-----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, BZoMt/Svf4RcoaaKzUXajtiTT+UllUMLcnm4qKP4dxtpG5AqPcBO6O971M58EXFs UjTVr2q6lCJV3h+1K77ZDQ== 0000916457-04-000086.txt : 20040809 0000916457-04-000086.hdr.sgml : 20040809 20040809172849 ACCESSION NUMBER: 0000916457-04-000086 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CALPINE CORP CENTRAL INDEX KEY: 0000916457 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC SERVICES [4911] IRS NUMBER: 770212977 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-12079 FILM NUMBER: 04962435 BUSINESS ADDRESS: STREET 1: 50 WEST SAN FERNANDO ST CITY: SAN JOSE STATE: CA ZIP: 95113 BUSINESS PHONE: 4089955115 MAIL ADDRESS: STREET 1: 50 W SAN FERNANDO STREET 2: SUITE 500 CITY: SAN JOSE STATE: CA ZIP: 95113 10-Q 1 q2-2004.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q --------------- (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number: 1-12079 Calpine Corporation (A Delaware Corporation) I.R.S. Employer Identification No. 77-0212977 50 West San Fernando Street San Jose, California 95113 Telephone: (408) 995-5115 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 443,828,145 shares of Common Stock, par value $.001 per share, outstanding on August 6, 2004. ================================================================================ CALPINE CORPORATION AND SUBSIDIARIES REPORT ON FORM 10-Q For the Quarter Ended June 30, 2004
INDEX Page No. -------- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Condensed Balance Sheets June 30, 2004 and December 31, 2003..................... 3 Consolidated Condensed Statements of Operations for the Three and Six Months Ended June 30, 2004 and 2003...................................................................... 5 Consolidated Condensed Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003...................................................................... 7 Notes to Consolidated Condensed Financial Statements.......................................... 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 38 Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................... 71 Item 4. Controls and Procedures.......................................................................... 71 PART II - OTHER INFORMATION Item 1. Legal Proceedings................................................................................ 72 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities................. 77 Item 4. Submission of Matters to a Vote of Security Holders.............................................. 78 Item 6. Exhibits and Reports on Form 8-K................................................................. 79 Signatures...................................................................................................... 81
-2- PART I - FINANCIAL INFORMATION Item 1. Financial Statements. CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS June 30, 2004 and December 31, 2003 (in thousands, except share and per share amounts)
June 30, December 31, 2004 2003 -------------- -------------- (Unaudited) ASSETS Current assets: Cash and cash equivalents....................................................... $ 844,031 $ 991,806 Accounts receivable, net........................................................ 1,170,130 988,947 Margin deposits and other prepaid expense....................................... 406,741 385,348 Inventories..................................................................... 144,913 139,654 Restricted cash................................................................. 317,833 383,788 Current derivative assets....................................................... 338,805 496,967 Current assets held for sale.................................................... -- 651 Other current assets............................................................ 72,117 89,593 -------------- -------------- Total current assets......................................................... 3,294,570 3,476,754 -------------- -------------- Restricted cash, net of current portion............................................ 191,695 575,027 Notes receivable, net of current portion........................................... 225,396 213,629 Project development costs.......................................................... 151,084 139,953 Investments in power projects and oil and gas properties........................... 417,303 472,749 Deferred financing costs........................................................... 423,499 400,732 Prepaid lease, net of current portion.............................................. 383,940 414,058 Property, plant and equipment, net................................................. 21,031,174 20,081,052 Goodwill, net...................................................................... 45,160 45,160 Other intangible assets, net....................................................... 89,411 89,924 Long-term derivative assets........................................................ 561,328 673,979 Long-term assets held for sale..................................................... -- 112,148 Other assets....................................................................... 627,202 608,767 -------------- -------------- Total assets............................................................... $ 27,441,762 $ 27,303,932 ============== ============== LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Accounts payable................................................................ $ 1,160,600 $ 938,644 Accrued payroll and related expense............................................. 72,644 96,693 Accrued interest payable........................................................ 362,497 321,176 Income taxes payable............................................................ 5,680 18,026 Notes payable and borrowings under lines of credit, current portion............. 239,289 254,292 Preferred interests, current portion............................................ 8,758 11,220 Capital lease obligation, current portion....................................... 8,466 4,008 CCFC I financing, current portion............................................... 3,208 3,208 Construction/project financing, current portion................................. 57,256 61,900 Senior notes and term loans, current portion.................................... 14,500 14,500 Current derivative liabilities.................................................. 383,097 456,688 Other current liabilities....................................................... 271,589 335,048 -------------- -------------- Total current liabilities.................................................... 2,587,584 2,515,403 -------------- -------------- Notes payable and borrowings under lines of credit, net of current portion......... 861,424 873,572 Notes payable to Calpine Capital Trusts............................................ 1,153,500 1,153,500 Preferred interests, net of current portion........................................ 142,064 232,412 Capital lease obligation, net of current portion................................... 283,005 193,741 CCFC I financing, net of current portion........................................... 784,661 785,781 CalGen/CCFC II financing........................................................... 2,448,907 2,200,358 Construction/project financing, net of current portion............................. 1,723,040 1,209,505 Convertible Senior Notes Due 2006.................................................. 72,126 660,059 Convertible Senior Notes Due 2023.................................................. 900,000 650,000 Senior notes and term loans, net of current portion................................ 9,370,936 9,369,253 Deferred income taxes, net......................................................... 1,185,712 1,310,335 Deferred lease incentive........................................................... -- 50,228 Deferred revenue................................................................... 110,087 116,001 Long-term derivative liabilities................................................... 599,495 692,088 Long-term liabilities held for sale................................................ -- 161 Other liabilities.................................................................. 267,769 259,390 -------------- -------------- Total liabilities.......................................................... 22,490,310 22,271,787 -------------- -------------- Minority interests................................................................. 350,561 410,892 -------------- --------------
-3-
June 30, December 31, 2004 2003 -------------- -------------- (Unaudited) Stockholders' equity: Preferred stock, $.001 par value per share; authorized 10,000,000 shares; none issued and outstanding in 2004 and 2003................................... -- -- Common stock, $.001 par value per share; authorized 1,000,000,000 shares at December 31, 2003, and 2,000,000,000 shares at June 30, 2004; issued and outstanding 439,326,249 shares in 2004 and 415,010,125 shares in 2003..................................................... 439 415 Additional paid-in capital...................................................... 3,109,778 2,995,735 Retained earnings............................................................... 1,468,619 1,568,509 Accumulated other comprehensive income.......................................... 22,055 56,594 -------------- -------------- Total stockholders' equity.............................................. $ 4,600,891 $ 4,621,253 -------------- -------------- Total liabilities and stockholders' equity.............................. $ 27,441,762 $ 27,303,932 ============== ==============
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements. -4- CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS For the Three and Six Months Ended June 30, 2004 and 2003
Three Months Ended Six Months Ended June 30, June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ (In thousands, except per share amounts) (Unaudited) Revenue: Electric generation and marketing revenue Electricity and steam revenue.......................... $ 1,312,792 $ 1,046,260 $ 2,558,678 $ 2,146,328 Sales of purchased power for hedging and optimization.. 496,652 744,805 876,680 1,426,089 ------------ ------------ ------------ ------------ Total electric generation and marketing revenue...... 1,809,444 1,791,065 3,435,358 3,572,417 Oil and gas production and marketing revenue Oil and gas sales...................................... 26,069 29,299 50,651 55,210 Sales of purchased gas for hedging and optimization.... 481,971 328,478 834,708 655,945 ------------ ------------ ------------ ------------ Total oil and gas production and marketing revenue... 508,040 357,777 885,359 711,155 Mark-to-market activities, net............................ (22,605) 1,839 (10,086) 22,282 Other revenue............................................. 19,755 14,627 46,741 25,386 ------------ ------------ ------------ ------------ Total revenue..................................... 2,314,634 2,165,308 4,357,372 4,331,240 ------------ ------------ ------------ ------------ Cost of revenue: Electric generation and marketing expense Plant operating expense................................ 223,664 159,646 399,498 321,574 Transmission purchase expense.......................... 14,651 11,330 31,078 20,156 Royalty expense........................................ 6,951 6,461 12,833 11,818 Purchased power expense for hedging and optimization... 445,169 738,719 820,108 1,418,668 ------------ ------------ ------------ ------------ Total electric generation and marketing expense...... 690,435 916,156 1,263,517 1,772,216 Oil and gas operating and marketing expense Oil and gas operating expense.......................... 23,443 29,033 45,770 54,694 Purchased gas expense for hedging and optimization..... 453,922 331,122 814,409 648,070 ------------ ------------ ------------ ------------ Total oil and gas operating and marketing expense.... 477,365 360,155 860,179 702,764 Fuel expense.............................................. 867,785 539,409 1,630,490 1,174,778 Depreciation, depletion and amortization expense.......... 161,789 138,957 311,203 272,771 Operating lease expense................................... 26,963 28,168 54,762 55,860 Other cost of revenue..................................... 22,607 6,870 48,988 12,121 ------------ ------------ ------------ ------------ Total cost of revenue............................. 2,246,944 1,989,715 4,169,139 3,990,510 ------------ ------------ ------------ ------------ Gross profit................................... 67,690 175,593 188,233 340,730 Loss (income) from unconsolidated investments in power projects and oil and gas properties......................... 718 (59,351) (1,788) (64,475) Equipment cancellation and impairment cost................... 7 19,222 2,367 19,309 Project development expense.................................. 4,030 6,072 11,748 11,158 Research and development expense............................. 5,124 2,469 8,939 4,860 Sales, general and administrative expense.................... 60,978 53,710 118,225 97,367 ------------ ------------ ------------ ------------ Income (loss) from operations............................. (3,167) 153,471 48,742 272,511 Interest expense............................................. 279,659 148,879 534,452 291,840 Distributions on trust preferred securities.................. -- 15,656 -- 31,313 Interest (income)............................................ (9,920) (9,003) (21,981) (17,037) Minority interest expense.................................... 4,724 5,335 13,159 7,612 (Income) from repurchase of various issuances of debt........ (2,559) (6,763) (3,394) (6,763) Other expense (income)....................................... (185,571) 20,467 (203,996) 55,056 ------------ ------------ ------------ ------------ Loss before (benefit) for income taxes.................... (89,500) (21,100) (269,498) (89,510) (Benefit) for income taxes................................... (60,604) (4,725) (146,553) (21,596) ------------ ------------ ------------ ------------ Loss before discontinued operations and cumulative effect of a change in accounting principle............... (28,896) (16,375) (122,945) (67,914) Discontinued operations, net of tax provision (benefit) of $126, $(4,484), $12,452, and $(5,275).................... 198 (6,991) 23,055 (7,997) Cumulative effect of a change in accounting principle, net of tax provision of $--, $--, $--and $450............... -- -- -- 529 ------------ ------------ ------------ ------------ Net loss....................................... $ (28,698) $ (23,366) $ (99,890) $ (75,382) ============ ============ ============ ============
-5-
Three Months Ended Six Months Ended June 30, June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ (In thousands, except per share amounts) (Unaudited) Basic and diluted loss per common share: Weighted average shares of common stock outstanding....... 417,357 381,219 416,332 381,089 Loss before discontinued operations and cumulative effect of a change in accounting principle............... $ (0.07) $ (0.04) $ (0.30) $ (0.18) Discontinued operations, net of tax....................... $ -- $ (0.02) $ 0.06 $ (0.02) Cumulative affect of a change in accounting principle, net of tax............................................... $ -- $ -- $ -- $ -- ------------ ------------ ------------ ------------ Net loss....................................... $ (0.07) $ (0.06) $ (0.24) $ (0.20) ============ ============ ============ ============
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements. -6- CALPINE CORPORATION AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS For the Six Months Ended June 30, 2004 and 2003 (in thousands) (unaudited)
Six Months Ended June 30, ------------------------------ 2004 2003 -------------- -------------- Cash flows from operating activities: Net loss......................................................................... $ (99,890) $ (75,382) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation, depletion and amortization (1)................................ 397,143 325,112 Deferred income taxes, net.................................................. (147,898) 101,802 (Gain) loss on sale of assets and development cost write-offs, net.......... (105,495) 9,367 Stock compensation expense.................................................. 9,766 8,423 Foreign exchange (gains) losses............................................. (4,832) 44,304 Change in net derivative assets and liabilities............................. (9,541) 33,099 Income from unconsolidated investments in power projects and oil and gas properties................................................. (1,788) (64,475) Distributions from unconsolidated investments in power projects............. 14,697 121,015 Other....................................................................... 9,765 18,351 Change in operating assets and liabilities, net of effects of acquisitions: Accounts receivable......................................................... (176,433) (191,717) Other current assets........................................................ 9,796 (145,349) Other assets................................................................ (36,222) (58,536) Accounts payable and accrued expense........................................ 235,725 (34,659) Other liabilities........................................................... (82,800) 21,949 -------------- -------------- Net cash provided by operating activities................................ 11,993 113,304 -------------- -------------- Cash flows from investing activities: Purchases of property, plant and equipment....................................... (795,403) (1,135,549) Disposals of property, plant and equipment....................................... 257,635 13,681 Acquisitions, net of cash acquired............................................... (187,614) (6,818) Advances to joint ventures....................................................... (4,088) (49,683) Project development costs........................................................ (16,324) (20,513) Sale of collateral securities.................................................... 93,963 -- Decrease (increase) in restricted cash........................................... 452,377 (122,623) Decrease (increase) in notes receivable.......................................... 6,012 (5,794) Other............................................................................ 26,051 29,496 -------------- -------------- Net cash used in investing activities.................................... (167,391) (1,297,803) -------------- -------------- Cash flows from financing activities: Borrowings from notes payable and borrowings under lines of credit............... 2,643,578 1,095,384 Repayments of notes payable and borrowings under lines of credit................. (2,520,059) (15,269) Borrowings from project financing................................................ 924,475 77,013 Repayments of project financing.................................................. (596,887) (143,998) Repayments of Senior Notes....................................................... (56,219) (16,100) Repurchase of 4% Convertible Senior Notes........................................ (586,926) -- Proceeds from issuance of 4.75% Convertible Senior Notes......................... 250,000 -- Proceeds from issuance of Senior Notes........................................... 100,000 -- Proceeds from income trust offering.............................................. -- 126,462 Financing costs.................................................................. (124,089) (134,443) Other............................................................................ (13,104) 28,265 -------------- -------------- Net cash provided by financing activities................................ 20,769 1,017,314 -------------- -------------- Effect of exchange rate changes on cash and cash equivalents........................ (13,146) 5,653 Net decrease in cash and cash equivalents........................................... (147,775) (161,532) Cash and cash equivalents, beginning of period...................................... 991,806 579,486 -------------- -------------- Cash and cash equivalents, end of period............................................ $ 844,031 $ 417,954 ============== ============== Cash paid during the period for: Interest, net of amounts capitalized............................................. $ 399,736 $ 217,543 Income taxes..................................................................... $ 21,621 $ 10,789 - ------------ (1) Includes depreciation and amortization that is charged to cost of revenue and also included within sales, general and administrative expense and to interest expense in the Consolidated Condensed Statements of Operations.
-7- Schedule of noncash investing and financing activities: 2004 issuance of 20.1 million shares of common stock in exchange for $20.0 million par value of HIGH TIDES I and $75.0 million par value of HIGH TIDES II. 2004 Capital lease entered into for the King City facility. See Note 6 of the Notes to Consolidated Condensed Financial Statements for further discussion. The accompanying notes are an integral part of these Consolidated Condensed Financial Statements. -8- CALPINE CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS June 30, 2004 (unaudited) 1. Organization and Operations of the Company Calpine Corporation ("Calpine" or "the Company"), a Delaware corporation, and subsidiaries (collectively, also referred to as the "Company") are engaged in the generation of electricity in the United States of America, Canada, Mexico and the United Kingdom. The Company is involved in the development, construction, ownership and operation of power generation facilities and the sale of electricity and its by-product, thermal energy, primarily in the form of steam. The Company has ownership interests in, and operates, gas-fired power generation and cogeneration facilities, gas fields, gathering systems and gas pipelines, geothermal steam fields and geothermal power generation facilities in the United States of America. In Canada, the Company owns oil and gas operations and has ownership interests in, and operates, gas-fired power generation facilities. In Mexico, Calpine is a joint venture participant in a gas-fired power generation facility under construction. In the United Kingdom, the Company owns and operates a gas-fired power cogeneration facility. Each of the generation facilities produces and markets electricity for sale to utilities and other third party purchasers. Thermal energy produced by the gas-fired power cogeneration facilities is primarily sold to industrial users. Gas produced, and not physically delivered to the Company's generating plants, is sold to third parties. 2. Summary of Significant Accounting Policies Basis of Interim Presentation -- The accompanying unaudited interim Consolidated Condensed Financial Statements of the Company have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the Consolidated Condensed Financial Statements include the adjustments necessary to present fairly the information required to be set forth therein. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted from these statements pursuant to such rules and regulations and, accordingly, these financial statements should be read in conjunction with the audited Consolidated Financial Statements of the Company for the year ended December 31, 2003, included in the Company's Annual Report on Form 10-K. The results for interim periods are not necessarily indicative of the results for the entire year. Reclassifications -- Certain prior years' amounts in the Consolidated Financial Statements have been reclassified to conform to the 2004 presentation including reclassification of transmission revenues from electricity and sales revenue to other revenue.. Use of Estimates in Preparation of Financial Statements -- The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America 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 revenue and expense during the reporting period. Actual results could differ from those estimates. The most significant estimates with regard to these financial statements relate to useful lives and carrying values of assets (including the carrying value of projects in development, construction retirement and operation), provision for income taxes, fair value calculations of derivative instruments and associated reserves, capitalization of interest, primary beneficiary determination for the Company's investments in variable interest entities, the outcome of pending litigation and estimates of oil and gas reserves used to calculate depletion, depreciation and impairment of natural gas and petroleum property and equipment. Effective Tax Rate -- For the three months ended June 30, 2004 and 2003, the effective rate was 68% and 22%, respectively. For the six months ended June 30, 2004 and 2003, the effective rate was 54% and 24%, respectively. This effective rate variance is due to the consideration of estimated year-end earnings in estimating the quarterly effective rate and due to the effect of significant permanent items. Derivative Instruments -- Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133") as amended and interpreted by other related accounting literature, establishes accounting and reporting standards for derivative instruments (including certain derivative instruments embedded in other contracts). SFAS No. 133 requires companies to record derivatives on their balance sheets as either assets or liabilities measured at their fair value unless exempted from derivative treatment as a normal purchase and sale. All changes in the fair value of derivatives are recognized currently in earnings unless specific hedge criteria are met, which requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. -9- Accounting for derivatives at fair value requires the Company to make estimates about future prices during periods for which price quotes are not available from sources external to the Company. As a result, the Company is required to rely on internally developed price estimates when external price quotes are unavailable. The Company derives its future price estimates, during periods where external price quotes are unavailable, based on an extrapolation of prices from periods where external price quotes are available. The Company performs this extrapolation using liquid and observable market prices and extending those prices to an internally generated long-term price forecast based on a generalized equilibrium model. SFAS No. 133 sets forth the accounting requirements for cash flow and fair value hedges. SFAS No. 133 provides that the effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedging instrument be reported as a component of other comprehensive income and be reclassified into earnings in the same period during which the hedged forecasted transaction affects earnings. The remaining gain or loss on the derivative instrument, if any, must be recognized currently in earnings. SFAS No. 133 provides that the changes in fair value of derivatives designated as fair value hedges and the corresponding changes in the fair value of the hedged risk attributable to a recognized asset, liability, or unrecognized firm commitment be recorded in earnings. If the fair value hedge is effective, the amounts recorded will offset in earnings. With respect to cash flow hedges, if the forecasted transaction is no longer probable of occurring, the associated gain or loss recorded in other comprehensive income is recognized currently. In the case of fair value hedges, if the underlying asset, liability or firm commitment being hedged is disposed of or otherwise terminated, the gain or loss associated with the underlying hedged item is recognized currently. If the hedging instrument is terminated prior to the occurrence of the hedged forecasted transaction for cash flow hedges, or prior to the settlement of the hedged asset, liability or firm commitment for fair value hedges, the gain or loss associated with the hedge instrument remains deferred. Where the Company's derivative instruments are subject to a master netting agreement and the criteria of FASB Interpretation ("FIN") 39 "Offsetting of Amounts Related to Certain Contracts (An Interpretation of APB Opinion No. 10 and SFAS No. 105)" are met, the Company presents its derivative assets and liabilities on a net basis in its balance sheet. The Company has chosen this method of presentation because it is consistent with the way related mark-to-market gains and losses on derivatives are recorded in its Consolidated Statements of Operations and within Other Comprehensive Income ("OCI"). Preferred Interests -- As required in SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," the Company classifies certain preferred interests that are mandatorily redeemable, in short-term and long-term debt. These instruments require the Company to make priority distributions of available cash, as defined in each preferred interest agreement, representing a return of the preferred interest holder's investment over a fixed period of time and at a specified rate of return in priority to certain other distributions to equity holders. The return on investment is recorded as interest expense under the interest method over the term of the priority period. Mark-to-Market Activity, Net -- This includes realized settlements of and unrealized mark-to-market gains and losses on both power and gas derivative instruments not designated as cash flow hedges, including those held for trading purposes. Gains and losses due to ineffectiveness on hedging instruments are also included in unrealized mark-to-market gains and losses. Trading activity is presented net in accordance with Emerging Issues Task Force ("EITF") Issue No. 02-3, "Issues Related to Accounting for Contracts Involved in Energy Trading and Risk Management Activities" ("EITF Issue No. 02-3"). Presentation of Revenue Under EITF Issue No. 03-11 "Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to SFAS No. 133 and Not `Held for Trading Purposes' As Defined in EITF Issue No. 02-3: "Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities" ("EITF Issue No. 03-11") -- The Company accounts for certain of its power sales and purchases on a net basis under EITF Issue No. 03-11, which the Company adopted on a prospective basis on October 1, 2003. Transactions with either of the following characteristics are presented net in the Company's Consolidated Condensed Financial Statements: (1) transactions executed in a back-to-back buy and sale pair, primarily because of market protocols; and (2) physical power purchase and sale transactions where the Company's power schedulers net the physical flow of the power purchase against the physical flow of the power sale (or "book out" the physical power flows) as a matter of scheduling convenience to eliminate the need to schedule actual power delivery. These book out transactions may occur with the same counterparty or between different counterparties where the Company has equal but offsetting physical purchase and delivery commitments. In accordance with EITF Issue No. 03-11, the Company netted the following amounts (in thousands): -10-
Three Months Ended Six Months Ended June 30, June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Sales of purchased power for hedging and optimization..... $ 321,954 $ -- $ 692,466 $ -- ------------ ------------ ------------ ------------ Purchased power expense for hedging and optimization...... 321,954 -- 692,466 -- ------------ ------------ ------------ ------------ $ -- $ -- $ -- $ -- ============ ============ ============ ============
New Accounting Pronouncements On January 1, 2003, the Company prospectively adopted the fair value method of accounting for stock-based employee compensation pursuant to SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") as amended by SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure" ("SFAS No. 148"). SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for companies that voluntarily change their accounting for stock-based compensation from the less preferred intrinsic value based method to the more preferred fair value based method. Prior to its amendment, SFAS No. 123 required that companies enacting a voluntary change in accounting principle from the intrinsic value methodology provided by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" could only do so on a prospective basis; no adoption or transition provisions were established to allow for a restatement of prior period financial statements. SFAS No. 148 provides two additional transition options to report the change in accounting principle -- the modified prospective method and the retroactive restatement method. Additionally, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has elected to adopt the provisions of SFAS No. 123 on a prospective basis; consequently, the Company is required to provide a pro-forma disclosure of net income and earnings per share as if SFAS No. 123 accounting had been applied to all prior periods presented within its financial statements. As shown below, the adoption of SFAS No. 123 has had a material impact on the Company's financial statements. The table below reflects the pro forma impact of stock-based compensation on the Company's net loss and loss per share for the three and six months ended June 30, 2004 and 2003, had the Company applied the accounting provisions of SFAS No. 123 to its prior years' financial statements (in thousands, except per share amounts):
Three Months Ended Six Months Ended June 30, June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Net loss As reported............................................... $ (28,698) $ (23,366) $ (99,890) $ (75,382) Pro Forma................................................. (29,974) (26,860) (102,813) (83,657) Loss per share data: Basic loss per share As reported............................................ $ (0.07) $ (0.06) $ (0.24) $ (0.20) Pro Forma.............................................. (0.07) (0.07) (0.25) (0.22) Diluted earnings per share As reported............................................ $ (0.07) $ (0.06) $ (0.24) $ (0.20) Pro Forma.............................................. (0.07) (0.07) (0.25) (0.22) Stock-based compensation cost, net of tax, included in net loss, as reported........................................... $ 3,499 $ 2,909 $ 6,080 $ 6,276 Stock-based compensation cost, net of tax, included in net loss, pro forma............................................. 4,775 6,403 9,003 14,551
The range of fair values of the Company's stock options granted for the three months ended June 30, 2004 and 2003, respectively, was as follows, based on varying historical stock option exercise patterns by different levels of Calpine employees: $1.90-$2.91 in 2004, $2.52-$4.38 in 2003, on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: expected dividend yields of 0%, expected volatility of 69.11%-88.07% and 70.82%-84.93% for the three months ended June 30, 2004 and 2003, respectively, risk-free interest rates of 3.18%-4.54% and 2.47%-3.40% for the three months ended June 30, 2004 and 2003, respectively, and expected option terms of 3-8 years and 4-9 1/2 years for the three months ended June 30, 2004 and 2003, respectively. -11- The range of fair values of the Company's stock options granted for the six months ended June 30, 2004 and 2003, respectively, was as follows, based on varying historical stock option exercise patterns by different levels of Calpine employees: $1.90-$4.45 in 2004, $2.43-3.41 in 2003, on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: expected dividend yields of 0%, expected volatility of 69.11%-97.99% and 70.44%-112.99% for the six months ended June 30, 2004 and 2003, respectively, risk-free interest rates of 2.35%-4.54% and 1.39%-4.04% for the six months ended June 30, 2004 and 2003, respectively, and expected option terms of 3-9 1/2 years and 2 1/2-9 1/2 years for the six months ended June 30, 2004 and 2003, respectively. In January 2003 FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB 51" ("FIN 46"). FIN 46 requires the consolidation of an entity by an enterprise that absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interest in the entity. Historically, entities have generally been consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity. The objectives of FIN 46 are to provide guidance on the identification of Variable Interest Entities ("VIEs") for which control is achieved through means other than ownership of a majority of the voting interest of the entity, and how to determine which business enterprise (if any), as the Primary Beneficiary, should consolidate the Variable Interest Entity ("VIE"). This new model for consolidation applies to an entity in which either (1) the at-risk equity is insufficient to absorb expected losses without additional subordinated financial support or (2) its at-risk equity holders as a group are not able to make decisions that have a significant impact on the success or failure of the entity's ongoing activities. A variable interest in a VIE, by definition, is an asset, liability, equity, contractual arrangement or other economic interest that absorbs the entity's variability. In December 2003 FASB modified FIN 46 with FIN 46-R to make certain technical corrections and to address certain implementation issues. FIN 46, as originally issued, was effective immediately for VIEs created or acquired after January 31, 2003. FIN 46-R delayed the effective date of the interpretation to no later than March 31, 2004, (for calendar-year enterprises), except for Special Purpose Entities ("SPEs") for which the effective date was December 31, 2003. The Company has adopted FIN 46-R for its investment in SPEs, equity method joint ventures, its wholly owned subsidiaries that are subject to long-term power purchase agreements and tolling arrangements, operating lease arrangements containing fixed price purchase options and its wholly owned subsidiaries that have issued mandatorily redeemable non-controlling preferred interests. On application of FIN 46 the Company evaluated its investments in joint ventures and operating lease arrangements containing fixed price purchase options and concluded that, in some instances, these entities were VIEs. However, in these instances, the Company was not the Primary Beneficiary, as the Company would not absorb a majority of these entities' expected variability. An enterprise that holds a significant variable interest in a VIE is required to make certain disclosures regarding the nature and timing of its involvement with the VIE and the nature, purpose, size and activities of the VIE. The fixed price purchase options under the Company's operating lease arrangements were not considered significant variable interests. However, the joint ventures in which the Company has invested were considered significant variable interests. See Note 5 for more information related to these joint venture investments. An analysis was performed for 100% Company-owned subsidiaries with significant long-term power sales or tolling agreements. Certain of the 100% Company-owned subsidiaries were deemed to be VIEs and held power sales and tolling contracts which may be considered variable interest under FIN 46-R. However, in all cases, the Company absorbed a majority of the entity's variability and continues to consolidate these 100% Company-owned subsidiaries. The Company qualitatively determined that power sales or tolling agreements less than 10 years in length and for less than 50% of the entity's capacity would not cause the power purchaser to be the Primary Beneficiary, due to the length of the economic life of the underlying assets. Also, power sales and tolling agreements meeting the definition of a lease under EITF Issue No. 01-08, "Determining Whether an Arrangement Contains a Lease," were not considered variable interests, due to certain exclusions under FIN 46-R. A similar analysis was performed for the Company's wholly owned subsidiaries that have issued mandatorily redeemable non-controlling preferred interests. These entities were determined to be VIEs in which the Company absorbs the majority of the variability, primarily due to the debt characteristics of the preferred interest, which are classified as debt in accordance with SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" in the Company's Consolidated Condensed Balance Sheets. Consequently, the Company continues to consolidate these wholly owned subsidiaries. -12- Significant judgment was required in making an assessment of whether or not a VIE was a special purpose entity ("SPE") for purposes of adopting and applying FIN 46-R, as of October 31, 2003. Entities that meet the definition of a business outlined in FIN 46-R and that satisfy other formation and involvement criteria are not subject to the FIN 46-R consolidation guidelines. The definitional characteristics of a business include having: inputs such as long-lived assets; the ability to obtain access to necessary materials and employees; processes such as strategic management, operations and resource management; and the ability to obtain access to the customers that purchase the outputs of the entity. Since the current accounting literature does not provide a definition of an SPE, the Company's assessment was primarily based on the degree to which the VIE aligned with the definition of a business. Based on this assessment, the Company determined that five VIE investments were in SPEs: Calpine Northbrook Energy Marketing, LLC ("CNEM"), Power Contract Financing, L.L.C. ("PCF") and the Calpine Capital Trusts I, II and III, and subject to FIN 46-R as of October 1, 2003. On May 15, 2003, the Company's wholly owned subsidiary, CNEM, completed the $82.8 million monetization of an existing power sales agreement with the Bonneville Power Administration ("BPA"). CNEM borrowed $82.8 million secured by the spread between the BPA contract and certain fixed power purchase contracts. CNEM was established as a bankruptcy-remote entity and the $82.8 million loan is recourse only to CNEM's assets and is not guaranteed by the Company. CNEM was determined to be a VIE in which the Company was the Primary Beneficiary. Accordingly, the entity's assets and liabilities were consolidated into the Company's accounts as of June 30, 2003. On June 13, 2003, PCF, a wholly owned stand-alone subsidiary of Calpine Energy Services, L.P. ("CES"), completed an offering of two tranches of Senior Secured Notes Due 2006 and 2010 (collectively called the "PCF Notes"), totaling $802.2 million. To facilitate the transaction, the Company formed PCF as a wholly owned, bankruptcy remote entity with assets and liabilities consisting of certain transferred power purchase and sales contracts, which serve as collateral for the PCF Notes. The PCF Notes are non-recourse to the Company's other consolidated subsidiaries. PCF was determined to be a VIE in which the Company was the Primary Beneficiary. Accordingly, the entity's assets and liabilities were consolidated into the Company's accounts as of June 30, 2003. Upon the adoption of FIN 46-R at December 31, 2003, for the Company's investments in SPEs, the Company determined that its equity investment in Calpine Capital Trusts I, II and III ("the Trusts") was not considered at-risk as defined in FIN 46-R and that the Company did not have a significant variable interest in the Trusts. Consequently, the Company deconsolidated the Trusts. In addition, as a result of the debt reserve monetization consummated on June 2, 2004, discussed in Note 8, the Company was required to evaluate its investment in the PCF and PCF III entities under FIN 46-R. The Company determined that the entities were VIEs but the Company was not the Primary Beneficiary and was, therefore, required to deconsolidate the entities. The Company created CNEM, PCF, PCF III and Calpine Capital Trust I, II and III to facilitate capital transactions. However, in cases such as this where the Company has continuing involvement with the assets held by the deconsolidated SPE, the Company accounts for the capital transaction with the SPE as a financing rather than a sale under Emerging Issues Task Force Issue No. 88-18, "Sales of Future Revenue" ("EITF 88-18") or Statement of Financial Accounting Standard No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140"), as appropriate. When EITF 88-18 and SFAS 140 require the Company to account for a transaction as a financing, derecognition of the assets underlying the financing is prohibited, and the proceeds received from the transaction must be recorded as debt. Accordingly, in situations where the Company accounts for transactions as financings under EITF 88-18 or SFAS 140, the Company continues to recognize the assets and the debt of the deconsolidated SPE on its balance sheet. The table below summarizes how the Company has accounted for its SPEs when it has continuing involvement under ETF 88-18 or SFAS 140: FIN 46-R Sale or Treatment Financing ------------- ---------- CNEM......................................... Consolidate N/A PCF.......................................... Deconsolidate Financing PCF III...................................... Deconsolidate Financing Calpine Capital Trust I, II and III.......... Deconsolidate Financing On July 19, 2004, the Emerging Issues Task Force ("EITF") reached a tentative conclusion on Issue No. 04-8 ("EITF 04-8"): "The Effect of Contingently Convertible Debt on Diluted Earnings per Share" that would require companies that have issued contingently convertible debt instruments, commonly referred to as "Co-Cos," with a market price trigger to include the effects of the conversion in earnings per share ("EPS"), regardless of whether the price trigger had been met. Currently, Co-Cos are not included in EPS if the price trigger has not been met. Typically, the affected instruments are convertible into common shares of the issuer after the common stock price has exceeded a -13- predetermined threshold for a specified time period. If EITF 04-8 is finalized as currently written, Calpine's $900 million of 4.75% Contingent Convertible Senior Notes Due 2023 may be affected. The Company is still in the process of evaluating what impact, if any, this new guidance will have on its diluted EPS. 3. Available-for-Sale Debt Securities During the quarter, the Company exchanged 20.1 million shares of Calpine common stock in privately negotiated transactions for $20.0 million par value of HIGH TIDES I and $75.0 million par value of HIGH TIDES II. These repurchased HIGH TIDES I and II are reflected on the balance sheet in Other Assets along with previously repurchased HIGH TIDES I due to the deconsolidation of the Calpine Capital Trusts upon the adoption of FIN 46-R. The Company is accounting for the HIGH TIDES as available-for-sale in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). Therefore, the following HIGH TIDES were recorded at fair market value at June 30, 2004, with the differences from their repurchase price recorded in Other Comprehensive Income (in thousands):
June 30, 2004 -------------------------------------------- Gross Gross Unrealized Unrealized Gains in Other Losses in Other Repurchase Comprehensive Comprehensive Fair Price Income/(Loss) Income/(Loss) Value ---------- -------------- --------------- -------- HIGH TIDES I....................................... $ 54,939 $ 980 $ -- $ 55,919 HIGH TIDES II ..................................... 71,341 -- (1,216) 70,125 --------- ------- ------- -------- Debt securities................................. $ 126,280 $ 980 $(1,216) $126,044 ========= ======= ======= ========
See Note 16 for HIGH TIDES exchanged in privately negotiated transactions subsequent to June 30, 2004. 4. Property, Plant and Equipment, Net and Capitalized Interest As of June 30, 2004 and December 31, 2003, the components of property, plant and equipment, net, are stated at cost less accumulated depreciation and depletion as follows (in thousands): June 30, December 31, 2004 2003 -------------- -------------- Buildings, machinery, and equipment............. $ 16,040,848 $ 13,226,310 Oil and gas properties, including pipelines..... 2,117,599 2,136,740 Geothermal properties........................... 467,932 460,602 Other........................................... 249,384 234,932 ------------- -------------- 18,875,763 16,058,584 Less: accumulated depreciation and depletion.... (2,100,264) (1,834,701) -------------- -------------- 16,775,499 14,223,883 Land............................................ 98,689 95,037 Construction in progress........................ 4,156,986 5,762,132 -------------- -------------- Property, plant and equipment, net.............. $ 21,031,174 $ 20,081,052 ============== ============== Capital Spending -- Construction and Development Construction and Development costs in process consisted of the following at June 30, 2004 (in thousands):
Equipment Project # of Included in Development Unassigned Projects CIP CIP Costs Equipment -------- ----------- ----------- ----------- ---------- Projects in active construction.......................... 9 $ 2,929,153 $ 980,425 $ -- $ -- Projects in advanced development......................... 13 720,982 585,866 129,158 -- Projects in suspended development........................ 6 463,320 203,437 12,993 -- Projects in early development............................ 3 -- -- 8,933 14,001 Other capital projects................................... NA 43,531 -- -- -- Unassigned............................................... NA -- -- -- 52,856 ----------- ----------- --------- --------- Total construction and development costs.............. $ 4,156,986 $ 1,769,728 $ 151,084 $ 66,857 =========== =========== ========= =========
-14- Construction in Progress -- Construction in progress ("CIP") is primarily attributable to gas-fired power projects under construction including prepayments on gas and steam turbine generators and other long lead-time items of equipment for certain development projects not yet in active construction. Upon commencement of plant operation, these costs are transferred to the applicable property category, generally buildings, machinery and equipment. Projects in Active Construction -- The 9 projects in active construction are estimated to come on line from September 2004 to June 2007. These projects will bring on line approximately 4,266 MW of base load capacity (4,825 MW with peaking capacity). Interest and other costs related to the construction activities necessary to bring these projects to their intended use are being capitalized. Five additional projects totaling 3,110 megawatts that were in active construction in the beginning of the quarter went on line during the quarter. At June 30, 2004, the estimated funding requirements to complete these 9 projects, net of expected project financing proceeds, is approximately $1.2 billion. Projects in Advanced Development -- There are 13 projects in advanced development. These projects will bring on line approximately 5,945 MW of base load capacity (7,096 MW with peaking capacity). Interest and other costs related to the development activities necessary to bring these projects to their intended use are being capitalized. However, the capitalization of interest has been suspended on two projects for which development activities are complete. The estimated cost to complete the 13 projects in advanced development is approximately $3.9 billion. The Company's current plan is to commence construction with project financing, once power purchase agreements are arranged. Suspended Development Projects -- Due to current electric market conditions, the Company has ceased capitalization of additional development costs and interest expense on certain development projects on which work has been suspended. Capitalization of costs may recommence as work on these projects resumes, if certain milestones and criteria are met. These projects would bring on line approximately 3,169 MW of base load capacity (3,629 MW with peaking capacity). The estimated cost to complete the six projects is approximately $1.9 billion. Projects in Early Development -- Costs for projects that are in early stages of development are capitalized only when it is highly probable that such costs are ultimately recoverable and significant project milestones are achieved. Until then all costs, including interest costs, are expensed. The projects in early development with capitalized costs relate to three projects and include geothermal drilling costs and equipment purchases. Other Capital Projects -- Other capital projects primarily consist of enhancements to operating power plants, oil and gas and geothermal resource and facilities development as well as software developed for internal use. Unassigned Equipment -- As of June 30, 2004, the Company had made progress payments on 4 turbines, 1 heat recovery steam generator and other equipment with an aggregate carrying value of $66.9 million representing unassigned equipment that is classified on the balance sheet as other assets because it is not assigned to specific development and construction projects. The Company is holding this equipment for potential use on future projects. It is possible that some of this unassigned equipment may eventually be sold, potentially in combination with the Company's engineering and construction services. For equipment that is not assigned to development or construction projects, interest is not capitalized. Capitalized Interest -- The Company capitalizes interest on capital invested in projects during the advanced stages of development and the construction period in accordance with SFAS No. 34, "Capitalization of Interest Cost" ("SFAS No. 34"), as amended by SFAS No. 58, "Capitalization of Interest Cost in Financial Statements That Include Investments Accounted for by the Equity Method (an Amendment of FASB Statement No. 34)" ("SFAS No. 58"). The Company's qualifying assets include construction in progress, certain oil and gas properties under development, construction costs related to unconsolidated investments in power projects under construction, and advanced stage development costs. For the three months ended June 30, 2004 and 2003, the total amount of interest capitalized was $102.2 million and $116.5 million, respectively, including $15.4 million and $18.8 million, respectively, of interest incurred on funds borrowed for specific construction projects and $86.8 million and $97.7 million, respectively, of interest incurred on general corporate funds used for construction. For the six months ended June 30, 2004 and 2003, the total amount of interest capitalized was $210.7 million and $235.0 million, respectively, including $34.0 million and $38.4 million, respectively, of interest incurred on funds borrowed for specific construction projects and $176.7 million and $196.6 million, respectively, of interest incurred on general corporate funds used for construction. Upon commencement of plant operation, capitalized interest, as a component of the total cost of the plant, is amortized over the estimated useful life of the plant. The decrease in the amount of interest capitalized during the three and six months ended June 30, 2004 reflects the completion of construction for several power plants and the result of the current suspension of certain of the Company's development projects. -15- In accordance with SFAS No. 34, the Company determines which debt instruments best represent a reasonable measure of the cost of financing construction assets in terms of interest cost incurred that otherwise could have been avoided. These debt instruments and associated interest cost are included in the calculation of the weighted average interest rate used for capitalizing interest on general funds. The primary debt instruments included in the rate calculation of interest incurred on general corporate funds, are certain of the Company's Senior Notes and term loan facilities and the secured working capital revolving credit facility. Impairment Evaluation -- All construction and development projects and unassigned turbines are reviewed for impairment whenever there is an indication of potential reduction in fair value. Equipment assigned to such projects is not evaluated for impairment separately, as it is integral to the assumed future operations of the project to which it is assigned. If it is determined that it is no longer probable that the projects will be completed and all capitalized costs recovered through future operations, the carrying values of the projects would be written down to the recoverable value in accordance with the provisions of SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). The Company reviews its unassigned equipment for potential impairment based on probability-weighted alternatives of utilizing the equipment for future projects versus selling the equipment. Utilizing this methodology, the Company does not believe that the equipment not committed to sale is impaired. 5. Investments in Power Projects and Oil and Gas Properties The Company's investments in power projects and oil and gas properties are integral to its operations. As discussed in Note 2, the Company's joint venture investments were evaluated under FIN 46-R to determine which, if any, entities were VIEs. Based on this evaluation, the Company determined that the Acadia Energy Center, Grays Ferry Power Plant, Whitby Cogeneration facility and the Androscoggin Power Plant were VIEs, in which the Company held a significant variable interest. However, based on a qualitative and quantitative assessment of the expected variability in these entities, the Company was not the Primary Beneficiary. Consequently, the Company continues to account for these VIEs and its other joint venture investments in power projects in accordance with APB Opinion No. 18, "The Equity Method of Accounting For Investments in Common Stock" and FASB Interpretation No. 35, "Criteria for Applying the Equity Method of Accounting for Investments in Common Stock (An Interpretation of APB Opinion No. 18)." Acadia Powers Partners, LLC ("Acadia") is the owner of a 1,160-megawatt electric wholesale generation facility located in Louisiana and is a joint venture between the Company and Cleco Corporation. The Company's involvement in this VIE began upon formation of the entity in March 2000. The Company's maximum potential exposure to loss at June 30, 2004, is limited to the book value of its investment of approximately $220.3 million. Grays Ferry Cogeneration Partnership ("Grays Ferry") is the owner of a 140-megawatt gas-fired cogeneration facility located in Pennsylvania and is a joint venture between the Company and Trigen-Schuylkill Cogeneration, Inc. The Company's involvement in this VIE began with its acquisition of the independent power producer, Cogeneration Corporation of America, Inc. ("Cogen America") in December 1999. The Grays Ferry joint venture project was part of the portfolio of assets owned by Cogen America. The Company's maximum potential exposure to loss at June 30, 2004, is limited to the book value of its investment of approximately $49.0 million. Androscoggin Energy LLC ("AELLC") is the owner of a 160-megawatt gas-fired cogeneration facility located in Maine and is a joint venture between the Company, Wisvest Corporation and Androscoggin Energy, Inc. The Company's involvement in this VIE began with its acquisition of the independent power producer, SkyGen Energy LLC ("SkyGen") in October 2000. The Androscoggin joint venture project was part of the portfolio of assets owned by SkyGen. The Company's maximum potential exposure to loss at June 30, 2004, is limited to $32.1 million, which represents the book value of its investment of approximately $14.5 million and a notes receivable balance due from AELLC of $17.6 million as described below. Whitby Energy LLP ("Whitby") is the owner of a 50-megawatt gas-fired cogeneration facility located in Ontario, Canada and is a joint venture between the Company and a privately held enterprise. The Company's involvement in this VIE began with its acquisition of a portfolio of assets from Westcoast Energy Inc. ("Westcoast") in September 2001, which included the Whitby joint venture project. The Company's maximum potential exposure to loss at June 30, 2004, is limited to the book value of its investment of approximately $34.8 million. -16- The following investments are accounted for under the equity method (in thousands):
Ownership Investment Balance at Interest as -------------------------- of June 30, June 30, December 31, 2004 2004 2003 ----------- ----------- ----------- Acadia Energy Center.................................................. 50.0% $ 220,323 $ 221,038 Valladolid III IPP.................................................... 45.0% 72,626 67,320 Grays Ferry Power Plant (1)........................................... 50.0% 49,008 53,272 Whitby Cogeneration (2)............................................... 15.0% 34,774 31,033 Calpine Natural Gas Trust............................................. 25.0% 24,712 28,598 Androscoggin Power Plant.............................................. 32.3% 14,510 11,823 Aries Power Plant (3)................................................. 100.0% -- 58,205 Other................................................................. -- 1,350 1,460 ----------- ----------- Total investments in power projects and oil and gas properties..... $ 417,303 $ 472,749 =========== =========== - ------------ (1) On March 23, 2004, the Company completed the acquisition of the remaining 20% interest in Calpine Cogen. As a result of the acquisition, the Company's ownership percentage in the Grays Ferry Power Plant increased to 50%. (2) Whitby is owned 50% by the Company but a 70% economic interest in the Company's ownership percentage has effectively been transferred to the Calpine Power Income Fund through a loan from Calpine Power Limited Partnership to the Company's entity which holds the investment interest in Whitby. (3) On March 26, 2004, the Company acquired the remaining 50 percent interest in Aries Power Plant. Accordingly, this plant is consolidated as of June 30, 2004.
The third-party debt on the books of the unconsolidated investments is not reflected on the Company's Consolidated Condensed Balance Sheets. At June 30, 2004, third-party investee debt is approximately $178.7 million. Based on the Company's pro rata ownership share of each of the investments, the Company's share would be approximately $58.3 million. However, all such debt is non-recourse to the Company. The Company owns a 32.3% interest in the unconsolidated equity method investee AELLC. AELLC owns the 160-MW Androscoggin Energy Center located in Maine and has construction debt of $59.3 million outstanding as of June 30, 2004. The debt is non-recourse to the Company (the "AELLC Non-Recourse Financing"). On June 30, 2004, and December 31, 2003, the Company's investment balance was $14.5 million and $11.8 million, respectively, and its notes receivable balance due from AELLC was $17.6 million and $13.3 million, respectively. On and after August 8, 2003, AELLC received letters from its lenders claiming that certain events of default had occurred under the credit agreement for the AELLC Non-Recourse Financing, including, among other things, that the project had been and remained in default under its credit agreement because the lending syndication had declined to extend the dates for the conversion of the construction loan to a term loan by a certain date. AELLC disputes the purported defaults. Also, the steam host for the AELLC project, International Paper Company ("IP"), filed a complaint against AELLC in October 2000, which is discussed in more detail in Note 13. IP's complaint has been a complicating factor in converting the construction debt to long term financing. As a result of these events, the Company reviewed its investment and notes receivable balances and believes that the assets are not impaired. The Company further believes that AELLC will eventually be able to convert the construction loan to a term loan. -17- The following details the Company's income and distributions from investments in unconsolidated power projects and oil and gas properties (in thousands):
Income (Loss) from Unconsolidated Investments in Power Projects and Oil and Gas Properties Distributions -------------------------- ------------------------ For the Six Months Ended June 30, ----------------------------------------------------- 2004 2003 2004 2003 ----------- ----------- ----------- ----------- Acadia Energy Center....................................... $ 6,913 $ 66,058 $ 8,454 $119,950 Aries Power Plant.......................................... (4,089) (599) -- -- Grays Ferry Power Plant.................................... (2,060) (1,929) -- -- Whitby Cogeneration........................................ 709 1,231 1,515 -- Calpine Natural Gas Trust.................................. 2,593 -- 4,586 -- Androscoggin Power Plant................................... (2,945) (3,804) -- -- Gordonsville Power Plant (1)............................... -- 3,210 -- 1,050 Other...................................................... 174 194 142 15 --------- --------- -------- -------- Total................................................... $ 1,295 $ 64,361 $ 14,697 $121,015 ========= ========= ======== ======== Interest income on notes receivable from power projects (2)........................................ $ 493 $ 114 --------- --------- Total................................................... $ 1,788 $ 64,475 ========= ========= - ------------ The Company provides for deferred taxes on its share of earnings. (1) On November 26, 2003, the Company completed the sale of its 50 percent interest in the Gordonsville Power Plant. (2) At June 30, 2004, and December 31, 2003, notes receivable from power projects represented an outstanding loan to the Company's investment, Androscoggin Energy Center LLC, in the amounts of $17.6 million and $13.3 million, respectively.
Related-Party Transactions with Equity Method Affiliates The Company and certain of its equity method affiliates have entered into various service agreements with respect to power projects and oil and gas properties. Following is a general description of each of the various agreements: Operation and Maintenance Agreements -- The Company operates and maintains the Acadia Power Plant and Androscoggin Power Plant. This includes routine maintenance, but not major maintenance, which is typically performed under agreements with the equipment manufacturers. Responsibilities include development of annual budgets and operating plans. Payments include reimbursement of costs, including Calpine's internal personnel and other costs, and annual fixed fees. Administrative Services Agreements -- The Company handles administrative matters such as bookkeeping for certain unconsolidated investments. Payment is on a cost reimbursement basis, including Calpine's internal costs, with no additional fee. Power Marketing Agreements -- Under agreements with the Company's Androscoggin Power Plant, CES can either market the plant's power as the power facility's agent or buy the power directly. Terms of any direct purchase are to be agreed upon at the time and incorporated into a transaction confirmation. Historically, CES has generally bought the power from the power facility rather than acting as its agent. Gas Supply Agreement -- CES can be directed to supply gas to the Androscoggin Power Plant facility pursuant to transaction confirmations between the facility and CES. Contract terms are reflected in individual transaction confirmations. -18- The power marketing and gas supply contracts with CES are accounted for as either purchase and sale arrangements or as tolling arrangements. In a purchase and sale arrangement, title and risk of loss associated with the purchase of gas is transferred from CES to the project at the gas delivery point. In a tolling arrangement, title to fuel provided to the project does not transfer, and CES pays the project a capacity and a variable fee based on the specific terms of the power marketing and gas supply agreements. In addition to the contracts specified above, CES maintains two tolling agreements with the Acadia facility. All of the other power marketing and gas supply contracts are accounted for as purchases and sales. The related party balances with equity method affiliates as of June 30, 2004 and December 31, 2003, reflected in the accompanying Consolidated Condensed Balance Sheets, and the related party transactions with equity method affiliates for the three and six months ended June 30, 2004, and 2003, reflected in the accompanying Consolidated Condensed Statements of Operations are summarized as follows (in thousands): June 30, December 31, 2004 2003 ------------ ------------ Accounts receivable.............................. $ 4,069 $ 1,156 Accounts payable................................. 10,820 12,172 Interest receivable.............................. 1,914 2,074 Note Receivable.................................. 17,602 13,262 Other receivables................................ 10,436 8,794 2004 2003 ------------ ------------ For the Three Months Ended June 30, Revenue.......................................... $ 52 $ -- Cost of Revenue.................................. 31,373 16,591 Maintenance fee revenue.......................... 39 160 Interest income.................................. 259 85 For the Six Months Ended June 30, Revenue.......................................... $ 699 $ 455 Cost of Revenue.................................. 64,119 31,083 Maintenance fee revenue.......................... 214 303 Interest income.................................. 493 114 Gain on sale of assets........................... 6,240 -- 6. King City Restructuring The California Power Income Fund ("CPIF") acquired the King City facility from a third party in a transaction that closed May 19, 2004. CPIF became the new lessor of the facility, which it purchased subject to the Company's pre-existing operating lease. The Company restructured certain provisions of the operating lease, including a 10-year extension and the elimination of the collateral requirements necessary to support the original lease payments. In the first quarter of 2004, the Company reclassified the securities that served as collateral under the original lease for the King City power plant from held-to-maturity to available-for-sale in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115"). At the close of the restructuring transaction, the Company sold the securities for total proceeds of $95.4 million and recorded a pre-tax gain of $12.3 million in Other Income. Also, in contemplation of the sale, the Company entered into an interest rate swap with a financial institution with the intent to hedge against a decline in value of the collateral debt securities. The swap did not meet the required criteria for hedge effectiveness under SFAS No. 133 and, as a result, the Company recorded all changes in the swap's fair value between the dates of inception and settlement in Other Income. Upon settlement of the swap, the Company had recognized a cumulative gain of $5.2 million. The Company used the proceeds from the sale of the securities to redeem a preferred interest in the project totaling $82.0 million. The preferred interest had been recorded as debt under SFAS No. 150. The Company expensed approximately $1.2 million in deferred finance costs related to the original issuance of the preferred interest and paid a $3.0 million termination fee. These debt extinguishment costs were recorded in Other Expense. Due to the lease extension and other modifications to the original lease, the lease classification was reevaluated under SFAS No. 13 "Accounting for Leases" and determined to be a capital lease. In determining the new lease classification, the Company included all increases due to step rent provision/escalation clauses in the minimum lease payments. Lease concessions and other executory costs such as taxes and insurance are excluded from the minimum lease payments. Certain future capital improvements associated with the leased facility may be deemed leasehold improvements and will be amortized over the shorter of the term of the lease or the economic life of the capital improvement. -19- At June 30, 2004, the asset balance for the leased asset was $114.9 million. The leased asset will be amortized over the 24-year lease term. The lease agreement provides for the Company to pay taxes, maintenance, insurance, and certain other operating costs of the leased property. The following is a schedule by years of future minimum lease payments under the capital lease together with the present value of the net minimum lease payments as of June 30, 2004 (in thousands): Year Ending December 31: 2004....................................................... $ 13,277 2005....................................................... 16,699 2006....................................................... 16,458 2007....................................................... 16,552 2008....................................................... 16,199 Thereafter................................................. 187,798 ----------- Total minimum lease payments............................ 266,983 Less: Amount representing interest(1)......................... 172,041 ----------- Present value of net minimum lease payments................ $ 94,942 Less: Capital lease obligation, current portion............... 4,051 ----------- Capital lease obligation, net of current portion........... $ 90,891 =========== - ------------ (1) Amount necessary to reduce net minimum lease payments to preset value calculated at the incremental rate at the time of acquisition. CPIF is considered a related party to the Company as the Company holds three of the seven CPIF Trustee positions. Contemporaneous with the acquisition, Calpine Canada Power Ltd., a wholly owned subsidiary of the Company, issued a 6-year promissory note to a CPIF affiliate, of which $34.4 million was outstanding at June 30, 2004. 7. Senior Notes On April 26, 2004, we announced the completion of consent solicitations to effect certain amendments to five indentures governing the Company's outstanding 10-1/2% Senior Notes Due 2006, 8-3/4% Senior Notes Due 2007, 7-7/8% Senior Notes Due 2008, 7-5/8% Senior Notes Due 2006 and 7-3/4% Senior Notes Due 2009. Supplemental indentures effecting such amendments were executed by the Company and the respective trustee for each series of senior notes as of April 26, 2004. During the three months ended June 30, 2004, the Company repurchased $46.6 million in principal amount of its outstanding Senior Notes in exchange for $41.5 million in cash. The Company recorded a pre-tax gain on these transactions in the amount of $4.9 million, net of write-offs of unamortized deferred financing costs and the unamortized premiums or discounts. 8. Financing On May 26, 2004, the Company and Jersey Central Power & Light Company ("JCPL") terminated their existing toll arrangements with the Newark and Parlin power plants, resulting in a pre-tax gain of $100.6 million. Proceeds from this transaction were used to retire project financing debt of $78.8 million. In conjunction with this termination, Utility Contract Funding II ("UCF"), a wholly owned subsidiary of CES, entered into a long-term power purchase agreement with JCPL. UCF was then sold. The Company recognized an $85.4 million pre-tax gain on the sale of UCF. The total pre-tax gain, net of transaction costs and the write-off of unamortized deferred financing costs, was $171.5 million. On June 2, 2004, the Company's wholly owned subsidiary, Power Contract Financing III, LLC ("PCF III"), issued $85.0 million of zero coupon notes collateralized PCF III's ownership of PCF. PCF III owns all of the equity interests in Power Contract Financing, L.L.C., which holds the California Department of Water Resources I contract monetized in June 2003 and maintains a debt reserve fund, which had a balance of approximately $94.4 million at June 30, 2004. The Company received cash proceeds of approximately $48.0 million from the issuance of the notes. On June 11, 2004, Citrus Trading Corp. negotiated the early partial termination of its out-of-the-money gas contract with the Auburndale facility. The Company recognized a pre-tax gain of $16.4 million as a result of this transaction. The pre-tax gain was partially offset by the recognition of $4.7 million in interest expense on the distribution of a share of the proceeds to an ArcLight affiliate, which holds a 70% preferred equity interest in the Auburndale power plant. The net pre-tax gain on this transaction was $11.7 million. On June 29, 2004, Rocky Mountain Energy Center, LLC and Riverside Energy Center, LLC, wholly owned stand-alone subsidiaries of the Company's Calpine Riverside Holdings, LLC subsidiary, received funding in the aggregate amount of $661.5 million comprised of $633.4 million of First Priority Secured Floating -20- Rate Term Loans Due 2011 priced at LIBOR plus 425 basis points and $28.1 million letter of credit-linked deposit facility. Net proceeds from the loans, after transaction costs and fees, were used to pay final construction costs and refinance amounts outstanding under the $250 million non-recourse project financing for the Rocky Mountain facility and the $230 million non-recourse project financing for the Riverside facility. In connection with this refinancing, the Company wrote off $13.2 million in deferred financing costs. In addition, approximately $160.0 million was used to reimburse the Company for costs incurred in connection with the development and construction of the Rocky Mountain and Riverside facilities. The Company also received approximately $79.0 million in proceeds via a combination of cash and increased credit capacity as a result of the elimination of certain reserves and cancellation of letters of credit associated with the original non-recourse project financings. During the three months ended June 30, 2004, the Company exchanged 20.1 million Calpine common shares in privately negotiated transactions for $20.0 million par value of HIGH TIDES I and $75.0 million par value of HIGH TIDES II. The repurchased HIGH TIDES are reflected in our balance sheet in other assets as available for sale securities. See Note 3 for more information regarding the Company's available for sale securities. Annual Debt Maturities The annual principal repayments or maturities of notes payable and borrowings under lines of credit, notes payable to Calpine Capital Trusts, preferred interests, construction/project financing, 2006 Convertible Senior Notes, 2023 Convertible Notes, senior notes and term loans, CCFC I financing, CalGen/CCFC II financing and capital lease obligations, net of unamortized premiums and discounts, as of June 30, 2004, are as follows (in thousands): July through December 2004.......................... $ 169,732 2005................................................ 580,784 2006................................................ 751,721 2007................................................ 2,086,843 2008................................................ 2,615,479 Thereafter.......................................... 11,866,581 -------------- Total............................................ $ 18,071,140 ============== 9. Discontinued Operations Set forth below are all of the Company's asset disposals by reportable segment that impacted the Company's Consolidated Condensed Financial Statements as of June 30, 2004 and December 31, 2003: Corporate and Other On July 31, 2003, the Company completed the sale of its specialty data center engineering business and recorded a pre-tax loss on the sale of $11.6 million. Oil and Gas Production and Marketing On November 20, 2003, the Company completed the sale of its Alvin South Field oil and gas assets located near Alvin, Texas for approximately $0.06 million to Cornerstone Energy, Inc. As a result of the sale, the Company recognized a pre-tax loss of $0.2 million. Electric Generation and Marketing On January 15, 2004, the Company completed the sale of its 50-percent undivided interest in the 545 megawatt Lost Pines 1 Power Project to GenTex Power Corporation, an affiliate of the Lower Colorado River Authority (LCRA). Under the terms of the agreement, Calpine received a cash payment of $146.8 million and recorded a pre-tax gain of $35.3 million. In addition, CES entered into a tolling agreement with LCRA providing for the option to purchase 250 megawatts of electricity through December 31, 2004. At December 31, 2003, the Company's undivided interest in the Lost Pines facility was classified as "held for sale." Summary The Company made reclassifications to current and prior period financial statements to reflect the sale or designation as "held for sale" of these oil and gas and power plant assets and liabilities and to separately classify the operating results of the assets sold and gain on sale of those assets from the operating results of continuing operations to discontinued operations. -21- The tables below present significant components of the Company's income from discontinued operations for the three and six months ended June 30, 2004, and 2003, respectively (in thousands):
Three Months Ended June 30, 2004 ------------------------------------------------------ Electric Oil and Gas Corporate Generation Production and and Marketing and Marketing Other Total ------------- ------------- --------- ---------- Total revenue................................................ $ -- $ -- $ -- $ -- ========== ==== ==== ========== Gain on disposal before taxes................................ $ -- $ -- $ -- $ -- Operating income from discontinued operations before taxes... 324 -- -- 324 ---------- ---- ---- ---------- Income from discontinued operations before taxes............. $ 324 $ -- $ -- 324 ========== ==== ==== ========== Gain on disposal, net of tax................................. $ -- $ -- $ -- $ -- Operating income from discontinued operations, net of tax.... 198 -- -- 198 ---------- ---- ---- ---------- Income from discontinued operations, net of tax.............. $ 198 $ -- $ -- $ 198 ========== ==== ==== ========== Three Months Ended June 30, 2003 ------------------------------------------------------ Electric Oil and Gas Corporate Generation Production and and Marketing and Marketing Other Total ------------- ------------- --------- ---------- Total revenue................................................ $ 20,558 $ 190 $ 1,985 $ 22,733 ========== ===== ======== ========== Loss on disposal before taxes................................ $ -- $ -- $ (3,294) $ (3,294) Operating income (loss) from discontinued operations before taxes................................................ 2,287 116 (10,584) (8,181) ---------- ----- -------- ---------- Income (loss) from discontinued operations before taxes...... $ 2,287 $ 116 $(13,878) $ (11,475) ========== ===== ======== ========== Loss on disposal, net of tax................................. $ -- $ -- $ (2,042) $ (2,042) Operating income (loss) from discontinued operations, net of tax.................................................. 1,486 71 (6,506) (4,949) ---------- ----- -------- ---------- Income (loss) from discontinued operations, net of tax....... $ 1,486 $ 71 $ (8,548) $ (6,991) ========== ===== ======== ========== Six Months Ended June 30, 2004 ------------------------------------------------------ Electric Oil and Gas Corporate Generation Production and and Marketing and Marketing Other Total ------------- ------------- --------- ---------- Total revenue................................................ $ 2,679 $ -- $ -- $ 2,679 ========== ===== ===== ========== Gain on disposal before taxes................................ $ 35,327 $ -- $ -- $ 35,327 Operating income from discontinued operations before taxes... 180 -- -- 180 ---------- ----- ----- ---------- Income from discontinued operations before taxes............. $ 35,507 $ -- $ -- 35,507 ========== ===== ===== ========== Gain on disposal, net of tax................................. $ 22,951 $ -- $ -- $ 22,951 Operating income from discontinued operations, net of tax.... 104 -- -- 104 ---------- ----- ----- ---------- Income from discontinued operations, net of tax.............. $ 23,055 $ -- $ -- $ 23,055 ========== ===== ===== ========== -22- Six Months Ended June 30, 2003 ------------------------------------------------------ Electric Oil and Gas Corporate Generation Production and and Marketing and Marketing Other Total ------------- ------------- --------- ---------- Total revenue................................................ $ 39,061 $ 268 $ 3,748 $ 43,077 ========== ===== ======== ========== Loss on disposal before taxes................................ $ -- $ -- $ (3,294) $ (3,294) Operating income (loss) from discontinued operations before taxes................................................ 3,165 146 (13,289) (9,978) ---------- ----- -------- ---------- Income (loss) from discontinued operations before taxes...... $ 3,165 $ 146 $(16,583) $ (13,272) ========== ===== ======== ========== Loss on disposal, net of tax................................. $ -- $ -- $ (2,042) $ (2,042) Operating income (loss) from discontinued operations, net of tax.................................................. 2,056 91 (8,102) (5,955) ---------- ----- -------- ---------- Income (loss) from discontinued operations, net of tax....... $ 2,056 $ 91 $(10,144) $ (7,997) ========== ===== ======== ==========
10. Derivative Instruments Commodity Derivative Instruments As an independent power producer primarily focused on generation of electricity using gas-fired turbines, the Company's natural physical commodity position is "short" fuel (i.e., natural gas consumer) and "long" power (i.e., electricity seller). To manage forward exposure to price fluctuation in these commodities, the Company enters into derivative commodity instruments. The Company enters into commodity instruments to convert floating or indexed electricity and gas prices to fixed prices in order to lessen its vulnerability to reductions in electric prices for the electricity it generates, and to increases in gas prices for the fuel it consumes in its power plants. The Company seeks to "self-hedge" its gas consumption exposure to an extent with its own gas production position. The hedging, balancing, and optimization activities that the Company engages in are directly related to the Company's asset-based business model of owning and operating gas-fired electric power plants and are designed to protect the Company's "spark spread" (the difference between the Company's fuel cost and the revenue it receives for its electric generation). The Company hedges exposures that arise from the ownership and operation of power plants and related sales of electricity and purchases of natural gas. The Company also utilizes derivatives to optimize the returns it is able to achieve from these assets. From time to time the Company has entered into contracts considered energy trading contracts under EITF Issue No. 02-3. However, the Company's traders have low capital at risk and value at risk limits for energy trading, and its risk management policy limits, at any given time, its net sales of power to its generation capacity and limits its net purchases of gas to its fuel consumption requirements on a total portfolio basis. This model is markedly different from that of companies that engage in significant commodity trading operations that are unrelated to underlying physical assets. Derivative commodity instruments are accounted for under the requirements of SFAS No. 133. The Company also routinely enters into physical commodity contracts for sales of its generated electricity and sales of its natural gas production to ensure favorable utilization of generation and production assets. Such contracts often meet the criteria of SFAS No. 133 as derivatives but are generally eligible for the normal purchases and sales exception. Some of those contracts that are not deemed normal purchases and sales can be designated as hedges of the underlying consumption of gas or production of electricity. Interest Rate and Currency Derivative Instruments The Company also enters into various interest rate swap agreements to hedge against changes in floating interest rates on certain of its project financing facilities and to adjust the mix between fixed and floating rate debt in our capital structure to desired levels. The interest rate swap agreements effectively convert floating rates into fixed rates so that the Company can predict with greater assurance what its future interest costs will be and protect itself against increases in floating rates. In conjunction with its capital markets activities, the Company enters into various forward interest rate agreements to hedge against interest rate fluctuations that may occur after the Company has decided to issue long-term fixed rate debt but before the debt is actually issued. The forward interest rate agreements effectively prevent the interest rates on anticipated future long-term debt from increasing beyond a certain level, allowing the Company to predict with greater assurance what its future interest costs on fixed rate long-term debt will be. -23- Also in conjunction with its capital market activities, the Company enters into various interest rate swap agreements to hedge against the changes in fair value on certain of its fixed rate Senior Notes. These interest rate swap agreements effectively convert fixed rates into floating rates so that the Company can predict with greater assurance what the fair value of its fixed rate Senior Notes will be and protect itself against unfavorable future fair value movements. The Company enters into various foreign currency swap agreements to hedge against changes in exchange rates on certain of its senior notes denominated in currencies other than the U.S. dollar. The foreign currency swaps effectively convert floating exchange rates into fixed exchange rates so that the Company can predict with greater assurance what its U.S. dollar cost will be for purchasing foreign currencies to satisfy the interest and principal payments on these senior notes. Summary of Derivative Values The table below reflects the amounts (in thousands) that are recorded as assets and liabilities at June 30, 2004, for the Company's derivative instruments:
Commodity Interest Rate Derivative Total Derivative Instruments Derivative Instruments Net Instruments ------------- ------------- ------------- Current derivative assets................................................ $ 1,271 $ 337,534 $ 338,805 Long-term derivative assets.............................................. 3,923 557,405 561,328 ---------- ------------ ------------- Total assets.......................................................... $ 5,194 $ 894,939 $ 900,133 ========== ============ ============= Current derivative liabilities........................................... $ 28,260 $ 354,837 $ 383,097 Long-term derivative liabilities......................................... 68,851 530,644 599,495 ---------- ------------ ------------- Total liabilities..................................................... $ 97,111 $ 885,481 $ 982,592 ========== ============ ============= Net derivative assets (liabilities)................................ $ (91,917) $ 9,458 $ (82,459) ========== ============ =============
Of the Company's net derivative assets, $366.6 million and $67.2 million are net derivative assets of Power Contract Financing, L.L.C. and Calpine Northbrook Energy Marketing, LLC ("CNEM"), respectively, each of which is an entity with its existence separate from the Company and other subsidiaries of the Company. The Company fully consolidates CNEM and, as discussed more fully in Note 2, the Company records the derivative assets of PCF in its balance sheet. At any point in time, it is highly unlikely that total net derivative assets and liabilities will equal accumulated OCI, net of tax from derivatives, for three primary reasons: Tax effect of OCI -- When the values and subsequent changes in values of derivatives that qualify as effective hedges are recorded into OCI, they are initially offset by a derivative asset or liability. Once in OCI, however, these values are tax effected against a deferred tax liability or asset account, thereby creating an imbalance between net OCI and net derivative assets and liabilities. Derivatives not designated as cash flow hedges and hedge ineffectiveness -- Only derivatives that qualify as effective cash flow hedges will have an offsetting amount recorded in OCI. Derivatives not designated as cash flow hedges and the ineffective portion of derivatives designated as cash flow hedges will be recorded into earnings instead of OCI, creating a difference between net derivative assets and liabilities and pre-tax OCI from derivatives. Termination of effective cash flow hedges prior to maturity -- Following the termination of a cash flow hedge, changes in the derivative asset or liability are no longer recorded to OCI. At this point, an accumulated OCI balance remains that is not recognized in earnings until the forecasted initially hedged transactions occur. As a result, there will be a temporary difference between OCI and derivative assets and liabilities on the books until the remaining OCI balance is recognized in earnings. -24- Below is a reconciliation of the Company's net derivative assets to its accumulated other comprehensive loss, net of tax from derivative instruments at June 30, 2004 (in thousands):
Net derivative liabilities........................................................................ $ (82,459) Derivatives not designated as cash flow hedges and recognized hedge ineffectiveness............... (73,512) Cash flow hedges terminated prior to maturity..................................................... (90,027) Deferred tax asset attributable to accumulated other comprehensive loss on cash flow hedges....... 77,334 Accumulated OCI from unconsolidated investees..................................................... 23,170 ------------ Accumulated other comprehensive loss from derivative instruments, net of tax(1)................... $ (145,494) ============ - ------------ (1) Amount represents one portion of the Company's total accumulated OCI balance. See Note 11 for further information.
