawsuit. In our cross-complaint against these individuals, we have alleged that various plaintiffs committed breach of conduct, unfair business practices, misappropriation of trade secrets, intentional interference with prospective economic advantage, unjust enrichment, slander and fraud. There can be no assurance that there are no other employees or former employees with similar claims and disputes related to stock option grants. ITEM 9.MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS There is currently no established public trading market for any class of our equity securities. As of January 31, 2002, 10,198,692 shares of our Common Stock are reserved for the exercise of outstanding stock options, 100,000 shares of our Common Stock are reserved for the exercise of outstanding warrants, and 775,000 shares of our Common Stock are reserved for issuance upon conversion of currently outstanding shares of our Series A Convertible Preferred Stock and other than pursuant to an employee benefit plan or dividend reinvestment plan, we are not currently offering or proposing to offer any shares of our Common Stock for sale to the public. As of January 31, 2002, there were approximately 2,573 holders of our Common Stock and 61 holders of our Series A Convertible Preferred Stock. We have declared and paid cash dividends on our Series A Convertible Preferred Stock. We currently intend to retain future earnings for use in our business and do not anticipate declaring or paying any dividends on shares of our Common Stock in the foreseeable future. As of January 7, 2002, all outstanding shares may be sold pursuant to Rule 144 under the Securities Act of 1933, as amended. We currently have no outstanding obligations to register shares for sale by security holders. ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES We have sold or issued the following securities during the last three years in reliance upon the exemption from registration provided by Section 3(a)(11) of the Securities Act of 1933, as amended. While the Company did not seek to rely on the safe harbor provided by Rule 147 promulgated under the Securities Act, we believe that all of the transactions summarized below complied with the requirements of Section 3(a)(11) for the following reasons: At the time of each such sale, and for the most recent fiscal year immediately preceding such sale, the company was a California corporation, maintained its principal office in California, derived at least 80 percent of its gross revenues from operations within California, had at least 80 percent of its assets located within California, intended to use, and did use, at least 80 percent of the net proceeds of the sales of the securities in the operation of its business in California and had a reasonable basis for believing that each purchaser resided in, and was doing business in, California. In addition, within a period of nine months after such sales, none of the purchasers had given the company notice of any resales of the securities to persons residing outside of California. On or about September 15, 1998, we sold an aggregate of 3,773,256 shares of our common stock to 484 investors at a price per share of $2.63, receiving gross proceeds in the amount of $9,905,216 in cash. On or about November 1, 1998, we sold an aggregate of 1,962,443 shares of our common stock to 284 investors at a price per share of $3.75, receiving gross proceeds in the amount of $7,359,510 in cash. On or about January 1, 1999, we sold an aggregate of 2,538,897 shares of our common stock to 499 investors at a price per share of $3.75, receiving gross proceeds in the amount of $9,520,837 in cash. During the period beginning on or about May 15, 1999 and through October 29, 1999, we sold an aggregate of 2,678,084 shares of our common stock to 718 investors at a price per share of $5.50, receiving gross proceeds in the amount of $14,729,571 in cash. 29 On June 28, 2000, we issued a warrant to purchase up to 100,000 shares of our common stock, at $5.50 per share, to Coast Business Credit, as partial consideration for a credit facility made available to us by Coast Business Credit. In December of 1998, January of 1999 and April of 1999, we issued stock options exercisable for an aggregate of 1,936,250 shares of our common stock to 46 individuals in return for consulting and other services having an aggregate value of $3,869,606, 1,483,500 of which are exercisable at $0.05 per share, 27,750 of which are exercisable at $1.00 per share and 425,000 of which are exercisable at $3.75 per share. In June and July of 2000, we issued stock options exercisable for an aggregate of 21,000 shares of our common stock, at an exercise price of $1.00, to 3 individuals in return for consulting and other services having an aggregate value of $31,500. In August, September, October, November and December of 1998, we issued stock options exercisable for an aggregate of 1,782,090 shares of our common stock to 76 employees and directors, 957,840 of which are exercisable at $0.01 per share, 57,500 of which are exercisable at $0.05 per share, 450,000 of which are exercisable at $0.50 per share and 316,750 of which are exercisable at $1.00 per share. In January, February, March, May, July and August of 1999, we issued stock options exercisable for an aggregate of 374,000 shares of our common stock to 14 employees and directors, 50,000 of which are exercisable at $0.05 per share, 100,000 of which are exercisable at $0.25 per share, 100,000 of which are exercisable at $0.50 per share and 124,000 of which are exercisable at $1.00 per share. In January, April, July, August, November and December of 2000, we issued stock options exercisable for an aggregate of 6,100,000 shares of our common stock to 12 employees and directors, 3,600,000 of which are exercisable at $2.50 per share and 2,500,000 of which are exercisable at $2.75 per share. In January of 2001, we issued stock options exercisable for an aggregate of 450,000 shares of our common stock to 3 employees and directors, 300,000 of which are exercisable at $2.50 per share and 150,000 of which are exercisable at $2.75 per share. In September, October and December of 1998, we issued stock options exercisable for an aggregate of 220,550 shares of our common stock to 7 consultants and vendors in return for consulting and other services having an aggregate value of $573,797, 110,000 of which are exercisable at $0.01 per share, 100,500 of which are exercisable at $0.05 per share, and 10,050 of which are exercisable at $1.00 per share. In January and March of 1999, we issued stock options exercisable for an aggregate of 34,125 shares of our common stock, at an exercise price of $1.00 per share, to 4 consultants and vendors in return for consulting and other services having an aggregate value of $95,550. In January and April of 2000, we issued stock options exercisable for an aggregate of 1,052,500 shares of our common stock, at an exercise price of $2.50 per share, to 4 non-employee members of our advisory board in return for consulting and other services and one ex-employee in connection with a severance agreement having an aggregate value of $436,577. The proceeds of $27,437,232 from the sales of common stock, net of issuance costs, for the year ended July 31, 1999 was used primarily to fund operating activities of $19,448,666, which included an increase in accounts receivables. A total of $3,406,000 was pledged as collateral for letters of credit in connection with the agreements for the purchase of electric power. Additionally, proceeds were used to purchase property and equipment of $1,988,000 and intangible asset of $500,000. The proceeds of $12,868,856 from the sale of common stock, net of issuance costs, for the year July 31, 2000 was used primarily to fund operating activities of $15,842,885, which included an increase in accounts receivables. 30 ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED Common Stock Although we became obligated to register our common stock under Section 12(g)(1) of the Securities Exchange Act of 1934, as amended (the "Act"), by the end of 1999, we were not able to file our registration statement until August 2001. The end of 1999 was the early stage of a transition period for our new management team. Our current management team found the corporate, financial and stock records, reports and documentation of our company in poor condition. Proper internal reviews and independent audits and investigations were necessary before registration on Form 10 and proper public disclosure could be made. Internal review and external audits took many months before we were able to represent the financial and corporate condition of our company to the Securities and Exchange Commission and the public trading markets. Registration under the Act prior to conclusion of all of these reviews and audits was of great concern to management because of the potential for materially misleading disclosures. By November 2000 our independent audits were completed and corporate and legal investigations continued until August 2001 when we determined sufficient due diligence had been completed to support public disclosure and our Registration on Form 10 was filed. All Shares of Common Stock entitle the holder thereof to: (i) one vote for each share held of record on all matters submitted to a vote of shareholders, (ii) to participate equally and to receive any and all such dividends as may be declared by the Board of Directors out of funds legally available therefor; and (iii) to participate pro rata in any distribution of assets upon liquidation of our Company. All shares of our stock are entitled as a matter of California law to cumulate votes for the election of directors. Our shareholders have no preemptive rights to acquire additional shares of Common Stock or any other securities. The Common Stock is not subject to redemption and carries no subscription or conversion rights. All outstanding shares of Common Stock are fully paid and nonassessable. There are no provisions in our Articles of Incorporation or Bylaws that would delay, defer or prevent a change in control of the Company. The convertible preferred stock provides for cumulative dividends which accrue at an annual rate of 10% and are payable at the discretion of the Company. Each convertible preferred share is convertible into one share of the Company's common stock at the shareholder's discretion and have full voting rights. Preferred shareholders are entitled to preferred liquidation rights over common stock in the amount of $1.00 per share plus an amount equal to all declared but unpaid dividends. ITEM 12. INDEMNIFICATION OF OFFICERS AND DIRECTORS Article Five of our Articles of Incorporation contains a provision that eliminates the personal liability of a director for monetary damages to the fullest extent permissible under California law. We maintain policies of directors and officers insurance with National Union Fire Insurance Company in the aggregate amount of $20 million with a deductible of $75,000. ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See the index included at "Item 15, Financial Statements and Exhibits". ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None 31 ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS (a)(1) Index to Consolidated Financial Statements: Report of Ernst & Young LLP, independent auditors........... F-1 Consolidated balance sheets at July 31, 2000 and 2001....... F-2 Consolidated statements of operations for the three years in the period ended July 31, 2001............................ F-3 Consolidated statements of shareholders' equity for the three years in the period ended July 31, 2001............. F-4 Consolidated statements of cash flows for the three years in the period ended July 31, 2001............................ F-5 Notes to consolidated financial statements.................. F-6
(a)(2) Index to Condensed Consolidated Interim Financial Statements (unaudited): Condensed consolidated balance sheet at January 31, 2002.... F-24 Condensed consolidated statements of income for the six months ended January 31, 2001 and 2002.................... F-25 Condensed consolidated statements of cash flows for the six months ended January 31, 2001 and 2002.................... F-26 Notes to condensed consolidated financial statements........ F-27
(a)(3) Schedule II -- Valuation and Qualifying Accounts All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (b) Reports on Form 8-K. None January 7, 2002. Adoption of $10 million Stock Repurchase Program and Stockholder Right Plan January 22, 2002. Report of the Inspector of Election in Connection with the Annual Meeting of Shareholder of Commonwealth Energy Corporation Held on November 27, 2001 (c) The following exhibits are attached hereto, as required by Item 601 of Regulation S-K:
EXHIBIT NUMBER TITLE OF EXHIBIT - ------- ---------------- 3.1 Articles of Incorporation of Commonwealth Energy Corporation dated August 14, 1997 and filed with the Secretary of State of the State of California on August 15, 1997* 3.2 Certificate of Amendment of Articles of Incorporation of Commonwealth Energy Corporation dated December 31, 1998 and filed with the Secretary of State of the State of California on February 19, 1999* 3.3 Bylaws of Commonwealth Energy Corporation, as amended* 3.4 Certificate of Determination of Commonwealth Energy Corporation dated September 22, 1997 and filed with the Secretary of State of California on March 13, 1998** 10.1 Power Purchase Agreement dated April 27, 1999, between Commonwealth Energy Corporation and Calpine Power Services Company+ 10.2 First Amendment to Power Purchase Agreement dated as of April 29, 1999+ 10.3 Second Amendment to Power Purchase Agreement dated as of May 28, 1999, between Commonwealth Energy Corporation and Calpine Power Services Company+ 10.4 Loan and Security Agreement dated June 28, 2000 between Commonwealth Energy Corporation, electricAmerica, Inc. and electric.com, Inc. and Coast Business Credit*
32
EXHIBIT NUMBER TITLE OF EXHIBIT - ------- ---------------- 10.5 Warrant dated June 28, 2000, issued by Commonwealth Energy Corporation in favor of Coast Business Credit.* 10.6 Limited Liability Company Agreement of Summit Energy Ventures, LLC, as amended by the First Amendment to the Limited Liability Company Agreement of Summit Energy Ventures, LLC, dated August 2001** 10.7 PECO Energy Company Confirmation Agreement dated January 30, 2001.* 10.8 Exelon Generation Company, LLC Confirmation Agreement dated May 13, 2001* 10.9 Standard Office Lease -- Gross dated April 1, 1997, for property located at 15941 Redhill Avenue, Suite 200, Tustin, California, together with Rules and Regulations and Work Letter attached thereto* 10.10 Standard Sublease dated November 12, 1998, between Kurt Busch and Commonwealth Energy Corporation, for property located at 15991 Redhill Avenue, Suite 200, Tustin, California.* 10.11 Severance Agreement dated June 1, 2000, among Commonwealth Energy Corporation, electricAmerica, Inc. and Frederick M. Bloom* 10.12 Employment Agreement dated January 1, 2000, between Commonwealth Energy Corporation and Ian Carter, as modified by an Addendum to Employment Agreement dated as of November 1, 2000* 10.13 Employment Agreement dated November 1, 2000, between Commonwealth Energy Corporation and Richard Paulsen** 10.14 Employment Agreement dated November 1, 2000, between Commonwealth Energy Corporation and James Oliver** 10.15 Employment Agreement dated November 1, 2000, between Commonwealth Energy Corporation and John Barthrop** 10.16 Commonwealth Energy Corporation 1999 Equity Incentive Plan for Employees* 10.17 Amendment Number 6 to lease by and between Warner/Redhill Associates and Frederick Michael Bloom** 10.18 Commonwealth vs. Bloom Settlement Agreement Terms dated August 10, 2001*** 10.19 Second Amendment to the Limited Liability Company Agreement of Summit Energy Ventures, LLC 10.20 Commonwealth Energy Corporation Summary of Rights to Purchase Preferred Stock 21.1 Subsidiaries of the Registrant*
- --------------- * Each of these exhibits is incorporated herein by reference to Commonwealth Energy's Form 10 filed with the Securities and Exchange Commission on August 9, 2001 (File No. 000-33069). ** Each of these exhibits is incorporated by reference to Commonwealth Energy's Form 10A filed with the Securities and Exchange Commission on November 14, 2001 (File No. 000-33069). *** Each of these exhibits is incorporated by reference to Commonwealth Energy's Form 10Q filed with the Securities and Exchange Commission on December 17, 2001 (File No. 000-33069). + Confidential treatment is being sought with respect to certain portions of this agreement. Such portions have been omitted from this filing and have been filed separately with the Securities and Exchange Commission. 33 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Board of Directors Commonwealth Energy Corporation We have audited the accompanying consolidated balance sheets of Commonwealth Energy Corporation as of July 31, 2000 and 2001, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended July 31, 2001. Our audit also included the financial statement schedule for each of the three years in the period ended July 31, 2001 listed in the index at Item 15(a)(3). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Commonwealth Energy Corporation at July 31, 2000 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended July 31, 2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Orange County, California October 12, 2001 F-1 COMMONWEALTH ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS ASSETS
JULY 31, ---------------------------- 2000 2001 ------------ ------------ Current assets: Cash and cash equivalents................................. $ 4,213,168 $ 41,114,046 Accounts receivable: Billed................................................. 17,468,027 16,818,659 Unbilled............................................... 6,333,096 3,338,172 Green power credits.................................... 2,806,508 1,176,611 ------------ ------------ 26,607,631 21,333,442 Less allowance for doubtful accounts................... (1,458,984) (3,946,388) ------------ ------------ Net accounts receivable................................... 25,148,647 17,387,054 Prepaid income taxes...................................... -- 2,109,997 Deferred tax asset........................................ -- 6,607,711 Prepaid expenses and other current assets................. 795,539 3,943,625 ------------ ------------ Total current assets.............................. 30,157,354 71,162,433 Property and equipment, net................................. 3,316,877 3,606,078 Restricted cash............................................. 6,146,339 28,242,911 Other assets: Intangible assets......................................... 997,500 945,000 Deposits and notes receivable............................. 972,135 388,466 Deferred tax asset........................................ -- 2,671,058 ------------ ------------ Total other assets................................ 1,969,635 4,004,524 ------------ ------------ Total assets...................................... $ 41,590,205 $107,015,946 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 8,148,848 $ 9,404,851 Notes payable under line of credit........................ 5,281,272 3,888,072 Other current liabilities................................. 3,924,083 7,685,954 ------------ ------------ Total current liabilities......................... 17,354,203 20,978,877 Commitments and contingencies Shareholders' equity: Convertible preferred stock -- 10,000,000 shares authorized with no par value; 939,000 and 862,500 shares issued and outstanding in 2000 and 2001, respectively........................................... 1,053,972 842,112 Common stock -- 50,000,000 shares authorized with no par value; 29,333,164 and 29,360,363 shares issued and outstanding in 2000 and 2001, respectively............. 58,740,149 60,304,847 Retained earnings (accumulated deficit)................... (35,558,119) 24,890,110 ------------ ------------ Total shareholders' equity........................ 24,236,002 86,037,069 ------------ ------------ Total liabilities and shareholders' equity........ $ 41,590,205 $107,015,946 ============ ============
See accompanying notes. F-2 COMMONWEALTH ENERGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED JULY 31, -------------------------------------------- 1999 2000 2001 ------------ ------------ ------------ Retail energy sales............................ $ 35,583,644 $ 87,320,533 $ 99,981,187 Wholesale energy sales......................... -- -- 79,303,586 ------------ ------------ ------------ Net energy sales............................... 35,583,644 87,320,533 179,284,773 Green power credits............................ 3,540,405 12,303,794 3,978,989 ------------ ------------ ------------ Net revenue.................................... 39,124,049 99,624,327 183,263,762 Direct energy costs............................ 38,728,563 86,731,876 76,615,138 ------------ ------------ ------------ Gross margin................................... 395,486 12,892,451 106,648,624 Selling and marketing expenses................. 2,038,139 6,211,360 3,597,001 General and administrative expenses............ 11,184,025 15,380,674 21,183,396 Stock-based compensation charges............... 5,718,410 445,277 1,080,000 ------------ ------------ ------------ Income (loss) from operations.................. (18,545,088) (9,144,860) 80,788,227 Interest income................................ 128,946 586,479 2,319,628 Interest expense............................... (5,585) (87,708) (726,446) ------------ ------------ ------------ Income (loss) before provision for income taxes........................................ (18,421,727) (8,646,089) 82,381,409 Provision for income taxes..................... -- -- 21,851,992 ------------ ------------ ------------ Net income (loss).............................. $(18,421,727) $ (8,646,089) $ 60,529,417 ============ ============ ============ Net income (loss) per common share (1999 and 2000 restated -- Note 1): Basic........................................ $ (.84) $ (.30) $ 2.06 ============ ============ ============ Diluted...................................... $ (.84) $ (.30) $ 1.77 ============ ============ ============ Stock-based compensation charges relate to the following: Selling and marketing expenses............... $ 1,454,427 $ 423,500 $ -- General and administrative expenses.......... 4,263,983 21,777 1,080,000 ------------ ------------ ------------ $ 5,718,410 $ 445,277 $ 1,080,000 ============ ============ ============
See accompanying notes. F-3 COMMONWEALTH ENERGY CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED JULY 31, 1999, 2000 AND 2001
CONVERTIBLE RETAINED COMMON STOCK PREFERRED STOCK EARNINGS ------------------------- ---------------------- (ACCUMULATED SHARES AMOUNT SHARES AMOUNT DEFICIT) TOTAL ---------- ----------- ------- ----------- ------------ ------------ Balance at July 31, 1998........... 16,928,526(A) $10,567,314 939,000 $ 885,232 $ (8,321,563) $ 3,130,983 Proceeds from sales of common stock, net of issuance costs of $7,399,016....................... 9,686,945 24,382,626 -- -- -- 24,382,626 Stock options granted included in issuance costs................... -- 3,869,606 -- -- -- 3,869,606 Stock options granted for services received......................... -- 669,347 -- -- -- 669,347 Compensation charge related to stock options granted............ -- 5,222,410 -- -- -- 5,222,410 Exercise of stock options.......... 39,750 798 -- -- -- 798 Transfer of common stock from founder to officer............... -- 496,000 -- -- -- 496,000 Common shares issued for acquisition of intangible assets........................... 100,000 550,000 -- -- -- 550,000 Cumulative unpaid dividends on convertible preferred stock...... -- -- -- 84,370 (84,370) -- Net loss and comprehensive loss.... -- -- -- -- (18,421,727) (18,421,727) ---------- ----------- ------- ----------- ------------ ------------ Balance at July 31, 1999........... 26,755,221(A) 45,758,101 939,000 969,602 (26,827,660) 19,900,043 Proceeds from sales of common stock, net of issuance costs of $1,828,665....................... 2,185,537 12,020,356 -- -- -- 12,020,356 Stock options granted included in issuance costs................... -- 31,500 -- -- -- 31,500 Exercise of stock options.......... 392,406 70,115 -- -- -- 70,115 Compensation charge related to stock options granted (including $414,800 of severance costs)..... -- 436,577 -- -- -- 436,577 Transfer of common stock from founder to officer............... -- 423,500 -- -- -- 423,500 Cumulative unpaid dividends on convertible preferred stock...... -- -- -- 84,370 (84,370) -- Net loss and comprehensive loss.... -- -- -- -- (8,646,089) (8,646,089) ---------- ----------- ------- ----------- ------------ ------------ Balance at July 31, 2000........... 29,333,164(A) 58,740,149 939,000 1,053,972 (35,558,119) 24,236,002 Exercise of stock options.......... 103,699 5,678 -- -- -- 5,678 Compensation charge related to settlement of employee stock option disputes.................. -- 139,725 -- -- -- 139,725 Compensation charge related to performance based stock options.......................... -- 1,080,000 -- -- -- 1,080,000 Income tax benefits arising from exercise of stock options........ -- 339,295 -- -- -- 339,295 Cumulative unpaid dividends on convertible preferred stock...... -- -- -- 81,188 (81,188) -- Payment of dividends on preferred stock............................ -- -- -- (216,548) -- (216,548) Repurchase of preferred stock...... (76,500) -- (76,500) (76,500) -- (76,500) Net income and comprehensive income........................... -- -- -- -- 60,529,417 60,529,417 ---------- ----------- ------- ----------- ------------ ------------ Balance at July 31, 2001........... 29,360,363 $60,304,847 862,500 $ 842,112 $ 24,890,110 $ 86,037,069 ========== =========== ======= =========== ============ ============
- --------------- (A) Restated as described in Note 1. See accompanying notes. F-4 COMMONWEALTH ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED JULY 31, -------------------------------------------- 1999 2000 2001 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss)............................... $(18,421,727) $ (8,646,089) $ 60,529,417 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation.................................. 251,566 687,125 860,726 Amortization.................................. -- 52,500 52,500 Provision for doubtful accounts............... 612,909 846,075 4,666,126 Stock-based compensation charges.............. 5,718,410 445,277 1,080,000 Fair value of stock options issued for services received.......................... 669,347 -- -- Fair value of stock options issued as severance costs............................ -- 414,800 -- Income tax benefits arising from exercise of stock options.............................. -- -- 339,295 Deferred income taxes......................... -- -- (9,278,769) Changes in operating assets and liabilities: Billed accounts receivable................. (7,746,794) (9,278,406) (1,529,354) Unbilled accounts receivable............... (1,620,743) (3,919,039) 2,994,924 Green power credits receivable............. (3,075,585) 269,077 1,629,897 Prepaid expenses and other assets.......... (535,752) (13,714) (4,674,414) Accounts payable........................... 3,168,835 2,809,368 1,256,003 Other current liabilities.................. 715,868 1,305,141 3,901,596 ------------ ------------ ------------ Net cash provided by (used in) operating activities.................................... (20,263,666) (15,027,885) 61,827,947 CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment............. (1,988,096) (1,760,064) (1,149,927) Purchase of intangible assets................... (500,000) -- -- ------------ ------------ ------------ Net cash used in investing activities........... (2,488,096) (1,760,064) (1,149,927) CASH FLOWS FROM FINANCING ACTIVITIES Borrowings under (repayments of) line of credit........................................ -- 5,281,272 (1,393,200) Increase in restricted cash..................... (3,406,200) (2,740,139) (22,096,572) Proceeds from sales of common stock............. 28,252,232 12,051,856 -- Repurchase of preferred stock................... -- -- (76,500) Dividends paid on preferred stock............... -- -- (216,548) Proceeds from exercises of stock options........ 798 70,115 5,678 ------------ ------------ ------------ Net cash provided by (used in) financing activities.................................... 24,846,830 14,663,104 (23,777,142) ------------ ------------ ------------ Increase (decrease) in cash and cash equivalents................................... 2,095,068 (2,124,845) 36,900,878 Cash and cash equivalents at beginning of year.......................................... 4,242,945 6,338,013 4,213,168 ------------ ------------ ------------ Cash and cash equivalents at end of year........ $ 6,338,013 $ 4,213,168 $ 41,114,046 ============ ============ ============ Cash paid for: Interest expense.............................. $ 5,585 $ 87,708 $ 726,446 Income taxes.................................. -- -- 32,900,800
SUPPLEMENTAL CASH FLOW INFORMATION During the year ended July 31, 1999, the Company issued 100,000 shares of common stock having a fair value of $550,000 for a portion of the $1,050,000 purchase price of the intangible assets. See accompanying notes. F-5 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JULY 31, 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business Commonwealth Energy Corporation (the "Company") was incorporated on August 15, 1997. The Company's primary business has been the sale of electric power to retail customers in California and, beginning January 2000, in Pennsylvania and, beginning in August 2000, sale of electric power to wholesale customers in California and Pennsylvania. The Company is licensed by the Federal Energy Regulatory Commission (FERC) as a power marketer, by California as an Electric Service Provider and by Pennsylvania as an Electric Generation Supplier. The Company plans to enter new deregulated electric power markets in the future. The electric power sold by the Company to its retail customers is delivered to the Company's customers by incumbent utilities that are called Utility Distribution Companies (UDCs) in California and Electric Distribution Companies (EDCs) in Pennsylvania, which measure electric power usage by the Company's customers and bill the customers on behalf of the Company. There are three UDCs in California and one EDC in Pennsylvania, which conduct these activities on behalf of the Company. The Company's operations have been in one reportable segment, the domestic electricity distribution industry. Basis of Presentation The consolidated financial statements of the Company include the accounts of the Company's wholly-owned subsidiaries and Summit Energy Ventures, LLC (Summit). All intercompany transactions have been eliminated in consolidation. Adjustment of Number of Outstanding Common Shares and Restatement of Per Share Information As more fully discussed in Note 11, the Company disputed whether certain shares of its common stock issued to its founder were validly issued. Litigation ensued between the Company and its founder regarding this and other matters. A settlement of this litigation was approved by the court having jurisdiction over the case on August 15, 2001 and stipulated that 4,720,000 of the founder's disputed common shares were void. The Company's counsel has advised that such shares should be considered void ab initio, or having never been issued. Accordingly, the Company has restated its prior years' financial statements to reflect the terms of this settlement. The only change to the Company's results of operations is in the reported net loss per share information for the years ended July 31, 1999 and 2000 which has been restated as follows:
YEAR ENDED JULY 31, --------------------------------- 1999 2000 --------------- --------------- BASIC DILUTED BASIC DILUTED ----- ------- ----- ------- As restated.......................................... $(.84) $(.84) $(.30) $(.30) As originally reported............................... (.69) (.69) (.26) (.26)
Estimates and Assumptions The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates in the Company's consolidated financial statements relate to the allowance for doubtful accounts, unbilled receivables, legal claims and the useful lives of property and equipment and intangible assets. Actual results could differ from those estimates. F-6 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 Revenue and Cost Recognition Net revenue from sales of electric power is recognized as the power is delivered to the Company's customers. Net revenue represents proceeds from energy sales. Direct energy costs include electric power purchased, independent system operator fees and scheduling coordination fees. Selling and marketing expenses include salaries of sales and marketing personnel and promotional and advertising costs. General and administrative expenses include salaries for corporate support personnel, rent expenses, insurance expenses, bad debts expenses, depreciation expenses and other costs of the corporate office. The Company's net revenue is derived from sales to the following class of customers:
YEAR ENDED JULY 31, ---------------------------------------- 1999 2000 2001 ----------- ----------- ------------ Retail and commercial end users.............. $35,583,644 $87,320,533 $ 99,981,187 Wholesale.................................... -- -- 79,303,586 ----------- ----------- ------------ $35,583,644 $87,320,533 $179,284,773 =========== =========== ============