The asset and liability balances for the Company's commodity derivative instruments represent the net totals after offsetting certain assets against certain liabilities under the criteria of FASB Interpretation No. 39, "Offsetting of Amounts Related to Certain Contracts (an Interpretation of APB Opinion No. 10 and FASB Statement No. 105)" ("FIN 39"). For a given contract, FIN 39 will allow the offsetting of assets against liabilities so long as four criteria are met: (1) each of the two parties under contract owes the other determinable amounts; (2) the party reporting under the offset method has the right to set off the amount it owes against the amount owed to it by the other party; (3) the party reporting under the offset method intends to exercise its right to set off; and; (4) the right of set-off is enforceable by law. The table below reflects both the amounts (in thousands) recorded as assets and liabilities by the Company and the amounts that would have been recorded had the Company's commodity derivative instrument contracts not qualified for offsetting as of June 30, 2004. June 30, 2004 ------------------------------ Gross Net -------------- -------------- Current derivative assets.................. $ 713,307 $ 337,534 Long-term derivative assets................ 1,043,294 557,405 -------------- -------------- Total derivative assets................. $ 1,756,601 $ 894,939 ============== ============== Current derivative liabilities............. $ 730,610 $ 354,837 Long-term derivative liabilities........... 1,016,533 530,644 -------------- -------------- Total derivative liabilities............ $ 1,747,143 $ 885,481 ============== ============== Net commodity derivative assets...... $ 9,458 $ 9,458 ============== ============== The table above excludes the value of interest rate and currency derivative instruments. The tables below reflect the impact of the Company's derivative instruments on its pre-tax earnings, both from cash flow hedge ineffectiveness and from the changes in market value of derivatives not designated as hedges of cash flows, for the three and six months ended June 30, 2004 and 2003, respectively (in thousands):
Three Months Ended June 30, ---------------------------------------------------------------------------------------- 2004 2003 ----------------------------------------- ------------------------------------------- Hedge Undesignated Hedge Undesignated Ineffectiveness Derivatives Total Ineffectiveness Derivatives Total --------------- ------------ ---------- --------------- ------------ ---------- Natural gas derivatives(1)..... $ 317 $ (3,737) $ (3,420) $ 2,067 $ 3,556 $ 5,623 Power derivatives(1)........... 666 (26,159) (25,493) (1,612) (11,232) (12,844) Interest rate derivatives(2)... (550) 5,939 5,389 (275) -- (275) ------- --------- ---------- -------- --------- --------- Total....................... $ 433 $ (23,957) $ (23,524) $ 180 $ (7,676) $ (7,496) ======= ========= ========== ======== ========= ========= -25- Six Months Ended June 30, ---------------------------------------------------------------------------------------- 2004 2003 ----------------------------------------- ------------------------------------------- Hedge Undesignated Hedge Undesignated Ineffectiveness Derivatives Total Ineffectiveness Derivatives Total --------------- ------------ ---------- --------------- ------------ ---------- Natural gas derivatives(1)..... $ 5,763 $ (3,102) $ 2,661 $ 8,180 $ 1,579 $ 9,759 Power derivatives(1)........... 126 (36,645) (36,519) (4,638) (13,113) (17,751) Interest rate derivatives(2)... (948) 6,035 5,087 (484) -- (484) ------- ---------- ---------- -------- --------- --------- Total....................... $ 4,941 $ (33,712) $ (28,771) $ 3,058 $ (11,534) $ (8,476) ======= ========== ========== ======== ========= ========= - ------------ (1) Represents the unrealized portion of mark-to-market activity on gas and power transactions. The unrealized portion of mark-to-market activity is combined with the realized portions of mark-to-market activity and presented in the Consolidated Statements of Operations as mark-to-market activities, net. (2) Recorded within Other Income
The table below reflects the contribution of the Company's cash flow hedge activity to pre-tax earnings based on the reclassification adjustment from OCI to earnings for the three and six months ended June 30, 2004 and 2003, respectively (in thousands): Three Months Ended June 30, --------------------------- 2004 2003 ------------ ------------ Natural gas and crude oil derivatives............... $ 25,040 $ (2,998) Power derivatives................................... (30,255) (4,223) Interest rate derivatives........................... (7,194) (3,451) Foreign currency derivatives........................ (496) (729) ----------- ----------- Total derivatives................................ $ (12,905) $ (11,401) =========== =========== Six Months Ended June 30, --------------------------- 2004 2003 ------------ ------------ Natural gas and crude oil derivatives............... $ 25,233 $ 32,164 Power derivatives................................... (43,023) (55,549) Interest rate derivatives........................... (9,966) (14,093) Foreign currency derivatives........................ (1,012) 11,828 ----------- ------------ Total derivatives................................ $ (28,768) $ (25,650) =========== =========== As of June 30, 2004 the maximum length of time over which the Company was hedging its exposure to the variability in future cash flows for forecasted transactions was 7.5 and 12.5 years, for commodity and interest rate derivative instruments, respectively. The Company estimates that pre-tax losses of $149.6 million would be reclassified from accumulated OCI into earnings during the twelve months ended June 30, 2005, as the hedged transactions affect earnings assuming constant gas and power prices, interest rates, and exchange rates over time; however, the actual amounts that will be reclassified will likely vary based on the probability that gas and power prices as well as interest rates and exchange rates will, in fact, change. Therefore, management is unable to predict what the actual reclassification from OCI to earnings (positive or negative) will be for the next twelve months. The table below presents (in thousands) the pre-tax gains (losses) currently held in OCI that will be recognized annually into earnings, assuming constant gas and power prices, interest rates, and exchange rates over time.
2009 & 2004 2005 2006 2007 2008 After Total ----------- ----------- ----------- ----------- ----------- ----------- ------------ Gas OCI.................... $ 30,075 $ 22,896 $ 43,672 $ 943 $ 853 $ 2,118 $ 100,557 Power OCI.................. (112,210) (93,270) (49,157) (2,273) 201 435 (256,274) Interest rate OCI.......... (9,594) (16,731) (8,258) (4,444) (1,866) (20,143) (61,036) - Foreign currency OCI....... (869) (1,872) (1,872) (1,481) 17 -- (6,077) ---------- ---------- ---------- ---------- ---------- ---------- ----------- Total pre-tax OCI....... $ (92,598) $ (88,977) $ (15,615) $ (7,255) $ (795) $ (17,590) $ (222,830) ========== ========== ========== ========== ========== ========== ===========
-26- 11. Comprehensive Income (Loss) Comprehensive income is the total of net income and all other non-owner changes in equity. Comprehensive income includes the Company's net income, unrealized gains and losses from derivative instruments that qualify as cash flow hedges and the effects of foreign currency translation adjustments. The Company reports Accumulated Other Comprehensive Income ("AOCI") in its Consolidated Balance Sheet. The tables below detail the changes during the six months ended June 30, 2004 and 2003, in the Company's AOCI balance and the components of the Company's comprehensive income (in thousands):
Comprehensive Income (Loss) Total for the Three Accumulated Months Ended Available- Foreign Other March 31, 2004 Cash Flow for-Sale Currency Comprehensive and June 30, Hedges Investments Translation Income 2004 ----------- ----------- ----------- -------------- -------------- Accumulated other comprehensive income (loss) at January 1, 2004.................................... $ (130,419) $ -- $ 187,013 $ 56,594 Net loss for the three months ended March 31, 2004.. $ (71,192) Cash flow hedges: Comprehensive pre-tax gain on cash flow hedges before reclassification adjustment during the three months ended March 31, 2004............ 4,426 Reclassification adjustment for loss included in net loss for the three months ended March 31, 2004............................... 15,863 Income tax provision for the three months ended March 31, 2004......................... (7,224) ---------- -------- 13,065 13,065 13,065 Available-for-sale investments: Pre-tax gain on available-for-sale investments for the three months ended March 31, 2004.... 19,526 Income tax provision for the three months ended March 31, 2004......................... (7,709) -------- 11,817 11,817 11,817 Foreign currency translation gain for the three months ended March 31, 2004............ 2,078 2,078 2,078 ---------- --------- -------- --------- Total comprehensive loss for the three months ended March 31, 2004..................................... $ (44,232) ========= Accumulated other comprehensive income (loss) at March 31, 2004.................................. $ (117,354) $ 11,817 $ 189,091 $ 83,554 ========== ======== ========= ======== Net loss for the three months ended June 30, 2004... $ (28,698) Cash flow hedges: Comprehensive pre-tax loss on cash flow hedges before reclassification adjustment during the three months ended June 30, 2004............. (54,414) Reclassification adjustment for loss included in net loss for the three months ended June 30, 2004................................ 12,905 Income tax benefit for the three months ended June 30, 2004................................ 13,369 ---------- -------- (28,140) (28,140) (28,140) Available-for-sale investments: Pre-tax loss on available-for-sale investments for the three months ended June 30, 2004..... (19,762) Income tax benefit for the three months ended June 30, 2004................................ 7,802 -------- (11,960) (11,960) (11,960) Foreign currency translation loss for the three months ended June 30, 2004............. (21,399) (21,399) (21,399) ---------- --------- -------- --------- Total comprehensive loss for the three months ended June 30, 2004...................................... (90,197) --------- Total comprehensive loss for the six months ended June 30, 2004...................................... $(134,429) ========= Accumulated other comprehensive income (loss) at June 30, 2004................................... $ (145,494) $ (143) $ 167,692 $ 22,055 ========== ======== ========= ======== -27- Comprehensive Total Income (Loss) Accumulated for the Three Other Months Ended Foreign Comprehensive March 31, 2003 Cash Flow Currency Income and June 30, Hedges Translation (Loss) 2003 ------------- ----------- -------------- -------------- Accumulated other comprehensive loss at January 1, 2003....... $ (224,414) $ (13,043) $ (237,457) Net loss for the three months ended March 31, 2003............ $ (52,016) Cash flow hedges: Comprehensive pre-tax gain on cash flow hedges before reclassification adjustment during the three months ended March 31, 2003................................... 27,827 Reclassification adjustment for loss included in net loss for the three months ended March 31, 2003.............. 14,249 Income tax provision for the three months ended March 31, 2003......................................... (10,927) ------------ ------------ 31,149 31,149 31,149 Foreign currency translation gain for the three months ended March 31, 2003................................... -- 84,062 84,062 84,062 ------------ ----------- ------------ ----------- Total comprehensive income for the three months ended March 31, 2003............................................... $ 63,195 =========== Accumulated other comprehensive income (loss) at March 31, 2003......................................................... $ (193,265) $ 71,019 $ (122,246) ============ =========== ============ Net loss for the three months ended June 30, 2003............. $ (23,366) Cash flow hedges: Comprehensive pre-tax gain on cash flow hedges before reclassification adjustment during the three months ended June 30, 2003.................................... 47,892 Reclassification adjustment for loss included in net loss for the three months ended June 30, 2003............... 11,401 Income tax provision for the three months ended June 30, 2003.......................................... (28,790) ------------ ------------ 30,503 30,503 30,503 Foreign currency translation gain for the three months ended June 30, 2003.................................... -- 63,494 63,494 63,494 ------------ ----------- ------------ ----------- Total comprehensive income for the three months ended June 30, 2003................................................ 70,631 ----------- Total comprehensive income for the six months ended June 30, 2003................................................ $ 133,826 =========== Accumulated other comprehensive income (loss) at June 30, 2003 $ (162,762) $ 134,513 $ (28,249) ============ =========== ============
12. Loss per Share Basic loss per common share were computed by dividing net loss by the weighted average number of common shares outstanding for the respective periods. The dilutive effect of the potential exercise of outstanding options to purchase shares of common stock is calculated using the treasury stock method. The dilutive effect of the assumed conversion of certain convertible securities into the Company's common stock is based on the dilutive common share equivalents and the after tax distribution expense avoided upon conversion. The calculation of basic loss per common share is shown in the following table (in thousands, except per share data).
Periods Ended June 30, -------------------------------------------------------------- 2004 2003 ----------------------------- ------------------------------- Net Loss Shares EPS Net Loss Shares EPS ---------- ------- -------- --------- -------- -------- THREE MONTHS: Basic and diluted loss per common share: Loss before discontinued operations and cumulative effect of a change in accounting principle.......... $ (28,896) 417,357 $ (0.07) $ (16,375) 381,219 $ (0.04) Discontinued operations, net of tax.................. 198 -- -- (6,991) -- (0.02) Cumulative effect of a change in accounting principle, net of tax............................... -- -- -- -- -- -- --------- -------- -------- --------- ------- ------- Net loss............................................. $ (28,698) 417,357 $ (0.07) $ (23,366) 381,219 $ (0.06) ========= ======== ======== ========= ======= ======= -28- Periods Ended June 30, -------------------------------------------------------------- 2004 2003 ----------------------------- ------------------------------- Net Loss Shares EPS Net Loss Shares EPS ---------- ------- -------- --------- -------- -------- SIX MONTHS: Basic and diluted loss per common share: Loss before discontinued operations and cumulative effect of a change in accounting principle.......... $(122,945) 416,332 $ (0.30) $ (67,914) 381,089 $ (0.18) Discontinued operations, net of tax.................. 23,055 -- 0.06 (7,997) -- (0.02) Cumulative effect of a change in accounting principle, net of tax............................... -- -- -- 529 -- -- --------- -------- ------- --------- ------- ------- Net loss............................................. $ (99,890) 416,332 $ (0.24) $ (75,382) 381,089 $ (0.20) ========= ======== ======== ========= ======= =======
Because of the Company's losses for the three and six months ended June 30, 2004 and 2003, basic shares were also used in the calculations of fully diluted loss per share, under the guidelines of SFAS No. 128, "Earnings per Share," as using the basic shares produced the more dilutive effect on the loss per share. Potentially convertible securities and unexercised employee stock options to purchase 60,551,462 and 118,701,972 shares of the Company's common stock were not included in the computation of diluted shares outstanding during the six months ended June 30, 2004 and 2003, respectively, because such inclusion would be anti-dilutive. For the three and six months ended June 30, 2004, approximately 4.0 million and 13.9 million weighted common shares of the Company's outstanding 4% convertible senior notes due 2006 were excluded from the diluted EPS calculations as the inclusion of such shares would have been antidilutive. Due to repurchases by the Company of these securities during the first quarter of 2004, at June 30, 2004, 4.0 million common shares were potentially issuable upon the conversion of 100% of these securities then outstanding. The holders have the right to require the Company to repurchase these securities on December 26, 2004, at a repurchase price equal to the issue price plus any accrued and unpaid interest, payable at the option of the Company in cash or common shares, or a combination of cash and common shares. In connection with the convertible notes payable to Calpine Capital Trust ("Trust I"), Calpine Capital Trust II ("Trust II") and Calpine Capital Trust III ("Trust III"), net of repurchases, there were 15.8 million, 14.1 million and 11.9 million common shares potentially issuable, respectively, that were excluded from the diluted EPS calculation for the three months ended June 30, 2004. For the six month period then ended, respectively, there were 16.1 million, 14.1 million, and 11.9 million potentially issuable weighted shares that were excluded from the EPS calculation as their inclusion would be antidilutive. These notes are convertible at any time at the applicable holder's option in connection with the conversion of convertible preferred securities issued by the Trusts, and may be redeemed at any time after their respective initial redemption date. The Company is required to remarket the convertible preferred securities issued by Trust I, Trust II and Trust III no later than November 1, 2004, February 1, 2005 and August 1, 2005, respectively. If the Company is not able to remarket those securities, it will result in additional interest costs and an adjusted conversion rate equal to 105% of the average closing price of our common stock for the five consecutive trading days after the failed remarketing. For the three and six months ended June 30, 2004, there were no shares potentially issuable with respect to the Company's 4.75% Convertible Senior Notes Due 2023. Upon the occurrence of certain contingencies (generally if the average trading price as calculated under the prescribed definition exceeds 120% of $6.50 per share, i.e. $7.80 per share), these securities are convertible at the holder's option for cash for the face amount and shares of the Company's common stock for the appreciated value in the Company's common stock over $6.50 per share. Holders have the right to require the Company to repurchase these securities at various times beginning on November 15, 2009, for the face amount plus any accrued and unpaid interest and liquidated damages, if any. The repurchase price is payable at the option of the Company in cash or common shares, or a combination of both. The Company may redeem these securities at any time on or after November 22, 2009, in cash for the face amount plus any accrued and unpaid interest and liquidated damages, if any. Approximately 138.4 million maximum potential shares are issuable upon conversion of these securities and are excluded from the diluted EPS calculations as there are currently no shares contingently issuable due to the Company's quarter end stock price being under $7.80. -29- 13. Commitments and Contingencies Turbines. The table below sets forth future turbine payments for construction and development projects, as well as for unassigned turbines. It includes previously delivered turbines, payments and delivery by year for the remaining 5 turbines to be delivered as well as payment required for the potential cancellation costs of the remaining 52 gas and steam turbines. The table does not include payments that would result if the Company were to release for manufacturing any of these remaining 52 turbines. Units to Year Total Be Delivered - ------------------------------------------ --------- ------------ (In thousands) July through December 2004................. $ 52,261 5 2005....................................... 21,117 -- 2006....................................... 2,706 -- ---------- --- Total................................... $ 76,084 5 ========== === Litigation The Company is party to various litigation matters arising out of the normal course of business, the more significant of which are summarized below. The ultimate outcome of each of these matters cannot presently be determined, nor can the liability that could potentially result from a negative outcome be reasonably estimated presently for every case. The liability the Company may ultimately incur with respect to any one of these matters in the event of a negative outcome may be in excess of amounts currently accrued with respect to such matters and, as a result of these matters, may potentially be material to the Company's Consolidated Condensed Financial Statements. Securities Class Action Lawsuits. Since March 11, 2002, fourteen shareholder lawsuits have been filed against Calpine and certain of its officers in the United States District Court for the Northern District of California. The actions captioned Weisz v. Calpine Corp., et al., filed March 11, 2002, and Labyrinth Technologies, Inc. v. Calpine Corp., et al., filed March 28, 2002, are purported class actions on behalf of purchasers of Calpine stock between March 15, 2001 and December 13, 2001. Gustaferro v. Calpine Corp., filed April 18, 2002, is a purported class action on behalf of purchasers of Calpine stock between February 6, 2001 and December 13, 2001. The eleven other actions, captioned Local 144 Nursing Home Pension Fund v. Calpine Corp., Lukowski v. Calpine Corp., Hart v. Calpine Corp., Atchison v. Calpine Corp., Laborers Local 1298 v. Calpine Corp., Bell v. Calpine Corp., Nowicki v. Calpine Corp. Pallotta v. Calpine Corp., Knepell v. Calpine Corp., Staub v. Calpine Corp., and Rose v. Calpine Corp. were filed between March 18, 2002 and April 23, 2002. The complaints in these eleven actions are virtually identical-- they are filed by three law firms, in conjunction with other law firms as co-counsel. All eleven lawsuits are purported class actions on behalf of purchasers of Calpine's securities between January 5, 2001 and December 13, 2001. The complaints in these fourteen actions allege that, during the purported class periods, certain Calpine executives issued false and misleading statements about Calpine's financial condition in violation of Sections 10(b) and 20(1) of the Securities Exchange Act of 1934, as well as Rule 10b-5. These actions seek an unspecified amount of damages, in addition to other forms of relief. In addition, a fifteenth securities class action, Ser v. Calpine, et al., was filed on May 13, 2002. The underlying allegations in the Ser action are substantially the same as those in the above-referenced actions. However, the Ser action is brought on behalf of a purported class of purchasers of Calpine's 8.5% Senior Notes Due February 15, 2011 ("2011 Notes") and the alleged class period is October 15, 2001 through December 13, 2001. The Ser complaint alleges that, in violation of Sections 11 and 15 of the Securities Act of 1933, the Supplemental Prospectus for the 2011 Notes contained false and misleading statements regarding Calpine's financial condition. This action names Calpine, certain of its officers and directors, and the underwriters of the 2011 Notes offering as defendants, and seeks an unspecified amount of damages, in addition to other forms of relief. All fifteen of these securities class action lawsuits were consolidated in the United States District Court for the Northern District of California. Plaintiffs filed a first amended complaint in October 2002. The amended complaint did not include the 1933 Act complaints raised in the bondholders' complaint, and the number of defendants named was reduced. On January 16, 2003, before the Company's response was due to this amended complaint, plaintiffs filed a further second complaint. This second amended complaint added three additional Calpine executives and Arthur Andersen LLP as defendants. The second amended complaint set forth additional alleged violations of Section 10 of the Securities Exchange Act of 1934 relating to allegedly false and misleading statements made regarding Calpine's role in the California energy crisis, the long term power contracts with the California Department of Water Resources, and Calpine's dealings with Enron, and additional claims under Section 11 and -30- Section 15 of the Securities Act of 1933 relating to statements regarding the causes of the California energy crisis. The Company filed a motion to dismiss this consolidated action in early April 2003. On August 29, 2003, the judge issued an order dismissing, with leave to amend, all of the allegations set forth in the second amended complaint except for a claim under Section 11 of the Securities Act relating to statements relating to the causes of the California energy crisis and the related increase in wholesale prices contained in the Supplemental Prospectuses for the 2011 Notes. The judge instructed plaintiff, Julies Ser, to file a third amended complaint, which he did on October 17, 2003. The third amended complaint names Calpine and three executives as defendants and alleges the Section 11 claim that survived the judge's August 29, 2003 order. On November 21, 2003, Calpine and the individual defendants moved to dismiss the third amended complaint on the grounds that plaintiff's Section 11 claim was barred by the applicable one-year statute of limitations. On February 4, 2004, the judge denied the Company's motion to dismiss but has asked the parties to be prepared to file summary judgment motions to address the statute of limitations issue. The Company filed its answer to the third amended complaint on February 28, 2004. In a separate order dated February 4, 2004, the court denied without prejudice Julies Ser's motion to be appointed lead plaintiff. Mr. Ser subsequently stated he no longer desired to serve as lead plaintiff. On April 4, 2004, the Policemen and Firemen Retirement System of the City of Detroit ("P&F") moved to be appointed lead plaintiff, which motion was granted on May 14, 2004. The Company considers the lawsuit to be without merit and intends to continue to defend vigorously against these allegations. Hawaii Structural Ironworkers Pension Fund v. Calpine, et al. A securities class action, Hawaii Structural Ironworkers Pension Fund v. Calpine, et al., was filed on March 11, 2003, against Calpine, its directors and certain investment banks in state superior court of San Diego County, California. The underlying allegations in the Hawaii Structural Ironworkers Pension Fund action ("Hawaii action") are substantially the same as the federal securities class actions described above. However, the Hawaii action is brought on behalf of a purported class of purchasers of Calpine's equity securities sold to public investors in its April 2002 equity offering. The Hawaii action alleges that the Registration Statement and Prospectus filed by Calpine which became effective on April 24, 2002, contained false and misleading statements regarding Calpine's financial condition in violation of Sections 11, 12 and 15 of the Securities Act of 1933. The Hawaii action relies in part on Calpine's restatement of certain past financial results, announced on March 3, 2003, to support its allegations. The Hawaii action seeks an unspecified amount of damages, in addition to other forms of relief. The Company removed the Hawaii action to federal court in April 2003 and filed a motion to transfer the case for consolidation with the other securities class action lawsuits in the United States District Court for the Northern District of California in May 2003. Plaintiff sought to have the action remanded to state court, and on August 27, 2003, the United States District Court for the Southern District of California granted plaintiff's motion to remand the action to state court. In early October 2003 plaintiff agreed to dismiss the claims it has against three of the outside directors. On November 5, 2003, Calpine, the individual defendants and the underwriter defendants filed motions to dismiss this complaint on numerous grounds. On February 6, 2004, the court issued a tentative ruling sustaining the Company's motion to dismiss on the issue of plaintiff's standing. The court found that plaintiff had not shown that it had purchased Calpine stock "traceable" to the April 2002 equity offering. The court overruled the Company's motion to dismiss on all other grounds. On March 12, 2004, after oral argument on the issues, the court confirmed its February 2, 2004, ruling. On February 20, 2004, plaintiff filed an amended complaint, and in late March 2004 the Company and the individual defendants filed answers to this complaint. On April 9, 2004, the Company and the individual defendants filed motions to transfer the lawsuit to Santa Clara County Superior Court, which motions were granted on May 7, 2004. The Company considers this lawsuit to be without merit and intends to continue to defend vigorously against it. Phelps v. Calpine Corporation, et al. On April 17, 2003, a participant in the Calpine Corporation Retirement Savings Plan (the "401(k) Plan") filed a class action lawsuit in the United States District Court for the Northern District of California. The underlying allegations in this action ("Phelps action") are substantially the same as those in the securities class actions described above. However, the Phelps action is brought on behalf of a purported class of participants in the 401(k) Plan. The Phelps action alleges that various filings and statements made by Calpine during the class period were materially false and misleading, and that defendants failed to fulfill their fiduciary -31- obligations as fiduciaries of the 401(k) Plan by allowing the 401(k) Plan to invest in Calpine common stock. The Phelps action seeks an unspecified amount of damages, in addition to other forms of relief. In May 2003 Lennette Poor-Herena, another participant in the 401(k) Plan, filed a substantially similar class action lawsuit as the Phelps action also in the Northern District of California. Plaintiffs' counsel is the same in both of these actions, and they have agreed to consolidate these two cases and to coordinate them with the consolidated federal securities class actions described above. On January 20, 2004, plaintiff James Phelps filed a consolidated ERISA complaint naming Calpine and numerous individual current and former Calpine Board members and employees as defendants. Pursuant to a stipulated agreement with plaintiff, Calpine's response to the amended complaint is due August 13, 2004. The Company considers this lawsuit to be without merit and intends to vigorously defend against it. Johnson v. Peter Cartwright, et al. On December 17, 2001, a shareholder filed a derivative lawsuit on behalf of Calpine against its directors and one of its senior officers. This lawsuit is captioned Johnson v. Cartwright, et al. and is pending in state superior court of Santa Clara County, California. Calpine is a nominal defendant in this lawsuit, which alleges claims relating to purportedly misleading statements about Calpine and stock sales by certain of the director defendants and the officer defendant. In December 2002 the court dismissed the complaint with respect to certain of the director defendants for lack of personal jurisdiction, though plaintiff may appeal this ruling. In early February 2003 plaintiff filed an amended complaint. In March 2003 Calpine and the individual defendants filed motions to dismiss and motions to stay this proceeding in favor of the federal securities class actions described above. In July 2003 the court granted the motions to stay this proceeding in favor of the consolidated federal securities class actions described above. The Company cannot estimate the possible loss or range of loss from this matter. The Company considers this lawsuit to be without merit and intends to vigorously defend against it. Gordon v. Peter Cartwright, et al. On August 8, 2002, a shareholder filed a derivative suit in the United States District Court for the Northern District of California on behalf of Calpine against its directors, captioned Gordon v. Cartwright, et al. similar to Johnson v. Cartwright. Motions have been filed to dismiss the action against certain of the director defendants on the grounds of lack of personal jurisdiction, as well as to dismiss the complaint in total on other grounds. In February 2003 plaintiff agreed to stay these proceedings in favor of the consolidated federal securities class action described above and to dismiss without prejudice certain director defendants. On March 4, 2003, plaintiff filed papers with the court voluntarily agreeing to dismiss without prejudice the claims he had against three of the outside directors. The Company cannot estimate the possible loss or range of loss from this matter. The Company considers this lawsuit to be without merit and intends to continue to defend vigorously against it. Calpine Corporation v. Automated Credit Exchange. On March 5, 2002, Calpine sued Automated Credit Exchange ("ACE") in state superior court of Alameda County, California for negligence and breach of contract to recover reclaim trading credits, a form of emission reduction credits that should have been held in Calpine's account with U.S. Trust Company ("US Trust"). Calpine wrote off $17.7 million in December 2001 related to losses that it alleged were caused by ACE. Calpine and ACE entered into a Settlement Agreement on March 29, 2002, pursuant to which ACE made a payment to Calpine of $7 million and transferred to Calpine the rights to the emission reduction credits to be held by ACE. The Company recognized the $7 million as income in the second quarter of 2002. In June 2002 a complaint was filed by InterGen North America, L.P. ("InterGen") against Anne M. Sholtz, the owner of ACE, and EonXchange, another Sholtz-controlled entity, which filed for bankruptcy protection on May 6, 2002. InterGen alleges it suffered a loss of emission reduction credits from EonXchange in a manner similar to Calpine's loss from ACE. InterGen's complaint alleges that Anne Sholtz co-mingled assets among ACE, EonXchange and other Sholtz entities and that ACE and other Sholtz entities should be deemed to be one economic enterprise and all retroactively included in the EonXchange bankruptcy filing as of May 6, 2002. By a judgment entered on October 30, 2002, the bankruptcy court consolidated ACE and the other Sholtz controlled entities with the bankruptcy estate of EonXchange. Subsequently, the Trustee of EonXchange filed a separate motion to substantively consolidate Anne Sholtz into the bankruptcy estate of EonXchange. Although Anne Sholtz initially opposed such motion, she entered into a settlement agreement with the Trustee consenting to her being substantively consolidated into the bankruptcy proceeding. The bankruptcy court entered an order approving Anne Sholtz's settlement agreement with the Trustee on April 3, 2002. On July 10, 2003, Howard Grobstein, the Trustee in the EonXchange bankruptcy, filed a complaint for avoidance against Calpine, seeking recovery of the $7 million (plus interest and costs) paid to Calpine in the March 29, 2002 Settlement Agreement. The complaint claims that the $7 million received by Calpine in the Settlement Agreement was transferred within 90 days of the filing of bankruptcy and therefore should be avoided and preserved for the benefit of the bankruptcy estate. On August 28, 2003, Calpine filed its answer denying that the $7 million is an avoidable preference. Following two settlement conferences, on or about May 21, 2004, Calpine and the Trustee entered into a Settlement Agreement, whereby Calpine agreed to pay $5.85 -32- million, which was approved by the Bankruptcy Court on June 16, 2004. The preference lawsuit will be dismissed with prejudice upon final payment of the settlement, which will occur on October 1, 2004. International Paper Company v. Androscoggin Energy LLC. In October 2000 International Paper Company ("IP") filed a complaint in the United States District Court for the Northern District of Illinois against Androscoggin Energy LLC ("AELLC") alleging that AELLC breached certain contractual representations and warranties by failing to disclose facts surrounding the termination, effective May 8, 1998, of one of AELLC's fixed-cost gas supply agreements. The Company acquired a 32.3% interest in AELLC as part of the SkyGen transaction which closed in October 2000. AELLC filed a counterclaim against IP that has been referred to arbitration that AELLC may commence at its discretion upon further evaluation. On November 7, 2002, the court issued an opinion on the parties' cross motions for summary judgment finding in AELLC's favor on certain matters though granting summary judgment to IP on the liability aspect of a particular claim against AELLC. The court also denied a motion submitted by IP for preliminary injunction to permit IP to make payment of funds into escrow (not directly to AELLC) and require AELLC to post a significant bond. In mid-April of 2003 IP unilaterally availed itself to self-help in withholding amounts in excess of $2.0 million as a set-off for litigation expenses and fees incurred to date as well as an estimated portion of a rate fund to AELLC. Upon AELLC's amended complaint and request for immediate injunctive relief against such actions, the court ordered that IP must pay the approximately $1.2 million withheld as attorneys' fees related to the litigation as any such perceived entitlement was premature, but deferred to provide injunctive relief on the incomplete record concerning the offset of $799,000 as an estimated pass-through of the rate fund. IP complied with the order on April 29, 2003, and tendered payment to AELLC of the approximately $1.2 million. On June 26, 2003, the court entered an order dismissing AELLC's amended counterclaim without prejudice to AELLC refiling the claims as breach of contract claims in a separate lawsuit. On December 11, 2003, the court denied in part IP's summary judgment motion pertaining to damages. In short, the court: (i) determined that, as a matter of law, IP is entitled to pursue an action for damages as a result of AELLC's breach, and (ii) ruled that sufficient questions of fact remain to deny IP summary judgment on the measure of damages as IP did not sufficiently establish causation resulting from AELLC's breach of contract (the liability aspect of which IP obtained a summary judgment in December 2002). On February 2, 2004, the parties filed a Final Pretrial Order with the court. The case appears likely scheduled for trial in the third quarter of 2004, subject to the court's discretion and calendar. The Company believes that it has adequately reserved for the possible loss, if any, that it may ultimately incur as a result of this matter. Pacific Gas and Electric Company v. Calpine Corporation, et al. On July 22, 2003, Pacific Gas and Electric Company ("PG&E") filed with the California Public Utilities Commission ("CPUC") a Complaint of PG&E and Request for Immediate Issuance of an Order to Show Cause ("complaint") against Calpine Corporation, CPN Pipeline Company, Calpine Energy Services, L.P., Calpine Natural Gas Company, and Lodi Gas Storage, LLC ("LGS"). The complaint requests the CPUC to issue an order requiring defendants to show cause why they should not be ordered to cease and desist from using any direct interconnections between the facilities of CPN Pipeline and those of LGS unless LGS and Calpine first seek and obtain regulatory approval from the CPUC. The complaint also seeks an order directing defendants to pay to PG&E any underpayments of PG&E's tariffed transportation rates and to make restitution for any profits earned from any business activity related to LGS' direct interconnections to any entity other than PG&E. The complaint further alleges that various natural gas consumers, including Calpine affiliated generation projects within California, are engaged with defendants in the acts complained of, and that the defendants unlawfully bypass PG&E's system and operate as an unregulated local distribution company within PG&E's service territory. On August 27, 2003, Calpine filed its answer and a motion to dismiss. LGS also made similar filings. On October 16, 2003, the presiding administrative law judge denied the motion to dismiss and on October 24, 2003, issued a Scoping Memo and Ruling establishing a procedural schedule and set the matter for an evidentiary hearing. On January 15, 2004, Calpine, LGS and PG&E executed a Settlement Agreement to resolve all outstanding allegations and claims raised in the complaint. Certain aspects of the Settlement Agreement are effective immediately and the effectiveness of other provisions is subject to the approval of the Settlement Agreement by the CPUC. In the event the CPUC fails to approve the Settlement Agreement, its operative terms and conditions become null and void. The Settlement Agreement provides, in part, for: 1) PG&E to be paid $2.7 million; 2) the disconnection of the LGS interconnections with Calpine; 3) Calpine to obtain PG&E consent or regulatory or other governmental approval before resuming any sales or exchanges at the Ryer Island Meter Station; 4) PG&E's withdrawal of its public utility claims against Calpine; and 5) no party admitting any wrongdoing. Accordingly, the presiding administrative law judge vacated the hearing schedule and established a new procedural schedule for the filing of the Settlement Agreement. On February 6, 2004, the Settlement Agreement was filed with the CPUC. The parties were given the opportunity to submit comments and reply comments on the Settlement Agreement. The CPUC approved the Settlement Agreement on July 8, 2004, and the $2.7 million was paid to PG&E on July 15, 2004. -33- Panda Energy International, Inc., et al. v. Calpine Corporation, et al. On November 5, 2003, Panda Energy International, Inc. and certain related parties, including PLC II, LLC, (collectively "Panda") filed suit against Calpine and certain of its affiliates in the United States District Court for the Northern District of Texas, alleging, among other things, that the Company breached duties of care and loyalty allegedly owed to Panda by failing to correctly construct and operate the Oneta Energy Center ("Oneta"), which the Company acquired from Panda, in accordance with Panda's original plans. Panda alleges that it is entitled to a portion of the profits from Oneta plant and that Calpine's actions have reduced the profits from Oneta plant thereby undermining Panda's ability to repay monies owed to Calpine on December 1, 2003, under a promissory note on which approximately $38.6 million (including interest) is currently outstanding and past due. The note is collateralized by Panda's carried interest in the income generated from Oneta, which achieved full commercial operations in June 2003. The company filed a counterclaim against Panda Energy International, Inc. (and PLC II, LLC) based on a guaranty, and have also filed a motion to dismiss as to the causes of action alleging federal and state securities laws violations. The motion to dismiss is currently pending before the court. However, at the present time, the Company cannot estimate the potential loss, if any, that might arise from this matter. The Company considers Panda's lawsuit to be without merit and intends to defend vigorously against it. The Company stopped accruing interest income on the promissory note due December 1, 2003, as of the due date because of Panda's default in repayment of the note. California Business & Professions Code Section 17200 Cases, of which the lead case is T&E Pastorino Nursery v. Duke Energy Trading and Marketing, L.L.C., et al. This purported class action complaint filed in May 2002 against twenty energy traders and energy companies, including CES, alleges that defendants exercised market power and manipulated prices in violation of California Business & Professions Code Section 17200 et seq., and seeks injunctive relief, restitution, and attorneys' fees. The Company also has been named in seven other similar complaints for violations of Section 17200. All seven cases were removed from the various state courts in which they were originally filed to federal court for pretrial proceedings with other cases in which the Company is not named as a defendant. However, at the present time, the Company cannot estimate the potential loss, if any, that might arise from this matter. The Company considers the allegations to be without merit, and filed a motion to dismiss on August 28, 2003. The court granted the motion, and plaintiffs have appealed. Prior to the motion to dismiss being granted, one of the actions, captioned Millar v. Allegheny Energy Supply Co., LLP, et al., was remanded to state superior court of Alameda County, California. On January 12, 2004, CES was added as a defendant in Millar. This action includes similar allegations to the other 17200 cases, but also seeks rescission of the long-term power contracts with the California Department of Water Resources. Upon motion from another newly added defendant, Millar was recently removed to federal court. It has now been transferred to the same judge that is presiding over the other Section 17200 cases described above, where it will be consolidated with such cases for pretrial purposes. The Company anticipates filing a timely motion for dismissal of Millar as well. Nevada Power Company and Sierra Pacific Power Company v. Calpine Energy Services, L.P. before the FERC, filed on December 4, 2001. Nevada Section 206 Complaint. On December 4, 2001, Nevada Power Company ("NPC") and Sierra Pacific Power Company ("SPPC") filed a complaint with FERC under Section 206 of the Federal Power Act against a number of parties to their power sales agreements, including Calpine. NPC and SPPC allege in their complaint, which seeks a refund, that the prices they agreed to pay in certain of the power sales agreements, including those signed with Calpine, were negotiated during a time when the power market was dysfunctional and that they are unjust and unreasonable. The administrative law judge issued an Initial Decision on December 19, 2002, that found for Calpine and the other respondents in the case and denied NPC the relief that it was seeking. In June 2003, FERC rejected the complaint. Some plaintiffs appealed to the FERC and their request for rehearing was denied. The matter is pending on appeal before the United States Court of Appeals for the Ninth Circuit, and is in the pleading stage. Transmission Service Agreement with Nevada Power. On March 16, 2004, NPC filed a petition for declaratory order at FERC (Docket No. EL04-90-000) asking that an order be issued requiring Calpine and Reliant Energy Services, Inc. to pay for transmission service under their Transmission Service Agreements ("TSAs") with NPC or, if the TSAs are terminated, to pay the lesser of the transmission charges or a pro rata share of the total cost of NPC's Centennial Project (approximately $33 million for Calpine). Calpine had previously provided security to NPC for these costs in the form of a surety bond issued by Fireman's Fund Insurance Company ("FFIC"). The Centennial Project involves construction of various transmission facilities in two phases; Calpine's Moapa Energy Center ("MEC") is scheduled to receive service under its TSA from facilities yet to be constructed in the second phase of the Centennial Project. Calpine has filed a protest to the petition asserting that Calpine will take service under the TSA if NPC proceeds to execute a purchase power agreement ("PPA") with MEC based on its winning bid in the Request for Proposals that NPC conducted in 2003. Calpine -34- also has taken the position that if NPC does not execute a PPA with MEC, it will terminate the TSA and any payment by Calpine would be limited to a pro rata allocation of costs incurred to date on the second phase of the project (approximately $4.5 million in total) among the three customers to be served. At this time, Calpine is unable to predict the final outcome of this proceeding or its impact on Calpine. On or about April 27, 2004, NPC alleged to FFIC that Calpine had defaulted on the TSA and made demand on FFIC for the full amount of the surety bond, $33,333,333.00. On April 29, 2004, FFIC filed a complaint for declaratory order in state superior court of Marin County, California in connection with this demand. FFIC's complaint asks that an order be issued declaring that it has no obligation to make payment under the bond. Further, if the court determines that FFIC does have an obligation to make payment, FFIC asks that an order be issued declaring that (i) Calpine has an obligation to replace it with funds equal to the amount of NPC's demand against the bond and (ii) Calpine is obligated to indemnify and hold FFIC harmless for all loss, costs and fees incurred as a result of the issuance of the bond. Calpine has filed its answer to the complaint arguing, among other items, that it did not default on its obligations under the TSA and therefore NPC is not entitled to make a demand upon the FFIC bond. At this time, Calpine is unable to predict the outcome of this proceeding or its impact on Calpine. Calpine Canada Natural Gas Partnership v. Enron Canada Corp. On February 6, 2002, Calpine Canada Natural Gas Partnership ("Calpine Canada") filed a complaint in the Alberta Court of Queens Branch alleging that Enron Canada Corp. ("Enron Canada") owed it approximately $1.5 million from the sale of gas in connection with two Master Firm gas Purchase and Sale Agreements. To date, Enron Canada has not sought bankruptcy relief and has counterclaimed in the amount of $18 million. Discovery is currently in progress, and the Company believes that Enron Canada's counterclaim is without merit and intends to vigorously defend against it. Jones v. Calpine Corporation. On June 11, 2003, the Estate of Darrell Jones and the Estate of Cynthia Jones filed a complaint against Calpine in the United States District Court for the Western District of Washington. Calpine purchased Goldendale Energy, Inc., a Washington corporation, from Darrell Jones. The agreement provided, among other things, that upon substantial completion of the Goldendale facility, Calpine would pay Mr. Jones (i) $6.0 million and (ii) $18.0 million less $0.2 million per day for each day that elapsed between July 1, 2002, and the date of substantial completion. Substantial completion of the Goldendale facility has not occurred and the daily reduction in the payment amount has reduced the $18.0 million payment to zero. The complaint alleges that by not achieving substantial completion by July 1, 2002, Calpine breached its contract with Mr. Jones, violated a duty of good faith and fair dealing, and caused an inequitable forfeiture. The complaint seeks damages in an unspecified amount in excess of $75,000. On July 28, 2003, Calpine filed a motion to dismiss the complaint for failure to state a claim upon which relief can be granted. The court granted Calpine's motion to dismiss the complaint on March 10, 2004. Plaintiffs filed a motion for reconsideration of the decision, which was denied. Subsequently, on June 7, 2004, plaintiffs filed a notice of appeal. Calpine also filed a motion to recover attorneys' fees from NESCO, which was recently granted at a reduced amount. Calpine still, however, expects to make the $6.0 million payment to the estates when the project is completed. In addition, the Company is involved in various other claims and legal actions arising out of the normal course of its business. The Company does not expect that the outcome of these proceedings will have a material adverse effect on its financial position or results of operations. 14. Operating Segments The Company is first and foremost an electric generating company. In pursuing this single business strategy, it is the Company's long-range objective to produce from its own natural gas reserves ("equity gas") at a level of up to 25% of its fuel consumption requirements. The Company's oil and gas production and marketing activity has reached the quantitative criteria to be considered a reportable segment under SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." The Company's segments are electric generation and marketing; oil and gas production and marketing; and corporate and other activities. Electric generation and marketing includes the development, acquisition, ownership and operation of power production facilities, and hedging, balancing, optimization, and trading activity transacted on behalf of the Company's power generation facilities. Oil and gas production includes the ownership and operation of gas fields, gathering systems and gas pipelines for internal gas consumption, third party sales and hedging, balancing, optimization, and trading activity transacted on behalf of the Company's oil and gas operations. Corporate activities and other consists primarily of financing activities, the Company's specialty data center engineering business, which was divested in the third quarter of 2003 and general and administrative costs. Certain costs related to company-wide -35- functions are allocated to each segment, such as interest expense, distributions on HIGH TIDES prior to October 1, 2003, and interest income, which are allocated based on a ratio of segment assets to total assets. The Company evaluates performance based upon several criteria including profits before tax. The financial results for the Company's operating segments have been prepared on a basis consistent with the manner in which the Company's management internally disaggregates financial information for the purposes of assisting in making internal operating decisions. Due to the integrated nature of the business segments, estimates and judgments have been made in allocating certain revenue and expense items, and reclassifications have been made to prior periods to present the allocation consistently.
Electric Oil and Gas Generation Production and Marketing and Marketing Corporate and Other Total ---------------------- ------------------ ------------------- ---------------------- 2004 2003 2004 2003 2004 2003 2004 2003 ---------- ---------- -------- -------- -------- --------- ---------- ---------- (In thousands) For the three months ended June 30, Total revenue from external customers.................... $2,274,080 $2,124,050 $ 26,069 $ 29,300 $ 14,485 $ 11,958 $2,314,634 $2,165,308 Intersegment revenue.......... -- -- 87,227 96,687 -- -- 87,227 96,687 Segment profit/(loss) before provision for income taxes... (216,195) 256 13,495 21,727 113,200 (43,083) (89,500) (21,100) Equipment cancellation and impairment cost.............. 7 19,222 -- -- -- -- 7 19,222 Electric Oil and Gas Generation Production and Marketing and Marketing Corporate and Other Total ---------------------- ------------------ ------------------- ---------------------- 2004 2003 2004 2003 2004 2003 2004 2003 ---------- ---------- -------- -------- -------- --------- ---------- ---------- (In thousands) For the six months ended June 30, Total revenue from external customers.................... $4,272,273 $4,261,529 $ 50,651 $ 55,210 $ 34,448 $ 14,501 $4,357,372 $4,331,240 Intersegment revenue.......... -- -- 167,337 223,044 -- -- 167,337 223,044 Segment profit/(loss) before provision for income taxes... (458,475) (73,165) 33,423 69,533 155,554 (85,878) (269,498) (89,510) Equipment cancellation and impairment cost.............. 2,367 19,309 -- -- -- -- 2,367 19,309 Electric Oil and Gas Corporate, Generation Production Other and and Marketing and Marketing Eliminations Total ------------- ------------- ------------ ------------- (In thousands) Total assets: June 30, 2004....................... $ 24,638,535 $ 1,631,915 $ 1,171,312 $ 27,441,762 December 31, 2003................... $ 24,067,448 $ 1,797,755 $ 1,438,729 $ 27,303,932
Intersegment revenues primarily relate to the use of internally produced gas for the Company's power plants. These intersegment revenues have been included in Total Revenue and Income before taxes in the oil and gas production and marketing reporting segment and eliminated in the Corporate and other reporting segment. 15. California Power Market California Refund Proceeding. On August 2, 2000, the California Refund Proceeding was initiated by a complaint made at FERC by San Diego Gas & Electric Company under Section 206 of the Federal Power Act alleging, among other things, that the markets operated by the California Independent System Operator ("CAISO") and the California Power Exchange ("CalPX") were dysfunctional. In addition to commencing an inquiry regarding the market structure, FERC established a refund effective period of October 2, 2000, to June 19, 2001, for sales made into those markets. -36- On December 12, 2002, the Administrative Law Judge ("ALJ") issued a Certification of Proposed Finding on California Refund Liability ("December 12 Certification") making an initial determination of refund liability. On March 26, 2003, FERC also issued an order adopting many of the ALJ's findings set forth in the December 12 Certification (the "March 26 Order"). In addition, as a result of certain findings by the FERC staff concerning the unreliability or misreporting of certain reported indices for gas prices in California during the refund period, FERC ordered that the basis for calculating a party's potential refund liability be modified by substituting a gas proxy price based upon gas prices in the producing areas plus the tariff transportation rate for the California gas price indices previously adopted in the refund proceeding. The Company believes, based on the available information, that any refund liability that may be attributable to it will increase modestly, from approximately $6.2 million to $8.4 million, after taking the appropriate set-offs for outstanding receivables owed by the CalPX and CAISO to Calpine. The Company has fully reserved the amount of refund liability that by its analysis would potentially be owed under the refund calculation clarification in the March 26 order. The final determination of the refund liability is subject to further Commission proceedings to ascertain the allocation of payment obligations among the numerous buyers and sellers in the California markets. At this time, the Company is unable to predict the timing of the completion of these proceedings or the final refund liability. Thus the impact on the Company's business is uncertain at this time. On April 26, 2004, Dynegy Inc. entered into a settlement of the California Refund Proceeding and other proceedings with California governmental entities and the three California investor-owned utilities. The California governmental entities include the Attorney General, the California Public Utilities Commission ("CPUC"), the California Department of Water Resources ("CDWR"), and the California Electricity Oversight Board. Also, on April 27, 2004, The Williams Companies, Inc. ("Williams") entered into a settlement of the California Refund Proceeding and other proceedings with the three California investor-owned utilities; previously, Williams had entered into a settlement of the same matters with the California governmental entities. The Williams settlement with the California governmental entities was similar to the settlement that Calpine entered into with the California governmental entities on April 22, 2002. Calpine's settlement was approved by FERC on March 26, 2004, in an order which partially dismissed Calpine from the California Refund Proceeding to the extent that any refunds are owed for power sold by Calpine to CDWR or any other agency of the State of California. On June 30, 2004, a settlement conference was convened at the FERC to explore settlements among additional parties. FERC Investigation into Western Markets. On February 13, 2002, FERC initiated an investigation of potential manipulation of electric and natural gas prices in the western United States. This investigation was initiated as a result of allegations that Enron and others used their market position to distort electric and natural gas markets in the West. The scope of the investigation is to consider whether, as a result of any manipulation in the short-term markets for electric energy or natural gas or other undue influence on the wholesale markets by any party since January 1, 2000, the rates of the long-term contracts subsequently entered into in the West are potentially unjust and unreasonable. FERC has stated that it may use the information gathered in connection with the investigation to determine how to proceed on any existing or future complaint brought under Section 206 of the Federal Power Act involving long-term power contracts entered into in the West since January 1, 2000, or to initiate a Federal Power Act Section 206 or Natural Gas Act Section 5 proceeding on its own initiative. On August 13, 2002, the FERC staff issued the Initial Report on Company-Specific Separate Proceedings and Generic Reevaluations; Published Natural Gas Price Data; and Enron Trading Strategies (the "Initial Report") summarizing its initial findings in this investigation. There were no findings or allegations of wrongdoing by Calpine set forth or described in the Initial Report. On March 26, 2003, the FERC staff issued a final report in this investigation (the "Final Report"). The FERC staff recommended that FERC issue a show cause order to a number of companies, including Calpine, regarding certain power scheduling practices that may have been be in violation of the CAISO's or CalPX's tariff. The Final Report also recommended that FERC modify the basis for determining potential liability in the California Refund Proceeding discussed above. Calpine believes that it did not violate these tariffs and that, to the extent that such a finding could be made, any potential liability would not be material. Also, on June 25, 2003, FERC issued a number of orders associated with these investigations, including the issuance of two show cause orders to certain industry participants. FERC did not subject Calpine to either of the show cause orders. FERC also issued an order directing the FERC Office of Markets and Investigations to investigate further whether market participants who bid a price in excess of $250 per megawatt hour into markets operated by either the CAISO or the CalPX during the period of May 1, 2000, to October 2, 2000, may have violated CAISO and CalPX tariff prohibitions. No individual market participant was identified. The Company believes that it did not violate the CAISO and CalPX tariff prohibitions referred to by FERC in this order; however, the Company is unable to predict at this time the final outcome of this proceeding or its impact on Calpine. -37- CPUC Proceeding Regarding QF Contract Pricing for Past Periods. The Company's Qualifying Facilities ("QF") contracts with PG&E provide that the CPUC has the authority to determine the appropriate utility "avoided cost" to be used to set energy payments for certain QF contracts by determining the short run avoided cost ("SRAC") energy price formula. In mid-2000 the Company's QF facilities elected the option set forth in Section 390 of the California Public Utility Code, which provides QFs the right to elect to receive energy payments based on the CalPX market clearing price instead of the price determined by SRAC. Having elected such option, the Company was paid based upon the PX zonal day-ahead clearing price ("PX Price") from summer 2000 until January 19, 2001, when the PX ceased operating a day-ahead market. The CPUC has conducted proceedings (R.99-11-022) to determine whether the PX Price was the appropriate price for the energy component upon which to base payments to QFs which had elected the PX-based pricing option. The CPUC at one point issued a proposed decision to the effect that the PX Price was the appropriate price for energy payments under the California Public Utility Code but tabled it, and a final decision has not been issued to date. Therefore, it is possible that the CPUC could order a payment adjustment based on a different energy price determination. On April 29, 2004, PG&E, The Utility Reform Network, which is a consumer advocacy group, and the Office of Ratepayer Advocates, which is an independent consumer advocacy department of the CPUC, (collectively, the "PG&E Parties") filed a Motion for Briefing Schedule Regarding True-Up of Payments to QF Switchers (the "April 29 Motion"). The April 29 Motion requests that the CPUC set a briefing schedule under the R.99-11-022 to determine refund liability of the QFs who had switched to the PX Price during the period of June 1, 2000, until January 19, 2001. The PG&E Parties allege that refund liability be determined using the methodology that has been developed thus far in the California Refund Proceeding discussed above. The Company believes that the PX Price was the appropriate price for energy payments and that the basis for any refund liability based on the interim determination by FERC in the California Refund Proceeding is unfounded, but there can be no assurance that this will be the outcome of the CPUC proceedings. Geysers Reliability Must Run Section 206 Proceeding. CAISO, California Electricity Oversight Board, Public Utilities Commission of the State of California, Pacific Gas and Electric Company, San Diego Gas & Electric Company, and Southern California Edison (collectively referred to as the "Buyers Coalition") filed a complaint on November 2, 2001 at the FERC requesting the commencement of a Federal Power Act Section 206 proceeding to challenge one component of a number of separate settlements previously reached on the terms and conditions of "reliability must run" contracts ("RMR Contracts") with certain generation owners, including Geysers Power Company, LLC, which settlements were also previously approved by the FERC. RMR Contracts require the owner of the specific generation unit to provide energy and ancillary services when called upon to do so by the ISO to meet local transmission reliability needs or to manage transmission constraints. The Buyers Coalition has asked FERC to find that the availability payments under these RMR Contracts are not just and reasonable. Geysers Power Company, LLC filed an answer to the complaint in November 2001. To date, FERC has not established a Section 206 proceeding. The outcome of this litigation and the impact on the Company's business cannot be determined at the present time. 16. Subsequent Events On July 1, 2004, the Company exchanged 4.2 million shares of Calpine common stock in privately negotiated transactions for approximately $20.0 million par value of HIGH TIDES I. On August 5, 2004, the Company announced that its newly created entity, Calpine Energy Management ("CEM"), entered into a $250.0 million letter of credit facility with Deutsche Bank (rated Aa3/AA-) that expires in October 2005. Deutsche Bank will guarantee CEM's power and gas obligations by issuing letters of credit. Receivables generated through power sales will serve as collateral to support the letters of credit. The Company expects the new credit enhancement structure to improve spark spreads and increase working capital at CES. The Company is currently evaluating the sale of its natural gas reserves located in Alberta, Canada, as well as the Company's 25% interest in reserves owned by the CNG Trust. In addition, the Company is evaluating the sale of certain of its unidentified U.S. natural gas reserves. Related to the potential sale of the gas reserves, the Company is working on the restructuring of a major power contract from a fixed price agreement to a capacity and variable energy arrangement. Item 2. Management's Discussion and Analysis ("MD&A") of Financial Condition and Results of Operations. In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as "believe," "intend," "expect," "anticipate," "plan," "may," "will" and similar expressions to identify forward-looking statements. Such statements include, among others, those concerning our expected financial performance and strategic and operational plans, as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are -38- cautioned that any such forward-looking statements are not guarantees of future performance and that a number of risks and uncertainties could cause actual results to differ materially from those anticipated in the forward-looking statements. Such risks and uncertainties include, but are not limited to, (i) the timing and extent of deregulation of energy markets and the rules and regulations adopted on a transitional basis with respect thereto, (ii) the timing and extent of changes in commodity prices for energy, particularly natural gas and electricity, and the impact of related derivatives transactions, (iii) unscheduled outages of operating plants, (iv) unseasonable weather patterns that reduce demand for power, (v) economic slowdowns that can adversely affect consumption of power by businesses and consumers, (vi) various development and construction risks that may delay or prevent commercial operations of new plants, such as failure to obtain the necessary permits to operate, failure of third-party contractors to perform their contractual obligations or failure to obtain project financing on acceptable terms, (vii) uncertainties associated with cost estimates, that actual costs may be higher than estimated, (viii) development of lower-cost power plants or of a lower cost means of operating a fleet of power plants by our competitors, (ix) risks associated with marketing and selling power from power plants in the evolving energy market, (x) factors that impact exploitation of oil or gas resources, such as the geology of a resource, the total amount and costs to develop recoverable reserves, and legal title, regulatory, gas administration, marketing and operational factors relating to the extraction of natural gas, (xi) uncertainties associated with estimates of oil and gas reserves, (xii) the effects on our business resulting from reduced liquidity in the trading and power generation industry, (xiii) our ability to access the capital markets on attractive terms or at all, (xiv) uncertainties associated with estimates of sources and uses of cash, that actual sources may be lower and actual uses may be higher than estimated, (xv) the direct or indirect effects on our business of a lowering of our credit rating (or actions we may take in response to changing credit rating criteria), including increased collateral requirements, refusal by our current or potential counterparties to enter into transactions with us and our inability to obtain credit or capital in desired amounts or on favorable terms, (xvi) present and possible future claims, litigation and enforcement actions, (xvii) effects of the application of regulations, including changes in regulations or the interpretation thereof, and (xviii) other risks identified in this report. You should also carefully review the risks described in other reports that we file with the Securities and Exchange Commission, including without limitation our annual report on Form 10-K for the year ended December 31, 2003, and our quarterly report on Form 10-Q for the three months ended March 31, 2004. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future developments or otherwise. We file annual, quarterly and periodic reports, proxy statements and other information with the SEC. You may obtain and copy any document we file with the SEC at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the SEC's public reference facilities by calling the SEC at 1-800-SEC-0330. You can request copies of these documents, upon payment of a duplicating fee, by writing to the SEC at its principal office at 450 Fifth Street, N.W., Washington, D.C. 20549-1004. The SEC maintains an Internet website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. Our SEC filings are accessible through the Internet at that website. Our reports on Forms 10-K, 10-Q and 8-K, and amendments to those reports, are available for download, free of charge, as soon as reasonably practicable after these reports are filed with the SEC, at our website at www.calpine.com. The content of our website is not a part of this report. You may request a copy of our SEC filings, at no cost to you, by writing or telephoning us at: Calpine Corporation, 50 West San Fernando Street, San Jose, California 95113, attention: Lisa M. Bodensteiner, Assistant Secretary, telephone: (408) 995-5115. We will not send exhibits to the documents, unless the exhibits are specifically requested and you pay our fee for duplication and delivery. Selected Operating Information Set forth below is certain selected operating information for our power plants for which results are consolidated in our Consolidated Condensed Statements of Operations. Electricity revenue is composed of fixed capacity payments, which are not related to production, and variable energy payments, which are related to production. Capacity revenues include, besides traditional capacity payments, other revenues such as Reliability Must Run and Ancillary Service revenues. The information set forth under thermal and other revenue consists of host steam sales and other thermal revenue ( in thousands except production and pricing data). -39-
Three Months Ended Six Months Ended June 30, June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Power Plants: Electricity and steam ("E&S") revenues: Energy................................................ $ 964,066 $ 714,237 $ 1,896,562 $ 1,529,047 Capacity.............................................. 228,200 220,414 409,664 377,857 Thermal and other..................................... 120,526 111,609 252,452 239,424 ------------ ------------ ------------ ------------ Subtotal.............................................. $ 1,312,792 $ 1,046,260 $ 2,558,678 $ 2,146,328 Spread on sales of purchased power(1).................... 51,483 6,086 56,572 7,421 ------------ ------------ ------------ ------------ Adjusted E&S revenues (non-GAAP)......................... $ 1,364,275 $ 1,052,346 $ 2,615,250 $ 2,153,749 Megawatt hours produced.................................. 22,082,911 17,518,737 43,131,994 36,622,157 All-in electricity price per megawatt hour generated..... $ 61.78 $ 60.07 $ 60.63 $ 58.81 - ------------ (1) From hedging, balancing and optimization activities related to our generating assets.
Set forth below is a table summarizing the dollar amounts and percentages of our total revenue for the three and six months ended June 30, 2004 and 2003, that represent purchased power and purchased gas sales for hedging and optimization and the costs we incurred to purchase the power and gas that we resold during these periods (in thousands, except percentage data):
Three Months Ended Six Months Ended June 30, June 30, -------------------------- -------------------------- 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Total revenue............................................ $ 2,314,634 $ 2,165,308 $ 4,357,372 $ 4,331,240 Sales of purchased power for hedging and optimization (1).................................... 496,652 744,805 876,680 1,426,089 As a percentage of total revenue......................... 21.5% 34.4% 20.1% 33.0% Sale of purchased gas for hedging and optimization........................................ 481,971 328,478 834,708 655,945 As a percentage of total revenue......................... 20.8% 15.2% 19.2% 15.1% Total cost of revenue ("COR")............................ 2,246,944 1,989,715 4,169,139 3,990,510 Purchased power expense for hedging and optimization (1).................................... 445,169 738,719 820,108 1,418,668 As a percentage of total COR............................. 19.8% 37.1% 19.7% 35.6% Purchased gas expense for hedging and optimization........................................ 453,922 331,122 814,409 648,070 As a percentage of total COR............................. 20.2% 16.6% 19.5% 16.2% - ------------ (1) On October 1, 2003, we adopted on a prospective basis Emerging Issues Task Force ("EITF") Issue No. 03-11 "Reporting Realized Gains and Losses on Derivative Instruments That Are Subject to FASB Statement No. 133 and Not `Held for Trading Purposes' As defined in EITF Issue No. 02-3: "Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities" ("EITF Issue No. 03-11") and netted purchased power expense against sales of purchased power. See Note 2 of the Notes to Consolidated Financial Statements for a discussion of our application of EITF Issue No. 03-11.
The primary reasons for the significant levels of these sales and costs of revenue items include: (a) significant levels of hedging, balancing and optimization activities by our Calpine Energy Services, L.P. ("CES") risk management organization; (b) particularly volatile markets for electricity and natural gas, which prompted us to frequently adjust our hedge positions by buying power and gas and reselling it; (c) the accounting requirements under Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," and EITF Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Asset," under which we show many of our hedging contracts on a gross basis (as opposed to netting sales and cost of revenue); and (d) rules in effect associated with the NEPOOL market in New England, which require that all power generated in NEPOOL be sold directly to the Independent System Operator ("ISO") in that market; we then buy from the ISO to serve our customer contracts. Generally accepted accounting principles required us to account for this activity, which applies to three of our merchant generating facilities, as the aggregate of two distinct sales and one purchase until our prospective -40- adoption of EITF Issue No. 03-11 on October 1, 2003. This gross basis presentation increases revenues but not gross profit. The table below details the financial extent of our transactions with NEPOOL for all financial periods prior to the adoption of EITF Issue No. 03-11. Our entrance into the NEPOOL market began with our acquisition of the Dighton, Tiverton and Rumford facilities on December 15, 2000.
Three Months Ended Six Months Ended June 30, 2003 June 30,2003 ------------------ ---------------- (In thousands) Sales to NEPOOL from power we generated............................. $ 75,642 $ 152,540 Sales to NEPOOL from hedging and other activity..................... 22,952 105,963 ---------- ---------- Total sales to NEPOOL............................................ $ 98,594 $ 258,503 Total purchases from NEPOOL...................................... $ 76,697 $ 210,865
Overview Our core business and primary source of revenue is the generation and delivery of electric power. We provide power to our U.S., Canadian and U.K. customers through the development and construction, or acquisition, and operation of efficient and environmentally friendly electric power plants fueled primarily by natural gas and, to a much lesser degree, by geothermal resources. We own and produce natural gas and to a lesser extent oil, which we use primarily to lower our costs of power production and provide a natural hedge of fuel costs for our electric power plants, but also to generate some revenue through sales to third parties. We protect and enhance the value of our electric and gas assets with a sophisticated risk management organization. We also protect our power generation assets and control certain of our costs by producing certain of the combustion turbine replacement parts that we use at our power plants, and we generate revenue by providing combustion turbine parts to third parties. Finally, we offer services to third parties to capture value in the skills we have honed in building, commissioning and operating power plants. Our key opportunities and challenges include: o preserving and enhancing our liquidity while spark spreads (the differential between power revenues and fuel costs) are depressed, o selectively adding new load-serving entities and power users to our satisfied customer list as we increase our power contract portfolio, o continuing to add value through prudent risk management and optimization activities, and o lowering our costs of production through various efficiency programs. Since the latter half of 2001, there has been a significant contraction in the availability of capital for participants in the energy sector. This has been due to a range of factors, including uncertainty arising from the collapse of Enron Corp. and a perceived near-term surplus supply of electric generating capacity. These factors have continued through 2003 and into 2004, during which decreased spark spreads have adversely impacted our liquidity and earnings. While we have been able to continue to access the capital and bank credit markets on attractive terms, we recognize that the terms of financing available to us in the future may not be attractive. To protect against this possibility and due to current market conditions, we scaled back our capital expenditure program to enable us to conserve our available capital resources. Set forth below are the Results of Operations for the three and six months ended June 30, 2004 and 2003. Results of Operations Three Months Ended June 30, 2004, Compared to Three Months Ended June 30, 2003 (in millions, except for unit pricing information, percentages and MW volumes). Revenue
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Total revenue................................................ $ 2,314.6 $ 2,165.3 $ 149.3 6.9%
-41- The increase in total revenue is explained by category below.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Electricity and steam revenue................................ $ 1,312.8 $ 1,046.3 $ 266.5 25.5% Sales of purchased power for hedging and optimization........ 496.6 744.8 (248.2) (33.3)% ----------- ----------- ---------- Total electric generation and marketing revenue........... $ 1,809.4 $ 1,791.1 $ 18.3 1.0% =========== =========== ==========
Electricity and steam revenue increased as we completed construction and brought into operation 4 new baseload power plants and 2 expansion projects completed subsequent to June 30, 2003. Average megawatts in operation of our consolidated plants increased by 26.7% to 24,357 MW while generation increased by 26.1%. Average realized electric price, before the effects of hedging, balancing and optimization, decreased from $59.72/MWh in 2003 to $59.45/MWh in 2004. Sales of purchased power for hedging and optimization decreased in the three months ended June 30, 2004, due primarily to netting approximately $322.0 of sales of purchased power with purchase power expense in the quarter ended June 30, 2004, in connection with the adoption of EITF Issue No. 03-11 on a prospective basis in the fourth quarter of 2003. The decrease was partly offset by higher realized prices on hedging, balancing and optimization activities. Without this netting, sales of purchased power would have increased by $73.8 or 9.9%.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Oil and gas sales............................................ $ 26.0 $ 29.3 $ (3.3) (11.3)% Sales of purchased gas for hedging and optimization.......... 482.0 328.5 153.5 46.7% ----------- ----------- ---------- Total oil and gas production and marketing revenue........ $ 508.0 $ 357.8 $ 150.2 42.0% =========== =========== ==========
Oil and gas sales are net of internal consumption, which is eliminated in consolidation. Internal consumption decreased from $96.7 in 2003 to $87.2 in 2004 primarily as a result of lower production following asset sales in October 2003, and again in February 2004, to the Calpine Natural Gas Trust in Canada. Before intercompany eliminations oil and gas sales decreased from $126.0 in 2003 to $113.2 in 2004. Sales of purchased gas for hedging and optimization increased during 2004 due to higher volumes and higher prices of natural gas as compared to the same period in 2003.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Realized gain on power and gas trading transactions, net..... $ 6.3 $ 9.0 $ (2.7) (30.0)% Unrealized loss on power and gas transactions, net........... (28.9) (7.2) (21.7) 301.4% ----------- ----------- ---------- Mark-to-market activities, net............................ $ (22.6) $ 1.8 $ (24.4) (1,355.5)% =========== =========== ==========
Mark-to-market activities, which are shown on a net basis, result from general market price movements against our open commodity derivative positions, including positions accounted for as trading under EITF Issue No. 02-3, "Issues Related to Accounting for Contracts Involved in Energy Trading and Risk Management Activities" ("EITF Issue No. 02-3") and other mark-to-market activities. These commodity positions represent a small portion of our overall commodity contract position. Realized revenue represents the portion of contracts actually settled, while unrealized revenue represents changes in the fair value of open contracts, and the ineffective portion of cash flow hedges. -42- The decrease in mark-to-market activities revenue in the three months ended June 30, 2004, as compared to the same period in 2003 is due primarily to unfavorable price movements which reduced the fair values of certain commodity derivative instruments.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Other revenue................................................ $ 19.8 $ 14.6 $ 5.2 35.6%
Other revenue increased during the three months ended June 30, 2004, primarily due to an increase of $3.9 of revenue derived from management services performed by our wholly owned subsidiary Calpine Power Services, LLC ("CPS"), and an increase of $1.3 of revenue from Thomassen Turbine Systems, ("TTS"), which we acquired in February 2003. Cost of Revenue
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Cost of revenue.............................................. $ 2,246.9 $ 1,989.7 $ 257.2 12.9%
The increase in total cost of revenue is explained by category below.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Plant operating expense...................................... $ 223.6 $ 159.6 $ 64.0 40.1% Transmission purchase expense................................ 14.7 11.3 3.4 30.1% Royalty expense.............................................. 6.9 6.5 0.4 6.2% Purchased power expense for hedging and optimization......... 445.2 738.7 (293.5) (39.7)% ----------- ----------- ---------- Total electric generation and marketing expense........... $ 690.4 $ 916.1 $ (225.7) (24.6)% =========== =========== ==========
Plant operating expense increased due to the addition of 4 new baseload power plants and 2 expansion projects completed subsequent to June 30, 2003. The addition of these units resulted in a 26.7% increase in average consolidated operating capacity. Additionally, major maintenance costs increased by $40.7 as more plants commissioned in recent years underwent initial major maintenance work. Transmission purchase expense increased primarily due to additional power plants achieving commercial operation subsequent to June 30, 2003. Royalty expense increased primarily due to an increase in electric revenues at The Geysers geothermal plants and due to an increase in contingent purchase price payments to the previous owner of the Texas City Power Plant, which are based on a percentage of gross revenues at this plant. At The Geysers royalties are paid mostly as a percentage of geothermal electricity revenues. Purchased power expense for hedging and optimization decreased during the three months ended June 30, 2004, as compared to the same period in 2003 due primarily to netting $322.0 of purchased power expense against sales of purchased power in the quarter ended June 30, 2004, in connection with the adoption of EITF Issue No. 03-11 in the fourth quarter of 2003, partly offset by higher realized prices on hedging, balancing and optimization activities. -43-
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Oil and gas production expense............................... $ 20.7 $ 22.5 $ (1.8) (8.0)% Oil and gas exploration expense.............................. 2.7 6.5 (3.8) (58.5)% Oil and gas operating expense............................. 23.4 29.0 (5.6) (19.3)% Purchased gas expense for hedging and optimization........... 453.9 331.1 122.8 37.1% ----------- ----------- ---------- Total oil and gas operating and marketing expense....... $ 477.3 $ 360.1 $ 117.2 32.5% =========== =========== ==========
Oil and gas production expense decreased during the three months ended June 30, 2004, as compared to the same period in 2003 primarily due to lower lease operating expense primarily due to the sale of properties in the fourth quarter of 2003 and the first quarter in 2004. Oil and gas exploration expense decreased primarily as a result of a decrease in dry hole cost. Purchased gas expense for hedging and optimization increased during the three months ended June 30, 2004, due to higher volumes and higher prices for natural gas as compared to the same period in 2003.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Fuel expense Cost of oil and gas burned by power plants................. $ 886.2 $ 535.6 $ 350.6 65.5% Recognized (gain) loss on gas hedges....................... (18.4) 3.8 (22.2) (584.2)% ----------- ----------- ---------- Total fuel expense...................................... $ 867.8 $ 539.4 $ 328.4 60.9% =========== =========== ==========
Cost of oil and gas burned by power plants increased during the three months ended June 30, 2004 as compared to the same period in 2003 due to a 32% increase in gas consumption and 22% higher prices excluding the effects of hedging, balancing and optimization. We recognized a gain on gas hedges during the three months ended June 30, 2004, as compared to a loss during the same period in 2003 due to favorable gas price movements against our gas financial instrument positions.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Depreciation, depletion and amortization expense............. $ 161.8 $ 139.0 $ 22.8 16.4%
Depreciation, depletion and amortization expense increased primarily due to the additional power facilities in consolidated operations subsequent to June 30, 2003.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Operating lease expense...................................... $ 27.0 $ 28.2 $ (1.2) (4.3)%
Operating lease expense decreased from the prior year as the King City lease was restructured in May 2004 and began to be accounted for as a capital lease at that point. Therefore, we began to cease incurring operating lease expense on that lease and instead began to incur depreciation and interest expense. -44-
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Other cost of revenue........................................ $ 22.6 $ 6.9 $ 15.7 227.5%
Other cost of revenue increased during the three months ended June 30, 2004, as compared to the same period in 2003 due primarily to $1.1 of additional expense from Power Systems Manufacturing, LLC ("PSM") and $8.0 of amortization expense incurred from the adoption of Derivatives Implementation Group ("DIG") Issue No. C20, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and Closely Related in Paragraph 10(b) regarding Contracts with a Price Adjustment Feature." In the fourth quarter of 2003, we recorded a pre-tax mark-to-market gain of $293.4 as the cumulative effect of a change in accounting principle. This gain is amortized as expense over the respective lives of the two power sales contracts from which the mark-to-market gains arose. Additionally, we incurred $3.8 of higher expenses at CPS, and we incurred $2.5 of insurance expense in our captive insurance company related to a property claim at the Acadia project. (Income)/Expenses
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Loss (income) from unconsolidated investments in power projects.............................................. $ 0.7 $ (59.4) $ 60.1 (101.2)%
During the three months ended June 30, 2003, a $52.8 gain on the termination of the tolling arrangement with Aquila Merchant Services, Inc. was recognized on the Acadia Power Plant. Also, we recognized $4.0 less income on the Aries investment, which we began to consolidate in March 2004 when we purchased the remaining 50% interest from Aquila.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Equipment cancellation and asset impairment cost............. $ -- $ 19.2 $ (19.2) (100.0)%
Equipment cancellation and asset impairment charge decreased during the three months ended June 30, 2004, as compared to the same period in 2003 primarily as a result of a loss recognized in 2003 of $17.2 in connection with the sale of two turbines and also commitment cancellation costs and storage and suspension costs related to unassigned equipment in 2003.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Project development expense.................................. $ 4.0 $ 6.1 $ (2.1) (34.4)%
Project development expense decreased during the three months ended June 30, 2004, primarily due to the write-off in 2003 of $3.4 of costs on the canceled Stony Brook expansion project.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Research and development expense............................. $ 5.1 $ 2.5 $ 2.6 104%
-45- Research and development expense increased during the three months ended June 30, 2004, as compared to the same period in 2003 primarily due to increased personnel expenses related to new research and development programs at our PSM subsidiary.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Sales, general and administrative expense.................... $ 61.0 $ 53.7 $ 7.3 13.6%
Sales, general and administrative expense increased during the three months ended June 30, 2004, primarily due to an increase in employee, consulting, rent, insurance and other professional fees. Over half of the variance is directly attributable to the Sarbanes-Oxley Section 404 internal controls project and audit work related thereto.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Interest expense............................................. $ 279.7 $ 148.9 $ 130.8 87.8%
Interest expense increased partially as a result of new plants that entered commercial operations (at which point capitalization of interest expense ceases). Interest capitalized decreased from $116.5 for the three months ended June 30, 2003, to $102.2 for the three months ended June 30, 2004. The remaining increase relates to a 12% increase in average indebtedness excluding the effect of the deconsolidation of the Calpine Capital Trusts, an increase in the amortization of terminated interest rate swaps and the recording of interest expense on debt to the three Calpine Capital Trusts due to the adoption of FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB 51" ("FIN 46") prospectively on October 1, 2003. See Note 2 of the Notes to Consolidated Condensed Financial Statements for a discussion of our adoption of FIN 46. We expect that interest expense will continue to increase and the amount of interest capitalized will decrease in future periods as our plants in construction are completed. Finally, our average interest rate increased by approximately 1.4% due to refinancings, such as the CalGen facilities, at higher rates.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Distributions on Trust Preferred Securities.................. $ -- $ 15.7 $ (15.7) (100)%
As a result of the deconsolidation of the three Calpine Capital Trusts upon adoption of FIN 46 as of October 1, 2003, the distributions paid on the Trust Preferred Securities during the three months ended June 30, 2004, were no longer recorded on our books and were replaced prospectively by interest expense on our debt to the Calpine Capital Trusts.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Interest (income)............................................ $ (9.9) $ (9.0) $ (0.9) 10.0%
Interest (income) increased during the three months ended June 30, 2004, due to an increase in cash and equivalents and restricted cash balances as compared to the same period in 2003. -46-
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Minority interest expense.................................... $ 4.7 $ 5.3 $ (0.6) (11.3)%
Minority interest expense decreased during the three months ended June 30, 2004, as compared to the same period in 2003 primarily due to a change in accounting for the preferred interest at King City under SFAS No. 150 to debt with interest expense instead of minority interest expense prior to the adoption of SFAS No. 150.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ (Income) from repurchases of various issuances of debt....... $ (2.6) $ (6.8) $ 4.2 (61.8)%
Income from repurchases of various issuances of debt during the three months ended June 30, 2004, decreased primarily as a result of $2.3 of higher deferred financing cost write-offs associated with repurchases and due to the fact that in 2003 senior notes repurchased were trading at a higher discount to face value.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Other expense (income)....................................... $ (185.6) $ 20.5 $ (206.1) (1,005.4)%
Other income was $206.1 higher in the three months ended June 30, 2004, compared to the prior year due primarily due to pre-tax income in the amount of $171.5 associated with the restructuring of a power purchase agreement for our Newark and Parlin power plants and the sale of a wholly owned subsidiary of CES, Utility Contract Funding II ("UCF"), net of transaction costs and the write-off of unamortized deferred financing costs, $16.4 pre-tax gain from the restructuring of a long-term gas supply contract, and a $12.3 pre-tax gain from the King City restructuring transaction related to the sale of our debt securities that had served as collateral under the King City lease, net of transaction costs.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Benefit for income taxes..................................... $ (60.6) $ (4.7) $ (55.9) 1,189.4%
For the three months ended June 30, 2004, the effective rate increased to 68% as compared to 22% for the three months ended June 30, 2003. This effective rate increase is due to the consideration of estimated full year earnings in estimating, and truing up to on a year-to-date basis, the annual effective rate and due to the effect of significant permanent items.
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Discontinued operations, net of tax.......................... $ 0.2 $ (7.0) $ (7.2) (102.9)%
During the three months ended June 30, 2003, discontinued operations activity included the effects of our sale of our 50% interest in the Lost Pines 1 Energy Center, the sale of our Alvin South Field oil and gas assets and the sale of our specialty data center engineering business. The sale of the Lost Pines 1 Energy Center closed in January 2004. -47-
Three Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Net loss..................................................... $ (28.7) $ (23.4) $ (5.3) 22.6%
We recorded a net loss of $28.7 for the three months ended June 30, 2004, compared to a net loss of $23.4 for the same period in 2003, as gross profit decreased by $107.9, or 61%, to $67.7. The gross profit decrease is the result of lower per megawatt-hour spark spreads realized during the three months ended June 30, 2004, and additional costs associated with new power plants coming on line. For the three months ended June 30, 2004, we generated 22.1 million megawatt-hours, which equated to a baseload capacity factor of 47%, and realized an average spark spread of $21.91 per megawatt-hour. For the same period in 2003, we generated 17.5 million megawatt-hours, which equated to a capacity factor of 48%, and realized an average spark spread of $26.93 per megawatt-hour. In the quarter ended June 30, 2004, we netted approximately $322.0 of sales of purchased power for hedging and optimization with purchased power expense. This was due to the adoption on October 1, 2003, on a prospective basis, of new accounting rules related to presentation of non-trading derivative activity. Without this netting, total revenue would have grown by approximately 21.8% versus 6.9% as reported. In the second quarter of 2004, as compared to the same period in 2003, generation did not increase commensurately with new average capacity coming on line (lower baseload capacity factor). Because of that and due to lower spark spreads per MWh, our spark spread margins did not keep pace with the additional operating and depreciation costs associated with the new capacity. Additional increases in power plant costs for the three months ended June 30, 2004, as compared to the three months ended June 30, 2003, include a $22.8 increase in depreciation expense and a $64.0 increase in plant operating expense. Also, during the three months ended June 30, 2004, financial results were affected by a $115.1 increase in interest expense and distributions on trust preferred securities, as compared to the same period in 2003. This occurred as a result of higher debt balances, higher average interest rates and lower capitalization of interest expense as new plants entered commercial operation. Other income was $206.1 higher in the three months ended June 30, 2004, for the reasons explained above. The results for the three months ended June 30, 2003, included a gain of approximately $0.10 per share, or $52.8, in connection with terminating a tolling arrangement with a unit of Aquila on the Acadia facility. Six Months Ended June 30, 2004, Compared to Six Months Ended June 30, 2003 (in millions, except for unit pricing information, percentages and MW volumes). Revenue
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Total revenue................................................ $ 4,357.4 $ 4,331.2 $ 26.2 0.6%
The increase in total revenue is explained by category below.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Electricity and steam revenue................................ $ 2,558.7 $ 2,146.3 $ 412.4 19.2% Sales of purchased power for hedging and optimization........ 876.7 1,426.1 (549.4) (38.5)% ----------- ----------- ---------- Total electric generation and marketing revenue........... $ 3,435.4 $ 3,572.4 $ (137.0) (3.8)% =========== =========== ==========
Electricity and steam revenue increased as we completed construction and brought into operation 4 new baseload power plants and 2 expansion projects completed subsequent to June 30, 2003. Average megawatts in operation of our consolidated plants increased by 23.9% to 23,134 MW while generation increased by 17.8%. The increase in generation lagged behind the increase in average MW in operation as our baseload capacity factor dropped to 48% in the six months ended June 30, 2004, from 52% in the six months ended June 30, 2003, primarily due to the increased occurrence of unattractive off-peak market spark spreads in certain areas reflecting mild weather in the first quarter of 2004 and -48- oversupply conditions which are expected to gradually work off over the next several years. This caused us to cycle off certain of our merchant plants without contracts in off-peak hours. Average realized electric price, before the effects of hedging, balancing and optimization, increased from $58.61/MWh in 2003 to $59.32/MWh in 2004. Sales of purchased power for hedging and optimization decreased in the six months ended June 30, 2004, due primarily to netting approximately $692.5 of sales of purchased power with purchase power expense in the quarter ended June 30, 2004, in connection with the adoption of EITF Issue No. 03-11 on a prospective basis in the fourth quarter of 2003 partly offset by higher volumes and higher realized prices on hedging, balancing and optimization activities. Without this netting, sales of purchased power would have increased by $143.1 or 10.0%.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Oil and gas sales............................................ $ 50.7 $ 55.2 $ (4.5) (8.2)% Sales of purchased gas for hedging and optimization.......... 834.7 656.0 178.7 27.2% ----------- ----------- ---------- Total oil and gas production and marketing revenue........ $ 885.4 $ 711.2 $ 174.2 24.4% =========== =========== ==========
Oil and gas sales are net of internal consumption, which is eliminated in consolidation. Internal consumption decreased primarily as a result of lower production following asset sales in October 2003 and again in February 2004 to the Calpine Natural Gas Trust in Canada, from $223.0 in 2003 to $167.3 in 2004. Before intercompany eliminations, oil and gas sales decreased by 21.6% or $60.2 to $218.0 in 2004 from $278.2 in 2003. Sales of purchased gas for hedging and optimization increased during 2004 due to higher volumes and higher prices of natural gas as compared to the same period in 2003.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Realized gain on power and gas trading transactions, net..... $ 23.8 $ 30.3 $ (6.5) (21.5)% Unrealized loss on power and gas transactions, net........... (33.9) (8.0) (25.9) 323.8% ----------- ----------- ---------- Mark-to-market activities, net............................ $ (10.1) $ 22.3 $ (32.4) (145.3)% =========== =========== ==========
Mark-to-market activities, which are shown on a net basis, result from general market price movements against our open commodity derivative positions, including positions accounted for as trading under EITF Issue No. 02-3, "Issues Related to Accounting for Contracts Involved in Energy Trading and Risk Management Activities" ("EITF Issue No. 02-3") and other mark-to-market activities. These commodity positions represent a small portion of our overall commodity contract position. Realized revenue represents the portion of contracts actually settled, while unrealized revenue represents changes in the fair value of open contracts, and the ineffective portion of cash flow hedges. The decrease in mark-to-market activities revenue in the six months ended June 30, 2004, as compared to the same period in 2003 is due primarily to unfavorable price movements which reduced the fair values of certain commodity derivative instruments.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Other revenue................................................ $ 46.7 $ 25.4 $ 21.3 83.9%
Other revenue increased during the six months ended June 30, 2004, primarily due to an increase of $13.5 of revenue from TTS, which we acquired in February 2003, and an increase of $5.3 of revenue from CPS. -49- Cost of Revenue
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Cost of revenue.............................................. $ 4,169.1 $ 3,990.5 $ 178.6 4.5%
The increase in total cost of revenue is explained by category below.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Plant operating expense...................................... $ 399.5 $ 321.6 $ 77.9 24.2% Transmission purchase expense................................ 31.1 20.2 10.9 54.0% Royalty expense.............................................. 12.8 11.8 1.0 8.5% Purchased power expense for hedging and optimization......... 820.1 1,418.6 (598.5) (42.2)% ----------- ----------- ---------- Total electric generation and marketing expense........... $ 1,263.5 $ 1,772.2 $ (508.7) (28.7)% =========== =========== ==========
Plant operating expense increased due to 4 new baseload power plants and 2 expansion projects completed subsequent to June 30, 2003. The addition of these units resulted in a 23.9% increase in average consolidated operating capacity. Additionally, major maintenance costs increased by $44.3 as more plants commissioned in recent years underwent initial major maintenance work. Transmission purchase expense increased primarily due to additional power plants achieving commercial operation subsequent to June 30, 2003. Approximately 71% of the first half of 2004 royalty expense is attributable to royalties paid to geothermal property owners at The Geysers, mostly as a percentage of geothermal electricity revenues. The increase in royalty expense in the first half of 2004 was due primarily to an increase in the accrual of contingent purchase price payments to the previous owners of the Texas City and Clear Lake Power Plants based on a percentage of gross revenues at these two plants. Purchased power expense for hedging and optimization decreased during the six months ended June 30, 2004, as compared to the same period in 2003 due primarily to netting $692.5 of purchased power expense against sales of purchased power in the quarter ended June 30, 2004, in connection with the adoption of EITF Issue No. 03-11 in the fourth quarter of 2003, partly offset by higher volumes and higher realized prices on hedging, balancing and optimization activities.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Oil and gas production expense............................... $ 41.4 $ 45.8 $ (4.4) (9.6)% Oil and gas exploration expense.............................. 4.4 8.9 (4.5) (50.6)% Oil and gas operating expense.............................. 45.8 54.7 (8.9) (16.3)% Purchased gas expense for hedging and optimization........... 814.4 648.1 166.3 25.7% ----------- ----------- ---------- Total oil and gas operating and marketing expense....... $ 860.2 $ 702.8 $ 157.4 22.4% =========== =========== ==========
Oil and gas production expense decreased during the six months ended June 30, 2004, as compared to the same period in 2003 primarily due to lower lease operating expense primarily due to the sale of properties in the fourth quarter of 2003. Oil and gas exploration expense decreased primarily as a result of a decrease in dry hole costs. Purchased gas expense for hedging and optimization increased during the six months ended June 30, 2004, due to higher volumes and higher prices of natural gas as compared to the same period in 2003. -50-
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Fuel expense Cost of oil and gas burned by power plants................. $ 1,648.3 $ 1,179.0 $ 469.3 39.8% Recognized (gain) loss on gas hedges....................... (17.8) (4.2) (13.6) 323.8% ----------- ----------- ---------- Total fuel expense...................................... $ 1,630.5 $ 1,174.8 $ 455.7 38.8% =========== =========== ==========
Cost of oil and gas burned by power plants increased during the six months ended June 30, 2004 as compared to the same period in 2003 due to an 27% increase in gas consumption and 9% higher prices for gas excluding the effects of hedging, balancing and optimization. We recognized a larger gain on gas hedges during the six months ended June 30, 2004, as compared to the same period in 2003 due to favorable gas price movements relative to our gas financial instrument positions.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Depreciation, depletion and amortization expense............. $ 311.2 $ 272.8 $ 38.4 14.1%
Depreciation, depletion and amortization expense increased primarily due to the additional power facilities in consolidated operations subsequent to June 30, 2003.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Operating lease expense...................................... $ 54.8 $ 55.9 $ (1.1) (2.0)%
Operating lease expense decreased from the prior year as the King City lease was restructured in May 2004 and began to be accounted for as a capital lease at that point. Therefore, we stopped incurring operating lease expense on that lease and instead began to incur depreciation and interest expense.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Other cost of revenue........................................ $ 49.0 $ 12.1 $ 36.9 305.0%
Other cost of revenue increased during the six months ended June 30, 2004, as compared to the same period in 2003 due primarily to $11.0 of additional expense from TTS and $16.8 of amortization expense incurred from the adoption of Derivatives Implementation Group ("DIG") Issue No. C20, "Scope Exceptions: Interpretation of the Meaning of Not Clearly and Closely Related in Paragraph 10(b) regarding Contracts with a Price Adjustment Feature." In the fourth quarter of 2003, we recorded a pre-tax mark-to-market gain of $293.4 as the cumulative effect of a change in accounting principle. This gain is amortized as expense over the respective lives of the two power sales contracts from which the mark-to-market gains arose. Additionally, we incurred $5.3 higher costs at CPS due to a higher level of activity in 2004. -51- (Income)/Expenses
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ (Income) from unconsolidated investments in power projects.............................................. $ (1.8) $ (64.5) $ 62.7 (97.2)%
During the six months ended June 30, 2003, a $52.8 gain on the termination of the tolling arrangement with Aquila Merchant Services, Inc. was recognized on the Acadia Power Plant. Also, in 2004 we recognized $6.4 less income on the Acadia investment, and $3.5 more loss from the Aries investment, which we began to consolidate in March 2004 when we purchased the remaining 50% interest from Aquila. In 2004, we recognized $2.6 of income on our interest in the Calpine Natural Gas Trust in Canada which was formed after June 30, 2003. This was offset by not having any income on the Gordonsville investment in 2004, as we sold our interests in this facility in November 2003. In the first half of 2003 we recognized $3.2 million of income on Gordonsville.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Equipment cancellation and asset impairment cost............. $ 2.4 $ 19.3 $ (16.9) (87.6)%
Equipment cancellation and asset impairment charge decreased during the six months ended June 30, 2004, as compared to the same period in 2003 as a result of a loss recognized in 2003 of $17.2 from the sale of two turbines. In 2004 we incurred costs in connection with the termination of a purchase contract for heat recovery steam generator components.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Project development expense.................................. $ 11.7 $ 11.2 $ 0.5 4.5%
Project development expense increased during the six months ended June 30, 2004, partly due to higher costs associated with cancelled projects.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Research and development expense............................. $ 8.9 $ 4.9 $ 4.0 81.6%
Research and development expense increased during the six months ended June 30, 2004, as compared to the same period in 2003 primarily due to increased personnel expenses related to new research and development programs at our PSM subsidiary.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Sales, general and administrative expense.................... $ 118.2 $ 97.4 $ 20.8 21.4%
Sales, general and administrative expense increased during the six months ended June 30, 2004, primarily due to an increase in employee, consulting, rent, insurance and other professional fees. Nearly a third of the variance is directly attributable to the Sarbanes-Oxley Section 404 internal control project and related audit work. -52-
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Interest expense............................................. $ 534.5 $ 291.8 $ 242.7 83.2%
Interest expense increased partially as a result of new plants that entered commercial operations (at which point capitalization of interest expense ceases). Interest capitalized decreased from $235.0 for the six months ended June 30, 2003, to $210.7 for the six months ended June 30, 2004. Additionally, we incurred approximately $12.5 in accelerated amortization of deferred financing costs due to the early refinancing of the CCFC II debt on March 23, 2004. The remaining increase relates to a 12% increase in average indebtedness due partially to the deconsolidation of the Calpine Capital Trusts and the recording of debt to the Calpine Capital Trusts due to the adoption of FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB 51" ("FIN 46") prospectively on October 1, 2003. See Note 2 of the Notes to Consolidated Condensed Financial Statements for a discussion of our adoption of FIN 46. We expect that interest expense will continue to increase and the amount of interest capitalized will decrease in future periods as our plants in construction are completed. And finally, our average interest rate increased by approximately 1.2% due to refinancings, such as the CalGen facilities, at higher rates.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Distributions on Trust Preferred Securities.................. $ -- $ 31.3 $ (31.3) (100)%
As a result of the deconsolidation of the Calpine Capital Trusts upon adoption of FIN 46 as of October 1, 2003, the distributions paid on the Trust Preferred Securities during the six months ended June 30, 2004, were no longer recorded on our books and were replaced prospectively by interest expense on our debt to the Calpine Capital Trusts.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Interest (income)............................................ $ (21.9) $ (17.0) $ (4.9) 28.8%
Interest (income) increased during the six months ended June 30, 2004, due to an increase in cash and equivalents and restricted cash balances as compared to the same period in 2003.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Minority interest expense.................................... $ 13.2 $ 7.6 $ 5.6 73.7%
Minority interest expense increased during the six months ended June 30, 2004, as compared to the same period in 2003 primarily due to an increase of $6.7 of minority interest expense associated with the Calpine Power Limited Partnership ("CLP"), which is 70% owned by CPIF. During 2003, as a result of a secondary offering of Calpine's interests in the Calpine Income Fund ("CFIF"), Calpine decreased its ownership interests in CLP to 30%, thus increasing minority interest expense. -53-
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ (Income) from repurchase of various issuances of debt........ $ (3.4) $ (6.8) $ 3.4 (50.0)%
Income from repurchases of various issuances of debt during the six months ended June 30, 2004, decreased primarily as a result of $7.6 of higher deferred financing cost write-offs associated with repurchases.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Other expense (income)....................................... $ (204.0) $ 55.1 $ (259.1) (470.2)%
Other income increased by $259.1 during the six months ended June 30, 2004, as compared to the same period in 2003, primarily due to pre-tax income in the amount of $171.5 associated with the restructuring of a power purchase agreement for our Newark and Parlin power plants and the sale of UCF, net of transaction costs and the write-off of unamortized deferred financing costs, $16.4 pre-tax gain from the restructuring of a long-term gas supply contract net of transaction costs, and a $12.3 pre-tax gain from the King City restructuring transaction related to the sale of the Company's debt securities that had served as collateral under the King City lease, net of transaction costs. Also, during the six months ended June 30, 2004, foreign currency transaction gains were $4.8 compared to a loss of $44.3 in the corresponding period in 2003.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Benefit for income taxes..................................... $ (146.0) $ (21.6) $ (124.4) 575.9%
For the six months ended June 30, 2004, the effective rate increased to 54% as compared to 24% for the six months ended June 30, 2003. This effective rate variance is due to the consideration of estimated year-end earnings in estimating the annual effective rate and due to the effect of significant permanent items.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Discontinued operations, net of tax.......................... $ 23.1 $ (8.0) $ 31.1 (388.8)%
In the first half of 2004, our discontinued operations was comprised primarily of the gain from the sale of our Lost Pines 1 Power Project. During the six months ended June 30, 2003, discontinued operations activity included the effects of our sale of our 50% interest in the Lost Pines 1 Energy Center, the sale of our Alvin South Field oil and gas assets and the sale of our specialty data center engineering business, reflecting the soft market for data centers for the foreseeable future.
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Cumulative effect of a change in accounting principle, net of tax.................................................. $ -- $ (0.5) $ 0.5 100.0%
The cumulative effect of a change in accounting principle, net of tax effect in 2003 resulted from adopting SFAS No. 143, "Accounting for Asset Retirement Obligations." -54-
Six Months Ended June 30, ------------------------ 2004 2003 $ Change % Change ----------- ----------- ----------- ------------ Net loss..................................................... $ (99.9) $ (75.4) $ (24.5) 32.5%
We recorded a net loss of $99.9 for the six months ended June 30, 2004, compared to a net loss of $75.4 for the six months ended June 30, 2003. Gross profit decreased by $152.5, or 45%, to $188.2. This decrease is the result of lower per megawatt-hour spark spreads realized during the six months ended June 30, 2004, and additional costs associated with new power plants coming on line. For the six months ended June 30, 2004, we generated 43.1 million megawatt-hours, which equated to a capacity factor of 48% and realized an average spark spread of $21.49 per megawatt-hour. For the same period in 2003, we generated 36.6 million megawatt-hours, which equated to a capacity factor of 52%, and realized an average spark spread of $24.83 per megawatt-hour. During the first six months of 2004, as compared to the same period in 2003, generation did not increase commensurately with new average capacity coming on line (lower baseload capacity factor). Because of that and due to lower spark spreads per MWh, our spark spread margins did not keep pace with the additional operating and depreciation costs associated with the new capacity. Additional increases in power plant costs for the six months ended June 30, 2004, as compared to the six months ended June 30, 2003, include a $38.4 increase in depreciation expense, a $77.9 increase in plant operating expense and a $10.9 increase in transmission purchase expense. Also, during the six months ended June 30, 2004, financial results were affected by a $211.3 increase in interest expense and distributions on trust preferred securities, as compared to the first six months of 2003. This occurred as a result of higher debt balances, higher average interest rates and lower capitalization of interest expense as new plants entered commercial operation. Other income increased $259.1 during the six months ended June 30, 2004, for the reasons explained above. Liquidity and Capital Resources Our business is capital intensive. Our ability to capitalize on growth opportunities is dependent on the availability of capital on attractive terms. The availability of such capital in today's environment is uncertain. To date, we have obtained cash from our operations; borrowings under our term loan and revolving credit facilities; issuance of debt, equity, trust preferred securities and convertible debentures; proceeds from sale/leaseback transactions; sale or partial sale of certain assets; contract monetizations and project financings. We have utilized this cash to fund our operations, service or prepay debt obligations, fund acquisitions, develop and construct power generation facilities, finance capital expenditures, support our hedging, balancing, optimization and trading activities at CES, and meet our other cash and liquidity needs. Our strategy is also to reinvest our cash from operations into our business development and construction program or to use it to reduce debt, rather than to pay cash dividends. As discussed below, we have a liquidity-enhancing program underway for funding the completion of our current construction portfolio, for refinancing and for general corporate purposes. Our $2.5 billion secured revolving construction financing facility through our wholly owned subsidiary Calpine Construction Finance Company II, LLC ("CCFC II") (renamed Calpine Generating Company, LLC ("CalGen")) was scheduled to mature in November 2004, requiring us to refinance this indebtedness. As of December 31, 2003, there was $2.3 billion outstanding under this facility including $53.2 million of letters of credit. On March 23, 2004, CalGen completed a secured institutional term loan and secured note financing, which replaced the old CCFC II facility. We realized total proceeds from the financing in the amount of $2.4 billion, before transaction costs and fees. The holders of our 4% Convertible Senior Notes Due 2006 ("2006 Convertible Senior Notes") have a right to require us to repurchase them at 100% of their principal amount plus any accrued and unpaid interest on December 26, 2004. We can effect the repurchase with cash, shares of Calpine stock or a combination of the two. In 2003 and 2004 we repurchased in open market and privately negotiated transactions approximately $1,127.9 million of the outstanding principal amount of 2006 Convertible Senior Notes, with proceeds of financings we consummated in July 2003, through equity swaps and with the proceeds of our offerings of our 4.75% Contingent Convertible Senior Notes Due 2023 ("2023 Convertible Notes") in November 2003. In addition, in February 2004, we initiated a cash tender offer for all of the outstanding 2006 Convertible Senior Notes for a price of par plus accrued interest. Approximately $409.4 million aggregate principal amount of the 2006 Convertible Senior Notes were tendered pursuant to the tender offer, for which we paid a total of $412.8 million (including accrued interest of $3.4 million). At June 30, 2004, 2006 Convertible Senior Notes in the aggregate principal amount of $72.1 million remain outstanding. -55- In addition, $276.0 million of our outstanding HIGH TIDES are scheduled to be remarketed no later than November 1, 2004, $360.0 million of our HIGH TIDES are scheduled to be remarketed no later than February 1, 2005 and $517.5 million of our HIGH TIDES are scheduled to be remarketed no later than August 1, 2005. In the event of a failed remarketing, the relevant HIGH TIDES will remain outstanding as convertible securities at a term rate equal to the treasury rate plus 6% per annum and with a term conversion price equal to 105% of the average closing price of our common stock for the five consecutive trading days after the applicable final failed remarketing termination date. While a failed remarketing of our HIGH TIDES would not have a material effect on our liquidity position, it would impact our calculation of diluted earnings per share and increase our interest expense. Even with a successful remarketing, we would expect to have an increased dilutive impact on our EPS based on a revised conversion ratio. See Note 3 of the Notes to Consolidated Condensed Financial Statements for a summary of HIGH TIDES repurchased by the Company through June 30, 2004. We expect to have sufficient liquidity from cash flow from operations, borrowings available under lines of credit, access to sale/leaseback and project financing markets, sale or monetization of certain assets and cash balances to satisfy all current obligations under our outstanding indebtedness, and to fund anticipated capital expenditures and working capital requirements for the next twelve months. On June 30, 2004, our liquidity totaled approximately $1.3 billion. This included cash and cash equivalents on hand of $0.8 billion, current portion of restricted cash and cash escrowed for debt repurchases of approximately $0.4 billion and approximately $0.1 billion of borrowing capacity under our various credit facilities. Cash Flow Activities -- The following table summarizes our cash flow activities for the periods indicated:
Six Months Ended June 30, ---------------------------- 2004 2003 ------------- ------------- (In thousands) Beginning cash and cash equivalents.................................. $ 991,806 $ 579,486 Net cash provided by (used in): Operating activities.............................................. 11,993 113,304 Investing activities.............................................. (167,391) (1,297,803) Financing activities.............................................. 20,769 1,017,314 Effect of exchange rates changes on cash and cash equivalents..... (13,146) 5,653 ------------ ------------ Net decrease in cash and cash equivalents......................... (147,775) (161,532) ------------ ------------ Ending cash and cash equivalents..................................... $ 844,031 $ 417,954 ============ ============
Operating activities for the six months ended June 30, 2004, provided net cash of $12.0 million, compared to $113.3 million for the same period in 2003. Operating cash flows in 2004 benefited from the receipt of $100.6 million from the restructuring and sale of power purchase agreements for two of our New Jersey power plants and $16.4 million from the restructuring of a long-term gas supply contract. In the first six months of 2004, there was a $49.9 million use of funds from net changes in operating assets and liabilities, comprised of a $39.9 million increase in net margin deposits posted to support CES contracting activity, in addition to net increases in accounts receivable and accounts payable and other working capital accounts. In the first six months of 2003, operating cash flows benefited from our equity method investment in the Acadia facility where distributions exceeded income recognized by $53.9 million, while there was a $408.3 million use of funds from net changes in operating assets and liabilities, which primarily was a result of higher accounts receivable balances and higher net margin deposits and prepaid gas balances to support our contracting activity in 2003. Investing activities for the six months ended June 30, 2004, consumed net cash of $167.4 million, as compared to $1,297.8 million in the same period of 2003. Capital expenditures for the completion of our power facilities decreased in 2004, as there were fewer projects under construction. Investing activities in 2004 reflect the receipt of $257.6 million from the sale our Lost Pines Power Plant, a portion of the proceeds from the sale of a subsidiary holding power purchase agreements for two of our New Jersey power plants, and from the sale of certain oil and gas properties. These sales compare to $13.7 million of proceeds from disposals in the prior year. We also reported a $180.8 million increase in cash used for acquisitions in 2004 vs. 2003, as we used the proceeds from the Lost Pines sale and cash on hand to purchase the Los Brazos Power Plant, the remaining 50% interest in the Aries Power Plant, and the remaining 20% interest in Calpine Cogeneration Company. Finally, the $452.4 million decrease in restricted cash served as an investing activity inflow in 2004. The restricted cash balance decreased in connection with the repurchase of debt with restricted cash (primarily the Convertible Senior Notes Due 2006.) -56- Financing activities for the six months ended June 30, 2004, provided $20.8 million, compared to $1,017.3 million for the same period in 2003. We continued our refinancing program in 2004, by raising $2.4 billion to repay $2.3 billion of CCFC II project financing. In 2004, we also raised $250 million from the issuance of Convertible Senior Notes Due 2023 pursuant to an option exercise and $924.5 million from various project financings. During the period, we repaid $596.9 million in project financing debt, and we used $586.9 million of proceeds from convertible senior notes offerings to repurchase the majority of outstanding Convertible Senior Notes Due 2006 that come due in December. Counterparties and Customers -- Our customer and supplier base is concentrated within the energy industry. Additionally, we have exposure to trends within the energy industry, including declines in the creditworthiness of our marketing counterparties. Currently, multiple companies within the energy industry are in bankruptcy or have below investment grade credit ratings. While our current credit exposure to CDWR is significant, CDWR has been paying its obligations to us on a current basis. Letter of Credit Facilities -- At June 30, 2004 and December 31, 2003, we had approximately $435.6 million and $410.8 million, respectively, in letters of credit outstanding under various credit facilities to support CES risk management and other operational and construction activities. Of the total letters of credit outstanding, $260.0 million and $272.1 million were in aggregate issued under our cash collateralized letter of credit facility and the corporate revolving credit facility at June 30, 2004 and December 31, 2003, respectively. In addition, in August 2004, our newly created entity Calpine Energy Management entered into a $250.0 million letter of credit facility with Deutsche Bank. See Note 16 of the Notes to Consolidated Condensed Financial Statements for more information regarding this letter of credit facility. CES Margin Deposits and Other Credit Support -- As of June 30, 2004 and December 31, 2003, CES had deposited net amounts of $227.9 million and $188.0 million, respectively, in cash as margin deposits with third parties and had letters of credit outstanding of $3.5 million and $14.5 million, respectively. CES uses these margin deposits and letters of credit as credit support for the gas procurement and risk management activities it conducts on Calpine's behalf. Future cash collateral requirements may increase based on the extent of our involvement in derivative activities and movements in commodity prices and also based on our credit ratings and general perception of creditworthiness in this market. While we believe that we have adequate liquidity to support CES's operations at this time, it is difficult to predict future developments and the amount of credit support that we may need to provide as part of our business operations. Capital Availability -- Access to capital for many in the energy sector, including us, has been restricted since late 2001. While we have been able to access the capital and bank credit markets in this new environment, it has been on significantly different terms than in the past. In particular, our senior working capital facility and term loan financings and the majority of our debt securities offered and sold in this period, have been secured by certain of our assets and equity interests. While we believe we will be successful in refinancing all debt before maturity, the terms of financing available to us now and in the future may not be attractive to us and the timing of the availability of capital is uncertain and is dependent, in part, on market conditions that are difficult to predict and are outside of our control. We do not have any significant debt obligations due from July 2004 through December 31, 2005. See Note 8 of the Notes to Consolidated Condensed Financial Statements for additional information on debt obligations. During the six months ended June 30, 2004: Our wholly owned subsidiary Calpine Generating Company, LLC ("CalGen"), formerly Calpine Construction Finance Company II, LLC ("CCFC II"), completed a secured institutional term loan and secured note financing, totaling $2.4 billion before transaction costs and fees. Net proceeds from the financing were used to refinance amounts outstanding under the $2.5 billion CCFC II revolving construction credit facility, which was scheduled to mature in November 2004, and to pay fees and transaction costs associated with the refinancing. One of the initial purchasers of the 2023 Convertible Notes exercised in full its option to purchase an additional $250.0 million of these notes. We repurchased approximately $178.5 million in principal amount of the 2006 Convertible Senior Notes in exchange for approximately $177.5 million in cash. Additionally, on February 9, 2004, we made a cash tender offer, which expired on March 9, 2004, for any and all of the then still outstanding 2006 Convertible Senior Notes at a price of par plus accrued interest. On March 10, 2004, we paid an aggregate amount of $412.8 million for the tendered 2006 Convertible Senior Notes, which included accrued interest of $3.4 million. At June 30, 2004, 2006 Convertible Senior Notes in the aggregate principal amount of $72.1 million remained outstanding. -57- Rocky Mountain Energy Center, LLC and Riverside Energy Center, LLC, wholly owned stand-alone subsidiaries of our subsidiary Calpine Riverside Holdings, LLC, received funding in the aggregate amount of $661.5 million of floating rate secured institutional term loans and a letter of credit-linked deposit. See Note 8 of the Notes to Consolidated Condensed Financial Statements for more information. Asset Sales -- As a result of the significant contraction in the availability of capital for participants in the energy sector, we have adopted a strategy of conserving our core strategic assets and disposing of certain less strategically important assets, which serves partially to strengthen our balance sheet through repayment of debt. Effective Tax Rate -- Our effective tax rate is significantly impacted by permanent items related to cross-border financings that are deductible for tax purposes but not for book income purposes. The potential sale of our Canadian oil and gas reserves (see Note 16 of the Notes to Consolidated Condensed Financial Statements for more information on this potential sale) could cause a significant decrease in certain of these permanent items and a corresponding increase in our effective tax rate from our estimated tax rate for 2004 as of June 30, 2004. However, because of significant net operating loss carryforwards at June 30, 2004, we don't expect a change in effective tax rate to have a material impact on cash taxes paid for 2004 or 2005. We believe that our completion of the financing and asset sales liquidity transactions described above in difficult conditions affecting the market, and our sector in general, demonstrate our probable ability to have access to the capital markets on acceptable terms in the future, although availability of capital has tightened significantly throughout the power generation industry and, therefore, there can be no assurance that we will have access to capital in the future as and when we may desire or on terms that are attractive to us. We expect to incur capital expenditures in the third and fourth quarters of 2004 of approximately $150 million, net of expected project financings. Off-Balance Sheet Commitments -- In accordance with Accounting Principles Board ("APB") Opinion No. 18, "The Equity Method of Accounting For Investments in Common Stock" and FASB Interpretation No. 35, "Criteria for Applying the Equity Method of Accounting for Investments in Common Stock (An Interpretation of APB Opinion No. 18)," the debt on the books of our unconsolidated investments in power projects is not reflected on our Consolidated Condensed Balance Sheet. At June 30, 2004, third-party investee debt was approximately $178.7 million. Based on our pro rata ownership share of each of the investments, our share would be approximately $58.3 million. However, all such debt is non-recourse to us. See Note 5 of the Notes to Consolidated Condensed Financial Statements for additional information on our equity method investments in power projects and oil and gas properties. We own a 32.3% interest in the unconsolidated equity method investee Androscoggin Energy LLC ("AELLC"). AELLC owns the 160-MW Androscoggin Energy Center located in Maine and has construction debt of $59.3 million outstanding as of June 30, 2004. The debt is non-recourse to us (the "AELLC Non-Recourse Financing"). On June 30, 2004, and December 31, 2003, our investment balance was $14.5 million and $11.8 million, respectively, and our notes receivable balance due from AELLC was $17.6 million and $13.3 million, respectively. On and after August 8, 2003, AELLC received letters from its lenders claiming that certain events of default hade occurred under the credit agreement for the AELLC Non-Recourse Financing, including, among other things, that the project had been and remained in default under its credit agreement because the lending syndication had declined to extend the date for the conversion of the construction loan to a term loan. AELLC disputes the purported defaults. Also, the steam host for the AELLC project, International Paper Company ("IP"), filed a complaint against AELLC in October 2000, which is discussed in more detail in Note 13 of the Notes to Consolidated Condensed Financial Statements. IP's complaint has been a complicating factor in converting the construction debt to long term financing. As a result of these events, we reviewed our investment and notes receivable balances and believe that the assets are not impaired. We further believe that AELLC will eventually be able to convert the construction loan to a term loan. -58- Capital Spending -- Development and Construction Construction and development costs in process consisted of the following at June 30, 2004 (dollars in thousands):
Equipment Project # of Included in Development Unassigned Projects CIP (1) CIP Costs Equipment -------- ------------- ------------- ------------- --------- Projects in active construction..................... 9 $ 2,929,153 $ 980,425 $ -- $ -- Projects in advanced development.................... 13 720,982 585,866 129,158 -- Projects in suspended development................... 6 463,320 203,437 12,993 -- Projects in early development....................... 3 -- -- 8,933 14,001 Other capital projects.............................. NA 43,531 -- -- -- Unassigned equipment................................ NA -- -- -- 52,856 ------------- ------------- ------------- --------- Total construction and development costs......... $ 4,156,986 $ 1,769,728 $ 151,084 $ 66,857 ============= ============= ============= ========= - ------------ (1) Construction in Progress ("CIP").