Common Stock Grant On January 20, 2000, the Board of Directors of the Company directed that, in consideration of the purchase price being paid in a nominal amount of cash by an officer of the Company on behalf of the Company's other shareholders, the Company shall grant on a pro rata basis one share of common stock for each share of common stock and preferred stock outstanding as of January 19, 1999. All per share and common share amounts presented in these consolidated financial statements have been retroactively adjusted to reflect this stock grant of 11,205,150 common shares, including 939,000 common shares related to the convertible preferred stock, which had the same effect as a stock split. Unbilled Receivables The Company's customers are billed monthly at various dates throughout the month. Unbilled receivables represent the amount of electric power delivered to customers as of the end of a period, but not yet billed. Unbilled receivables from sales in California through January 19, 2001 were estimated by the Company as the number of kilowatt hours delivered times 95% of the California Power Exchange ("PX") cost as published by Southern California Edison for residential customers. On January 20, 2001, the PX ceased operations and the Company replaced 95% of the PX cost amount with 95% of the individual Utility Purchased Energy cost as published by each individual utility. Cash and Cash Equivalents Cash and cash equivalents consist of cash and short-term investments with original maturities of three months or less. Property and Equipment Property and equipment are carried at cost. Depreciation of property and equipment is provided over their estimated useful lives, generally five to ten years, using the straight line method. Expenditures for maintenance, repairs and renewals are expensed as incurred. The Company capitalizes certain software development costs incurred on significant projects for internal use in accordance with the provisions of AICPA Statement of Position 98-1, Accounting for Software Costs. Qualifying internal and external costs, consisting primarily of third-party system development costs incurred during the application development stage are capitalized and amortized on the straight-line basis over five years. F-7 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 Intangible Assets Intangible assets are carried at cost. Amortization of intangible assets is provided over their estimated useful life of 20 years. Income Taxes The Company utilizes the liability method of accounting for income taxes as set forth in FASB Statement No. 109, Accounting for Income Taxes. Under the liability method, deferred taxes are determined based on the differences between the financial statement and tax bases of assets and liabilities using currently enacted tax rates. Advertising Costs Advertising costs, consisting primarily of media advertising, are expensed as incurred. Advertising costs were $1,670,270, $2,175,400 and $253,120 for 1999, 2000 and 2001, respectively. Stock-Based Compensation As permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123) and FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, the Company accounts for stock options granted to its employees and outside directors using the intrinsic value method. Most of the Company's stock option grants were granted with exercise prices below the fair value of the Company's common stock as determined by the Company's management for financial reporting purposes. In addition, since all stock option grants were vested at their dates of grant, the difference between the exercise prices and such estimated fair values was expensed as stock-based compensation charges as of the date of grant. Certain employees whose function was to sell shares of the Company's common stock received a portion of their commissions for such sales in the form of stock options. The intrinsic value of such stock options has been charged against the proceeds of such sales in the accompanying consolidated statements of shareholders' equity. The Company has also granted performance-based stock options for which vesting is contingent upon the occurrence of certain events or the achievements of certain levels of financial performance by the Company. The difference between the exercise price of these stock options and the estimated fair value of the Company's common stock as estimated by the Company's management for financial reporting purposes is recorded as stock-based compensation charges over the period prior to the selling of the options which are expected to eventually vest. Stock options were granted to certain service providers to the Company. These options were recorded at their fair values using the Black-Scholes option pricing model method, in accordance with SFAS No. 123. Concentration of Credit Risk The Company maintains allowances for potential credit losses. As of July 31, 2001, 52.3% of the Company's billed and unbilled receivables are due from a large number of retail and commercial end users in California and Pennsylvania who are billed by and make remittances to the UDC's or the EDC that deliver their electricity which, in turn, forward such remittances to the Company. One of the UDC's, Pacific Gas and Electric (PG&E), filed for bankruptcy in April 2001 and has withheld from payment to the Company a portion of the remittances due to the Company. The Company has filed a Proof of Claim in PG&E's bankruptcy proceedings to recover these amounts which approximated $1,100,000 F-8 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 at July 31, 2001. The Company has provided fully for these disputed amounts in its allowance for doubtful accounts. The Company does not have any similar disputes with its other UDC's. The remainder of the Company's billed and unbilled accounts receivable are due primarily from wholesale customers including $4,417,841 due from Automated Power Exchange (APX). This amount includes $2,226,630 in ISO credit holdbacks relating to November 2000 and January 2001 activity. APX has informed the Company that the holdbacks were made, in part, because certain organizations, including PG&E and PX, which have declared bankruptcy, did not make their scheduled payments to APX. The Company has provided an allowance of $1,471,142 for doubtful accounts related to the APX holdbacks. No customer has accounted for more than 10% of net revenue in 1999, 2000 or 2001, except for two wholesale customers, the state of California Department of Water Resources and the PX, which represented 22.0% and 10.6%, respectively, of net revenue in 2001. Impairment of Long-Lived Assets Long-lived assets to be held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If such assets are considered to be impaired, the impairment loss is measured by the amount by which the carrying amount of the assets exceeds fair values. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133), which establishes accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. This statement was amended by SFAS No. 137 which deferred the effective date to all fiscal quarters of fiscal years beginning after June 15, 2000. Accordingly, SFAS No. 133 was effective as of August 1, 2000 for the Company and did not have an effect on the Company's financial position or results of operations. The Company has not entered into any derivative instruments or hedging contracts. The Company's long-term contracts for the purchase and sale of electricity are considered "normal purchases" and "normal sales," respectively, within the context of SFAS No. 133 and related pronouncements. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, Business Combinations (SFAS No. 141), and No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). These statements change the accounting for business combinations, goodwill and intangibles. SFAS No. 141 eliminates the use of the pooling of interests method for all business combinations completed after June 30, 2001. It also provides new criteria to determine whether an acquired intangible asset should be recognized separately from goodwill. SFAS No. 142 eliminates the amortization of goodwill and intangible assets with an indefinite life. It also introduces a new impairment-only approach, which should be tested annually, to goodwill. The Company does not expect SFAS No. 141 or SFAS No. 142 to have any material effect on the Company's financial position or results of operations. Fair Value of Financial Instruments The Company's financial instruments consist primarily of cash, billed and unbilled accounts receivable, accounts payable and notes payable. The carrying amounts of these financial instruments are reflected in the accompanying consolidated balance sheets at amounts considered by management to approximate their fair values due to their short-term nature. F-9 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 2. MARKET AND REGULATORY RISKS California Deregulated Electric Power Markets California has been experiencing significant fluctuations in the cost of wholesale energy since May 2000. During the summer of 2000 and winter of 2001, the price of electricity in wholesale markets reached unprecedented highs. Since the winter of 2001, the price of electricity has returned to near historical levels. In reaction to this crisis, FERC, the California Public Utilities Commission ("CPUC"), the State Legislature and the Governor have proposed a varying number of methods to help restore price stability to the California electricity marketplace. On September 20, 2001, the CPUC issued a ruling suspending "direct access" pursuant to legislation by the California state legislature requiring the CPUC to suspend "direct access" in California. The suspension of "direct access" means that retail electricity suppliers, such as the Company, will not be allowed to actively seek customers. This ruling permits the Company to keep its current customer base, but prohibits the Company from signing up new customers for an undetermined period of time. The Company is actively seeking relief from this ruling. There is no assurance that any legislative or legal appeal will give the Company relief from the state's suspension of direct access. In addition regulatory and legislative risks, one of the UDC's in California, PG&E, with which the Company interacts to conduct its business has filed for bankruptcy protection. Other utilities in California also could seek protection of bankruptcy in the future. Commitments to Purchase Electric Power For the California market, the Company has entered into a contract, which expires on June 30, 2002 with Calpine Power Services Company, to acquire 3,000 MWH of electric power per day for the remainder of the contract. The Company is obligated to minimum electric purchases of $32.3 million for the year ending July 31, 2002 under this commitment. The electric power acquired under this contract qualifies for the California "Green Power Credit" upon its resale to certain classes of customers. For the Pennsylvania market, the Company has entered into various contractual arrangements for the purchase of electric power through May 2004. The Company is obligated to minimum electric power purchases of $37.6 million for the year ending July 31, 2002, and $51.9 million thereafter under these contracts. Since the prices at which the Company purchases this electric power are fixed during the terms of the contracts, if the price at which the Company can resell this electric power falls below the contract purchase price plus distribution and scheduling costs, the Company would incur operating losses during such periods. Pennsylvania Operations During the year ended July 31, 2000, the Company began selling electric power in Pennsylvania. In accordance with its standard customer contract in Pennsylvania, the Company may only charge certain maximum rates for its sales of electric power which, at times, could be less than the Company's costs of acquiring, distributing and scheduling such electric power. Energy capacity charges for servicing electric power in the Pennsylvania market varies significantly from month to month and can effect gross profit margins. California Green Power Credits The state of California enacted the Public Purpose Program (Program) which established a $540 million fund to provide overall incentives to suppliers of "green" power to initially reduce, among other things, the net costs of such power to certain consumers by 1.5 cents per KWH which, as of July 31, 2001, is at a rate 1.0 cent F-10 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 per KWH. "Green Power" is defined by the Program as electricity produced by at least 50% renewable energy resources. The benefit of Green Power Credits has been passed through to the Company's customers. The Program provides that this subsidy is available to suppliers of "green power" through March 31, 2002 and the Company does not know if the subsidy will be continued thereafter. 3. PER SHARE INFORMATION Basic and diluted net income (loss) per common share, restated as described in Note 1, is computed as follows:
YEAR ENDED JULY 31, ----------------------------------------- 1999 2000 2001 ------------ ----------- ----------- NUMERATOR: Net income (loss)............................ $(18,421,727) $(8,646,089) $60,529,417 Preferred stock dividend..................... (84,370) (84,370) (81,188) ------------ ----------- ----------- Income (loss) applicable to common stock -- Basic............................. (18,506,097) (8,730,459) 60,448,229 Assumed conversion of preferred stock........ -- -- 81,188 ------------ ----------- ----------- Net income (loss) -- Dilutive................ $(18,506,097) $(8,730,459) $60,529,417 ============ =========== =========== DENOMINATOR (restated for 1999 and 2000): Weighted - average outstanding shares -- Basic............................ 21,905,210 28,794,921 29,384,617 Dilutive shares: Exercise of dilutive stock options......... -- -- 3,842,866 Conversion of preferred stock into common stock................................... -- -- 924,538 ------------ ----------- ----------- Weighted - average outstanding shares -- Dilutive......................... 21,905,210 28,794,921 34,152,021 ============ =========== ===========
For the years ended July 31, 1999 and 2000, the effects of the exercise of potentially dilutive stock options and warrants and the assumed conversion of preferred stock into common stock have been excluded from the calculation of dilutive earnings per share information because the effect of their inclusion would be anti-dilutive. For the year ended July 31, 2001, the effects of stock options with exercise prices in excess of the estimated fair value of the Company's common stock and of the exercise of warrants have been excluded from the calculation of diluted earnings per share because the effect of their inclusion would be anti-dilutive. 4. INVESTMENT IN SUMMIT ENERGY VENTURES, LLC In July 2001, the Company invested $15,000,000 in Summit and, if Summit invests 75% of the initial $15,000,000 investment by the Company, is committed to invest up to an additional $10,000,000 in Summit. Summit was formed in July 2001 for the purpose of investing in energy and energy related companies. Summit is to exist through June 29, 2006, which date may be extended for up to two additional one year periods by mutual agreement of the parties. Summit's Investment Committee, which is comprised of three members appointed by the Company's management, must approve of any investments to be made by Summit. Accordingly, because of this control over Summit's investments, Summit's financial statements are included in the Company's consolidated financial statements. As of July 31, 2001, the Company's interest in Summit is a 100% preferred membership interest and, after the Company receives its original capital and a 10% preferred return, profits of Summit are to be allocated 50% to the Company and 50% to its partner, Northwest Power Management (Northwest); net losses are allocated per capital contribution. Northwest receives no return until after the Company receives return of its investment and 10% preferred annual return on its investment. The Company shall have the option to F-11 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 purchase any of Summit's investments on such terms and conditions that are established between the Company and Northwest. Condensed balance sheet information for Summit at July 31, 2001, which is included in the Company's consolidated financial statements, is as follows: Assets: Cash and cash equivalents................................. $14,635,411 Prepaid management fees................................... 379,110 ----------- $15,014,521 =========== Members' equity............................................. $15,014,521 ===========
The effect of Summit's results of operations from its date of inception through July 31, 2001 on the Company's consolidated results of operations was insignificant. 5. OTHER CURRENT LIABILITIES AND RELATED MATTERS Other current liabilities is comprised of:
JULY 31, ------------------------ 2000 2001 ---------- ---------- Payroll and related......................................... $ 450,302 $ 467,511 Severance costs............................................. 956,978 75,000 Legal accruals.............................................. 1,249,897 1,476,584 Customer termination costs.................................. 681,270 65,000 Settlement of litigation with founder....................... -- 4,790,000 Other....................................................... 585,636 811,859 ---------- ---------- $3,924,083 $7,685,954 ========== ==========
Severance Arrangements The Company's founder and former Chairman and Chief Executive Officer had an employment agreement with a subsidiary of the Company. He resigned from his positions with the subsidiary in consideration of a severance agreement effective June 1, 2000. The present value of $927,254 of this obligation, based upon a discount rate of 10%, was recorded as of June 1, 2000 and is included in general and administrative expenses for 2000. During 2001, the Company paid $92,138 to its founder pursuant to this agreement. The Company ceased making payments under this agreement to its founder in December 2000 pending resolution of the litigation with the founder described in Note 11. In the settlement of this litigation in August 2001, the founder released his claims for any further payments due under the severance agreement. The Company had granted its former President an option to acquire 1,000,000 shares of the Company's common stock. The options were fully vested at their date of grant, had an exercise price of $2.50 per share and were to expire on December 31, 2002. The fair value of $414,800 of these stock options, as determined on the minimum value method, was included in general and administrative expenses for 2000. By a subsequent agreement the former President released his rights and waived any claims to said option. In addition, costs of $425,000 and $300,000 were recorded in 1999 and 2000, respectively, related to the severance of other employees. F-12 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 Customer Termination Costs The Company terminated certain California commercial and industrial customers during June and July 2000. At July 31, 2000, an accrual of $681,270 was recorded to provide for the estimated costs of terminating these customers including meter lease termination settlement costs and settlement of terminated customer damage claims. Except for $65,000 which was accrued at July 31, 2001, all of these customer termination costs were paid during 2001. 6. PROPERTY AND EQUIPMENT, NET Property and equipment, net is comprised of the following:
JULY 31, ------------------------- 2000 2001 ---------- ----------- Office furniture and equipment............................. $1,237,053 $ 1,227,536 Information technology equipment and systems............... 2,882,360 4,094,531 Leasehold improvements..................................... 172,356 119,629 ---------- ----------- 4,291,769 5,441,696 Less accumulated depreciation and amortization............. (974,892) (1,835,618) ---------- ----------- $3,316,877 $ 3,606,078 ========== ===========
7. RESTRICTED CASH AND INTANGIBLE ASSETS Restricted Cash Restricted cash consists of the following:
JULY 31, ------------------------- 2000 2001 ---------- ----------- Short-term investments pledged as collateral for letters of credit in connection with agreements for the purchase of electric power........................................... $6,146,339 $13,607,500 Cash and cash equivalents of Summit........................ -- 14,635,411 ---------- ----------- $6,146,339 $28,242,911 ========== ===========
The Company is required to pledge an amount equivalent to 45 days of energy purchases under the contracts for the purchase of electric power. The funds in Summit are committed to the purpose of investing in energy and energy related companies. Intangible Assets The Company's intangible assets represent the net unamortized costs of purchasing, in July 1999, the 1-800-Electric telephone number and the rights to eight internet domain names. The initial cost of these intangible assets was $1,050,000. Amortization expense for these intangible assets was $52,500 in 2000 and 2001. 8. LINE OF CREDIT On June 29, 2000, the Company entered into a three-year, $15 million line of credit. Borrowings under the line of credit, which amounted to $3,888,072 at July 31, 2001, are collateralized by accounts receivable, inventory and other assets. In connection with obtaining the line of credit, the Company agreed to pay a commitment fee of $300,000, one-half of which was paid at closing and the remainder to be paid incrementally at each annual renewal date. The Company also issued the lender a warrant expiring June 29, F-13 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 2003 to purchase 100,000 shares of the Company's common stock at a price of $5.50 per share. Interest on borrowings is based on the lender's prime rate plus 1.75%. At July 31, 2001, the interest rate on borrowings under the line of credit was 8.5% and the average effective interest rate on borrowings outstanding during the years ended July 31, 2000 and 2001 was 11.25% and 13.0%, respectively. The credit line is subject to certain financial covenants in the event the Company's net worth falls below $15 million or the Company operates with a negative gross profit. On August 10, 2001, the Company restructured its line of credit to shorten the maturity date to June 29, 2002 and to reduce the amount of the line of credit to $10 million. 9. SHAREHOLDERS' EQUITY Convertible Preferred Stock The convertible preferred stock, which was initially issued on September 15, 1997, provides for cumulative dividends which accrue at an annual rate of 10% and are payable at the discretion of the Company. Cumulative unpaid dividends were $97,612 as of July 31, 2001. Each convertible preferred share is convertible into one share of the Company's common stock at the shareholder's discretion and has full voting rights. In addition, preferred shareholders are entitled to preferential liquidation rights over common stock in the amount of $1.00 per share plus an amount equal to all declared but unpaid dividends. During 2001, all holders of the convertible preferred stock were offered the option to rescind their initial purchase of convertible preferred stock at the initial offering price of $1.00 per share. Holders of 76,500 shares of convertible preferred stock, who had also received 76,500 shares of the Company's common stock subsequently as part of the stock grant described in Note 1, elected to rescind their initial purchase and the Company repurchased both their preferred and common shares. Common Stock The common stock of the Company has no conversion or preemptive shareholder rights as to any securities issued by the Company and are not liable for assessments and further calls. Each share of common stock is entitled to one vote on all matters voted on by shareholders, and is entitled to equal dividends when and as declared by the Board of Directors from funds legally available. The Company has sold shares of its common stock in a series of private placements. These sales of common shares were made by a specific group of employees within the Company who were employed by the Company at the time of the sales for this purpose. The sales commissions paid to these employees, both in the form of cash and stock options granted, have been charged against the proceeds of the common stock sales in the accompanying consolidated statements of shareholders' equity. The amount of the charge for the stock options granted represented the difference between the option exercise price and the fair value of the Company's common stock at the date of grant as determined by the Company for financial reporting purposes. All other costs related to these employees were charged to expense. At July 31, 2001, the Company has reserved the following shares of its common stock for issuance upon conversion of the issued and outstanding shares of convertible preferred stock, exercise of warrants and exercise of outstanding stock options: Reserved for conversion of convertible preferred stock...... 862,500 Reserved for exercise of warrants........................... 100,000 Reserved for exercise of outstanding stock options.......... 10,283,192 ---------- 11,245,692 ==========
See Note 11 for a description of the legal status of common shares issued to the Company's founder. F-14 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 Stock Options The Company's Board of Directors has approved grants of options to acquire a total of 12,901,825 shares of the Company's common stock to the Company's employees, outside directors and service providers. As of July 31, 2001, 10,283,192 of these stock options were outstanding. The options were vested as of their date of grant and expire in December 2002 for the options granted prior to December 1999 and expire in December 2004 through 2010 for the options granted after December 1999. Stock option activity is set forth below:
OPTIONS OUTSTANDING ------------------------------------------------------------- WEIGHTED- AVERAGE WEIGHTED- FAIR VALUE NUMBER OF EXERCISE PRICE AVERAGE OF COMMON SHARES PER SHARE EXERCISE PRICE STOCK(A) ---------- -------------- -------------- -------------- Balance at July 31, 1998.................. 931,310 $.01 - $ .05 $0.011 $0.71 Options granted: Exercise price less than fair value of common stock(A): -- Employee commissions for stock sales.............................. 1,511,250 $.01 - $1.00 $0.067 $2.63 -- Other employee.................... 2,104,090 $.01 - $1.00 $0.339 $2.85 -- Outside service providers......... 254,675 $.01 - $1.00 $0.212 $3.54 -- Outside directors................. 40,000 $1.00 $ 1.00 $3.75 Exercise price equal to fair value of common stock(A): -- Employee commissions for stock sales.............................. 425,000 $3.75 $3.750 $3.75 Options exercised......................... (39,750) $.01 - $ .05 $0.020 ---------- ------------ ------ Balance at July 31, 1999.................. 5,226,575 $.01 - $3.75 $0.478 Options granted: Exercise price less than fair value of common stock(A): -- Employee commissions for stock sales.............................. 21,000 $1.00 $1.000 $2.50 -- Other employees................... 12,000 $1.00 $1.000 $2.50 Exercise price equal to fair value of common stock(A): -- Employee performance-based........ 2,600,000 $2.50 $2.500 $2.50 -- Other employee.................... 750,000 $2.50 $2.500 $2.50 -- Outside directors................. 250,000 $2.50 $2.500 $2.50 -- Non-employee...................... 52,500 $2.50 $ 2.50 $2.50 -- Settlement and Severance of former president......................... 1,000,000 $2.50 $ 2.50 $2.50 Options exercised......................... (392,406) $.01 - $1.00 $0.179 Options cancelled......................... (269,777) $.05 - $3.75 $1.902 ---------- ------------ ------ Balance at July 31, 2000.................. 9,249,892 $.01 - $3.75 $1.469 Options granted: Exercise price less than fair value of common stock(A): -- Employee performance-based........ 300,000 $2.50 $2.500 $2.75
F-15 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001
OPTIONS OUTSTANDING ------------------------------------------------------------- WEIGHTED- AVERAGE WEIGHTED- FAIR VALUE NUMBER OF EXERCISE PRICE AVERAGE OF COMMON SHARES PER SHARE EXERCISE PRICE STOCK(A) ---------- -------------- -------------- -------------- Exercise price equal to fair value of common stock(A): -- Other employees................... 2,500,000 $2.75 $2.750 $2.75 -- Outside directors................. 150,000 $2.75 $2.750 $2.75 Options exercised......................... (67,200) $.01 - $1.00 $0.072 Options cancelled......................... (1,849,500) $.01 - $3.75 $1.723 ---------- ------------ ------ Balance at July 31, 2001.................. 10,283,192 $.01 - $3.75 $1.792 ========== ============ ======
- --------------- (A) At date of grant. The weighted average remaining contractual life and weighted average exercise price of options outstanding and of options exercisable as of July 31, 2001 were as follows:
AVERAGE NUMBER OF REMAINING WEIGHTED RANGE OF SHARES CONTRACTUAL SHARES AVERAGE EXERCISE PRICES OUTSTANDING LIFE (YEARS) EXERCISABLE EXERCISE PRICE - --------------- ----------- ------------ ----------- -------------- $ .01 - $ .50 3,126,017 1.63 3,126,017 $ 0.11 $1.00 512,175 1.44 512,175 $ 1.00 $2.50 - $3.75 6,645,000 6.97 2,922,500 $ 2.65 ---------- ---- --------- ------ Total 10,283,192 5.07 6,560,692 $ 1.31 ========== ==== ========= ======
Stock Options Granted to Company's Chairman and Chief Executive Officer and Related Stock-based Compensation On January 1, 2000, as part of an employment agreement with a term expiring January 31, 2005, the Company granted 3,600,000 stock options to the Company's Chairman and Chief Executive Officer which have an exercise price of $2.50 per share and expire on January 1, 2010. As of January 1, 2000, 300,000 of the options were vested and 100,000 options vest annually on January 1 of each year from 2001 through 2004. The remaining 2,900,000 options are performance-based and vest upon the occurrence of certain events. When granted, the terms for 2,000,000 of these performance-based options provided for the vesting upon completion of a successful Initial Public Offering by the Company. Subsequently, on November 1, 2000, the terms of the vesting of these 2,000,000 stock options were modified to the performance criteria indicated with an (A) below. F-16 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 Performance criteria which were met during the year ended July 31, 2001, the number of related stock options vested and not earned, and stock-based compensation recognized during the year ended July 31, 2001 are as follows:
NUMBER OF OPTIONS STOCK-BASED ---------------------- COMPENSATION VESTED NOT EARNED RECOGNIZED --------- ---------- ------------ Completion of the audit of the Company's July 31, 2000 consolidated financial statements(A)....... 500,000 -- $125,000 Settlement of the California Department of Corporations investigation(A)................... 250,000 -- 62,500 Settlement of the California Public Utilities Commission investigation(A)..................... 500,000 -- 125,000 Exceeding the Company's business plans for the calendar year ended December 31, 2000 by 10% or more............................................ 100,000 200,000 25,000 --------- ------- -------- 1,350,000 200,000 $337,500 ========= ======= ========
Performance criteria which have not been met as of July 31, 2001, the number of related stock options which vest upon meeting the performance criteria and stock-based compensation recognized during the year ended July 31, 2001 are as follows:
STOCK-BASED NUMBER OF COMPENSATION UNVESTED OPTIONS RECOGNIZED ---------------- ------------ Completion of liquidity event, as defined in related agreement(A)......................................... 750,000 $412,500 Completion of a successful initial public offering..... 300,000 165,000 Exceeding the Company's business plans for the calendar year ending December 31, 2001 by 10% or more......... 300,000 165,000 --------- -------- 1,350,000 $742,500 ========= ========
If during the term of the employment agreement, the Company makes a public offering of its shares or if the Company supports any other form of liquidity event, then all stock options related to this employment agreement, whether earned or not, shall be considered vested prior to such event. The employment agreement also provides that in the event the Company terminates the agreement early or a change in control of the Company occurs, the Company's Chairman and Chief Executive Officer has the right to require the Company to repurchase all his capital stock and stock options of the Company, then earned or to be earned, at a repurchase price equal to two times the then price value of the Company's common stock. Options Granted during the Year Ended July 31, 2001 During the year ended July 31, 2001, the Company granted 2,500,000 stock options to employees and 150,000 stock options to non-employee directors. The stock options granted to employees were 25% vested on their date of grant and vest 25% at the anniversary of the dates of grant over the next three years. These stock options expire on November 11, 2007. F-17 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 Other Stock-Based Compensation In connection with the granting of stock options to certain employees and the Company's outside directors, the amount of related compensation to be recognized was determined by the Company to be the difference between the option exercise price and the fair value of the Company's common stock at the date of grant as determined by the Company's management for financial reporting purposes. Inasmuch as all options granted by the Company through July 31, 2000 were fully vested as of their date of grant, the related compensation was expensed as of the date of grant, except for the compensation related to options granted as commissions to employees for the sales of the Company's common stock which was charged against the proceeds of the common stock sales. The Company's founder and, at the time, its Chairman and Chief Executive Officer, gave a total of 248,000 and 123,500 shares of the Company's common stock owned by him to two officers of the Company in 1999 and 2000, respectively. In accordance with Staff Accounting Bulletin No. 79, Accounting for Expenses or Liabilities Paid by Principal Stockholder, the estimated fair value of such shares of $496,000 and $423,500 was included in stock-based compensation charges in 1999 and 2000, respectively. Stock-based compensation charges relate to the following:
YEAR ENDED JULY 31, ------------------------------------- 1999 2000 2001 ----------- -------- ---------- Stock options granted with fair value of Company's common stock in excess of exercise price of options............................. $ 8,548,500 $ 53,277 $ -- Performance-based stock options................ -- -- 1,080,000 Gift of shares from founder to officers........ 496,000 423,500 -- ----------- -------- ---------- 9,044,500 476,777 1,080,000 Less amount related to commissions on sales of the Company's common stock................... (3,326,090) (31,500) -- ----------- -------- ---------- $ 5,718,410 $445,277 $1,080,000 =========== ======== ==========
Warrants As part of the $15 million credit line agreement dated June 29, 2000, the lender received warrants to purchase 100,000 shares of common stock. The warrants are exercisable at $5.50 per share and expire upon the maturity of the loan agreement on June 29, 2003. The fair value of the warrants was nominal at their date of issuance. Pro Forma Disclosures of the Effect of Stock-Based Compensation Plans Pro forma information regarding results of operations and net income (loss) per common share is required by SFAS No. 123 for stock-based awards to employees, which are comprised of stock options for the purchase of the Company's common stock, as if the Company had accounted for such awards using a valuation method permitted under SFAS No. 123. In determining such pro forma information, stock options to employees and outside directors were valued using the minimum value method assuming no expected dividends, an average expected life through the option expiration dates, and a weighted-average risk-free interest rate of 6.0%. The minimum value method does not consider stock price volatility. For pro forma purposes, the estimated minimum value of the Company's stock-based awards to employees and outside directors were expensed at the date of grant of the stock options for options that were fully vested at date of grant and was expensed over the vesting period of stock options that vest over a period of time. The results of applying Statement No. 123 to the Company's stock option grants to employees and outside directors on the F-18 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 assumptions described above approximate the Company's reported amounts of net income (loss) and net income (loss) per common share for each year. 10. INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Net deferred income taxes consist of the following:
JULY 31, --------------------------- 2000 2001 ------------ ----------- Deferred tax assets: Net operating loss carryforwards....................... $ 9,846,000 $ 1,021,000 Stock options.......................................... 2,232,000 2,756,000 Allowance for doubtful accounts........................ 625,000 601,000 Reserves and accruals.................................. 1,641,000 4,421,000 State income taxes..................................... -- 1,586,000 ------------ ----------- 14,344,000 10,385,000 Less valuation allowance............................... (14,254,000) (1,021,000) ------------ ----------- 90,000 9,364,000 Deferred tax liabilities: Depreciation and amortization.......................... (72,000) (85,000) Other.................................................. (18,000) -- ------------ ----------- Net deferred tax asset................................... $ -- $ 9,279,000 ============ ===========
For the year ended July 31, 2001, the Company's provisions for income taxes was comprised of the following:
CURRENT DEFERRED TOTAL ----------- ----------- ----------- Federal..................................... $24,953,000 $(7,728,000) $17,225,000 State....................................... 6,178,000 (1,551,000) 4,627,000 ----------- ----------- ----------- $31,131,000 $(9,279,000) $21,852,000 =========== =========== ===========
There was no provision for income taxes for the years ended July 31, 1999 and 2000. A reconciliation of the federal statutory income tax rate to the Company's provision for income taxes as a percentage of loss before income taxes is as follows:
YEAR ENDED JULY 31, ----------------------- 1999 2000 2001 ----- ----- ----- Federal statutory income tax rate........................... 34.0% 34.0% 35.0% Valuation allowance recorded due to losses.................. (34.0) (34.0) -- Reversal of valuation allowance............................. -- -- (13.1) State income taxes, net of federal benefit.................. -- -- 3.6 Other....................................................... -- -- 1.1 ----- ----- ----- Income tax rate per financial statements.................... --% --% 26.6% ===== ===== =====
A valuation allowance was recorded to reflect the uncertainty of realization of the deferred tax asset during 1999 and 2000. The valuation allowance at July 31, 2001 was recorded to reflect the uncertainty of the F-19 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 deferred tax asset related to the net operating loss carryforward, the use of which is limited as described in the following paragraph. The valuation allowance increased by $7,881,000 and $2,840,000 during 1999 and 2000, respectively, and during 2001 was increased by $362,000 for a change in the federal income tax rate applied to the Company's temporary differences and decreased by $13,595,000 for the release of the valuation allowance because of the Company's profitable operations during the year ended July 31, 2001. At July 31, 2001, the Company had net operating loss carryforwards of approximately $2,330,000 for federal and state income tax purposes that begin to expire in years 2018 and 2006, respectively. The timing of the utilization of federal net operating loss carryforwards is subject to an annual limitation due to the "change of ownership" provision of the Tax Reform Act of 1986. As a result of the annual limitation, a portion of these carryforwards may expire before ultimately becoming available to reduce future income tax liabilities. 11. COMMITMENTS AND CONTINGENCIES COMMITMENTS Purchase Commitments See Note 2 for a description of commitments to purchase electric power. Leasing Arrangements The Company is obligated under long-term leases for the rental of real estate and office equipment. The Company conducts its main operations from facilities that are leased under a five-year non-cancelable operating lease expiring on April 24, 2004. The Company also leases four other locations for its sales staff. The leases for certain locations contain escalation clauses relating to increases to real property taxes and maintenance costs. The following is a schedule of the future minimum rental payments required under the above operating leases as of July 31, 2001:
YEAR ENDING JULY 31, -------------------- 2002......................................... $ 841,087 2003........................................ 652,949 2004........................................ 371,835 2005........................................ 27,588 ---------- $1,893,459 ==========
Rent expense for operating leases amounted to $367,300, $786,300 and $697,498 in 1999, 2000 and 2001, respectively. Employment contracts The Company has entered into employment contracts with four of its executives which provide for aggregate base salaries as follows during the term of the contracts:
YEAR ENDING JULY 31, -------------------- 2002......................................... $1,017,916 2003........................................ 1,172,917 2004........................................ 1,346,250 2005........................................ 627,083
F-20 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 Two of the contracts provide that in the event of a change in control as defined in the contracts, the executive is to receive an amount equal to eight times the annual base salary plus the amount of income taxes payable under Internal Revenue Service (IRS) Code sec.280G whereas the other two contracts provide that, in the event of a change in control as defined in the contracts, the executive is to receive an amount equal to four times the annual base salary plus the amount of income taxes payable under IRS Code sec.280G. Three of the agreements provide that if the executive's employment is terminated for other than death, disability, material breach of agreement or voluntary termination, the executive will be entitled to receive one and one-half times his then current base salary. The other agreement provides that the Company may only terminate the executive's employment for death, disability or cause. In the event of death or disability, the executive is entitled to receive his then current base salary and bonus for a period of one year or until the expiration of the term of the agreement, whichever comes first. CONTINGENCIES California Department of Corporations Investigation The California Department of Corporations ("DOC") initiated an investigation of the Company in 1999 regarding the manner and extent of the offers and sales of the Company's stock and whether or not said offers and sales conformed to the requirements of the California Securities laws or allowable exemptions to registration, and whether the Company's employees involved in such sales should have been licensed. Shortly after the initial inquiry, there was a change in management of the Company and all of such sales activities ceased, and the employment of all employees involved in such sales activities was terminated. The Company had entered into negotiations with the DOC to resolve this investigation and reached mutually agreeable terms of settlement, which include a payment of $150,000 by the Company to the DOC, which the Company accrued as of July 31, 2000, and an agreement to cooperate with the DOC in any further investigations which may arise related to these matters. In February 2001, upon the payment of $150,000 by the Company to the DOC, this investigation was closed. California Public Utilities Commission Investigation In 1999, the Consumer Services Division of the CPUC ordered an investigation relating to non-disclosure by the Company's former Chairman and Chief Executive Officer of cease and desist actions taken against him prior to his association with the Company and to a supplemental billing by the Company covering a six-month period during which the Company had under-billed its customers. The Company negotiated a settlement of all issues with the CPUC and both parties signed a settlement agreement on January 7, 2000. The terms included a payment of $100,000 by the Company to the CPUC and reimbursement by the Company of the amount of the supplemental billing to its customers through refunding amounts previously paid or issuing credits for unpaid amounts, and that the Company's Chief Executive Officer from July 1, 1997 through December 31, 1998 would not have any responsibility for the business practices, management or operation of the Company in California for a period of at least two years after the effective date of the settlement agreement. The Company accrued for the financial impact of the January 7, 2000 settlement agreement during the year ended July 31, 2000. In July 2001, the CPUC investigation was ordered settled by the CPUC. The settlement provided for among other things, the Company to pay a fine of $219,500 and audit costs of $37,000 plus reimbursement of the supplemental billings to its customers (which reimbursement had taken place in prior periods). Litigation with Company's Founder The Company's corporate records state 8,000,000 shares of the Company's common stock were issued to its founder on August 15, 1997 in exchange for $140,000 in the form of cash payments totaling $90,000 and personal property having a value of $50,000; however, the Company was unable to verify that all of this F-21 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 consideration was actually paid to the Company. Accordingly, on February 23, 2001, the Company's Board of Directors instructed the Company's management to reflect on the corporate stock records that only a portion of the shares issued the founder be recognized as validly issued. Previously, at the time the Company entered into the severance agreement with the founder as more fully described in Note 5, the founder and the Company entered into an Accommodation Agreement pursuant to which 1,200,000 of the founders' common shares were placed into an escrow account for a period of three years from which the Company could use shares to settle claims of former employees of the Company. At the end of the three year period, any shares remaining in the escrow account were to be released to the founder. Subsequent to the actions described above, claims and counterclaims were filed by the Company and the founder. On August 10, 2001, a settlement was reached with the founder which was approved by the court having jurisdiction over the case on August 15, 2001. The material terms of the settlement provided that the Company pay the founder $4,790,000 in damages and an additional $2,400,000 to purchase 1,175,160 shares of the Company's common stock claimed to be held by the founder. The settlement agreement also provided that the remaining 4,720,000 shares of the Company's common stock claimed to be held by the founder were void. Founder also agreed to release his claims to the shares of the Company's common stock held in the escrow account pursuant to the Accommodation Agreement and to the Company's obligation to him under the severance agreement described in Note 5. The founder also agreed that he would have no future ownership in the Company. The loss on the settlement of $4,790,000, which is net of the previously accrued severance payable to the founder of $927,554, was recorded as of July 31, 2001 and is included in general and administrative expenses for the year then ended. Litigation From time to time, the Company is involved in legal proceedings, claims, and litigation arising in the ordinary course of business. Management does not believe the outcome of these matters will have a material effect on the Company's consolidated financial condition or its consolidated results of operations. F-22 COMMONWEALTH ENERGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) JULY 31, 2001 12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
THREE MONTHS ENDED -------------------------------------------------- OCTOBER 31 JANUARY 31 APRIL 30 JULY 31 ---------- ---------- --------- --------- (IN THOUSANDS EXCEPT PER SHARE INFORMATION) Year ended July 31, 2000: Net revenue................................... $20,169.4 $18,670.8 $17,950.0 $42,834.1 Gross margin.................................. 2,796.8 1,040.0 2,389.6 6,666.0 Net income (loss)............................. (2,137.8) (3,548.7) (3,305.1) 345.5 Net income (loss) per common share (restated)(A): Basic and diluted........................... (.08) (.12) (.11) .01 Net income (loss) per common share (as originally reported)(A): Basic and diluted........................... (.07) (.10) (.10) .01 Year ended July 31, 2001: Net revenue................................... $43,106.0 $52,659.0 $48,272.6 $39,226.1 Gross margin.................................. 18,833.0 41,153.9 28,431.2 18,230.0 Net income.................................... 11,759.2 27,865.2 14,509.6 6,395.5 Net income per common share (restated)(A): Basic....................................... .40 .95 .49 .22 Diluted..................................... .34 .81 .43 .19 Net income per common share (as originally reported)(A): Basic....................................... .35 .86 .51 Diluted..................................... .30 .75 .44
- --------------- (A) See Note 1, "Adjustment of Number of Outstanding Shares and Restatement of Per Share Information" for a description of the basis of the restatement of the per share information for the quarters ended October 31, 1999 and 2000, January 31, 2000 and 2001, and April 30, 2000 and 2001. F-23 COMMONWEALTH ENERGY CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS JANUARY 31, 2002 (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $33,340,460 Accounts receivable: Billed................................................. 17,895,613 Unbilled............................................... 4,173,991 Green power credits.................................... 839,150 ----------- 22,908,754 Less allowance for doubtful accounts................... (5,210,196) ----------- Net accounts receivable................................... 17,698,558 Prepaid income taxes...................................... 2,138,428 Deferred tax asset........................................ 2,481,510 Prepaid expenses and other assets......................... 2,812,119 ----------- Total current assets.............................. 58,471,075 Property and equipment, net................................. 4,117,592 Restricted cash............................................. 23,520,306 Other assets: Intangible assets......................................... 918,750 Investments, at cost...................................... 4,866,468 Deposits and notes receivable............................. 478,465 Deferred tax asset........................................ 6,476,774 ----------- Total other assets................................ 12,740,457 ----------- Total assets...................................... $98,849,430 =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 7,828,267 Notes payable under line of credit........................ 3,578,753 Other current liabilities................................. 3,435,961 ----------- Total current liabilities......................... 14,842,981 Commitments and contingencies Shareholders' equity: Convertible preferred stock -- 10,000,000 shares authorized with no par value; 775,000 shares issued and outstanding............................................ 790,246 Common stock -- 50,000,000 shares authorized with no par value; 27,323,071 shares issued and outstanding........ 57,925,497 Retained earnings........................................... 25,290,706 ----------- Total shareholders' equity........................ 84,006,449 ----------- Total liabilities and shareholders' equity........ $98,849,430 ===========
See accompanying notes. F-24 COMMONWEALTH ENERGY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
SIX MONTHS ENDED JANUARY 31, ---------------------------- 2001 2002 ------------ ------------ Retail energy sales......................................... $64,520,514 $38,462,130 Wholesale energy sales...................................... 28,937,152 13,842,353 ----------- ----------- Net energy sales............................................ 93,457,666 52,304,483 Green power credits......................................... 2,307,336 2,072,963 ----------- ----------- Net revenue................................................. 95,765,002 54,377,446 Direct energy costs......................................... 35,778,144 43,069,180 ----------- ----------- Gross margin................................................ 59,986,858 11,308,266 Selling and marketing expenses.............................. 2,001,679 1,784,220 General and administrative expenses......................... 7,302,185 9,414,685 ----------- ----------- Income from operations...................................... 50,682,992 109,361 Interest income............................................. 678,649 819,746 Interest expense............................................ (419,076) (200,503) ----------- ----------- Income before provision for income taxes.................... 50,942,567 728,604 Provision for income taxes.................................. 11,318,240 292,054 ----------- ----------- Net income.................................................. $39,624,327 $ 436,550 =========== =========== Net income per common share: Basic..................................................... $ 1.35 $ .02 =========== =========== Diluted................................................... $ 1.16 $ .01 =========== ===========
See accompanying notes. F-25 COMMONWEALTH ENERGY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JANUARY 31, ---------------------------- 2001 2002 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income.................................................. $39,624,327 $ 436,550 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation.............................................. 379,400 605,560 Amortization.............................................. 26,250 26,250 Provision for doubtful accounts........................... 953,126 1,263,808 Tax benefit arising from exercise of stock options........ 144,317 -- Deferred income taxes..................................... (1,295,492) 320,485 Changes in operating assets and liabilities: Billed accounts receivable............................. (2,019,172) (1,076,954) Unbilled accounts receivable........................... (3,102,257) (835,819) Green power credits receivable......................... 1,605,558 337,461 Prepaid expenses and other assets...................... (2,032,982) 1,013,077 Accounts payable....................................... 1,035,182 (1,576,584) Income taxes payable................................... 12,613,732 -- Accrued expenses....................................... (162,333) (4,249,993) ----------- ----------- Net cash provided by (used in) operating activities......... 47,769,656 (3,736,159) CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment......................... (253,874) (1,117,074) Purchase of investments..................................... -- (4,866,468) ----------- ----------- Net cash used in investing activities....................... (253,874) (5,983,542) CASH FLOWS FROM FINANCING ACTIVITIES Borrowings under (repayments of) line of credit............. 34,202 (309,319) Decrease (increase) in restricted cash...................... (2,488,934) 4,722,605 Dividends paid on preferred stock........................... -- (25,321) Repurchase of preferred stock............................... -- (62,500) Repurchase of common stock.................................. -- (2,400,000) Proceeds from exercise of stock options..................... -- 20,650 ----------- ----------- Net cash provided by (used in) financing activities......... (2,454,732) 1,946,115 ----------- ----------- Increase (decrease) in cash and cash equivalents............ 45,061,050 (7,773,586) Cash and cash equivalents at beginning of period............ 4,213,168 41,114,046 ----------- ----------- Cash and cash equivalents at end of period.................. $49,274,218 $33,340,460 =========== =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Interest expense.......................................... $ 419,076 $ 200,503 =========== =========== Income taxes.............................................. $12,613,732 $ -- =========== ===========
See accompanying notes. F-26 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2002 (UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business Commonwealth Energy Corporation (the "Company") was incorporated on August 15, 1997. The Company's primary business has been the sale of electric power to retail customers in California and, beginning January 2000, in Pennsylvania and beginning in August 2000, the sale of electric power to wholesale customers in California and Pennsylvania. The Company is licensed by the Federal Energy Regulatory Commission (FERC) as a power marketer, by California as an Electric Service Provider and by Pennsylvania as an Electric Generation Supplier. The Company plans to enter new deregulated electric power markets in the future. The electric power sold by the Company to its retail customers is delivered to the Company's customers by Utility Distribution Companies (UDCs) in California and an Electric Distribution Company (EDC) in Pennsylvania, which measure electric power usage by the Company's customers and bill the customers on behalf of the Company. There are three UDCs in California and one EDC in Pennsylvania which conduct these activities on behalf of the Company. The Company's operations have been in one reportable segment, the domestic electricity distribution industry. Basis of Presentation The condensed consolidated interim financial statements of the Company include the accounts of the Company's wholly-owned subsidiaries and Summit Energy Ventures, LLC (Summit). All intercompany transactions have been eliminated in consolidation. The condensed consolidated interim financial statements as of January 31, 2002 and for the six month periods ended January 31, 2001 and 2002 are unaudited but, in the opinion of management, have been prepared on the same basis as the audited financial statements and reflect all adjustments, consisting of normal recurring accruals necessary for a fair presentation of the information set forth therein. The results of operations for the six month period ended January 31, 2002 are not necessarily indicative of the operating results to be expected for the full year or any other period. These financial statements and notes should be read in conjunction with the financial statements and notes included in the audited consolidated financial statements of the Company for the year ended July 31, 2001. Adjustment of Number of Outstanding Common Shares and Restatement of Per Share Information The Company disputed whether certain shares of its common stock issued to its founder were validly issued. Litigation ensued between the Company its founder regarding this and other matters. A settlement of this litigation was approved by the court having jurisdiction over the case on August 15, 2001 and stipulated that 4,720,000 of the founder's disputed common shares were void. The Company's legal counsel has advised that such shares should be considered void ab initio, or having never been issued. Accordingly, the Company has restated its prior years' financial statements to reflect the terms of this settlement. The only change to the Company's results of operations is in certain previously reported net income per share information, including the results for the six months ended January 31, 2001 which have been restated as follows:
BASIC DILUTED ----- ------- As restated................................................. $1.35 $1.16 As originally reported...................................... $1.21 $1.05
F-27 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JANUARY 31, 2002 (UNAUDITED) Estimates and Assumptions The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates in the Company's consolidated financial statements relate to independent system operator costs, allowance for doubtful accounts, and unbilled receivables and legal claims. Actual results could differ from those estimates. Revenue and Cost Recognition Net revenue from sales of electric power is recognized as the power is delivered to the Company's customers. Net revenue represents proceeds from energy sales. Direct energy costs include electric power purchased, independent system operator (ISO) fees and scheduling coordination fees. The actual ISO costs are not finalized until a settlement process by the ISO is performed of each day's activities of all grid participants. Prior to the completion of settlement, the Company estimates and accrues for these costs based on preliminary settlement information. Selling and marketing expenses include salaries of sales and marketing personnel and promotional and advertising costs. General and administrative expenses include salaries for corporate support personnel, rent expenses, insurance expenses, bad debt expenses, depreciation expenses and other costs of the corporate office. The Company's net revenue, including green power credits, is derived from sales to the following class of customers:
SIX MONTHS ENDED JANUARY 31, ---------------------------- 2001 2002 ------------ ------------ Retail and commercial end users........................... $66,827,850 $40,535,093 Wholesale................................................. 28,937,152 13,842,353 ----------- ----------- $95,765,002 $54,377,446 =========== ===========
Unbilled Receivables The Company's customers are billed monthly at various dates throughout the month. Unbilled receivables represent the amount of electric power delivered to customers at the end of a period, but not yet billed. Unbilled receivables from sales in California through January 19, 2001 were estimated by the Company as the number of kilowatt hours delivered times 95% of the California Power Exchange ("PX") cost as published by Southern California Edison for residential customers. On January 20, 2001, the PX ceased operations and the Company replaced the PX cost amount with the individual Utility Purchased Energy cost as published by each individual utility. Stock-Based Compensation As permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123) and FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, the Company accounts for stock options granted to its employees and outside directors using the intrinsic value method. Most of the Company's stock option grants were granted with exercise prices below the fair value of the Company's common stock as estimated by the Company's management for financial reporting purposes. In addition, since most stock option grants were vested at their dates of grant, the difference between the exercise prices and such estimated fair values was expensed as stock-based compensation charges as of the date of grant. F-28 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JANUARY 31, 2002 (UNAUDITED) Concentration of Credit Risk The Company's concentration of credit risk with respect to accounts receivable is limited due to the large number of customers who are spread primarily throughout California and Pennsylvania. In addition, the Company maintains allowances for potential credit losses. As of January 31, 2002, 53.0% of the Company's billed and unbilled receivables are due from a large number of retail and commercial end users in California and Pennsylvania who are billed by and make remittances to the UDC's or the EDC that deliver their electricity which, in turn, forward such remittances to the Company. One of the UDC's, Pacific Gas and Electric (PG&E), filed for bankruptcy in April 2001 and has withheld from payment to the Company a portion of the remittances due to the Company. The Company has filed a Proof of Claim in PG&E's bankruptcy proceedings to recover these amounts which approximated $1,104,000 at January 31, 2002. The Company has provided fully for these disputed amounts in its allowance for doubtful accounts. The Company does not have any similar disputes with its other UDC's. The remainder of the Company's billed and unbilled accounts receivable are due primarily from wholesale customers including $3,696,854 due from Automated Power Exchange (APX). This amount includes $2,356,879 in ISO credit holdbacks relating to November 2000, January 2001, and August 2001 activity. APX has informed the Company that the holdbacks were made, in part, because certain organizations, including PG&E and PX, which have declared bankruptcy, did not make their scheduled payments to APX. We have established an allowance of $2,327,171 for doubtful accounts related to the APX holdbacks based on our estimates of the amounts that will ultimately be collected from APX. In addition, PG&E has withheld payment of approximately $1,104,000 from their remittances to us. Although we have filed a Proof of Claim in PG&E's bankruptcy to recover these amounts, we have established an allowance for doubtful accounts in the amount of these withholdings. During the six months ended January 31, 2002, sales to PJM Interconnection in Pennsylvania represented approximately 15% of the Company's total net revenue. Payment terms of these energy sales are net 15 days of the invoice date. During the six months ended January 31, 2002, no other customer represented over 10% of the Company's net revenue. During the six months ended January 31, 2001, sales to the California Power Exchange represented approximately 20% of the Company's total net revenue. No other customer represented over 10% of the Company's net revenue during the six months ended January 31, 2001. 2. MARKET AND REGULATORY RISKS California Deregulated Electric Power Markets California has been experiencing extreme fluctuations in the cost of wholesale energy since May 2000. During the summer of 2000 and winter of 2001, the price of electricity in wholesale markets reached unprecedented highs. Since the winter of 2001, the price of electricity has returned to near historical levels. In reaction to this crisis, FERC, the California Public Utilities Commission ("CPUC"), the State Legislature and the Governor have proposed a varying number of methods to help restore price stability to the California electricity marketplace. On September 20, 2001, the CPUC issued a ruling, which was revisited on March 21, 2002 and upheld, suspending "direct access" pursuant to legislation by the California state legislature requiring the CPUC to suspend "direct access" in California. The suspension of "direct access" means that retail electricity suppliers, such as the Company, will not be allowed to actively seek customers. This ruling permits the Company to keep its current customer base, but prohibits the Company from signing up new customers for an undetermined period of time. F-29 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JANUARY 31, 2002 (UNAUDITED) In addition to regulatory and legislative risks, one of the UDC's in California, PG&E, with which the Company interacts to conduct its business has filed for bankruptcy protection. Other utilities in California also could seek protection of bankruptcy in the future. Commitments to Purchase Electric Power For the California market, the Company has entered into a contract, which expires on June 30, 2002, to acquire 2,400 MWH of electric power per day through December 31, 2000 and 3,000 MWH per day for the remainder of the contract. The Company is obligated to minimum electric purchases of $32.3 million during the year ending July 31, 2002, under this commitment. The electric power acquired under this contract qualifies for the California "Green Power Credit" upon its resale to certain classes of customers. For the Pennsylvania market, the Company has entered into various contractual arrangements for the purchase of electric power through May 2004. The Company is obligated to minimum electric power purchases of $37.9 million during the year ending July 31, 2002 and $51.9 million thereafter under these contracts. Since the price at which the Company can purchase this electric power is fixed during the terms of the contracts, if the price at which the Company can resell this electric power falls below the contract purchase price plus distribution and scheduling costs, the Company would incur operating losses during such periods. Pennsylvania Operations In accordance with its standard customer contract in Pennsylvania, the Company may charge only certain maximum rates for its sales of electric power which, at times, could be less than the Company's costs of acquiring, distributing and scheduling such electric power. Energy capacity charges for servicing electric power in Pennsylvania market varies significantly from month to month and can effect gross profit margins. California Green Power Credits The state of California enacted the Public Purpose Program which established a $540 million fund to provide overall incentives to suppliers of "green" power to initially reduce, among other things, the net costs of such power to certain consumers by 1.5 cents per kWh which effective July 31, 2000, has been at a rate 1.0 cent per kWh. The Company received Green Power Credits of $2,307,336 for the six months ended January 31, 2001 and $2,072,964 for the six months ended January 31, 2002, which are included in the Company's net revenue. The benefit of these credits has been passed through to the Company's customers. The January 2002 green power credit revenue was fully reserved because the legislative action required to extend the program past December 31, 2001 had not been approved and the Company does not know if the subsidy will be continued. 3. PER SHARE INFORMATION The amount of net income used in the calculations of basic and diluted net income per common share includes cumulative preferred dividend requirements of $42,474 and $35,954 for the six months ended January 31, 2001 and 2002, respectively. F-30 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JANUARY 31, 2002 (UNAUDITED) Basic and diluted net income per common share is computed as follows:
SIX MONTHS ENDED JANUARY 31, ----------------------------- 2001 2002 ------------- ------------- NUMERATOR: Net income.................................................. $39,624,327 $ 436,550 Preferred stock dividend.................................... (42,474) (35,954) ----------- ----------- Income applicable to common stock -- Basic.................. 39,581,853 400,596 Assumed conversion of preferred stock....................... 42,474 35,954 ----------- ----------- Net income -- Dilutive...................................... $39,624,327 $ 436,550 =========== =========== DENOMINATOR: Average outstanding shares -- Basic......................... 29,372,935 27,607,421 Dilutive shares: Exercise of stock options................................. 3,872,594 3,606,230 Conversion of preferred stock into common stock........... 939,000 814,286 ----------- ----------- Average outstanding shares -- Dilutive...................... 34,184,529 32,027,937 =========== ===========
For all periods presented, the effects of stock options with exercise prices in excess of the estimated fair value of the Company's common stock and of the exercise of warrants have been excluded from the calculation of diluted earnings per share because the effect of their inclusion would be anti-dilutive. 4. INVESTMENT IN SUMMIT ENERGY VENTURES, LLC In July 2001, the Company invested $15,000,000 in Summit and, if Summit invests 75% of the initial $15,000,000 investment, the Company may, solely at its discretion, invest up to an additional $10,000,000 in Summit. Summit was formed in July 2001 for the purpose of investing in energy and energy-related companies. Summit is to exist through June 29, 2006, which date may be extended for up to two additional one year periods by mutual agreement of the parties. Summit's Investment Committee, which is comprised of three members appointed by the Company's management, must approve of any investments to be made by Summit. Accordingly, because of this control over Summit's investments, Summit financial statements are included in the Company's consolidated financial statements. As of January 31, 2002, the Company's interest in Summit is a 100% preferred membership interest and, after the Company receives its original capital and a 10% preferred return, profits of Summit are to be allocated 60% to the Company and 40% to Steven Z. Strasser, the owner of Summit's investment manager, Northwest Power Management (Northwest). Net losses are allocated per capital contribution. Northwest receives no return until after the Company receives return of its investment and 10% preferred annual return on its investment. The Company shall have the option to purchase any of Summit's investments on such terms and conditions that are established between the Company and Northwest. F-31 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JANUARY 31, 2002 (UNAUDITED) Condensed balance sheet information for Summit at January 31, 2002, which is included in the Company's consolidated financial statements, is as follows: Assets: Cash and cash equivalents................................. $ 9,801,064 Prepaid management fees................................... 227,055 Investment in Envenergy, Inc., at cost.................... 2,029,669 Investment in Turbocor, Inc., at cost..................... 2,836,800 ----------- $14,894,588 =========== Members equity.............................................. $14,894,588 ===========
The effect of Summit's results of operations during the six months ended January 31, 2002 on the Company's consolidated results of operations was insignificant. In October 2001, Summit Energy invested $2,029,669 in Envenergy, Inc. representing a 9% ownership in that company. In January 2002, Summit Energy invested $2,836,800 in Turbocor, Inc. representing a 7% ownership in that company. These investments will be accounted for as an available for sale equity investments. 5. OTHER CURRENT LIABILITIES Other current liabilities are comprised of the following at January 31, 2002: Payroll and related......................................... $ 668,538 Legal accruals.............................................. 1,168,034 Customer termination costs.................................. 58,922 Other....................................................... 1,540,467 ---------- $3,435,961 ==========
6. PROPERTY AND EQUIPMENT, NET Property and equipment, net is comprised of the following at January 31, 2002: Office furniture and equipment.............................. $ 1,265,635 Information technology equipment and systems................ 5,167,697 Leasehold improvements...................................... 125,438 ----------- 6,558,770 Less accumulated depreciation and amortization.............. (2,441,178) ----------- $ 4,117,592 ===========
7. RESTRICTED CASH AND INTANGIBLE ASSETS Restricted Cash Restricted cash consists of the following at January 31, 2002: Short-term investments pledged as collateral for letters of credit in connection with agreements for the purchase of electric power............................................ $13,719,242 Cash and cash equivalents of Summit......................... 9,801,064 ----------- $23,520,306 ===========
F-32 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JANUARY 31, 2002 (UNAUDITED) The Company is required to pledge an amount equivalent to 45 days of energy purchases under the contracts for the purchase of electric power. The funds in Summit are committed to the purpose of investing in energy and energy related companies. Intangible Assets The Company's intangible assets represent the net unamortized costs of purchasing, in July 1999, the 1-800-Electric telephone number and the rights to eight internet domain names. The initial cost of these intangible assets was $1,050,000. Amortization expense for these intangible assets was $26,250 for the six months ended January 31, 2001 and 2002. 8. LINE OF CREDIT On June 29, 2000, the Company entered into a three-year, $15 million line of credit. Borrowings under the line of credit, which amounted to $3,578,753 at January 31, 2002, are collateralized by accounts receivable, inventory and other assets. In connection with obtaining the line of credit, the Company agreed to pay a closing fee of $300,000, one-half of which was paid at closing and the remainder to be paid incrementally at each annual renewal date. The Company also issued the lender a warrant expiring June 29, 2003 to purchase 100,000 shares of the Company's common stock at a price of $5.50 per share. Interest on borrowings is based on the lender's prime rate plus 1.75%. At January 31, 2002, the interest rate on borrowings under the line of credit was 9.0%. The credit line is subject to certain financial covenants in the event the Company's net worth falls below $10 million or the Company operates with a negative gross profit. On August 10, 2001, the Company restructured its line of credit to shorten the maturity date to June 29, 2002 and to reduce the amount of the line of credit to $10 million. 9. SHAREHOLDERS' EQUITY Convertible Preferred Stock The convertible preferred stock provides cumulative dividends which accrue at an annual rate of 10% and are payable at the discretion of the Company. Cumulative unpaid dividends were $98,247 as of January 31, 2002. Each convertible preferred share is convertible into one share of the Company's common stock at the shareholder's discretion and has full voting rights. In addition, preferred shareholders are entitled to preferential liquidation rights over common stock in the amount of $1.00 per share plus an amount equal to all declared but unpaid dividends. Common Stock At January 31, 2002, the Company has reserved the following shares of its common stock for issuance upon conversion of the issued and outstanding shares of convertible preferred stock, exercise of warrants and exercise of outstanding stock options: Reserved for conversion of convertible preferred stock...... 775,000 Reserved for exercise of common stock warrants.............. 100,000 Reserved for exercise of outstanding stock options.......... 10,198,692 ---------- 11,073,692 ==========