Projects in Active Construction -- The 9 projects in active construction are estimated to come on line from September 2004 to June 2007. These projects will bring on line approximately 4,266 MW of base load capacity (4,825 MW with peaking capacity). Interest and other costs related to the construction activities necessary to bring these projects to their intended use are being capitalized. Five additional projects totaling 3,110 megawatts that were in active construction in the beginning of the quarter went on line during the quarter. At June 30, 2004, the estimated funding requirements to complete these 9 projects, net of expected project financing proceeds, is approximately $1.2 billion. Projects in Advanced Development -- There are 13 projects in advanced development. These projects will bring on line approximately 5,945 MW of base load capacity (7,096 MW with peaking capacity). Interest and other costs related to the development activities necessary to bring these projects to their intended use are being capitalized. However, the capitalization of interest has been suspended on two projects for which development activities are complete but construction will not commence until a power purchase agreement and financing are obtained. At June 30, 2004, the estimated cost to complete the 13 projects in advanced development is approximately $3.9 billion. Our current plan is to project finance these costs as power purchase agreements are arranged. Suspended Development Projects -- Due to current electric market conditions, we have ceased capitalization of additional development costs and interest expense on certain development projects on which work has been suspended. Capitalization of costs may recommence as work on these projects resumes, if certain milestones and criteria are met. These projects would bring on line approximately 3,169 MW of base load capacity (3,629 MW with peaking capacity). At June 30, 2004, the estimated cost to complete the six projects is approximately $1.9 billion. Projects in Early Development -- Costs for projects that are in early stages of development are capitalized only when it is highly probable that such costs are ultimately recoverable and significant project milestones are achieved. Until then all costs, including interest costs, are expensed. The projects in early development with capitalized costs relate to three projects and include geothermal drilling costs and equipment purchases. Other Capital Projects -- Other capital projects primarily consist of enhancements to operating power plants, oil and gas and geothermal resource and facilities development as well as software developed for internal use. Unassigned Equipment -- As of June 30, 2004, we had made progress payments on 4 turbines, 1 heat recovery steam generator, and other equipment with an aggregate carrying value of $66.9 million representing unassigned equipment that is classified on the balance sheet as other assets because it is not assigned to specific development and construction projects. We are holding this equipment for potential use on future projects. It is possible that some of this unassigned equipment may eventually be sold, potentially in combination with our engineering and construction services. For equipment that is not assigned to development or construction projects, interest is not capitalized. Impairment Evaluation -- All construction and development projects and unassigned turbines are reviewed for impairment whenever there is an indication of potential reduction in fair value. Equipment assigned to such projects is not evaluated for impairment separately, as it is integral to the assumed future operations of the project to which it is assigned. If it is determined that it is no longer probable that the projects will be completed and all capitalized costs recovered through future operations, the carrying values of the projects -59- would be written down to the recoverable value in accordance with the provisions of SFAS No. 144. We review our unassigned equipment for potential impairment based on probability-weighted alternatives of utilizing the equipment for future projects versus selling the equipment. Utilizing this methodology, we do not believe that the equipment not committed to sale is impaired. Performance Metrics In understanding our business, we believe that certain non-GAAP operating performance metrics are particularly important. These are described below: Total deliveries of power. We both generate power that we sell to third parties and purchase power for sale to third parties in hedging, balancing and optimization ("HBO") transactions. The former sales are recorded as electricity and steam revenue and the latter sales are recorded as sales of purchased power for hedging and optimization. The volumes in MWh for each are key indicators of our respective levels of generation and HBO activity and the sum of the two, our total deliveries of power, is relevant because there are occasions where we can either generate or purchase power to fulfill contractual sales commitments. Prospectively beginning October 1, 2003, in accordance with EITF 03-11, certain sales of purchased power for hedging and optimization are shown net of purchased power expense for hedging and optimization in our consolidated statement of operations. Accordingly, we have also netted HBO volumes on the same basis as of October 1, 2003, in the table below. Average availability and average baseload capacity factor or operating rate. Availability represents the percent of total hours during the period that our plants were available to run after taking into account the downtime associated with both scheduled and unscheduled outages. The baseload capacity factor, sometimes called operating rate, is calculated by dividing (a) total megawatt hours generated by our power plants (excluding peakers) by the product of multiplying (b) the weighted average megawatts in operation during the period by (c) the total hours in the period. The capacity factor is thus a measure of total actual generation as a percent of total potential generation. If we elect not to generate during periods when electricity pricing is too low or gas prices too high to operate profitably, the baseload capacity factor will reflect that decision as well as both scheduled and unscheduled outages due to maintenance and repair requirements. Average heat rate for gas-fired fleet of power plants expressed in British Thermal Units ("Btu") of fuel consumed per KWh generated. We calculate the average heat rate for our gas-fired power plants (excluding peakers) by dividing (a) fuel consumed in Btu's by (b) KWh generated. The resultant heat rate is a measure of fuel efficiency, so the lower the heat rate, the better. We also calculate a "steam-adjusted" heat rate, in which we adjust the fuel consumption in Btu's down by the equivalent heat content in steam or other thermal energy exported to a third party, such as to steam hosts for our cogeneration facilities. Our goal is to have the lowest average heat rate in the industry. Average all-in realized electric price expressed in dollars per MWh generated. Our risk management and optimization activities are integral to our power generation business and directly impact our total realized revenues from generation. Accordingly, we calculate the all-in realized electric price per MWh generated by dividing (a) adjusted electricity and steam revenue, which includes capacity revenues, energy revenues, thermal revenues and the spread on sales of purchased power for hedging, balancing, and optimization activity, by (b) total generated MWh in the period. Average cost of natural gas expressed in dollars per millions of Btu's of fuel consumed. Our risk management and optimization activities related to fuel procurement directly impact our total fuel expense. The fuel costs for our gas-fired power plants are a function of the price we pay for fuel purchased and the results of the fuel hedging, balancing, and optimization activities by CES. Accordingly, we calculate the cost of natural gas per millions of Btu's of fuel consumed in our power plants by dividing (a) adjusted fuel expense which includes the cost of fuel consumed by our plants (adding back cost of inter-company "equity" gas from Calpine Natural Gas, which is eliminated in consolidation), and the spread on sales of purchased gas for hedging, balancing, and optimization activity by (b) the heat content in millions of Btu's of the fuel we consumed in our power plants for the period. Average spark spread expressed in dollars per MWh generated. Our risk management activities focus on managing the spark spread for our portfolio of power plants, the spread between the sales price for electricity generated and the cost of fuel. We calculate the spark spread per MWh generated by subtracting (a) adjusted fuel expense from (b) adjusted E&S revenue and dividing the difference by (c) total generated MWh in the period. Average plant operating expense per normalized MWh. To assess trends in electric power plant operating expense ("POX") per MWh, we normalize the results from period to period by assuming a constant 70% total company-wide capacity factor (including both base load and peaker capacity) in deriving normalized MWh. By normalizing the cost per MWh with a constant capacity factor, we can better analyze trends and the results of our program to realize economies of scale, cost reductions and efficiencies at our electric generating plants. -60- The table below presents, the operating performance metrics discussed above.
Three Months Ended June 30, Six Months Ended June 30, ---------------------------- ---------------------------- 2004 2003 2004 2003 ------------- ------------- ------------- ------------- (In thousands) Operating Performance Metrics: Total deliveries of power: MWh generated...................................... 22,083 17,519 43,132 36,622 HBO and trading MWh sold........................... 20,883 20,647 40,481 38,168 ------------- ------------- ------------- ------------- MWh delivered...................................... 42,966 38,166 83,613 74,790 ============= ============= ============= ============= Average availability.................................. 89% 87% 90% 88% Average baseload capacity factor: Average total MW in operation...................... 24,357 19,218 23,134 18,666 Less: Average MW of pure peakers................... 2,951 2,684 2,951 2,451 ------------- ------------- ------------- ------------- Average baseload MW in operation................... 21,406 16,534 20,183 16,215 Hours in the period................................ 2,184 2,184 4,368 4,344 Potential baseload generation (MWh)................ 46,751 36,110 88,159 70,438 Actual total generation (MWh)...................... 22,083 17,519 43,132 36,622 Less: Actual pure peakers' generation (MWh)........ 300 140 573 311 ------------- ------------- ------------- ------------- Actual baseload generation (MWh)................... 21,783 17,379 42,559 36,311 Average baseload capacity factor................... 47% 48% 48% 52% Average heat rate for gas-fired power plants (excluding peakers) (Btu's/KWh): Not steam adjusted................................. 8,272 8,019 8,221 7,992 Steam adjusted..................................... 7,203 7,234 7,160 7,231 Average all-in realized electric price: Electricity and steam revenue...................... $ 1,312,792 $ 1,046,260 $ 2,558,678 $ 2,146,328 Spread on sales of purchased power for hedging and optimization.......................... 51,483 6,086 56,572 7,421 ------------- ------------- ------------- ------------- Adjusted electricity and steam revenue (in thousands)........................................ $ 1,364,275 $ 1,052,346 $ 2,615,250 $ 2,153,749 MWh generated (in thousands)....................... 22,083 17,519 43,132 36,622 Average all-in realized electric price per MWh..... $ 61.78 $ 60.07 $ 60.63 $ 58.81 Average cost of natural gas: Cost of oil and natural gas burned by power plants (in thousands)............................. $ 839,736 $ 542,053 $ 1,610,190 $ 1,166,902 Fuel cost elimination.............................. 87,227 96,461 167,337 206,795 ------------- ------------- ------------- ------------- Adjusted fuel expense.............................. $ 926,963 $ 638,514 $ 1,777,527 $ 1,373,697 Million Btu's ("MMBtu") of fuel consumed by generating plants (in thousands).................. 162,078 122,422 312,435 245,358 Average cost of natural gas per MMBtu.............. $ 5.72 $ 5.22 $ 5.69 $ 5.60 MWh generated (in thousands)....................... 22,083 17,519 43,132 36,622 Average cost of adjusted fuel expense per MWh...... $ 41.98 $ 36.45 $ 41.21 $ 37.51 Average spark spread: Adjusted electricity and steam revenue (in thousands)........................................ $ 1,364,275 $ 1,052,346 $ 2,615,250 $ 2,153,749 Less: Adjusted fuel expense (in thousands)......... 926,963 638,514 1,777,527 1,373,697 ------------- ------------- ------------- ------------- Spark spread (in thousands)........................ $ 437,312 $ 413,832 $ 837,723 $ 780,052 MWh generated (in thousands)....................... 22,083 17,519 43,132 36,622 Average spark spread per MWh....................... $ 19.80 $ 23.62 $ 19.42 $ 21.30 Add: Equity gas contribution(1).................... $ 46,547 $ 57,984 $ 89,233 $ 129,260 Spark spread with equity gas benefits (in thousands)........................................ $ 483,859 $ 471,816 $ 926,956 $ 909,312 Average spark spread with equity gas benefits per MWh........................................... $ 21.91 $ 26.93 $ 21.49 $ 24.83 Average plant operating expense ("POX") per normalized MWh (We also show POX per actual MWh for comparison): Average total consolidated MW in operations........ 24,357 19,218 23,134 18,666 Hours in the period................................ 2,184 2,184 4,368 4,344 Total potential MWh................................ 53,196 41,972 101,049 81,085 Normalized MWh (at 70% capacity factor)............ 37,237 29,380 70,735 56,760 Plant operating expense (POX)...................... $ 223,664 $ 159,647 $ 399,498 $ 321,574 POX per normalized MWh............................. $ 6.01 $ 5.43 $ 5.65 $ 5.67 POX per actual MWh................................. $ 10.13 $ 9.11 $ 9.26 $ 8.78 - ------------ (1) Equity gas contribution margin: -61- Three Months Ended June 30, Six Months Ended June 30, ---------------------------- ---------------------------- 2004 2003 2004 2003 ------------- ------------- ------------- ------------- (In thousands) Oil and gas sales................................... $ 26,069 $ 29,299 $ 50,651 $ 55,210 Add: Fuel cost eliminated in consolidation.......... 87,227 96,461 167,337 206,795 ------------- ------------- ------------- ------------- Subtotal......................................... $ 113,296 $ 125,760 $ 217,988 $ 262,005 Less: Oil and gas operating expense................. 23,443 29,033 45,770 54,694 Less: Depletion, depreciation and amortization...... 43,307 38,743 82,985 78,051 ------------- ------------- ------------- ------------- Equity gas contribution margin...................... $ 46,546 57,984 $ 89,233 129,260 MWh generated (in thousands)........................ 22,083 17,519 43,132 36,622 Equity gas contribution margin per MWh.............. $ 2.11 $ 3.31 $ 2.07 $ 3.53
The table below provides additional detail of total mark-to-market activity. For the three and six months ended June 30, 2004 and 2003, mark-to-market activity, net consisted of (dollars in thousands):
Three Months Ended June 30, Six Months Ended June 30, ---------------------------- ---------------------------- 2004 2003 2004 2003 ------------- ------------- ------------- ------------- Mark-to-market activity, net Realized: Power activity "Trading Activity" as defined in EITF No. 02-03.... $ 11,138 $ 9,826 $ 29,847 $ 24,662 Ineffectiveness related to cash flow hedges........ -- -- -- -- Other mark-to-market activity(1)................... (4,773) -- (5,944) -- ------------- ------------- ------------- ------------- Total realized power activity.................... $ 6,365 $ 9,826 $ 23,903 $ 24,662 ============= ============= ============= ============= Gas activity "Trading Activity" as defined in EITF No. 02-03.... $ (57) $ (766) $ (131) $ 5,612 Ineffectiveness related to cash flow hedges........ -- -- -- -- Other mark-to-market activity(1)................... -- -- -- -- ------------- ------------- ------------- ------------- Total realized gas activity...................... $ (57) $ (766) $ (131) $ 5,612 ============= ============= ============= ============= Total realized activity: "Trading Activity" as defined in EITF No. 02-03.... $ 11,081 $ 9,060 $ 29,716 $ 30,274 Ineffectiveness related to cash flow hedges........ -- -- -- -- Other mark-to-market activity(1)................... (4,773) -- (5,944) -- ------------- ------------- ------------- ------------- Total realized activity.......................... $ 6,308 $ 9,060 $ 23,772 $ 30,274 ============= ============= ============= ============= Unrealized: Power activity "Trading Activity" as defined in EITF No. 02-03.... $ (23,178) $ (11,232) $ (23,869) $ (13,113) Ineffectiveness related to cash flow hedges........ 666 (1,612) 126 (4,638) Other mark-to-market activity(1)................... (2,981) -- (12,776) -- ------------- ------------- ------------- ------------- Total unrealized power activity.................. $ (25,493) $ (12,844) $ (36,519) $ (17,751) ============= ============= ============= ============= Gas activity "Trading Activity" as defined in EITF No. 02-03.... $ (3,737) $ 3,556 $ (3,102) $ 1,579 Ineffectiveness related to cash flow hedges........ 317 2,067 5,763 8,180 Other mark-to-market activity(1)................... -- -- -- -- ------------- ------------- ------------- ------------- Total unrealized gas activity.................... $ (3,420) $ 5,623 $ 2,661 $ 9,759 ============= ============= ============= ============= Total unrealized activity: "Trading Activity" as defined in EITF No. 02-03....... $ (26,915) $ (7,676) $ (26,971) $ (11,534) Ineffectiveness related to cash flow hedges........... 983 455 5,889 3,542 Other mark-to-market activity(1)...................... (2,981) -- (12,776) -- ------------- ------------- ------------- ------------- Total unrealized activity........................ $ (28,913) $ (7,221)$ (33,858) $ (7,992) ============= ============= ============= ============= Total mark-to-market activity: "Trading Activity" as defined in EITF No. 02-03....... $ (15,834) $ 1,384 $ 2,745 $ 18,740 Ineffectiveness related to cash flow hedges........... 983 455 5,889 3,542 Other mark-to-market activity(1)...................... (7,754) -- (18,720) -- ------------- ------------- ------------- ------------- Total mark-to-market activity.................... $ (22,605) $ 1,839 $ (10,086) $ 22,282 ============= ============= ============= ============= - ------------ (1) Activity related to our assets but does not qualify for hedge accounting.
-62- Overview Summary of Key Activities Finance - New Issuances Date Amount Description - --------- -------------- ----------------------------------------------------- 6/2/04 $85.0 million PCF III issued $85.0 million in zero coupon notes 6/29/04 $661.5 million Rocky Mountain Energy Center, LLC, and Riverside Energy Center, LLC, closed an offering of First Priority Secured Floating Rate Term Loans Due 2011 and a letter of credit-linked deposit facility Finance - Repurchases/Retirements Date Amount Description - --------- -------------- ----------------------------------------------------- 5/04 $78.8 million Retirement of Newark and Parlin Power Plants project financing 4/04-6/04 $46.6 million Repurchased $46.6 million in principal amount of outstanding senior notes for $41.5 million in cash 4/04-6/04 $95.0 million Exchanged 20.1 million Calpine common shares in privately negotiated transactions for approximately $20.0 million par value of HIGH TIDES I and approximately $75.0 million par value of HIGH TIDES II Other: Date Description - --------- -------------------------------------------------------------------- 4/26/04 Successfully completed consent solicitation to effect certain amendments to the Indentures governing the Senior Notes issued between 1996 and 1999 5/19/04 Restructured King City lease 5/25/04 Signed a 25-year agreement to sell up to 200 megawatts of electricity and 1 million pounds per hour of steam to The Dow Chemical Company 5/26/04 JCPL terminated its existing tolling arrangements with the Newark and Parlin Power Plants resulting in a gain of $100.6 million before transaction costs 5/26/04 Sold Utility Contract Funding II, a wholly owned subsidiary of CES, which had sold a long-term power purchase agreement related to Newark and Parlin Power Plants, for a pre-tax gain of $85.4 million before transaction costs 6/9/04 Received approval from the CPUC for a tolling agreement with San Diego Gas and Electric that provides for the delivery of up to 600 megawatts of capacity for ten years beginning in 2008 6/11/04 Citrus Trading Corp. negotiated early partial termination of its gas contract with the Auburndale facility for a net gain of $11.7 million Power Plant Development and Construction: Date Project Description - --------- ---------------------------------- -------------------- 5/04 Osprey Energy Center Commercial operation 5/04 Columbia Energy Center Commercial operation 5/04 Rocky Mountain Energy Center Commercial operation 5/04 Valladolid III IP Construction began 6/04 Riverside Energy Center Commercial operation 6/04 Deer Park Energy Center Expansion Commercial operation 6/04 Freeport Energy Center Construction began California Power Market California Refund Proceeding. On August 2, 2000, the California Refund Proceeding was initiated by a complaint made at FERC by San Diego Gas & Electric Company under Section 206 of the Federal Power Act alleging, among other things, that the markets operated by the California Independent System Operator ("CAISO") and the California Power Exchange ("CalPX") were dysfunctional. In addition to commencing an inquiry regarding the market structure, FERC established a refund effective period of October 2, 2000, to June 19, 2001, for sales made into those markets. On December 12, 2002, the Administrative Law Judge ("ALJ") issued a Certification of Proposed Finding on California Refund Liability ("December 12 Certification") making an initial determination of refund liability. On March 26, 2003, FERC also issued an order adopting many of the ALJ's findings set forth in the December 12 Certification (the "March 26 Order"). In addition, as a result of certain findings by the FERC staff concerning the unreliability or misreporting of certain reported indices for gas prices in California during the refund period, FERC ordered that the basis for calculating a party's potential refund liability be modified by substituting a gas proxy price based upon gas -63- prices in the producing areas plus the tariff transportation rate for the California gas price indices previously adopted in the refund proceeding. We believe, based on the available information, that any refund liability that may be attributable to us will increase modestly, from approximately $6.2 million to $8.4 million, after taking the appropriate set-offs for outstanding receivables owed by the CalPX and CAISO to us. We have fully reserved the amount of refund liability that by our analysis would potentially be owed under the refund calculation clarification in the March 26 order. The final determination of the refund liability is subject to further Commission proceedings to ascertain the allocation of payment obligations among the numerous buyers and sellers in the California markets. At this time, we are unable to predict the timing of the completion of these proceedings or the final refund liability. Thus the impact on our business is uncertain at this time. On April 26, 2004, Dynegy Inc. entered into a settlement of the California Refund Proceeding and other proceedings with California governmental entities and the three California investor-owned utilities. The California governmental entities include the Attorney General, the California Public Utilities Commission ("CPUC"), the California Department of Water Resources ("CDWR"), and the California Electricity Oversight Board. Also, on April 27, 2004, The Williams Companies, Inc. ("Williams") entered into a settlement of the California Refund Proceeding and other proceedings with the three California investor-owned utilities; previously, Williams had entered into a settlement of the same matters with the California governmental entities. The Williams settlement with the California governmental entities was similar to the settlement that we entered into with the California governmental entities on April 22, 2002. Our settlement was approved by FERC on March 26, 2004, in an order which partially dismissed us from the California Refund Proceeding to the extent that any refunds are owed for power sold by us to CDWR or any other agency of the State of California. On June 30, 2004, a settlement conference was convened at the FERC to explore settlements among additional parties. FERC Investigation into Western Markets. On February 13, 2002, FERC initiated an investigation of potential manipulation of electric and natural gas prices in the western United States. This investigation was initiated as a result of allegations that Enron and others used their market position to distort electric and natural gas markets in the West. The scope of the investigation is to consider whether, as a result of any manipulation in the short-term markets for electric energy or natural gas or other undue influence on the wholesale markets by any party since January 1, 2000, the rates of the long-term contracts subsequently entered into in the West are potentially unjust and unreasonable. FERC has stated that it may use the information gathered in connection with the investigation to determine how to proceed on any existing or future complaint brought under Section 206 of the Federal Power Act involving long-term power contracts entered into in the West since January 1, 2000, or to initiate a Federal Power Act Section 206 or Natural Gas Act Section 5 proceeding on its own initiative. On August 13, 2002, the FERC staff issued the Initial Report on Company-Specific Separate Proceedings and Generic Reevaluations; Published Natural Gas Price Data; and Enron Trading Strategies (the "Initial Report") summarizing its initial findings in this investigation. There were no findings or allegations of wrongdoing by us set forth or described in the Initial Report. On March 26, 2003, the FERC staff issued a final report in this investigation (the "Final Report"). The FERC staff recommended that FERC issue a show cause order to a number of companies, including us, regarding certain power scheduling practices that may have been be in violation of the CAISO's or CalPX's tariff. The Final Report also recommended that FERC modify the basis for determining potential liability in the California Refund Proceeding discussed above. We believe that we did not violate these tariffs and that, to the extent that such a finding could be made, any potential liability would not be material. Also, on June 25, 2003, FERC issued a number of orders associated with these investigations, including the issuance of two show cause orders to certain industry participants. FERC did not subject us to either of the show cause orders. FERC also issued an order directing the FERC Office of Markets and Investigations to investigate further whether market participants who bid a price in excess of $250 per megawatt hour into markets operated by either the CAISO or the CalPX during the period of May 1, 2000, to October 2, 2000, may have violated CAISO and CalPX tariff prohibitions. No individual market participant was identified. We believe that we did not violate the CAISO and CalPX tariff prohibitions referred to by FERC in this order; however, we are unable to predict at this time the final outcome of this proceeding or its impact on us. CPUC Proceeding Regarding QF Contract Pricing for Past Periods. Our Qualifying Facilities ("QF") contracts with PG&E provide that the CPUC has the authority to determine the appropriate utility "avoided cost" to be used to set energy payments for certain QF contracts by determining the short run avoided cost ("SRAC") energy price formula. In mid-2000 our QF facilities elected the option set forth in Section 390 of the California Public Utility Code, which provides QFs the right to elect to receive energy payments based on the CalPX market clearing price instead of the price determined by SRAC. Having elected such option, we were paid based upon the PX zonal day-ahead clearing price ("PX Price") from summer 2000 until January 19, 2001, when the PX ceased operating a day-ahead market. The CPUC has conducted proceedings (R.99-11-022) to determine -64- whether the PX Price was the appropriate price for the energy component upon which to base payments to QFs which had elected the PX-based pricing option. The CPUC at one point issued a proposed decision to the effect that the PX Price was the appropriate price for energy payments under the California Public Utility Code but tabled it, and a final decision has not been issued to date. Therefore, it is possible that the CPUC could order a payment adjustment based on a different energy price determination. On April 29, 2004, PG&E, The Utility Reform Network, which is a consumer advocacy group, and the Office of Ratepayer Advocates, which is an independent consumer advocacy department of the CPUC, (collectively, the "PG&E Parties") filed a Motion for Briefing Schedule Regarding True-Up of Payments to QF Switchers (the "April 29 Motion"). The April 29 Motion requests that the CPUC set a briefing schedule under the R.99-11-022 to determine refund liability of the QFs who had switched to the PX Price during the period of June 1, 2000, until January 19, 2001. The PG&E Parties allege that refund liability be determined using the methodology that has been developed thus far in the California Refund Proceeding discussed above. We believe that the PX Price was the appropriate price for energy payments and that the basis for any refund liability based on the interim determination by FERC in the California Refund Proceeding is unfounded, but there can be no assurance that this will be the outcome of the CPUC proceedings. Geysers Reliability Must Run Section 206 Proceeding. CAISO, California Electricity Oversight Board, Public Utilities Commission of the State of California, Pacific Gas and Electric Company, San Diego Gas & Electric Company, and Southern California Edison (collectively referred to as the "Buyers Coalition") filed a complaint on November 2, 2001 at the FERC requesting the commencement of a Federal Power Act Section 206 proceeding to challenge one component of a number of separate settlements previously reached on the terms and conditions of "reliability must run" contracts ("RMR Contracts") with certain generation owners, including Geysers Power Company, LLC, which settlements were also previously approved by the FERC. RMR Contracts require the owner of the specific generation unit to provide energy and ancillary services when called upon to do so by the ISO to meet local transmission reliability needs or to manage transmission constraints. The Buyers Coalition has asked FERC to find that the availability payments under these RMR Contracts are not just and reasonable. Geysers Power Company, LLC filed an answer to the complaint in November 2001. To date, FERC has not established a Section 206 proceeding. The outcome of this litigation and the impact on our business cannot be determined at the present time. Financial Market Risks As we are primarily focused on generation of electricity using gas-fired turbines, our natural physical commodity position is "short" fuel (i.e., natural gas consumer) and "long" power (i.e., electricity seller). To manage forward exposure to price fluctuation in these and (to a lesser extent) other commodities, we enter into derivative commodity instruments. The change in fair value of outstanding commodity derivative instruments from January 1, 2004 through June 30, 2004, is summarized in the table below (in thousands): Fair value of contracts outstanding at January 1, 2004............. $ 76,541 Gains recognized or otherwise settled during the period(1)......... (15,781) Changes in fair value attributable to new contracts................ (8,943) Changes in fair value attributable to price movements.............. (42,359) ----------- Fair value of contracts outstanding at June 30, 2004(2)......... $ 9,458 =========== - ------------ (1) Recognized losses from commodity cash flow hedges of $(8.0) million (represents realized value of cash flow hedge activity of $(17.8) million as disclosed in Note 10 of the Notes to Consolidated Condensed Financial Statements, net of terminated derivatives of $(14.7) million and equity method hedges of $4.9 million) and $23.8 million realized gain on mark-to-market activity, which is reported in the Consolidated Condensed Statements of Operations under mark-to-market activities, net. (2) Net commodity derivative assets reported in Note 10 of the Notes to Consolidated Condensed Financial Statements. The fair value of outstanding derivative commodity instruments at June 30 based on price source and the period during which the instruments will mature, are summarized in the table below (in thousands):
Fair Value Source 2004 2005-2006 2007-2008 After 2008 Total - ----------------------------------------------------- ----------- ----------- ----------- ---------- ---------- Prices actively quoted............................... $ 50,589 $ 124,089 $ -- $ -- $ 174,678 Prices provided by other external sources............ (103,584) (35,028) 7,421 (20,799) (151,990) Prices based on models and other valuation methods... -- 3,782 1,063 (18,075) (13,230) ---------- ---------- ---------- --------- ---------- Total fair value.................................. $ (52,995) $ 92,843 $ 8,484 $ (38,874) $ 9,458 ========== ========== ========== ========= ==========
-65- Our risk managers maintain fair value price information derived from various sources in our risk management systems. The propriety of that information is validated by our Risk Control group. Prices actively quoted include validation with prices sourced from commodities exchanges (e.g., New York Mercantile Exchange). Prices provided by other external sources include quotes from commodity brokers and electronic trading platforms. Prices based on models and other valuation methods are validated using quantitative methods. The counterparty credit quality associated with the fair value of outstanding derivative commodity instruments at June 30 and the period during which the instruments will mature are summarized in the table below (in thousands):
Credit Quality 2004 2005-2006 2007-2008 After 2008 Total - ----------------------------------------------------- ----------- ----------- ----------- ---------- ---------- (Based on Standard & Poor's Ratings as of July 7, 2004) Investment grade..................................... $ (60,497) $ 73,585 $ 8,831 $ (38,874) $ (16,955) Non-investment grade................................. 10,930 20,093 -- -- 31,023 No external ratings.................................. (3,428) (835) (347) -- (4,610) ---------- ---------- ---------- ---------- ---------- Total fair value.................................. $ (52,995) $ 92,843 $ 8,484 $ (38,874) $ 9,458 ========== ========== ========== ========== ==========
The fair value of outstanding derivative commodity instruments and the fair value that would be expected after a 10% adverse price change are shown in the table below (in thousands): Fair Value After 10% Adverse Fair Value Price Change ------------ ------------ At June 30, 2004: Electricity............................. $ (150,394) $ (316,003) Natural gas............................. 159,852 70,495 ----------- ----------- Total................................ $ 9,458 $ (245,508) =========== =========== Derivative commodity instruments included in the table are those included in Note 10 of the Notes to Consolidated Condensed Financial Statements. The fair value of derivative commodity instruments included in the table is based on present value adjusted quoted market prices of comparable contracts. The fair value of electricity derivative commodity instruments after a 10% adverse price change includes the effect of increased power prices versus our derivative forward commitments. Conversely, the fair value of the natural gas derivatives after a 10% adverse price change reflects a general decline in gas prices versus our derivative forward commitments. Derivative commodity instruments offset the price risk exposure of our physical assets. None of the offsetting physical positions are included in the table above. Price changes were calculated by assuming an across-the-board ten percent adverse price change regardless of term or historical relationship between the contract price of an instrument and the underlying commodity price. In the event of an actual ten percent change in prices, the fair value of our derivative portfolio would typically change by more than ten percent for earlier forward months and less than ten percent for later forward months because of the higher volatilities in the near term and the effects of discounting expected future cash flows. The primary factors affecting the fair value of our derivatives at any point in time are (1) the volume of open derivative positions (MMBtu and MWh), and (2) changing commodity market prices, principally for electricity and natural gas. The total volume of open gas derivative positions increased 154% from December 31, 2003, to June 30, 2004, while the total volume of open power derivative positions increased 41% for the same period. In that prices for electricity and natural gas are among the most volatile of all commodity prices, there may be material changes in the fair value of our derivatives over time, driven both by price volatility and the changes in volume of open derivative transactions. Under SFAS No. 133, the change since the last balance sheet date in the total value of the derivatives (both assets and liabilities) is reflected either in Other Comprehensive Income ("OCI"), net of tax, or in the statement of operations as an item (gain or loss) of current earnings. As of June 30, 2004, a significant component of the balance in accumulated OCI represented the unrealized net loss associated with commodity cash flow hedging transactions. As noted above, there is a substantial amount of volatility inherent in accounting for the fair value of these derivatives, and our results during the three and six months ended June 30, 2004, have reflected this. See Note 11 of the Notes to Consolidated Condensed Financial Statements for additional information on derivative activity and OCI. -66- Available-for-Sale Debt Securities -- We have exchanged 26.6 million Calpine common shares in privately negotiated transactions for approximately $132.5 million par value of HIGH TIDES I and HIGH TIDES II. As of June 30, 2004, the repurchased HIGH TIDES are classified as available-for-sale and recorded at fair market value in Other Assets. The following tables present our different classes of debt securities held by expected maturity date and fair market value as of June 30, 2004, (dollars in thousands):
Weighted Average Interest Rate 2004 2005 2006 2007 2008 Thereafter Total -------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- HIGH TIDES I........... 5.75% $ -- $ -- $ -- $ -- $ -- $ 57,500 $ 57,500 HIGH TIDES II.......... 5.50% -- -- -- -- -- 75,000 75,000 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total............... $ -- $ -- $ -- $ -- $ -- $ 132,500 $ 132,500 ========== ========== ========== ========== ========== ========== ========== Fair Market Value ---------- HIGH TIDES I............................ $ 55,919 HIGH TIDES II........................... 70,125 ---------- Total................................ $ 126,044 ==========
Interest Rate Swaps -- From time to time, we use interest rate swap agreements to mitigate our exposure to interest rate fluctuations associated with certain of our debt instruments and to adjust the mix between fixed and floating rate debt in our capital structure to desired levels. We do not use interest rate swap agreements for speculative or trading purposes. The following tables summarize the fair market values of our existing interest rate swap agreements as of June 30, 2004, (dollars in thousands): Variable to fixed Swaps
Weighted Average Weighted Average Notional Interest Rate Interest Rate Fair Market Maturity Date Principal Amount (Pay) (Receive) Value - -------------- ---------------- ---------------- ----------------- --------------- 2011.......... $ 58,178 4.5% 3-month US $LIBOR (887) 2011.......... 291,897 4.5% 3-month US $LIBOR (4,466) 2011.......... 209,833 4.4% 3-month US $LIBOR (2,741) 2011.......... 41,822 4.4% 3-month US $LIBOR (546) 2011.......... 40,746 6.9% 3-month US $LIBOR (4,305) 2012.......... 108,612 6.5% 3-month US $LIBOR (11,219) 2014.......... 58,682 6.7% 3-month US $LIBOR (5,832) 2016.......... 21,540 7.3% 3-month US $LIBOR (3,363) 2016.......... 14,360 7.3% 3-month US $LIBOR (2,242) 2016.......... 43,080 7.3% 3-month US $LIBOR (6,726) 2016.......... 28,720 7.3% 3-month US $LIBOR (4,484) 2016.......... 35,900 7.3% 3-month US $LIBOR (5,607) ----------- ---- --------- Total...... $ 953,370 5.3% $ (52,418) =========== === =========
Fixed to Variable Swaps
Weighted Average Weighted Average Notional Interest Rate Interest Rate Fair Market Maturity Date Principal Amount (Pay) (Receive) Value - -------------- ---------------- ----------------- ----------------- -------------- 2011.......... $ 100,000 6-month US $LIBOR 8.5% $ (8,548) 2011.......... 100,000 6-month US $LIBOR 8.5% (6,739) 2011.......... 200,000 6-month US $LIBOR 8.5% (13,838) 2011.......... 100,000 6-month US $LIBOR 8.5% (10,374) ----------- --- --------- Total...... $ 500,000 8.5% $ (39,499) =========== === =========
-67- The fair value of outstanding interest rate swaps and cross currency swaps and the fair value that would be expected after a one percent adverse interest rate change are shown in the table below (in thousands): Variable to Fixed Swaps Fair Value After a 1.0% (100 basis point) Fair Value as of June 30, 2004 Adverse Interest Rate Change ------------------------------ ---------------------------- $ (52,418) $ (94,618) Fixed to Variable Swaps Fair Value After a 1.0% (100 basis point) Fair Value as of June 30, 2004 Adverse Interest Rate Change ------------------------------ ---------------------------- $ (39,499) $ (67,378) Currency Exposure. We own subsidiary entities in several countries. These entities generally have functional currencies other than the U.S. dollar. In most cases, the functional currency is consistent with the local currency of the host country where the particular entity is located. In certain cases, we and our foreign subsidiary entities hold monetary assets and/or liabilities that are not denominated in the functional currencies referred to above. In such instances, we apply the provisions of SFAS No. 52, "Foreign Currency Translation," to account for the monthly re-measurement gains and losses of these assets and liabilities into the functional currencies for each entity. In some cases we can reduce our potential exposures to net income by designating liabilities denominated in non-functional currencies as hedges of our net investment in a foreign subsidiary or by entering into derivative instruments and designating them in hedging relationships against a foreign exchange exposure. Based on our unhedged exposures at June 30, 2004, the impact to our pre-tax earnings that would be expected after a 10% adverse change in exchange rates is shown in the table below (in thousands): Impact to Pre-Tax Net Income After 10% Adverse Exchange Currency Exposure Rate Change ----------------- ---------------------------- GBP-Euro $ (21,895) $C-$US (305) $C-Euro (1,483) Significant changes in exchange rates will also impact our Cumulative Translation Adjustment ("CTA") balance when translating the financial statements of our foreign operations from their respective functional currencies into our reporting currency, the U.S. dollar. An example of the impact that significant exchange rate movements can have on our Balance Sheet position occurred in 2003. During 2003 CTA increased by approximately $200 million primarily due to a weakening of the U.S. dollar of approximately 18% and 10% against the Canadian dollar and Great British Pound, respectively. Debt Financing -- Because of the significant capital requirements within our industry, debt financing is often needed to fund our growth. Certain debt instruments may affect us adversely because of changes in market conditions. We have used two primary forms of debt which are subject to market risk: (1) Variable rate construction/project financing and (2) Other variable-rate instruments. Significant LIBOR increases could have a negative impact on our future interest expense. Our variable-rate construction/project financing is primarily through CalGen. Borrowings under this credit agreement are used exclusively to fund the construction of our power plants. Other variable-rate instruments consist primarily of our revolving credit and term loan facilities, which are used for general corporate purposes. Both our variable-rate construction/project financing and other variable-rate instruments are indexed to base rates, generally LIBOR, as shown below. -68- The following table summarizes our variable-rate debt exposed to interest rate risk as of June 30, 2004. All outstanding balances and fair market values are shown net of applicable premium or discount, if any (dollars in thousands):
Fair Value 2004(8) 2005 2006 2007 2008 Thereafter 6/30/2004(9) ------- -------- ------- ---------- ------- ---------- ------------ 3-month US$LIBOR weighted average interest rate basis (4) First Priority Senior Secured Term Loan B Notes Due 2007........................... $ 1,000 $ 2,000 $ 2,000 $ 193,500 $ -- $ -- $ 198,500 MEP Pleasant Hill Term Loan, Tranche A.... 2,275 6,700 7,482 8,132 9,271 95,235 129,096 ------- -------- ------- ---------- ------- ---------- ---------- Total of 3-month US$LIBOR rate debt.... 3,275 8,700 9,482 201,632 9,271 95,235 327,596 1-month EURLIBOR weighted average interest rate basis (4) Thomassen revolving line of credit........ -- 3,147 -- -- -- -- 3,147 ------- -------- ------- ---------- ------- ---------- ---------- Total of 1-month EURLIBOR rate debt.... -- 3,147 -- -- -- -- 3,147 1-month US$LIBOR weighted average interest rate basis (4) Corporate revolving line of credit........ -- 100,000 -- -- -- -- 100,000 First Priority Secured Floating Rate Notes Due 2009 (CalGen)............. -- -- -- 1,175 2,350 231,475 235,000 CalGen Revolver........................... -- -- -- 54,500 -- -- 54,500 ------- -------- ------- ---------- ------- ---------- ---------- Total of 1-month US$LIBOR rate debt.... -- 100,000 -- 55,675 2,350 231,475 389,500 6-month US$LIBOR weighted average interest rate basis (4) Third Priority Secured Floating Rate Notes Due 2011 (CalGen)............. -- -- -- -- -- 680,000 680,000 ------- -------- ------- ---------- ------- ---------- ---------- Total of 6-month US$LIBOR rate debt.... -- -- -- -- -- 680,000 680,000 5-month US$LIBOR weighted average interest rate basis (4) Riverside Energy Center project financing. -- 3,685 3,685 3,685 3,685 353,760 368,500 Rocky Mountain Energy Center project financing................................ -- 2,649 2,649 2,649 2,649 254,304 264,900 ------- -------- ------- ---------- ------- ---------- ---------- Total of 6-month US$LIBOR rate debt.... -- 6,334 6,334 6,334 6,334 608,064 633,400 (1)(4) First Priority Secured Institutional Term Loan Due 2009 (CCFC I).............. 1,711 3,208 3,208 3,208 3,208 365,242 379,785 Second Priority Senior Secured Floating Rate Notes Due 2011 (CCFC I)............. -- -- -- -- -- 408,083 408,083 ------- -------- ------- ---------- ------- ---------- ---------- Total of variable rate debt as defined at (1) below.......................... 1,711 3,208 3,208 3,208 3,208 773,325 787,868 (2)(4) Second Priority Senior Secured Term Loan B Notes Due 2007.................... 3,750 7,500 7,500 725,625 -- -- 744,375 ------- -------- ------- ---------- ------- ---------- ---------- Total of variable rate debt as defined at (2) below.......................... 3,750 7,500 7,500 725,625 -- -- 744,375 (3)(4) Second Priority Senior Secured Floating Due 2007................................. 2,500 5,000 5,000 483,750 -- -- 496,250 Blue Spruce Energy Center project financing................................ -- 1,875 3,750 3,750 3,750 106,675 119,800 ------- -------- ------- ---------- ------- ---------- ---------- Total of variable rate debt as defined at (3) below.......................... 2,500 6,875 8,750 487,500 3,750 106,675 616,050 (5)(4) First Priority Secured Term Loans Due 2009 (CalGen)........................ -- -- -- 3,000 6,000 591,000 600,000 Second Priority Secured Floating Rate Notes Due 2010 (CalGen)............. -- -- -- -- 3,200 627,639 630,839 Second Priority Secured Term Loans Due 2010 (CalGen)........................ -- -- -- -- 500 98,069 98,569 ------- -------- ------- ---------- ------- ---------- ---------- Total of variable rate debt as defined at (5) below.......................... -- -- -- 3,000 9,700 1,316,708 1,329,408 ------- -------- ------- ---------- ------- ---------- ---------- -69- Fair Value 2004(8) 2005 2006 2007 2008 Thereafter 6/30/2004(9) ------- -------- ------- ---------- ------- ---------- ------------ (6)(4) Island Cogen.............................. -- 5,947 -- -- -- -- 5,947 ------- -------- ------- ---------- ------- ---------- ---------- Total of variable rate debt as defined at (6) below.......................... -- 5,947 -- -- -- -- 5,947 (6)(4) Contra Costa.............................. -- 168 175 182 190 1,561 2,276 ------- -------- ------- ---------- ------- ---------- ---------- Total of variable rate debt as defined at (6) below.......................... -- 168 175 182 190 1,561 2,276 ------- -------- ------- ---------- ------- ---------- ---------- Grand total variable-rate debt instruments......................... $11,236 $141,879 $35,449 $1,483,156 $34,803 $3,813,043 $5,519,567 ======= ======== ======= ========== ======= ========== ========== - ------------ (1) British Bankers Association LIBOR Rate for deposit in US dollars for a period of six months. (2) U.S. prime rate in combination with the Federal Funds Effective Rate. (3) British Bankers Association LIBOR Rate for deposit in US dollars for a period of three months. (4) Actual interest rates include a spread over the basis amount. (5) Choice of 1-month US $LIBOR, 2-month US $LIBOR, 3-month US $LIBOR, 6-month US $LIBOR, 12-month US $LIBOR or a base rate. (6) Bankers Acceptance Rate. (7) Local Agency Fund. (8) For 6 months remaining in 2004. (9) Fair value equals carrying value.
Construction/project financing facility -- In November 2004 the $2.5 billion secured construction financing revolving facility for our wholly owned subsidiary CCFC II (renamed CalGen) was scheduled to mature. On March 23, 2004, CalGen completed its offering of secured institutional term loans and secured notes, which refinanced the CCFC II facility. We realized total proceeds from the offering in the amount of $2.4 billion, before transaction costs and fees. Riverside Holdings, LLC and Rocky Mountain Energy Center, LLC refinancing - -- On June 29, 2004, Rocky Mountain Energy Center, LLC and Riverside Energy Center, LLC, wholly owned stand-alone subsidiaries of the Company's Calpine Riverside Holdings, LLC subsidiary, received funding in the aggregate amount of $661.5 million comprised of $633.4 million of First Priority Secured Floating Rate Term Loans Due 2011 priced at LIBOR plus 425 basis points and $28.1 million letter of credit-linked deposit. Net proceeds from the loans, after transaction costs and fees, were used to pay final construction costs and refinance amounts outstanding under the $250 million non-recourse project financing for the Rocky Mountain facility and the $230 million non-recourse project financing for the Riverside facility. See Note 8 of the Notes to Consolidated Condensed Financial Statements. New Accounting Pronouncements In January 2003 FASB issued FIN 46. FIN 46 requires the consolidation of an entity by an enterprise that absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interest in the entity. Historically, entities have generally been consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity. The objectives of FIN 46 are to provide guidance on the identification of Variable Interest Entities ("VIEs") for which control is achieved through means other than ownership of a majority of the voting interest of the entity, and how to determine which business enterprise (if any), as the Primary Beneficiary, should consolidate the Variable Interest Entity ("VIE"). This new model for consolidation applies to an entity in which either (1) the at-risk equity is insufficient to absorb expected losses without additional subordinated financial support or (2) its at-risk equity holders as a group are not able to make decisions that have a significant impact on the success or failure of the entity's ongoing activities. A variable interest in a VIE, by definition, is an asset, liability, equity, contractual arrangement or other economic interest that absorbs the entity's variability. -70- In December 2003 FASB modified FIN 46 with FIN 46-R to make certain technical corrections and to address certain implementation issues. FIN 46, as originally issued, was effective immediately for VIEs created or acquired after January 31, 2003. FIN 46-R delayed the effective date of the interpretation to no later than March 31, 2004, (for calendar-year enterprises), except for Special Purpose Entities ("SPEs") for which the effective date was December 31, 2003. We have adopted FIN 46-R for our investment in SPEs, equity method joint ventures, our wholly owned subsidiaries that are subject to long-term power purchase agreements and tolling arrangements, operating lease arrangements containing fixed price purchase options and our wholly owned subsidiaries that have issued mandatorily redeemable non-controlling preferred interests. On application of FIN 46, we evaluated our investments in joint ventures and operating lease arrangements containing fixed price purchase options and concluded that, in some instances, these entities were VIEs. However, in these instances, we were not the Primary Beneficiary, as we would not absorb a majority of these entities' expected variability. An enterprise that holds a significant variable interest in a VIE is required to make certain disclosures regarding the nature and timing of its involvement with the VIE and the nature, purpose, size and activities of the VIE. The fixed price purchase options under our operating lease arrangements were not considered significant variable interests. However, our investments in joint ventures were considered significant. See Note 5 of the Notes to Consolidated Condensed Financial Statements for more information related to these joint venture investments. An analysis was performed for 100% Company-owned subsidiaries with significant long-term power sales or tolling agreements. Certain of the 100% Company-owned subsidiaries were deemed to be VIEs by virtue of a power sales or tolling agreement which was longer than 10 years and for more than 50% of the entity's capacity. However, in all cases, we absorbed a majority of the entity's variability and continue to consolidate these 100% Company-owned subsidiaries. We qualitatively determined that power sales or tolling agreements less than 10 years in length and for less than 50% of the entity's capacity would not cause the power purchaser to be the Primary Beneficiary, due to the length of the economic life of the underlying assets. Also, power sales and tolling agreements meeting the definition of a lease under EITF Issue No. 01-08, "Determining Whether an Arrangement Contains a Lease," were not considered variable interests due to certain exclusions under FIN 46-R. A similar analysis was performed for our wholly owned subsidiaries that have issued mandatorily redeemable non-controlling preferred interests. These entities were determined to be VIEs in which we absorb the majority of the variability, primarily due to the debt characteristics of the preferred interest, which are classified as debt in accordance with SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" in our Consolidated Condensed Balance Sheets. Consequently, we continue to consolidate these wholly owned subsidiaries. See Note 2 of the Notes to Consolidated Condensed Financial Statements for more information. On July 19, 2004, the Emerging Issues Task Force ("EITF") reached a tentative conclusion on Issue No. 04-8 ("EITF 04-8"): "The Effect of Contingently Convertible Debt on Diluted Earnings per Share" that would require companies that have issued contingently convertible debt instruments, commonly referred to as "Co-Cos," with a market price trigger to include the effects of the conversion in earnings per share ("EPS"), regardless of whether the price trigger had been met. Currently, Co-Cos are not included in EPS if the price trigger has not been met. Typically, the affected instruments are convertible into common shares of the issuer after the common stock price has exceeded a predetermined threshold for a specified time period. If EITF 04-8 is finalized as currently written, our $900 million of 4.75% Contingent Convertible Senior Notes Due 2023 may be affected. We are still in the process of determining what impact, if any, this new guidance will have on our diluted EPS. Item 3. Quantitative and Qualitative Disclosures About Market Risk. See "Financial Market Risks" in Item 2. Item 4. Controls and Procedures. As reported in the Company's Form 10-K filing for the year ended December 31, 2003, in connection with the audit of the Company's financial statements for the fiscal year ended December 31, 2003, its independent registered public accounting firm reviewed the Company's information systems control framework and identified to the Company certain significant deficiencies in the design of such systems. These design deficiencies generally related to the number of persons having access to certain of the Company's information systems databases, as well as the segregation of duties of persons with such access. The Company has concluded that, in the aggregate, these deficiencies constituted a material weakness in its internal control over financial reporting, and the Company has performed substantial analytical and post-closing procedures as a result of these design deficiencies. Based on the Company's compensating controls and testing, it has concluded that these design deficiencies did not result in any material errors in its financial statements. Additionally, the Company has -71- completed the process of correcting these design deficiencies by taking the following steps: o manual procedures have been replaced with system-based controls to ensure proper segregation of duties and documentation of approval for the Journal Entry and Vendor Maintenance processes; and o system access rights for financial system software updates have been redefined and restricted to segregate certain activities and allow user activities to be monitored. The Company continues to test the effectiveness of these changes. Other than correcting the material control weakness identified above, there were no other changes in the Company's internal controls over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting. The Company's Chief Executive Officer and Chief Financial Officer, based on the evaluation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities and Exchange Act of 1934, as amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, as of June 30, 2004, and taking into account the material weakness described above including the analysis and testing performed by the Company, have concluded that the Company's disclosure controls and procedures were effective to ensure the timely collection, evaluation and disclosure of information relating to the Company that would potentially be subject to disclosure under the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. PART II -- OTHER INFORMATION Item 1. Legal Proceedings. We are party to various litigation matters arising out of the normal course of business, the more significant of which are summarized below. The ultimate outcome of each of these matters cannot presently be determined, nor can the liability that could potentially result from a negative outcome be reasonably estimated presently for every case. The liability we may ultimately incur with respect to any one of these matters in the event of a negative outcome may be in excess of amounts currently accrued with respect to such matters and, as a result of these matters, may potentially be material to our Consolidated Condensed Financial Statements. Securities Class Action Lawsuits. Since March 11, 2002, fourteen shareholder lawsuits have been filed against Calpine and certain of its officers in the United States District Court for the Northern District of California. The actions captioned Weisz v. Calpine Corp., et al., filed March 11, 2002, and Labyrinth Technologies, Inc. v. Calpine Corp., et al., filed March 28, 2002, are purported class actions on behalf of purchasers of Calpine stock between March 15, 2001 and December 13, 2001. Gustaferro v. Calpine Corp., filed April 18, 2002, is a purported class action on behalf of purchasers of Calpine stock between February 6, 2001 and December 13, 2001. The eleven other actions, captioned Local 144 Nursing Home Pension Fund v. Calpine Corp., Lukowski v. Calpine Corp., Hart v. Calpine Corp., Atchison v. Calpine Corp., Laborers Local 1298 v. Calpine Corp., Bell v. Calpine Corp., Nowicki v. Calpine Corp. Pallotta v. Calpine Corp., Knepell v. Calpine Corp., Staub v. Calpine Corp., and Rose v. Calpine Corp. were filed between March 18, 2002 and April 23, 2002. The complaints in these eleven actions are virtually identical-- they are filed by three law firms, in conjunction with other law firms as co-counsel. All eleven lawsuits are purported class actions on behalf of purchasers of Calpine's securities between January 5, 2001 and December 13, 2001. The complaints in these fourteen actions allege that, during the purported class periods, certain Calpine executives issued false and misleading statements about Calpine's financial condition in violation of Sections 10(b) and 20(1) of the Securities Exchange Act of 1934, as well as Rule 10b-5. These actions seek an unspecified amount of damages, in addition to other forms of relief. In addition, a fifteenth securities class action, Ser v. Calpine, et al., was filed on May 13, 2002. The underlying allegations in the Ser action are substantially the same as those in the above-referenced actions. However, the Ser action is brought on behalf of a purported class of purchasers of Calpine's 8.5% Senior Notes Due February 15, 2011 ("2011 Notes") and the alleged class period is October 15, 2001 through December 13, 2001. The Ser complaint alleges that, in violation of Sections 11 and 15 of the Securities Act of 1933, the Supplemental Prospectus for the 2011 Notes contained false and misleading statements regarding Calpine's financial condition. This action names Calpine, certain of its officers and directors, and the underwriters of the 2011 Notes offering as defendants, and seeks an unspecified amount of damages, in addition to other forms of relief. -72- All fifteen of these securities class action lawsuits were consolidated in the United States District Court for the Northern District of California. Plaintiffs filed a first amended complaint in October 2002. The amended complaint did not include the 1933 Act complaints raised in the bondholders' complaint, and the number of defendants named was reduced. On January 16, 2003, before our response was due to this amended complaint, plaintiffs filed a further second complaint. This second amended complaint added three additional Calpine executives and Arthur Andersen LLP as defendants. The second amended complaint set forth additional alleged violations of Section 10 of the Securities Exchange Act of 1934 relating to allegedly false and misleading statements made regarding Calpine's role in the California energy crisis, the long term power contracts with the California Department of Water Resources, and Calpine's dealings with Enron, and additional claims under Section 11 and Section 15 of the Securities Act of 1933 relating to statements regarding the causes of the California energy crisis. We filed a motion to dismiss this consolidated action in early April 2003. On August 29, 2003, the judge issued an order dismissing, with leave to amend, all of the allegations set forth in the second amended complaint except for a claim under Section 11 of the Securities Act relating to statements relating to the causes of the California energy crisis and the related increase in wholesale prices contained in the Supplemental Prospectuses for the 2011 Notes. The judge instructed plaintiff, Julies Ser, to file a third amended complaint, which he did on October 17, 2003. The third amended complaint names Calpine and three executives as defendants and alleges the Section 11 claim that survived the judge's August 29, 2003 order. On November 21, 2003, Calpine and the individual defendants moved to dismiss the third amended complaint on the grounds that plaintiff's Section 11 claim was barred by the applicable one-year statute of limitations. On February 4, 2004, the judge denied the motion to dismiss but has asked the parties to be prepared to file summary judgment motions to address the statute of limitations issue. We filed our answer to the third amended complaint on February 28, 2004. In a separate order dated February 4, 2004, the court denied without prejudice Julies Ser's motion to be appointed lead plaintiff. Mr. Ser subsequently stated he no longer desired to serve as lead plaintiff. On April 4, 2004, the Policemen and Firemen Retirement System of the City of Detroit ("P&F") moved to be appointed lead plaintiff which motion was granted on May 14, 2004. We consider the lawsuit to be without merit and we intend to continue to defend vigorously against these allegations. Hawaii Structural Ironworkers Pension Fund v. Calpine, et al. A securities class action, Hawaii Structural Ironworkers Pension Fund v. Calpine, et al., was filed on March 11, 2003, against Calpine, its directors and certain investment banks in state superior court of San Diego County, California. The underlying allegations in the Hawaii Structural Ironworkers Pension Fund action ("Hawaii action") are substantially the same as the federal securities class actions described above. However, the Hawaii action is brought on behalf of a purported class of purchasers of Calpine's equity securities sold to public investors in its April 2002 equity offering. The Hawaii action alleges that the Registration Statement and Prospectus filed by Calpine which became effective on April 24, 2002, contained false and misleading statements regarding Calpine's financial condition in violation of Sections 11, 12 and 15 of the Securities Act of 1933. The Hawaii action relies in part on Calpine's restatement of certain past financial results, announced on March 3, 2003, to support its allegations. The Hawaii action seeks an unspecified amount of damages, in addition to other forms of relief. We removed the Hawaii action to federal court in April 2003 and filed a motion to transfer the case for consolidation with the other securities class action lawsuits in the United States District Court for the Northern District of California in May 2003. Plaintiff sought to have the action remanded to state court, and on August 27, 2003, the United States District Court for the Southern District of California granted plaintiff's motion to remand the action to state court. In early October 2003 plaintiff agreed to dismiss the claims it has against three of the outside directors. On November 5, 2003, Calpine, the individual defendants and the underwriter defendants filed motions to dismiss this complaint on numerous grounds. On February 6, 2004, the court issued a tentative ruling sustaining our motion to dismiss on the issue of plaintiff's standing. The court found that plaintiff had not shown that it had purchased Calpine stock "traceable" to the April 2002 equity offering. The court overruled our motion to dismiss on all other grounds. On March 12, 2004, after oral argument on the issues, the court confirmed its February 2, 2004, ruling. -73- On February 20, 2004, plaintiff filed an amended complaint, and in late March 2004 Calpine and the individual defendants filed answers to this complaint. On April 9, 2004, we and the individual defendants filed motions to transfer the lawsuit to Santa Clara County Superior Court, which motions were granted on May 7, 2004. We consider this lawsuit to be without merit and intend to continue to defend vigorously against it. Phelps v. Calpine Corporation, et al. On April 17, 2003, a participant in the Calpine Corporation Retirement Savings Plan (the "401(k) Plan") filed a class action lawsuit in the United States District Court for the Northern District of California. The underlying allegations in this action ("Phelps action") are substantially the same as those in the securities class actions described above. However, the Phelps action is brought on behalf of a purported class of participants in the 401(k) Plan. The Phelps action alleges that various filings and statements made by Calpine during the class period were materially false and misleading, and that defendants failed to fulfill their fiduciary obligations as fiduciaries of the 401(k) Plan by allowing the 401(k) Plan to invest in Calpine common stock. The Phelps action seeks an unspecified amount of damages, in addition to other forms of relief. In May 2003, Lennette Poor-Herena, another participant in the 401(k) Plan, filed a substantially similar class action lawsuit as the Phelps action also in the Northern District of California. Plaintiffs' counsel is the same in both of these actions, and they have agreed to consolidate these two cases and to coordinate them with the consolidated federal securities class actions described above. On January 20, 2004, plaintiff James Phelps filed a consolidated ERISA complaint naming Calpine and numerous individual current and former Calpine Board members and employees as defendants. Pursuant to a stipulated agreement with plaintiff, Calpine's response to the amended complaint is due on August 13, 2004. We consider this lawsuit to be without merit and intend to vigorously defend against it. Johnson v. Peter Cartwright, et al. On December 17, 2001, a shareholder filed a derivative lawsuit on behalf of Calpine against its directors and one of its senior officers. This lawsuit is captioned Johnson v. Cartwright, et al. and is pending in state superior court of Santa Clara County, California. Calpine is a nominal defendant in this lawsuit, which alleges claims relating to purportedly misleading statements about Calpine and stock sales by certain of the director defendants and the officer defendant. In December 2002 the court dismissed the complaint with respect to certain of the director defendants for lack of personal jurisdiction, though plaintiff may appeal this ruling. In early February 2003 plaintiff filed an amended complaint. In March 2003 Calpine and the individual defendants filed motions to dismiss and motions to stay this proceeding in favor of the federal securities class actions described above. In July 2003 the court granted the motions to stay this proceeding in favor of the consolidated federal securities class actions described above. We cannot estimate the possible loss or range of possible loss from this matter. We consider this lawsuit to be without merit and intend to vigorously defend against it. Gordon v. Peter Cartwright, et al. On August 8, 2002, a shareholder filed a derivative suit in the United States District Court for the Northern District of California on behalf of Calpine against its directors, captioned Gordon v. Cartwright, et al. similar to Johnson v. Cartwright. Motions have been filed to dismiss the action against certain of the director defendants on the grounds of lack of personal jurisdiction, as well as to dismiss the complaint in total on other grounds. In February 2003 plaintiff agreed to stay these proceedings in favor of the consolidated federal securities class action described above and to dismiss without prejudice certain director defendants. On March 4, 2003, plaintiff filed papers with the court voluntarily agreeing to dismiss without prejudice the claims he had against three of the outside directors. We cannot estimate the possible loss or range of possible loss from this matter. We consider this lawsuit to be without merit and intend to continue to defend vigorously against it. Calpine Corporation v. Automated Credit Exchange. On March 5, 2002, Calpine sued Automated Credit Exchange ("ACE") in state superior court of Alameda County, California for negligence and breach of contract to recover reclaim trading credits, a form of emission reduction credits that should have been held in Calpine's account with U.S. Trust Company ("US Trust"). Calpine wrote off $17.7 million in December 2001 related to losses that it alleged were caused by ACE. Calpine and ACE entered into a Settlement Agreement on March 29, 2002, pursuant to which ACE made a payment to Calpine of $7 million and transferred to Calpine the rights to the emission reduction credits to be held by ACE. We recognized the $7 million as income in the second quarter of 2002. In June 2002 a complaint was filed by InterGen North America, L.P. ("InterGen") against Anne M. Sholtz, the owner of ACE, and EonXchange, another Sholtz-controlled entity, which filed for bankruptcy protection on May 6, 2002. InterGen alleges it suffered a loss of emission reduction credits from EonXchange in a manner similar to Calpine's loss from ACE. InterGen's complaint alleges that Anne Sholtz co-mingled assets among ACE, EonXchange and other Sholtz entities and that ACE and other Sholtz entities should be deemed to be one economic enterprise and all retroactively included in the EonXchange bankruptcy filing as of May 6, 2002. By a judgment entered on October 30, 2002, the bankruptcy court consolidated ACE and the other Sholtz controlled entities with the bankruptcy estate of EonXchange. Subsequently, the Trustee of EonXchange filed a separate motion to substantively consolidate Anne Sholtz into the bankruptcy estate of -74- EonXchange. Although Anne Sholtz initially opposed such motion, she entered into a settlement agreement with the Trustee consenting to her being substantively consolidated into the bankruptcy proceeding. The bankruptcy court entered an order approving Anne Sholtz's settlement agreement with the Trustee on April 3, 2002. On July 10, 2003, Howard Grobstein, the Trustee in the EonXchange bankruptcy, filed a complaint for avoidance against Calpine, seeking recovery of the $7 million (plus interest and costs) paid to Calpine in the March 29, 2002 Settlement Agreement. The complaint claims that the $7 million received by Calpine in the Settlement Agreement was transferred within 90 days of the filing of bankruptcy and therefore should be avoided and preserved for the benefit of the bankruptcy estate. On August 28, 2003, Calpine filed its answer denying that the $7 million is an avoidable preference. Following two settlement conferences, on or about May 21, 2004, Calpine and the Trustee entered into a Settlement Agreement, whereby Calpine agreed to pay $5.85 million, which was approved by the Bankruptcy Court on June 16, 2004. The preference lawsuit will be dismissed with prejudice upon final payment of the settlement, which will occur on October 1, 2004. International Paper Company v. Androscoggin Energy LLC. In October 2000 International Paper Company ("IP") filed a complaint in the United States District Court for the Northern District of Illinois against Androscoggin Energy LLC ("AELLC") alleging that AELLC breached certain contractual representations and warranties by failing to disclose facts surrounding the termination, effective May 8, 1998, of one of AELLC's fixed-cost gas supply agreements. We had acquired a 32.3% interest in AELLC as part of the SkyGen transaction which closed in October 2000. AELLC filed a counterclaim against IP that has been referred to arbitration that AELLC may commence at its discretion upon further evaluation. On November 7, 2002, the court issued an opinion on the parties' cross motions for summary judgment finding in AELLC's favor on certain matters though granting summary judgment to IP on the liability aspect of a particular claim against AELLC. The court also denied a motion submitted by IP for preliminary injunction to permit IP to make payment of funds into escrow (not directly to AELLC) and require AELLC to post a significant bond. In mid-April of 2003 IP unilaterally availed itself to self-help in withholding amounts in excess of $2.0 million as a set-off for litigation expenses and fees incurred to date as well as an estimated portion of a rate fund to AELLC. Upon AELLC's amended complaint and request for immediate injunctive relief against such actions, the court ordered that IP must pay the approximately $1.2 million withheld as attorneys' fees related to the litigation as any such perceived entitlement was premature, but deferred to provide injunctive relief on the incomplete record concerning the offset of $799,000 as an estimated pass-through of the rate fund. IP complied with the order on April 29, 2003, and tendered payment to AELLC of the approximately $1.2 million. On June 26, 2003, the court entered an order dismissing AELLC's amended counterclaim without prejudice to AELLC refiling the claims as breach of contract claims in a separate lawsuit. On December 11, 2003, the court denied in part IP's summary judgment motion pertaining to damages. In short, the court: (i) determined that, as a matter of law, IP is entitled to pursue an action for damages as a result of AELLC's breach, and (ii) ruled that sufficient questions of fact remain to deny IP summary judgment on the measure of damages as IP did not sufficiently establish causation resulting from AELLC's breach of contract (the liability aspect of which IP obtained a summary judgment in December 2002). On February 2, 2004, the parties filed a Final Pretrial Order with the court. The case appears likely scheduled for trial in the third quarter of 2004, subject to the court's discretion and calendar. We believe we have adequately reserved for the possible loss, if any, we may ultimately incur as a result of this matter. Pacific Gas and Electric Company v. Calpine Corporation, et al. On July 22, 2003, PG&E filed with the CPUC a Complaint of PG&E and Request for Immediate Issuance of an Order to Show Cause ("complaint") against Calpine Corporation, CPN Pipeline Company, Calpine Energy Services, L.P., Calpine Natural Gas Company, and Lodi Gas Storage, LLC ("LGS"). The complaint requests the CPUC to issue an order requiring defendants to show cause why they should not be ordered to cease and desist from using any direct interconnections between the facilities of CPN Pipeline and those of LGS unless LGS and Calpine first seek and obtain regulatory approval from the CPUC. The complaint also seeks an order directing defendants to pay to PG&E any underpayments of PG&E's tariffed transportation rates and to make restitution for any profits earned from any business activity related to LGS' direct interconnections to any entity other than PG&E. The complaint further alleges that various natural gas consumers, including Calpine affiliated generation projects within California, are engaged with defendants in the acts complained of, and that the defendants unlawfully bypass PG&E's system and operate as an unregulated local distribution company within PG&E's service territory. On August 27, 2003, Calpine filed its answer and a motion to dismiss. LGS also made similar filings. On October 16, 2003, the presiding administrative law judge denied the motion to dismiss and on October 24, 2003, issued a Scoping Memo and Ruling establishing a procedural schedule and set the matter for an evidentiary hearing. On January 15, 2004, Calpine, LGS and PG&E executed a Settlement Agreement to resolve all outstanding allegations and claims raised in the complaint. Certain aspects of the Settlement Agreement are effective immediately and the effectiveness of other provisions is subject to the approval of the Settlement Agreement by the CPUC. In the event the CPUC fails to approve the Settlement Agreement, its operative terms and conditions -75- become null and void. The Settlement Agreement provides, in part, for: 1) PG&E to be paid $2.7 million; 2) the disconnection of the LGS interconnections with Calpine; 3) Calpine to obtain PG&E consent or regulatory or other governmental approval before resuming any sales or exchanges at the Ryer Island Meter Station; 4) PG&E's withdrawal of its public utility claims against Calpine; and 5) no party admitting any wrongdoing. Accordingly, the presiding administrative law judge vacated the hearing schedule and established a new procedural schedule for the filing of the Settlement Agreement. On February 6, 2004, the Settlement Agreement was filed with the CPUC. The parties were given the opportunity to submit comments and reply comments on the Settlement Agreement. The CPUC approved the Settlement Agreement on July 8, 2004 and the $2.7 million was paid to PG&E on July 15, 2004. Panda Energy International, Inc., et al. v. Calpine Corporation, et al. On November 5, 2003, Panda Energy International, Inc. and certain related parties, including PLC II, LLC, (collectively "Panda") filed suit against Calpine and certain of its affiliates in the United States District Court for the Northern District of Texas, alleging, among other things, that we breached duties of care and loyalty allegedly owed to Panda by failing to correctly construct and operate the Oneta Energy Center ("Oneta"), which we acquired from Panda, in accordance with Panda's original plans. Panda alleges that it is entitled to a portion of the profits from Oneta plant and that Calpine's actions have reduced the profits from Oneta plant thereby undermining Panda's ability to repay monies owed to Calpine on December 1, 2003, under a promissory note on which approximately $38.6 million (including interest) is currently outstanding and past due. The note is collateralized by Panda's carried interest in the income generated from Oneta, which achieved full commercial operations in June 2003. We have filed a counterclaim against Panda Energy International, Inc. (and PLC II, LLC) based on a guaranty, and have also filed a motion to dismiss as to the causes of action alleging federal and state securities laws violations. The motion to dismiss is currently pending before the court. However, at the present time, we cannot estimate the potential loss, if any, that might arise from this matter. We consider Panda's lawsuit to be without merit and intend to defend vigorously against it. We stopped accruing interest income on the promissory note due December 1, 2003, as of the due date because of Panda's default in repayment of the note. California Business & Professions Code Section 17200 Cases, of which the lead case is T&E Pastorino Nursery v. Duke Energy Trading and Marketing, L.L.C., et al. This purported class action complaint filed in May 2002 against twenty energy traders and energy companies, including CES, alleges that defendants exercised market power and manipulated prices in violation of California Business & Professions Code Section 17200 et seq., and seeks injunctive relief, restitution, and attorneys' fees. We also have been named in seven other similar complaints for violations of Section 17200. All seven cases were removed from the various state courts in which they were originally filed to federal court for pretrial proceedings with other cases in which we are not named as a defendant. However, at the present time, we cannot estimate the potential loss, if any, that might arise from this matter. We consider the allegations to be without merit, and filed a motion to dismiss on August 28, 2003. The court granted the motion, and plaintiffs have appealed. Prior to the motion to dismiss being granted, one of the actions, captioned Millar v. Allegheny Energy Supply Co., LLP, et al., was remanded to state superior court of Alameda County, California. On January 12, 2004, CES was added as a defendant in Millar. This action includes similar allegations to the other 17200 cases, but also seeks rescission of the long-term power contracts with CDWR. Upon motion from another newly added defendant, Millar was recently removed to federal court. It has now been transferred to the same judge that is presiding over the other 17200 cases described above, where it will be consolidated with such cases for pretrial purposes. We anticipate filing a timely motion for dismissal of Millar as well. Nevada Power Company and Sierra Pacific Power Company v. Calpine Energy Services, L.P. before the FERC, filed on December 4, 2001. Nevada Section 206 Complaint. On December 4, 2001, Nevada Power Company ("NPC") and Sierra Pacific Power Company ("SPPC") filed a complaint with FERC under Section 206 of the Federal Power Act against a number of parties to their power sales agreements, including Calpine. NPC and SPPC allege in their complaint, which seeks a refund, that the prices they agreed to pay in certain of the power sales agreements, including those signed with Calpine, were negotiated during a time when the power market was dysfunctional and that they are unjust and unreasonable. The administrative law judge issued an Initial Decision on December 19, 2002, that found for Calpine and the other respondents in the case and denied NPC the relief that it was seeking. In June 2003, FERC rejected the complaint. Some plaintiffs appealed to the FERC and their request for rehearing was denied. The matter is pending on appeal before the United States Court of Appeals for the Ninth Circuit and is in the pleading stage. Transmission Service Agreement with Nevada Power. On March 16, 2004, NPC filed a petition for declaratory order at FERC (Docket No. EL04-90-000) asking that an order be issued requiring Calpine and Reliant Energy Services, Inc. to pay for transmission service under their Transmission Service Agreements -76- ("TSAs") with NPC or, if the TSAs are terminated, to pay the lesser of the transmission charges or a pro rata share of the total cost of NPC's Centennial Project (approximately $33 million for Calpine). Calpine had previously provided security to NPC for these costs in the form of a surety bond issued by Fireman's Fund Insurance Company ("FFIC"). The Centennial Project involves construction of various transmission facilities in two phases; Calpine's Moapa Energy Center ("MEC") is scheduled to receive service under its TSA from facilities yet to be constructed in the second phase of the Centennial Project. Calpine has filed a protest to the petition asserting that Calpine will take service under the TSA if NPC proceeds to execute a purchase power agreement ("PPA") with MEC based on its winning bid in the Request for Proposals that NPC conducted in 2003. Calpine also has taken the position that if NPC does not execute a PPA with MEC, it will terminate the TSA and any payment by Calpine would be limited to a pro rata allocation of costs incurred to date on the second phase of the project (approximately $4.5 million in total) among the three customers to be served. At this time, we are unable to predict the final outcome of this proceeding or its impact on us. On or about April 27, 2004, NPC alleged to FFIC that Calpine had defaulted on the TSA and made demand on FFIC for the full amount of the surety bond, $33,333,333.00. On April 29, 2004, FFIC filed a complaint for declaratory order in state superior court of Marin County, California in connection with this demand. FFIC's complaint asks that an order be issued declaring that it has no obligation to make payment under the bond. Further, if the court determines that FFIC does have an obligation to make payment, FFIC asks that an order be issued declaring that (i) Calpine has an obligation to replace it with funds equal to the amount of NPC's demand against the bond and (ii) Calpine is obligated to indemnify and hold FFIC harmless for all loss, costs and fees incurred as a result of the issuance of the bond. Calpine has filed its answer to the complaint arguing, among other items, that it did not default on its obligations under the TSA and therefore NPC is not entitled to make a demand upon the FFIC bond. At this time, we are unable to predict the outcome of this proceeding or its impact on us. Calpine Canada Natural Gas Partnership v. Enron Canada Corp. On February 6, 2002, Calpine Canada Natural Gas Partnership ("Calpine Canada") filed a complaint in the Alberta Court of Queens Branch alleging that Enron Canada Corp. ("Enron Canada") owed it approximately $1.5 million from the sale of gas in connection with two Master Firm gas Purchase and Sale Agreements. To date, Enron Canada has not sought bankruptcy relief and has counterclaimed in the amount of $18 million. Discovery is currently in progress, and we believe that Enron Canada's counterclaim is without merit and intend to vigorously defend against it. Jones v. Calpine Corporation. On June 11, 2003, the Estate of Darrell Jones and the Estate of Cynthia Jones filed a complaint against Calpine in the United States District Court for the Western District of Washington. Calpine purchased Goldendale Energy, Inc., a Washington corporation, from Darrell Jones. The agreement provided, among other things, that upon substantial completion of the Goldendale facility, Calpine would pay Mr. Jones (i) $6.0 million and (ii) $18.0 million less $0.2 million per day for each day that elapsed between July 1, 2002, and the date of substantial completion. Substantial completion of the Goldendale facility has not occurred and the daily reduction in the payment amount has reduced the $18.0 million payment to zero. The complaint alleges that by not achieving substantial completion by July 1, 2002, Calpine breached its contract with Mr. Jones, violated a duty of good faith and fair dealing, and caused an inequitable forfeiture. The complaint seeks damages in an unspecified amount in excess of $75,000. On July 28, 2003, Calpine filed a motion to dismiss the complaint for failure to state a claim upon which relief can be granted. The court granted Calpine's motion to dismiss the complaint on March 10, 2004. Plaintiffs have filed a motion for reconsideration of the decision, which was denied. Subsequently, on June 7, 2004, plaintiffs filed a notice of appeal. Calpine also filed a motion to recover attorneys' fees from NESCO, which was recently granted at a reduced amount. Calpine still, however, expects to make the $6.0 million payment to the estates when the project is completed. In addition, we are involved in various other claims and legal actions arising out of the normal course of our business. We do not expect that the outcome of these proceedings will have a material adverse effect on our financial position or results of operations. Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. During the second quarter the Company issued unregistered shares of its common stock in exchange for its HIGH TIDES, which are exchangeable for common stock, as follows: o On June 28, 2004, the Company exchanged 4.3 million shares of Calpine common stock in privately negotiated transactions for approximately $20.0 million par value of HIGH TIDES I. -77- o On June 29, 2004, the Company exchanged 5.4 million shares of Calpine common stock in privately negotiated transactions for approximately $25.0 million par value of HIGH TIDES II. o On June 30, 2004, the Company exchanged 10.4 million shares of Calpine common stock in privately negotiated transactions for approximately $50.0 million par value HIGH TIDES II. All of the shares of Calpine common stock issued in exchange for the HIGH TIDES were issued without registration under the Securities Act of 1933 in reliance upon the exemption afforded by Section 3(a)(9) thereof. The following table sets forth the total units of HIGH TIDES purchased by the Company during the second quarter, which are the only equity securities, or securities convertible into equity securities, of the Company were purchased by it during the period. All such purchases were made in privately negotiated transactions.
Total Number of Maximum Number Units Purchased as of Units that May Part of Publicly Yet Be Purchased Total Number of Average Price Paid Announced Plans Under the Plans Period Units Purchased Per Share or Programs or Programs - -------------- --------------- ------------------ ----------------- ----------------- 4/1/04-4/30/04......... -- -- -- -- 5/1/04-5/31/04......... -- -- -- -- 6/1/04-6/30/04......... 1,900,000 $48.08 -- --
Item 4. Submission of Matters to a Vote of Security Holders. Our Annual Meeting of Stockholders was held on May 26, 2004 (the "Annual Meeting"), in Aptos, California. At the Annual Meeting, the stockholders voted on the following matters: (i) the proposal to elect three Class II Directors to the Board of Directors for a term of three years expiring in 2007, (ii) the proposal to amend the Company's Amended and Restated Certificate of Incorporation to increase the number of authorized shares of Common Stock, par value $.001 per share ("Common Stock"), (iii) the proposal to amend the Company's 1996 Stock Incentive Plan to increase the number of shares of the Company's Common Stock available for grants of options and other stock-based awards under such plan, (iv) the proposal to amend the Company's 2000 Employee Stock Purchase Plan to increase the number of shares of the Company's Common Stock available for grants of purchase rights under such plan, (v) three stockholder proposals regarding (a) the Company's geothermal development activities in the Medicine Lake Highlands and a request that the Company adopt an indigenous peoples policy, (b) the Company's senior executive equity compensation plans, and (c) stockholder voting, and (iv) the proposal to ratify the appointment of PricewaterhouseCoopers LLP as independent accountants for the Company for the fiscal year ending December 31, 2004. The stockholders elected management's nominees as the Class II Directors in an uncontested election, approved amending the Company's Amended and Restated Certificate of Incorporation, approved amending the Company's 1996 Stock Incentive Plan, approved amending the Company's 2000 Employee Stock Purchase Plan, did not approve the stockholder proposal requesting that the Company cease its geothermal development activities in the Medicine Lake Highlands and that the Company adopt an indigenous peoples policy, did not approve the stockholder proposal regarding the Company's senior executive equity compensation plans, did not approve the stockholder proposal regarding stockholder voting, and ratified the appointment of independent accountants by the following votes, respectively: (i) Election of Ann B. Curtis as Class II Director for a three-year term expiring 2007: 340,549,179 FOR and 39,650,521 WITHHELD; Election of Kenneth T. Derr as Class II Director for a three-year term expiring 2007: 340,944,921 FOR and 39,254,779 WITHHELD; Election of Gerald Greenwald as Class II Director for a three-year term expiring 2007: 340,885,215 FOR and 39,314,485 WITHHELD; (ii) Proposal to amend the Company's Amended and Restated Certificate of Incorporation to increase the number of authorized shares of Common Stock: 344,016,567 FOR, 33,379,497 AGAINST, and 2,803,636 ABSTAIN (iii) Proposal to amend the Company's 1996 Stock Incentive Plan to increase the number of shares of the Company's Common Stock available for grants of options and other stock-based awards under such plan: 112,195,541 FOR, 80,997,504 AGAINST, 2,687,696 ABSTAIN, and 184,318,959 Broker non-votes, (iv) Proposal to amend the Company's 2000 Employee Stock Purchase Plan to increase the number of shares of the Company's Common Stock available for grants of purchase rights under such plan: 172,353,952 FOR, 20,788,375 AGAINST, 2,738,414 ABSTAIN, and 184,318,959 Broker non-votes -78- (v) Proposal that the Company cease and desist geothermal development activities in the Medicine Lake Highlands and requesting the Company to adopt an indigenous peoples policy: 8,250,567 FOR, 181,409,173 AGAINST, 6,220,001 ABSTAIN, and 184,318,959 Broker non-votes; (vi) Proposal that the Company's Compensation Committee of its Board of Directors utilize performance and time-based restricted share programs in lieu of stock options in developing future senior executive equity compensation plans: 33,255,357 FOR, 158,444,552 AGAINST, 4,179,832 ABSTAIN, and 184,319,959 Broker non-votes; (vii) Proposal requesting the Company's Board of Directors to study and report on the feasibility of enabling stockholders to imitate the voting decisions of an institutional investor: 17,537,323 FOR, 173,771,064 AGAINST, 4,571,354 ABSTAIN, and 184,319,959 Broker non-votes; (viii) Ratification of the appointment of PricewaterhouseCoopers LLP as independent accountants for the fiscal year ending December 31, 2004: 369,214,181, FOR, 8,353,462 AGAINST, and 2,631,557 ABSTAIN. The three-year terms of Class III and Class II Directors continued after the Annual Meeting and will expire in 2005 and 2006, respectively. The Class III Directors are Susan C. Schwab, Susan Wang and Peter Cartwright. The Class I Directors are Jeffrey E. Garten, George J. Stathakis, and John O. Wilson. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits The following exhibits are filed herewith unless otherwise indicated: EXHIBIT INDEX Exhibit Number Description - ------- --------------------------------------------------------------------- +3.1 Amended and Restated Certificate of Incorporation of Calpine Corporation, as amended through June 2, 2004. *3.2 Amended and Restated By-laws of Calpine Corporation.(a) *4.1.1 Indenture, dated as of May 16, 1996, between the Company and U.S. Bank (as successor trustee to Fleet National Bank), as Trustee, including form of Notes.(b) *4.1.2 First Supplemental Indenture, dated as of August 1, 2000, between the Company and U.S. Bank National Association (as successor trustee to Fleet National Bank), as Trustee.(c) *4.1.3 Second Supplemental Indenture, dated as of April 26, 2004, between the Company and U.S. Bank National Association (as successor trustee to Fleet National Bank), as Trustee.(d) *4.2.1 Indenture, dated as of July 8, 1997, between the Company and The Bank of New York, as Trustee, including form of Notes.(e) *4.2.2 Supplemental Indenture, dated as of September 10, 1997, between the Company and The Bank of New York, as Trustee.(f) *4.2.3 Second Supplemental Indenture, dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(c) *4.2.4 Third Supplemental Indenture, dated as of April 26, 2004, between the Company and The Bank of New York, as Trustee.(d) *4.3.1 Indenture, dated as of March 31, 1998, between the Company and The Bank of New York, as Trustee, including form of Notes.(g) *4.3.2 Supplemental Indenture, dated as of July 24, 1998, between the Company and The Bank of New York, as Trustee.(g) *4.3.3 Second Supplemental Indenture, dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(c) *4.3.4 Third Supplemental Indenture, dated as of April 26, 2004, between the Company and The Bank of New York, as Trustee.(d) *4.4.1 Indenture, dated as of March 29, 1999, between the Company and The Bank of New York, as Trustee, including form of Notes.(h) *4.4.2 First Supplemental Indenture, dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(c) *4.4.3 Second Supplemental Indenture, dated as of April 26, 2004, between the Company and The Bank of New York, as Trustee.(d) *4.5.1 Indenture, dated as of March 29, 1999, between the Company and The Bank of New York, as Trustee, including form of Notes.(h) *4.5.2 First Supplemental Indenture, dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(c) *4.5.3 Second Supplemental Indenture, dated as of April 26, 2004, between the Company and The Bank of New York, as Trustee.(d) +4.6 Indenture, dated as of June 2, 2004, between Power Contract Financing III, LLC, and Wilmington Trust Company, as Trustee, Accounts Agent, Paying Agent and Registrar, including form of Notes. +31.1 Certification of the Chairman, President and Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. -79- Exhibit Number Description - ------- --------------------------------------------------------------------- +31.2 Certification of the Executive Vice President and Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - ---------- + Filed herewith. * Incorporated by reference. (a) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. (b) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-4 (Registration No. 333-06259) filed with the SEC on June 19, 1996. (c) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 2000, filed with the SEC on March 15, 2001. (d) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated March 31, 2004, filed with the SEC on May 10, 2004. (e) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated June 30, 1997, filed with the SEC on August 14, 1997. (f) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-4 (Registration No. 333-41261) filed with the SEC on November 28, 1997. (g) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-4 (Registration No. 333-61047) filed with the SEC on August 10, 1998. (h) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3/A (Registration No. 333-72583) filed with the SEC on March 8, 1999. (b) Reports on Form 8-K The registrant filed the following reports on Form 8-K during the quarter ended June 30, 2004: Date of Report Date Filed Item Reported -------------------- ------------------ ------------- April 15, 2004 April 19, 2004 5 April 26, 2004 April 28, 2004 5 May 6, 2004 May 12, 2004 12 May 26, 2004 May 27, 2004 5 June 3, 2004 June 9, 2004 5 June 14, 2004 June 15, 2004 5 June 29, 2004 June 29, 2004 5 -80- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Calpine Corporation By: /s/ ROBERT D. KELLY ------------------------------------- Robert D. Kelly Executive Vice President and Chief Financial Officer (Principal Financial Officer) Date: August 9, 2004 By: /s/ CHARLES B. CLARK, JR. ------------------------------------- Charles B. Clark, Jr. Senior Vice President and Corporate Controller (Principal Accounting Officer) Date: August 9, 2004 -81- The following exhibits are filed herewith unless otherwise indicated: EXHIBIT INDEX Exhibit Number Description - ------- --------------------------------------------------------------------- +3.1 Amended and Restated Certificate of Incorporation of Calpine Corporation, as amended through June 2, 2004. *3.2 Amended and Restated By-laws of Calpine Corporation.(a) *4.1.1 Indenture, dated as of May 16, 1996, between the Company and U.S. Bank (as successor trustee to Fleet National Bank), as Trustee, including form of Notes.(b) *4.1.2 First Supplemental Indenture, dated as of August 1, 2000, between the Company and U.S. Bank National Association (as successor trustee to Fleet National Bank), as Trustee.(c) *4.1.3 Second Supplemental Indenture, dated as of April 26, 2004, between the Company and U.S. Bank National Association (as successor trustee to Fleet National Bank), as Trustee.(d) *4.2.1 Indenture, dated as of July 8, 1997, between the Company and The Bank of New York, as Trustee, including form of Notes.(e) *4.2.2 Supplemental Indenture, dated as of September 10, 1997, between the Company and The Bank of New York, as Trustee.(f) *4.2.3 Second Supplemental Indenture, dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(c) *4.2.4 Third Supplemental Indenture, dated as of April 26, 2004, between the Company and The Bank of New York, as Trustee.(d) *4.3.1 Indenture, dated as of March 31, 1998, between the Company and The Bank of New York, as Trustee, including form of Notes.(g) *4.3.2 Supplemental Indenture, dated as of July 24, 1998, between the Company and The Bank of New York, as Trustee.(g) *4.3.3 Second Supplemental Indenture, dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(c) *4.3.4 Third Supplemental Indenture, dated as of April 26, 2004, between the Company and The Bank of New York, as Trustee.(d) *4.4.1 Indenture, dated as of March 29, 1999, between the Company and The Bank of New York, as Trustee, including form of Notes.(h) *4.4.2 First Supplemental Indenture, dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(c) *4.4.3 Second Supplemental Indenture, dated as of April 26, 2004, between the Company and The Bank of New York, as Trustee.(d) *4.5.1 Indenture, dated as of March 29, 1999, between the Company and The Bank of New York, as Trustee, including form of Notes.(h) *4.5.2 First Supplemental Indenture, dated as of July 31, 2000, between the Company and The Bank of New York, as Trustee.(c) *4.5.3 Second Supplemental Indenture, dated as of April 26, 2004, between the Company and The Bank of New York, as Trustee.(d) +4.6 Indenture, dated as of June 2, 2004, between Power Contract Financing III, LLC, and Wilmington Trust Company, as Trustee, Accounts Agent, Paying Agent and Registrar, including form of Notes. +31.1 Certification of the Chairman, President and Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 Certification of the Executive Vice President and Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - ---------- + Filed herewith. * Incorporated by reference. (a) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 2001, filed with the SEC on March 29, 2002. (b) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-4 (Registration No. 333-06259) filed with the SEC on June 19, 1996. (c) Incorporated by reference to Calpine Corporation's Annual Report on Form 10-K for the year ended December 31, 2000, filed with the SEC on March 15, 2001. (d) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated March 31, 2004, filed with the SEC on May 10, 2004. (e) Incorporated by reference to Calpine Corporation's Quarterly Report on Form 10-Q dated June 30, 1997, filed with the SEC on August 14, 1997. -82- (f) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-4 (Registration No. 333-41261) filed with the SEC on November 28, 1997. (g) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-4 (Registration No. 333-61047) filed with the SEC on August 10, 1998. (h) Incorporated by reference to Calpine Corporation's Registration Statement on Form S-3/A (Registration No. 333-72583) filed with the SEC on March 8, 1999. -83- EX-3 2 ex3-1.txt EXHIBIT 3.1 AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF CALPINE CORPORATION FIRST. The name of the corporation is Calpine Corporation (the "Corporation"). SECOND. The address of its registered office in the State of Delaware is 1209 Orange Street, in the City of Wilmington, County of New Castle. The name of its registered agent at such address is The Corporation Trust Company. THIRD. The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware. FOURTH. (a) The Corporation is authorized to issue 110,000,000 shares of capital stock, $.001 par value. The shares shall be divided into two classes, designated as follows: Designation of Class Number of Shares -------------------- ---------------- Common Stock 500,000,000 Preferred Stock 10,000,000 ----------- Total: 510,000,000 (b) The Preferred Stock may be issued from time to time in one or more series. The Board of Directors is expressly authorized, in the resolution or resolutions providing for the issuance of any wholly unissued series of Preferred Stock, to fix, state and express the powers, rights, designations, preferences, qualifications, limitations and restrictions thereof, including without limitation: the rate of dividends upon which and the times at which dividends on shares of such series shall be payable and the preference, if any, which such dividends shall have relative to dividends on shares of any other class or classes or any other series of stock of the Corporation; whether such dividends shall be cumulative or noncumulative, and if cumulative, the date or dates from which dividends on shares of such series shall be cumulative; the voting rights, if any, to be provided for shares of such series; the rights, if any, which the holders of shares of such series shall have in the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Corporation; the rights, if any, which the holders of shares of such series shall have to convert such shares into or exchange such shares for shares of stock of the Corporation, and the terms and conditions, including price and rate of exchange of such conversion or exchange; the redemption rights (including sinking fund provisions), if any, for shares of such series; and such other powers, rights, designations, preferences, qualifications, limitations and restrictions as the Board of Directors may desire to so fix. The Board of Directors is also expressly authorized to fix the number of shares constituting such series and to increase or decrease the number of shares of any series prior to the issuance of shares of that series and to increase or decrease the number of shares of any series subsequent to the issuance of shares of that series, but not to decrease such number below the number of shares of such series then outstanding. In case the number of shares of any series shall be so decreased, the shares constituting such decrease shall resume the status which they had prior to the adoption of the resolution originally fixing the number of shares of such series. FIFTH. In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is authorized to make, alter or repeal any or all of the Bylaws of the Corporation; provided, however, that any Bylaw amendment adopted by the Board of Directors increasing or reducing the authorized number of Directors shall require the affirmative vote of a majority of the total number of Directors which the Corporation would have if there were no vacancies. In addition, new Bylaws may be adopted or the Bylaws may be amended or repealed by the affirmative vote of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class. Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, change, amend, repeal or adopt any provision inconsistent with, this Article FIFTH. SIXTH. (a) Any action required or permitted to be taken by the stockholders of the Corporation must be effected at an annual or special meeting of stockholders of the Corporation and may not be effected by any consent in writing of such stockholders. (b) Special meetings of stockholders of the Corporation may be called only (i) by the Chairman of the Board of Directors, or (ii) by the Chairman or the Secretary at the written request of a majority of the total number of Directors which the Corporation would have if there were no vacancies upon not fewer than 10 nor more than 60 days' written notice. Any request for a special meeting of stockholders shall be sent to the Chairman and the Secretary and shall state the purposes of the proposed meeting. Special meetings of holders of the outstanding Preferred Stock may be called in the manner and for the purposes provided in the resolutions of the Board of Directors providing for the issue of such stock. Business transacted at special meetings shall be confined to the purpose or purposes stated in the notice of meeting. (c) Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, change, amend, repeal or adopt any provision inconsistent with, this Article SIXTH. SEVENTH. (a) The number of Directors which shall constitute the whole Board of Directors of this corporation shall be as specified in the Bylaws of this corporation, subject to this Article SEVENTH. (b) The Directors shall be classified with respect to the time for which they severally hold office into three classes designated Class I, Class II and Class III, as nearly equal in number as possible, as shall be provided in the manner specified in the Bylaws of the Corporation. Each Director shall serve for a term ending on the date of the third annual meeting of stockholders -2- following the annual meeting at which the Director was elected; provided, however, that each initial Director in Class I shall hold office until the annual meeting of stockholders in 1997, each initial Director in Class II shall hold office until the annual meeting of stockholders in 1998 and each initial Director in Class III shall hold office until the annual meeting of stockholders in 1999. Notwithstanding the foregoing provisions of this Article SEVENTH, each Director shall serve until his successor is duly elected and qualified or until such Director's death, resignation or removal. (c) In the event of any increase or decrease in the authorized number of Directors, (i) each Director then serving as such shall nevertheless continue as a Director of the class of which such Director is a member until the expiration of his current term, or his early resignation, removal from office or death and (ii) the newly created or eliminated directorship resulting from such increase or decrease shall be apportioned by the Board of Directors among the three classes of Directors so as to maintain such classes as nearly equally as possible. (d) Any Director or the entire Board of Directors may be removed by the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class. (e) Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, change, amend, repeal or adopt any provision inconsistent with, this Article SEVENTH. EIGHTH. (a) 1. In addition to any affirmative vote required by law, any Business Combination (as hereinafter defined) shall require the affirmative vote of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class (for purposes of this Article EIGHTH, the "Voting Shares"). Such affirmative vote shall be required notwithstanding the fact that no vote may be required, or that some lesser percentage may be specified by law or in any agreement with any national securities exchange or otherwise. 2. The term "Business Combination" as used in this Article EIGHTH shall mean any transaction which is referred to in any one or more of the following clauses (A) through (E): (A) any merger or consolidation of the Corporation or any Subsidiary (as hereinafter defined) with or into (i) any Interested Stockholder (as hereinafter defined) or (ii) any other corporation (whether or not itself an Interested Stockholder) which is, or after such merger or consolidation would be, an Affiliate (as hereinafter defined) or Associate (as hereinafter defined) of an Interested Stockholder; or (B) any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or a series of related transactions) to or with, or proposed by or on behalf of, any -3- Interested Stockholder or any Affiliate or Associate of any Interested Stockholder, of any assets of the Corporation or any Subsidiary constituting not less than five percent of the total assets of the Corporation, as reported in the consolidated balance sheet of the Corporation as of the end of the most recent quarter with respect to which such balance sheet has been prepared; or (C) the issuance or transfer by the Corporation or any Subsidiary (in one transaction or a series of related transactions) of any securities of the Corporation or any Subsidiary to, or proposed by or on behalf of, any Interested Stockholder or any Affiliate or Associate of any Interested Stockholder in exchange for cash, securities or other property (or a combination thereof) constituting not less than five percent of the total assets of the Corporation, as reported in the consolidated balance sheet of the Corporation as of the end of the most recent quarter with respect to which such balance sheet has been prepared; or (D) the adoption of any plan or proposal for the liquidation or dissolution of the Corporation, or any spin-off or split-up of any kind of the Corporation or any Subsidiary, proposed by or on behalf of an Interested Stockholder or any Affiliate or Associate of any Interested Stockholder; or (E) any reclassification of securities (including any reverse stock split), or recapitalization of the Corporation, or any merger or consolidation of the Corporation with any of its Subsidiaries or any similar transaction (whether or not with or into or otherwise involving an Interested Stockholder) which has the effect, directly or indirectly, of increasing the percentage of the outstanding shares of (i) any class of equity securities of the Corporation or any Subsidiary or (ii) any class of securities of the Corporation or any Subsidiary convertible into equity securities of the Corporation or any Subsidiary, represented by securities of such class which are directly or indirectly owned by any Interested Stockholder or any Affiliate or Associate of any Interested Stockholder. (b) The provisions of section (a) of this Article EIGHTH shall not be applicable to any particular Business Combination, and such Business Combination shall require only such affirmative vote as is required by law and any other provision of this Certificate of Incorporation, if such Business Combination has been approved by two-thirds of the whole Board of Directors. (c) For the purposes of this Article EIGHTH: 1. A "person" shall mean any individual, firm, corporation or other entity. 2. "Interested Stockholder" shall mean, in respect of any Business Combination, any person (other than the Corporation or any Subsidiary) who or which, as of the record date for the determination of stockholders entitled to notice of and to vote on such Business Combination, or immediately prior to the consummation of any such transaction -4- (A) is or was, at any time within two years prior thereto, the beneficial owner, directly or indirectly, of 15% or more of the then outstanding Voting Shares, or (B) is an Affiliate or Associate of the Corporation and at any time within two years prior thereto was the beneficial owner, directly or indirectly, of 15% or more of the then outstanding Voting Shares, or (C) is an assignee of or has otherwise succeeded to any shares of capital stock of the Corporation which were at any time within two years prior thereto beneficially owned by any Interested Stockholder, if such assignment or succession shall have occurred in the course of a transaction, or series of transactions, not involving a public offering within the meaning of the Securities Act of 1933, as amended. 3. A "person" shall be the "beneficial owner" of any Voting Shares (A) which such person or any of its Affiliates and Associates (as hereinafter defined) beneficially own, directly or indirectly, or (B) which such person or any of its Affiliates or Associates has (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise, or (ii) the right to vote pursuant to any agreement, arrangement or understanding, or (C) which are beneficially owned, directly or indirectly, by any other person with which such first mentioned person or any of its Affiliates or Associates has any agreement, arrangement or understanding for the purposes of acquiring, holding, voting or disposing of any shares of capital stock of the Corporation. 4. The outstanding Voting Shares shall include shares deemed owned through application of paragraph 3 above but shall not include any other Voting Shares which may be issuable pursuant to any agreement, or upon exercise of conversion rights, warrants or options, or otherwise. 5. "Affiliate" and "Associate" shall have the respective meanings given those terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as in effect on the date of adoption of this Certificate of Incorporation (the "Exchange Act"). 6. "Subsidiary" shall mean any corporation of which a majority of any class of equity security (as defined in Rule 3a11-1 of the General Rules and Regulations under the Exchange Act) is owned, directly or indirectly, by the Corporation; provided, however, that for the purposes of the definition of Interested Stockholder set forth in paragraph 2 of this section (c) the term "Subsidiary" shall mean only a corporation of which a majority of each class of equity security is owned, directly or indirectly, by the Corporation. -5- (d) A majority of the directors shall have the power and duty to determine for the purposes of this Article EIGHTH on the basis of information known to them, (1) whether a person is an Interested Stockholder, (2) the number of Voting Shares beneficially owned by any person, (3) whether a person is an Affiliate or Associate of another, (4) whether a person has an agreement, arrangement or understanding with another as to the matters referred to in paragraph 3 of section (c) or (5) whether the assets subject to any Business Combination or the consideration received for the issuance or transfer of securities by the Corporation or any Subsidiary constitutes not less than five percent of the total assets of the Corporation. (e) Nothing contained in this Article EIGHTH shall be construed to relieve any Interested Stockholder from any fiduciary obligation imposed by law. (f) Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, change, amend, repeal or adopt any provision inconsistent with, this Article EIGHTH. NINTH. This Corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred on stockholders herein are granted subject to this reservation. TENTH. A Director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a Director, except for liability (i) for any breach of the Director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the General Corporation Law of Delaware or (iv) for any transaction from which the Director derived any improper personal benefit. If the General Corporation Law of Delaware is hereafter amended to authorize, with the approval of a corporation's stockholders, further reductions in the liability of a corporation's directors for breach of fiduciary duty, then a Director of the Corporation shall not be liable for any such breach to the fullest extent permitted by the General Corporation Law of Delaware as so amended. Any repeal or modification of the foregoing provisions of this Article NINTH by the stockholders of the Corporation shall not adversely affect any right or protection of a Director of the Corporation existing at the time of such repeal or modification. This corporation is authorized to indemnify the directors and officers of the corporation to the fullest extent permissible under Delaware law. -6- STATE OF DELAWARE SECRETARY OF STATE DIVISION OF CORPORATIONS FILED 09:00 AM 05/19/2000 001257248 - 0939652 AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF CALPINE CORPORATION A Delaware Corporation (Pursuant to Sections 242 and 245 of the Delaware General Corporation Law) CALPINE CORPORATION, a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, hereby certifies as follows: FIRST: That the name of the corporation is Calpine Corporation, and that the corporation was originally incorporated on June 21, 1982 under the name Electrowatt Services, Inc., pursuant to the General Corporation Law. SECOND: The Certificate of Incorporation of this corporation shall be amended and restated to read in full as is set forth on Exhibit A attached hereto. THIRD: That said amendment and restatement was duly adopted in accordance with the provisions of Section 242 and Section 245 of the General Corporation Law by obtaining a majority vote of the Common Stock in favor of said amendment and restatement in the manner set forth in Section 222 of the General Corporation Law. IN WITNESS WHEREOF, Calpine Corporation has caused its corporate seal to be hereunto affixed and this Amended and Restated Certificate of Incorporation to be signed by its President and attested to by its Secretary this 18th day of May, 2000. CALPINE CORPORATION /s/ PETER CARTWRIGHT -------------------- Name: Peter Cartwright Title: President [SEAL] ATTEST: /s/ ANN B. CURTIS - ----------------- Name: Ann B. Curtis Title: Secretary EXHIBIT A AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF CALPINE CORPORATION FIRST. The name of the corporation is Calpine Corporation (the "Corporation"). SECOND. The address of its registered office in the State of Delaware is 9 East Loockerman Street, City of Dover, 19901, County of Kent. The name of its registered agent at such address is National Registered Agents, Inc. THIRD. The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware. FOURTH. (a) The Corporation is authorized to issue 510,000,000 shares of capital stock, $.001 par value. The shares shall be divided into two classes, designated as follows: Designation of Class Number of Shares -------------------- ---------------- Common Stock 500,000,000 Preferred Stock 10,000,000 ----------- Total 510,000,000 (b) The Preferred Stock may be issued from time to time in one or more series. The Board of Directors is expressly authorized, in the resolution or resolutions providing for the issuance of any wholly unissued series of Preferred Stock, to fix, state and express the powers, rights, designations, preferences, qualifications, limitations and restrictions thereof, including without limitation; the rate of dividends upon which and the times at which dividends on shares of such series shall be payable and the preference, if any, which such dividends shall have relative to dividends on shares of any other class or classes or any other series of stock of the Corporation; whether such dividends shall be cumulative or noncumulative, and if cumulative, the date or dates from which dividends on shares of such series shall be cumulative; the voting rights, if any, to be provided for shares of such series; the rights, if any, which the holders of shares of such series shall have in the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Corporation; the rights, if any, which the holders of shares of such series shall have to convert such shares into or exchange such shares for shares of stock of the Corporation, and the terms and conditions, including price and rate of exchange of such conversion or exchange; the redemption rights (including sinking fund provisions), if any, for shares of such series; and such other powers, rights, designations, preferences, qualifications, limitations and restrictions as the Board of Directors may desire to so fix. The Board of Directors is also expressly authorized to fix the number of shares constituting such series and to increase or decrease the number of shares of any series prior to the issuance of shares of that series and to increase or decrease the number of shares of any series subsequent to the issuance of shares of that series, but not to decrease such number below the number of shares of such series then outstanding. In case the number of shares of any series shall be so decreased, the shares constituting such decrease shall resume the status which they had prior to the adoption of the resolution originally fixing the number of shares of such series. FIFTH. In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is authorized to make, alter or repeal any or all of the Bylaws of the Corporation; provided, however, that any Bylaw amendment adopted by the Board of Directors increasing or reducing the authorized number of Directors shall require the affirmative vote of a majority of the total number of Directors which the Corporation would have if there were no vacancies. In addition, new Bylaws may be adopted or the Bylaws may be amended or repealed by the affirmative vote of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class. Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, change, amend, repeal or adopt any provision inconsistent with, this Article FIFTH. SIXTH. (a) Any action required or permitted to be taken by the stockholders of the Corporation must be effected at an annual or special meeting of stockholders of the Corporation and may not be effected by any consent in writing of such stockholders. (b) Special meetings of stockholders of the Corporation may be called only (i) by the Chairman of the Board of Directors, or (ii) by the Chairman or the Secretary at the written request of a majority of the total number of Directors which the Corporation would have if there were no vacancies upon not fewer than 10 nor more than 60 days' written notice. Any request for a special meeting of stockholders shall be sent to the Chairman and the Secretary and shall state the purposes of the proposed meeting. Special meetings of holders of the outstanding Preferred Stock may be called in the manner and for the purposes provided in the resolutions of the Board of Directors providing for the issue of such stock. Business transacted at special meetings shall be confined to the purpose or purposes stated in the notice of meeting. (c) Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, change, amend, repeal or adopt any provision inconsistent with, this Article SIXTH. SEVENTH. (a) The number of Directors which shall constitute the whole Board of Directors of this corporation shall be as specified in the Bylaws of this corporation, subject to this Article SEVENTH. (b) The Directors shall be classified with respect to the time for which they severally hold office into three classes designated Class I, Class II and Class III, as nearly equal in number as possible, as shall be provided in the manner specified in the Bylaws of the Corporation. Each Director shall serve for a term ending on the date of the third annual meeting of stockholders following the -2- annual meeting at which the Director was elected; provided, however, that each initial Director in Class I shall hold office until the annual meeting of stockholders in 1997, each initial Director in Class II shall hold office until the annul meeting of stockholders in 1998 and each initial Director in Class III shall hold office until the annual meeting of stockholders in 1999. Notwithstanding the foregoing provisions of this Article SEVENTH, each Director shall serve until his successor is duly elected and qualified or until such Director's death, resignation or removal. (c) In the event of any increase or decrease in the authorized number of Directors, (i) each Director then serving as such shall nevertheless continue as a Director of the class of which such Director is a member until the expiration of his current term, or his early resignation, removal from office or death and (ii) the newly created or eliminated directorship resulting from such increase or decrease shall be apportioned by the Board of Directors among the three classes of Directors so as to maintain such classes as nearly equally as possible. (d) Any Director or the entire Board of Directors may be removed by the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class. (e) Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, change, amend, repeal or adopt any provision inconsistent with, this Article SEVENTH. EIGHTH. (a) 1. In addition to any affirmative vote required by law, any Business Combination (as hereinafter defined) shall require the affirmative vote of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class (for purposes of this Article EIGHTH, the "Voting Shares"). Such affirmative vote shall be required notwithstanding the fact that no vote may be required, or that some lesser percentage may be specified by law or in any agreement with any national securities exchange or otherwise. 2. The term "Business Combination" as used in this Article EIGHTH shall mean any transaction which is referred to in any one or more of the following clauses (A) through (E); (A) any merger or consolidation of the Corporation or any Subsidiary (as hereinafter defined) with or into (i) any Interested Stockholder (as hereinafter defined) or (ii) any other corporation (whether or not itself an Interested Stockholder) which is, or after such merger or consolidation would be, an Affiliate (as hereinafter defined) or Associate (as hereinafter defined) or an Interested Stockholder; or (B) any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or a series or related transactions) to or with, or proposed by or on behalf of, any Interested Stockholder or any Affiliate or Associate of any Interested Stockholder, of any assets of the Corporation or any Subsidiary -3- constituting not less than five percent of the total assets of the Corporation, as reported in the consolidated balance sheet of the Corporation as of the end of the most recent quarter with respect to which such balance sheet has been prepared; or (C) the issuance or transfer by the Corporation or any Subsidiary (in one transaction or a series of related transactions) of any securities of the Corporation or any Subsidiary to, or proposed by or on behalf of, any Interested Stockholder or any affiliate or Associate of any Interested Stockholder in exchange for cash, securities or other property (or a combination thereof) constituting not less than five percent of the total assets of the Corporation, as reported in the consolidated balance sheet of the Corporation as of the end of the most recent quarter with respect to which such balance sheet has been prepared; or (D) the adoption of any plan or proposal for the liquidation or dissolution of the Corporation, or any spin-off or split-up of any kind of the Corporation or any Subsidiary, proposed by or on behalf of an Interested Stockholder or any Affiliate or Associate of any Interested Stockholder; or (E) any reclassification of securities (including any reverse stock split), or recapitalization of the Corporation, or any merger or consolidation of the Corporation with any of its Subsidiaries or any similar transaction (whether or not with or into or otherwise involving an Interested Stockholder) which has the effect, directly or indirectly, of increasing the percentage of the outstanding shares of (i) any class of equity securities of the Corporation or any Subsidiary or (ii) any class of securities of the Corporation or any Subsidiary convertible into equity securities of the Corporation or any Subsidiary, represented by securities of such class which are directly or indirectly owned by any Interested Stockholder or any Affiliate or Associate of any Interested Stockholder. (b) The provisions of section (a) of this Article EIGHTH shall not be applicable to any particular Business Combination, and such Business Combination shall require only such affirmative vote as is required by law and any other provision of this Certificate of Incorporation, if such Business Combination has been approved by two-thirds of the whole Board of Directors. (c) For the purposes of this Article EIGHTH: 1. A "person" shall mean any individual, firm, corporation or other entity. 2. "Interested Stockholder" shall mean, in respect of any Business Combination, any person (other than the Corporation or any Subsidiary) who or which, as of the record date for the determination of stockholders entitled to notice of and to vote on such Business Combination, or immediately prior to the consummation of any such transaction (A) is or was, at any time within two years prior thereto, the beneficial owner, directly or indirectly, of 15% or more of the then outstanding Voting Shares, or (B) is an Affiliate or Associate of the Corporation and at any time within two years prior thereto was the beneficial owner, directly or indirectly, of 15% or more of the then outstanding Voting Shares, or -4- (C) is an assignee of or has otherwise succeeded to any shares of capital stock of the Corporation which were at any time within two years prior thereto beneficially owned by any Interested Stockholder, if such assignment or succession shall have occurred in the course of a transaction, or series of transactions, not involving a public offering within the meaning of the Securities Act of 1933, as amended. 3. A "person" shall be the "beneficial owner" of any Voting Shares (A) which such person or any of its Affiliates and Associates (as hereinafter defined) beneficially own, directly or indirectly, or (B) which such person or any of its Affiliates or Associates has (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants or options, or otherwise, or (ii) the right to vote pursuant to any agreement, arrangement or understanding, or (C) which are beneficially owned, directly or indirectly, by any other person with which such first mentioned person or any of its Affiliates or Associates has any agreement, arrangement or understanding for the purposes of acquiring, holding, voting or disposing of any shares of capital stock of the Corporation. 4. The outstanding Voting Shares shall include shares deemed owned through application of paragraph 3 above but shall not include any other Voting Shares which may be issuable pursuant to any agreement, or upon exercise of conversion rights, warrants or options, or otherwise. 5. "Affiliate" and "Associate" shall have the respective meanings given those terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as in effect on the date of adoption of this Certificate of Incorporation (the "Exchange Act"). 6. "Subsidiary" shall mean any corporation of which a majority of any class of equity security (as defined in Rule 3a11-1 of the General Rules and Regulations under the Exchange Act) is owned, directly or indirectly, by the Corporation; provided, however, that for the purposes of the definition of Interested Stockholder set forth in paragraph 2 of this section (c) the term "Subsidiary" shall mean only a corporation of which a majority of each class of equity security is owned, directly or indirectly, by the Corporation. (d) A majority of the directors shall have the power and duty to determine for the purposes of this Article EIGHTH on the basis of information known to them, (1) whether a person is an Interested Stockholder, (2) the number of Voting Shares beneficially owned by any person, (3) whether a person is an Affiliate or Associate of another, (4) whether a person has an agreement, arrangement or understanding with another as to the matters referred to in paragraph 3 of section (c) or (5) whether the assets subject to any Business Combination or the consideration received for the issuance or transfer of securities by the Corporation or any Subsidiary constitutes not less than five percent of the total assets of the Corporation. -5- (e) Nothing contained in this Article EIGHTH shall be construed to relieve any Interested Stockholder from any fiduciary obligations imposed by law. (f) Notwithstanding anything contained in this Certificate of Incorporation to the contrary, the affirmative vote of the holders of at least 66-2/3% of the combined voting power of all shares of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to alter, change, amend, repeal or adopt any provision inconsistent with, this Article EIGHTH. NINTH. This Corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statue, and all rights conferred on stockholders herein are granted subject to this reservation. TENTH. A Director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a Director, except for liability (i) for any breach of the Director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the General Corporation Law of Delaware or (iv) for any transaction from which the Director derived any improper personal benefit. If the General Corporation Law of Delaware is hereafter amended to authorize, with the approval of a corporation's stockholders, further reductions in the liability of a corporation's directors for breach of fiduciary duty, then a Director of the Corporation shall not be liable for any such breach to the fullest extent permitted by the General Corporation Law of Delaware as so amended. Any repeal or modification of the foregoing provisions of this Article TENTH by the stockholders of the Corporation shall not adversely affect any right or protection of a Director of the Corporation existing at the time of such repeal or modification. This corporation is authorized to indemnify the directors and officers of the corporation to the fullest extent permissible under Delaware law. -6- CERTIFICATE OF CORRECTION OF CALPINE CORPORATION Calpine Corporation, a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware (the "Corporation"), DOES HEREBY CERTIFY: 1. The name of the Corporation is Calpine Corporation. 2. An Amended and Restated Certificate of Incorporation (the "Instrument") was filed with the Secretary of State of the State of Delaware on May 19, 2000 which contains an inaccurate record of the corporate action taken therein, and said Instrument requires correction as permitted by subsection (f) of Section 103 of the General Corporation Law of the State of Delaware. 3. The inaccuracy in said Instrument is as follows: Since the Board of Directors and stockholders of the Corporation merely approved an amendment to the Amended and Restated Certificate of Incorporation of the Corporation, as opposed to an amendment and restatement thereof, the heading of the Instrument incorrectly identifies the Instrument as the "Amended and Restated Certificate of Incorporation of Calpine Corporation" and incorrectly restates the text of the Amended and Restated Certificate of Incorporation of Calpine Corporation as filed with the Secretary of State of the State of Delaware on September 13, 1996. The Instrument further incorrectly states in paragraph THIRD that the restatement was duly adopted in accordance with the provisions of Section 245 of the General Corporation Law of the State of Delaware. 4. The heading of the document filed on May 19, 2000 is corrected to read as follows: "Certificate of Amendment of Amended and Restated Certificate of Incorporation of Calpine Corporation" 5. The text of the Instrument filed on May 19, 2000 is corrected to read in its entirety as follows: CERTIFICATE OF AMENDMENT OF AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF CALPINE CORPORATION CALPINE CORPORATION, a corporation duly organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), does hereby certify that: 1. The Amended and Restated Certificate of Incorporation of the Corporation is hereby amended by deleting paragraph (a) of Article FOURTH thereof and inserting the following in lieu thereof: (a) The Corporation is authorized to issue 510,000,000 shares of capital stock, $.001 par value. The shares shall be divided into two classes, designated as follows: Designation of Class Number of Shares -------------------- ---------------- Common Stock 500,000,000 Preferred Stock 10,000,000 ----------- Total 510,000,000 2. The foregoing amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, Calpine Corporation has caused this Certificate to be executed by Lisa Bodensteiner, its duly authorized officer, this 28th day of February, 2001. CALPINE CORPORATION By: /s/ LISA BODENSTEINER ----------------------- Name: Lisa Bodensteiner Title: Vice President, General Counsel and Assistant Secretary CERTIFICATE OF AMENDMENT OF AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF CALPINE CORPORATION CALPINE CORPORATION, a corporation duly organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), does hereby certify that: 1. The Amended and Restated Certificate of Incorporation of the Corporation, as amended on March 2, 2001, is hereby amended by deleting paragraph (a) of Article FOURTH thereof and inserting the following in lieu thereof: (a) The Corporation is authorized to issue 1,010,000,000 shares of capital stock, $.001 par value. The shares shall be divided into two classes, designated as follows: Designation of Class Number of Shares -------------------- ---------------- Common Stock 1,000,000,000 Preferred Stock 10,000,000 ------------- Total 1,010,000,000 2. The foregoing amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, Calpine Corporation has caused this Certificate to be executed by Ann B. Curtis, its duly authorized officer, this 25th day of July, 2001. CALPINE CORPORATION By: /s/ Ann B. Curtis ----------------- Name: Ann B. Curtis Title: Executive Vice President, Chief Financial Officer and Secretary CERTIFICATE OF DESIGNATION of SERIES A PARTICIPATING PREFERRED STOCK of CALPINE CORPORATION (Pursuant to Section 151 of the Delaware General Corporation Law) --------------------------------------- Calpine Corporation, a corporation organized and existing under the General Corporation Law of the State of Delaware (hereinafter called the "Corporation"), hereby certifies that the following resolution was adopted by the Board of Directors of the Corporation as required by Section 151 of the General Corporation Law at a meeting duly called and held on June 5, 1997: RESOLVED, that pursuant to the authority granted to and vested in the Board of Directors of the Corporation (hereinafter called the "Board of Directors" or the "Board") in accordance with the provisions of the Certificate of Incorporation, the Board of Directors hereby creates a series of Preferred Stock, par value $0.001 per share (the "Preferred Stock"), of the Corporation and hereby states the designation and number of shares, and fixes the relative rights, preferences, and limitations thereof as follows: Series A Participating Preferred Stock: Section 1. Designation and Amount. The shares of such series shall be designated as "Series A Participating Preferred Stock" (the "Series A Preferred Stock") and the number of shares constituting the Series A Preferred Stock shall be One Hundred Thousand (100,000). Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, however, that no decrease shall reduce the number of shares of Series A Preferred Stock to a number less than the number of shares then outstanding plus the number of shares reserved for issuance upon the exercise of outstanding options, rights or warrants or upon the conversion of any outstanding securities issued by the Corporation convertible into Series A Preferred Stock. Section 2. Dividends and Distributions. (A) Subject to the rights of the holders of any shares of any series of Preferred Stock (or any similar stock) ranking prior and superior to the Series A Preferred Stock with respect to dividends, each holder of a share of Series A Preferred Stock, in preference to the holders of shares of Common Stock, par value $0.001 per share (the "Common Stock"), of the Corporation, and of any other junior stock, shall be entitled to receive, when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the first day of March, June, September and December in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series A Preferred Stock, in an amount per share (rounded to the nearest cent) equal to, subject to the provision for adjustment hereinafter set forth, One Thousand (1,000) times the aggregate per share amount of all cash dividends, and One Thousand (1,000) times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions, other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock since the immediately preceding Quarterly Dividend Payment Date or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of a share or fraction of a share of Series A Preferred Stock. In the event the Corporation shall at any time declare or pay any dividend on the 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 amount to which holders of shares of Series A Preferred Stock were entitled immediately prior to such event under clause (b) 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. (B) The Corporation shall declare a dividend or distribution on the shares of Series A Preferred Stock as provided in paragraph (A) of this Section 2 immediately after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock); provided, however, that, in the event no dividend or distribution shall have been declared on the Common Stock during the period between any Quarterly Distribution Date and the next subsequent Quarterly Dividend Payment Date, a dividend of $1.00 per share of Series A Preferred Stock shall nevertheless be payable on such subsequent Quarterly Dividend Payment Date. (C) Dividends shall begin to accrue and be cumulative on each outstanding share of Series A Participating Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such share of Series A Participating Preferred Stock, unless the date of issue of such share is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such share shall begin to accrue from the date of issue of such share, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares -2- of Series A Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue and be cumulative from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of Series A Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series A Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be not more than 60 days prior to the date fixed for the payment thereof. Section 3. Voting Rights. The holders of shares of Series A Preferred Stock shall have the following voting rights: (A) Subject to the provision for adjustment hereinafter set forth, each share of Series A Preferred Stock shall entitle the holder thereof to One Thousand (1,000) votes on all matters submitted to a vote of the stockholders of the Corporation. In the event the Corporation shall at any time declare or pay any dividend on the 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 Series A 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. (B) Except as otherwise provided herein, in any other Certificate of Designations creating a series of Preferred Stock or any similar stock, or by law, the holders of shares of Series A Preferred Stock and the holders of shares of Common Stock and any other capital stock of the Corporation having general voting rights shall vote together as one class on all matters submitted to a vote of stockholders of the Corporation. (C) (i) If at any time dividends on any shares of Series A Preferred Stock shall be in arrears in an amount equal to six quarterly dividends thereon, then during the period (a "default period") from the occurrence of such event until such time as all accrued and unpaid dividends for all previous quarterly dividend periods and for the current quarterly dividend period on all shares of Series A Preferred Stock then outstanding shall have been declared and paid or set apart for payment, all holders of shares of Series A Preferred Stock, voting separately as a class, shall have the right to elect two (2) Directors. (ii) During any default period, such voting rights of the holders of shares of Series A Preferred Stock may be exercised initially at a special meeting called pursuant to subparagraph (iii) of this Section 3(C) or at any annual meeting of stockholders, and thereafter at annual meetings of stockholders, provided that neither such voting rights nor any right of the holders of shares of Series A Preferred Stock to increase, in certain cases, the authorized number of Directors may be exercised at any meeting unless one-third of the outstanding shares of Preferred Stock shall be present at such meeting in person or by proxy. The absence of a quorum of the holders of Common Stock shall not affect the exercise by the holders of shares of Series A Preferred Stock of such rights. At any meeting at which the holders of shares of Series A Preferred Stock shall exercise such voting rights initially during an existing default period, they shall have the right, voting separately as a class, to elect Directors to fill up to two (2) vacancies in the Board of Directors, if any such vacancies may then exist, or, if such right is exercised at an annual meeting, to elect two (2) Directors. If the -3- number which may be so elected at any special meeting does not amount to the required number, the holders of the Series A Preferred Stock shall have the right to make such increase in the number of Directors as shall be necessary to permit the election by them of the required number. After the holders of shares of Series A Preferred Stock shall have exercised their right to elect Directors during any default period, the number of Directors shall not be increased or decreased except as approved by a vote of the holders of shares of Series A Preferred Stock as herein provided or pursuant to the rights of any equity securities ranking senior to the Series A Preferred Stock. (iii) Unless the holders of Series A Preferred Stock shall, during an existing default period, have previously exercised their right to elect Directors, the Board of Directors may order, or any stockholder or stockholders owning in the aggregate not less than 25% of the total number of the shares of Series A Preferred Stock outstanding may request, the calling of a special meeting of the holders of shares of Series A Preferred Stock, which meeting shall thereupon be called by the Secretary of the Corporation. Notice of such meeting and of any annual meeting at which holders of shares of Series A Preferred Stock are entitled to vote pursuant to this Section 3(C)(iii) shall be given to each holder of record of shares of Series A Preferred Stock by mailing a copy of such notice to such holder at such holder's last address as the same appears on the books of the Corporation. Such meeting shall be called for a time not earlier than 20 days and not later than 60 days after such order or request or in default of the calling of such meeting within 60 days after such order or request, such meeting may be called on similar notice by any stockholder or stockholders owning in the aggregate not less than 25% of the total number of outstanding shares of Series A Preferred Stock. Notwithstanding the provisions of this Section 3(C)(iii), no such special meeting shall be called during the 60 days immediately preceding the date fixed for the next annual meeting of the stockholders. (iv) During any default period, the holders of shares of Common Stock and shares of Series A Preferred Stock, and other classes or series of stock of the Corporation, if applicable, shall continue to be entitled to elect all the Directors until holders of the shares of Series A Preferred Stock shall have exercised their right to elect two (2) Directors voting as a separate class, after the exercise of which right (x) the Directors so elected by the holders of shares of Series A Preferred Stock shall continue in office until their successors shall have been elected by such holders or until the expiration of the default period, and (y) any vacancy in the Board of Directors may (except as provided in Section 3(C)(ii)) be filled by vote of a majority of the remaining Directors theretofore elected by the holders of the class of capital stock which elected the Director whose office shall have become vacant. References in this Section 3(C) to Directors elected by the holders of a particular class of capital stock shall include Directors elected by such Directors to fill vacancies as provided in clause (y) of the foregoing sentence. (v) Immediately upon the expiration of a default period, (x) the right of the holders of shares of Series A Preferred Stock as a separate class to elect Directors shall cease, (y) the term of any Directors elected by the holders of shares of Series A Preferred Stock as a separate class shall terminate, and (z) the number of Directors shall be such number as may be provided for in the Certificate of Incorporation or by-laws irrespective of any increase made pursuant to the provisions of Section 3(C)(ii) (such number being subject, -4- however, to change thereafter in any manner provided by law or in the Certificate of Incorporation or by-laws). Any vacancies in the Board of Directors effected by the provisions of clauses (y) and (z) in the preceding sentence may be filled by a majority of the remaining Directors. (vi) The provisions of this Section 3(C) shall govern the election of Directors by holders of shares of Preferred Stock during any default period notwithstanding any provisions of the Certificate of Incorporation to the contrary, including, without limitation, the provisions of Article Sixth of the Certificate of Incorporation. (D) Except as set forth herein, or as otherwise provided by law, holders of Series A 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 4. Certain Restrictions. (A) Whenever quarterly dividends or other dividends or distributions payable on the Series A Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Preferred Stock outstanding shall have been paid in full, the Corporation shall not: (i) declare or pay dividends, or make any other distributions, on any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock; (ii) declare or pay dividends, or make any other distributions, on any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except dividends paid ratably on the shares of Series A Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such junior stock in exchange for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Preferred Stock; or (iv) redeem or purchase or otherwise acquire for consideration any shares of Series A Preferred Stock, or any shares of stock ranking on a parity with the Series A Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of such shares upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. -5- (B) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (A) of this Section 4, purchase or otherwise acquire such shares at such time and in such manner. Section 5. Reacquired Shares. Any shares of Series A 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 subject to the conditions and restrictions on issuance set forth herein, in the Certificate of Incorporation, or in any other Certificate of Designations creating a series of Preferred Stock or any similar stock or as otherwise required by law. Section 6. Liquidation, Dissolution or Winding Up. (A) 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 Series A Preferred Stock unless, prior thereto, the holders of shares of Series A Preferred Stock shall have received One Thousand Dollars ($1,000), per share, plus an amount equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment; provided, however, that the holders of shares of Series A Preferred Stock shall be entitled to receive an aggregate amount per share, subject to the provision for adjustment hereinafter set forth, equal to one thousand (1,000), times the aggregate amount to be distributed per share to holders of shares of Common Stock, or (2) to the holders of shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Preferred Stock, except distributions made ratably on the Series A Preferred Stock and all 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 declare or pay any dividend on the 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 Series A 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. (B) In the event, however, that there are not sufficient assets available to permit payment in full the Series A Liquidation Preference and the liquidation preferences of all other series of Preferred Stock, if any, which rank on a parity with the Series A Preferred Stock, then such remaining assets shall be distributed ratably to the holders of such parity shares in proportion to their respective liquidation preferences. -6- Section 7. Consolidation, Merger, etc. In 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 and/or any other property, then in any such case each share of Series A Preferred Stock shall at the same time be similarly exchanged or changed into an amount per share, subject to the provision for adjustment hereinafter set forth, equal to One Thousand (1,000) times the aggregate amount of stock, securities, cash and/or any 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 declare or pay any dividend on the 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 amount set forth in the preceding sentence with respect to the exchange or change of shares of Series A 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 8. No Redemption. The shares of Series A Preferred Stock shall not be redeemable. Section 9. Rank. The Series A Preferred Stock shall rank, with respect to the payment of dividends and the distribution of assets, junior to all series of any other class of the Corporation's Preferred Stock. Section 10. 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 Series A Preferred Stock so as to affect them adversely without the affirmative vote of the holders of at least a majority of the outstanding shares of Series A Preferred Stock, voting together as a single class. IN WITNESS WHEREOF, this Certificate of Designation is executed on behalf of the Corporation by its President and its corporate seal attested by its Secretary this 16th day of June, 1997. /s/ PETER CARTWRIGHT -------------------- Name: Peter Cartwright Title: Chairman, President and Chief Executive Officer Attest: /s/ ANN B. CURTIS - ----------------- Name: Ann B. Curtis Title: Senior Vice President and Corporate Secretary -7- AMENDED CERTIFICATE OF DESIGNATION OF SERIES A PARTICIPATING PREFERRED STOCK OF CALPINE CORPORATION (PURSUANT TO SECTION 151 OF THE DELAWARE GENERAL CORPORATION LAW) --------------- CALPINE CORPORATION, a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Company"), in accordance with the provisions of Section 103 of the General Corporation Law of the State of Delaware, certifies as follows: 1. That by resolution of the Board of Directors of the Company dated June 5, 1997, and by a Certificate of Designation filed in the office of the Secretary of State of the State of Delaware on June 16, 1997, the Company authorized a series of 100,000 shares of Series A Participating Preferred Stock, par value $0.001 per share, of the Company (the "Series A Preferred Stock") and established the powers, designations, preferences and relative, participating, optional and other rights of the Series A Preferred Stock and the qualifications, limitations or restrictions thereof. 2. As of the date hereof, no shares of Series A Preferred Stock are outstanding and no shares of Series A Preferred Stock have been issued. 3. The pursuant to the authority conferred on the Board of Directors of the Company by its Restated Certificate of Incorporation and the provisions of Section 151(g) of the General Corporation Law of the State of Delaware, the Board of Directors on February 6, 2001, adopted the following resolution amending certain provision s of said Certificate of Designation: RESOLVED FURTHER, that the Board finds it advisable to amend the Certificate of Designation of Series A Participating Preferred Stock of Calpine Corporation (the "Series A Preferred Certificate of Designation"), and the Series A Preferred Stock Certificate of Designation is hereby amended, as follows: the phrase "One Hundred Thousand (100,000)" in the first sentence of Section 1 of the Series A Preferred Certificate of Designation is deleted and replaced with the phrase "Five Hundred Thousand (500,000)". IN WITNESS WHEREOF, CALPINE CORPORATION has caused this certificate to be executed by Lisa M. Bodensteiner, the Vice President, General Counsel and Assistant Secretary of the Company, this 28th day of February, 2001. /s/ LISA M. BODENSTEINER ------------------------ Lisa M. Bodensteiner Vice President, General Counsel and Assistant Secretary STATE OF DELAWARE SECRETARY OF STATE DIVISION OF CORPORATIONS FILED 09:30 AM 04/18/2001 010185705 - 0939652 CERTIFICATE OF DESIGNATION of SPECIAL VOTING PREFERRED STOCK of CALPINE CORPORATION (Pursuant to Section 151 of the Delaware General Corporation Law) ------------------------------------ Calpine Corporation, a corporation organized and existing under the General Corporation Law of the State of Delaware (hereinafter called the "Corporation"), hereby certifies that the following resolution was adopted by the unanimous consent of the Board of Directors of the Corporation as required by Section 151 of the General Corporation Law on April [ ], 2001: RESOLVED, that pursuant to the authority granted to and vested in the Board of Directors of the Corporation (hereinafter called the "Board of Directors" or the "Board") in accordance with the provisions of the Certificate of Incorporation of the Corporation, the Board of Directors hereby creates a series of Preferred Stock, par value $.001 per share, of the Corporation and hereby states the designation and number of shares, and fixes the relative rights, preferences and limitations thereof as follows: Special Voting Preferred Stock: Section 1. Designation and Amount. A series of Preferred Stock is hereby created designated as "Special Voting Preferred Stock." The number of shares constituting such series shall be one (1). So long as any Exchangeable Shares, without par value (the "Exchangeable Shares"), of Calpine Canada Holdings Ltd., an Alberta corporation, shall be outstanding, the number of shares comprising the Special Voting Preferred Stock shall not be increased or decreased. Section 2. Voting Rights. The holder of the Special Voting Preferred Stock shall have no voting rights except as provided in this Section 2 and under applicable law. Except as provided in Section 7, the share of Special Voting Preferred Stock shall be entitled at any relevant date (which date shall be the applicable record date with respect to such matter if a record date is set) to the number of votes determined in accordance with the following calculation on any matter on which the holders of Common Stock, par value $.001 (the "Common Stock"), of the Corporation are entitled to vote, consent or otherwise act. The number of votes to which the share of Special Voting Preferred Stock shall be entitled at any relevant date (which date shall be the applicable record date with respect to such matter if a record date is set) shall equal the product of (i) the number of Exchangeable Shares issued and outstanding on such date and held by holders other than the Corporation or any Subsidiary of the Corporation multiplied by (ii) the number of votes to which a holder of one share of Common Stock is entitled with respect to such matter on such date. Except as otherwise provided by law, the Special Voting Preferred Stock shall vote with the Common Stock as a single class. So long as any Exchangeable Shares shall be outstanding, no term of the Special Voting Preferred Stock shall be amended, except upon the approval of a majority of the shares of Common Stock and the holder of the Special Voting Preferred Stock. As used herein, a "Subsidiary of the Corporation" is any entity of which more than 50% of the total voting power of the shares of stock or units of ownership or beneficial interest entitled to vote in the election of directors (or members of a comparable governing body) are owned or controlled, directly or indirectly, by the Corporation. Section 3. Liquidation, Dissolution or Winding Up. Upon the liquidation, dissolution or winding up of the Corporation, the holder of the Special Voting Preferred Stock shall be entitled, prior and in preference to any distribution to holders of Common Stock and after the distribution to holders of any class or series of Preferred Stock ranking senior to the Special Voting Preferred Stock of all amounts to which such holders are entitled, to receive the sum of $.001. Section 4. Dividends and Distributions. Except as provided in Section 3, no dividends or distributions shall be payable to the holder of the Special Voting Preferred Stock. Section 5. Voting Trust Agreement. The Special Voting Preferred Stock is subject to the Voting and Exchange Trust Agreement, dated April 18, 2001, between the Corporation, Calpine Canada Holdings Ltd. and CIBC Mellon Trust Company, a Canadian corporation. Section 6. No Conversion. The Special Voting Preferred Stock shall not be convertible into any other class or series of capital stock of the Corporation or into cash, property or other rights. Section 7. Redemption; Cancellation. From and after the first time after April 19, 2001, that there are no longer outstanding any Exchangeable Shares (other than Exchangeable Shares owned by the Corporation or any Subsidiary of the Corporation) and there are no shares of stock, debt, options or other agreements which could give rise to the issuance of any Exchangeable Shares to any person (other than the Corporation or any Subsidiary of the Corporation), the share of Special Voting Preferred Stock shall no longer be entitled to vote on any matter involving the Corporation or on any matter presented for a vote to the holders of any of the stock of the Corporation, and shall automatically be redeemed for $1.00, and upon such redemption or other purchase or acquisition of the Special Voting Preferred Stock by the Corporation the share of Special Voting Preferred Stock shall be deemed retired and canceled and may not be reissued. -2- IN WITNESS WHEREOF, this Certificate of Designation is executed on behalf of the Corporation by its President this 18th day of April, 2001. /s/ PETER CARTWRIGHT --------------------- Peter Cartwright Chairman, President and Chief Executive Officer -3- AMENDED CERTIFICATE OF DESIGNATION OF SERIES A PARTICIPATING PREFERRED STOCK OF CALPINE CORPORATION (PURSUANT TO SECTION 151 OF THE DELAWARE GENERAL CORPORATION LAW) --------------- CALPINE CORPORATION, a corporation organized and existing under the General Corporation Law of the State of Delaware (the "Company"), in accordance with the provisions of Section 103 of the General Corporation Law of the State of Delaware, certifies as follows: 1. That by resolution of the Board of Directors of the Company dated June 5, 1997, and by a Certificate of Designation filed in the office of the Secretary of State of the State of Delaware on June 16, 1997, as thereafter amended by an Amended Certificate of Designation filed in the office of the Secretary of State of the State of Delaware on March 2, 2001, the Company authorized a series of shares of Series A Participating Preferred Stock, par value $0.001 per share, of the Company (the "Series A Preferred Stock") and established the powers, designations, preferences and relative, participating, optional and other rights of the Series A Preferred Stock and the qualifications, limitations or restrictions thereof. 