F-33 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JANUARY 31, 2002 (UNAUDITED) Founder's Shares The Company's corporate records state that the founder's shares of common stock were issued in exchange for the payment of $140,000 in the form of cash payments totaling $90,000 and personal property having a value of $50,000; however, the Company was not able to verify that all of this consideration was actually paid to the Company. Accordingly, the Company's Board of Directors, on February 23, 2001, instructed the Company's management to reflect on the corporate records that only a portion of the shares issued to the founder be recognized as validly issued. Subsequent to the actions described above, claims and counterclaims were filed by the Company and the founder. On August 10, 2001, a settlement was reached with the founder which was approved by the court having jurisdiction over the case on August 15, 2001. The material terms of the settlement provided that the Company pay the founder $4,790,000 in damages and an additional $2,400,000 to purchase 1,175,160 shares of the Company's common stock claimed to be held by the founder. The settlement agreement also provided that the remaining 4,720,000 shares of the Company's common stock claimed be held by the founder were void. The Founder also agreed to release his claims to the shares of the Company's common stock held by the Company pursuant to the Accommodation Agreement and to the Company's obligation to him under a severance agreement. The founder also agreed that he would have no future ownership in the Company. The loss on the settlement of $4,790,000, which is net of the previously accrued severance payable to the founder of $927,554, was recorded as of July 31, 2001. Stock Options The Company's Board of Directors has approved grants of options to acquire a total of 12,903,825 shares of the Company's common stock to the Company's employees, outside directors and service providers. As of January 31, 2002, 10,198,692 of these stock options were outstanding. Stock option activity for the six months ended January 31, 2002 is set forth below:
OPTIONS OUTSTANDING ------------------------------------------ EXERCISE WEIGHTED- NUMBER PRICE AVERAGE OF SHARES PER SHARE EXERCISE PRICE ---------- ------------ -------------- Balance at July 31, 2001......................... 10,283,192 $.01 - $3.75 $1.792 Options granted.................................. 2,000 3.75 3.750 Options exercised................................ (30,000) .01 - 1.00 0.600 Options expired or forfeited..................... (56,500) .05 - 3.75 0.849 ---------- ------------ ------ Balance at January 31, 2002...................... 10,198,692 $.01 - $3.75 $1.793 ========== ============ ======
Warrants As part of the $15 million credit line agreement dated June 29, 2000, the lender received warrants to purchase 100,000 shares of common stock. The warrants are exercisable at $5.50 per share and expire upon the maturity of the loan agreement on June 29, 2003. The fair value of the warrants was nominal at their date of issuance. Shareholder Rights Plan In January 2002, the Company adopted a Stockholder Rights Plan that is triggered whenever an Acquiring Person accumulates 15% or more of the Company's stock or if an Adverse Person acquires 10% or more of the Company's stock and intends to implement measures which the Board of Directors believes to be F-34 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JANUARY 31, 2002 (UNAUDITED) adverse to the Company's interests. An Acquiring Person is a person or group, together with the person's or group's affiliates, that has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of our Common Stock. An Adverse Person is a person, alone or with affiliates, that has become the beneficial owner of more than 10% of the outstanding shares of Common Stock and (A) such beneficial ownership is intended to cause us to repurchase the Common Stock owned by such person or pressure us to take action or enter into transactions intended to provide such person with short-term financial gain under circumstances where our board of directors determines that our best long-term interests would not be served by taking such action or entering into such transactions or (B) such beneficial ownership is causing or reasonably likely to cause a material adverse impact on our business or prospects, provided, however, that our board of directors does not have the right to declare a person to be an Adverse Person if such person has reported or is required to report its ownership of our Common Stock on Schedule 13G under the Securities Exchange Act of 1934, as amended, or on Schedule 13D if that schedule does not state any intention to, or reserve the right to, control or influence our company or engage in certain other actions, so long as such person neither reports nor is required to report such ownership. Once the rights vest, shareholders other than the Acquiring Person or Adverse Person will be able to purchase at a predetermined price two shares of Common Stock for the price of one share of Common Stock. 10. INCOME TAXES For the six months ended January 31, 2002, the Company's provision for income taxes was comprised of the following:
CURRENT DEFERRED TOTAL -------- -------- -------- Federal............................................ $(28,431) $125,383 $ 96,952 State.............................................. -- 195,102 195,102 -------- -------- -------- Total.............................................. $(28,431) $320,485 $292,054 ======== ======== ========
The Company's net deferred tax asset as of January 31, 2002 was $8,958,284 and is net of a valuation allowance of $908,816. During the six months ended January 31, 2002, the valuation allowance remained unchanged. Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company has available for federal and state income tax purposes a net operating loss carry forward of approximately $2,300,000, which will begin to expire in 2018 and 2006, respectively, if not sooner utilized. The Company has experienced an ownership change under federal and state income tax law. Accordingly, the amount of the Company's taxable income which may be offset by losses generated prior to the ownership change is limited. 11. COMMITMENTS AND CONTINGENCIES Severance Agreement and Litigation with Company's Founder The Company's founder and former chairman and Chief Executive Officer had an employment agreement with a subsidiary of the Company. He was asked to resign and he subsequently resigned from his positions with the subsidiary in consideration of a severance agreement effective June 1, 2000. Said severance agreement expressly waives any claims by him for any bonuses otherwise referenced in his previous five-year employment agreement with the subsidiary of the Company. The severance agreement also provides for monthly payments to him of $21,261 through December 31, 2004. The present value of $927,254 of this F-35 COMMONWEALTH ENERGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) JANUARY 31, 2002 (UNAUDITED) obligation to the Company's former chairman and Chief Executive Officer, based upon a discount rate of 10%, was recorded as of June 1, 2000. In December 2000, the Company ceased making severance payments under this arrangement pending the outcome of litigation between the Company and its founder as more fully described in Note 9. Litigation From time to time, the Company is involved in legal proceedings, claims, and litigation arising in the ordinary course of business. Management does not believe the outcome of these matters will have a material effect on the Company's financial condition or its results of operations. F-36 SCHEDULE II COMMONWEALTH ENERGY CORPORATION VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D ---------- ------------ ---------- ------------- CHARGED TO COSTS AND EXPENSES BEGINNING OR SALES BALANCE AT OF PERIOD ALLOWANCES DEDUCTIONS END OF PERIOD ---------- ------------ ---------- ------------- Six months ended January 31, 2002 (unaudited): Allowance for Bad Debts...................... $3,946,388 $1,263,808 $ -- $5,210,196 Year ended July 31, 2001: Allowance for Bad Debts...................... 1,458,984 4,666,126 2,178,722 3,946,388 Year ended July 31, 2000: Allowance for Bad Debts...................... 612,909 846,075 -- 1,458,984 Year ended July 31, 1999: Allowance for Bad Debts...................... -- 612,909 -- 612,909
F-37 SIGNATURES Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: April 3, 2002 COMMONWEALTH ENERGY CORPORATION By: /s/ IAN B. CARTER -------------------------------------- Name: Ian B. Carter Title: Chief Executive Officer EXHIBIT INDEX
EXHIBIT NUMBER TITLE OF EXHIBIT - ------- ---------------- 3.1 Articles of Incorporation of Commonwealth Energy Corporation dated August 14, 1997 and filed with the Secretary of State of the State of California on August 15, 1997* 3.2 Certificate of Amendment of Articles of Incorporation of Commonwealth Energy Corporation dated December 31, 1998 and filed with the Secretary of State of the State of California on February 19, 1999* 3.3 Bylaws of Commonwealth Energy Corporation, as amended* 3.4 Certificate of Determination of Commonwealth Energy Corporation dated September 22, 1997 and filed with the Secretary of State of California on March 13, 1998** 10.1 Power Purchase Agreement dated April 27, 1999, between Commonwealth Energy Corporation and Calpine Power Services Company+ 10.2 First Amendment to Power Purchase Agreement dated as of April 29, 1999+ 10.3 Second Amendment to Power Purchase Agreement dated as of May 28, 1999, between Commonwealth Energy Corporation and Calpine Power Services Company+ 10.4 Loan and Security Agreement dated June 28, 2000 between Commonwealth Energy Corporation, electricAmerica, Inc. and electric.com, Inc. and Coast Business Credit* 10.5 Warrant dated June 28, 2000, issued by Commonwealth Energy Corporation in favor of Coast Business Credit.* 10.6 Limited Liability Company Agreement of Summit Energy Ventures, LLC, as amended by the First Amendment to the Limited Liability Company Agreement of Summit Energy Ventures, LLC, dated August 2001** 10.7 PECO Energy Company Confirmation Agreement dated January 30, 2001.* 10.8 Exelon Generation Company, LLC Confirmation Agreement dated May 13, 2001* 10.9 Standard Office Lease -- Gross dated April 1, 1997, for property located at 15941 Redhill Avenue, Suite 200, Tustin, California, together with Rules and Regulations and Work Letter attached thereto* 10.10 Standard Sublease dated November 12, 1998, between Kurt Busch and Commonwealth Energy Corporation, for property located at 15991 Redhill Avenue, Suite 200, Tustin, California.* 10.11 Severance Agreement dated June 1, 2000, among Commonwealth Energy Corporation, electricAmerica, Inc. and Frederick M. Bloom* 10.12 Employment Agreement dated January 1, 2000, between Commonwealth Energy Corporation and Ian Carter, as modified by an Addendum to Employment Agreement dated as of November 1, 2000* 10.13 Employment Agreement dated November 1, 2000, between Commonwealth Energy Corporation and Richard Paulsen** 10.14 Employment Agreement dated November 1, 2000, between Commonwealth Energy Corporation and James Oliver** 10.15 Employment Agreement dated November 1, 2000, between Commonwealth Energy Corporation and John Barthrop** 10.16 Commonwealth Energy Corporation 1999 Equity Incentive Plan for Employees* 10.17 Amendment Number 6 to Lease by and between Warner/Redhill Associates and Frederick Michael Bloom** 10.18 Commonwealth vs. Bloom Settlement Agreement Terms dated August 10, 2001*** 10.19 Second Amendment to the Limited Liability Company Agreement of Summit Energy Ventures, LLC 10.20 Commonwealth Energy Corporation Summary of Rights to Purchase Preferred Stock 21.1 Subsidiaries of the Registrant*
- --------------- * Each of these exhibits is incorporated by reference to Commonwealth Energy's Form 10 filed with the Securities and Exchange Commission on August 9, 2001 (File No. 000-33069). ** Each of these exhibits is incorporated by reference to Commonwealth Energy's Form 10A filed with the Securities and Exchange Commission on November 14, 2001 (File No. 000-33069). *** Each of these exhibits is incorporated by reference to Commonwealth Energy's Form 10Q filed with the Securities and Exchange Commission on December 17, 2001 (File No. 000-33069). + Confidential treatment is being sought with respect to certain portions of this agreement. Such portions have been omitted from this filing and have been filed separately with the Securities and Exchange Commission. EX-10.1 3 a80144a2ex10-1.txt EXHIBIT 10.1 EXHIBIT 10.1 POWER PURCHASE AGREEMENT EXECUTION ORIGINAL POWER PURCHASE AGREEMENT BETWEEN COMMONWEALTH ENERGY CORPORATION AND CALPINE POWER SERVICES COMPANY FOR POWER FROM THE GEYSERS UNITS 5/07/99-6/30/02 POWER PURCHASE AGREEMENT This Power Purchase Agreement ("Agreement") is made and entered into as of April ___, 1999, by and between the Commonwealth Energy Corporation, a California corporation ("Commonwealth"), and Calpine Power Services Company, a California corporation ("Calpine"), and sets forth the terms and conditions for the purchase and sale of power from certain electrical generating power plants located within "The Geysers" Known Geothermal Resource Area in Sonoma and Lake Counties, California, which is powered by geothermal steam (said plants are commonly known collectively as the "Geysers Units"). RECITALS A. The electricity generated from certain units at the Geysers is classified as in-state renewable electricity generation technology within the meaning of the California Public Utilities Code Section 383.5(a)(1) ("Renewable Energy") because the fuel source for the units is geothermal steam. Commonwealth wants its total electric energy portfolio to be Renewable Energy. Accordingly, Commonwealth desires to purchase energy generated Geysers Units which is certified to be Renewable Energy and therefore is eligible to be matched with retail customers to be eligible for the receipt of funds from the Consumer Credit program administered by the California Energy Commission ("CEC"). The Geysers Units are controlled and operated by affiliates of Calpine, and Calpine has the right to sell energy generated at the Geysers Units. B. Commonwealth and Calpine have negotiated the terms, provisions, covenants and conditions for a power purchase agreement, and wish to reduce their agreement to writing. NOW, THEREFORE, the parties agree as set forth below. 1. DEFINITIONS. The following terms when used in this Agreement or in attachments to this Agreement with initial capitalized letters or all capitalized letters, as applicable, shall have the meanings set forth below in this Section 1. The definitions are equally applicable to both the singular and plural forms of the terms defined. 1.1 Day. "Day" or "day" means a calendar day, beginning and ending at twelve o'clock midnight. 1.2 Delivery Points. "Delivery Points" means the electric energy delivery points identified in Schedule III hereto. 1.3 Green Tickets. "Green Tickets" means the certification, document or other identification supplied by Calpine's Scheduling Coordinator or other authorized person that indicates that a unit of electric energy was produced by an in-state renewable electricity generation source in connection with which application may be made for credit or reimbursement from the CEC's Customer Credit Sub-account. 1.4 ISO. "ISO" means the California Independent System Operator. 1.5 Participating Buyer. "Participating Buyer shall have the meaning provided in Appendix A to the ISO Tariff as amended from time to time. The current ISO Tariff definition is: a Direct Access End-User or a wholesale buyer of energy or ancillary services through Scheduling Coordinators. 1.6 Participating Generator. "Participating Generator shall have the meaning provided in Appendix A to the ISO Tariff as amended from time to time. The current ISO Tariff definition is: a generator or other seller of energy or ancillary services through a Scheduling Coordinator over the ISO Controlled Grid and which has undertaken to be bound by the terms of the ISO Tariff. 1.7 PG&E. "PG&E" means Pacific Gas and Electric Company. -1- 1.8 Renewable Energy. "Renewable Energy" shall have the meaning set forth in Recital A. 1.9 Scheduling Coordinator. "Scheduling Coordinator" shall have the meaning provided in Appendix A to the ISO Tariff as amended from time to time. The current ISO Tariff definition is: an entity certified by the ISO for the purposes of undertaking the functions specified in Section 2.2.6 of the ISO Tariff. 1.10 Commonwealth Analyst. "Commonwealth Analyst" shall have the meaning provided in Section 11.1. 1.11 Commonwealth Operator. "Commonwealth Operator" shall have the meaning provided in Section 13.1. 1.12 Commonwealth Scheduler. "Commonwealth Scheduler" shall have the meaning provided in Section 13.1. 1.13 Uncontrollable Force. "Uncontrollable Force" shall have the meaning as provided in Section 16. 1.14 WSCC. "WSCC" means the Western Systems Coordinating Council. 2. CONTRACT TERM. The term of this Agreement shall commence at 0001 hour on the date that is the later of (i) the 7th day of May, 1999 or (ii) the first day after the day Calpine's affiliates complete their acquisition of the Geysers Units, and such term shall continue until the hour ending 2400 on June 30, 2002. 3. COMMONWEALTH PURCHASE OBLIGATIONS. Commencing on the first minute of the term and continuing during the term of this Agreement, Calpine shall deliver to Commonwealth (at various Delivery Points in accordance with Section 6) electric energy in the amounts set forth in Section 4, and Commonwealth shall accept delivery of such electric energy at the Delivery Points and shall pay Calpine for such electric energy at the rates set forth in Section 5. 4. QUANTITY OF POWER. Unless otherwise agreed to by the parties from time to time in writing, during each hour of each day during the term hereof, Calpine shall deliver and Commonwealth shall purchase the following amounts of electric energy: From May 1, 1999 to December 31, 1999................. * MWh From January 1, 2000 to December 31, 2000............. * MWh From January 1, 2001 to December 31, 2001............. * MWh From January 1, 2002 to June 30, 2002................. * MWh [CONFIDENTIAL TREATMENT REQUESTED]* The parties further agree to implement such procedures whereby from time to time at the election of Commonwealth, in its sole discretion, Commonwealth may request delivery of electric energy in amounts greater than the foregoing, and Calpine, in its sole discretion, may agree to deliver such greater amounts. 5. PRICE CHARGED FOR POWER. Commonwealth shall pay Calpine the following amounts for the electric energy delivered hereunder: From May 1, 1999 to December 31, 1999................. $* per MWh From January 1, 2000 to December 31, 2000............. $* per MWh From January 1, 2001 to December 31, 2001............. $* per MWh From January 1, 2002 to June 30, 2002................. $* per MWh [CONFIDENTIAL TREATMENT REQUESTED]* 6. DELIVERY POINTS: TITLE TRANSFER: INDEMNITY. - -------- * The omitted information has been filed separately with the Securities and Exchange Commission pursuant to Rule 406. -2- 6.1 Delivery Points. Calpine shall cause electric energy sold hereunder to be delivered to any one or more of the Delivery Points in accordance with Section 10. The specific Delivery Points to be used at any given time and from time to time shall be determined by Calpine in its sole discretion. 6.2 Title Transfer and Indemnity. As between the parties, Calpine shall be deemed to be in exclusive control (and responsible for any damages or injury caused thereby) of electric energy prior to delivery to the Delivery Points, and Commonwealth shall be deemed to be in exclusive control (and responsible for any damages or injury caused thereby) of electric energy at and from the Delivery Points. Title to and risk of loss related to electric energy shall transfer from Calpine to Commonwealth upon delivery thereof at the Delivery Points. Each party (a "First Party") shall indemnify, defend and hold harmless the other party from any and all claims, actions, damages, losses and other liabilities involving personal injury or property damage arising out of or relating to any act or incident involving electric energy on the First Party's side of the Delivery Points. 7. SOURCE OF POWER. Calpine shall provide Commonwealth with electric energy produced from the Geyers Units, except that Commonwealth and Calpine acknowledge and agree that since the ISO requires scheduled deliveries of electric energy to be deemed delivered with an imbalance process mandating the purchase of electric energy from the ISO to account for Under-deliveries of scheduled electric energy, Calpine may substitute imbalance energy provided by the ISO for scheduled energy Calpine fails to deliver hereunder, and any such imbalance energy so delivered shall be deemed to satisfy Calpine's obligations hereunder. Calpine shall provide Commonwealth with Green Tickets in respect of any such imbalance energy, at no additional charge to Commonwealth. 8. OPERATION OF THE GEYSERS UNITS. Calpine will cause the delivery of all electric energy hereunder in a manner consistent with PG&E transmission interconnection requirements, as well as ISO, WSCC and North America Electric Reliability Council requirements. 9. LIMITATION ON DAMAGES. If either party fails to perform under this Agreement, and such failure is not otherwise excused under the provisions of Section 16, damages shall be limited as follows: 9.1 If Commonwealth fails to purchase any quantity of electric energy hereunder, Calpine's sole remedy shall be to receive from Commonwealth a payment equal to the amount. If any, by which the aggregate purchase price for such quantity here under exceeds the aggregate amount actually received by Calpine from any alternative buyer of such quantity of electric energy. Calpine shall exercise good faith efforts to notify Commonwealth before entering into such alternative sale and to sell such power at the highest reasonable price available. 9.2 If Calpine is unable during any period to deliver the required amount of electric energy from the Geysers Units hereunder, and such performance is not rectified by the ISOs provision of imbalance energy and Calpine's supply of Green Tickets as described in Section 7 above, then Calpine's exclusive obligations and liabilities, and Commonwealth's exclusive remedies, shall be at Commonwealth's election, to obtain an alternate supply for such quantity of energy (either with alternate Renewable Energy or non-Renewable Energy) to cover such quantity of electric energy not delivered by Calpine, and in the event that the purchase price for such alternative electric energy is greater than the contract price for such electric energy in this Agreement. Calpine shall reimburse Commonwealth for such difference. In any such event, Commonwealth shall exercise good faith efforts to notify Calpine before purchasing electric energy to replace that which Calpine failed to supply and to purchase such alternative electric energy at the lowest cost available, subject to ensuring that the alternative power satisfies Commonwealth's reliability, quality and delivery requirements. 9.3 Both Commonwealth and Calpine acknowledge and agree that any remedies and/or damages that might otherwise be available to either of them arising from an unexcused failure to purchase or deliver electric energy hereunder, in addition to the remedies expressly set forth in Section 9.1 and 9.2, are waived, and that Section 9.1 and 9.2 are the exclusive remedies and damages of the parties arising out of or in -3- connection with nay such unexcused failure. Without limiting the foregoing, neither party shall in any event be liable to the other party for any indirect, consequential or punitive damages. 9.4 If Commonwealth is in default or any of its obligations hereunder (including its obligation to maintain a Letter of Credit under Section 11.6), then Calpine may immediately cease, and shall be excused from, delivering any further electric energy hereunder. 10. ISO CHARGES. 10.1 The parties understand that the Geysers Units and all associated transmission facilities are located in the control area of the ISO. Calpine and Commonwealth shall carry out all their activities hereunder in compliance with all applicable ISO tariffs, protocols and procedures, Calpine in its capacity as a Participating Generator, and Commonwealth in its capacity as a Participating Buyer. Calpine (or its affiliates) will be responsible for any requirements that the ISO imposes on the Geysers Units, including metering enhancements and telecommunications. 10.2 Calpine will be solely responsible for arranging, managing and paying all costs necessary for Calpine to deliver electric energy to the Delivery Points (including all ISO charging or Scheduling Coordinator charges incurred by Calpine in scheduling the sale of power to Commonwealth at the Delivery Points), and Commonwealth shall be responsible for arranging, managing and paying all costs necessary for Commonwealth to accept electric energy at the Delivery Points (including all Scheduling Coordinator charges, and all ISO charges, including charges for transmission, grid management, line losses and similar charges). 10.3 Calpine shall be responsible for any and all charges or penalties imposed on or associated with imbalances in the delivery of electric power which are caused by Calpine. Commonwealth shall be responsible for any and all charges or penalties imposed on or associated with imbalances in the delivery of electric power which are caused by Commonwealth. The parties will cooperate to minimize or avoid any such imbalance charges. 11. BILLING AND PAYMENT. 11.1 Monthly Bills. On or before the fifteenth (15th) day of each calendar month Calpine shall render to Commonwealth a bill for power delivery to Commonwealth during the prior calendar month, the amount of which will be calculated at the price set forth in Section 5. A bill shall be deemed to have been rendered if sent via first class mail, fax or overnight courier to the Commonwealth Power System Analyst ("Commonwealth Analyst"), address as provided in the contact information attached as Schedule I. Such bill shall include supporting detail showing the amount of power supplied during all hours on a daily basis, and the price for such power for all hours on a daily basis. 11.2 Estimate. If charges under this Agreement cannot be determined accurately for preparing a monthly bill, Calpine may use its best estimate in preparing the monthly bill and such estimated monthly bill shall be paid by Commonwealth in accordance with Section 11.3. Calpine's estimate will be based on reasonably available information including, but not limited to, records of historical usage, physical condition of the metering facility, and available meter readings. When final and complete information becomes available and the estimated charges can be determined more accurately, Calpine shall promptly prepare and submit, to the extent necessary, an adjusted monthly bill to Commonwealth. Any additional payment or refund, including any applicable interest at the rate provided in Section 11.4. shall be made as appropriate. 11.3 Payment. Commonwealth shall pay all bills rendered pursuant to this Section by separate check or electronic transfer within fifteen (15) days after such bills are received by Commonwealth. 11.4 Interest. Interest shall accrue on any portion of the bill for which payment has not been received by the due date specified in Section 11.3, prorated by calendar day. Such interest will accrue at an -4- annual rate of interest equal to the prime rate of interest quoted by Nations Bank from time to time, plus two percent (2%), or the maximum rate of interest allowed under applicable law, whichever is less. 11.5 Disputed Bills. If any portion of any bill is disputed by Commonwealth in good faith pursuant to Section 26, Commonwealth shall pay to Calpine the undisputed portion of the bill by the due date specified in Section 11.3. If the protested portion of the bill is found to have been correct, Commonwealth shall pay to Calpine the disputed portion which was withheld from payment plus interest, at the rate specified in Section 11.4, prorated by calendar day, for the period from the day such disputed payment was due pursuant to Section 11.3 to the day such payment is received by Calpine. 11.6 Letter of Credit. As security for its obligations under this Agreement, Commonwealth shall obtain and maintain during the term hereof for the benefit of Calpine a Letter of Credit (the "LOC") in the form of Exhibit A hereto in the applicable amounts specified by Schedule IV, as amended with respect to the amounts, and at the dates, as specified by Schedule IV. Commonwealth shall cause the LOC to be issued by a bank reasonably acceptable to Calpine and delivered to Calpine five working days before the term of this Agreement commences under Section 2. Calpine may draw down on the LOC at any time and from time to time in accordance with the terms thereof in the event that (i) Commonwealth is in default of any of its obligations under this Agreement or (ii) if at any time during the term of this Agreement, Commonwealth has failed to cause the LOC to be renewed, maintained or extended as provided herein and in a manner such that there is never less than ten days remaining prior to the expiration date thereof. In the event that Calpine makes any draw under the LOC, Commonwealth shall cause the principal amount of the LOC to be increased to the applicable amount specified in Section IV or otherwise re-issued to the applicable amount specified in Schedule IV, within five days after the date of such draw. 11.7 ISO Accounting. The accounting of actual deliveries of power from Calpine to Commonwealth pursuant to this Agreement shall be based upon final ISO actual deliveries as provided by Commonwealth's and Calpine's respective ISO Schedule Coordinators. 11.8 Taxes. Commonwealth shall be responsible for and shall pay, caused to be paid, or reimburse Calpine if Calpine is required to pay, any and all sales, use, excise, energy or other taxes, assessments or other similar governmental charges, whether federal, state or local, applicable to the sale or purchase of electric energy and the other transactions hereunder. 12. AUDITS. Each of Commonwealth and Calpine shall have the right to audit and to examine any cost, payment, settlement or supporting documentation related to any billing associated with any item set forth in this Agreement. Any such audit shall be at the requesting party's expense and undertaken by such party or its representatives at reasonable times and in conformance with generally accepted auditing standards. The right to audit a bill shall extend for a period of twelve (12) months following the receipt of the bill and shall survive the termination of this Agreement. Each party shall retain all necessary records or documentation for the entire length of the audit period and shall take all steps reasonably available to assure the confidentiality of the other party's accounting records and supporting documents. Any bill as to which no exception has been taken within twelve (12) months after receipt by the party receiving the same shall conclusively be true and correct. 13. ROUTINE NOTIFICATION TO BE REGULARLY PROVIDED BY CALPINE TO COMMONWEALTH. Calpine shall provide notification to Commonwealth as set forth in this Section 13. 13.1 Weekly Notification. On a weekly basis, Calpine will inform the Commonwealth Power System Scheduler ("Commonwealth Scheduler") of Calpine's plans regarding electric energy deliveries hereunder during the following calendar week (i.e., commencing on the following Monday). The information shall include; (1) specification of those days upon which generation is expected to take place; (2) the expected power to be delivered for Commonwealth in MW reported for each hour of the day; and (3) any special circumstance, such as testing, outages, etc., that might impact the delivery of power to Commonwealth at the Delivery Points. The information described in this Section shall be provided to the Commonwealth Scheduler by Calpine on the Thursday prior to the affected week and shall be transmitted -5- via facsimile, or electronically, the receipt of which shall be confirmed by phone. The contact information for the Commonwealth Scheduler is provided in Scheduler I. 13.2 Prescheduling. Prescheduled days are those days upon which the Commonwealth Scheduler plans for the resources and generation necessary to serve the Commonwealth load for a day or number of days subsequent to the day of prescheduling. The following is the current typical prescheduling pattern followed by Commonwealth Schedulers: Monday is the prescheduling day for Tuesday, Tuesday is the prescheduling day for Wednesday, Wednesday is the prescheduling day for Thursday, Thursday is the prescheduling day for Friday and Saturday, and Friday is the prescheduling day for Sunday and Monday. The pattern will change periodically to accommodate WSCC designated holidays, and may change due to changes in ISO scheduling practices or scheduling protocols. No later than 0600, Pacific time, Calpine will provide the Commonwealth Scheduler with a schedule or schedules of hourly expected power to be delivered to Commonwealth for the day or days being prescheduled. A sample schedule is included in Schedule II. Calpine shall transmit the information described in this Section to the Commonwealth Scheduler via facsimile, or electronically, the receipt of which shall be confirmed by phone. The contact information for the Commonwealth Scheduler is provider in Schedule I. Both Commonwealth and Calpine will submit daily schedules to their respective ISO Scheduling Coordinators in a manner such that daily schedules are included in the ISO's Day-Ahead Market for bilateral transactions. 13.3 Dispatching. Calpine shall provide to the Commonwealth Power Systems Operator ("Commonwealth Operator") notification of variations from the prescheduled power provided pursuant to Section 13.2 to the extent notice of such variation is provided to the ISO in accordance with ISO tariff and scheduling protocols. The contact information for the Commonwealth Operator is provided in Schedule I. 13.4 Revisions. The parties will modify the deadlines for submission of the various schedules provided for in this Section 13 to the extent such modification becomes necessary as a result of future changes to the ISO tariff and to Calpine's interconnection agreements and arrangements with PG&E. 14. NOTICES. 14.1 Notice of Routing Operational Issues. Any routine operational issue shall be communicated to the applicable individuals listed in the contact list provided as Schedule I. 14.2 Notice Of Issues Which Are Not Routine Operational Issues. Notification of an issue which is not and does not relate to a routine operational issue should be provided in writing and shall be deemed properly served, given or made if delivered in person or sent by facsimile, or sent by registered or certified mail, addressed as set forth below: (i) If to Commonwealth: Commonwealth Energy Corporation c/o Chief Executive Officer 15991 Redhill Avenue, Suite 201 Tustin, California 92780 FAX (714) 258-0480 A copy should be sent to the Commonwealth contact persons listed in Attachment L. (ii) If to Calpine: Calpine Corporation Attn: General Counsel 50 West San Fernando Street Fifth Floor San Jose, CA 95113 Fax: (408) 975-4648 A copy should be sent to the Calpine contact persons listed in Scheduler I. -6- Any party may designate different persons or different addresses for the giving of notices for purposes of this Agreement by giving the other party written notice of the new address or different designee in the manner set forth in this Section. 15. THE RIGHTS OF THE PARTIES AT TERMINATION. On the date of termination of this Agreement, all rights to services provided under this agreement and any rates the incorporate this Agreement shall cease, and neither party shall claim or assert any continuing right to such services under this Agreement. However, termination of this Agreement shall not after rights and obligations incurred but not satisfied or any obligation to pay moneys for transactions occurring prior to determination of this Agreement. 16. UNCONTROLLABLE FORCE. Neither party shall be considered to be in default in the performance of any of its obligations under this Agreement when a failure of performance, including any temporary curtailment or interruption of service by Calpine, shall be due to an Uncontrollable Force. An Uncontrollable Force is any act, event or cause beyond the reasonable control of a party which adversely affects the ability of that party to perform, which could not reasonably have been avoided by such party through the exercise of due diligence, and which such party has been unable to avoid by the exercise of due diligence, including failure of or threat of failure of facilities (including breakage or accident to, or the necessity for making reasonable repairs to or reconditioning, the Geyser Units and related equipment, wells, machinery, equipment or lines of pipe), flood, earthquake, storm, fire, pestilence, lightning or other natural catastrophes, epidemic, famine, war, riot, civil disturbance or disobedience, labor dispute, strike, labor or material shortage, sabotage, government priorities, restraint by court order or public authority, and after a good faith effort by the affected party to so obtain, action or nonaction by inability to obtain necessary authorizations or approvals from any governmental agency or authority. Additionally, Uncontrollable Force shall in any event include shortfalls in steam production from the wells providing steam to the Geyser Units, and neither Calpine nor its affiliates shall have any obligation here under to rework or redrill any existing steam wells or to drill new steam wells to maintain an adequate quantity of steam to maintain any level of electric energy output. In the event a party is rendered unable to fulfill any of its obligations under this Agreement by reason of an Uncontrollable Force, such party shall give prompt written notice of such fact to the other party. A party rendered unable to fulfill any of its obligations under this Agreement by reason of an Uncontrollable Force shall exercise due diligence to remove such inability with all reasonable dispatch. Nothing contained herein shall be construed so as to require a party to settle any strike or labor dispute in which it may be involved nor to relieve a party from an obligation to pay amounts otherwise owned pursuant to this Agreement. 17. EFFECT OF SECTION HEADINGS. Section headings appearing in this Agreement are inserted for convenience and only shall not be construed as interpretations of text. 18. NO DEDICATION OF FACILITIES. Any undertaking by either party to the other party under this Agreement shall not constitute the dedication of the electrical system, facilities, or any portion thereof, of that party to the public or to the other party's electronic system, nor affect the status of that party as an independent company or entity. Any such undertaking by the parties under this Agreement shall automatically cease upon the termination of this agreement. 19. RELATIONSHIP OF PARTIES. The covenants, obligations and liabilities of Commonwealth and Calpine as set forth in this Agreement are intended to be several and nothing contained in this Agreement shall ever be construed to create an association, joint venture, trust or partnership, or to impose a trust or partnership covenant, obligation or liability on either party. Neither Commonwealth nor Calpine shall be deemed to be under the control of or to control the other. Neither Commonwealth nor Calpine shall be deemed to be the agent of or have a right to power to bind the other without the express written consent of the other. Each of Commonwealth and Calpine shall be responsible only for its own obligations as provided in this Agreement. 20. ASSIGNMENT. Neither party shall assign this Agreement without the prior written consent of the other party, except that (i) such consent in the case of a proposed assignment by either party to an -7- affiliate shall not be unreasonably withheld by either party and (ii) such consent shall not be required in the case of any assignment by Calpine to a lender or other party providing Calpine or its affiliates with financing. 21. NO THIRD PARTY BENEFICIARIES. This Agreement is for the benefit of Commonwealth and Calpine. Nothing in this Agreement whether express or implied, is intended to confer any rights or remedies under or by reason of this Agreement upon any person or entity other than Commonwealth and Calpine and each of their respective successors and assigns. Furthermore, nothing in this Agreement is intended to relieve or discharge any obligation of liability owned to either Commonwealth or Calpine by any person or entity not a party to this agreement, nor shall any provision give any person or entity not a party to this Agreement any right of subrogation or action against either Commonwealth or Calpine. 22. GOVERNING LAW. The validity, interpretation and effect of this Agreement shall be governed exclusively by the laws of the State of California 23. MEANING OF CERTAIN WORDS. Unless otherwise stated, any reference in this Agreement to a Section, Schedule, Exhibit or similar term refers to a Section, Schedule, Exhibit or similar term of this Agreement, as the case may be. Unless otherwise stated, a reference to a Section includes that Section and all of its Subsections. The words "include," "includes" and "including" when used in this Agreement shall be deemed in each case to be followed by the words "without limitation." 24. ENTIRE AGREEMENT, MODIFICATION AND WAIVER. This Agreement constitutes the entire understanding and agreement between Commonwealth and Calpine with respect to the subject matter hereof, and supersedes all negotiations, representations, warrantees, commitments, offers, contracts and writings prior to the execution date of this agreement, written or oral. Now waiver, supplement, modification, or amendment of any provision of this Agreement shall be binding unless specifically made in writing and duly executed by both Commonwealth and Calpine. 25. DUE AUTHORIZATION. Each of Commonwealth and Calpine represents to the pother that the execution of this agreement by such party has been duly authorized by all requisite corporate, partnership, Board or other applicable authority as required for such party to enter into this Agreement. 26. DISPUTE RESOLUTION. should a dispute arise between the parties as to the interpretation or enforcement of this Agreement either party may, by written notice to the other, require that a member of senior management of each of the parties (a Corporate officer or higher from Commonwealth, and a Vice President of higher from Calpine) meet and attempt in good faith to resolve the dispute within a period of twenty (20) days following receipt of the notice requesting such resolution. If the senior management of the parties cannot resolve the dispute within such twenty (20) day period, either party may elect within ten (10) days of the end of such initial twenty ()20) day period, by written notice to the other party, to submit such dispute to final resolution by arbitration before a single arbitrator to be appointed by the San Francisco office of the American Arbitration Association ("AAA") in accordance with the commercial arbitration rules of the AAA. Discovery shall be permitted in any such arbitration, but may be permitted in the discretion of the appointed arbitrator. 27. DEFAULT BANKRUPTCY. Should either party default in the performance of its obligations under this Agreement and fail to remedy such default within a period of fifteen (15) days following receipt of a written notice of such default from the other party (or fail to commence and thereafter diligently pursue the cure of a default not reasonably susceptible to cure within such fifteen (15) day period), then, in addition to any other remedies, the aggrieved party may terminate this Agreement by written notice of termination to the party in default. Should either party become Bankrupt, the other party may terminate this Agreement by written notice of termination to the Bankrupt party. For purposes hereof, a party shall be deemed "Bankrupt" if such party (i) makes an assignment or any general arrangement for the benefit of creditors; (ii) files a petition or otherwise commences, authorizes or acquiesces in the commencement of a proceeding or cause of action under any bankruptcy or similar law for the protection of creditors, or has such petition filed against it and such petition is not withdrawn or dismissed for sixty (60) -8- days after such filing, (iii) otherwise becomes bankrupt or insolvent (however evidenced) under any bankruptcy or insolvency related law, or (iv) is unable to pay it debts as they fall due. 28. PRESS RELEASES; PUBLIC ANNOUNCEMENTS. Each party shall hold as confidential and not disclose to any person (which term shall be broadly considered to include any partnership, corporation company, other entity or individual) without the prior written consent of the other party any information (including, but not limited to, the other parties' name, reference to the Geysers Units, the terms and conditions of this Agreement) regarding this Agreement or the transactions contemplated hereby, except as necessary to carry out the terms and conditions of this Agreement. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed on the date set forth under their respective signatures. COMMONWEALTH ENERGY CORPORATION Date: 4-27-99 By: /s/ Frederick M. Bloom ----------------------------------- Frederick M. Bloom Title: Chief Executive Officer CALPINE POWER SERVICES COMPANY Date: 4/27/99 By: /s/ Peter Cartwright ----------------------------------- Peter Cartwright Title: President -9- TABLE OF CONTENTS SCHEDULE I Contact List for Routine Operational Notification SCHEDULE II Sample Preschedule SCHEDULE III Delivery Points SCHEDULE IV Letter of Credit Amounts During Agreement Term -13- SCHEDULE I CONTACT LIST FOR ROUTINE OPERATIONAL NOTIFICATION COMMONWEALTH ENERGY CORPORATION Name and/or Title Operations Manager Telephone (714) 258-0470 Fax (714) 258-0480 Address/Location 15991 Redhill Avenue Suite 201 City, State, Zip Tustin, CA 92780 SCHEDULE COORDINATOR/ ILLINOVA POWER MARKETING, INC. Name and/or Title Layne Brown (Director of Operations) Telephone 801-568-2150 Fax 801-568-2149 Address/location 6955 Union Park Center #300 City, State, Zip Midvale, UT 84047 Name and/or Title Gastan Mejia (Short Term Trader) Telephone 801-568-2129 Fax 801-568-2149 Address/location 6955 Union Park Center #300 City, State, Zip Midvale, UT 84047 CALPINE CORPORATION Name and/or Title Geysers Power Scheduler Telephone (707) 987-9238 ext. 16 Fax (707) 987-9364 Address/Location Kincade Road City, State, Zip Middletown, CA 95461 and to Name and/or Title Geysers Power Plant Power Scheduling Manager Telephone (707) 987-9238 ext. 21 Fax (707) 987-9364 Address/Location City, State, Zip Middletown, CA 95461 and to Name and/or Title Manager - Fuels Telephone (925) 600-2000 Fax (925) 600-8925 Address/Location 6700 Koll Center Parkway, City, State, Zip Suite 200 Pleasanton, CA 94566 SCHEDULE II SAMPLE PRESCHEDULE #1 For Saturday, May 30, 1999 PRESCHEDULE FOR COMMONWEALTH FROM GEYSERS UNITS UNIT #
- ----------------------------------------------------------------------------------------- Hour MW Delivered to 5-6 7-8 9- 11 12 13 14 16 17 18 20 SPP Ending Commonwealth 10 - ----------------------------------------------------------------------------------------- 1 0 - ----------------------------------------------------------------------------------------- 2 0 - ----------------------------------------------------------------------------------------- 3 0 - ----------------------------------------------------------------------------------------- 4 0 - ----------------------------------------------------------------------------------------- 5 0 - ----------------------------------------------------------------------------------------- 6 0 - ----------------------------------------------------------------------------------------- 7 0 - ----------------------------------------------------------------------------------------- 8 0 - ----------------------------------------------------------------------------------------- 9 0 - ----------------------------------------------------------------------------------------- 10 0 - ----------------------------------------------------------------------------------------- 11 0 - ----------------------------------------------------------------------------------------- 12 0 - ----------------------------------------------------------------------------------------- 13 0 - ----------------------------------------------------------------------------------------- 14 0 - ----------------------------------------------------------------------------------------- 15 0 - ----------------------------------------------------------------------------------------- 16 0 - ----------------------------------------------------------------------------------------- 17 0 - ----------------------------------------------------------------------------------------- 18 0 - ----------------------------------------------------------------------------------------- 19 0 - ----------------------------------------------------------------------------------------- 20 0 - ----------------------------------------------------------------------------------------- 21 0 - ----------------------------------------------------------------------------------------- 22 0 - ----------------------------------------------------------------------------------------- 23 0 - ----------------------------------------------------------------------------------------- 24 0 - -----------------------------------------------------------------------------------------
SCHEDULE III DELIVERY POINTS
- ---------------------------------------------------------------------------------------------------------------------------------- NAME OF THE FACILITY LOCATION RESOURCE ID/METER NUMBER POINT OF DELIVERY - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 5/6 Sec.12 & Sec. 13, T11N, R9W, M.D. GYS5X6_7_UNITS / 00036811 Geysers 5 to Geysers 3 115 kv - Mer. Disconnect 173 - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 7/8 Sec. 7, T11N, R8W, M.D. Mer. GYS7X8_7_UNITS / 00036560 Geysers 7 to Eagle Rock 115 kv - Disconnect 185 - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 9/10 Sec. 20, T11N, R8W, M.D. Mer. GYS910_7_UNITS / 00036842 Geysers 9 to Lakeville 230 kv - Disconnect 293/line trap - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 11 Sec. 7, T11N, R8W, M.D. Mer. GEYS11_7_UNIT11 / 00036809 Geysers 11 to Eagle Rock 115 kv - Disconnect 313 - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 12 Sec.18, T11N, R8W, M.D. Mer. GEYS12_7_UNIT12 / 00036841 Geysers 12 to Fulton 230 kv - Disconnect 323 - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 13 Sec. 27 & 34, T11N, R8W, M.D. Mer. GEYS13_7_UNIT13 / 00036810 Geysers 9 to Lakeville 230 kv - Disconnect 333/line trap - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 14 Sec. 19 & 30, T11N, R8W, M.D. Mer. GEYS14_7_UNIT14 / 00036840 Geysers 12 to Fulton 230 kv - Disconnect 343 - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 16 Sec. 35, T11N, R8W, M.D. Mer. GEYS16_7_UNIT16 / 00035750 Geysers 12 to Fulton 230 kv - Disconnect 363 - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 17 Sec. 7, T11N, R8W, M.D. Mer. GEYS17_7_UNIT17 / 00036808 Geysers 17 to Fulton 230 kv - Disconnect 373 - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 18 Sec. 33, T11N, R8W, M.D. Mer. GEYS18_7_UNIT18 / 00036522 Geysers 9 to Lakeville 230 kv - Disconnect 383/line trap - ---------------------------------------------------------------------------------------------------------------------------------- Geysers Power Plant 20 Sec. 28, T11N, R8W, M.D. Mer. GEYS20_7_UNIT20 / 00036521 Geysers 9 to Lakeville 230 kv - Disconnect 403/line trap - ---------------------------------------------------------------------------------------------------------------------------------- Sonoma (formerly Sec. 21, T11N, R8W, M.D. Mer. SMUDG0_7_UNIT1 / 615786 Geysers 9 to Castle Rock Junction SMUDGEO#1) 230 kv - Disconnect 945 - ----------------------------------------------------------------------------------------------------------------------------------
SCHEDULE IV LETTER OF CREDIT AMOUNTS DURING AGREEMENT TERM Required for the Commonwealth Geysers Contract - --------------------------------------------------------------------------------
Date in force 4/30/99 12/15/99 12/15/00 12/15/01 - -------------------------------------------------------------------------------- Time Period Covered 5/7/99-12/31/99 1/01/00- 1/01/01- 01/01/02-6/30/02 12/31/01 12/31/01 - -------------------------------------------------------------------------------- # of Days in Period 245 366 365 181 - -------------------------------------------------------------------------------- MW sold - -------------------------------------------------------------------------------- Price - -------------------------------------------------------------------------------- # of Days for 60 60 60 60 LC - -------------------------------------------------------------------------------- Amount of $ $ $ $ LC
Notes: 1.) The initial letter of credit must be in place 5 working days before the commencement of power delivery. 2.) For each subsequent delivery period, the additional letters of credit amount must be in place 15 calendar days in advance of the delivery period (each December 15th). EX-10.2 4 a80144a2ex10-2.txt EXHIBIT 10.2 EXHIBIT 10.2 FIRST AMENDMENT TO POWER PURCHASE AGREEMENT FIRST AMENDMENT TO THE POWER PURCHASE AGREEMENT BETWEEN COMMONWEALTH ENERGY CORPORATION AND CALPINE POWER SERVICES COMPANY FOR POWER FROM THE GEYSERS UNITS 5/07/99 - 6/30/02 The above referenced Power Purchase Agreement (PPA) is hereby amended with respect to the following Sections (as to quantity of power sold, price charged for power sold and the amount of the Letter of Credit, all for the period of the PPA in 1999) which replace in entirety the corresponding provisions in the original Power Purchase Agreement: 4. QUANTITY OF POWER. Unless otherwise agreed by the parties from time to time in writing, during each hour of each day during the term hereof, Calpine shall deliver and Commonwealth shall purchase the following amounts of electric energy: From May 7, 1999 to December 31, 1999 * mwh From January 1, 2000 to December 31, 2000 * mwh From January 1, 2001 to December 31, 2001 * mwh From January 1, 2002 to June 30, 2002 * mwh [CONFIDENTIAL TREATMENT REQUESTED]* The parties further agree to implement such procedures whereby from time to time at the election of Commonwealth, in its sole discretion, Commonwealth may request delivery of electric energy in amounts greater than the foregoing, and Calpine, in its sole discretion, may agree to deliver such greater amounts. 5. PRICE CHARGED FOR POWER. Commonwealth shall pay Calpine the following amounts for the electric energy delivered hereunder: From May 7, 1999 to December 31, 1999 $* per mwh From January 1, 2000 to December 31, 2000 $* per mwh From January 1, 2001 to December 31, 2001 $* per mwh From January 1, 2002 to June 30, 2002 $* per mwh [CONFIDENTIAL TREATMENT REQUESTED]* - ----------- * The omitted information has been filed separately with the Securities and Exchange Commission pursuant to Rule 406. IN WITNESS WHEREOF, the parties have caused this amendment to the original Power Purchase Agreement to be executed on the date set forth under their respective signatures. COMMONWEALTH ENERGY CORPORATION Date: 4-29-99 By: /s/ Frederick M. Bloom ------------------------------ Frederick M. Bloom Title: Chief Executive Officer CALPINE POWER SERVICES Date: By: /s/ Peter Cartwright ------------------------------ Peter Cartwright Title: President SCHEDULE IV LETTER OF CREDIT AMOUNTS DURING AGREEMENT TERM Required for the Commonwealth Geysers Contract - -------------------------------------------------------------------------------------------------- Date in force 4/30/99 12/15/99 12/15/00 12/15/01 - -------------------------------------------------------------------------------------------------- Time Period Covered 5/7/99-12/31/99 1/01/00- 1/01/01- 1/01/02-6/30/02 12/31/00 12/31/01 - -------------------------------------------------------------------------------------------------- # of Days in Period 238 366 365 181 - -------------------------------------------------------------------------------------------------- MW sold - -------------------------------------------------------------------------------------------------- Price - -------------------------------------------------------------------------------------------------- # of Days for 60 60 60 60 LC - -------------------------------------------------------------------------------------------------- Amount of $ $ $ $ LC
Notes: 1.) The initial letter of credit must be in place 5 working days before the commencement of power delivery. 2.) For each subsequent delivery period, the additional letters of credit amount must be in place 15 calendar days in advance of the delivery period (each December 15th). All other sections of the original executed agreement shall remain unchanged and in full force. EX-10.3 5 a80144a2ex10-3.txt EXHIBIT 10.3 EXHIBIT 10.3 SECOND AMENDMENT TO POWER PURCHASE AGREEMENT SECOND AMENDMENT TO THE POWER PURCHASE AGREEMENT BETWEEN COMMONWEALTH ENERGY CORPORATION AND CALPINE POWER SERVICES COMPANY FOR POWER FROM THE GEYSERS UNITS 5/07/99 - 6/30/02 (ADDITIONAL [Confidential Treatment Requested]* MW PURCHASE IN JUNE 1999) The above referenced Power Purchase Agreement (PPA) is hereby amended as of May 28, 1999 with respect to the following Section 4 (as to quantity of power sold) which replaces in entirety the corresponding provisions in the original Power Purchase Agreement: 4. QUANTITY OF POWER. Unless otherwise agreed by the parties from time to time in writing, during each hour of each day during the term hereof, Calpine shall deliver and Commonwealth shall purchase the following amounts of electric energy: From May 7, 1999 through May 31, 1999 and July 1, 1999 through December 31, 1999 * mwh From June 1, 1999 through June 30, 1999 * mwh From January 1, 2000 to December 31, 2000 * mwh From January 1, 2001 to December 31, 2001 * mwh From January 1, 2002 to June 30, 2002 * mwh [CONFIDENTIAL TREATMENT REQUESTED]* The parties further agree to implement such procedures whereby from time to time at the election of Commonwealth, in its sole discretion, Commonwealth may request delivery of electric energy in amounts greater than the foregoing, and Calpine, in its sole discretion, may agree to deliver such greater amounts. Additionally, the parties agree to add the following Section 11.9 (to address the payment for the purchase of [Confidential Treatment Requested]* mw of the [Confidential Treatment Requested]* mw of energy delivered in June, 1999): 11.9 Pre-billing and Payment for [Confidential Treatment Requested]* mw in June, 1999. The amount of [CONFIDENTIAL TREATMENT REQUESTED]* will be billed by Calpine on June 7, 1999, in advance of the complete delivery of the power for June, 1999. Commonwealth will pay as required under Section 11.3. Failure to pay [CONFIDENTIAL TREATMENT REQUESTED]* by June 22, 1999 will constitute a default of Commonwealth's obligations as referenced in Section 11.6, Letter of Credit. Furthermore, Commonwealth will cause Union Bank to reissue the Letter of Credit by June 4, 1999 with the phrase "as amended from time to time" in Paragraph #4, 1st Line after the word "agreement". All other sections of the original executed agreement (as amended by amendment #1) shall remain unchanged and in full force. - ---------------- * The omitted information has been filed separately with the Securities and Exchange Commission pursuant to Rule 406. * CONFIDENTIAL TREATMENT REQUESTED IN WITNESS WHEREOF, the parties have caused this amendment #2 to the original Power Purchase Agreement to be executed on the date set forth under their respective signatures. COMMONWEALTH ENERGY CORPORATION Date: May 27, 1999 By: /s/ Frederick M. Bloom -------------------------------- Frederick M. Bloom Title: Chief Executive Officer CALPINE POWER SERVICES Date: May 28, 1999 By:/s/ Jacob M. Rudisill -------------------------------- Jacob M. Rudisill Title: Vice President EX-10.19 6 a80144a2ex10-19.txt EXHIBIT 10.19 EXHIBIT 10.19 SECOND AMENDMENT TO THE LIMITED LIABILITY COMPANY AGREEMENT OF SUMMIT ENERGY VENTURES, LLC This Second Amendment, dated as of February 27, 2002 (this "Amendment") to the Limited Liability Company Agreement dated as of June 29, 2001 (the "LLC Agreement"), and amended by the First Amendment to the Limited Liability Company Agreement dated August 1, 2001, and further amended by a letter agreement dated September 24, 2001 by and among Northwest Power Management Inc., a Washington corporation ("NPM"), in its capacity as Investment Manager, Steven Z. Strasser, an individual, in his capacity as member, and Commonwealth Energy Corporation, a California corporation ("Commonwealth"), in its capacity as member, of Summit Energy Ventures, L.L.C. Capitalized terms not defined herein shall have the meaning ascribed to them in the LLC Agreement. WITNESSETH: WHEREAS, Section 12.1 of the LLC Agreement requires the consent of the Members so affected before the LLC Agreement may be amended; and WHEREAS, the Members desire to amend the LLC Agreement; NOW, THEREFORE, in accordance with the terms of the LLC Agreement, the LLC Agreement is hereby amended as follows: 1. Amendment. (a) The definition of "Percentage Interest(s)" in Article I is deleted in its entirety and replaced with the following: ""Percentage Interest(s)" as of any date after the date of the Second Amendment means 60% as to CEC, and 40% as to Steven Z. Strasser (all allocations under Section 3.5 having been previously made)." (b) There is added to Article I the following definition: ""Second Amendment" means the Second Amendment to the Limited Liability Company Agreement of Summit Energy Ventures, LLC dated as of February 27, 2002." Section 3.4 is deleted in its entirety and replaced with the following: "Section 3.4 Capital Contributions. Effective as the Agreement Date, CEC and NPM are admitted to the Company as Common Members. On the Agreement Date, CEC and the Company shall execute a Contribution Agreement in the form attached hereto pursuant to which CEC shall make a Capital Contribution of $15,000,000 (fifteen million) and a Capital 1 Commitment of $10,000,000 (ten million). The funding of the Capital Commitment shall be at the sole discretion of CEC." (d) Section 4.3(a) is deleted in its entirety and replaced with the following: "(a) The Company shall pay to the Investment Manager, as compensation for its performance of the Investment Management Services and the Administrative Services a semi-annual fee (the "Management Fee") of $350,000 (three hundred fifty thousand) payable on the second Wednesday of January and July of each calendar year for the succeeding period commencing on the Agreement Date; provided that the Management Fee shall be prorated for any period less than a full six (6) Calendar Months. The Fees shall cover all Administration Expenses set forth in Section 43(c). Commonwealth shall have no responsibility to pay any of the costs and expenses to operate the Company, other than the Management Fee. Upon termination of this Agreement, any Management Fees paid but not earned shall be returned to the Company based on multiplying the Management Fee times the quotient where the numerator equals the days remaining in that half of the calendar year and the denominator equals 183. Management Fees shall only be paid from Capital Contributions or cash flow generated by the LLC, and CEC shall have no responsibility for payment of any Management Fees." (e) Schedule A to the Agreement is deleted in its entirety and replaced with the following: "Names, Addresses, Percentage Interests, Capital Commitment and Capital Contributions of the Members Name: Commonwealth Energy Corporation Address: 125901 Red Hill Ave., Tustin, CA 92780 Preferred Percentage Interest: One hundred percent (100%) to CEC. Common Percentage Interest: Sixty percent (60%) to CEC. Capital Contribution: Fifteen million dollars ($15,000,000) Capital Commitment: Ten million dollars ($10,000,000), whether or not this capital commitment is funded shall be at the sole discretion of Commonwealth Energy Corporation. Name: Steven Z. Strasser Address: 700 5th Ave., Suite 6100, Seattle, WA 98104 Percentage Interest: Forty (40) percent of Common Interest; NPM and Strasser own no Preferred Interest. Capital Contribution: Zero Capital Commitment: Zero 2 (f) Schedule B to the Agreement is changed as follows: Paragraph 1 of the RECITALS shall be deleted in its entirety and replaced with, the following: "I. Capital Contribution. CEC hereby makes a cash capital contribution to the Company in an amount equal to $15,000,000 (the "Capital Contribution") and a commitment to make an additional cash capital contribution to the Company in an amount equal to $10,000,000 (the "Capital Commitment"), said Capital Commitment shall be funded at the sole discretion of CEC." Paragraph 3 of the RECITALS shall be deleted in its entirety and shall not be replaced. Paragraph 4 of the RECITALS shall be changed to read as follows: "forty (40) percent" shall be changed to read "sixty (60) percent" 2. Survival of LLC Agreement. Except as otherwise amended in this Amendment, the LLC Agreement shall remain in full force and effect. Any reference to the LLC Agreement shall hereafter be understood as a reference to the LLC Agreement as amended by this Amendment. 3. Governing Law. This Amendment shall be governed by and construed in accordance with the laws of the State of Delaware applicable to a contract executed and performed in such state without giving effect to the conflicts of laws principles thereof. 4. Effective Date. The effective date of this Amendment shall be January 1, 2002. 3 IN WITNESS WHEREOF, the undersigned Member has caused this Amendment to Limited Liability Company Agreement of Summit Energy Ventures, LLC to be duly executed as of the date first above written. COMMONWEALTH ENERGY CORPORATION By: /s/ IAN B. CARTER ----------------------------------- Name: IAN B. CARTER Title: CEO IN WITNESS WHEREOF, the undersigned Investment Manager has caused this Amendment to Limited Liability Company Agreement of Summit Energy Ventures, LLC to be duly executed as of the date first above written. NORTHWEST POWER MANAGEMENT INC. By: /s/ Steven Z. Strasser ----------------------------------- Steven Z. Strasser Its: President EX-10.20 7 a80144a2ex10-20.txt EXHIBIT 10.20 Exhibit 10.20 ================================================================================ RIGHTS AGREEMENT DATED AS OF JANUARY 4, 2002 BY AND BETWEEN COMMONWEALTH ENERGY CORPORATION AND COMPUTERSHARE TRUST COMPANY, RIGHTS AGENT ================================================================================ TABLE OF CONTENTS
PAGE Section 1. Certain Definitions..........................................................1 Section 2. Appointment of Rights Agent..................................................5 Section 3. Issuance of Rights Certificates..............................................5 Section 4. Form of Rights Certificates..................................................7 Section 5. Countersignature and Registration............................................7 Section 6. Transfer, Split Up, Combination and Exchange of Rights, Certificates; Mutilated, Destroyed, Lost or Stolen Rights Certificates.................................................................8 Section 7. Exercise of Rights; Purchase Price; Expiration Date of Rights................8 Section 8. Cancellation and Destruction of Rights Certificates.........................11 Section 9. Reservation and Availability of Preferred Stock.............................11 Section 10. Preferred Stock Record Date.................................................12 Section 11. The Flip-In.................................................................12 Section 12. The Flip-Over...............................................................15 Section 13. Adjustment of Purchase Price, Number and Kind of Shares or Number of Rights............................................................17 Section 14. Rights of Action............................................................22 Section 15. Agreement of Rights Holders.................................................22 Section 16. Rights Holder Not Deemed a Stockholder......................................23 Section 17. Concerning the Rights Agent.................................................24 Section 18. Merger or Consolidation or Change of Name of Rights Agent...................24 Section 19. Duties of Rights Agent......................................................24 Section 20. Change of Rights Agent......................................................26 Section 21. Issuance of New Rights Certificates.........................................27
-i- TABLE OF CONTENTS (CONTINUED)
PAGE Section 22. Redemption and Termination..................................................27 Section 23. Exchange....................................................................28 Section 24. Notice of Certain Events....................................................29 Section 25. Notices.....................................................................30 Section 26. Supplements and Amendments..................................................30 Section 27. Successors..................................................................31 Section 28. Benefits of this Agreement..................................................31 Section 29. Severability................................................................31 Section 30. Governing Law...............................................................31 Section 31. Counterparts................................................................31 Section 32. Descriptive Headings........................................................31
EXHIBIT A -- FORM OF CERTIFICATE OF DESIGNATIONS OF PREFERRED STOCK EXHIBIT B -- FORM OF RIGHTS CERTIFICATE EXHIBIT C -- FORM OF SUMMARY OF RIGHTS TO PURCHASE PREFERRED STOCK -ii- RIGHTS AGREEMENT Rights Agreement, dated as of January 4, 2002 (this "AGREEMENT"), between COMMONWEALTH ENERGY CORPORATION, a California corporation (the "COMPANY"), and Computershare Trust Company (the "RIGHTS AGENT"). W I T N E S S E T H: WHEREAS, on January 4, 2002, the Board of Directors of the Company authorized and declared a dividend distribution of one Right (as such term is hereinafter defined) for each outstanding share of common stock, par value $0.001 per share (the "COMMON STOCK"), of the Company outstanding on January 4, 2002 (the "RECORD DATE"), and the issuance of one Right for each share of Common Stock of the Company issued between the Record Date and the Distribution Date (as such term is hereinafter defined), each Right entitles the holder thereof to purchase 1/1000th of a share of Preferred Stock of the Company having the rights, powers and preferences set forth in the form of Certificate of Designations attached hereto as Exhibit A, upon the terms and subject to the conditions hereinafter set forth (the "RIGHTS"); NOW, THEREFORE, in consideration of the premises and the mutual agreements herein set forth, the parties hereby agree as follows: Section 1. Certain Definitions. For purposes of this Agreement, the following terms have the meanings indicated: (a) "ACQUIRING PERSON" shall mean any Person (as such term is hereinafter defined) who or which, together with all Affiliates (as such term is hereinafter defined) and Associates (as such term is hereinafter defined) of the Person, shall be the Beneficial Owner (as such term is hereinafter defined) of 15% or more of the shares of Common Stock then outstanding and shall include all Affiliates and Associates of the Person, but shall not include the Company, any Subsidiary (as such term is hereinafter defined) of the Company, any employee benefit plan of the Company or any Subsidiary of the Company or any entity holding shares of Common Stock organized, appointed or established by the Company for or pursuant to the terms of any such plan. (b) "ADVERSE PERSON" shall mean a Person who or which, pursuant to a determination of the Board of Directors of the Company, has become the Beneficial Owner of more than 10% of the outstanding shares of Common Stock and that (i) such Beneficial Ownership is intended to cause the Company to repurchase the Common Stock Beneficially Owned by such Person or to cause pressure on the Company to take action or enter into transactions intended to provide such Person with short-term financial gain under circumstances where the Board of Directors of the Company determines that the best long-term interests of the Company would not be served by taking such action or entering into such transactions or (ii) such Beneficial Ownership is causing or reasonably likely to cause a material adverse impact on the business or prospects of the Company; provided, however, that the Board of Directors of the Company shall not declare any Person to be an Adverse Person if such Person has 1 reported or is required to report its ownership of Common Stock on Schedule 13G under the Exchange Act, or on Schedule 13D under the Exchange Act (as such term is hereinafter defined) which Schedule 13D does not state any intention to, or reserve the right to, control or influence the Company or engage in certain other actions, so long as such Person neither reports nor is required to report such ownership other than as so described. (c) "AFFILIATE" shall mean, with respect to a specified Person, a Person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the Person specified. (d) "ASSOCIATE" shall mean, with respect to a specified Person, (i) any corporation or organization (other than the Company or a Subsidiary of the Company) of which the Person is an officer, director or partner or is, directly or indirectly, the beneficial owner of 10% or more of any class of equity security as defined in Rule 3a-11 of the General Rules and Regulations under the Exchange Act, (ii) any trust or other estate in which the Person has a substantial beneficial interest or as to which the Person serves as trustee or in a similar fiduciary capacity, and (iii) any relative or spouse of the Person, or any relative of the spouse, who has the same home as the Person, or is an officer or director of any corporation controlling or controlled by the Person. (e) "BENEFICIAL OWNERSHIP" shall be determined pursuant to Rule 13d-3 of the General Rules and Regulations under the Securities Exchange Act of 1934 (or any successor rule or statutory provision) or, if Rule 13d-3 shall be rescinded and there shall be no successor rule or statutory provision thereto, pursuant to Rule 13d-3 as in effect on the date hereof; provided, however, that a Person shall, in any event, also be deemed to be the "Beneficial Owner" of any securities: (i) which the Person or any Affiliate or Associate thereof beneficially owns, directly or indirectly (ii) which the Person or any Affiliate or Associate thereof, directly or indirectly, has the right to acquire (whether the right is exercisable immediately or only after the passage of time) pursuant to any agreement, arrangement or understanding (whether or not in writing) or upon the exercise of conversion rights, exchange rights, rights, warrants or options, or otherwise; provided, however, that a Person shall not be deemed the "Beneficial Owner" of, or to "beneficially own," (A) securities tendered pursuant to a tender or exchange offer made by or on behalf of the Person or any Affiliate or Associate thereof until the tendered securities are accepted for purchase or exchange, or (B) securities issuable upon exercise of the Rights; (iii) which the Person or any Affiliate or Associate