2. As of the date hereof, no shares of Series A Preferred Stock are outstanding and no shares of Series A Preferred Stock have been issued. 3. The pursuant to the authority conferred on the Board of Directors of the Company by its Restated Certificate of Incorporation and the provisions of Section 151(g) of the General Corporation Law of the State of Delaware, the Board of Directors on July 25, 2001, adopted the following resolution amending certain provisions of said Certificate of Designation: RESOLVED FURTHER, that the Board finds it advisable to amend the Certificate of Designation of Series A Participating Preferred Stock of Calpine Corporation (as amended on March 2, 2001, the "Series A Preferred Certificate of Designation"), and the Series A Preferred Certificate of Designation is hereby amended, as follows: the phrase "Five Hundred Thousand (500,000)" in the first sentence of Section 1 of the Series A Preferred Certificate of Designation is deleted and replaced with the phrase "One Million (1,000,000)". IN WITNESS WHEREOF, CALPINE CORPORATION has caused this certificate to be executed by Ann B. Curtis, the Executive Vice President, Chief Financial Officer and Secretary of the Company, this 25th day of July, 2001. /s/ Ann B. Curtis ----------------- Ann B. Curtis Executive Vice President, Chief Financial Officer and Secretary -2- CERTIFICATE OF OWNERSHIP AND MERGER MERGING CALPINE NATURAL GAS COMPANY a Delaware corporation INTO CALPINE CORPORATION a Delaware corporation (Pursuant to Section 253 of the General Corporation Law of the State of Delaware) Calpine Corporation, a corporation duly organized and existing under and by virtue of the General Corporation Law of the State of Delaware, does hereby certify: FIRST: That Calpine Corporation (the "Company") and Calpine Natural Gas Company ("CNGC") are corporations duly organized and existing under and by virtue of the General Corporation Law of the State of Delaware. SECOND: That the Company owns all of the issued and outstanding shares of the capital stock of CNGC. THIRD: That the Company, by resolutions of its board of directors duly adopted at a meeting held on the 22nd day of April, 2002, determined to and did merge into itself said CNGC, and that such resolutions have not been rescinded and are in full force and effect on the date hereof, which resolutions are in the following words, to wit: "WHEREAS, the merger of Calpine Natural Gas GP, Inc., a Delaware corporation, with and into the Company and the receipt of 990 shares of the common stock of Calpine Natural Gas Company, a Delaware corporation, from Calpine Natural Gas Holdings, LLC, a Delaware limited liability company and wholly owned subsidiary of the Company (the "Stock Transfer"), resulted in CNGC becoming a wholly owned subsidiary of the Company; WHEREAS, the board of directors of the Company deems it advisable and in the best interests of the Company to merge CNGC with and into the Company, with the Company being the surviving corporation; NOW, THEREFORE, BE IT RESOLVED, that CNGC be merged with and into the Company pursuant to Section 253 of the General Corporation Law of the State of Delaware, and that the Company succeed to and possess all the rights and assets of CNGC and be subject to all of the liabilities and obligations of CNGC; RESOLVED FURTHER, that each share of the capital stock of CNGC issued and outstanding immediately prior to the effective time of the merger shall, upon the effective time and by virtue of the merger, be cancelled without payment therefor; STATE OF DELAWARE SECRETARY OF STATE DIVISION OF CORPORATIONS FILED 04:02 PM 04/24/2002 020262278 - 0939652 -1- RESOLVED FURTHER, that the merger shall become effective at such time designated in the Certificate of Ownership and Merger filed by the Company with the Secretary of State of the State of Delaware to effect the merger; RESOLVED FURTHER, that the appropriate officers of the Company are hereby authorized and empowered to file the necessary documents with the Secretary of State of the State of Delaware, to incur the necessary expenses therefor and to take, or cause to be taken, all such further action and to execute and deliver or cause to be executed and delivered, in the name of and on behalf of the Company, all such further instruments and documents as any such officer may deem to be necessary or advisable in order to effect the purpose and intent of the foregoing resolutions and to be in the best interests of the Company (as conclusively evidenced by the taking of such action or the execution and delivery of such instruments and documents, as the case may be, by or under the direction of any such officer); RESOLVED FURTHER, that the prior actions of the officers and directors of the Company in undertaking to carry out the transactions contemplated by the foregoing resolutions be, and the same hereby are, in all respects, approved, adopted, ratified and confirmed; and RESOLVED FURTHER, anything herein or elsewhere to the contrary notwithstanding, the merger may be amended or terminated and abandoned by the board of directors of the Company at any time prior to the time that the Certificate of Ownership and Merger filed with the Secretary of State of Delaware becomes effective." FOURTH: The merger shall become effective at 11:59 p.m., Eastern Time on April 24, 2002. IN WITNESS WHEREOF, the Company has caused this Certificate to be signed by its duly authorized officer this 24 day of April, 2002. CALPINE CORPORATION By: /s/ Peter Cartwright --------------------------- Peter Cartwright, President -2- STATE OF DELAWARE SECRETARY OF STATE DIVISION OF CORPORATIONS FILED 04:01 PM 04/24/2002 020262655 - 0939652 CERTIFICATE OF OWNERSHIP AND MERGER MERGING CALPINE NATURAL GAS GP, INC. a Delaware corporation INTO CALPINE CORPORATION a Delaware corporation (Pursuant to Section 253 of the General Corporation Law of the State of Delaware) Calpine Corporation, a corporation duly organized and existing under and by virtue of the General Corporation Law of the State of Delaware, does hereby certify: FIRST: That Calpine Corporation (the "Company") and Calpine Natural Gas GP, Inc. ("Calpine GP") are corporations duly organized and existing under and by virtue of the General Corporation Law of the State of Delaware. SECOND: That the Company owns all of the issued and outstanding shares of the capital stock of Calpine GP. THIRD: That the Company, by resolutions of its board of directors duly adopted at a meeting held on the 22nd day of April, 2002, determined to and did merge into itself said Calpine GP, and that such resolutions have not been rescinded and are in full force and effect on the date hereof, which resolutions are in the following words, to wit: "WHEREAS, Calpine Natural Gas GP, Inc., a Delaware corporation ("Calpine GP"), is a wholly owned subsidiary of the Company; WHEREAS, the board of directors of the Company deems it advisable and in the best interest of the Company to merge Calpine GP with and into the Company, with the Company being the surviving corporation; NOW, THEREFORE, BE IT RESOLVED, that Calpine GP be merged with and into the Company pursuant to Section 253 of the General Corporation Law of the State of Delaware, and that the Company succeed to and possess all the rights and assets of Calpine GP and be subject to all of the liabilities and obligations of Calpine GP; RESOLVED FURTHER, that each share of the capital stock of Calpine GP issued and outstanding immediately prior to the effective time of the merger shall, upon the effective time and by virtue of the merger, be cancelled without payment therefor; RESOLVED FURTHER, that the merger shall become effective at such time designated in the Certificate of Ownership and Merger filed by the Company with the Secretary of State of the State of Delaware to effect the merger; RESOLVED FURTHER, that the appropriate officers of the Company are hereby authorized and empowered to file the necessary documents with the Secretary of State of the State of Delaware, to incur the necessary -1- expenses therefor and to take, or cause to be taken, all such further action and to execute and deliver or cause to be executed and delivered, in the name of and on behalf of the Company, all such further instruments and documents as any such officer may deem to be necessary or advisable in order to effect the purpose and intent of the foregoing resolutions and to be in the best interests of the Company (as conclusively evidenced by the taking of such action or the execution and delivery of such instruments and documents, as the case may be, by or under the direction of any such officer); RESOLVED FURTHER, that the prior actions of the officers and directors of the Company in undertaking to carry out the transactions contemplated by the foregoing resolutions be, and the same hereby are, in all respects, approved, adopted, ratified and confirmed; and RESOLVED FURTHER, anything herein or elsewhere to the contrary notwithstanding, the merger may be amended or terminated and abandoned by the board of directors of the Company at any time prior to the time that the Certificate of Ownership and Merger filed with the Secretary of State of Delaware becomes effective." FOURTH: The merger shall become effective at 11:58 p.m., Eastern Time on April 24, 2002. IN WITNESS WHEREOF, the Company has caused this Certificate to be signed by its duly authorized officer this 24 day of April, 2002. CALPINE CORPORATION By: /s/ Peter Cartwright ----------------------- Peter Cartwright, President -2- 3 CERTIFICATE OF OWNERSHIP AND MERGER MERGING GOLDENDALE ENERGY, INC. a Washington corporation WITH AND INTO CALPINE CORPORATION a Delaware corporation (Pursuant to Section 253 of the General Corporation Law of the State of Delaware) Calpine Corporation, a corporation duly organized and existing under and by virtue of the General Corporation Law of the State of Delaware, does hereby certify: FIRST: That Calpine Corporation (the "Company") is a corporation duly organized and existing under and by virtue of the General Corporation Law of the State of Delaware, and Goldendale Energy, Inc. ("Goldendale") is a corporation duly organized and existing under and by virtue of theWashington Business Corporation Act. SECOND: That the Company owns all of the issued and outstanding shares of each class of the capital stock of Goldendale. THIRD: That the board of directors of the Company (the "Board") adopted the following resolutions on July 10, 2003, and that such resolutions have not been rescinded and are in full force and effect on the date hereof: WHEREAS, the Company owns all of the issued and outstanding shares of each class of the capital stock of Goldendale; and WHEREAS, the Board deems it advisable and in the best interests of the Company to merge Goldendale with and into the Company pursuant to Section 253 of the General Corporation Law of the State of Delaware (the "DGCL") and RCW 23B.11.050 of the Washington Business Corporation Act, Title 23B RCW (the "WBCA"), with the Company being the surviving corporation; NOW, THEREFORE, BE IT RESOLVED, that Goldendale be merged with and into the Company pursuant to Section 253 of the DGCL and RCW 23B.11.050 of the WBCA with the Company being the surviving corporation (the "Merger"), and that the Company succeed to and possess all the rights and assets of Goldendale and be subject to all of the liabilities and obligations of Goldendale; RESOLVED FURTHER, that by virtue of the Merger and without any action on the part of the holder thereof, each then outstanding share of capital stock of the Company shall remain unchanged and continue to remain outstanding as capital stock of the Company, held by the holder that was the holder of such share of capital stock of the Company immediately prior to the Merger; State of Delaware Secretary of State Division of Corporations Delivered 08:02 AM 07/16/2003 FILED 08:02 AM 07/16/2003 SRV 030464644 - 0939652 FILE RESOLVED FURTHER, that by virtue of the Merger and without any action on the part of the holder thereof, each share of the capital stock of Goldendale issued and outstanding immediately prior to the effective time of the Merger shall, upon the effective time of the Merger, be cancelled without payment therefor; RESOLVED FURTHER, that the appropriate officers of the Company be and hereby are authorized and empowered to file the necessary documents with the Secretary of State of the State of Delaware and the Secretary of State of the State of Washington, including, without limitation, a Certificate of Ownership and Merger complying with Section 253 of the DGCL (the "Certificate of Merger"), Articles of Merger complying with RCW 23B.11.050 of the WBCA (the "Articles of Merger") and the Plan of Merger between the Company and Goldendale to be attached to the Articles of Merger (the "Plan of Merger"), to incur the necessary expenses therefor and to take, or cause to be taken, all such further action and to execute and deliver or cause to be executed and delivered, in the name of and on behalf of the Company, all such further instruments and documents as any such officer may deem to be necessary or advisable in order to effect the purpose and intent of the foregoing resolutions and to be in the best interests of the Company (as conclusively evidenced by the taking of such action or the execution and delivery of such instruments and documents, as the case may be, by or under the direction of any such officer); RESOLVED FURTHER, that the prior actions of the officers and directors of the Company in undertaking to carry out the transactions contemplated by the foregoing resolutions be, and the same hereby are, in all respects, approved, adopted, ratified and confirmed; and RESOLVED FURTHER, anything herein or elsewhere to the contrary notwithstanding, the Merger may be amended or terminated and abandoned by the Board at any time prior to the time that the Certificate of Merger filed with the Secretary of State of the State of Delaware and the Articles of Merger and the Plan of Merger filed with the Secretary of State of the State of Washington become effective. FOURTH: The Company shall be the surviving corporation of the Merger. FIFTH: The certificate of incorporation of the Company as in effect immediately prior to the merger shall be the certificate of incorporation of the surviving corporation. SIXTH: The Merger shall become effective at 8:30 a.m., Eastern Daylight Time, on the 16th day of July, 2003. -2- IN WITNESS WHEREOF, the Company has caused this Certificate to be signed by its duly authorized officer this 16th day of July, 2003. CALPINE CORPORATION By: /s/ Ann B. Curtis ----------------------------------- Name: Ann B. Curtis Title: Executive Vice President, Secretary and Vice Chairman of the Board -3- CERTIFICATE OF MERGER MERGING CALPINE DEER PARK GP, LLC AND CALPINE DEER PARK LP, LLC WITH AND INTO CALPINE CORPORATION (Pursuant to Section 264 of the General Corporation Law of the State of Delaware and Section 18-209 of the Delaware Limited Liability Company Act) The undersigned Calpine Corporation, a Delaware corporation, DOES HEREBY CERTIFY: FIRST: The name and jurisdiction of formation or organization and domicile of each of the constituent entities are as follows: Jurisdiction of Name Formation or Organization and Domicile - ---- -------------------------------------- Calpine Corporation Delaware Calpine Deer Park GP, LLC Delaware Calpine Deer Park LP, LLC Delaware SECOND: An Agreement and Plan of Merger has been approved, adopted, certified, executed and acknowledged by each of the constituent entities in accordance with Section 264(c) of the General Corporation Law of the State of Delaware, 8 Del. C. Section 101, et seq., and Section 18-209 of the Delaware Limited Liability Company Act, 6 Del.C. Section 18-101, et seq. THIRD: The name of the surviving Delaware corporation is Calpine Corporation (the "Surviving Corporation"). FOURTH: The certificate of incorporation of Calpine Corporation as in effect immediately prior to the merger shall be the certificate of incorporation of the Surviving Corporation. FIFTH: The executed Agreement and Plan of Merger is on file at an office and a place of business of the Surviving Corporation at 50 West San Fernando Street, San Jose, California 95113. SIXTH: A copy of the Agreement and Plan of Merger will be furnished by the Surviving Corporation, on request and without cost, to any member of Calpine Deer Park GP, LLC or Calpine Deer Park LP, LLC or any stockholder of Calpine Corporation. SEVENTH: The merger shall become effective at 8:30 a.m., Eastern Daylight Time, on the 16th day of July, 2003. State of Delaware Secretary of State Division of Corporations Delivered 08:02 AM 07/16/2003 FILED 08:02 AM 07/16/2003 SRV 030464645 - 0939652 FILE IN WITNESS WHEREOF, Surviving Corporation has caused this Certificate to be signed by its duly authorized officer this 16th day of July, 2003. CALPINE CORPORATION By: /s/ Ann B. Curtis ----------------------------------- Name: Ann B. Curtis Title: Executive Vice President, Secretary and Vice Chairman of the Board -2- State of Delaware Secretary of State Division of Corporations Delivered 08:02 AM 07/16/2003 FILED 08:04 AM 07/16/2003 SRV 030464646 - 0939652 FILE CERTIFICATE OF MERGER MERGING DEER PARK ENERGY CENTER, LP WITH AND INTO CALPINE CORPORATION (Pursuant to Section 263 of the General Corporation Law of the State of Delaware and Section 17-211 of the Delaware Revised Uniform Limited Partnership Act) The undersigned Calpine Corporation, a Delaware corporation, DOES HEREBY CERTIFY: FIRST: The name and jurisdiction of formation or organization and domicile of each of the constituent entities are as follows: Jurisdiction of Name Formation or Organization and Domicile ---- -------------------------------------- Calpine Corporation Delaware Deer Park Energy Center, LP Delaware SECOND: An Agreement and Plan of Merger has been approved, adopted, certified, executed and acknowledged by each of the constituent entities in accordance with Section 263(c) of the General Corporation Law of the State of Delaware, 8 Del. C. Section 101, et seq., and Section 17-211 of the Delaware Revised Uniform Limited Partnership Act, 6 Del.C. Section 17-101, et seq. THIRD: The name of the surviving Delaware corporation is Calpine Corporation (the "Surviving Corporation"). FOURTH: The certificate of incorporation of Calpine Corporation as in effect immediately prior to the merger shall be the certificate of incorporation of the Surviving Corporation. FIFTH: The executed Agreement and Plan of Merger is on file at an office and a place of business of the Surviving Corporation at 50 West San Fernando Street, San Jose, California 95113. SIXTH: A copy of the Agreement and Plan of Merger will be furnished by the Surviving Corporation, on request and without cost, to any partner of Deer Park Energy Center LP or any stockholder of Calpine Corporation. SEVENTH: The merger shall become effective at 8:30 a.m., Eastern Daylight Time, on the 16th day of July, 2003. IN WITNESS WHEREOF, Surviving Corporation has caused this Certificate to be signed by its duly authorized officer this 16th day of July, 2003. CALPINE CORPORATION By: /s/ Ann B. Curtis ----------------------------------- Name: Ann B. Curtis Title: Executive Vice President, Secretary and Vice Chairman of the Board -2- CERTIFICATE OF MERGER MERGING CPN MEC HOLDINGS, LLC, MEC HOLDINGS, LLC, AND METCALF ENERGY CENTER, LLC WITH AND INTO CALPINE CORPORATION (Pursuant to Section 264 of the General Corporation Law of the State of Delaware and Section 18-209 of the Delaware Limited Liability Company Act) The undersigned Calpine Corporation, a Delaware corporation, DOES HEREBY CERTIFY: FIRST: The name and jurisdiction of formation or organization and domicile of each of the constituent entities are as follows: Jurisdiction of Name Formation or Organization and Domicile ---- -------------------------------------- Calpine Corporation Delaware CPN MEC Holdings, LLC Delaware MEC Holdings, LLC Delaware Metcalf Energy Center, LLC Delaware SECOND: An Agreement and Plan of Merger has been approved, adopted, certified, executed and acknowledged by each of the constituent entities in accordance with Section 264(c) of the General Corporation Law of the State of Delaware, 8 Del. C. Section 101, et seq., and Section 18-209 of the Delaware Limited Liability Company Act, 6 Del.C. Section 18-101, et seq. THIRD: The name of the surviving Delaware corporation is Calpine Corporation (the "Surviving Corporation"). FOURTH: The certificate of incorporation of Calpine Corporation as in effect immediately prior to the merger shall be the certificate of incorporation of the Surviving Corporation. FIFTH: The executed Agreement and Plan of Merger is on file at an office and a place of business of the Surviving Corporation at 50 West San Fernando Street, San Jose, California 95113. SIXTH: A copy of the Agreement and Plan of Merger will be furnished by the Surviving Corporation, on request and without cost, to any member of CPN MEC Holdings, LLC, MEC Holdings, LLC, or Metcalf Energy Center, LLC or any stockholder of Calpine Corporation. State of Delaware Secretary of State Division of Corporations Delivered 08:02 AM 07/16/2003 FILED 08:05 AM 07/16/2003 SRV 030464647 - 0939652 FILE IN WITNESS WHEREOF, Surviving Corporation has caused this Certificate to be signed by its duly authorized officer this 16th day of July, 2003. CALPINE CORPORATION By: /s/ Ann B. Curtis ----------------------------------- Name: Ann B. Curtis Title: Executive Vice President, Secretary and Vice Chairman of the Board -2- State of Delaware Secretary of State Division of Corporations Delivered 08:02 AM 07/16/2003 FILED 08:06 AM 07/16/2003 SRV 030464648 - 0939652 FILE CERTIFICATE OF MERGER MERGING AUGUSTA ENERGY LLC, OTAY MESA GENERATING COMPANY, LLC, SANTA ROSA ENERGY, LLC AND WASHINGTON PARISH ENERGY CENTER, LLC WITH AND INTO CALPINE CORPORATION (Pursuant to Section 264 of the General Corporation Law of the State of Delaware and Section 18-209 of the Delaware Limited Liability Company Act) The undersigned Calpine Corporation, a Delaware corporation, DOES HEREBY CERTIFY: FIRST: The name and jurisdiction of formation or organization and domicile of each of the constituent entities are as follows: Jurisdiction of Name Formation or Organization and Domicile ---- -------------------------------------- Calpine Corporation Delaware Augusta Energy LLC Delaware Otay Mesa Generating Company, LLC Delaware Santa Rosa Energy, LLC Delaware Washington Parish Energy Center, LLC Delaware SECOND: An Agreement and Plan of Merger has been approved, adopted, certified, executed and acknowledged by each of the constituent entities in accordance with Section 264(c) of the General Corporation Law of the State of Delaware, 8 Del. C. Section 101, et seq., and Section 18-209 of the Delaware Limited Liability Company Act, 6 Del.C. Section 18-101, et seq.. THIRD: The name of the surviving Delaware corporation is Calpine Corporation (the "Surviving Corporation"). FOURTH: The certificate of incorporation of Calpine Corporation as in effect immediately prior to the merger shall be the certificate of incorporation of the Surviving Corporation. FIFTH: The executed Agreement and Plan of Merger is on file at an office and a place of business of the Surviving Corporation at 50 West San Fernando Street, San Jose, California 95113. SIXTH: A copy of the Agreement and Plan of Merger will be furnished by the Surviving Corporation, on request and without cost, to any member of Augusta Energy LLC, Otay Mesa Generating Company, LLC, Santa Rosa Energy, LLC or Washington Parish Energy Center, LLC, or any stockholder of Calpine Corporation. -2- IN WITNESS WHEREOF, Surviving Corporation has caused this Certificate to be signed by its duly authorized officer this 16th day of July, 2003. CALPINE CORPORATION By: /s/ Ann B. Curtis ----------------------------------- Name: Ann B. Curtis Title: Executive Vice President, Secretary and Vice Chairman of the Board -3- CERTIFICATE OF CHANGE OF LOCATION OF REGISTERED OFFICE AND OF REGISTERED AGENT OF CALPINE CORPORATION It is hereby certified that: 1. The name of the corporation (hereinafter called the "corporation") is CALPINE CORPORATION 2. The registered office of the corporation within the State of Delaware is hereby changed to 2711 Centerville Road, Suite 400, City of Wilmington 19808, County of New Castle. 3. The registered agent of the corporation within the State of Delaware is hereby changed to Corporation Service Company, the business office of which is identical with the registered office of the corporation as hereby changed. 4. The corporation has authorized the changes hereinbefore set forth by resolution of its Board of Directors. Signed on July 23, 2003. /s/ Lisa M. Bodensteiner ------------------------------ Name: Lisa M. Bodensteiner Title: Assistant Secretary State of Delaware Secretary of State Division of Corporations Delivered 04:08 PM 07/23/2003 FILED 03:41 PM 07/23/2003 SRV 030482533 - 0939652 FILE State of Delaware Secretary of State Division of Corporations Delivered 08:05 AM 11/18/2003 FILED 08:05 AM 11/18/2003 SRV 030738126 - 0939652 FILE CERTIFICATE OF MERGER MERGING FREMONT ENERGY CENTER LLC WITH AND INTO CALPINE CORPORATION (Pursuant to Section 264 of the General Corporation Law of the State of Delaware and Section 18-209 of the Delaware Limited Liability Company Act) The undersigned Calpine Corporation, a Delaware corporation, DOES HEREBY CERTIFY: FIRST: The name and jurisdiction of formation or organization and domicile of the constituent entities are as follows: Jurisdiction of Name Formation or Organization and Domicile ---- -------------------------------------- Calpine Corporation Delaware Fremont Energy Center LLC Delaware SECOND: An Agreement and Plan of Merger has been approved, adopted, certified, executed and acknowledged by each of the constituent entities in accordance with Section 264(c) of the General Corporation Law of the State of Delaware, 8 Del. C. Section 101, et seq., and Section 18-209 of the Delaware Limited Liability Company Act, 6 Del.C. Section 18-101, et seq. THIRD: The name of the surviving Delaware corporation is Calpine Corporation (the "Surviving Corporation"). FOURTH: The certificate of incorporation of Calpine Corporation as in effect immediately prior to the merger shall be the certificate of incorporation of the Surviving Corporation. FIFTH: The executed Agreement and Plan of Merger is on file at an office and a place of business of the Surviving Corporation at 50 West San Fernando Street, San Jose, California 95113. SIXTH: A copy of the Agreement and Plan of Merger will be furnished by the Surviving Corporation, on request and without cost, to any member of Fremont Energy Center LLC, or any stockholder of Calpine Corporation. IN WITNESS WHEREOF, Surviving Corporation has caused this Certificate to be signed by its duly authorized officer this 18th day of November, 2003. CALPINE CORPORATION By: /s/ Eric Pryor -------------------------------------- Name: Eric Pryor Title: Senior Vice President -2- State of Delaware Secretary of State Division of Corporations Delivered 07:12 PM 06/02/2004 FILED 07:05 PM 06/02/2004 SRV 040411614 - 0939652 FILE CERTIFICATE OF AMENDMENT OF AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF CALPINE CORPORATION CALPINE CORPORATION, a corporation duly organized and existing under the General Corporation Law of the State of Delaware (the "Corporation"), does hereby certify that: 1. The Amended and Restated Certificate of Incorporation of the Corporation, as amended on July 26, 2001, is hereby amended by deleting paragraph (a) of Article FOURTH thereof and inserting the following in lieu thereof: (a) The Corporation is authorized to issue 2,010,000,000 shares of capital stock, $.001 par value. The shares shall be divided into two classes, designated as follows: Designation of Class Number of Shares -------------------- ---------------- Common Stock 2,000,000,000 Preferred Stock 10,000,000 ------------- Total 2,010,000,000 2. The foregoing amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, Calpine Corporation has caused this Certificate to be executed by Ann B. Curtis, its duly authorized officer, this 2nd day of June, 2004. CALPINE CORPORATION By: /s/ Ann B. Curtis -------------------------------------- Name: Ann B. Curtis Title: Executive Vice President, Vice Chairman of the Board and Corporate Secretary -2- EX-4 3 ex4-6.txt EXHIBIT 4.6 THIS NOTES TO BE ISSUED HEREUNDER SHALL BE ISSUED WITH ORIGINAL ISSUE DISCOUNT UNDER SECTION 1272, 1273 AND 1275 OF THE INTERNAL REVENUE CODE OF 1986, AS AMENDED. YOU MAY CONTACT THE CHIEF FINANCIAL OFFICER OF THE ISSUER, AT 50 West San Fernando Street, San Jose, Ca 95113, WHO WILL PROVIDE YOU WITH ANY REQUIRED INFORMATION REGARDING THE ORIGINAL ISSUE DISCOUNT. ================================================================================ POWER CONTRACT FINANCING III, LLC, Issuer, and WILMINGTON TRUST COMPANY, Trustee, Accounts Agent, Paying Agent and Registrar ---------- INDENTURE Dated as of June 2, 2004 Senior Secured Notes due 2010 ================================================================================ TABLE OF CONTENTS Page ARTICLE ONE DEFINITIONS AND OTHER PROVISIONS OF GENERAL APPLICATION SECTION 101. Definitions...................................................1 SECTION 102. Compliance Certificates and Opinions..........................2 SECTION 103. Form of Documents Delivered to Trustee........................3 SECTION 104. Acts of Holders...............................................4 SECTION 105. Notices, Etc. to Trustee and Issuer...........................5 SECTION 106. Notice to Holders: Waiver.....................................5 SECTION 107. Effect of Headings and Table of Contents......................6 SECTION 108. Successors and Assigns........................................6 SECTION 109. Severability Clause...........................................6 SECTION 110. Benefits of Indenture.........................................6 SECTION 111. Conflict with Trust Indenture Act.............................6 SECTION 112. Governing Law; Consent to Jurisdiction and Service of Process.......................................................6 SECTION 113. Legal Holidays................................................8 SECTION 114. Non-Recourse..................................................8 SECTION 115. Execution in Counterparts.....................................8 ARTICLE TWO FORM OF NOTES SECTION 201. Form of Note..................................................8 SECTION 202. Restrictive Legends..........................................10 ARTICLE THREE THE NOTES SECTION 301. Amount13 SECTION 302. Denominations................................................15 SECTION 303. Execution, Authentication, Delivery and Dating...............15 SECTION 304. Temporary Notes..............................................16 SECTION 305. Registration, Registration of Transfer and Exchange..........17 SECTION 306. Book Entry Provisions for Global Notes.......................18 SECTION 307. Special Transfer Provisions..................................19 SECTION 308. Mutilated, Destroyed, Lost and Stolen Notes..................22 SECTION 309. Payment on Notes; Rights Preserved...........................23 SECTION 310. Persons Deemed Owners........................................24 SECTION 311. Cancellation.................................................24 SECTION 312. CUSIP and CINS Numbers.......................................24 SECTION 313. Parity of Notes..............................................24 ARTICLE FOUR APPLICATION OF PROCEEDS FROM SALE OF NOTES i SECTION 401. Application of Proceeds from Sale of Notes...................25 ARTICLE FIVE ACCOUNTS SECTION 501. Establishment of Accounts....................................25 SECTION 502. Collections Account..........................................26 SECTION 503. Redemption Account and Working Capital Account...............27 SECTION 504. Statements; Investment of Funds..............................28 ARTICLE SIX SATISFACTION AND DISCHARGE SECTION 601. Satisfaction and Discharge of Indenture......................29 SECTION 602. Application of Trust Money...................................30 ARTICLE SEVEN EVENTS OF DEFAULT AND REMEDIES SECTION 701. Events of Default............................................30 SECTION 702. Acceleration of Maturity: Rescission and Annulment...........32 SECTION 703. Remedies upon an Event of Default............................32 SECTION 704. Certain Sales of Collateral..................................33 SECTION 705. No Marshaling................................................33 SECTION 706. Trustee May Recover Unpaid Indebtedness After Sale of Collateral...................................................34 SECTION 707. Recovery of Judgment Does Not Affect Rights..................34 SECTION 708. Collection of Indebtedness and Suits for Enforcement by Trustee......................................................34 SECTION 709. Trustee May File Proofs of Claim.............................35 SECTION 710. Trustee May Enforce Claims Without Possession of Notes.......36 SECTION 711. Application of Money Collected...............................36 SECTION 712. Limitation on Suits..........................................36 SECTION 713. Unconditional Right of Holders to Receive Principal and Additional Interest..........................................37 SECTION 714. Restoration of Rights and Remedies...........................37 SECTION 715. Rights and Remedies Cumulative...............................37 SECTION 716. Delay or Omission Not Waiver.................................38 SECTION 717. Control by Holders...........................................38 SECTION 718. Waiver of Past Defaults......................................38 SECTION 719. Waiver of Force Majeure and Stay or Extension Laws...........39 SECTION 720. Trustee to Give Notice of Default, but May Withhold in Certain Circumstances........................................39 SECTION 721. Undertaking for Costs........................................39 ARTICLE EIGHT THE TRUSTEE SECTION 801. Duties and Responsibilities of the Trustee; During Default; Prior to Default.............................................40 SECTION 802. Certain Rights of Trustee....................................41 SECTION 803. Trustee Not Responsible for Recitals or Issuance of Notes....42 ii SECTION 804. May Hold Notes...............................................43 SECTION 805. Money Held In Trust..........................................43 SECTION 806. Compensation and Indemnification of Trustee, Accounts Agent, Paying Agent and Registrar and Its Prior Claim........43 SECTION 807. Right of Trustee to Rely on Officer's Certificate, Etc.......44 SECTION 808. Corporate Trustee Required; Eligibility......................44 SECTION 809. Qualification of Trustee; Conflicting Interests..............45 SECTION 810. Resignation and Removal; Appointment of Successor Trustee....45 SECTION 811. Acceptance of Appointment by Successor.......................46 SECTION 812. Merger Conversion, Consolidation or Succession to Business...47 SECTION 813. Preferential Collection of Claims Against Issuer.............47 SECTION 814. No Liability for Clean-up of Hazardous Materials.............48 SECTION 815. Accounts Agent Registrar and Paving Agent....................48 SECTION 816. Filing Fees..................................................48 SECTION 817. Fee Agreement................................................48 ARTICLE NINE HOLDERS' LISTS AND REPORTS BY TRUSTEE AND ISSUER SECTION 901. Holder Lists.................................................48 SECTION 902. Disclosure of Names and Addresses of Holders.................49 SECTION 903. Reports by Trustee...........................................49 SECTION 904. Reports by Issuer............................................49 ARTICLE TEN SUPPLEMENTS AND AMENDMENTS TO INDENTURE AND SECURITY DOCUMENTS SECTION 1001. Without Vote of Holders......................................50 SECTION 1002. With Consent of Holders......................................51 SECTION 1003. Execution of Supplemental Indentures.........................52 SECTION 1004. Effect of Supplemental Indentures............................52 SECTION 1005. Conformity with Trust Indenture Act..........................52 SECTION 1006. Reference in Notes to Supplemental Indentures................52 SECTION 1007. Notice of Supplemental Indentures............................53 ARTICLE ELEVEN AFFIRMATIVE COVENANTS SECTION 1101. Distributions................................................53 SECTION 1102. Performance of Obligations...................................53 SECTION 1103. Compliance with the PCF Indenture............................53 SECTION 1104. Preservation of Rights.......................................53 SECTION 1105. Liens .......................................................53 SECTION 1106. Payment of Principal and Interest............................54 SECTION 1107. Maintenance of Office or Agency..............................54 SECTION 1108. Maintenance of Existence, Properties.........................54 SECTION 1109. Permits......................................................54 iii SECTION 1110. Payments of Taxes and Other Claims...........................55 SECTION 1111. Notice of Certain Events.....................................55 SECTION 1112. Compliance with Laws and Other Agreements....................56 SECTION 1113. Maintenance of Books and Records.............................56 SECTION 1114. Rule 144A Information for the Holders........................56 SECTION 1115. Further Assurances...........................................57 SECTION 1116. Return of Monies Held by Trustee.............................57 ARTICLE TWELVE NEGATIVE COVENANTS SECTION 1201. Liens .......................................................57 SECTION 1202. Indebtedness.................................................57 SECTION 1203. Transactions with Affiliates.................................58 SECTION 1204. Investments, Loans and Advances..............................58 SECTION 1205. Material Agreements and Financing Documents; Additional Contracts.........................................58 SECTION 1206. Account......................................................58 SECTION 1207. Fundamental Change...........................................58 SECTION 1208. Restricted Payments..........................................59 SECTION 1209. Compliance with ERISA........................................59 SECTION 1210. Margin Stock.................................................59 SECTION 1211. Purchasing Notes.............................................59 ARTICLE THIRTEEN REDEMPTION OF NOTES SECTION 1301. Applicability of Article.....................................59 SECTION 1302. Mandatory Redemption; Notice to Trustee......................59 SECTION 1303. Notice of Redemption.........................................60 SECTION 1304. Notes Payable on Redemption Date.............................60 ARTICLE FOURTEEN DEFEASANCE AND COVENANT DEFEASANCE SECTION 1401. Issuer's Option to Effect Defeasance or Covenant Defeasance...................................................61 SECTION 1402. Defeasance and Discharge.....................................61 SECTION 1403. Covenant Defeasance..........................................61 SECTION 1404. Conditions to Defeasance or Covenant Defeasance..............62 SECTION 1405. Deposited Money to Be Held in Trust; Other Miscellaneous Provisions...................................................63 SECTION 1406. Reinstatement................................................63 ARTICLE FIFTEEN MEETINGS OF HOLDERS OF NOTES SECTION 1501. Purposes for Which Holders' Meetings May Be Called...........64 SECTION 1502. Call of Meetings by Trustee..................................64 SECTION 1503. Issuer and Holders May Call Meeting..........................64 SECTION 1504. Persons Entitled to Vote at Meeting..........................64 iv SECTION 1505. Determination of Voting Rights: Conduct and Adjournment of Meeting...................................................65 SECTION 1506. Counting Votes and Recording Action of Meeting...............65 ARTICLE SIXTEEN COVENANTS OF HOLDERS OF NOTES SECTION 1601. Treatment of Notes as Indebtedness for Tax Purposes..........66 EXHIBIT A Definitions EXHIBIT B Form of Face of Note Power Contract Financing III, LLC Senior Secured Note Due 2010 EXHIBIT C Form of Certificate to Be Delivered upon Termination of Distribution Compliance Period on or after July 13, 2004 EXHIBIT D Form of Certificate to Be Delivered in Connection with Transfers to Non-QIB Institutional Accredited Investors EXHIBIT E Form of Certificate to Be Delivered in Connection with Transfers Pursuant to Regulation S EXHIBIT F Form of Issuer Order and Officer's Certificate of Power Contract Financing III, LLC - -------------------------------------------------------------------------------- v POWER CONTRACT FINANCING III, LLC Reconciliation and tie between Trust Indenture Act of 1939 and Indenture, dated as of June 2, 2004 Trust Indenture Act Section Indenture Section Section 310 (a)(1) ............................. 808 (a)(2) ............................. 808 (b) ............................. 808, 809, 810 Section 311 (a) ............................. 813 (b) ............................. 813 Section 312 (a) ............................. 901 (b) ............................. 902 (c) ............................. 902 Section 313 (a) ............................. 903 (b) ............................. 903 (c) ............................. 720, 903 (d) ............................. 903 Section 314 (a) ............................. 904, 1106 (b) ............................. 1111 (c)(1) ............................. 102 (c)(2) ............................. 102 (d) ............................. 1111 (e) ............................. 102 Section 315 (a) ............................. 801 (b) ............................. 720 (c) ............................. 801 (d) ............................. 801 (e) ............................. 721 Section 316 (a) (last sentence).............. 101 ("Outstanding") (a)(1)(A) ............................. 717 (a)(1)(B) ............................. 718 (b) ............................. 713 (c) ............................. 104 Section 317 (a)(1) ............................. 708, 709 (a)(2) ............................. 709 (b) ............................. 1115 Section 318 (a) ............................. 111 (c) ............................. 111 - ------------------------ Note: This reconciliation and tie shall not, for any purpose, be deemed part of the Indenture i This INDENTURE, dated as of June 2, 2004 (this "Indenture"), is made by and between Power Contract Financing III, LLC, a limited liability company organized and existing under the laws of the State of Delaware, having its principal executive offices at 50 West San Fernando Street, San Jose, California 95113 (the "Issuer"), and WILMINGTON TRUST COMPANY, a Delaware banking corporation (the "Trustee"). RECITALS WHEREAS, the Issuer has duly authorized the execution and delivery of this Indenture to provide for the creation and issuance on the Closing Date, of Senior Secured Notes due February 5, 2010 in the aggregate principal amount at maturity of $84,997,000 (the "Notes"); WHEREAS, all necessary actions to ensure that this Indenture is a valid indenture and agreement according to its terms have been taken; WHEREAS, as security for the payment and performance by the Issuer of its obligations under this Indenture and the Notes, the Issuer has agreed to assign and pledge the Collateral (as defined below) as collateral to the Trustee for the benefit of the Trustee and the Holders (as defined below); and WHEREAS, the Trustee has agreed to act as trustee, accounts agent, paying agent and registrar under this Indenture on the following terms and conditions. NOW, THEREFORE, for and in consideration of the premises herein contained and the purchase of the Notes by the Holders, it is mutually covenanted and agreed, for the benefit of the parties hereto and the equal and proportionate benefit of all Holders, as follows: ARTICLE ONE DEFINITIONS AND OTHER PROVISIONS OF GENERAL APPLICATION SECTION 101. Definitions. For all purposes of this Indenture, except as otherwise expressly provided or unless the context otherwise requires: (a) capitalized terms used herein shall have the respective meanings assigned to them in Exhibit A; (b) the terms defined in Exhibit A include the plural as well as the singular; (c) all other terms used herein that are defined in the Trust Indenture Act, either directly or by reference therein, have the meanings assigned to them therein; (d) the words "herein," "hereof' and "hereunder" and other words of similar import refer to this Indenture as a whole and not to any particular Article, Section or other subdivision; -1- (e) except as otherwise expressly provided herein, (i) all accounting terms used herein shall be interpreted, (ii) all financial statements and all certificates and reports as to financial matters required to be delivered to the Trustee hereunder shall be prepared and (iii) all calculations made for the purposes of determining compliance with this Indenture shall (except as otherwise expressly provided herein) be made in accordance with, or by application of, GAAP applied on a basis consistent with that used in the preparation of the latest corresponding financial statements furnished hereunder to the Trustee; (f) all references in this Indenture to "Articles," "Sections," "Exhibits" and other subdivisions of this Indenture are to the designated articles, sections and other subdivisions of, and the exhibits to, this Indenture; (g) unless otherwise expressly specified or the context otherwise requires, all references in this Indenture or any Exhibit to any agreement, contract or document (including this Indenture) shall include reference to all exhibits to such agreement, contract or document; (h) unless otherwise expressly specified or the context otherwise requires, any agreement, contract or document defined or referred to herein shall mean such agreement, contract or document as in effect as of the date hereof, as the same may thereafter be amended, supplemented or otherwise modified from time to time in accordance with the terms thereof and hereof; (i) unless otherwise expressly specified or the context otherwise requires, pronouns having a masculine or feminine gender shall be deemed to include the other; (j) any reference to any Person shall include its permitted successors and assigns in accordance with the terms of this Indenture and the other Financing Documents and, in the case of any Governmental Agency, any Person succeeding to its functions and capacities; and (k) the term "including" denotes an example and not a limitation. SECTION 102. Compliance Certificates and Opinions. (a) Upon any application or request by the Issuer to the Trustee to take any action under any provision of this Indenture, the Issuer shall furnish to the Trustee an Officer's Certificate stating that all conditions precedent, if any, provided for in this Indenture (including any covenant compliance with which constitutes a condition precedent) relating to the proposed action have been complied with and an Opinion of Counsel stating that in the opinion of such counsel all such conditions precedent, if any, have been complied with, except that in the case of any application or request as to which the furnishing of such documents is specifically required by any provision of this Indenture, no additional certificate or opinion need be furnished. (b) Every Officer's Certificate or Opinion of Counsel with respect to compliance with a covenant or condition provided for in this Indenture shall include: (i) a statement that each individual signing such Officer's Certificate -2- or Opinion of Counsel has read such covenant or condition and the definitions herein relating thereto; (ii) a brief statement as to the nature and scope of the examination or investigation upon which the statements or opinions contained in such Officer's Certificate or Opinion of Counsel are based; (iii) a statement that, in the opinion of each such individual, he has made such examination or investigation as is necessary to enable him to express an informed opinion as to whether or not such covenant or condition has been complied with; (iv) a statement as to whether, in the opinion of each such individual, such covenant or condition has been complied with; and (v) a statement that, in the opinion of each such individual, such Officer's Certificate or Opinion of Counsel complies with the provisions of this Section 102 and that the Trustee may rely on such Officer's Certificate or Opinion of Counsel. (c) Any certificate, statement or opinion of an officer of the Issuer may be based, insofar as it relates to legal matters, upon a certificate or Opinion of Counsel or representations by counsel (which shall also be addressed to the Trustee and the Holders), unless such officer knows that the certificate or Opinion of Counsel or representations with respect to the matters upon which his certificate, statement or Opinion of Counsel will be based are erroneous, or in the exercise of reasonable care should know that the same are erroneous. Any certificate, statement or Opinion of Counsel may be based, insofar as it relates to factual matters or information which is in the possession of the Issuer, upon the certificate, statement or opinion of or representations by an officer or officers of the Issuer, unless such counsel knows that the certificate, statement or opinion or representations with respect to the matters upon which his certificate, statement or opinion may be based as aforesaid are erroneous, or in the exercise of reasonable care should know that the same are erroneous. (d) Any certificate, statement or opinion of an officer of the Issuer or of counsel may be based, insofar as it relates to accounting matters, upon a certificate or opinion of an Accountant in the employ of the Issuer (which shall be additionally addressed to the Trustee and the Holders), unless such officer or counsel, as the case may be, knows that the certificate or opinion with respect to the accounting matters upon which his certificate, statement or opinion may be based as aforesaid are erroneous, or in the exercise of reasonable care should know that the same are erroneous. (e) Any certificate or opinion of any Independent Accountant filed with the Trustee shall contain a statement that such Accountant is Independent. SECTION 103. Form of Documents Delivered to Trustee. (a) In any case where several matters are required to be certified by, or covered by an opinion of, any specified Person, it is not necessary that all such matters be certified by, or covered by the opinion of, only one such Person, or that they be so certified or covered by only one document, but one such Person may certify or give an opinion with respect to some matters and one or more other such Persons as to other matters, and any such Person may certify or give an opinion as to such matters in one or several documents. -3- (b) Where any Person is required to make, give or execute two or more applications, requests, consents, certificates, statements, opinions or other instruments under this Indenture, they may, but need not, be consolidated and form one instrument. SECTION 104. Acts of Holders. (a) Any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Indenture to be made, given or taken by Holders may be embodied in and evidenced by (i) one or more instruments of substantially similar tenor signed by the Holders in person or by their respective agents or proxies duly appointed in writing, (ii) the record of Holders voting in favor thereof, either in person or by their respective agents or proxies duly appointed in writing, at any meeting of Holders duly called and held in accordance with the provisions of Article Fifteen, or (iii) a combination of such instruments and any such record. Except as herein otherwise expressly provided, such action shall become effective when such instrument or instruments or record or both are delivered to the Trustee and, where it is expressly required hereby, to the Issuer. Such instrument or instruments and any such record (and the action embodied therein and evidenced thereby) are herein sometimes referred to as the "Act" of the Holders signing such instrument or instruments or so voting at any such meeting. Proof of execution of any such instrument or of a writing appointing any such agent, or of the holding by any Person of a Note, shall be sufficient for any purpose of this Indenture and conclusive in favor of the Trustee and the Issuer, if made in the manner provided in this Section 104. The record of any meeting of Holders shall be proved in the manner provided in Section 1506. (b) The affidavit of a witness of such execution sworn to before a notary public or other officer authorized by law to take acknowledgments of deeds or administer oaths, or by a certificate of such notary or other officer, certifying that the individual signing such instrument or writing acknowledged to him the execution thereof shall be conclusive evidence of the fact and date of execution by any Person of any such instrument or writing. Where such execution is by a signer acting in a capacity other than his individual capacity, such certificate or affidavit shall also constitute sufficient proof of authority. The fact and date of the execution of any such instrument or writing, or the authority of the Person executing the same, may also be proved in any other manner that the Trustee deems sufficient. (c) Entries in the Security Register shall be conclusive evidence of the principal amount and serial numbers of Notes held by any Person, and the date of holding the same, and the Trustee shall not be affected by notice to the contrary. (d) If the Issuer shall solicit from the Holders of the Notes any request, demand, authorization, direction, notice, consent, waiver or other Act, the Issuer may, at its option, by or pursuant to a Management Committee's Consent, fix in advance a record date for the determination of such Holders entitled to give such request, demand, authorization, direction, notice, consent, waiver or other Act, but the Issuer shall have no obligation to do so. Notwithstanding Trust Indenture Act Section 316(c), such record date shall be the record date specified in or pursuant to such Management Committee's Consent, which shall be a date not earlier than the date thirty (30) days prior to the -4- first solicitation of Holders generally in connection therewith and not later than the date such solicitation is completed unless otherwise specified herein. If such a record date is fixed, such request, demand, authorization, direction, notice, consent, waiver or other Act may be given before or after such record date, but only the Holders of record at the close of business on such record date shall be deemed to be Holders for the purposes of determining whether Holders of the requisite proportion of Outstanding Notes have authorized or agreed or consented to such request, demand, authorization, direction, notice, consent, waiver or other Act, and for that purpose the Outstanding Notes shall be computed as of such record date; provided, that no such authorization, agreement or consent by the Holders on such record date shall be deemed effective unless it shall become effective pursuant to the provisions of this Indenture not later than eleven (11) months after the record date. (e) Any request, demand, authorization, direction, notice, consent, waiver or other Act of the Holder of any Note shall bind every future Holder of the same Note and the Holder of every Note issued upon the registration of transfer thereof or in exchange therefor or in lieu thereof in respect of anything done, omitted or suffered to be done by the Trustee or the Issuer in reliance thereon, whether or not notation of such action is made upon such Note. SECTION 105. Notices, Etc. to Trustee and Issuer. Any request, demand, authorization, direction, notice, consent, waiver or other Act of Holders or other documents provided or permitted by this Indenture to be made upon, given or furnished to, or filed with: (a) the Trustee by any Holder or by the Issuer shall be sufficient for every purpose hereunder if made, given, furnished or filed in writing to or with the Trustee at its Corporate Trust Office; or (b) the Issuer by the Trustee or by any Holder shall be sufficient for every purpose hereunder (unless otherwise herein expressly provided) if in writing and mailed, first-class postage prepaid, to the Issuer addressed to it at the address of its principal office specified in the first paragraph of this Indenture or at any other address previously furnished in writing to the Trustee by the Issuer. SECTION 106. Notice to Holders: Waiver. (a) Where this Indenture provides for notice to Holders of any event, such notice shall be sufficiently given (unless otherwise herein expressly provided) if in writing and mailed, first-class postage prepaid, or delivered by overnight courier or facsimile, to each Holder, at its address or facsimile number (as applicable) as it appears in the Security Register, not later than the latest date (if any), and not earlier than the earliest date (if any), prescribed for the giving of such notice. Where this Indenture provides for notice in any manner, such notice and the manner of its giving may be waived in writing by the Person entitled to receive such notice, either before or after the event and such waiver shall be the equivalent of such notice. Waivers of notice by Holders shall be filed with the Trustee, but such filing shall not be a condition precedent to the validity of any action taken in reliance upon such waiver. In any case where notice to Holders is given -5- by mail or fax (as applicable), neither the failure to mail or fax such notice, nor any defect in any notice so mailed or faxed (as the case may be), to any particular Holder shall affect the sufficiency of such notice with respect to other Holders, and any notice that is mailed or faxed in the manner herein provided shall be conclusively presumed to have been duly given, whether or not such Holder actually receives notice. (b) In case by reason of the suspension of or irregularities in regular mail service or by reason of any other cause, it shall be impracticable to mail or deliver notice of any event to Holders when such notice is required to be given pursuant to any provision of this Indenture, then any manner of giving such notice as shall be satisfactory to the Trustee shall be deemed to be a sufficient giving of such notice for every purpose hereunder. SECTION 107. Effect of Headings and Table of Contents. The Article and Section headings herein and the Table of Contents are for convenience only and shall not affect the meaning or construction of any of the provisions hereof. SECTION 108. Successors and Assigns. All covenants, stipulations, promises and agreements in this Indenture by or on behalf of each of the Trustee and the Issuer shall bind and inure to the benefit of their respective successors and assigns, whether so expressed or not. SECTION 109. Severability Clause. In case any provision in this Indenture or in any Note shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. SECTION 110. Benefits of Indenture. Nothing in this Indenture or in the Notes, express or implied, shall give to any Person, other than the parties hereto, any Accounts Agent, any Paying Agent, any Registrar, and their successors and permitted assigns hereunder, and the Holders of Notes, any benefit or any legal or equitable right, remedy or claim under this Indenture. SECTION 111. Conflict with Trust Indenture Act. If any provision hereof limits, qualifies or conflicts with the duties imposed by the Trust Indenture Act Sections 310 to 318, inclusive, or conflicts with any provision of the Trust Indenture Act that is required under the Trust Indenture Act to be a part of and govern this Indenture, such duties or provision of the Trust Indenture Act shall control. If any provision of this Indenture modifies or excludes any provision of the Trust Indenture Act that may be so modified or excluded by its terms, such provision shall be deemed to apply to this Indenture as so modified or to be excluded, as the case may be. SECTION 112. Governing Law; Consent to Jurisdiction and Service of Process. (a) This Indenture and the Notes shall be governed by, and construed in accordance with, the law of the State of New York without giving effect to the principles thereof relating to conflicts of law except Section 5-1401 of the New York General Obligations Law. -6- (b) The Issuer consents to the non-exclusive jurisdiction of any court of the State of New York or any United States federal court sitting in New York County, New York, United States, and any appellate court from any thereof, and waives any immunity from the jurisdiction of such courts over any suit, action, or proceeding that may be brought in connection with this Indenture, the Financing Documents or the Notes. The Issuer irrevocably waives, to the fullest extent permitted by law, any objection to any suit, action, or proceeding that may be brought in connection with this Indenture, the Financing Documents or the Notes in such courts whether on the grounds of venue, residence or domicile or on the ground that any such suit, action or proceeding has been brought in an inconvenient forum. The Issuer agrees that final judgment in any such suit, action or proceeding brought in such court shall be conclusive and binding upon the Issuer and may be enforced in any court to the jurisdiction of which the Issuer is subject by a suit upon such judgment. The Issuer agrees that service of all writs, process, and summonses in any suit, action, or proceeding brought in connection with this Indenture, the Financing Documents or the Notes against the Issuer, or with respect to its property and assets, in any court of the State of New York or any United States federal court sitting in the Borough of Manhattan, New York City may be made upon Lord Securities Corporation at 48 Wall Street - 27th Floor, New York, NY 10005, Attention: Power Contract Financing III, LLC Program Manager, whom the Issuer appoints as its authorized agent for service of process. The Issuer represents and warrants that Lord Securities Corporation has agreed to act as the Issuer's agent for service of process. The Issuer agrees that such appointment shall be irrevocable for the term of the Administrative Services Agreement or until the irrevocable appointment by the Issuer of a successor in New York City as its authorized agent for such purpose and the acceptance (on terms reasonably satisfactory to the Trustee) of such appointment by such successor. The Issuer further agrees to take any and all action, including the filing of any and all documents and instruments, that may be necessary to continue such appointment in full force and effect as aforesaid. If Lord Securities Corporation shall cease to act as the Issuer's agent for service of process, the Issuer shall appoint without delay another such agent and provide prompt written notice to the Trustee of such appointment. With respect to any such action in any court of the State of New York or any United States federal court in the Borough of Manhattan, New York City, service of process upon Lord Securities Corporation, as the authorized agent of the Issuer for service of process, and written notice of such service to the Issuer, shall be deemed in every respect effective service of process upon the Issuer. Without prejudice to the foregoing, the Issuer hereby irrevocably consents to the service of process out of any of the aforementioned courts in any such action or proceeding by the mailing of copies thereof by registered or certified mail, postage prepaid, to the Issuer at the address of its principal office specified the first paragraph of this Indenture or at any other address previously furnished in writing to the Trustee by the Issuer. (c) Nothing in this Section 112 shall affect the right of any party to serve legal process in any other manner permitted by law or affect the right of any party to bring any action or proceeding against any other party or its property in the courts of other jurisdictions. -7- SECTION 113. Legal Holidays. If any Payment Date, Redemption Date or the Maturity Date, shall not be a Business Day at any Place of Payment, then (notwithstanding any other provision of this Indenture or of any Note) payment of Additional Interest, interest on accrued and unpaid Additional Interest or principal need not be made at such Place of Payment on such date, but may be made on the next succeeding Business Day at such Place of Payment with the same force and effect as if made on the Payment Date, Redemption Date, or Maturity Date; provided, that no interest shall accrue on the amount then due for the period from and after such Payment Date, Redemption Date, or Maturity Date, as the case may be, to the date of such payment. SECTION 114. Non-Recourse. No recourse under or upon any obligation, covenant or agreement contained in this Indenture or any Security Document, or because of any indebtedness evidenced thereby, shall be had against any incorporator, past, present or future, member, manager, officer or director, as such, of the Issuer or the Issuer's members, or of any successor, either directly or through the Issuer or the Issuer's members, as the case may be, or any successor, under any rule of law, statute, or constitutional provision or by the enforcement of any assessment or by any legal or equitable proceeding or otherwise, all such liability being expressly waived and released by the acceptance of the Notes by the Holders and as part of the consideration for the issuance of the Notes. Nothing contained in this Section 114 shall, however, limit the liability of any Person for any fraud, gross negligence or willful misconduct on their part. The obligations to pay the principal of and all accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes are solely the Issuer's obligations and any recourse against the Issuer for failure to satisfy its obligations under the Notes is limited to the Collateral. SECTION 115. Execution in Counterparts. This instrument may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original, but all such counterparts shall together constitute but one and the same instrument. ARTICLE TWO FORM OF NOTES SECTION 201. Form of Note. (a) The Notes and the accompanying Trustee's certificate of authentication shall be substantially in the form annexed hereto as Exhibit B. The Notes may have such appropriate insertions, omissions, substitutions and other variations as are required or permitted by this Indenture and may have letters, notations or other marks of identification and such notations, legends or endorsements required by law, the rules of any stock exchange, agreements to which the Issuer is subject or usage. Any portion of the text of any Note may be set forth on the reverse thereof, with an appropriate reference thereto on the face of the Note. The Issuer shall approve the form of the Notes and any notation, legend or endorsement on the Notes. Each Note shall be dated the date of its authentication. -8- (b) The definitive Notes shall be printed, lithographed or engraved on steel-engraved borders or may be produced in any other manner permitted by the rules under any applicable securities laws, all as determined by the officers of the Issuer executing such Notes, as evidenced by their execution of such Notes. (c) The terms and provisions contained in the form of the Notes annexed hereto as Exhibit B shall constitute, and are hereby expressly made, a part of this Indenture; provided, that to the extent any provision of any Note conflicts with the express provisions of this Indenture, the provisions of this Indenture shall govern and be controlling. To the extent applicable, the Issuer and the Trustee, by their execution and delivery of this Indenture, and the Holders and beneficial owners of the Notes by their acceptance of the Notes expressly agree to such terms and provisions and to be bound thereby. (d) Notes offered and sold to QIBs in reliance on Rule 144A shall be issued initially in the form of one or more permanent global Notes in registered form, substantially in the form set forth in Exhibit B, (each, a "Rule 144A Global Note"), deposited with the Trustee as custodian for DTC and registered in the name of a nominee of DTC, duly executed by the Issuer and authenticated by the Trustee as hereinafter provided. The aggregate principal amount of each Rule 144A Global Note may from time to time be increased or decreased by adjustments made on the records of the Trustee, as custodian for DTC or its nominee, as hereinafter provided. (e) Notes offered and sold in offshore transactions in reliance on Regulation S shall be initially issued in the form of one or more temporary global Notes in registered form, substantially in the form set forth in Exhibit B (each, a "Temporary Regulation S Global Note"), deposited with the Trustee as custodian for DTC and registered in the name of a nominee of DTC for the accounts of Euroclear Bank, S.A./N.V., as operator of Euroclear and Clearstream Luxembourg, duly executed by the Issuer and authenticated by the Trustee as hereinafter provided. Each Temporary Regulation S Global Note will be exchangeable for one or more permanent global Notes (each, a "Permanent Regulation S Global Note"; and together with the Temporary Regulation S Global Notes, the "Regulation S Global Notes") after the fortieth (40th) day following the Closing Date, upon certification (substantially in the form of Exhibit C) that the beneficial interests in such global Note are owned by either Non-U.S. Persons or U.S. Persons who purchased such interests pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act. The aggregate principal amount of each Regulation S Global Note may from time to time be increased or decreased by adjustments made in the records of the Trustee, as custodian for DTC or its nominee, as herein provided. (f) Notes offered and sold to institutional "accredited investors" (as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act) who are not QIBs (excluding Non-U.S. Persons) shall initially be issued in the form of permanent certificated Notes in registered form in substantially the form of Exhibit B ("U.S. Physical Notes"). Notes issued pursuant to Section 306 in exchange for or upon transfer of interests in a Rule 144A Global Note or a -9- Regulation S Global Note shall be in the form of U.S. Physical Notes and permanent certificated Notes in registered form substantially in the form set forth in Exhibit B (the "Regulation S Physical Note"), respectively. (g) The U.S. Physical Notes and the Regulation S Physical Notes are sometimes collectively herein referred to as the "Physical Notes." The Regulation S Global Notes and the Rule 144A Global Notes are sometimes collectively referred to as the "Global Notes." SECTION 202. Restrictive Legends. (a) Unless and until a Note is sold under an effective Registration Statement, (i) each Rule 144A Global Note and each U.S. Physical Note shall bear the legend set forth below (the "Private Placement Legend") on the face thereof, except as otherwise provided in Section 307(e), and (ii), and each Regulation S Global Note and each Regulation S Physical Note shall bear the legend set forth below on the face thereof until at least June 2, 2006, and receipt by the Issuer and the Trustee of a certificate substantially in the form of Exhibit C: THIS NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE SECURITIES LAWS. NEITHER THIS NOTE NOR ANY INTEREST OR PARTICIPATION HEREIN MAY BE OFFERED, RESOLD, ASSIGNED, TRANSFERRED, PLEDGED, ENCUMBERED OR OTHERWISE DISPOSED OF IN THE ABSENCE OF SUCH REGISTRATION OR UNLESS SUCH TRANSACTION IS EXEMPT FROM, OR NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND APPLICABLE STATE SECURITIES LAWS. EACH PURCHASER OF THIS NOTE IS HEREBY NOTIFIED THAT THE SELLER OF THIS NOTE MAY BE RELYING ON THE EXEMPTION FROM THE PROVISIONS OF SECTION 5 OF THE SECURITIES ACT PROVIDED BY RULE 144A THEREUNDER. THE HOLDER OF THIS NOTE BY ITS ACCEPTANCE HEREOF AGREES THAT ANY OFFER, SALE OR OTHER TRANSFER OF SUCH SECURITY, PRIOR TO THE DATE WHICH IS TWO YEARS AFTER THE LATER OF THE ORIGINAL ISSUE DATE HEREOF AND THE LAST DATE ON WHICH THE ISSUER OR ANY AFFILIATE OF THE ISSUER WAS THE OWNER OF THIS NOTE (OR ANY PREDECESSOR OF THIS NOTE) (THE "RESALE RESTRICTION TERMINATION DATE"), SHALL ONLY BE MADE: (A) TO THE ISSUER OR ANY SUBSIDIARY, (B) PURSUANT TO AN EFFECTIVE REGISTRATION -10- STATEMENT UNDER THE SECURITIES ACT, (C) FOR SO LONG AS THE NOTES ARE ELIGIBLE FOR RESALE PURSUANT TO RULE 144A UNDER THE SECURITIES ACT ("RULE 144A"), TO A PERSON IT REASONABLY BELIEVES IS A "QUALIFIED INSTITUTIONAL BUYER," AS DEFINED IN RULE 144A THAT PURCHASES FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS GIVEN THAT THE TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A, (D) PURSUANT TO OFFERS AND SALES TO NON-U.S. PERSONS THAT OCCUR OUTSIDE THE UNITED STATES WITHIN THE MEANING OF REGULATION S UNDER THE SECURITIES ACT, (E) TO AN INSTITUTIONAL "ACCREDITED INVESTOR" WITHIN THE MEANING OF SUBPARAGRAPH (a)(1), (2), (3) OR (7) OF RULE 501 UNDER THE SECURITIES ACT THAT IS ACQUIRING THIS NOTE FOR ITS OWN ACCOUNT, OR FOR THE ACCOUNT OF SUCH AN INSTITUTIONAL "ACCREDITED INVESTOR," FOR INVESTMENT PURPOSES ONLY AND NOT WITH A VIEW TO, OR FOR OFFER OR RESALE IN CONNECTION WITH, ANY DISTRIBUTION IN VIOLATION OF THE SECURITIES ACT OR APPLICABLE STATE SECURITIES LAWS, OR (F) PURSUANT TO ANOTHER AVAILABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT, SUBJECT TO THE ISSUER'S AND THE TRUSTEE'S RIGHT, PRIOR TO ANY SUCH OFFER, RESALE OR TRANSFER (i) PURSUANT TO CLAUSE (D) PRIOR TO THE END OF THE 40-DAY DISTRIBUTION COMPLIANCE PERIOD WITHIN THE MEANING OF REGULATION S UNDER THE SECURITIES ACT OR PURSUANT TO CLAUSE (E) OR (F) PRIOR TO THE RESALE RESTRICTION TERMINATION DATE, TO REQUIRE THE DELIVERY OF AN OPINION OF COUNSEL, CERTIFICATION AND/OR OTHER INFORMATION SATISFACTORY TO EACH OF THEM AND FURTHER SUBJECT, IN EACH OF THE FOREGOING CASES, EXCEPT (D), TO COMPLIANCE WITH APPLICABLE STATE SECURITIES LAWS, AND (ii) IN EACH OF THE FOREGOING CASES, TO REQUIRE THAT A CERTIFICATE OF TRANSFER IN THE FORM APPEARING ON THIS -11- SECURITY IS COMPLETED AND DELIVERED BY THE TRANSFEROR TO THE TRUSTEE. THIS LEGEND WILL BE REMOVED UPON THE REQUEST OF A HOLDER AFTER THE RESALE RESTRICTION TERMINATION DATE. (b) Each Global Note shall also bear the following legend on the face thereof UNLESS THIS CERTIFICATE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITORY TRUST COMPANY, A NEW YORK CORPORATION ("DTC"), TO THE ISSUER OR ITS AGENT FOR REGISTRATION OF TRANSFER, EXCHANGE, OR PAYMENT, AND ANY CERTIFICATE ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR IN SUCH OTHER NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT HEREON IS MADE TO CEDE & CO. OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC) ANY TRANSFER, PLEDGE, OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL INASMUCH AS THE REGISTERED OWNER HEREOF, CEDE & CO., HAS AN INTEREST HEREIN. TRANSFERS OF THIS GLOBAL NOTE SHALL BE LIMITED TO TRANSFERS IN WHOLE, BUT NOT IN PART, TO NOMINEES OF CEDE & CO. OR TO A SUCCESSOR THEREOF OR SUCH SUCCESSOR'S NOMINEE AND TRANSFERS OF PORTIONS OF THIS GLOBAL NOTE SHALL BE LIMITED TO TRANSFERS MADE IN ACCORDANCE WITH THE RESTRICTIONS SET FORTH IN SECTIONS 306 AND 307 OF THE INDENTURE. THE HOLDER OF THIS GLOBAL NOTE REPRESENTS THAT (i) IT IS NOT AN EMPLOYEE BENEFIT PLAN AS DEFINED IN SECTION 3(3) OF THE EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974, AS AMENDED ("ERISA") (AN "ERISA PLAN") OR OTHER PLAN, AN ENTITY WHOSE UNDERLYING ASSETS INCLUDE THE ASSETS OF ANY SUCH ERISA PLAN OR OTHER PLAN OR A GOVERNMENTAL PLAN THAT IS SUBSTANTIALLY SIMILAR TO THE PROVISIONS OF SECTION 406 OF ERISA OR SECTION 4975 OF THE INTERNAL REVENUE CODE OF 1986, AS AMENDED (THE "CODE"), OR (ii) THE PURCHASE -12- AND HOLDING BY IT OF THIS NOTE WILL NOT RESULT IN A PROHIBITED TRANSACTION UNDER SECTION 406 OF ERISA OR SECTION 4975 OF THE CODE (OR, IN THE CASE OF A GOVERNMENTAL PLAN, ANY SUBSTANTIALLY SIMILAR FEDERAL, STATE OR LOCAL LAW) FOR WHICH AN EXEMPTION IS NOT AVAILABLE. ARTICLE THREE THE NOTES SECTION 301. Amount. (a) The Notes to be issued under this Indenture are hereby created. The maximum Principal Amount at ------ Maturity of Notes that may be authenticated and delivered under this Indenture on the Closing Date is $84,997,000. (b) The Notes shall be known and designated as the "Senior Secured Notes due 2010" of the Issuer. The Principal Amount at Maturity and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) shall be payable in full in cash on the Maturity Date of the Notes, which shall be February 5, 2010. Prior to the Maturity Date, the aggregate principal amount of the Notes will be deemed to be equal to the aggregate accreted value of the Notes as set forth in the table below (the "Accreted Value"): For the period -------------- Aggregate Accreted Commencing on: Through: Value of the Notes: ---------------- --------------- ------------------- Date of offering August 5, 2004 $63,976,859 August 6, 2004 February 5, 2005 $65,271,638 February 6, 2005 August 5, 2005 $66,894,693 August 6, 2005 February 5, 2006 $68,291,596 February 6, 2006 August 5, 2006 $70,020,349 August 6, 2006 February 5, 2007 $71,526,650 February 6, 2007 August 5, 2007 $73,740,666 August 6, 2007 February 5, 2008 $75,755,380 February 6, 2008 August 5, 2008 $78,114,324 August 6, 2008 February 5, 2009 $80,282,117 February 6, 2009 August 5, 2009 $82,669,289 August 6, 2009 February 5, 2010 $84,997,000 All principal of the Notes that is not paid when due (whether on the Maturity Date or following any redemption or acceleration of the Notes) will bear interest (to the extent lawful) at a rate of 11% per annum, computed on the basis of a 360-day year of twelve 30-day months. -13- (c) Interest payments on the Notes ("Additional Interest") will be payable on each of the dates set forth below (each, a "Payment Date") in an amount equal to the amount set forth opposite the applicable Payment Date: Additional Interest Payment Date Payable Amount ---------------- -------------- August 5, 2004 .............. $929,064 February 5, 2005 .............. $944,411 August 5, 2005 .............. $661,453 February 5, 2006 .............. $944,411 August 5, 2006 .............. $661,453 February 5, 2007 .............. $944,411 August 5, 2007 .............. $289,417 February 5, 2008 .............. $566,209 August 5, 2008 .............. $292,494 February 5, 2009 .............. $566,209 August 5, 2009 .............. $422,702 February 5, 2010 .............. $565,714 Additional Interest will be paid in cash to the extent sufficient funds are available in the Collections Account on such Payment Date to make such Additional Interest payment. Any Additional Interest that is not paid in cash on the applicable Payment Date will be added to the Additional Interest payable on the next Payment Date. Such past due amounts will be payable (to the extent sufficient funds are available in the Collections Account to make such payments) prior to amounts then scheduled to be paid. All accrued Additional Interest that is not paid when due (whether on the applicable Payment Date or following any redemption or acceleration of the Notes) will bear interest (to the extent lawful) at a rate of 11% per annum, computed on the basis of a 360-day year of twelve 30-day months. On any date that Additional Interest is due and payable on a day other than a Payment Date, the accrued and unpaid Additional Interest due with respect to the period immediately preceding such date shall be prorated based on the number of days elapsed from the last Payment Date to such date divided by the number of days in the period from the last Payment Date through and including the next Payment Date, based upon a 360-day year of twelve 30-day months. (d) The principal of and Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes shall be payable, and the Notes shall be exchangeable and transferable, at the office or agency of the Issuer in New York County, New York, maintained for such purposes in accordance with Section 309. (e) The Notes shall be redeemable as provided in Article Thirteen. (f) This Indenture shall, to the extent applicable, incorporate and be governed by the provisions of the Trust Indenture Act that are required to be part of and to govern indentures qualified under the Trust Indenture Act. -14- SECTION 302. Denominations. The Notes shall be issuable only in registered form without coupons and initially only in minimum denominations of $100,000 and integral multiples of $1,000 in excess thereof; provided, that initial purchases of the Notes by purchasers who are institutional "accredited investors" who are not QIBs shall be in minimum amounts of $250,000; and provided, further that after initial issuance, Notes may be issued upon exchange or transfer in such amounts as may be necessary to evidence the entire unpaid principal amount of any Note surrendered or exchanged. SECTION 303. Execution, Authentication, Delivery and Dating. (a) The Notes shall be executed on behalf of the Issuer by its President or a Vice President and attested by a Vice President, its Secretary or an Assistant Secretary. The signature of any of these officers on the Notes may be manual or facsimile signatures of the present or any future such authorized officer and may be imprinted or otherwise reproduced on the Notes. (b) Notes bearing the manual or facsimile signatures of individuals who were at any time the proper officers of the Issuer shall bind the Issuer, notwithstanding that such individuals or any of them have ceased to hold such offices prior to the authentication and delivery of such Notes or did not hold such offices at the date of such Notes. (c) At any time and from time to time after the execution and delivery of this Indenture, the Issuer may deliver Notes executed by the Issuer to the Trustee for authentication, together with an Issuer Order for the authentication and delivery of such Notes, directing the Trustee to authenticate the Notes; and the Trustee, in accordance with such Issuer Order, shall authenticate and deliver such Notes as in this Indenture provided and not otherwise. Each such Issuer Order shall specify the amount of Notes to be authenticated, the date on which the Notes are to be authenticated, whether the Notes are to be Initial Notes or Unrestricted Notes and whether the Notes are to be issued as Physical Notes or Global Notes or such other information as the Trustee may reasonably request. The Trustee shall receive, as part of any such Issuer Order, an Officer's Certificate certifying that all conditions precedent to the issuance of Notes contained herein have been fully complied with. Any Issuer Order and Officer's Certificate delivered by the Issuer to the Trustee pursuant to this Section 303(c) shall be substantially in the form annexed hereto as Exhibit F. The Trustee may also request an Opinion of Counsel of the Issuer in connection with such authentication of Notes. Upon receipt of any such Issuer Order, the Trustee shall, in accordance with such Issuer Order, authenticate the Notes in the aggregate principal amount at maturity of $84,997,000. The aggregate principal amount of Notes outstanding at any time may not exceed $84,997,000. (d) Each Note shall be dated the date of its authentication. (e) The Trustee may appoint an authenticating agent or agents reasonably acceptable to the Issuer to authenticate Notes. Unless limited by terms of such appointment, an authenticating agent may authenticate Notes -15- whenever the Trustee may do so. Any authenticating agent has the same rights as an agent to deal with the Issuer or an Affiliate of the Issuer. (f) No Note shall be entitled to any benefit under this Indenture or be valid or obligatory for any purpose unless there appears on such Note a certificate of authentication substantially in the form provided for in Exhibit B, as applicable duly executed by the Trustee by manual signature of an authorized signatory, and such certificate upon any Note shall be conclusive evidence, and the only evidence, that such Note has been duly authenticated and delivered hereunder and is entitled to the benefits of this Indenture. (g) In case the Issuer shall have executed an indenture supplemental hereto with the Trustee pursuant to Section 1001(a), any of the Notes authenticated or delivered prior to the assumption of the Issuer's obligations by any successor Person, may, from time to time, at the request of the successor Person, be exchanged for other Notes executed in the name of the successor Person with such changes in phraseology and form as may be appropriate, but otherwise in substance and of like tenor as the Notes surrendered for such exchange and of like principal amount, and the Trustee, upon Issuer Request of the successor Person, shall authenticate and deliver Notes as specified in such request for the purpose of such exchange. If Notes shall at any time be authenticated and delivered in any new name of a successor Person pursuant to this Section 303 in exchange or substitution for or upon registration of transfer of any Notes, such successor Person, at the option of the Holders but without expense to them, shall provide for the exchange of all Notes at the time Outstanding for Notes authenticated and delivered in such new name. SECTION 304. Temporary Notes. (a) Pending the preparation of definitive Notes, the Issuer may execute, and upon an Issuer Order, the Trustee shall authenticate and deliver, temporary Notes which are printed, lithographed, typewritten, mimeographed or otherwise produced, in any authorized denomination, substantially of the tenor of the definitive Notes in lieu of which they are issued and with such appropriate insertions, omissions, substitutions and other variations as the officers executing such Notes may determine, as conclusively evidenced by their execution of such Notes. (b) If temporary Notes are issued, the Issuer will cause definitive Notes to be prepared without unreasonable delay. After the preparation of definitive Notes, the temporary Notes shall be exchangeable for definitive Notes upon surrender of the temporary Notes at the office or agency of the Issuer designated for such purpose pursuant to Section 1102, without charge to the Holder. Upon surrender for cancellation of any one or more temporary Notes, the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order, shall authenticate and deliver, in exchange therefor a like principal amount of definitive Notes of authorized denominations. Until so exchanged, the temporary Notes shall in all respects be entitled to the same benefits under this Indenture as definitive Notes. -16- SECTION 305. Registration, Registration of Transfer and Exchange. (a) The Issuer shall cause to be kept at the Corporate Trust Office of the Registrar a register which, subject to such reasonable regulations as the Issuer may prescribe, shall provide for the registration of Notes and for the registration of transfers and exchanges of Notes, and the Trustee is hereby appointed "Registrar" for the purposes of registering Notes and transfers and exchanges of Notes as herein provided. This register shall be sometimes referred to herein as the "Security Register," and shall be in written form or any other form capable of being converted into written form within a reasonable time. At all reasonable times, the Security Register shall be open to inspection by the Trustee. (b) The Notes shall be transferable only upon the surrender of a Note to the Issuer for registration of transfer. Subject to the provisions of Section 307, upon surrender for registration of transfer of any Note at the office or agency of the Issuer designated pursuant to Section 1102, the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order, shall authenticate and deliver, in the name of the designated transferee or transferees, one or more new Notes of any authorized denomination or denominations of a like aggregate principal amount. (c) At the option of the Holder thereof, Notes may be exchanged for other Notes to be registered in the name of such Holder, of authorized denominations and of like tenor, maturity and aggregate principal amount, upon surrender of the Notes to be exchanged at any office or agency maintained for such purpose. Whenever any Notes are so surrendered for exchange, the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order, shall authenticate and make available for delivery, the Notes which the Holder making the exchange is entitled to receive. (d) All Notes issued upon any registration of transfer or exchange of Notes shall be the valid obligations of the Issuer, evidencing the same debt, and entitled to the same benefits under this Indenture, as the Notes surrendered upon such registration of transfer or exchange. (e) Every Note presented or surrendered for registration of transfer or for exchange shall (if so required by the Issuer or the Registrar) be duly endorsed or be accompanied by a written instrument of transfer in form satisfactory to the Issuer and the Registrar, duly executed by the Holder thereof or his or her attorney duly authorized in writing. (f) No service charge shall be made for any registration of transfer or exchange or redemption of Notes; provided, that the Issuer may require payment in certain circumstances of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any registration of transfer or exchange of Notes, other than exchanges pursuant to Section 304, 1006 or 1307 not involving any transfer. (g) The Issuer shall not be required (i) to issue, register the transfer of or exchange any Notes during a period beginning at the opening of business 15 days before the selection of Notes to be redeemed under Section 1303 -17- and ending at the close of business on the day of such mailing of the relevant notice of redemption or (ii) to register the transfer of or exchange any Note so selected for redemption in whole or in part, except the unredeemed portion of any Note being redeemed in part. SECTION 306. Book Entry Provisions for Global Notes. (a) Each Global Note initially shall (i) be registered in the name of Cede & Co., as nominee of DTC (such nominee being referred to herein as the "Global Note Holder"), (ii) be deposited with, or on behalf of, DTC or with the Trustee, as custodian for DTC and (iii) bear legends as set forth in Section 202. (b) Members of, or participants in, DTC (collectively, the "Participants" or the "DTC Participants") shall have no rights under this Indenture with respect to any Global Note held on their behalf by DTC, or the Trustee as its custodian, or under any Global Note, and DTC may be treated by the Issuer, the Trustee and any agent of the Issuer or the Trustee as the absolute owner of such Global Note for all purposes whatsoever. Notwithstanding the foregoing, nothing herein shall prevent the Issuer, the Trustee or any agent of the Issuer or the Trustee from giving effect to any written certification, proxy or other authorization furnished by DTC or shall impair, as between DTC and its Participants, the operation of customary practices governing the exercise of the rights of a Holder of any Note. (c) Transfers of any Global Note shall be limited to transfers of such Global Note in whole, but not in part, to DTC, its successors or their respective nominees. Interests of beneficial owners in a Global Note may be transferred in accordance with the applicable rules and procedures of DTC and the provisions of Section 307. In addition, U.S. Physical Notes or Regulation S Physical Notes shall be transferred to all beneficial owners in exchange for their beneficial interests in the Rule 144A Global Notes or Regulation S Global Notes, respectively, if (i) the Issuer notifies the Trustee in writing that DTC is unwilling or unable to continue as depository for the Global Notes or DTC ceases to be a "Clearing Agency" registered under the Exchange Act and a successor depository is not appointed by the Issuer within ninety (90) days or (ii) the Issuer, at its option, notifies the Trustee in writing that it elects to have the Physical Notes so issued. (d) Any beneficial interest in one of the Global Notes that is transferred to a person who takes delivery in the form of an interest in the other Global Note will, upon transfer, cease to be an interest in such Global Note and become an interest in the other Global Note and, accordingly, will thereafter be subject to all transfer restrictions, if any, and other procedures applicable to beneficial interests in such other Global Note for as long as it remains such an interest. (e) In connection with the transfer of an entire Rule 144A Global Note or Regulation S Global Note to beneficial owners pursuant to paragraph (c) of this Section 306, the Rule 144A Global Note or Regulation S Global Note, as the case may be, shall be deemed to be surrendered to the Trustee for cancellation, and the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order, shall authenticate and deliver, to each beneficial owner -18- identified by DTC in exchange for its beneficial interest in the Rule 144A Global Note or Regulation S Global Note, as the case may be, an equal aggregate principal amount of Physical Notes of authorized denominations. (f) Any U.S. Physical Note delivered in exchange for an interest in the Rule 144A Global Note pursuant to subsection (c) of this Section 306 shall, unless such exchange is made on or after the Resale Restriction Termination Date for such Note, bear the Private Placement Legend. (g) The registered Global Note Holder may grant proxies and otherwise authorize any person, including DTC's Participants and persons that may hold interests through DTC's Participants, to take any action which a Holder is entitled to take under this Indenture or the Notes. (h) Any beneficial owner of interests in a Global Note may receive Physical Notes (which shall bear the Private Placement Legend if required by Section 202) in accordance with the procedures of DTC. In connection with the execution, authentication and delivery of such Physical Notes in exchange for beneficial interests in a Global Note pursuant to this paragraph (h) or paragraph (c) above, the Registrar shall reflect on its books and records the date and a decrease in the principal amount of the applicable Global Note in an amount equal to the principal amount of the beneficial interest in such Global Note to be transferred, and the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order, shall authenticate and deliver, one or more Physical Notes of like tenor and having an equal aggregate principal amount. SECTION 307. Special Transfer Provisions. Unless and until a Note is sold under an effective Registration Statement, the following provisions shall apply: (a) Transfers to Non-QIB Institutional Accredited Investors. The following provisions shall apply with respect to the registration of any proposed transfer of a Note to any institutional "accredited investor" (as defined in Rule 501(a)(1), (2), (3) or (7) of Regulation D under the Securities Act) which is not a QIB (excluding Non-U.S. Persons): (i) The Registrar shall register the transfer of any Note, whether or not such Note bears the Private Placement Legend, if (x) the requested transfer is on or after the Resale Restriction Termination Date or (y) the proposed transferee has delivered to the Registrar a certificate substantially in the form of Exhibit D. (ii) If the proposed transferor is a DTC Participant holding a beneficial interest in the Rule 144A Global Note, upon receipt by the Registrar of (x) the documents, if any, required by paragraph (i) above and (y) instructions given in accordance with DTC's and the Registrar's procedures therefor, the Registrar shall reflect on its books and records the date and a decrease in the principal amount of the Rule 144A Global Note in an amount equal to the principal amount of the beneficial interest -19- in the Rule 144A Global Note to be transferred, and the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order, shall authenticate and deliver, one or more Physical Notes of like tenor and amount. (b) Transfers to QIBs. The following provisions shall apply with respect to the registration of any proposed transfer of a U.S. Physical Note or an interest in the Rule 144A Global Note to a QIB (excluding Non-U.S. Persons): (i) If the Note to be transferred consists of (x) a U.S. Physical Note, the Registrar shall register the transfer and the Issuer shall execute, and the Trustee shall authenticate and deliver, one or more U.S. Physical Notes if such transfer is being made by a proposed transferor who has checked the box provided for on the form of Note stating, or has otherwise advised the Issuer and the Registrar in writing, that the sale has been made in compliance with the provisions of Rule 144A to a transferee who has signed the certification provided for on the form of Note stating, or has otherwise advised the Issuer and the Registrar in writing, that it is purchasing the Note for its own account or an account with respect to which it exercises sole investment discretion and that it, or the Person on whose behalf it is acting with respect to any such account, is a QIB within the meaning of Rule 144A, is aware that the sale to it is being made in reliance on Rule 144A and acknowledges that it has received such information regarding the Issuer as it has requested pursuant to Rule 144A or has determined not to request such information and that it is aware that the transferor is relying upon its foregoing representations in order to claim the exemption from registration provided by Rule 144A or (y) an interest in a Rule 144A Global Note, the transfer of such interest may be effected only through the book-entry system maintained by DTC. (ii) If the proposed transferee is a DTC Participant, and the Notes to be transferred consist of U.S. Physical Notes, upon receipt by the Registrar of instructions given in accordance with DTC's and the Registrar's procedures therefor, the Registrar shall reflect on its books and records the date and an increase in the principal amount of the Rule 144A Global Note in an amount equal to the principal amount of the U.S. Physical Notes to be transferred, and the Trustee shall cancel the U.S. Physical Notes so transferred. (c) Transfers of Interests in the Regulation S Global Note or Regulation S Physical Notes to U.S. Persons. The following provisions shall apply with respect to any transfer of interests in the Regulation S Global Note or Regulation S Physical Notes to U.S. Persons: (i) prior to the removal of the Private Placement Legend for the Regulation S Global Notes or the Regulation S Physical Notes pursuant to Section 202, the Registrar shall refuse to register such transfer; and -20- (ii) after such removal pursuant to Section 202, the Registrar shall register the transfer of any such Note without requiring any additional certification. (d) Transfers to Non-U.S. Persons at Any Time. The following provisions shall apply with respect to any transfer of a Note to a Non-U.S. Person: (i) Prior to July 13, 2004, the Registrar shall register any proposed transfer of a Note to a Non-U.S. Person upon receipt of a certificate substantially in the form of Exhibit E from the proposed transferor and the Issuer shall execute, and the Trustee shall, upon receipt of an Issuer Order, authenticate and deliver, one or more Temporary Regulation S Global Notes of like tenor and amount. (ii) On and after July 13, 2004, the Registrar shall register any proposed transfer to any Non-U.S. Person (x) if the Note to be transferred is a Regulation S Physical Note, (y) if the Note to be transferred is a U.S. Physical Note or an interest in the Rule 144A Global Note, upon receipt of a certificate substantially in the form of Exhibit E from the proposed transferor and, (z) in the case of either clause (x) or (y), the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order, shall authenticate and deliver, one or more Physical Notes of like tenor and amount. (iii) If the proposed transferor is a DTC Participant holding a beneficial interest in the Rule 144A Global Note, upon receipt by the Registrar of (x) the document, if any, required by paragraph (i) and (y) instructions in accordance with DTC's and the Registrar's procedures therefor, the Registrar shall reflect on its books and records the date and a decrease in the principal amount of the Rule 144A Global Note in an amount equal to the principal amount of the beneficial interest in the Rule 144A Global Note to be transferred and the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order, shall authenticate and deliver, one or more Regulation S Global Notes or Physical Notes of like tenor and amount. (e) Private Placement Legend. Upon the transfer, exchange or replacement of Notes not bearing the Private Placement Legend, the Registrar shall deliver Notes that do not bear the Private Placement Legend unless the Issuer has reasonable cause to believe that a Note is a Restricted Security and delivers to the Trustee an Issuer Order, in which case the Trustee shall authenticate and deliver a new Note bearing a Private Placement Legend. Upon the transfer, exchange or replacement of Notes bearing the Private Placement Legend, the Registrar shall deliver only Notes that bear the Private Placement Legend unless either (i) the circumstances contemplated by paragraph (a)(i)(x) of this Section 307 exist or (ii) there is delivered to the Registrar an Opinion of Counsel reasonably satisfactory to the Issuer and the Registrar to the effect -21- that neither such legend nor the related restrictions on transfer are required in order to maintain compliance with the provisions of the Securities Act. (f) General. By its acceptance of any Note bearing the Private Placement Legend, each Holder of such a Note acknowledges the restrictions on transfer of such Note set forth in this Indenture and in the Private Placement Legend and agrees that it will transfer such Note only as provided in this Indenture and such Note. (g) Retention of Records. The Registrar shall retain until such time as no Notes remain Outstanding copies of all letters, notices and other written communications received pursuant to Section 306 or this Section 307. The Issuer shall have the right to inspect and make copies of all such letters, notices or other written communications at any reasonable time upon the giving of reasonable written notice to the Registrar. (h) No Duty to Monitor. Neither the Trustee nor the Registrar shall have an obligation or duty to monitor, determine or inquire as to compliance with any restrictions on transfer imposed under this Indenture or under applicable law with respect to any transfer of any interest in any Note other than to require delivery of such certificates and other documentation or evidence as are expressly required by, and to do so if and when expressly required by the terms of, this Indenture, and to examine the same to determine substantial compliance as to form with the express requirements hereof. SECTION 308. Mutilated, Destroyed, Lost and Stolen Notes. (a) If any mutilated Note is surrendered to the Trustee or the Registrar, the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order and such security or indemnity as may be required by the Trustee, Registrar and the Issuer to save each of them and any agent of theirs harmless, shall authenticate and deliver, in exchange therefor a new Note of like tenor and principal amount and bearing a number not contemporaneously Outstanding, or, in case any such mutilated Note has become or is about to become due and payable, the Issuer in its discretion may, instead of issuing a new Note, pay such Note. (b) If there shall be delivered to the Issuer and to the Trustee (i) evidence to their satisfaction of the destruction, loss or theft of any Note and (ii) such security or indemnity as may be required by them to save each of them and any agent of either of them harmless, then, in the absence of notice to the Issuer or the Trustee that such Note has been acquired by a bona fide purchaser, the Issuer shall execute, and the Trustee, upon receipt of an Issuer Order, shall authenticate and deliver, in lieu of any such destroyed, lost or stolen Note, a new Note of like tenor and principal amount and bearing a number not contemporaneously Outstanding, or, in case any such destroyed, lost or stolen Note has become or is about to become due and payable, the Issuer in its discretion may, instead of issuing a new Note, pay such Note. (c) Upon the issuance of any new Note under this Section 308, the Issuer may require the payment of a sum sufficient to cover any tax or other -22- governmental charge that may be imposed in relation thereto and any other expenses (including the fees and expenses of the Trustee) connected therewith. (d) Every new Note issued pursuant to this Section 308 in lieu of any destroyed, lost or stolen Note shall constitute an original additional contractual obligation of the Issuer, whether or not the destroyed, lost or stolen Note shall be at any time enforceable by anyone, and shall be entitled to all the benefits of this Indenture equally and proportionately with any and all other Notes, duly issued hereunder. (e) The provisions of this Section 308 are exclusive and shall preclude (to the extent lawful) all other rights and remedies with respect to the replacement or payment of mutilated, destroyed, lost or stolen Notes. SECTION 309. Payment on Notes; Rights Preserved. (a) Principal of the Notes that is payable will be paid to the Person in whose name such Note is registered at the close of business on the Maturity Date, the Redemption Date or the date of acceleration (as provided in Section 702), as applicable, upon presentation and surrender of such Note at the office or agency of the Issuer in New York County, New York, maintained for such purpose or such other place as may be designated for such purpose pursuant to this Indenture, provided, that, upon written request from any Holder of Outstanding Notes in the aggregate principal amount of $1,000,000, payments of principal of such Notes shall be made by wire transfer to such Holder. (b) Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes which is payable, and that is paid or duly provided for, on any Payment Date, Redemption Date or date of acceleration (as provided in Section 702) will be paid to the Person in whose name such Note (or one or more Predecessor Notes) is registered at the close of business on the Regular Record Date applicable to such Payment Date, Redemption Date or date of acceleration at the office or agency of the Issuer in New York County, New York, maintained for such purposes pursuant to Section 1107 or, at the option of the Issuer, may be paid by check mailed to the address of the Person entitled thereto pursuant to Section 310 as such address appears in the Security Register; provided, that (i) upon written request from any Holder of Outstanding Notes in the aggregate principal amount of $1,000,000, all payments with respect to the Global Notes and Physical Notes the Holders of which have given wire transfer instructions to the Trustee by the Regular Record Date shall be required to be made by wire transfer of immediately available funds to the accounts specified by the Holders thereof; and (ii) the final payment of Additional Interest (and interest on accrued and unpaid Additional Interest) with respect to each Note shall only be made upon presentation and surrender of such Note at the office or agency of the Issuer in New York County, New York, maintained for such purposes pursuant to Section 1107 or such other place as may be designated pursuant to this Indenture. (c) Subject to the foregoing provisions of this Section 309, each Note delivered under this Indenture upon registration of transfer of or in exchange for or in lieu of any other Note shall carry the rights to interest accrued and unpaid, and to accrue, which were carried by such other Note. -23- SECTION 310. Persons Deemed Owners. (a) Prior to the due presentment of a Note for registration of transfer, the Issuer, the Trustee and any agent of the Issuer or the Trustee may treat the Person in whose name such Note is registered as the owner of such Note for the purpose of receiving payment of principal of and, subject to Section 309, Additional Interest (and interest on accrued and unpaid Additional Interest) with respect to such Note and for all other purposes whatsoever, whether or not such Note be overdue, and none of the Issuer, the Trustee or any agent of the Issuer or the Trustee shall be affected by notice to the contrary. (b) None of the Issuer, the Trustee and any agent of the Issuer or the Trustee shall have any responsibility or liability for any aspect of the records relating to or payments made on account of beneficial ownership interests of a Note in global form or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests. SECTION 311. Cancellation. All Notes surrendered for payment, redemption, registration of transfer or exchange shall, if surrendered to any Person other than the Trustee, be delivered to the Trustee and shall be promptly canceled by the Trustee. The Issuer at any time may deliver to the Trustee (or to any other Person for delivery to the Trustee) for cancellation any Notes previously authenticated and delivered hereunder which the Issuer may have acquired in any manner whatsoever and any Notes previously authenticated hereunder which the Issuer has not issued and sold, and all Notes so delivered shall be promptly canceled by the Trustee. If the Issuer shall so acquire any of the Notes, however, such acquisition shall not operate as a redemption or satisfaction of the indebtedness represented by such Notes unless and until the same are surrendered to the Trustee for cancellation. No Notes shall be authenticated in lieu of or in exchange for any Notes canceled as provided in this Section 311, except as expressly permitted by this Indenture. All canceled Notes held by the Trustee shall be disposed of by the Trustee in accordance with its customary procedures and certification of their disposal delivered to the Issuer unless by Issuer Order the Issuer shall direct that canceled Notes be returned to it; provided, that such Issuer Order is timely and the Notes have not been previously disposed of by the Trustee; and provided further, that the Trustee shall not be required to destroy such canceled Notes. SECTION 312. CUSIP and CINS Numbers. The Issuer in issuing the Notes may use "CUSIP" and "CINS" numbers (if then generally in use), and, if so, the Trustee shall use "CUSIP" or "CINS" numbers in notices of redemption or exchange as a convenience to Holders; provided, that any such notice shall state that no representation is made as to the correctness of such numbers either as printed on the Notes or as contained in any notice of a redemption or exchange, that reliance may be placed only on the other identification numbers printed on the Notes and that any such redemption shall not be affected by any defect in or omission of such numbers. SECTION 313. Parity of Notes. All Notes issued and Outstanding hereunder, regardless of the time or times of their issuance, rank on a parity with each other Note and each Note shall be secured equally and ratably by this Indenture and the Security Documents with each other Note, without preference, -24- priority or distinction of any one thereof over any other by reason of difference in time of issuance or otherwise, and each Note shall be entitled to the same benefits and security in this Indenture and the Security Documents as each other Note. ARTICLE FOUR APPLICATION OF PROCEEDS FROM SALE OF NOTES SECTION 401. Application of Proceeds from Sale of Notes. The Issuer covenants to use the net proceeds from the issuance and sale of the Notes (a) to purchase the member interests in PCF as set forth in the Member Interest Purchase Agreement, (b) to pay for all costs, fees and expenses incurred in connection with this offering, including any fees payable to Morgan Stanley & Co. Incorporated for structuring the offering of the Notes and acting as initial purchaser of the Notes in the offering and (c) to pay any remaining amounts to its sole Member, CES. ARTICLE FIVE ACCOUNTS SECTION 501. Establishment of Accounts. (a) Wilmington Trust Company, a Delaware banking corporation, is hereby appointed as the "Accounts Agent" and, in such capacity, will act, in accordance with Article 8 of the UCC, as the "securities intermediary" with respect to any "securities accounts" and as a "bank" with respect to any "deposit accounts" (as each such term is defined in the UCC) in which a security interest may be granted under the UCC pursuant hereto and pursuant to the Assignment and Security Agreement (together with its successors and permitted assigns in each such capacity, the "Accounts Agent"). Pursuant hereto and to the Assignment and Security Agreement, the Accounts Agent shall establish and maintain the following non-interest bearing accounts (collectively, the "Accounts") in the name of the Trustee for the benefit of the Trustee and the Holders as provided in this Indenture: (i) the Collections Account, (ii) the Redemption Account and (iii) the Working Capital Account (each as defined below). The Accounts Agent will invest funds in each such Account in accordance with Section 504 and act with respect to all "financial assets" (as such term is defined in Article 8 of the UCC) credited to the Accounts as a "securities intermediary" (as such term is defined in Article 8 of the UCC). The Accounts Agent shall hold and safeguard the Accounts during the term of this Indenture and the Assignment and Security Agreement and shall treat the "security entitlements" (as such term is defined in Article 8 of the UCC) in the Accounts as security entitlements pledged by the Issuer to the Trustee for the benefit of the Trustee and the Holders to be held in accordance with the provisions of this Indenture and the Assignment and Security Agreement. Neither the Issuer nor any Affiliate of the Issuer shall have any rights against the Accounts Agent hereunder (other than rights which may arise as a result of the Accounts Agent's gross negligence or willful misconduct as determined by a court of competent jurisdiction in a final, non-appealable judgment), as a third-party beneficiary or otherwise, including, any right to direct the Accounts Agent to distribute or allocate any funds in the Accounts (except as expressly provided herein or as provided in the Assignment and Security Agreement). The Accounts Agent shall comply with Part 5 of Article 8 of the UCC. -25- (b) All monies and Permitted Investments credited to the Accounts from time to time shall constitute part of the Collateral and shall be collateral security for the payment and performance by the Issuer of all its obligations under the Financing Documents and, subject to the terms of this Indenture, shall at all times be subject to the sole dominion and control of the Trustee for the purposes and on the terms set forth in this Indenture and the other Financing Documents. Until payment and performance of all the obligations of the Issuer under the Financing Documents in accordance with the provisions hereof, the Issuer shall have no right to the funds credited to the Accounts, except as provided in this Article Five. If a Notice of an Actionable Event shall have been given and be outstanding, the Trustee shall apply all or any of the monies in the Accounts in accordance with the express terms of the Indenture and in the order of priority set forth in Section 711. SECTION 502. Collections Account. (a) On or prior to the Closing Date, the Accounts Agent shall establish and maintain a segregated trust account no. 066532-001, in the name of the Trustee in its trust capacity and entitled "Collections Account" (the "Collections Account"). Thereafter, without limitation of any other amounts required or permitted under this Indenture to be deposited in the Collections Account (including any profit or interest earned on the investment of moneys held in any Account pursuant to Section 504), all Collections shall be deposited with the Accounts Agent for the benefit of the Trustee in the Collections Account. The Issuer shall instruct each Person from whom it receives or is entitled to receive Collections to pay such Collections (identifying them as such in writing to the Trustee) directly to the Trustee for deposit in the Collections Account, and the Trustee shall be entitled to receive directly all Collections from the Persons owing the same. In the event that any Collections are remitted directly to, or are otherwise received by, the Issuer, all such Collections shall be held by the Issuer in trust for the Trustee, and the Issuer shall promptly remit such Collections in the form received (with any necessary endorsement) to the Trustee for deposit in the Collections Account. (b) Unless a Notice of an Actionable Event shall have been given in writing to the Trustee and be outstanding, in which case the provisions of Section 711 shall be applicable, the Trustee shall apply amounts in the Collections Account on the dates specified below and in the following order of priority for payment to the appropriate Person, but in each case only to the extent that all current and past due amounts ranking prior thereto have been paid in full (if a date is specified and that date is not a Business Day, the payment will be made on the next Business Day): (i) FIRST, on the fifth day of August of each year, beginning on August 5, 2005, to pay to the Trustee the amount of Trustee Fees due and payable at such time in connection with the Notes; (ii) SECOND, on the fifth day of each month, to pay to the payee thereof all governmental fees and other expenses (including legal fees and the expenses of the independent members of the Management Committee, the Administrative Agent, and the Trustee, but excluding the annual fees of any of the foregoing) required to be paid by the Issuer to -26- third-parties in order for the Issuer to remain in compliance with its obligations under this Indenture (as specified in an Officer's Certificate of the Issuer delivered to the Trustee at least three Business Days prior to the fifth day of each month); (iii) THIRD, on the fifth day of August of each year (beginning on August 5, 2005), to pay in advance to the Administrative Agent an amount equal to the annual fees payable to the Administrative Agent under the Administrative Services Agreement, to pay to our Independent Managers an amount equal to the annual fees payable to the Independent Managers under the Lord Engagement Letter and premiums, fees or other charges for insurance (all as specified in an Officer's Certificate of the Issuer delivered to the Trustee at least three Business Days prior to the fifth day of August of each year); (iv) FOURTH, on each Payment Date, to pay, on a pro rata basis to the Holders, an amount equal to any accrued and unpaid Additional Interest that was scheduled to be paid on a prior Payment Date, plus any accrued and unpaid interest on such unpaid Additional Interest as provided in Section 301(c); (v) FIFTH, on each Payment Date, to pay, on a pro rata basis to the Holders, an amount equal to the Additional Interest due and payable at that time on the Notes; (vi) SIXTH, on each Payment Date, provided, that (as specified in an Officer's Certificate of the Issuer delivered to the Trustee no later than 10:00 a.m. (EDT) on such Payment Date) (A) no Event of Default or Default has occurred and is continuing on such Payment Date or would occur as a result of the Trustee's application of funds according to this Section 502(b)(vi), (B) the Trustee's application of funds according to this Section 502(b)(vi) complies with all legal requirements and (C) there has been no optional redemption of the PCF Notes in full, at the Member's election (as specified in the Officer's Certificate), to the Member, to PCF or to the Working Capital Account. Notwithstanding the foregoing, if there has been an optional redemption of the PCF Notes in full (as specified in the Officer's Certificate) any amounts remaining in the Collections Account following the application of clauses (i) through (v) of this Section 502(b) shall be transferred to the Redemption Account. SECTION 503. Redemption Account and Working Capital Account. (a) On or prior to the Closing Date, the Accounts Agent shall establish and maintain a segregated trust account no. 066532-002, in the name of the Trustee in its trust capacity and entitled "Redemption Account" (the "Redemption Account"). The Redemption Account shall be funded with all amounts distributed to the Issuer which constitute PCF Reserve Proceeds and any amounts transferred from the Collections Account in accordance with clause (vi) of Section 502(b). Amounts on -27- deposit in the Redemption Account shall be applied in accordance with the provisions of Article 13 hereof. (b) On or prior to the Closing Date, the Accounts Agent shall establish and maintain a segregated trust account no. 066532-003, in the name of the Trustee in its trust capacity and entitled "Working Capital Account" (the "Working Capital Account"). The Working Capital Account shall initially be funded with any amounts remaining after application of the proceeds from the sale of the Notes and shall thereafter be funded with amounts transferred at the Member's election from the Collections Account in accordance with the provisions of Section 502(b)(vi). Subject to Section 3(c)(v) of the Assignment and Security Agreement, any amounts held in the Working Capital Account may be used by the Issuer to purchase the member interests of PCF on the Closing Date or pursuant to an Issuer Request to the Trustee at least three Business Days prior to the requested fund transfer date, for reasonable working capital, including for distribution to the Member, contribution to PCF or transfer to the Collections Account. So long as no Event of Default has occurred and is continuing, the Trustee shall not issue instructions or orders that are contrary to those issued by the Issuer pursuant to an Issuer Request with respect to the Working Capital Account and any funds held therein. SECTION 504. Statements; Investment of Funds. On or before the tenth (10th) Business Day of each calendar month the Trustee shall provide the Issuer with a written statement of (a) the balances in each of the Accounts at the end of the immediately preceding Payment Month, (b) the amounts deposited into each of the Accounts for the immediately preceding Payment Month (and the sources of such amounts) and (c) the application and payees of amounts withdrawn from each of the Accounts for the immediately preceding Payment Month. Funds on deposit in the Accounts shall be invested by the Trustee, as specified in an Issuer Order, in Permitted Investments. The Issuer shall deliver to the Trustee on the date hereof an Issuer Order specifying its initial investment instructions which shall remain in effect until changed by a subsequent Issuer Order given not less than five (5) Business Days before the effective date of such change. All such Permitted Investments shall be maintained in the name of the Trustee and pledged to the Trustee to be held by it as part of the Collateral hereunder, and the Trustee shall be authorized to endorse any of such Permitted Investments in a manner satisfactory to it, on behalf of the Issuer. The Trustee and, as applicable, the Accounts Agent may rely and shall be fully protected, as provided in Section 807, in their reliance on an Issuer Order that complies with the provisions of this Section 504, and shall be indemnified as provided in Section 806. All earnings on Permitted Investments in the Collections Account and the Redemption Account shall be credited to the Collections Account upon receipt thereof by the Trustee. All losses shall be charged to the applicable Account. Whenever the Trustee or the Accounts Agent is required or permitted to make any payment or transfer under this Indenture, the Trustee or the Accounts Agent, as the case may be, shall have the right, and is hereby irrevocably authorized, to sell or otherwise liquidate any Permitted Investments to the extent necessary to make such payment or transfer and shall have no liability for and shall be fully protected from and against any losses incurred in connection with such sale or liquidation. The Trustee or the Accounts Agent shall have no obligation to invest and reinvest any cash held in the Accounts in the absence of timely and specific written investment direction from the Issuer. Other than by reason of each of their own negligent failure to -28- act or each of their own willful misconduct, in no event shall the Trustee or the Accounts Agent, as the case may be, be liable for the selection of investments or for investment losses incurred thereon. Other than by reason of each of their own negligent failure to act or each of their own willful misconduct, the Trustee or the Accounts Agent, as the case may be, shall have no liability in respect of losses incurred as a result of the liquidation of any investment prior to its stated maturity or the failure of the Issuer to provide timely written investment direction. ARTICLE SIX SATISFACTION AND DISCHARGE SECTION 601. Satisfaction and Discharge of Indenture. (a) This Indenture shall, upon receipt by the Trustee of an Issuer Request, cease to be of further effect with respect to the Notes (except as to any surviving rights of registration of transfer or exchange of Notes herein expressly provided for and except as otherwise specifically provided in this Indenture) and the Trustee, at the expense of the Issuer, shall execute proper instruments acknowledging satisfaction and discharge of this Indenture when: (i) either: (A) all Notes theretofore authenticated and delivered (other than (1) Notes which have been destroyed, lost or stolen and which have been replaced or paid as provided in Section 308 and (2) Notes for whose payment money has theretofore been deposited in trust with the Trustee or any Paying Agent or segregated and held in trust by the Issuer and thereafter repaid to the Issuer, as provided in Section 1402) have been delivered to the Trustee for cancellation; or (B) all Notes not theretofore delivered to the Trustee for cancellation (1) have become due and payable, or (2) will become due and payable at the Maturity Date within one year, and the Issuer, in the case of (i)(B)(1) or (2) above, has irrevocably deposited or caused to be deposited with the Trustee as trust funds in trust for the purpose an amount sufficient to pay and discharge the entire indebtedness on such Notes not theretofore delivered to the Trustee for cancellation, for principal, Additional Interest, accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) and any other amount, in each case to become due through the Maturity Date or Redemption Date, as the case may be; -29- (ii) the Issuer has paid or caused to be paid all other sums then due and payable hereunder by the Issuer with respect to such Notes; and (iii) the Issuer has delivered to the Trustee an Officer's Certificate and an Opinion of Counsel, each stating that all conditions precedent herein provided for relating to the satisfaction and discharge of this Indenture with respect to such Notes have been complied with. (b) Notwithstanding the satisfaction and discharge of this Indenture pursuant to this Article Six, the obligations of the Issuer to the Trustee or any agent of the Trustee appointed in accordance with the provisions hereof and the Paying Agent under Section 806 and, if money shall have been deposited with the Trustee pursuant to subclause (B) of clause (i) of this Section 601, the obligations of the Trustee under Section 801 shall survive. SECTION 602. Application of Trust Money. All money deposited with the Trustee pursuant to Section 601 shall be held in trust and applied by the Trustee, in accordance with the provisions of the Notes and this Indenture, to the payment, either directly or through any Paying Agent (including the Issuer acting as its own Paying Agent) as the Trustee may determine, to the Persons entitled thereto, of the principal, Additional Interest and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) for whose payment such money has been deposited with the Trustee; provided, that such money need not be segregated from other funds except to the extent required in this Indenture or by law. ARTICLE SEVEN EVENTS OF DEFAULT AND REMEDIES SECTION 701. Events of Default. "Event of Default," wherever used herein, means the occurrence of any one of the following events with respect to any Notes (whatever the reason for such Event of Default and whether it shall be voluntary or involuntary or be effected by operation of law (including, but not limited to, force majeure and any other impossibility of performance) or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body): (a) the Issuer shall default in the payment of any principal with respect to any Note when the same shall become due and payable; or (b) the Issuer shall default in the payment of Additional Interest (or interest on accrued and unpaid Additional Interest) required to be paid with respect to any of the Notes at the Maturity Date, the Redemption Date or date of acceleration (as provided in Section 702); or (c) the Issuer shall default in the payment of any other fees, costs, charges or sums due hereunder or under the other Financing Documents when the same shall become due and payable (other than Additional Interest and -30- interest on accrued and unpaid additional interest accrued in accordance with Section 301(c)), and such failure continues for a period of five days; or (d) any "event of default" (as defined in the PCF Indenture) occurs under the PCF Indenture; or (e) the Issuer shall fail to observe or perform any of the covenants set forth in Section 1108(a) or Article 12 of this Indenture; or (f) the Issuer shall fail to observe or perform any of the covenants set forth in Section 1101 or Section 1102(a) of this Indenture, and such failure shall continue unremedied for 5 days after the Issuer becomes aware of such failure or receives written notice thereof from any Holder; or (g) the Issuer shall fail to observe or perform any of the covenants set forth herein or in any other Financing Document not otherwise specifically provided for in this Section 701, and such failure shall continue unremedied for 30 days after the Issuer becomes aware thereof or receives written notice thereof from the Trustee or any Holder; or (h) any Financing Document fails, except as the result of the acts or omissions of the Trustee or the other Secured Parties, to provide to the Trustee, for the benefit of the Secured Parties, the Liens, first priority security interest, rights, titles, interest, remedies permitted by law, powers or privileges intended to be created thereby or (except in accordance with its terms) ceases to be in full force and effect, or the first priority or validity thereof or the applicability thereof to the Notes or any other obligations purported to be secured or guaranteed thereby or any part thereof are disaffirmed by or on behalf of the Issuer; or (i) the Issuer or PCF shall become subject to a Bankruptcy Event; or (j) at any time after the execution and delivery thereof, any material provision of any of the Material Agreements or Financing Documents ceases to be in full force and effect (other than by reason of the satisfaction in full of the obligations thereof or any other termination in accordance herewith or with the terms of the applicable Material Agreement or Financing Document) or any of the Material Agreements or Financing Documents shall be declared null and void by a Governmental Agency of competent jurisdiction; or (k) any representation or warranty made or deemed made by the Issuer in any Financing Document, or in any separate statement, certificate or document delivered to the Trustee or any Holder under this Indenture or under any other Financing Document to which such person is a party, is untrue or misleading in any material respect as of the time made; or (l) a judgment is or judgments are entered against the Issuer for the payment of money in excess of $100,000 in the aggregate, other than (i) a judgment which is fully covered by insurance or discharged within the later of -31- 60 days after its entry and the day before the next Payment Date, or (b) a judgment, the execution of which is effectively stayed within 60 days after its entry but only for 60 days after the later of the date on which such stay is terminated or expires and the day before the next Payment Date; or (m) PCF permits the PCF Indenture to be amended, modified or supplemented or PCF enters into any new contract, lease, agreement or instrument unless, in either case, doing so could not reasonably be expected to result in a Material Adverse Effect. SECTION 702. Acceleration of Maturity: Rescission and Annulment. (a) If an Event of Default (other than a Bankruptcy Event of Default) occurs and is continuing, then and in every such case the Trustee, upon the direction of the Holders of no less than twenty-five percent (25%) principal amount of the Outstanding Notes (for an Event of Default specified in clauses (a) or (b) of Section 701) or the Majority Holders (for any other Event of Default other than a Bankruptcy Event of Default), shall declare the then applicable principal amount of all the Notes as of such date (as provided in Section 301(b)) to be due and payable immediately, by a notice in writing to the Issuer (and to the Trustee, if given by the Holders), and upon receipt of such notes the then applicable principal amount of the Notes (as provided in Section 301(b)) and any accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest), and all other unpaid fees, costs, charges and other amounts due under the Financing Documents, shall become immediately due and payable. (b) If a Bankruptcy Event of Default occurs, the then applicable principal amount of the Notes (as provided for in Section 301(b)) and any accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest), and all other amounts payable under the Outstanding Notes, shall become immediately due and payable. (c) In addition, if one or more of the Events of Default (other than a Bankruptcy Event of Default) shall have occurred and be continuing, the Trustee may accelerate the maturity of the Notes as provided in clause (a) of this Section 702 notwithstanding the absence of direction from the Holders if in the judgment of the Trustee such action is necessary to protect the interests of the Holders. (d) At any time after the principal amount of the Notes shall have become due and payable upon a declared acceleration as provided in this Section 702, and before any judgment or decree for the payment of the money so due, or any portion thereof, shall be entered, the Majority Holders, by written notice to the Issuer and the Trustee, may rescind and annul such declaration and its consequences if all Events of Default giving rise to such acceleration have been cured or waived. SECTION 703. Remedies upon an Event of Default. If any Event of Default shall have occurred and be continuing and acceleration shall have occurred pursuant to Section 702, the Trustee may, subject in each case to the provisions of Section 807, exercise any or all of the rights and remedies granted to it in any Security Document. Without limiting the generality of the -32- foregoing, the Issuer expressly agrees that in any such event the Trustee, without demand of performance or any other demand, advertisement or notice of any kind (except the notice specified below of the time and place of public or private sale) to or upon the Issuer or any other Person (all and each of which demands, advertisements and/or notices are hereby expressly waived to the extent permitted by applicable law), may, and at the written instruction of the Majority Holders shall, subject to the provisions of the Material Agreements and to the provisions of any law or regulation having the force of law: (a) collect, receive and appropriate any or all of the Collateral and exercise any right, remedy, power or privilege of the Issuer in respect of the Collateral; (b) set off against all amounts due and payable hereunder with funds held in the Accounts; (c) proceed by suit at law or in equity to seek specific performance of any obligation of the Issuer; (d) take possession of the Collateral forthwith or any time thereafter, in which case the Issuer shall marshal and deliver the Collateral to the Trustee or its designee at such time or times and such place or places as the Trustee may reasonably specify; (e) subject to the provisions of Section 704, forthwith sell, lease, assign, give an option or options to purchase or otherwise dispose of and deliver all or any part of the Collateral (or contract to do so) at one or more public or private sales, at any exchange, broker's board or at any of the Trustee's offices or elsewhere at such prices as it may deem best, for cash or on credit or for future delivery without assumption of any credit risk; or (f) proceed by suit at law or in equity to foreclose upon, or appoint a receiver with respect to, the Collateral or exercise any other right or remedy (including specific performance of the Issuer's obligations under the Financing Documents) available under applicable law. The Trustee may sell any or all of the Collateral as provided above at any private or public sale, it being hereby agreed that twenty (20) Business Days' notice by the Trustee to the Issuer shall be deemed to be reasonable notice of any such sale. The Issuer hereby waives, to the extent permitted by applicable law, any claims against the Trustee arising by reason of the fact that the price at which Collateral may have been sold at any such private sale was less than the price which might have been obtained at a public sale. SECTION 704. Certain Sales of Collateral. In connection with the exercise of any remedies under Section 703(e) the Trustee will not sell the Collateral or any portion thereof without the written consent of all of the Holders of the Notes Outstanding unless the proceeds of such sale will be sufficient to satisfy all of the outstanding principal amount (as reflected by the then applicable Accreted Value of the Notes), accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest), and all other amounts due and payable under the Notes. SECTION 705. No Marshaling. To the extent that it lawfully may, the Issuer hereby agrees that it will not at any time plead, claim or take the benefit of any appraisement, valuation, stay, extension, moratorium or redemption law now or hereafter in force and any requirement of marshaling in the event of foreclosure of the security interests hereby created, the effect of which might be to prevent or delay the enforcement of any Security Document or the absolute sale of the whole or any part of the Collateral or the possession thereof by the Trustee or any purchaser at any sale by the Trustee. The Issuer, for itself and all who may claim under the Issuer, as far as the Issuer may lawfully do so, hereby waives and releases the benefit of all such laws. Except -33- as otherwise expressly provided in this Indenture, to the extent permitted by applicable law, the Issuer hereby waives presentment, demand, protest or any notice of any kind in connection with, and not expressly set forth in, any Security Document or herein. SECTION 706. Trustee May Recover Unpaid Indebtedness After Sale of Collateral. Subject to Section 114, in the case of a sale of the Collateral and of the application of the proceeds of such sale to the payment of the indebtedness secured by this Indenture and the Security Documents, the Trustee in its own name, and as trustee of an express trust, shall be entitled and empowered, by any appropriate means, legal, equitable or otherwise to enforce payment of, and to receive all amounts then remaining due and unpaid upon, all or any of the Notes, for the benefit of the Holders thereof, and upon any other portion of the indebtedness remaining unpaid, with interest at the rates specified in Section 301(b) or Section 301(c), as applicable. SECTION 707. Recovery of Judgment Does Not Affect Rights. No recovery of any such judgment or final decree by the Trustee and no levy of any execution under any such judgment upon any of the Collateral, or upon any other property, shall in any manner or to any extent affect any rights, powers or remedies of the Trustee, or any liens, rights, powers or remedies of the Holders, but all such liens, rights, powers or remedies shall continue unimpaired as before. SECTION 708. Collection of Indebtedness and Suits for Enforcement by Trustee. (a) The Issuer covenants that if: (i) default is made in the payment of any accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on any Note at the Maturity Date, at the Redemption Date or upon an acceleration pursuant to Section 702, as the case may be or (ii) default is made in the payment of the principal of any Note when such becomes due and payable, the Issuer will, upon demand of the Trustee, pay to the Trustee for the benefit of the Holders of such Notes, the whole amount then due and payable on such Notes for principal (as reflected by the then Accreted Value of the Notes) and Additional Interest, and interest on any overdue principal and upon any accrued and unpaid Additional Interest, at the applicable rate specified in Section 301(b) or Section 301(c), as applicable, and, in addition thereto, such further amount as shall be sufficient to cover the costs and expenses of collection, including the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel. -34- (b) If the Issuer fails to pay such amounts forthwith upon such demand, the Trustee, in its own name as trustee of an express trust, at the direction of the Holders as set forth herein, may institute a judicial proceeding for the collection of the sums so due and unpaid, may