thereof, directly or indirectly, has sole or shared voting or investment 2 power with respect thereto pursuant to any agreement, arrangement or understanding (whether or not in writing); provided, however, that a Person shall not be deemed the "Beneficial Owner" of, or to "beneficially own," any security under this subparagraph (iii) as a result of an agreement, arrangement or understanding to vote the security if such agreement, arrangement or understanding (A) arises solely from a revocable proxy given in response to a public proxy or consent solicitation made pursuant to, and in accordance with, the applicable provisions of the General Rules and Regulations under the Exchange Act and (B) is not also then reportable by the Person on Schedule 13D under the Exchange Act; or (iv) which are beneficially owned, directly or indirectly, by any other Person or any Affiliate or Associate thereof with which the Person or any Affiliate or Associate thereof has any agreement, arrangement or understanding (whether or not in writing), for the purpose of acquiring, holding, voting (except pursuant to a revocable proxy as described in subparagraph (iii) of this paragraph (e)) or disposing of any voting securities of the Company. Nothing in this Section 1(e) shall cause a Person engaged in business as an underwriter to be the "Beneficial Owner" of, or to "beneficially own," any securities acquired through the Person's participation in good faith in a firm commitment underwriting until the expiration of 40 days after the date of acquisition. (f) "BUSINESS DAY" shall mean any day other than a Saturday, Sunday or other day on which banking institutions in the State of California are authorized or obligated by law or executive order to close. (g) "CLOSE OF BUSINESS" on any given date shall mean 5:00 p.m., California time, on that date; provided, however, that if the date is not a Business Day it shall mean 5:00 p.m., California time, on the next succeeding Business Day. (h) "CLOSING PRICE" of any security on any given day shall be the last sale price, regular way, of the security or, in case no such sale takes place on such day, the average of the closing bid and asked prices, regular way, on the principal trading market on which the security is then traded. (i) "COMMON STOCK" shall mean the common stock, par value $0.001 per share, of the Company, and "common stock" when used with reference to any Person other than the Company shall mean the capital stock with the greatest voting power, or the equity securities or other equity interest having power to control or direct the management of the Person. (j) "CURRENT MARKET PRICE" of any security on any given date shall be deemed to be the average of the daily Closing Prices per share or other trading unit of the security for 10 consecutive Trading Days (as such term is hereinafter defined) 3 immediately preceding the date; provided, however, that with respect to shares of capital stock, in the event that the current market price per share of the capital stock is determined during a period following the announcement of (i) a dividend or distribution on the capital stock payable in shares of the capital stock or securities convertible into shares of the capital stock (other than the Rights), or (ii) any subdivision, combination or reclassification of the capital stock, and prior to the expiration of the requisite 10 Trading Day period, as set forth above, after the ex-dividend date for the dividend or distribution, or the record date for the subdivision, combination or reclassification, then and in each case, the "Current Market Price, shall be properly adjusted to take into account ex-dividend trading; and provided further, that if the security is not publicly held or not so listed or traded, Current Market Price per share or other trading unit shall mean the fair value per share or other trading unit as determined in good faith by the Board of Directors of the Company, whose determination shall be described in a statement filed with the Rights Agent and shall be conclusive for all purposes. (k) "DISTRIBUTION DATE" shall mean the earliest of (i) the 10th day after the Stock Acquisition Date (as such term is hereinafter defined), (ii) the 10th business day after the date of the commencement of, or first public announcement of the intent to commence, a tender or exchange offer by any Person (other than the Company, any Subsidiary of the Company, any employee benefit plan of the Company or any Subsidiary of the Company or any entity holding shares of Common Stock organized, appointed or established by the Company for or pursuant to the terms of any such plan), if upon consummation thereof, the Person would be the Beneficial Owner of 15% or more of the shares of Common Stock then outstanding (including any date that is after the date of this Agreement and prior to issue of the Rights) and (iii) the 10th business day following a determination by the Board of Directors of the Company that a Person has become an Adverse Person. (l) "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934, as amended and in effect on the date of this Agreement, and all references to any rule or regulation of the General Rules and Regulations under the Exchange Act shall be, except as otherwise specifically provided herein, to the rule or regulation as was in effect on the date of this Agreement. (m) "EXCHANGE DATE" shall mean the date at which the rights are exchanges as provided in Section 23 of this Agreement. (n) "EXPIRATION DATE" shall mean the Close of Business on January 4, 2012, subject to extension as provided in Section 12(c) of this Agreement. (o) "FLIP-IN EVENT" shall mean any of the events described in Section 11(a) of this Agreement. (p) "FLIP-OVER EVENT" shall mean any of the events described in Section 12(a) of this Agreement. 4 (q) "PERSON" shall mean any individual, firm, corporation, partnership, limited liability company, sole proprietorship or other entity and shall include any "group" as that term is used in Rule 13d-5(b) under the Exchange Act. (r) "PURCHASE PRICE" shall mean the price to be paid by the holders of Rights, upon the exercise thereof, in exchange for shares of Preferred Stock. The initial Purchase Price shall be U.S.$50 per 1/1000th share of Preferred Stock, subject to adjustment in accordance with Section 13 of this Agreement. (s) "PREFERRED STOCK" shall mean shares of Preferred Stock, par value $0.001 per share, of the Company. (t) "RECORD DATE" shall mean January 4, 2002. (u) "REDEMPTION DATE" shall mean the time at which the Rights are ordered to be redeemed pursuant to Section 22 of this Agreement. (v) "STOCK ACQUISITION DATE" shall mean the first date of public announcement by the Company, an Acquiring Person or otherwise, that an Acquiring Person has become an Acquiring Person. (w) "SUBSIDIARY" shall mean, with reference to any Person, any Person of which a majority of any class of equity security is Beneficially Owned, directly or indirectly, by another Person. (x) "TRADING DAY", with respect to any security, shall mean a day on which the principal national securities exchange on which such security is listed or admitted to trading is open for the transaction of business or, if such security is not listed or admitted to trading on any national securities exchange, a Business Day. (y) "TRIGGERING EVENT" shall mean a Flip-In Event or a Flip-Over Event. Any determination required by the definitions contained in this Section 1 shall be made by the Board of Directors of the Company in its good faith judgment, which determination shall be final and binding on the Rights Agent. Section 2. Appointment of Rights Agent. The Company hereby appoints the Rights Agent to act as agent for the Company and the holders of the Rights (who, in accordance with Section 3 of this Agreement, shall prior to the Distribution Date also be the holders of the Common Stock) in accordance with the terms and conditions hereof, and the Rights Agent hereby accepts the appointment. The Company may from time to time appoint whichever co-Rights Agents it may deem necessary or desirable. Section 3. Issuance of Rights Certificates. (a) Until the Distribution Date, (i) the Rights will be evidenced by the certificates for the Common Stock registered in the names of the holders of the Common Stock (which certificates for Common Stock shall be deemed also to be 5 certificates for Rights) and not by separate certificates, and (ii) the Rights will be transferable only in connection with the transfer of the underlying shares of Common Stock (including a transfer to the Company). (b) As soon as practicable after the Company has notified the Rights Agent of the occurrence of the Distribution Date, the Rights Agent will send by first-class, insured, postage prepaid mail, to each record holder of the Common Stock as of the Close of Business on the Distribution Date, at the address of the holder shown on the records of the Company, a Rights certificate (the "RIGHTS CERTIFICATE"), evidencing one Right (as adjusted from time to time prior to the Distribution Date pursuant to this Agreement) for each share of Common Stock so held. As of and after the Distribution Date, the Rights will be evidenced solely by Rights Certificates. (c) As soon as practicable after the Record Date, the Company will send a copy of a Summary of Rights, in substantially the form attached hereto as Exhibit C (the "SUMMARY OF RIGHTS"), by first-class, postage prepaid mail to each record holder of the Common Stock as of the Close of Business on the Record Date, at the address of the holder shown on the records of the Company. (d) Certificates evidencing the Common Stock issued after the Record Date but prior to the earlier of the Distribution Date or the Expiration Date (as such term is hereinafter defined), shall be deemed also to be certificates evidencing Rights, and shall bear the following legend: THIS CERTIFICATE ALSO EVIDENCES AND ENTITLES THE HOLDER HEREOF TO CERTAIN RIGHTS AS SET FORTH IN THE RIGHTS AGREEMENT BETWEEN COMMONWEALTH ENERGY CORPORATION (THE "COMPANY") AND COMPUTERSHARE TRUST COMPANY, DATED AS OF JANUARY 4, 2002 (THE "RIGHTS AGREEMENT"), THE TERMS OF WHICH ARE HEREBY INCORPORATED HEREIN BY REFERENCE AND A COPY OF WHICH IS ON FILE AT THE PRINCIPAL OFFICES OF THE COMPANY. UNDER CERTAIN CIRCUMSTANCES, AS SET FORTH IN THE RIGHTS AGREEMENT, THE RIGHTS WILL BE EVIDENCED BY SEPARATE CERTIFICATES AND WILL NO LONGER BE EVIDENCED BY THIS CERTIFICATE. THE COMPANY WILL MAIL TO THE HOLDER OF THIS CERTIFICATE A COPY OF THE RIGHTS AGREEMENT WITHOUT CHARGE AFTER RECEIPT OF A WRITTEN REQUEST THEREFOR. UNDER CERTAIN CIRCUMSTANCES, RIGHTS BENEFICIALLY OWNED BY ACQUIRING PERSONS (AS SUCH TERM IS DEFINED IN THE RIGHTS AGREEMENT) BECOME NULL AND VOID AND THE HOLDER OF THOSE RIGHTS (INCLUDING ANY SUBSEQUENT HOLDER) SHALL NOT HAVE ANY RIGHT TO EXERCISE THE RIGHTS. (e) After the Distribution Date but prior to the Expiration Date, Rights shall only be issued in connection with the issue of Common Stock upon the exercise of stock options granted prior to the Distribution Date or pursuant to other benefits under 6 any employee plan or arrangement established prior to the Distribution Date; provided, however, that if, pursuant to the terms of any option or other benefit plan, the number of shares issuable thereunder is adjusted after the Distribution Date, the number of Rights issuable upon issuance of the shares shall be equal only to the number of shares which would have been issuable prior to the adjustment. Section 4. Form of Rights Certificates. (a) The Rights Certificates (and the form of election to purchase shares and form of assignment) shall be in substantially the form of Exhibit B and may contain whatever marks of identification or designation and/or legends, summaries or endorsements printed thereon as the Company may deem appropriate and as are not inconsistent with the provisions of this Agreement, or as may be required to comply with any applicable law or with any rule or regulation made pursuant thereto or with any rule or regulation of any stock exchange on which the Rights may from time to time be listed or to conform to usage. Subject to the provisions of this Agreement, the Rights Certificates, whenever issued, shall be dated as of the Record Date and on their face shall entitle the holders thereof to purchase the number of shares of Preferred Stock which shall be set forth therein at the Purchase Price set forth therein, subject to adjustment as provided in this Agreement. (b) Any Rights Certificate issued pursuant to Section 3(a) of this Agreement that represents Rights beneficially owned by an Acquiring Person or that represents any Rights owned on or after the Distribution Date by any Person who subsequently becomes an Acquiring Person and any Rights Certificate issued at any time upon the transfer of any Rights to an Acquiring Person thereof or to any nominee of the Acquiring Person and any Rights Certificate issued pursuant to Section 6 or Section 13 of this Agreement upon transfer, exchange, replacement or adjustment of any other Rights Certificate referred to in this sentence, may contain the following legend: THE RIGHTS REPRESENTED BY THIS RIGHTS CERTIFICATE WERE ISSUED TO A PERSON WHO WAS OR BECAME AN ACQUIRING PERSON. THIS RIGHTS CERTIFICATE AND THE RIGHTS REPRESENTED HEREBY MAY BECOME VOID IN THE CIRCUMSTANCES SPECIFIED IN SECTION 7(e) OF THE RIGHTS AGREEMENT. Section 5. Countersignature and Registration. (a) The Rights Certificates shall be executed on behalf of the Company by the Chairman of its Board of Directors, its President or any Vice President, either manually or by facsimile signature and shall have affixed thereto the Company's seal or a facsimile thereof which shall be attested by the Secretary or an Assistant Secretary of the Company, either manually or by facsimile signature. Each Rights Certificate shall be manually countersigned by the Rights Agent and shall not be valid for any purpose unless so countersigned. In case any officer of the Company who shall have signed 7 any of the Rights Certificates shall cease to be an officer of the Company before countersignature by the Rights Agent and issue and delivery by the Company, the Rights Certificates, nevertheless, may be countersigned by the Rights Agent, and issued and delivered by the Company with the same force and effect as though the person who signed the Rights Certificates had not ceased to be an officer of the Company; and any Rights Certificate may be signed on behalf of the Company by any person who, at the actual date of the execution of the Rights Certificate, is an officer of the Company, even if on the date of execution of this Rights Agreement that person was not an officer. (b) Following the Distribution Date, the Rights Agent will keep or cause to be kept, at one of its offices, books for registration and transfer of the Rights Certificates issued hereunder. The books shall show the names and addresses of the respective holders of the Rights Certificates, the number of Rights evidenced by each of the Rights Certificates, and the certificate number and the date of each of the Rights Certificates. Section 6. Transfer, Split Up, Combination and Exchange of Rights Certificates; Mutilated, Destroyed, Lost or Stolen Rights Certificates. (a) At any time after the Close of Business on the Distribution Date, and at or prior to the Close of Business on the Expiration Date, any Rights Certificate or Certificates may be transferred, split up, combined or exchanged for another Rights Certificate or Certificates, entitling the registered holder to purchase a like number of shares of Preferred Stock (or other securities, cash or other property, as the case may be) as the Rights Certificate or Certificates surrendered then entitled the holder (or former holder in the case of a transfer) to purchase. Any registered holder desiring to transfer, split up, combine or exchange any Rights Certificate or Certificates shall make the request in writing delivered to the Rights Agent, and shall surrender the Rights Certificate or Certificates to be transferred, split up, combined or exchanged at the principal office of the Rights Agent designated for that purpose. Thereupon, the Rights Agent shall countersign and deliver to the Person entitled thereto a Rights Certificate or Rights Certificates, as the case may be, as so requested. The Company may require payment of a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any transfer, split up, combination or exchange of Rights Certificates. (b) Upon receipt by the Company and the Rights Agent of evidence reasonably satisfactory to them of the loss, theft, destruction or mutilation of a Rights Certificate, and, in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to them, and reimbursement to the Company and the Rights Agent of all reasonable expenses incidental thereto, and upon surrender to the Rights Agent and cancellation of the Rights Certificate if mutilated, the Company will execute and deliver a new Rights Certificate of like tenor to the Rights Agent for countersignature and delivery to the registered owner in lieu of the Rights Certificate so lost, stolen, destroyed or mutilated. Section 7. Exercise of Rights; Purchase Price; Expiration Date of Rights. 8 (a) Each Right shall entitle (except as otherwise provided in this Agreement) the registered holder thereof, upon the exercise thereof as provided in this Agreement, to purchase, for the Purchase Price, at any time after the Distribution Date and prior to the earlier of the Expiration Date and the Redemption Date, 1/1000th share of Preferred Stock, subject to adjustment from time to time as provided in Section 13 of this Agreement, payable in lawful money of the United States of America in accordance with Paragraph (c) below. (b) Subject to Section 7(e), Section 22(a) and Section 23 of this Agreement, the registered holder of any Rights Certificate may exercise the Rights evidenced thereby in whole or in part at any time after the Distribution Date upon surrender of the Rights Certificate, with the form of election to purchase on the reverse side thereof including the certificate contained therein duly executed, to the Rights Agent at the principal office of the Rights Agent, together with payment of the Purchase Price for each 1/1000th share of Preferred Stock as to which the Rights are exercised prior to the earliest of the Expiration Date, the Exchange Date and the Redemption Date. The Purchase Price and the number of shares of Preferred Stock to be acquired upon exercise of a Right shall be subject to adjustment from time to time as provided in Section 13 of this Agreement. (c) Upon receipt of a Rights Certificate representing exercisable Rights, with the form of election to purchase including the certificate contained therein duly executed, accompanied by payment of the Purchase Price for the shares (or cash or other assets as the case may be) to be purchased and an amount equal to any applicable transfer tax in cash, or by certified check or bank draft payable to the order of the Company, the Rights Agent shall thereupon promptly: (i)(A) requisition from any transfer agent for the Preferred Stock certificates for the number of 1/1000th of a share of Preferred Stock to be purchased and the Company hereby irrevocably authorizes its transfer agent to comply with all such requests, or (B) requisition from the depositary agent depositary receipts representing the number of 1/1000th of a share of Preferred Stock as are to be purchased (in which case certificates for the shares of Preferred Stock represented by the receipts shall be deposited by the transfer agent with the depositary agent) and the Company will direct the depositary agent to comply with the request; (ii) after receipt of the certificates or depositary receipts, cause the same to be delivered to or upon the order of the registered holder of the Rights Certificate, registered in whatever name or names may be designated by the holder; and (iii) after receipt, deliver the cash, if any, to or upon the order of the registered holder of the Rights Certificate. If the Company becomes obligated to issue other securities of the Company, pay cash and/or distribute other property pursuant to this Agreement, the Company shall 9 make all arrangements necessary so that the other securities, cash and/or other property are available for distribution by the Rights Agent, if and when appropriate. (d) If the registered holder of any Rights Certificate shall exercise less than all the Rights evidenced thereby, a new Rights Certificate evidencing Rights equivalent to the Rights remaining unexercised shall be issued by the Rights Agent and delivered to the registered holder of the Rights Certificate or to his duly authorized assigns, subject to the provisions of Section 6 of this Agreement. (e) Notwithstanding anything in this Agreement to the contrary, upon the occurrence of the earliest of: (x) the date on which the Board of Directors of the Company decides to exchange the Rights pursuant to Section 23 of this Agreement, (y) a Triggering Event and (z) the date any Person becomes an Acquiring Person, any unexercised Rights that are or were (at any time on or after the earlier to occur of: (1) the Distribution Date and (2) the Stock Acquisition Date) beneficially owned by (i) an Acquiring Person, an Adverse Person or an Associate or Affiliate of an Acquiring Person or Adverse Person, (ii) a transferee of an Acquiring Person or an Adverse Person (or of any Associate or Affiliate thereof) that becomes a transferee after such Acquiring Person becomes an Acquiring Person or such Adverse Person becomes an Adverse Person, as the case may be, (iii) a transferee of an Acquiring Person or an Adverse Person (or of any Associate or Affiliate thereof) that becomes a transferee prior to or concurrently with such Acquiring Person or such Adverse Person becoming an Acquiring Person or Adverse Person, as the case may be, and receives the Rights pursuant to either (A) a transfer (whether or not for consideration) from such Acquiring Person or such Adverse Person to holders of equity interests in such Acquiring Person or such Adverse Person or to any Person with whom such Acquiring Person or such Adverse Person has any continuing agreement, arrangement or understanding regarding the transferred Rights or (B) a transfer which the Board of Directors of the Company has determined is part of a plan, arrangement or understanding which has, as a primary purpose or effect, the avoidance of this Section 7(e), shall immediately become permanently null and void without any further action, and no holder of the Rights shall have any right whatsoever with respect to the Rights under this Agreement or otherwise. The Company shall use all reasonable efforts to ensure that the provisions of this Section 7(e) and Section 4(b) of this Agreement are complied with, but shall have no liability to any holder of Rights Certificates or to any other Person as a result of its failure to make any determinations with respect to an Acquiring Person [or Adverse Person] or its Affiliates, Associates or transferees hereunder. (f) Notwithstanding anything in this Agreement to the contrary, neither the Rights Agent nor the Company shall be obligated to undertake any action with respect to a registered holder of any Rights Certificate upon the occurrence of any purported exercise thereof unless the registered holder shall have (i) completed and signed the certificate contained in the form of election to purchase set forth on the reverse side of the Rights Certificate surrendered for the exercise and (ii) provided the additional evidence of the identity of the Beneficial Owner (or former or proposed Beneficial Owner) or Affiliates thereof as the Company shall reasonably request. 10 Section 8. Cancellation and Destruction of Rights Certificates. All Rights Certificates surrendered for the purpose of exercise, transfer, split-up, combination or exchange shall, if surrendered to the Company or any of its agents, be delivered to the Rights Agent for cancellation or in cancelled form, or, if surrendered to the Rights Agent, shall be cancelled by it, and no Rights Certificates shall be issued in lieu thereof except as expressly permitted by any of the provisions of this Agreement. The Company shall deliver to the Rights Agent for cancellation and retirement, and the Rights Agent shall so cancel and retire, any other Rights Certificates purchased or acquired by the Company otherwise than upon the exercise thereof. The Rights Agent shall deliver all cancelled Rights Certificates to the Company, or shall, at the written request of the Company, destroy the cancelled Rights Certificates, and in that case shall deliver a certificate of destruction thereof to the Company. Section 9. Reservation and Availability of Preferred Stock. (a) The Company covenants and agrees that it will cause to be reserved and kept available at all times out of its authorized and unissued shares of Preferred Stock or its authorized and issued shares of Preferred Stock held in its treasury, free from preemptive rights or any right of first refusal, the number of shares of Preferred Stock that will be sufficient to permit the exercise in full of all Rights from time to time outstanding. (b) So long as the shares of Preferred Stock issuable upon the exercise of the Rights may be listed on any national securities exchange, the Company shall use its best efforts to cause, from and after the time the Rights become exercisable, all shares reserved for issue to be listed on the exchange upon official notice of issue when exercised. (c) The Company shall use its best efforts to: (i) file, as soon as practicable following the earlier of the Distribution Date or as soon as is required by law, a registration statement under the Securities Act of 1933, as amended (the "Act"), with respect to the Preferred Stock purchasable upon exercise of the Rights on an appropriate form; (ii) cause the registration statement to become effective as soon as practicable after the filing; and (iii) cause the registration statement to remain effective (with a prospectus at all times meeting the requirements of the Act) until the earliest of (A) the date as of which Rights are no longer exercisable for the securities, (B) the Expiration Date and (C) the Redemption Date. The Company will also take all action necessary to ensure compliance with the securities or "blue sky" laws of the various states in connection with the exercisability of the Rights. The Company may temporarily suspend, for a period of time not to exceed 11 ninety (90) days after the date set forth in clause (i) of the first sentence of this Section 9(c), the exercisability of the Rights in order to prepare and file the registration statements and permit them to become effective. Upon any such suspension, the Company shall issue a public announcement stating that the exercisability of the Rights has been temporarily suspended, as well as a public announcement at such time as the suspension is no longer in effect. Notwithstanding any provision of this Agreement to the contrary, the Rights shall not be exercisable in any jurisdiction unless the requisite qualification in that jurisdiction shall have been obtained and, if applicable, until a registration statement has been declared effective. (d) The Company covenants and agrees that it will take all action as may be necessary to ensure that all shares of Preferred Stock delivered upon exercise of Rights shall, at the time of delivery of the certificates for the shares (subject to payment of the Purchase Price), be duly and validly authorized and issued, fully paid and nonassessable. (e) The Company further covenants and agrees that it will pay when due and payable any and all federal and state transfer taxes and charges which may be payable in respect of the issuance or delivery of the Rights Certificates and of any shares of Preferred Stock upon the exercise of Rights. The Company shall not, however, be required to pay any transfer tax that may be payable in connection with the transfer or delivery of any Rights Certificates or share of Preferred Stock to any Person other than the registered holder thereof, and the Company shall not be required to transfer or issue any Rights Certificate or share of Preferred Stock to such Person until the tax has been paid by the registered holder thereof, or it has been determined to the Company's satisfaction that no tax is due. Section 10. Preferred Stock Record Date. Each Person in whose name any certificate for shares of Preferred Stock is issued upon the exercise of Rights shall for all purposes be deemed to have become the holder of record of the shares of Preferred Stock represented thereby on, and the certificate shall be dated, the date upon which the Rights Certificate evidencing the Rights was duly surrendered and payment of the Purchase Price (and all applicable transfer taxes) was made; provided, however, that if the date of surrender and payment is a date upon which the Preferred Stock transfer books of the Company are closed, the Person shall be deemed to have become the record holder of the shares on, and the certificate shall be dated, the next succeeding Business Day on which the Preferred Stock transfer books of the Company are open. Section 11. The Flip-In. (a) If: (i) any Acquiring Person, directly or indirectly, shall merge into the Company or otherwise combine with the Company and the Company shall be the continuing or surviving corporation of the merger or combination and the Common Stock of the Company shall remain outstanding and unchanged; or 12 (ii) any Person (other than the Company, any Subsidiary of the Company, any employee benefit plan of the Company or of any Subsidiary of the Company, or any entity organized, appointed or established pursuant to the terms of such plan) shall become the Beneficial Owner of 15% or more of the shares of Common Stock then outstanding; then, and in each case, subject to the provisions of Section 23 of this Agreement, each holder of a Right, except as provided below and in Section 7(e) of this Agreement, shall thereafter have a right to receive, upon exercise thereof at the then current Purchase Price in accordance with the terms of this Agreement, in lieu of shares of Preferred Stock, the number of shares of Common Stock of the Company as shall equal the result obtained by (x) multiplying the then current Purchase Price by the then number of 1/1000th of a share of Preferred Stock for which a Right is then exercisable and dividing that product by (y) 50% of the Current Market Price per share of the Common Stock on the date on which the first of the events listed above in this subparagraph (a) occurs (such number of shares hereinafter the "ADJUSTMENT SHARES"). (b) In the event that there shall not be sufficient issued but not outstanding, and authorized but unissued, shares of Common Stock to permit the exercise in full of the Rights in accordance with the foregoing subparagraph (a), the Company shall take all action as may be necessary to authorize additional shares of Common Stock for issue upon exercise of the Rights; provided, however, that if the Company is unable to cause the authorization of a sufficient number of additional shares of Common Stock, then, in the event the Rights become so exercisable, the Company, with respect to each Right and to the extent necessary and permitted by applicable law and any agreements or instruments in effect on the date hereof to which the Company is a party, shall, upon the exercise of the Rights, (i) pay an amount in cash equal to the excess of (A) the product of (1) the number of Adjustment Shares, multiplied by (2) the Current Market Price of the Common Stock (hereinafter the "CURRENT VALUE"), over (B) the Purchase Price, in lieu of issuing shares of Common Stock and requiring payment therefor, or (ii) issue debt or equity securities, or a combination thereof, having a value equal to the Current Value, where the value of the securities shall be determined by a nationally recognized investment banking firm selected by the Board of Directors of the Company, and require the payment of the Purchase Price, or (iii) deliver any combination of cash, property, Common Stock and/or other securities having the requisite value, and require payment of all or any requisite portion of the Purchase Price. If the Company determines that some action need be taken pursuant to clauses (i), (ii), or (iii) of the proviso of this Section 11(b), a majority of the Board of Directors may 13 suspend the exercisability of the Rights for a period of up to 45 days following the date on which the first of the events listed in Section 11(a)(i) or (ii) of this Agreement shall have occurred, in order to decide the appropriate form of distribution to be made pursuant to the above proviso and to determine the value thereof. In the event of any suspension, the Company shall issue a public announcement stating that the exercisability of the Rights has been temporarily suspended, as well as a public announcement at the time the suspension is no longer in effect. Section 12. The Flip-Over. (a) If, following the Distribution Date, directly or indirectly, (w) the Company shall consolidate with, or merge with and into, any other Person; or (x) any Person shall consolidate with the Company, or merge with and into the Company and the Company shall be the continuing or surviving corporation of the merger and, in connection with the merger, all or part of the shares of Common Stock shall be changed into or exchanged for stock or other securities of any other Person or cash or any other property; or (y) the Company shall effect a share exchange in which all or part of the Common Stock of the Company shall be exchanged into (including, without limitation, any conversion into or exchange for) securities of any other Person, cash or any other property; or (z) the Company shall sell, lease, exchange or otherwise transfer or dispose of (or one or more of its Subsidiaries shall sell, lease, exchange or otherwise transfer or dispose of), in one transaction or a series of related transactions, assets or earning power aggregating more than 50% of the assets or earning power of the Company and its Subsidiaries (taken as a whole) to any other Person or Persons, then, and in each case, subject to the provisions of Section 23 of this Agreement, (i) each holder of a Right, except as provided in Section 7(e) of this Agreement, shall thereafter have the right to receive, upon the exercise thereof at the then current Purchase Price in accordance with the terms of this Agreement, the number of shares of freely tradable common stock of the Principal Party, free and clear of any lien, encumbrance or other adverse claim, as shall be equal to the result obtained by (1) multiplying the then current Purchase Price by the number of 1/1000th of a share of Preferred Stock for which a Right is then exercisable (or the number of 1/1000th of a share of Preferred Stock for which a Right was exercisable immediately prior to the 14 occurrence of the Flip-In Event if a Flip-In Event has previously occurred) and dividing that product by (2) 50% of the Current Market Price per share of the common stock of the Principal Party on the date of consummation of the Flip-over Event; (ii) all common stock of any Person for which any Right may be exercised after consummation of a business combination as provided in this Section 12(a) shall, when issued upon exercise thereof in accordance with this Agreement, be duly and validly authorized and issued and fully paid and nonassessable; (iii) the Principal Party shall thereafter be liable for, and shall assume, by virtue of the Flip-Over Event, all the obligations and duties of the Company pursuant to this Agreement; (iv) the term "Company" shall thereafter be deemed to refer to the Principal Party, it being specifically intended that the provisions of Section 13 hereof shall apply to the Principal Party; (v) the Principal Party shall take whatever steps (including, but not limited to, the reservation of a sufficient number of shares of its common stock) in connection with the consummation as may be necessary to assure that the provisions hereof shall thereafter be applicable, as nearly as reasonably may be, in relation to its shares of common stock thereafter deliverable upon the exercise of the Rights; and (vi) the provisions of Section 11 of this Agreement shall be of no effect following the first occurrence of any Flip-Over Event. (b) "PRINCIPAL PARTY" shall mean: (i) in the case of any transaction described in (w), (x) or (y) of the first sentence of Section 12(a), the Person that is the issuer of any securities into which shares of Common Stock of the Company are converted in the merger or consolidation, and if no securities are so issued, the Person that is the other party to the merger or consolidation; and (ii) in the case of any transaction described in (z) of the first sentence in Section 12(a), the Person that is the party receiving the greatest portion of the assets or earning power transferred pursuant to the transaction or transactions; provided, however, that in any case, (1) if the common stock of the Person is not at such time and has not been continuously over the preceding 12-month period registered under Section 12 of the Securities Exchange Act of 1934, as then in effect, and the Person is a direct or indirect 15 Subsidiary of another Person the common stock of which is and has been so registered, "Principal Party" shall refer to the other Person; and (2) in case the Person is a Subsidiary, directly or indirectly, of more than one Person, the common stocks of two or more of which are and have been so registered, "Principal Party" shall refer to whichever of the Persons is the issuer of the common stock having the greatest aggregate market value. (c) The Company shall not consummate any Flip-over Event unless prior thereto the Company and each Principal Party and each other Person who may become a Principal Party shall have executed and delivered to the Rights Agent a supplemental agreement providing for the terms set forth in paragraphs (a) and (b) of this Section 12 and further providing that, as soon as practicable after the date of any Flip-Over Event, the Principal Party will: (i) prepare and file at its own expense a registration statement under the Act with respect to the Rights and the securities purchasable upon exercise of the Rights on an appropriate form, will use its best efforts to cause the registration statement to become effective as soon as practicable after the filing and will use its best efforts to cause the registration statement to remain effective (with a prospectus at all times meeting the requirements of the Act) until the earliest of the Expiration Date, the Exchange Date and the Redemption Date; and (ii) will deliver to holders of the Rights historical financial statements for the Principal Party and each of its Affiliates that comply in all respects with the requirements for registration on Form 10 under the Exchange Act. The Principal Party shall temporarily suspend, for a period of time not to exceed 90 days following the occurrence of a Flip-Over Event, the exercisability of the Rights in order to prepare an file the registration statement referred to in clause (i) above, and the Expiration Date shall be extended by the number of days of the suspension. The provisions of this Section 12 shall similarly apply to successive Flip-Over Events. In the event that a Flip-Over Event shall occur at any time after the occurrence of a Flip-In Event, the Rights that have not theretofore been exercised shall thereafter become exercisable in the manner described in Section 12(a). Section 13. Adjustment of Purchase Price, Number and Kind of Shares or Number of Rights. The Purchase Price, the number and kind of shares covered by each Right and the number of Rights outstanding are subject to adjustment from time to time as provided in this Section 13. (a) In the event the Company shall at any time after the date of this Agreement (A) declare a dividend or make a distribution on the Preferred Stock payable in shares of Preferred Stock into a larger number of shares, (B) subdivide the 16 outstanding Preferred Stock into a larger number of shares, (C) combine the outstanding Preferred Stock into a smaller number of shares, or (D) issue any shares of its capital stock in a reclassification of the Preferred Stock (including any such reclassification in connection with a consolidation or merger in which the Company is the continuing or surviving corporation), then in each event, except as otherwise provided in this Section 13(a), the Purchase Price in effect at the time of the record date for the dividend or distribution, or of the effective date of the subdivision, combination or reclassification, and the number and kind of shares of Preferred Stock or capital stock issuable on that date, shall be proportionately adjusted so that the holder of any Rights (except as provided in Section 7(e) of this Agreement) exercised on or after that time shall be entitled to receive upon payment of the Purchase Price in effect immediately prior to that date, the aggregate number and kind of shares of Preferred Stock or capital stock which, if the Rights had been exercised immediately prior to that date and at a time when the Preferred Stock transfer books of the Company were open, he would have owned upon such exercise and been entitled to receive by virtue of the dividend, distribution, subdivision, combination or reclassification. If an event occurs which would require an adjustment under both Section 11(a) of this Agreement and this Section 13(a), the adjustment provided for in this Section 13(a) shall be in addition to, and shall be made prior to, any adjustment required pursuant to Section 11(a). (b) In case the Company shall fix a record date for the issuance of rights, options or warrants to all holders of Preferred Stock entitling them to subscribe for or purchase (for a period expiring within 45 calendar days after the record date) Preferred Stock (or shares having the same rights, privileges and preferences as the shares of Preferred Stock ("EQUIVALENT PREFERRED STOCK") or securities convertible into Preferred Stock or Equivalent Preferred Stock at a price per share of Preferred Stock or per share of Equivalent Preferred Stock (or having a conversion price per share, if a security convertible into Preferred Stock or Equivalent Preferred Stock) of less than the Current Market Price per share of Preferred Stock on the record date, the Purchase Price to be in effect after the record date shall be determined by multiplying the Purchase Price in effect immediately prior to the record date by a fraction, the numerator of which shall be the number of 1/1000th of shares of Preferred Stock outstanding on the record date, plus the number of 1/1000th of shares of Preferred Stock which the aggregate offering price of the total number of shares of 1/1000th of Preferred Stock and/or Equivalent Preferred Stock so to be offered (and/or the aggregate initial conversion price of the convertible securities so to be offered) would purchase at the current market price and the denominator of which shall be the number of 1/1000th of shares of Preferred Stock outstanding on the record date, plus the number of additional 1/1000th of shares of Preferred Stock and/or Equivalent Preferred Stock to be offered for subscription or purchase (or into which the convertible securities so to be offered are initially convertible). In case the subscription price is paid in a form of consideration all or part of which is in a form other than cash, the value of the consideration shall be determined in good faith by the Board of Directors of the Company, whose determination shall be described in a statement filed with the Rights Agent and shall be binding on the Rights Agent. Shares of Preferred Stock owned by or held for the account of the Company shall not be deemed outstanding for the purpose of any such computation. The adjustment shall be made successively whenever a record date is fixed; and in the 17 event that rights or warrants are not issued following an adjustment, the Purchase Price shall be adjusted to be the Purchase Price that would have been in effect if the record date had not been fixed. (c) In case the Company shall fix a record date for a distribution to all holders of Preferred Stock (including any distribution made in connection with a consolidation or merger in which the Company is the continuing corporation) of evidences of indebtedness, cash (other than a regular quarterly cash dividend), assets (other than a dividend payable in Preferred Stock, but including any dividend payable in stock other than Preferred Stock) or subscription rights or warrants (excluding those referred to in Section 13(b)), the Purchase Price to be in effect after the record date shall be determined by multiplying the Purchase Price in effect immediately prior to the record date by a fraction, the numerator of which shall be the Current Market Price per 1/1000th of a share of the Preferred Stock on the record date, less the fair market value (as determined in good faith by the Board of Directors of the Company, whose determination shall be described in a statement filed with the Rights Agent) of the portion of the cash, assets or evidences of indebtedness to be so distributed or of the subscription rights or warrants applicable to 1/1000th of a share of Preferred Stock and the denominator of which shall be the Current Market Price per 1/1000th of a share of the Preferred Stock. The adjustments shall be made successively whenever a record date is fixed; and in the event that a distribution is not so made, the Purchase Price shall again be adjusted to be the Purchase Price that would be in effect if the record date had not been fixed. (d) Anything herein to the contrary notwithstanding, no adjustment in the Purchase Price shall be required unless the adjustment would require an increase or decrease of at least 1% in the Purchase Price; provided, however, that any adjustments which by reason of this Section 13(d) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 13 shall be made to the nearest cent or to the nearest ten-thousandth of a share of Common Stock or other share of one-millionth of a share of Preferred Stock, as the case may be. Notwithstanding the first sentence of this Section 13(d), any adjustment required by this Section 13 shall be made no later than the earlier of (i) three years from the date of the transaction which mandates such adjustment or (ii) the earliest of the Expiration Date, the Exchange Date and the Redemption Date. (e) If as a result of an adjustment made pursuant to Section 11(a), the holder of any Rights thereafter exercised shall become entitled to receive any shares of capital stock of the Company other than Preferred Stock, thereafter the number of the other shares so receivable upon exercise of any Rights shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the shares contained in Section 13(a) through (c), inclusive, and the provisions of Sections 7, 9, 10 and 12 hereof with respect to the Preferred Stock shall apply on like terms to any other shares. (f) All Rights originally issued by the Company subsequent to any adjustment made to the Purchase Price hereunder shall evidence the right to purchase, 18 at the adjusted Purchase Price, the number of shares of Preferred Stock purchasable from time to time hereunder upon exercise of the Rights, all subject to further adjustment as provided herein. (g) Unless the Company shall have exercised its election as provided in Section 13(h), upon each adjustment of the Purchase Price as a result of the calculations made in Sections 13(b) and (c), each Rights outstanding immediately prior to the making of the adjustment shall thereafter evidence the right to purchase, at the adjusted Purchase Price, that number of 1/1000th of a share of Preferred Stock (calculated to the nearest one-millionth) obtained by (i) multiplying (x) the number of 1/1000th of a share covered by a Right immediately prior to this adjustment by (y) the Purchase Price in effect immediately prior to the adjustment of the Purchase Price and (ii) dividing the product so obtained by the Purchase Price in effect immediately after adjustment of the Purchase Price. (h) The Company may elect on or after the date of any adjustment of the Purchase Price to adjust the number of Rights, in substitution for any adjustment in the number of shares of Preferred Stock purchasable upon the exercise of a Right. Each of the Rights outstanding after the adjustment in the number of Rights shall be exercisable for the number of 1/1000th of a share of Preferred Stock for which a Right was exercisable immediately prior to the adjustment. Each Right held of record prior to the adjustment of the number of Rights shall become that number of Rights (calculated to the nearest one-millionth) obtained by dividing the Purchase Price in effect immediately prior to adjustment of the Purchase Price by the Purchase Price in effect immediately after adjustment of the Purchase Price. The Company shall make a public announcement of its election to adjust the number of Rights, indicating the record date for the adjustment, and, if known at the time, the amount of the adjustment to be made. This record date may be the date on which the Purchase Price is adjusted or any day thereafter, but, if the Rights Certificates have been issued, shall be at least 10 days later than the date of the public announcement. If Rights Certificates have been issued, upon each adjustment of the number of Rights pursuant to this Section 13(h), the Company shall, as promptly as practicable, cause to be distributed to holders of record of Rights Certificates on the record date Rights Certificates evidencing the additional Rights to which the holders shall be-entitled as a result of the adjustment, or, at the option of the Company, shall cause to be distributed to the holders of record in substitution and replacement for the Rights Certificates held by the holders prior to the date of adjustment, and upon surrender thereof, if required by the Company, new Rights Certificates evidencing all the Rights to which the holders shall be entitled after the adjustment. Rights Certificates so to be distributed shall be issued, executed and countersigned in the manner provided for herein (and may bear, at the option of the Company, the adjusted Purchase Price) and shall be registered in the names of the holders of record of Rights Certificates on the record date specified in the public announcement. (i) Irrespective of any adjustment or change in the Purchase Price or the number of 1/1000th of a share of Preferred Stock issuable upon the exercise of the Rights, the Rights Certificates theretofore and thereafter issued may continue to 19 express the Purchase Price per share and the number of shares which were expressed in the initial Rights Certificates issued hereunder. (j) Before taking any action that would cause an adjustment reducing the Purchase Price below the par value of the shares of Preferred Stock issuable upon exercise of the Rights, the Company shall take any corporate action which may, in the opinion of its counsel, be necessary in order that the Company may validly and legally issue fully paid and nonassessable shares of Preferred Stock at the adjusted Purchase Price. (k) In any case in which this Section 13 shall require that an adjustment in the Purchase Price be made effective as of a record date for a specified event, the Company may elect to defer until the occurrence of such event the issuance to the holder of any Rights exercised after the record date, the shares of Preferred Stock and other capital stock or securities of the Company, if any, issuable upon the exercise over and above the shares of Preferred Stock and other capital stock or securities of the Company, if any, issuable upon the exercise on the basis of the Purchase Price in effect prior to the adjustment; provided, however, that the Company shall deliver to the holder a due bill or other appropriate instrument evidencing the holder's right to receive the additional shares upon the occurrence of the event requiring the adjustment. (l) Anything in this Section 13 to the contrary notwithstanding, the Company shall be entitled to make reductions in the Purchase Price, in addition to those adjustments expressly required by this Section 13, as and to the extent that in its sole discretion the Company shall determine to be advisable in order that any (i) consolidation or subdivision of the Preferred Stock, (ii) issuance wholly for cash of any shares of Preferred Stock at less than the Current Market Price, (iii) issuance wholly for cash of shares of Preferred Stock or securities which by their terms are convertible into or exchangeable for shares of Preferred Stock, (iv) stock dividends, or (v) issuance of rights, options or warrants referred to in this Section 13, hereafter made by the Company to holders of its Preferred Stock shall, if practicable, not be taxable to the stockholders. (m) The Company covenants and agrees that it shall not (i) consolidate with, (ii) merge with or into, or (iii) sell or transfer to, in one or more transactions, assets or earning power aggregating more than 50% of the assets or earning power of the Company and its Subsidiaries taken as a whole, any other Person if at the time of or immediately after the consolidation, merger or sale there are any rights, warrants or other instruments or securities outstanding or agreements in effect which would substantially diminish or otherwise eliminate the benefits intended to be afforded by the Rights. (n) The Company covenants and agrees that, after the Stock Acquisition Date, it will not, except as permitted by Section 22 or Section 26 hereof, take any action the purpose or effect of which is to diminish substantially or otherwise eliminate the benefits intended to be afforded by the Rights. 20 (o) Anything in this Agreement to the contrary notwithstanding, in the event that the Company shall at any time prior to the Distribution Date (i) declare a dividend or distribution on the outstanding shares of Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding shares of Common Stock, or (iii) combine the outstanding shares of Common Stock into a smaller number of shares, the number of Rights associated with each share of Common Stock then outstanding, or issued or delivered thereafter but prior to the Distribution Date, shall be proportionately adjusted so that the number of Rights thereafter associated with each share of Common Stock following any such event shall equal the result obtained by multiplying the number of Rights associated with each share of Common Stock immediately prior to the event by a fraction, (1) the numerator of which shall be the total number of shares of Common Stock outstanding immediately prior to the occurrence of the event and (2) the denominator of which shall be the total number of shares of Common Stock outstanding immediately following the occurrence of the event. (p) Whenever an adjustment is made as provided in Sections 11, 12 and 13 hereof, the Company shall (a) promptly prepare a certificate setting forth the adjustment and a brief statement of the facts accounting for the adjustment, (b) promptly file with the Rights Agent and with each transfer agent for the Preferred Stock and the Common Stock a copy of the Certificate and (c) mail a brief summary thereof to each holder of a Rights Certificate in accordance with Section 25 hereof. The Rights Agent shall be fully protected in relying on any such certificate and on any adjustment therein contained. Section 14. Rights of Action. All rights of action in respect of this Agreement are vested in the respective registered holders of the Rights Certificates (and, prior to the Distribution Date, the registered holders of the Common Stock); and any registered holder of any Rights Certificate (or, prior to the Distribution Date, of the Common Stock) without the consent of the Rights Agent or of the holder of any other Rights Certificate (or, prior to the Distribution Date, of the Common Stock), may, in his own behalf and for his own benefit, enforce, and may institute and maintain any suit, action or proceeding against the Company to enforce, or otherwise act in respect of, his nights pursuant to this Agreement. Without limiting the foregoing or any remedies available to the holders of Rights, it is specifically acknowledged that the holders of Rights would not have an adequate remedy at law for any breach of this Agreement and shall be entitled to specific performance of the obligations hereunder and injunctive relief against actual or threatened violations of the obligations hereunder of any Person subject to this Agreement. Section 15. Agreement of Rights Holders. Every holder of a Right by accepting the same consents and agrees with the Company and the Rights Agent and with every other holder of a Right that: (a) prior to the Distribution Date, the Rights will be transferable only in connection with the transfer of Common Stock; 21 (b) after the Distribution Date, the Rights Certificates are transferable only on the registry books of the Rights Agent if surrendered at the principal corporate trust office of the Rights Agent, duly endorsed or accompanied by a proper instrument of transfer; (c) the Company and the Rights Agent may deem and treat the person in whose name a Rights Certificate (or, prior to the Distribution Date, the associated Common Stock certificate) is registered as the absolute owner thereof and of the Rights evidenced thereby (notwithstanding any notations of ownership or writing on the Rights Certificates or the associated Common Stock certificate made by anyone other than the Company or the Rights Agent) for all purposes whatsoever, and neither the Company nor the Rights Agent shall be affected by any notice to the contrary; and (d) notwithstanding anything in this Agreement to the contrary, neither the Company nor the Rights Agent shall have any liability to any holder of a Right or other Person as a result of its inability to perform any of its obligations under this Agreement by reason of any preliminary or permanent injunction or other order, decree or ruling issued by a court or by a governmental, regulatory or administrative agency or commission, or any statute, rule, regulation or executive order promulgated or enacted by any governmental authority prohibiting or otherwise restraining performance of the obligation; provided, however, the Company must use its best efforts to have any order, decree or ruling lifted or otherwise overturned. Section 16. Rights Holder Not Deemed a Stockholder. Except as otherwise expressly provided in this Agreement, no holder, as such, of any Rights Certificate shall be entitled to vote, receive dividends or be deemed for any purpose the holder of the shares of Preferred Stock or any other securities of the Company which may at any time be issuable on the exercise of the Rights represented thereby, nor shall anything contained herein or in any Rights Certificate be construed to confer upon the holder of any Rights Certificate, as such, any of the rights of a Stockholder of the Company or any right to vote for the election of directors or upon any matter submitted to Stockholders at any meeting thereof, or to give or withhold consent to any corporate action, or to receive notice of meetings or other actions affecting Stockholders, or to receive dividends or subscription rights, or otherwise, until and only to the extent that the Right or Rights evidenced by the Rights Certificate shall have been exercised in accordance with the provisions of this Agreement. Section 17. Concerning the Rights Agent. The Company agrees to pay to the Rights Agent reasonable compensation for all services rendered by it hereunder and, from time to time, on demand of the Rights Agent, its reasonable expenses and counsel fees and disbursements and other disbursements incurred in the administration and execution of this Agreement and the exercise and performance of its duties hereunder. The Company also agrees to indemnify the Rights Agent for, and to hold it harmless against, any loss, liability, or expense, incurred without negligence, bad faith or willful misconduct on the part of the Rights Agent, for anything done or omitted by the Rights Agent in connection with the acceptance and administration of this Agreement, including the costs and expenses of defending against any claim of liability in the 22 premises. The indemnification provided for hereunder shall survive the expiration of the Rights and the termination of this Agreement. The Rights Agent shall be protected and shall incur no liability for or in respect of any action taken, suffered or omitted by it in connection with its administration of this Agreement in reliance upon any Rights Certificate or certificate for Common Stock or for other securities of the Company, instrument of assignment or transfer, power of attorney, endorsement, affidavit, letter, notice, direction, consent, certificate, statement, or other paper or document believed by it to be genuine and to be signed, executed and, where necessary, verified or acknowledged, by the proper Person or Persons. Section 18. Merger or Consolidation or Change of Name of Rights Agent. Any corporation into which the Rights Agent or any successor Rights Agent may be merged or with which it may be consolidated, or any corporation resulting from any merger or consolidation to which the Rights Agent or any successor Rights Agent shall be a party, or any corporation succeeding to the corporate trust business of the Rights Agent or any successor Rights Agent, shall be the successor to the Rights Agent under this Agreement without the execution or filing of any paper or any further act on the part of any of the parties hereto, provided that the corporation would be eligible for appointment as a successor Rights Agent under the provisions of Section 20 of this Agreement. In case at the time the successor Rights Agent shall succeed to the agency created by this Agreement, any of the Rights Certificates shall have been countersigned but not delivered, any successor Rights Agent may adopt the countersignature of the predecessor Rights Agent and deliver the Rights Certificates so countersigned; and in case at that time any of the Rights Certificates shall not have been countersigned, any successor Rights Agent may countersign the Rights Certificates either in the name of the predecessor or in the name of the successor Rights Agent; and in all cases the Rights Certificates shall have the full force provided in the Rights Certificates and in this Agreement. In case at any time the name of the Rights Agent shall be changed and at that time any of the Rights Certificates shall have been countersigned but not delivered, the Rights Agent may adopt the countersignature under its prior name and deliver Rights Certificates so countersigned; and in case at that time any of the Rights Certificates shall not have been countersigned, the Rights Agent may countersign the Rights Certificates either in its prior name or in its changed name; and in all cases the Rights Certificates shall have the full force provided in the Rights Certificates and in this Agreement. Section 19. Duties of Rights Agent. The Rights Agent undertakes the duties and obligations imposed by this Agreement upon the following terms and conditions, by all of which the Company and the holders of Rights Certificates, by their acceptance thereof, shall be bound: (a) The Rights Agent may consult with legal counsel (who may be legal counsel for the Company), and the opinion of the counsel shall be full and complete 23 authorization and protection to the Rights Agent as to any action taken or omitted by it in good faith and in accordance with the opinion. (b) Whenever in the performance of its duties under this Agreement the Rights Agent shall deem it necessary or desirable that any fact or matter (including, without limitation, the identity of any Acquiring Person) be proved or established by the Company prior to taking or suffering any action hereunder, the fact or matter (unless other evidence in respect thereof be herein specifically prescribed) may be deemed to be conclusively proved and established by a certificate signed by the Chairman of the Board, the President, any Vice President, the Treasurer, any Assistant Treasurer, the Secretary or any Assistant Secretary of the Company and delivered to the Rights Agent; and the certificate shall be full authorization to the Rights Agent, for any action taken or suffered in good faith by it under the provisions of this Agreement in reliance upon the certificate. (c) The Rights Agent shall be liable hereunder only for its own negligence, bad faith or willful misconduct. (d) The Rights Agent shall not be liable for or by reason of any of the statements of facts or recitals contained in this Agreement or in the Rights Certificates or be required to verify the same (except as to its countersignature on the Rights Certificates), but all statements and recitals are and shall be deemed to have been made by the Company only. (e) The Rights Agent shall not be under any responsibility in respect of the validity of this Agreement or the execution and delivery hereof (except the due execution hereof by the Rights Agent) or in respect of the validity or execution of any Rights Certificate (except its countersignature thereof); nor shall it be responsible for any breach by the Company of any covenant or condition contained in this Agreement or in any Rights Certificate; nor shall it be responsible for any adjustment required under the provisions of Sections 11 or 13 of this Agreement or responsible for the manner, method or amount of any such adjustment or the ascertaining of the existence of facts that would require any such adjustment (except with respect to the exercise of Rights evidenced by Rights Certificates after actual notice of any adjustment); nor shall it by any act hereunder be deemed to make any representation or warranty as to the authorization or reservation of any shares of Common Stock or Preferred Stock to be issued pursuant to this Agreement or any Rights Certificate or as to whether any shares of Common Stock or Preferred Stock will, when so issued, be validly authorized and issued, fully paid and nonassessable. (f) The Company agrees that it will perform, execute, acknowledge and deliver or cause to be performed, executed, acknowledged and delivered all further and other acts, instruments and assurances as may reasonably be required by the Rights Agent for the carrying out or performing by the Rights Agent of the provisions of this Agreement. 24 (g) The Rights Agent is hereby authorized and directed to accept instructions with respect to the performance of its duties hereunder from the Chairman of the Board, the President, any Vice President, the Secretary, any Assistant Secretary, the Treasurer or any Assistant Treasurer of the Company, and to apply to the officers for advice or instructions in connection with its duties, and it shall not be liable for any action taken or suffered to be taken by it in good faith in accordance with instructions of any officer. (h) The Rights Agent and any stockholder, director, officer or employee of the Rights Agent may buy, sell or deal in any of the Rights or other securities of the Company or become pecuniarily interested in any transaction in which the Company may be interested, or contract with or lend money to the Company or otherwise act as fully and freely as though it were not Rights Agent under this Agreement. Nothing herein shall preclude the Rights Agent from acting in any other capacity for the Company or for any other legal entity. (i) The Rights Agent may execute and exercise any of the rights or powers hereby vested in it or perform any duty hereunder either itself or by or through its attorneys or agents, and the Rights Agent shall not be answerable or accountable for any act, default, neglect or misconduct of any attorneys or agents or for any loss to the Company resulting from any act, default, neglect or misconduct provided reasonable care was exercised in the selection and continued employment thereof. (j) No provision of this Agreement shall require the Rights Agent to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties hereunder or in the exercise of its rights if there shall be reasonable grounds for believing that repayment of such funds or adequate indemnification against such risk or liability is not reasonably assured to it. (k) The Rights Agent shall not be required to take notice or be deemed to have notice of any fact event or determination under the Rights Agreement unless and until the Rights Agent shall be specifically notified in writing by the Company of such fact, event or determination. Section 20. Change of Rights Agent. The Rights Agent or any successor Rights Agent may resign and be discharged from its duties under this Agreement upon 30 days' notice in writing mailed to the Company, and to each transfer agent of the Common Stock and Preferred Stock by registered or certified mail, and to the holders of the Rights Certificates by first-class mail. The Company may remove the Rights Agent or any successor Rights Agent upon 30 days' notice in writing, mailed to the Rights Agent or successor Rights Agent, as the case may be, and to each transfer agent of the Common Stock and Preferred Stock, by registered or certified mail, and to the holders of the Rights Certificates by first-class mail. If the Rights Agent shall resign or be removed or shall otherwise become incapable of acting, the Company shall appoint a successor to the Rights Agent. If the Company shall fail to make such appointment within a period of 30 days after giving notice of such removal or after it has been notified in writing of such resignation or incapacity by the resigning or incapacitated Rights 25 Agent or by the holder of a Rights Certificate (who shall, with such notice, submit his Rights Certificate for inspection by the Company), then the registered holder of any Rights Certificate may apply to any court of competent jurisdiction for the appointment of a new Rights Agent. Any successor Rights Agent, whether appointed by the Company or by such a court, shall be a corporation organized and doing business under the laws of the United States or of the State of California (or of any other state of the United States so long as such corporation is authorized to do business as a banking institution in the State of California), in good standing, having a principal office in the State of California, which is authorized under such laws to exercise corporate trust powers and is subject to supervision or examination by federal or state authority and which has at the time of its appointment as Rights Agent a combined capital and surplus of at least $100,000,000. After appointment, the successor Rights Agent shall be vested with the same powers, rights, duties and responsibilities as if it had been originally named as Rights Agent without further act or deed; but the predecessor Rights Agent shall deliver and transfer to the successor Rights Agent any property at the time held by it hereunder, and execute and deliver any further assurance, conveyance, act or deed necessary for the purpose. Not later than the effective date of any such appointment, the Company shall file notice thereof in writing with the predecessor Rights Agent and each transfer agent of the Common Stock and the Preferred Stock, and mail a notice thereof in writing to the registered holders of the Rights Certificates. Failure to give any notice provided for in this Section 20, however, or any defect therein, shall not affect the legality or validity of the resignation or removal of the Rights Agent or the appointment of the successor Rights Agent, as the case may be. Section 21. Issuance of New Rights Certificates. Notwithstanding any of the provisions of this Agreement or of the Rights to the contrary, the Company may, at its option, issue new Rights Certificates evidencing Rights in such form as may be approved by its Board of Directors to reflect any adjustment or change in the Purchase Price per share and the number or kind or class of shares or other securities or property purchasable under the Rights Certificates made in accordance with the provision of this Agreement. Section 22. Redemption and Termination. (a) The Board of Directors of the Company may, at its option, at any time prior to 5:00 p.m., California time, on the earlier of (i) the tenth day following the Stock Acquisition Date, subject to extension by the Board of Directors for a period of time up to, but not exceeding, ten additional days, and (ii) the Expiration Date, redeem all but not less than all the then outstanding Rights at a redemption price of $0.001 per Right, appropriately adjusted to reflect any stock split, stock dividend or similar transaction occurring after the date hereof (such redemption price being hereinafter referred to as the "REDEMPTION PRICE"). The Company may, at its option, pay such redemption price in cash, shares of Common Stock (based on the market price of the Common Stock at the time of redemption) or any other form of consideration deemed appropriate by the Board of Directors of the Company. Notwithstanding anything in this Agreement to the 26 contrary, no Rights may be exercised at any time that the Rights are subject to redemption in accordance with the terms of this Agreement. (b) Immediately upon the action of the Board of Directors of the Company extending the redemption period pursuant to Section 22(a)(i), evidence of which shall have been filed with the Rights Agent, the Company shall issue a press release indicating the date to which the Board of Directors has extended its right to redeem the Rights. (c) Notwithstanding anything in this Agreement to the contrary, no redemption of the Rights shall be permitted after 5:00 p.m. California time, on the earlier of (i) the tenth day following the Stock Acquisition Date, subject to extension by the Board of Directors for a period of time up to, but not exceeding, ten additional days, or (ii) the Expiration Date. (d) Immediately upon the action of the Board of Directors of the Company ordering the redemption of the Rights, evidence of which shall have been filed with the Rights Agent and without any further action and without any notice, the right to exercise the Rights will terminate and the only right thereafter of the holders of Rights shall be to receive the Redemption Price. Within ten days after the action of the Board of Directors ordering the redemption of the Rights, the Company shall give notice of such redemption to the Rights Agent and the holders of the then outstanding Rights by mailing such notice to all such holders at their last addresses as they appear upon the registry books of the Rights Agent or prior to the Distribution Date, on the registry books of the Transfer Agent for the Common Stock. Any notice mailed in the manner herein provided shall be deemed given, whether or not the holder receives the notice. Each such notice of redemption will state the method by which the payment of the Redemption Price will be made. In any case, failure to give such notice to any particular holder of Rights shall not affect the sufficiency of the notice to other holders of Rights. Neither the Company nor any of its Affiliates or Associates may redeem, acquire or purchase for value any Rights at any time, in any manner, other than that specifically set forth in this Section 22, and neither the Company nor any of its Affiliates or Associates may acquire or purchase for value any Rights at any time, in any manner, other than in connection with the purchase of shares of associated Common Stock prior to the Distribution Date. Section 23. Exchange. (a) The Company may, at its option but subject to receipt of any required regulatory approvals, by action of the Board of Directors, at any time after any Person becomes an Acquiring Person, exchange all or part of the then outstanding and exercisable Rights (which shall not include Rights owned by the Acquiring Person or that otherwise have become void pursuant to Section 7(e) hereof) for shares of Common Stock at an exchange ratio of one share of Common Stock per Right, appropriately adjusted to reflect any stock split, stock dividend or similar transaction occurring after the date hereof (such exchange ratio being herein referred to as the "EXCHANGE RATIO"). 27 (b) Immediately upon the action of the Board of Directors of the Company ordering the exchange of any Rights pursuant to paragraph (a) of this Section 23 and without any further action and without any notice, the right to exercise such Rights shall terminate and the only right thereafter of a holder of such Rights shall be to receive that number of shares of Common Stock equal to the number of such Rights held by such holder multiplied by the Exchange Ratio. The Company shall promptly give public notice of any such exchange; provided, however, that the failure to give, or any defect in, such notice shall not affect the validity of such exchange. The Company promptly shall mail a notice of any exchange to all holders of such Rights at their last addresses as they appear upon the registry books of Rights Agent. Any notice that is mailed in the manner herein provided shall be deemed given, whether or not the holder receives the notice. Each such notice of exchange will state the method by which the exchange of the Common Stock for Rights will be effected and, in the event of any partial exchange, the number of Rights which will be exchanged. Any partial exchange shall be effected pro rata based on the number of Rights (other than Rights which have become void pursuant to the provisions of Section 7(e) hereof) held by each holder of Rights. (c) In any exchange pursuant to this Section 23, the Company, at its option, may substitute Preferred (or Equivalent Preferred Stock, for shares of Common Stock exchangeable for Rights, at the initial rate of 1/1000th of a share of Preferred Stock (or Equivalent Preferred Stock) for each share of Common Stock, as appropriately adjusted to reflect adjustments in the voting rights of the Preferred Stock pursuant to the terms thereof, so that the fraction of a share of Preferred Stock delivered in lieu of each share of Common Stock shall have at least the same voting rights as one share of Common Stock. Section 24. Notice of Certain Events. (a) In case the Company shall propose (i) to pay any dividend payable in stock of any class to the holders of Preferred Stock or to make any other distribution to the holders of Preferred Stock (other than a regular quarterly cash dividend) or (ii) to offer to the holders of Preferred Stock rights or warrants to subscribe for or to purchase any additional shares of Preferred Stock or shares of stock of any class or any other securities, rights or options or (iii) to effect any reclassification of its Preferred Stock (other than a reclassification involving only the subdivision of outstanding shares of Preferred Stock) or (iv) to effect any Flip-Over Event or (v) to effect the liquidation, dissolution or winding up of the Company, then, in each such case, the Company shall give to each holder of a Rights Certificate, in accordance with Section 25, a notice of such proposed action, which shall specify the record date for the purposes of such stock dividend, distribution of rights or warrants, or the date on which such reclassification, Flip-Over Event, liquidation, dissolution, or winding up is to take place and the date of participation therein by the holders of the shares of Preferred Stock, if any such date is to be fixed, and such notice shall be so given in the case of any action covered by clause (i) or (ii) above at least ten days prior to the record date for determining holders of the shares of Preferred Stock for purposes of such action, and in the case of any such other action, at least ten days prior to the date of the taking of such proposed 28 action or the date of participation therein by the holders of the shares of Preferred Stock whichever shall be the earlier. (b) Upon the occurrence of a Flip-In Event or a Flip-Over Event, the Company or Principal Party, as the case may be, shall as soon as practicable thereafter give to each holder of a Rights Certificate, to the extent feasible and in accordance with Section 25, a notice of the occurrence of such event and the consequences thereof. Section 25. Notices. Notices or demands authorized by this Agreement to be given or made by the Rights Agent or by the holder of any Rights Certificate to or on the Company shall be sufficiently given or made if sent by first-class mail, postage prepaid, addressed (until another address is filed in writing with the Rights Agent) as follows: Commonwealth Energy Corporation 15901 Red Hill Avenue, Suite 100 Tustin, CA 92780 Attention: Ian Carter With copy to: McDermott, Will & Emery 2049 Century Park East, 34th Floor Los Angeles, CA 90067-3208 Attention: Joel Bernstein, Esq. Subject to the provisions of Section 20, any notice or demand authorized by this Agreement to be given or made by the Company or by the holder of any Rights Certificate to or on the Rights Agent shall be sufficiently given or made if delivered by first-class mail, postage prepaid, addressed (until another address is filed in writing with the Company) as follows: -------------------------- -------------------------- -------------------------- Attention: --------------- Notices or demands authorized by this Agreement to be given or made by the Company or the Rights Agent to the holder of any Rights Certificate shall be sufficiently given or made if sent by first-class mail, postage prepaid, addressed to such holder at the address of such holder as shown on the registry books of the Company. The Company shall deliver a copy of any notice or demand it delivers to the holder of any Rights Certificate to the Rights Agent and the Rights Agent shall deliver a copy of any notice or demand it deliver to the holder of any Rights Certificate to the Company. Section 26. Supplements and Amendments. The Company and the Rights Agent may from time to time supplement or amend this Agreement without the approval of any holders of Rights Certificates in order to cure any ambiguity, to correct or supplement any provision contained herein which may be defective or inconsistent 29 with any other provisions herein or to change or supplement the provisions hereunder in any manner which the Company may deem necessary or desirable and which shall not adversely affect the interests of the holders of Rights Certificates other than an Acquiring Person; provided, however, that no amendment or supplement may be made if the effect would be to extend or shorten the redemption period after the Stock Acquisition Date or change the Purchase Price or the Redemption Price. Notwithstanding any other provisions of this Section 26, the Board of Directors shall retain the right to amend the Purchase Price for a period of six months from the date of this Agreement. Section 27. Successors. All the covenants and provisions of this Agreement by or for the benefit of the Company or the Rights Agent shall bind and inure to the benefit of their respective successors and assigns hereunder. Section 28. Benefits of this Agreement. Nothing in this Agreement shall be construed to give to any Person other than the Company, the Rights Agent and the registered holders of the Rights Certificates (and, prior to the Distribution Date, the Common Stock) any legal or equitable right, remedy or claim under this Agreement; but this Agreement shall be for the sole and exclusive benefit of the Company, the Rights Agent and the registered holders of the Rights Certificates (and, prior to the Distribution Date, the Common Stock). Section 29. Severability. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction or other authority to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. Section 30. Governing Law. This Agreement, each Right and each Rights Certificate issued hereunder shall be deemed to be a contract made under the laws of the State of California and for all purposes shall be governed by and construed in accordance with the laws of such State applicable to contracts made and to be performed entirely within such State. Section 31. Counterparts. This Agreement may be executed in any number of counterparts and each of such counterparts shall for all purposes be deemed to be an original, and all such counterparts shall together constitute but one and the same instrument. Section 32. Descriptive Headings. Descriptive headings of the several Sections of this Agreement are inserted for convenience only and shall not control or affect the meaning or construction of any of the provisions hereof. 30 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and their respective corporate seals to be hereunto affixed and attested, all as of the day and year first above written. COMMONWEALTH ENERGY CORPORATION By: /s/ Ian B. Carter -------------------------------- Name: Ian B. Carter Title: Chairman and Chief Executive Officer 31 Exhibit A to Rights Agreement [FORM OF] CERTIFICATE OF DESIGNATIONS OF PREFERRED STOCK of COMMONWEALTH ENERGY CORPORATION We, ______________, Chairman of the Board of Directors and ______________, Secretary, of Commonwealth Energy Corporation, a corporation organized and existing under the General Corporation Law of the State of California (the "Corporation"), in accordance with the provisions of Section _____ thereof, DO HEREBY CERTIFY: That pursuant to the authority conferred upon the Board of Directors by the Certificate of Incorporation of the Corporation, the Board of Directors, on January 4, 2002, adopted, ratified and approved this Certificate of Designations and the series of preferred stock designated herein. Section 1. Designation and Amount. A series of the Corporation's preferred stock, $0.001 par value per share, shall be designated as "Preferred Stock" (the "Preferred Stock") and the number of shares constituting such series shall be ________. Section 2. Voting Rights. The holders of shares of Preferred Stock shall have the following voting rights: (A) Subject to the provision for adjustment hereinafter set forth, each share of Preferred Stock shall entitle the holder thereof to 1000 votes on all matters submitted to a vote of the stockholders of the Corporation. In the event the Corporation shall at any time on or after January 4, 2002 declare or pay any dividend on Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the number of votes per share to which holders of shares of Preferred Stock were entitled immediately prior to such event shall be adjusted by multiplying such number by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event, and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. A-1 (B) Except as otherwise provided herein or by law, the holders of shares of Preferred Stock and the holders of shares of Common Stock shall vote together as one class on all matters submitted to a vote of stockholders of the Corporation. (C) Except as set forth herein, holders of Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for taking any corporate action. Section 3. Reacquired Shares. Any shares of Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and cancelled promptly after the acquisition thereof. All such shares shall upon their cancellation become authorized but unissued shares of preferred stock and may be reissued as part of a new series of preferred stock to be created by resolution or resolutions of the Board of Directors, subject to the conditions and restrictions on issuance set forth herein. Section 4. Liquidation, Dissolution or Winding Up. Upon any liquidation, dissolution or winding up of the Corporation, no distribution shall be made (1) to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Preferred Stock unless, prior thereto, the holders of shares of Preferred Stock shall have received an aggregate amount per share, subject to the provision for adjustment hereinafter set forth, equal to 1000 times the aggregate amount to be distributed per share to holders of Common Stock, or (2) to the holders of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Preferred Stock, except distributions made ratably on the Preferred Stock and all other such parity stock in proportion to the total amounts to which the holders of all such shares are entitled upon such liquidation, dissolution or winding up. In the event the Corporation shall at any time on or after January 4, 2002 declare or pay any dividend on Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then in each such case the aggregate amount to which holders of shares of Preferred Stock were entitled immediately prior to such event under the proviso in clause (1) of the preceding sentence shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. Section 5. Consolidation, Merger, etc. In the event that case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash or other property, then in any such case the shares of Preferred Stock then outstanding shall at the same time be similarly exchanged or changed in an amount per share (subject to the provision for adjustment hereinafter set forth) equal to 1000 times A-2 the aggregate amount of stock, securities, cash or other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. In the event the Corporation shall at any time on or after January 4, 2002 declare or pay any dividend on Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise) into a greater or lesser number of shares of Common Stock, then in each such case the amount set forth in the preceding sentence with respect to the exchange or change of shares of Preferred Stock shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. Section 6. No Redemption. The shares of Preferred Stock shall not be redeemable. Section 7. Amendment. The Certificate of Incorporation of the Corporation shall not be amended in any manner which would materially alter or change the powers, preferences or special rights of the Preferred Stock so as to affect them adversely without the affirmative vote of the holders of two-thirds or more of the outstanding shares of Preferred Stock, voting together as a single class. A-3 IN WITNESS WHEREOF, we have executed and subscribed this Certificate and do affirm the foregoing as true under the penalties of perjury as of this _____ day of January, 2002. ----------------------------------- Ian Carter Chief Executive Officer ATTEST: - ----------------------------------- Name: [_________________] Title: [_________________] A-4 Exhibit B to Rights Agreement [FORM OF] RIGHTS CERTIFICATE Certificate No. R-____________ Rights NOT EXERCISABLE AFTER [____________] OR EARLIER IF NOTICE OF REDEMPTION OR EXCHANGE IS GIVEN. THE RIGHTS ARE SUBJECT TO REDEMPTION, AT THE OPTION OF THE COMPANY, ON THE TERMS SET FORTH IN THE RIGHTS AGREEMENT. [THE RIGHTS REPRESENTED BY THIS CERTIFICATE ARE OR WERE BENEFICIALLY OWNED BY A PERSON WHO WAS OR BECAME AN ACQUIRING PERSON OR AN AFFILIATE OR ASSOCIATE OF AN ACQUIRING PERSON (AS SUCH TERMS ARE DEFINED IN THE RIGHTS AGREEMENT. ACCORDINGLY, THIS RIGHTS CERTIFICATE AND THE RIGHTS REPRESENTED HEREBY MAY BECOME NULL AND VOID IN THE CIRCUMSTANCES SPECIFIED IN SECTION 7(e) OF THE RIGHTS AGREEMENT.] RIGHTS CERTIFICATE COMMONWEALTH ENERGY CORPORATION This certifies that ___________________ or registered assigns, is the registered owner of the number of Rights set forth above, each of which entitles the owner thereof, subject to the terms, provisions and conditions of the Rights Agreement, dated as of January 4, 2002 (the "RIGHTS AGREEMENT"), between Commonwealth Energy Corporation, a California corporation (the "COMPANY"), and Computershare Trust Company (the "RIGHTS AGENT"), unless notice of redemption shall have been previously given by the Company, to purchase from the Company at any time after the Distribution Date (as such term is defined in the Rights Agreement) and prior to 5:00 p.m. (California time) on [______________] at the principal corporate trust office of the Rights Agent, or at the office of its successor as Rights Agent, [_______________] of a fully paid nonassessable share of the Preferred Stock (the "PREFERRED STOCK"), par value $0.001 per share, of the Company, at a purchase price of $50 per share upon presentation and surrender of this Rights Certificate with the Form of Election to Purchase duly executed. The Purchase Price may be paid in cash or by certified bank check or money order payable to the order of the Company. The number of Rights evidenced by this Rights Certificate (and the number of shares of Preferred Stock which may be purchased upon exercise thereof) and the Purchase Price set forth above have been determined as of ____________, based on B-1 the Common Stock of the Company as constituted at such date. As provided in the Rights Agreement, the Purchase Price and the number of shares of Preferred Stock or other securities, cash or other property which may be purchased upon the exercise of the Rights evidenced by this Rights Certificate are subject to modification and adjustment upon the happening of certain events. If the Rights evidenced by this Rights Certificate are or were formerly beneficially owned, on or after the earlier of the Distribution Date and the Stock Acquisition Date, by an Acquiring Person or an Affiliate, Associate or direct or indirect transferee of an Acquiring Person, such Rights may become null and void and the holder of any such Right (including any subsequent holder) shall not have any right with respect to such Right. This Rights Certificate is subject to all of the terms, provisions and conditions of the Rights Agreement, which terms, provisions and conditions are hereby incorporated herein by reference and made a part hereof and to which Rights Agreement reference is hereby made for a full description of the rights, limitations of rights, obligations, duties and immunities hereunder of the Rights Agent, the Company and the holders of the Rights Certificates. Capitalized terms used in this Rights Certificate have the same meanings as such terms are defined in the Rights Agreement. Copies of the Rights Agreement are on file at the principal executive offices of the Company and the above-mentioned office of the Rights Agent. This Rights Certificate, with or without other Rights Certificates, upon surrender at the principal corporate trust office of the Rights Agent, may be exchanged for another Rights Certificate or Rights Certificates of like tenor and date evidencing Rights entitling the holder to purchase a like aggregate number of shares of Preferred Stock or other property as the Rights evidenced by the Rights Certificate or Rights Certificates surrendered entitled such holder to purchase. If this Rights Certificate shall be exercised in part, the holder shall be entitled to receive, upon surrender hereof, another Rights Certificate or Rights Certificates for the number of whole Rights not exercised. Subject to the provisions of the Rights Agreement, the Rights evidenced by this Certificate may be redeemed by the Company at its option at a redemption price of $0.001 per Right at any time prior to the earlier of (i) the close of business on the 10th day following the time it becomes public that an Acquiring Person has become such (with the possibility of an extension for an additional 10 days) and (ii) the Expiration Date. Subject to the provisions of the Rights Agreement, the Rights evidenced by this Certificate may be exchanged by the Company, at its option, at any time after any person becomes an Acquiring Person, for a number of shares of common stock of the Company determined in accordance with the Rights Agreement. No holder of this Rights Certificate, as such, shall be entitled to vote or to receive dividends or shall be deemed, for any purpose, the holder of Preferred Stock or of any B-2 other securities, cash or property which may at any time be issuable on the exercise hereof, nor shall anything contained in the Rights Agreement or this Certificate be construed to confer upon the holder hereof, as such, any of the rights of a stockholder of the Company, including, without limitation, any right to vote for the election of directors or upon any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action, or to receive notice of meetings or other actions affecting stockholders (except as provided in the Rights Agreement), or to receive dividends or subscription rights, or to institute, as a holder of Preferred Stock or other securities issuable on the exercise of the Rights represented by this Certificate, any derivative action, or otherwise, until and only to the extent the Right or Rights evidenced by this Rights Certificate shall have been exercised as provided in the Rights Agreement. This Rights Certificate shall not be valid or obligatory for any purpose until the Rights Agent shall have countersigned it. B-3 WITNESS the facsimile signature of the proper officers of the Company and its corporate seal. Dated as of _____ ___, 20__. COMMONWEALTH ENERGY CORPORATION By: -------------------------------- Name: Title: ATTEST: - ----------------------------------- Secretary Countersigned: - ----------------------------------- By: Authorized Signature B-4 [FORM OF] REVERSE SIDE OF RIGHTS CERTIFICATE FORM OF ASSIGNMENT (To be executed by the registered holder if such holder desires to transfer the Rights Certificates.) FOR VALUE RECEIVED, _________________________________ hereby sells, assigns and transfers unto ____________________________ (Please print name and address of transferee) this Rights Certificate, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint _____________________ Attorney to transfer the within Rights Certificate on the books of the within-named Company, with full power of substitution. Dated: , 20 ----------- --- -- ----------------------------------- Signature Signature Guaranteed: Signatures must be guaranteed by a member firm of a registered national securities exchange, a member of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States. B-5 CERTIFICATE The undersigned hereby certifies by checking the appropriate boxes that: (1) this Rights Certificate [ ] is [ ] is not being sold, assigned and transferred by or on behalf of a Person who is or was an Acquiring Person or an Affiliate or Associate of any such Acquiring Person (as such terms are defined pursuant to the Rights Agreement); (2) after due inquiry and to the best knowledge of the undersigned, it [ ] did [ ] did not acquire the Rights evidenced by this Rights Certificate from any Person who is or was an Acquiring Person or an Affiliate or Associate of an Acquiring Person. Dated: , 20 ----------------------------------- ----------- --- -- Signature Signature Guaranteed: Signatures must be guaranteed by a member firm of a registered national securities exchange, a member of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States. NOTICE The signature to the foregoing Assignment must correspond to the name as written upon the face of this Rights Certificate in every particular, without alteration or enlargement or any change whatsoever. In the event the certification set forth above in the Form of Assignment is not completed, the Company will deem the beneficial owner of the Rights evidenced by this Right Certificate to be an Acquiring Person or an Affiliate or Associate thereof (as defined in the Rights Agreement) and, in the case of an Assignment, will affix a legend to that effect on any Rights Certificate issued in exchange for this Rights Certificate. B-6 FORM OF ELECTION TO PURCHASE (To be executed if holder desires to exercise the Rights represented by this Rights Certificate) To: Commonwealth Energy Corporation The undersigned hereby irrevocably elects to exercise __________________ Rights represented by this Rights Certificate to purchase the shares of Preferred Stock ______________ or other securities, cash or other property issuable upon the exercise of such Rights and requests that certificates for such shares or other securities be issued in the name of, and such cash or other property be paid to: Please insert social security or other identifying number: - -------------------------------------------------------------------------- (Please print name and address) - -------------------------------------------------------------------------- If such number of Rights shall not be all the Rights evidenced by this Rights Certificate, a new Rights Certificate for the remaining balance of such Rights shall be registered in the name of and delivered to: Please insert social security or other identifying number: - -------------------------------------------------------------------------- (Please print name and address) - -------------------------------------------------------------------------- Dated: , 20 Signature ----------- --- -- ----------------------------------- (Signature must conform in all respects to name of holder as specified on the face of this Rights Certificate) Signature Guaranteed: Signatures must be guaranteed by a member firm of a registered national securities exchange, a member of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States. B-7 CERTIFICATE The undersigned hereby certifies by checking the appropriate boxes that: (1) this Rights Certificate [ ] is [ ] is not being exercised by or on behalf of a Person who is or was an Acquiring Person or an Affiliate or Associate of any such Acquiring Person (as such terms are defined pursuant to the Rights Agreement); (2) after due inquiry and to the best knowledge of the undersigned, it [ ] did [ ] did not acquire the Rights evidenced by this Rights Certificate from any Person who is or was an Acquiring Person or an Affiliate or Associate of an Acquiring Person. Dated: , 20 Signature ----------- --- -- ----------------------------------- Signature Guaranteed: Signatures must be guaranteed by a member firm of a registered national securities exchange, a member of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States. NOTICE The signature on the foregoing Form of Election to Purchase and Certificate must correspond to the name as written upon the face of this Rights Certificate in every particular, without alteration or enlargement or any change whatsoever. In the event the certification set forth above in the Form of Election is not completed, the Company will deem the beneficial owner of the Rights evidenced by this Rights Certificate to be an Acquiring Person or an Affiliate or Associate thereof (as defined in the Rights Agreement) and, in the case of an Assignment, will affix a legend to that effect on any Rights Certificate issued in exchange for this Rights Certificate. B-8 Exhibit C to Rights Agreement [SEE ATTACHED] C-1 COMMONWEALTH ENERGY CORPORATION SUMMARY OF RIGHTS TO PURCHASE PREFERRED STOCK On January 4, 2002, the Board of Directors of Commonwealth Energy Corporation, a California corporation (the "COMPANY"), declared a dividend distribution of one preferred stock purchase right (a "RIGHT") for each share of common stock, par value $0.001 per share (the "COMMON STOCK"), of the Company. The dividend is payable on January 4, 2002 to stockholders of record at the close of business on January 4, 2002 (the "RECORD DATE") and in respect of all shares of Common Stock that become outstanding after the Record Date and prior to the earliest of (a) the Distribution Date (as such term is hereinafter defined), (b) the redemption of the Rights, (c) the exchange of the Rights and (d) the expiration of the Rights. Except as described herein and subject to adjustment as provided in the Rights Agreement (as such term is hereinafter defined), each Right entitles the registered holder to purchase from the Company 1/1000th of a share of the Company's Preferred Stock, par value $0.001 per share (the "PREFERRED STOCK"), at a purchase price of $50 per share (the "PURCHASE PRICE"). The description and terms of the Rights are set forth in a Rights Agreement, dated as of January 4, 2002 (the "RIGHTS AGREEMENT"), between the Company and Computershare Trust Company, as Rights Agent (the "RIGHTS AGENT"). The Rights will be evidenced by Common Stock certificates and not separate certificates until the earliest of (i) ten days following the date of public disclosure that a person or group, together with persons affiliated or associated with it (an "ACQUIRING PERSON"), has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of Common Stock (the "STOCK ACQUISITION Date"), (ii) ten business days following commencement or disclosure of an intention to commence a tender offer or exchange offer by a person or group other than the Company and certain related entities if, upon consummation of such offer, such person or group, together with persons affiliated or associated therewith, would beneficially own 15% or more of the outstanding shares of Common Stock , and (iii) ten business days following a determination by the Board of Directors of the Company that a person, as such term is defined below (referred to herein as an "ADVERSE PERSON"), alone or together with persons affiliated or associated therewith, has become the beneficial owner of more than 10% of the outstanding shares of Common Stock and that (A) such beneficial ownership is intended to cause the Company to repurchase the Common Stock beneficially owned by such person or to cause pressure on the Company to take action or enter into transactions intended to provide such person with short-term financial gain under circumstances where the Board of Directors of the Company determines that the best long-term interests of the Company would not be served by taking such action or entering into such transactions or (B) such beneficial ownership is causing or reasonably likely to cause a material adverse impact on the business or prospects of the Company; provided, however, that the Board of Directors of the Company shall not declare any person to be an Adverse Person if such person has reported or is required to report its ownership of Common Stock on Schedule 13G under the Securities Exchange Act of 1934, as amended (the "EXCHANGE ACT"), or on Schedule 13D under C-2 the Exchange Act which Schedule 13D does not state any intention to, or reserve the right to, control or influence the Company or engage in certain other actions, so long as such person neither reports nor is required to report such ownership other than as so described (the earlier of such dates being the "DISTRIBUTION DATE"). Until the Distribution Date (or earlier redemption or expiration of the Rights), the transfer of Common Stock will also constitute transfer of the associated Rights. Following the Distribution Date, separate certificates will evidence the Rights. The Rights will first become exercisable on the Distribution Date (unless sooner redeemed); provided, however, that no Rights will be exercisable at any time that the Rights are subject to redemption by the Company in accordance with the terms of the Rights Agreement. The Rights will expire at the close of business on January 4, 2012 (the "EXPIRATION DATE"), unless earlier redeemed by the Company as hereinafter described. The Purchase Price and the number of shares of Preferred Stock or other securities, cash or other property issuable upon exercise of the Rights are subject to adjustment from time to time to prevent dilution (i) in the event of a stock dividend or distribution on, or a subdivision, combination or reclassification of, the Preferred Stock, (ii) upon the grant to holders of the Preferred Stock of certain rights, options or warrants to subscribe for Preferred Stock or securities convertible into Preferred Stock at less than the current market price of the Preferred Stock or (iii) upon the distribution to holders of the Preferred Stock of other securities, cash (excluding regular periodic cash dividends, property, evidences of indebtedness or assets). The number of outstanding Rights and the number of 1/1000th of a share of Preferred Stock issuable upon exercise of each Right and the Purchase Price are also subject to adjustment in the event of a stock dividend on the Common Stock or a stock split of the Common Stock or subdivision, consolidation or combination of the Common Stock occurring, in any case, prior to the Distribution Date. If (i) a person acquires beneficial ownership of 15% or more of the Common Stock, or (ii) the Company is the surviving corporation in a merger with an Acquiring Person and the Common Stock remains outstanding and unchanged, the Rights will "FLIP IN" and entitle each holder of a Right, except as provided below, to purchase, upon exercise at the then-current Purchase Price, that number of shares of Common Stock having a market value of two times the Purchase Price. In the event that, following the Distribution Date, the Company is acquired in a merger or other business combination in which the Common Stock does not remain outstanding or is changed or 15% or more of the Company's consolidated assets or earning power is sold, leased, exchanged or otherwise transferred or disposed of (in one transaction or a series of related transactions) the Rights will "FLIP OVER" and entitle each holder of a Right to purchase, upon the exercise of the Right at the then-current Purchase Price, that number of shares of common stock of the acquiring company (or, in certain circumstances, one of its affiliates) which at the time of the transaction would have a market value of two times the Purchase Price. C-3 Any "flip-in" event or "flip-over" event is a "TRIGGERING EVENT." Any Rights beneficially owned at any time on or after the Distribution Date by an Acquiring Person or an Adverse Person or any affiliate or associate of an Acquiring Person or Adverse Person (whether or not ownership is subsequently transferred) will become null and void upon the occurrence of a Triggering Event, and any such holder of Rights will have no right to exercise such Rights. With certain exceptions, no adjustment in the Purchase Price will be required until cumulative adjustments require an adjustment of at least 1% in the Purchase Price. At any time prior to the earlier of (i) the close of business on the tenth day following the Stock Acquisition Date (with the possibility for the Board of Directors to extend this time for an additional ten days) and (ii) the Expiration Date, the Company may redeem the Rights in whole, but not in part, at a price of $0.001 per Right. The Company may, at its option, pay such redemption price in cash, shares of Common Stock (based on the market price of the Common Stock at the time of redemption) or any other form of consideration deemed appropriate by the Board of Directors of the Company. Immediately upon the action of the Company's Board of Directors electing to redeem the Rights, the right to exercise the Rights will terminate and the only right of the holders of Rights thereafter will be to receive the applicable redemption price. The Company may, at any time after the occurrence of a Triggering Event, provided that all necessary regulatory approvals have been obtained, exchange the Rights (other than Rights owned by the Acquiring Person [or an Adverse Person]), in whole or in part, at a ratio of one share of Common Stock per Right, subject to adjustment. Until a Right is exercised, the holder has no rights as a Stockholder of the Company, including, without limitation, the right to vote or to receive dividends or distributions. At any time prior to the Distribution Date, the Company may, without the approval of any holder of the Rights, supplement or amend any provision of the Rights Agreement (including the date on which the Distribution Date will occur), except the Purchase Price, the number of shares of Preferred Stock, other securities, cash or other property obtainable upon exercise of a Right, the redemption price or the Expiration Date. Thereafter, the Rights Agreement may be amended only to cure ambiguities, to correct inconsistent provisions or in ways that do not adversely affect the holders of the Rights. In the event of any merger or other business combination in which Common Stock is exchanged, each share of Preferred Stock will be entitled to receive two times the amount received per share of Common Stock. Customary antidilution provisions protect these rights. C-4 Because of the nature of the Preferred Stock's dividend, liquidation and voting rights, the value of the 1/1000th of a share of Preferred Stock purchasable upon exercise of each Right is intended to approximate the value of one share of Common Stock. The Rights have certain anti-takeover effects. The Rights may cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by the Company's Board of Directors. The Rights should not interfere with any merger or other business combination approved by the Board of Directors of the Company because, at any time until ten days following the Stock Acquisition Date, subject to extension by the Board of Directors for a period of time up to ten additional days, the Rights may be redeemed by the Company at $0.001 per Right. A copy of the Rights Agreement has been filed with the Securities and Exchange Commission and is available free of charge from the Company. This summary description of the Rights does not purport to be complete and is qualified in its entirety by reference to the Rights Agreement, which is hereby incorporated herein by this reference. C-5 -----END PRIVACY-ENHANCED MESSAGE-----