prosecute such proceeding to judgment or final decree and may enforce the same against the Issuer or any other obligor upon the Notes and collect the moneys adjudged or decreed to be payable in the manner provided by law out of the property of the Issuer or any other obligor upon the Notes, wherever situated. (c) If an Event of Default with respect to the Notes occurs and is continuing, the Trustee may in its discretion proceed to protect and enforce its rights and the rights of the Holders of Notes by such appropriate judicial proceedings as the Trustee shall deem most effectual to protect and enforce any such rights, whether for the specific enforcement of any covenant or agreement in this Indenture or in aid of the exercise of any power granted herein, or to enforce any other proper remedy. SECTION 709. Trustee May File Proofs of Claim. (a) In case of the pendency of any receivership, insolvency, liquidation, bankruptcy, reorganization, arrangement, adjustment, composition or other judicial proceeding relative to the Issuer or any other obligor upon the Notes or the Property of the Issuer or of such other obligor or their creditors, the Trustee (irrespective of whether the principal of the Notes shall then be due and payable as therein expressed or by declaration or otherwise and irrespective of whether the Trustee shall have made any demand on the Issuer for the payment of overdue principal, accrued and unpaid Additional Interest or interest on accrued and unpaid Additional Interest shall be entitled and empowered, by intervention in such proceeding or otherwise, (i) to file and prove a claim for the whole amount of principal and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) owing and unpaid in respect of the Notes and to file such other papers or documents as may be necessary or advisable in order to have the claims of the Trustee (including any claim for the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel) and of the Holders allowed in such judicial proceeding, and (ii) to collect and receive any moneys or other property payable or deliverable on any such claims and to distribute the same; and any custodian, receiver, assignee, trustee, liquidator, sequestrator or other similar official in any such judicial proceeding is hereby authorized by each Holder to make such payments to the Trustee and, in the event that the Trustee shall consent to the making of such payments directly to the Holders, to pay to the Trustee any amount due it for the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel, and any other amounts due the Trustee under Section 806. (b) Nothing herein contained shall be deemed to authorize the Trustee to authorize or consent to or accept or adopt on behalf of any Holder any plan of reorganization, arrangement, adjustment or composition affecting the -35- Notes or the rights of any Holder thereof or to authorize the Trustee to vote in respect of the claim of any Holder in any such proceeding; provided, however, that the Trustee may, on behalf of the Holders, vote for the election of a trustee in bankruptcy or similar official and be a member of a creditors' or other similar committee. SECTION 710. Trustee May Enforce Claims Without Possession of Notes. All rights of action and claims under this Indenture or the Notes may be prosecuted and enforced by the Trustee without the possession of any of the Notes or the production thereof in any proceeding relating thereto, and any such proceeding instituted by the Trustee shall be brought in its own name as trustee of an express trust, and any recovery of judgment shall, after provision for the payment of the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel, be for the ratable benefit of the Holders. SECTION 711. Application of Money Collected. Any money collected by the Trustee pursuant to this Article Seven or the Security Documents shall be applied in the following order, at the date or dates fixed by the Trustee and, in case of the distribution of such money on account of principal, interest on overdue principal, or Additional Interest (and interest on accrued and unpaid Additional Interest), upon presentation of the Notes and the notation thereon of the payment if only partially paid and upon surrender thereof if fully paid: (a) First, to the payment of all amounts due to the Trustee and each predecessor Trustee, if any, under Section 806; (b) Second, to the payment of the amounts then due and unpaid for principal of and Additional Interest (and interest on overdue principal and accrued and unpaid Additional Interest) on the Notes in respect of which or for the benefit of which such money has been collected, ratably, without preference or priority of any kind, according to the amounts then due and payable on such Notes for principal and Additional Interest and interest thereon, respectively; (c) Third, to the payment of all amounts due and payable to the Administrative Agent under the Administrative Services Agreement, as set forth in an Officer's Certificate from the Issuer, or as determined by a court of competent jurisdiction; and (d) Fourth, to the Issuer or to whoever may be lawfully entitled to receive the same or as a court of competent jurisdiction may direct. SECTION 712. Limitation on Suits. No Holder of any Note shall have any right to institute any proceeding, judicial or otherwise, with respect to this Indenture, or for the appointment of a receiver or trustee, or for any other remedy hereunder, unless (a) such Holder has previously given written notice to the Trustee of a continuing Event of Default, with respect to the Notes; -36- (b) the Majority Holders of the Outstanding Notes shall have made written request to the Trustee to institute proceedings in respect of such Event of Default in its own name as Trustee hereunder; (c) such Holder or Holders have offered to the Trustee indemnity reasonably satisfactory to the Trustee against the costs, expenses and liabilities to be incurred in compliance with such request; (d) the Trustee for sixty (60) days after its receipt of such notice, request and offer of indemnity has failed to institute any such proceeding; and (e) no direction inconsistent with such written request has been given to the Trustee during such 60-day period by the Majority Holders of the Outstanding Notes; it being understood and intended that no one or more of such Holders shall have any right in any manner whatever by virtue of, or by availing of, any provision of this Indenture to affect, disturb or prejudice the rights of any other Holders of Notes, or to obtain or to seek to obtain priority or preference over any other of such Holders or to enforce any right under this Indenture, except in the manner herein provided and for the equal and ratable benefit of all Holders. SECTION 713. Unconditional Right of Holders to Receive Principal and Additional Interest. Notwithstanding any other provision in this Indenture, the Holder of any Note shall have the right, which is absolute and unconditional, to receive payment, as provided herein (including, if applicable, Article Fourteen), of the principal and Additional Interest on such Note and (subject to Section 301) any interest on accrued and unpaid Additional Interest, on the Maturity Date expressed in such Note (or, in the case of redemption, on the Redemption Date), including any interest accrued during any grace period provided in Section 701, and to institute suit for the enforcement of any such payment, and such rights shall not be impaired without the consent of such Holder. SECTION 714. Restoration of Rights and Remedies. If the Trustee or any Holder has instituted any proceeding to enforce any right or remedy under this Indenture and such proceeding has been discontinued or abandoned for any reason, or has been determined adversely to the Trustee or to such Holder, then and in every such case, subject to any determination in such proceeding, the Issuer, the Trustee and the Holders shall be restored severally and respectively to their former positions hereunder and thereafter all rights and remedies of the Trustee and the Holders shall continue as though no such proceeding had been instituted. SECTION 715. Rights and Remedies Cumulative. Except as otherwise provided with respect to the replacement or payment of mutilated, destroyed, lost or stolen Notes in clause (e) of Section 308, no right or remedy herein conferred upon or reserved to the Trustee or to the Holders is intended to be exclusive of any other right or remedy, and every right and remedy shall, to the -37- extent permitted by law, be cumulative and in addition to every other right and remedy given hereunder or now or hereafter existing at law or in equity or otherwise. The assertion or employment of any right or remedy hereunder, or otherwise, shall not prevent the concurrent assertion or employment of any other appropriate right or remedy. SECTION 716. Delay or Omission Not Waiver. No delay or omission of the Trustee or of any Holder to exercise any right or remedy accruing upon any Event of Default shall impair any such right or remedy or constitute a waiver of any such Event of Default or an acquiescence therein. Every right and remedy given by this Article Seven or by law to the Trustee or to the Holders may be exercised from time to time, and as often as may be deemed expedient, by the Trustee or by the Holders, as the case may be. SECTION 717. Control by Holders. (a) The Majority Holders shall have the right to direct in writing the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred on the Trustee, provided, that such Majority Holders have provided the Trustee with indemnity acceptable to the Trustee against the costs, expenses (including reasonable attorneys' fees and expenses) and liabilities to be incurred in following such direction and that direction shall not be in conflict with any law and the provisions of this Indenture and provided, further, that (subject to the provisions of Section 801) the Trustee shall have the right to decline to follow any such direction if such directions are unclear or inconsistent with any other directives given to the Trustee or if the Trustee, being advised by counsel, shall determine that the action or proceeding so directed may not lawfully be taken or if the Trustee in good faith by a Responsible Officer of the Trustee shall determine that the action or proceedings so directed would involve the Trustee in personal liability or if the Trustee in good faith shall so determine that the actions or forbearances specified in or pursuant to such direction would be unduly prejudicial to the interests of Holders so affected not joining in the giving of said direction, it being understood that (subject to Section 801) the Trustee shall have no duty to ascertain whether or not such actions or forbearances are unduly prejudicial to such Holders. (b) Nothing in this Indenture shall impair the right of the Trustee in its discretion to take any action deemed proper by the Trustee and which is not inconsistent with such direction or directions by the Majority Holders. SECTION 718. Waiver of Past Defaults. (a) The Majority Holders of the Outstanding Notes affected may on behalf of the Holders of all the Notes waive any past default, except a default in the payment of the principal of or Additional Interest (and interest on overdue principal and on accrued and unpaid Additional Interest) with respect to any Note or in respect of a covenant or provision hereof that cannot be modified or amended without the unanimous affirmative vote of all Holders. (b) Upon any such waiver, any such default shall cease to exist, and any Event of Default arising therefrom shall be deemed to have been cured, for every purpose of this Indenture and the Trustee, Issuer and the Holders, as -38- the case may be, shall be restored respectively to their former positions and rights hereunder; provided, that no such waiver shall extend to any subsequent or other default or Event of Default or impair any right consequent thereon. SECTION 719. Waiver of Force Majeure and Stay or Extension Laws. The Issuer covenants (to the extent that it may lawfully do so) that it will not at any time insist upon, or plead, or in any manner whatsoever claim or take the benefit or advantage of, any force majeure, impossibility of performance and any stay or extension law wherever enacted, now or at any time hereafter in force, which may affect the covenants or the performance of this Indenture, and the Issuer (to the extent that it may lawfully do so) hereby expressly waives all benefit or advantage of any such force majeure, impossibility or law and covenants that the Issuer will not hinder, delay or impede the execution of any power herein granted to the Trustee, but will suffer and permit the execution of every such power as though no such law had been enacted or such force majeure or impossibility grounds have occurred. SECTION 720. Trustee to Give Notice of Default, but May Withhold in Certain Circumstances. Within forty-five (45) days after a Responsible Officer assigned to the Corporate Trust Office of the Trustee obtains actual knowledge of the occurrence of any Default hereunder, the Trustee shall transmit by mail to all Holders as their names shall appear on the Security Register, in the manner and to the extent provided in Trust Indenture Act Section 313(c), notice of such Default hereunder, unless such Default shall have been cured or waived; provided, that except in the case of a Default in the payment of the principal of or Additional Interest (and interest on accrued and unpaid Additional Interest) with respect to any Note, the Trustee shall be protected in withholding such notice if and so long as the board of directors, the executive committee or a trust committee of directors or Responsible Officers of the Trustee in good faith determine that the withholding of such notice is in the interest of the Holders. SECTION 721. Undertaking for Costs. In any suit for the enforcement of any right or remedy under this Indenture, or in any suit against the Trustee for any action taken, suffered or omitted by it as Trustee, a court may require any party litigant in such suit to file an undertaking to pay the costs of such suit, and may assess costs (including reasonable attorneys' fees and expenses) against any such party litigant, in the manner and to the extent provided in the Trust Indenture Act; provided, that the provisions of this Section 721 shall not apply to any suit instituted by the Trustee, or the Issuer to any suit instituted by any Holder or group of Holders, holding in the aggregate more than ten percent (10%) in Principal Amount at Maturity of the Outstanding Notes, or any suit instituted by any Holder for the enforcement of the payment of the principal of or Additional Interest (and interest on overdue principal and on accrued and unpaid Additional Interest) with respect to any Note on or after the respective due dates expressed in such Note (or, in the case of redemption, on or after the Redemption Date). -39- ARTICLE EIGHT THE TRUSTEE SECTION 801. Duties and Responsibilities of the Trustee; During Default; Prior to Default. (a) The Trustee, prior to the occurrence of an Event of Default and after the curing or waiving of all Events of Default that may have occurred, shall undertake to perform such duties and only such duties as are specifically set forth in this Indenture. In case an Event of Default has occurred (which has not been cured or waived) the Trustee shall exercise such of the rights and powers vested in it by this Indenture and use the same degree of care and skill in their exercise as a prudent man would exercise or use under the circumstances in the conduct of his own affairs. (b) No provision of this Indenture shall be construed to relieve the Trustee from liability for its own negligent action, its own negligent failure to act or its own willful misconduct, except that: (i) during the continuance of an Event of Default: (A) the duties and obligations of the Trustee shall be determined solely by the express provisions of this Indenture, and the Trustee shall not be liable except for the performance of such duties and obligations as are specifically set forth in this Indenture, and no implied covenants or obligations shall be read into this Indenture against the Trustee; and (B) in the absence of bad faith on the part of the Trustee, the Trustee may conclusively rely, as to the truth of the statements and the correctness of the opinions expressed therein, upon any statements, certificates or opinions furnished to the Trustee and conforming to the requirements of this Indenture; provided, that in the case of any such statements, certificates or opinions which by any provision hereof are specifically required to be furnished to the Trustee, the Trustee shall be under a duty to examine the same to determine whether or not they conform to the requirements of this Indenture (but need not confirm or investigate the accuracy of mathematical calculations or other facts stated therein); (ii) the Trustee shall not be liable for any error of judgment made in good faith by a Responsible Officer or Responsible Officers of the Trustee, unless it shall be conclusively determined by a court of competent jurisdiction that the Trustee was negligent in ascertaining the pertinent facts; and (iii) the Trustee shall not be liable with respect to any action taken or omitted to be taken by it in good faith in accordance with the direction of the Holders pursuant to Section 717 relating to the time, -40- method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred upon the Trustee, under this Indenture. (c) None of the provisions contained in this Indenture shall require the Trustee to expend or risk its own funds or otherwise incur personal financial liability in the performance of any of its duties or in the exercise of any of its rights or powers, if there shall be reasonable ground for believing that the repayment of such funds or indemnity satisfactory to it against such liability is not assured to it. Notwithstanding anything to the contrary contained herein, in no event shall the Trustee be liable under this Indenture or any of the other Financing Documents to which it is a party for special, indirect or consequential loss or damage of any kind whatsoever (including but not limited to lost profits). SECTION 802. Certain Rights of Trustee. Subject to the provisions of Section 801: (a) the Trustee and, as applicable, the Accounts Agent, may conclusively rely and shall be fully protected in acting or refraining from acting in reliance upon any resolution, Officer's Certificate or any other certificate, statement, instrument, opinion, report, notice, request, direction, consent, order, bond, debenture, note, other evidence of indebtedness or other paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties; (b) any request, direction, order or demand of the Issuer mentioned herein shall be sufficiently evidenced by an Officer's Certificate, Issuer Request or Issuer Order (unless other evidence in respect thereof be herein specifically prescribed), and any Management Committee's Consent may be sufficiently evidenced to the Trustee by a copy thereof certified by the secretary or a member of the Issuer; (c) the Trustee may consult with counsel of its selection and any advice of counsel or Opinion of Counsel shall be full and complete authorization and protection in respect of any action taken, suffered or omitted by it hereunder or under any Security Document in good faith and in accordance with such advice or Opinion of Counsel; (d) the Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Indenture or under any other Financing Document at the request or direction of any of the Holders pursuant to this Indenture, unless such Holders shall have offered to the Trustee security or indemnity reasonably satisfactory to the Trustee against the costs, expenses and liabilities which might be incurred therein or thereby; (e) the Trustee shall not be bound to make any investigation into the facts or matters stated in any resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, approval, appraisal, bond, debenture, notice, security or other paper or document unless requested in writing so to do by the Majority Holders; provided, that if the -41- payment within a reasonable time to the Trustee of the costs, expenses or liabilities likely to be incurred by it in the making of such investigation is, in the opinion of the Trustee, not reasonably assured to the Trustee by the security afforded to it by the terms of this Indenture, the Trustee may require indemnity satisfactory to it against such expenses or liabilities as a condition to proceeding; the reasonable expenses of every such investigation shall be paid by the Issuer or, if paid by the Trustee, any predecessor trustee or the Holders of any Outstanding Notes, shall be repaid by the Issuer upon demand; (f) the Trustee may execute any of the trusts or powers hereunder or perform any duties hereunder or under any other Financing Document either directly or by or through agents or attorneys not regularly in its employ and the Trustee shall not be responsible for any misconduct or negligence on the part of any agent or attorney appointed with due care by it hereunder; (g) neither the Trustee nor the Accounts Agent shall be liable for any action taken, suffered or omitted by either of them in good faith and believed by the Trustee or the Accounts Agent, as the case may be, to be authorized or within the discretion or rights or powers conferred upon the Trustee or the Accounts Agent, as the case may be, by this Indenture; (h) except during the continuance of an Event of Default, the Trustee need perform only those duties as are specifically set forth in this Indenture; (i) the Trustee is hereby authorized and directed to enter into the Security Documents; (j) the Trustee shall not be deemed to have notice of any Default or Event of Default unless a Responsible Officer of the Trustee has actual knowledge thereof or unless written notice of any event which is in fact such a default is received by the Trustee at the Corporate Trust Office of the Trustee, and such notice references the Notes and this Indenture; and (k) the rights, privileges, protections, immunities and benefits given to the Trustee, including its right to be indemnified, are extended to, and shall be enforceable by, the Trustee in each of its capacities hereunder, and to each agent, custodian and other Person employed to act hereunder and under the Security Documents. SECTION 803. Trustee Not Responsible for Recitals or Issuance of Notes. Other than as specifically provided in the Trustee recitals of this Indenture; the recitals contained herein and in the Notes, except for the Trustee's certificates of authentication, shall be taken as the statements of the Issuer, and the Trustee assumes no responsibility for their correctness. The Trustee makes no representations as to the validity or sufficiency of this Indenture or of any disclosure document or offering materials or of the Notes. -42- Neither the Trustee nor its agents appointed in accordance with the provisions hereof shall be accountable for the use or application by the Issuer of the Notes or the proceeds thereof. SECTION 804. May Hold Notes. The Trustee, any Paying Agent, the Registrar or any other agent of the Issuer or of the Trustee, in its individual or any other capacity, may become the owner or pledgee of Notes and, subject to Trust Indenture Act Sections 310(b) and 311, may otherwise deal with the Issuer with the same rights it would have if it were not the Trustee, any Paying Agent, the Registrar or any other agent of the Issuer or such agent and, subject to Sections 809 and 813, if operative, may otherwise deal with the Issuer and receive, collect, hold and retain collections from the Issuer with the same rights it would have if it were not the Trustee, any Paying Agent, the Registrar or any other agent of the Issuer. SECTION 805. Money Held In Trust. All moneys received by the Trustee shall, until used or applied as herein provided, be held in trust for the purposes for which they were received, but need not be segregated from other funds except to the extent required by law. Neither the Trustee nor any agent of the Issuer shall be under any liability for interest on any moneys received by it hereunder except as otherwise agreed with the Issuer. SECTION 806. Compensation and Indemnification of Trustee, Accounts Agent, Paying Agent and Registrar and Its Prior Claim. (a) The Issuer covenants and agrees to pay to the Trustee, the Accounts Agent and to each Paying Agent and Registrar, and the Trustee, the Accounts Agent and each Paying Agent and Registrar shall be entitled to, such compensation as set forth in any fee agreement between the Issuer and the Trustee entered into in connection with the execution and delivery of this Indenture by the parties hereto or in connection with the issuance of the Notes (which shall not be limited by any provision of law in regard to the compensation of a trustee of an express trust) and the Issuer covenants and agrees to pay or reimburse the Trustee, the Accounts Agent and each Paying Agent and Registrar and their respective predecessors upon its request for all reasonable expenses, disbursements and advances incurred or made by or on behalf of it in accordance with any of the provisions of this Indenture (including the reasonable compensation and the reasonable expenses and disbursements of its counsel and of all agents and other persons not regularly in its employ) except any such expenses, disbursement or advance as may arise from its negligence or bad faith. As security for such payment and for all of the other obligations of the Issuer set forth in this Section 806 (and any fees referred to in Section 816), the Trustee shall have a security interest and Lien prior to the Notes upon all Collateral. The provisions of this Section 806 shall survive the resignation or removal of the Trustee and the termination of the other provisions of this Indenture. (b) The Issuer also covenants to indemnify the Trustee, the Accounts Agent and each Paying Agent and Registrar and their respective predecessors, officers, directors, employees, representatives and agents for, and to hold it harmless against, any and all loss, liability, damage, claim or expense, including taxes (other than taxes based on the income of the Trustee, the Accounts Agent and each Paying Agent and Registrar and their respective predecessors, officers, directors, employees, representatives and agents) -43- incurred without negligence or bad faith on its part, arising out of or in connection with the acceptance, administration or enforcement of this Indenture and under the other Financing Documents or the trusts hereunder and its duties hereunder and the other Financing Documents, including any liability which the Trustee, the Accounts Agent or any Paying Agent or Registrar may incur as a result of failure to withhold, pay or report any tax, assessment or other governmental charge and the costs and expenses of defending itself against or investigating any claim of liability in the premises. The obligations of the Issuer under this Section 806(b) to compensate and indemnify the Trustee, the Accounts Agent and each Paying Agent and Registrar and their respective predecessors and to pay or reimburse the Trustee, the Accounts Agent and each Paying Agent and Registrar and their respective predecessors for expenses, disbursements and advances shall constitute additional indebtedness hereunder and shall survive the termination, satisfaction and discharge of this Indenture. References herein to the "Trustee" shall be deemed to also refer to the Trustee acting in its capacity as Accounts Agent, Paying Agent, Registrar or in any other capacity as contemplated herein or in any Financing Document. (c) Where the Trustee incurs expenses or renders services in connection with a Bankruptcy Event of Default, such expenses (including reasonable attorneys' fees and expenses) and the compensation for the services are intended to constitute expenses of administration under applicable federal or state bankruptcy, insolvency or other law. SECTION 807. Right of Trustee to Rely on Officer's Certificate, Etc. Subject to Sections 801 and 802, whenever in the administration of the trusts of this Indenture the Trustee, or in the carrying out of its duties under Article Five, the Accounts Agent, shall deem it necessary or desirable that a matter be proved or established prior to taking or suffering or omitting any action hereunder, such matter (unless other evidence in respect thereof be herein specifically prescribed) may, in the absence of bad faith on the part of the Trustee or the Accounts Agent, as the case may be, be deemed to be conclusively proved and established by an Officer's Certificate delivered to the Trustee or the Accounts Agent, as the case may be, and such certificate, in the absence of bad faith on the part of the Trustee or the Accounts Agent, as the case may be, shall be full warranty to the Trustee or the Accounts Agent, as the case may be, for any action taken, suffered or omitted by the Trustee or the Accounts Agent, as the case may be, under the provisions of this Indenture upon the faith thereof. SECTION 808. Corporate Trustee Required; Eligibility. There shall at all times be a Trustee hereunder which shall be eligible to act as Trustee under Trust Indenture Act Section 310(a)(1) and (2) and which shall have a combined capital and surplus of at least one hundred fifty million Dollars ($150,000,000). If such corporation publishes reports of condition at least annually, pursuant to law or to the requirements of federal, state, territorial or District of Columbia supervising or examining authority, then for the purposes of this Section 808, the combined capital and surplus of such corporation shall be deemed to be its combined capital and surplus as set forth in its most recent report of condition so published. The Trustee shall comply with the provisions of the Trust Indenture Act Section 310(b). If at any time -44- the Trustee shall cease to be eligible in accordance with the provisions of this Section 808, it shall resign immediately in the manner and with the effect hereinafter specified in this Article Eight. SECTION 809. Qualification of Trustee; Conflicting Interests. If the Trustee has or shall acquire any conflicting interest within the meaning of the Trust Indenture Act, the Trustee shall, within 90 days after ascertaining that it has a conflicting interest and if the Event of Default to which such conflicting interest relates has not been cured or duly waived before the end of such 90 day period, either eliminate such conflicting interest or resign, to the extent and in the manner provided by, and subject to the provisions of, the Trust Indenture Act and this Indenture. SECTION 810. Resignation and Removal; Appointment of Successor Trustee. (a) The Trustee may at anytime resign by giving written notice of resignation to the Issuer and by mailing written notice thereof by first-class mail, postage prepaid, to all Holders at their last addresses as they shall appear on the Security Register specifying the day upon which the resignation is to take effect, and such resignation will take effect immediately upon the later of the appointment of a successor trustee pursuant to this Article Eight and such specified day. Upon receiving such notice of resignation, the Issuer, by a Management Committee's Consent, shall promptly appoint a successor trustee satisfying the requirements of Section 808 by written instrument in duplicate, one copy of which instrument shall be delivered to the resigning Trustee and one copy to the successor trustee or trustees. If no successor trustee shall have been so appointed and have accepted appointment within thirty (30) days after the mailing of such notice of resignation, the resigning Trustee may petition any court of competent jurisdiction for the appointment of a successor trustee, or any Holder who has been a bona fide Holder of a Note or Notes for at least six (6) months may, on behalf of himself and all others similarly situated, petition any such court for the appointment of a successor trustee. Such court may thereupon, after such notice, if any, as it may deem proper, appoint a successor trustee. (b) In case at any time any of the following shall occur: (i) the Trustee shall fail to comply with the provisions of Section 809 and Trust Indenture Act Section 310(b) after written request therefor by the Issuer or by any Holder who has been a bona fide Holder for at least six (6) months, except when the Trustee's duty to resign is stayed in accordance with the provisions of Trust Indenture Act Section 310(b); or (ii) the Trustee shall cease to be eligible in accordance with the provisions of Section 808 and shall fail to resign after written request therefor by the Issuer or by any Holder who has been a bona fide Holder for at least six (6) months; or (iii) the Trustee shall become incapable of acting or shall be adjudged a bankrupt or insolvent, or a receiver or liquidator of the Trustee or of its property shall be appointed, or any public officer shall -45- take charge or control of the Trustee or of its property or affairs for the purpose of rehabilitation, conservation or liquidation; then, in any such case, the Issuer may, by Management Committee's Consent, remove the Trustee and appoint a successor trustee by written instrument, in duplicate, executed by order of the members, one copy of which instrument shall be delivered to the Trustee so removed and one copy to the successor trustee, or, subject to the provisions of Section 811, unless the Trustee's duty to resign is stayed as provided herein, any Holder who has been a bona fide Holder for at least six (6) months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the removal of the Trustee and the appointment of a successor trustee. (c) If the Trustee shall resign, be removed or become incapable of acting, or if a vacancy shall occur in the office of Trustee for any cause, the Issuer, by a Management Committee's Consent, shall promptly appoint a successor trustee satisfying the requirements of Section 808. If, within one year after such resignation, removal or incapability, or the occurrence of such vacancy, a successor trustee shall be appointed by an Act of the Majority Holders delivered to the Issuer and the retiring Trustee, the successor trustee so appointed shall, forthwith upon its acceptance of such appointment, become the successor trustee and to that extent supersede the successor trustee appointed by the Issuer. If no successor trustee shall have been so appointed by the Issuer or the Holders and accepted appointment in the manner hereinafter provided within 60 days, any Holder who has been a bona fide Holder for at least six (6) months may, on behalf of himself and all others similarly situated, petition any court of competent jurisdiction for the appointment of a successor trustee. (d) It is the purpose of this Indenture that there shall be no violation of any law of any jurisdiction denying or restricting the right of banking corporations or associations to transact business as an indenture trustee in such jurisdiction. (e) The Issuer shall give notice of each resignation and each removal of the Trustee and each appointment of a successor trustee in the manner provided for in Section 106. Each notice shall include the name of the successor trustee and the address of its Corporate Trust Office. (f) The Holders, by Act of the Majority Holders, may at any time remove the Trustee and appoint a successor trustee by delivering to the Trustee so removed, to the successor trustee so appointed and to the Issuer the evidence provided for in Section 104 of the action in that regard taken by the Majority Holders. (g) No resignation or removal of the Trustee and no appointment of a successor trustee pursuant to any of the provisions of this Section 810 shall become effective until the acceptance of appointment by the successor trustee as provided in Section 811. SECTION 811. Acceptance of Appointment by Successor. (a) In case of the appointment hereunder of a successor trustee, every such successor -46- trustee so appointed shall execute, acknowledge and deliver to the Issuer and to the retiring Trustee an instrument accepting such appointment, and thereupon the resignation or removal of the retiring Trustee shall become effective and such successor trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, trusts and duties of the retiring Trustee; provided, that on the request of the Issuer or the successor trustee, such retiring Trustee shall, upon payment of its charges, execute and deliver an instrument transferring to such successor trustee all the rights, powers and trusts of the retiring Trustee and shall duly assign, transfer and deliver to such successor trustee all property and money held by such retiring Trustee hereunder. (b) Upon request of any such successor trustee, the Issuer shall execute any and all instruments for more fully and certainly vesting in and confirming to such successor Trustee all rights, powers and trusts referred to in clause (a) of this Section 811. (c) No successor trustee shall accept its appointment unless at the time of such acceptance such successor trustee shall be qualified and eligible under this Article Eight. (d) In no event shall the retiring Trustee be liable for the acts or omissions of any successor trustee. SECTION 812. Merger Conversion, Consolidation or Succession to Business. Any corporation into which the Trustee may be merged or converted or with which it may be consolidated, or any corporation resulting from any merger, conversion or consolidation to which the Trustee shall be a party, or any corporation succeeding to all or substantially all the corporate trust business of the Trustee, shall be the successor of the Trustee hereunder; provided, that such corporation shall be otherwise qualified and eligible under this Article Eight, without the execution or filing of any paper or any further act on the part of any of the parties hereto. In case any Notes shall have been authenticated, but not delivered, by the Trustee then in office, any successor by merger, conversion or consolidation to such authenticating Trustee may adopt such authentication and deliver the Notes so authenticated with the same effect as if such successor trustee had itself authenticated such Notes; and in case at that time any of the Notes shall not have been authenticated, any successor trustee may authenticate such Notes either in the name of any predecessor hereunder or in the name of the successor trustee; and in all such cases such certificates shall have the full force which it is anywhere in the Notes or in this Indenture provided that the certificate of the Trustee shall have; provided, further, that the right to adopt the certificate of authentication of any predecessor Trustee or to authenticate Notes in the name of any predecessor trustee shall apply only to its successor or successors by merger, conversion or consolidation. SECTION 813. Preferential Collection of Claims Against Issuer. If and when the Trustee shall be or become a creditor of the Issuer (or any other obligor under the Notes), the Trustee shall be subject to the provisions of the Trust Indenture Act regarding the collection of claims against the Issuer (or any such other obligor), excluding any creditor relationships described in Trust -47- Indenture Act Section 311(b). A Trustee who has resigned or has been removed shall be subject to Trust Indenture Act Section 311(a) to the extent indicated therein. SECTION 814. No Liability for Clean-up of Hazardous Materials. (a) In the event that the Trustee is required to acquire title to an asset for any reason, or take any managerial action of any kind in regard thereto, in order to carry out any fiduciary or trust obligation for the benefit of another, which in the Trustee's sole discretion may cause the Trustee to be considered an "owner or operator" under the provisions of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), 42 U.S.C. Sections 9601, et seq., or otherwise cause the Trustee to incur liability under CERCLA or any other federal, state or local law, the Trustee reserves the right to, instead of taking such action, either resign as Trustee or arrange for the transfer of the title or control of the asset to a court appointed receiver. (b) The Trustee shall not be liable to the Issuer or Holders or any other person for any environmental claims or contribution actions under any federal, state or local law, rule or regulation by reason of the Trustee's actions and conduct as authorized, empowered and directed hereunder or relating to the discharge, release or threatened release of hazardous materials into the environment, except to the extent of the Trustee's negligence or willful misconduct. SECTION 815. Accounts Agent Registrar and Paving Agent. Insofar as such provisions may be applicable, the Accounts Agent, the Registrar, the Paying Agent and any other agent appointed in accordance with the provisions hereof shall enjoy the same protections, immunities and indemnities as are provided for in this Article Eight with respect to the Trustee. SECTION 816. Filing Fees. The Issuer agrees to pay or to reimburse the Trustee for any and all amounts in respect of all filing, recording and registration fees which may be payable or determined to be payable in respect of the execution, delivery, performance and enforcement of the Financing Documents and agrees to save the Trustee harmless from and against any and all liabilities with respect to or resulting from any delay in paying or omitting to pay such fees. The obligations of the Issuer under this Section 816 shall survive the resignation or removal of the Trustee and the termination of the other provisions of this Indenture. SECTION 817. Fee Agreement. The Fee Agreement provides for the compensation of the Trustee hereunder for its services as such, and the Trustee will not look to the holders of the Notes for any payment for such services, provided, that this Section 817 shall not alter the provisions of Section 502(b)(i) or the lien provided in Section 806(a). ARTICLE NINE HOLDERS' LISTS AND REPORTS BY TRUSTEE AND ISSUER SECTION 901. Holder Lists. The Trustee shall preserve in as current a form as is reasonably practicable the most recent list available to it -48- of the names and addresses of the Holders. If the Trustee is not the Registrar, the Issuer shall furnish to the Trustee at least five (5) Business Days before each Payment Date, and at such other times as the Trustee may request in writing, a list in such form and as of such date as the Trustee may reasonably require of the names and addresses of the Holders. The Trustee may conclusively rely upon such list provided by the Issuer until otherwise notified by the Issuer or such list is amended by the Issuer. SECTION 902. Disclosure of Names and Addresses of Holders. Every Holder of Notes, by receiving and holding the same, agrees with the Issuer and the Trustee that none of the Issuer or the Trustee or any agent of either of them shall be held accountable by reason of the disclosure of any such information as to the names and addresses of the Holders in accordance with Trust Indenture Act Section 312, regardless of the source from which such information was derived, and that the Trustee shall not be held accountable by reason of mailing any material pursuant to a request made under Trust Indenture Act Section 312(b). SECTION 903. Reports by Trustee. (a) Within sixty (60) days after May 1 of each year commencing with the first May 1 after the first issuance of Notes pursuant to this Indenture, the Trustee shall transmit to the Holders in the manner and to the extent provided in Trust Indenture Act Section 313(c), a brief report dated as of such May 1 if required by Trust Indenture Act Section 313(a). (b) The Trustee shall transmit to the Holders, in the manner and to the extent provided in Trust Indenture Act Section 313(c), a brief report, if required, by Trust Indenture Act Section 313(b). SECTION 904. Reports by Issuer. (a) The Issuer shall: (i) file with the Trustee, within fifteen (15) days after the Issuer is required to file the same with the Commission, copies of the annual reports and of the information, documents and other reports (or copies of such portions of any of the foregoing as the Commission may from time to time by rules and regulations prescribe) which the Issuer may be required to file with the Commission pursuant to Section 13 or Section 15(d) of the Securities Exchange Act or, if the Issuer is not required to file information, documents or reports pursuant to either of such Sections, then it shall file with the Trustee and the Commission, in accordance with rules and regulations prescribed from time to time by the Commission, such of the supplementary and periodic information, documents and reports which may be required pursuant to Section 13 of the Securities Exchange Act in respect of a security listed and registered on a national securities exchange as may be prescribed from time to time in such rules and regulations; (ii) file with the Trustee and the Commission, in accordance with rules and regulations prescribed from time to time by the Commission, such additional information, documents and reports with respect to -49- compliance by the Issuer with the conditions and covenants of this Indenture as may be required from time to time by such rules and regulations; and (iii) transmit to all Holders, in the manner and to the extent provided in Trust Indenture Act Section 313(c), within thirty (30) days after the filing thereof with the Trustee, such summaries of any information, documents and reports required to be filed by the Issuer pursuant to paragraphs (i) and (ii) of clause (a) of this Section 904 as may be required by rules and regulations prescribed from time to time by the Commission. (b) Delivery of such reports, information and documents to the Trustee is for informational purposes only and the Trustee's receipt of such shall not constitute constructive notice of any information contained therein or determinable from information contained therein, including the Issuer's compliance with any of its covenants hereunder (as to which the Trustee is entitled to rely exclusively on Officer's Certificates). ARTICLE TEN SUPPLEMENTS AND AMENDMENTS TO INDENTURE AND SECURITY DOCUMENTS SECTION 1001. Without Vote of Holders. Without the vote or approval of any Holders, the Issuer, when authorized by or pursuant to a Management Committee's Consent, and the Trustee, at any time and from time to time, may amend or supplement this Indenture, any Security Documents or the Notes, in form satisfactory to the Trustee, for any of the following purposes: (a) to evidence the succession of another Person to the Issuer to the extent such succession is permitted under the terms of this Indenture and the assumption by any such successor of the covenants of the Issuer contained herein and in the Notes; or (b) to add to the covenants of the Issuer for the benefit of the Holders or to surrender any right or power herein conferred upon the Issuer; or (c) to add any additional Events of Default; or (d) to secure the Notes with additional collateral; or (e) to evidence and provide for the acceptance of appointment hereunder by a successor Trustee and to add to or change any of the provisions hereof as shall be necessary to provide for or facilitate the administration of the trusts hereunder by more than one trustee; or (f) to cure any ambiguity, to correct or supplement any provision hereof which may be inconsistent with any other provision in this Indenture -50- provided that such action shall not adversely affect the interests of the Holders in any material respect; or (g) to supplement any of the provisions of this Indenture to such extent as shall be necessary to permit or facilitate the defeasance and discharge of the Notes; provided, that any such action does not adversely affect the interests of the Holders in any material respect. SECTION 1002. With Consent of Holders. (a) The Issuer, when authorized by or pursuant to a Management Committee's Consent, and the Trustee may amend or supplement this Indenture or the Notes for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture or the Notes or of modifying in any manner the rights of the Holders under this Indenture with the consent of the Majority Holders of the Notes affected by such amendment or supplement (voting as a single class), by Act of said Holders delivered to the Issuer and the Trustee; provided, that no such amendment or supplement shall, without the consent of the Holder of each Outstanding Note, (i) change the Maturity Date of the principal of, or any scheduled payment of Additional Interest with respect to, any Note; (ii) reduce the principal amount of any Note or reduce the amount of any Additional Interest payment with respect to any Note, including discharge of repayment of principal of or Additional Interest with respect to any Note; (iii) reduce (A) the percentage in Principal Amount at Maturity of Outstanding Notes, the consent of the Holders of which is required for the adoption of a resolution, (B) the quorum required at any meeting of Holders at which a resolution is adopted or (C) the percentage in Principal Amount at Maturity of Outstanding Notes the Holders of which are entitled to request the calling of a Holder's meeting; (iv) change the percentage rules established for adopting resolutions at meetings of Holders or regarding the quorum necessary to constitute a meeting; (v) modify any of the provisions of this Section 1002 and Section 718, except to increase any percentage specified herein or therein; (vi) change the place or coin or currency for payment of principal of or Additional Interest (or interest on accrued and unpaid Additional Interest) with respect to, any Note; (vii) impair the right to institute suit for the enforcement of any payment on or after the Maturity Date or any Redemption Date or Payment Date therefor; -51- (viii) permit the creation of any Lien with respect to all or any substantial portion of the Collateral, or release or terminate the Lien of the Security Documents on all or any substantial portion of the Collateral or deprive any Holder of the security afforded by the Lien of the Security Documents, except to the extent expressly permitted by this Indenture or any of the Security Documents; (ix) modify the ranking or priority of the Notes; or (x) waive a default in the payment of principal of or accrued and unpaid Additional Interest (or interest on overdue principal or on accrued and unpaid Additional Interest) with respect to, the Notes. (b) It shall not be necessary for any Act of Holders under this Section 1002 to approve the particular form of any proposed supplemental indenture, but it shall be sufficient if such Act shall approve the substance thereof. SECTION 1003. Execution of Supplemental Indentures. In executing or accepting the additional trusts created by any amended or supplemental indenture permitted by this Article Ten or the modifications thereby of the trusts created by this Indenture, the Trustee shall be entitled to receive, and shall be fully protected in relying upon, an Opinion of Counsel stating that the execution of such supplemental indenture is authorized or permitted by this Indenture. The Trustee may, but shall not be obligated to, enter into any such supplemental indenture which affects the Trustee's own rights, duties or immunities under this Indenture or otherwise. SECTION 1004. Effect of Supplemental Indentures. Upon the execution of any supplemental indenture under this Article Ten, (a) this Indenture or the applicable Security Document shall be modified in accordance therewith, (b) such supplemental indenture, amendment, modification or waiver shall form a part of this Indenture or the applicable Security Document (as the case may be) for all purposes and (c) every Holder of Notes theretofore or thereafter authenticated and delivered hereunder shall be bound thereby. SECTION 1005. Conformity with Trust Indenture Act. Every supplemental indenture executed pursuant to this Article Ten shall conform to the requirements of the Trust Indenture Act as then in effect. SECTION 1006. Reference in Notes to Supplemental Indentures. Notes authenticated and delivered after the execution of any supplemental indenture pursuant to this Article Ten may, and shall if required by the Trustee, bear a notation in form approved by the Trustee as to any matter provided for in such supplemental indenture. If the Issuer shall so determine, new Notes so modified as to conform, in the opinion of the Trustee and the Issuer, to any such supplemental indenture may be prepared and executed by the Issuer, and, upon receipt of an Issuer Order, authenticated and delivered by the Trustee, in -52- exchange for Outstanding Notes. Failure to make the appropriate notation or to issue a new Note shall not affect the validity of such supplemental indenture, amendment, modification or waiver. SECTION 1007. Notice of Supplemental Indentures. Promptly after the execution by the Issuer and the Trustee of any supplemental indenture, amendment, modification or waiver pursuant to the provisions of Section 1002, the Issuer shall give notice thereof to the Holders, in the manner provided for in Section 106, setting forth in general terms the substance of such supplemental indenture, amendment, modification or waiver. ARTICLE ELEVEN AFFIRMATIVE COVENANTS SECTION 1101. Distributions. The Issuer shall cause PCF to distribute or dividend to the Issuer any amounts on deposit in or credited to the PCF Reserve Account or the PCF Working Capital Account on any date on which PCF may distribute or dividend such amounts. SECTION 1102. Performance of Obligations. (a) The Issuer shall cause PCF to pay all sums due under the PCF Indenture according to the terms thereof; (b) the Issuer shall pay, and shall cause PCF to pay, all of the Issuer's and PCF's (as the case may be) obligations under any contractual arrangement to which the Issuer or PCF (as the case may be) is a party, howsoever arising, as and when due and payable, except such as may be contested in good faith or as to which a bona fide dispute may exist; and (c) the Issuer shall perform, and shall cause PCF to perform, all of the Issuer's and PCF's (as the case may be) obligations under any contractual arrangement to which the Issuer or PCF (as the case may be) is a party, however so arising, as and when required, except (i) such as may be contested in good faith or as to which a bona fide dispute may exist or (ii) any obligation the failure of which to perform could not reasonably be expected to have a Material Adverse Effect. SECTION 1103. Compliance with the PCF Indenture. The Issuer shall cause PCF to comply with the covenants set forth in the PCF Indenture whether or not such indenture is in effect, including after an optional redemption of the PCF Notes in full or other termination of the covenants set forth in Article 11 or Article 12 of the PCF Indenture. SECTION 1104. Preservation of Rights. The Issuer shall maintain, preserve, protect and defend its material rights under and take all reasonable action necessary to prevent termination of each of its agreements, unless the failure to do so could not reasonably be expected to result in a Material Adverse Effect. SECTION 1105. Liens. The Issuer shall preserve and maintain good, legal and valid title to all of its properties and assets. The Issuer shall cause PCF to maintain good, legal and valid title to all of its properties and assets free and clear of all Liens, other than Liens which are permitted under the PCF Indenture and Liens which could not reasonably be expected to result in a Material Adverse Effect. -53- SECTION 1106. Payment of Principal and Interest. The Issuer shall duly and punctually pay the principal of, Additional Interest and accrued and unpaid Additional Interest (and interest on overdue principal and accrued and unpaid Additional Interest) with respect to the Notes in accordance with the terms of the Notes and this Indenture. SECTION 1107. Maintenance of Office or Agency. (a) The Issuer will maintain in New York County, New York, an office or agency where Notes may be presented or surrendered for payment, where Notes may be surrendered for registration of transfer or exchange and where notices and demands to or upon the Issuer in respect of the Notes and this Indenture may be served. (b) The Issuer will give prompt written notice to the Trustee of the location, and any change in the location, of such office or agency. If at any time the Issuer shall fail to maintain any such required office or agency or shall fail to furnish the Trustee with the address thereof, such presentations, surrenders, notices and demands may be made or served at the Corporate Trust Office of the Trustee and the Issuer hereby appoints the same as its agent to receive such respective presentations, surrenders, notices and demands. (c) The Issuer may also from time to time designate one or more other offices or agencies where Notes may be presented or surrendered for any or all such purposes and may from time to time rescind any such designation; provided, that no such designation or rescission shall in any manner relieve the Issuer of its obligation to maintain an office or agency in accordance with the requirements set forth above for such purposes. The Issuer will give prompt written notice to the Trustee of any such designation or rescission and of any change in the location of any such other office or agency. SECTION 1108. Maintenance of Existence, Properties. (a) The Issuer shall preserve and maintain its and PCF's legal existence and form as separate, bankruptcy-remote, special purpose Delaware limited liability companies separate from any other entity, and shall preserve and maintain all registrations necessary therefor. (b) The Issuer shall preserve and maintain all of its rights, privileges and franchises necessary for the conduct of its business and the performance of its obligations under the Material Agreements and the Financing Documents, except to the extent failure to do so could not reasonably be expected to result in a Material Adverse Effect. The Issuer shall cause PCF to preserve and maintain all of PCF's licenses, rights, privileges and franchises necessary for the conduct of PCF's business and the performance of PCF's obligations under the PCF Material Agreements and the PCF Financing Documents, except to the extent failure to do so could not reasonably be expected to result in a Material Adverse Effect SECTION 1109. Permits. The Issuer shall, and shall cause PCF to, obtain any Permit at or before the time that such Permit becomes an Applicable -54- Permit, except to the extent that failure to do so could not reasonably be expected to result in a Material Adverse Effect. SECTION 1110. Payments of Taxes and Other Claims. The Issuer shall, and shall cause PCF to, pay and discharge or cause to be paid and discharged, before the same shall become delinquent, all taxes, assessments and governmental charges levied or imposed upon the Issuer or PCF, and all lawful claims or obligations which, if unpaid, might by law become a Lien upon the Property of the Issuer or PCF, as applicable; provided, that the Issuer will not be required to, and will not be required to cause PCF to, pay or discharge or cause to be paid or discharged any such tax, assessment, charge or claims whose amount, applicability or validity is being contested in good faith by appropriate proceedings and for which adequate funds have been set aside. SECTION 1111. Notice of Certain Events. The Issuer shall furnish to the Trustee: (a) within 120 days after the end of each fiscal year of the Issuer ending after the date hereof, an Officer's Certificate of a Responsible Officer stating that (i) no Default has occurred and is continuing (or if any such Default has occurred and is continuing, describing such Default in reasonable detail and describing the steps being taken to remedy such Default) and (ii) the Issuer is in compliance with all conditions and covenants under this Indenture, the Notes and the other Financing Documents to which it is a party; and (b) each of the following items promptly after the Issuer learns of the occurrence or existence thereof: (i) written notice of the occurrence of any event or condition which constitutes a Default or an Event of Default, stating that such event or condition has occurred and describing it and any action being or proposed to be taken with respect thereto; (ii) written notice of the Issuer's failure to observe or perform any term, covenant or obligation of the LLC Agreement (unless such failure could not reasonably be expected to result in a Material Adverse Effect), stating that failure has occurred and describing it and any action being or proposed to be taken with respect thereto; (iii) any actually proposed amendment, termination, rescission, discharge (other than by performance) or waiver under or with respect to any Financing Document or Material Agreement; (iv) any written notice requiring the Issuer to make any indemnity payments under any Material Agreement; (v) written notice of any material litigation filed against the Issuer; and -55- (vi) written notice of any change which could be reasonably expected to result in a Material Adverse Effect. With respect to the information and documents required to be delivered to the Trustee pursuant to clauses (a) and (b) of this Section 1106, the Issuer hereby further covenants and agrees to deliver or cause to be delivered any such documents and information (i) to each Holder who makes a request in writing to the Issuer and (ii) to any owner of a beneficial interest in a Global Note who makes a request in writing to the Issuer (which request may indicate that it is a continuing request for such information until further notice from a Holder or such owner of a beneficial interest in a Global Note to the contrary) for such documents or information. Delivery of such reports, information and documents to the Trustee is for information purposes only and the Trustee's receipt of such shall not constitute constructive notice of any information contained therein (other than an expressly stated notice of Default or Event of Default) or determinable from information contained therein, including the Issuer's compliance with any of its covenants hereunder. SECTION 1112. Compliance with Laws and Other Agreements. The Issuer shall, and shall cause PCF to, comply with (a) all applicable laws, rules, regulations, orders and directions of any Governmental Agency having jurisdiction over it or its business and (b) all of its and, as applicable, PCF's covenants and obligations contained in any agreement to which the Issuer or PCF, as applicable, is a party, unless, in each case, the failure to so comply could not reasonably be expected to result in a Material Adverse Effect. The Issuer will comply with all applicable provisions of the Trust Indenture Act, including Trust Indenture Act Sections 314(b) and (d). SECTION 1113. Maintenance of Books and Records. The Issuer shall at all times maintain proper books, accounts and records in accordance with GAAP. The Issuer shall permit the Trustee and its representatives, upon reasonable notice and during normal business hours, to visit its premises and inspect all books, accounts and records of the Issuer. SECTION 1114. Rule 144A Information for the Holders. At any time when the Issuer is not subject to Section 13 or 15(d) of the Securities Exchange Act, upon the request of a Holder, the Issuer shall promptly furnish to such Holder or to a prospective purchaser who is a qualified institutional buyer of such Note designated by such Holder, as the case may be, information specified in Rule 144A(d)(4) under the Securities Act ("Rule 144A Information") in order to permit compliance by such Holder with Rule 144A in connection with the resale of such Note by such Holder; provided, that the Issuer shall not be required to furnish Rule 144A Information in connection with any request made on or after the date which is two (2) years from the later of (a) the date such Note (or any Predecessor Note) was acquired from the Issuer or (b) the date such Note (or any Predecessor Note) was last acquired from an "affiliate" of the Issuer within the meaning of Rule 144 under the Securities Act; provided, further, that the Issuer shall not be required to furnish such information at any time to a prospective purchaser located outside the United States who is not a "United States Person" within the meaning of Regulation S under the Securities Act if such Note may -56- then be sold to such prospective purchaser in accordance with Rule 904 under the Securities Act (or any successor provision thereto). SECTION 1115. Further Assurances. The Issuer shall, at its own cost and expense, execute and deliver, and cause to be executed and delivered, to the Trustee all such documents, instruments and agreements, and do all such other acts and things as may be reasonably required to preserve the Liens in favor of the Trustee with the required first-ranking priority and to enable the Trustee to exercise and enforce its rights under this Indenture, the Security Documents and the other documents, instruments and agreements required under this Indenture and to carry out the intent of this Indenture and the other Financing Documents. SECTION 1116. Return of Monies Held by Trustee. (a) On any date on which the principal of any Note becomes due in full, if the outstanding principal of such Note, together with all accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) to the due date, and any other amounts payable by the Issuer to the Trustee or the Holders under this Indenture or any other Financing Document, have been finally and irrevocably paid to the Trustee for the benefit of the Holders, all interest and Additional Interest on such Notes shall cease to accrue on the date of such payment. (b) Moneys so deposited with the Trustee or then held by the Issuer in trust for the payment of the principal of or Additional Interest (and interest on accrued and unpaid Additional Interest) on any Note which remain unclaimed two (2) years after the date that all amounts payable by the Issuer to the Trustee or to the Holders under this Indenture or any other Financing Document has been finally and irrevocably paid to the Trustee for the benefit of the Holders, shall, at the request of the Issuer if at the time, to the knowledge of the Trustee, no Event of Default shall have occurred and be continuing, be paid to the Issuer and the Holders shall thereafter look solely to the Issuer for payment with respect to amounts deposited with the Trustee and returned to the Issuer pursuant to this Section 1116(b). ARTICLE TWELVE NEGATIVE COVENANTS SECTION 1201. Liens. The Issuer shall not create, assume or suffer to exist any Lien on any of its properties and assets other than the Liens created by this Indenture and by the other Security Documents. The Issuer shall cause PCF to not create, assume or suffer to exist any lien on the PCF Reserve Account or the PCF Working Capital Account or any amounts on deposit in, credited to or released from such accounts, except for Liens permitted under the PCF Indenture. SECTION 1202. Indebtedness. The Issuer shall not incur, create, assume or permit to exist any Indebtedness, except for Indebtedness represented by the Notes. -57- SECTION 1203. Transactions with Affiliates. The Issuer shall not enter into directly or indirectly any transaction with any of its Affiliates (other than the LLC Agreement), except in the ordinary course and pursuant to the reasonable requirements of its business and upon fair and reasonable terms no less favorable to the Issuer than would be obtainable in a comparable transaction on an arm's-length dealing with an unrelated third party. SECTION 1204. Investments, Loans and Advances. Except for Permitted Investments and investments in PCF made with amounts contributed to the Issuer by its member or amounts in the Collections Account that are available for such purpose, the Issuer shall not make any investments, whether by purchase of stocks, bonds, notes or other securities, loan, extension of credit, advance or otherwise. SECTION 1205. Material Agreements and Financing Documents; Additional Contracts. (a) The Issuer shall not assign any of its rights or obligations under any Material Agreement or Financing Document nor will the Issuer amend in any respect or suffer any such amendment of, or grant any waiver of material and timely performance with respect to, or agree to the assignment of the rights or obligations of any party to, any Material Agreement or Financing Document; provided, that the Issuer may make amendments to the Material Agreements and the Financing Documents which are of a routine, ministerial or administrative nature to the extent that what is contemplated under any such amendment is not otherwise expressly prohibited hereunder or could reasonably be expected to result in a Material Adverse Effect; provided, however, that any amendment or modification to any Material Agreement or Financing Document which extends or modifies the time for payment due thereunder shall not be deemed to be an amendment of a routine, ministerial or administrative nature; provided, further, that nothing in this Section 1205(a) shall prevent the Trustee from terminating the Administrative Services Agreement in connection with a breach thereof by the Administrative Agent in accordance with the Administrative Agent Consent so long as the Issuer enters into a replacement agreement substantially similar to the terminated Administrative Services Agreement. (b) The Issuer shall not become a party to any contract, lease, agreement or instrument other than the agreements expressly identified in the definitions of Material Agreements and Financing Documents and agreements for permitted substitution of the Administrative Agent or the Trustee. SECTION 1206. Account. The Issuer shall not maintain, establish or use any account other than the Accounts. SECTION 1207. Fundamental Change. The Issuer shall not (a) sell, lease, assign, transfer or otherwise dispose of any of its right, title or interest in or to its assets, (b) conduct any business other than the business of owning 100% of the economic and voting interests of PCF, (c) liquidate, dissolve, combine, merge or consolidate with or into any other entity, or purchase or otherwise acquire all or substantially all of the assets of any entity, (d) change its legal form, name or fiscal year or (e) create or hold, or permit PCF to create or hold, an ownership interest in any subsidiary (other -58- than the member interests in PCF sold to the Issuer) or enter into, or permit PCF to enter into, any joint venture or general or limited partnership. SECTION 1208. Restricted Payments. Except as permitted in accordance with the conditions set forth in clause (vi) of Section 502(b), the Issuer shall not, directly or indirectly, (a) make or declare any dividend or other distribution (by reduction of capital or otherwise), whether in cash, property, or obligation or other payment on account of any interest in the Issuer. SECTION 1209. Compliance with ERISA. The Issuer shall not, nor shall it permit PCF to, have any employees. The Issuer shall not, nor shall it permit PCF to, maintain any employee benefit plans subject to ERISA. SECTION 1210. Margin Stock. The Issuer shall not directly or indirectly apply any part of the proceeds of the Notes or other funds to the "buying", "carrying" or "purchasing" of any margin stock within the meaning of Regulations T, U or X of the Federal Reserve Board, or any regulations, interpretations or rulings thereunder. SECTION 1211. Purchasing Notes. The Issuer shall not, and shall not permit any Affiliate to, purchase, redeem, prepay or otherwise acquire, directly or indirectly, any of the outstanding Notes except in accordance with the terms hereof and the Notes, or except for any purchase of the entire Principal Amount at Maturity of the Notes. ARTICLE THIRTEEN REDEMPTION OF NOTES SECTION 1301. Applicability of Article. The Notes shall be redeemable (in whole only) before the Maturity Date in accordance with the terms of such Notes and in accordance with this Article Thirteen. SECTION 1302. Mandatory Redemption; Notice to Trustee. The Issuer shall apply (i) PCF Reserve Proceeds deposited in the Redemption Account prior to February 1, 2010 and (ii) amounts transferred from the Collections Account following an optional redemption of the PCF Notes in full to the Redemption Account prior to February 1, 2010, first, to make payments of accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes to the Redemption Date and second, to redeem the Notes at the Redemption Price. Any such mandatory redemption shall only be required, and shall only occur, if the amount on deposit in the Redemption Account equals or exceeds the amount of any accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes to the Redemption Date plus the Redemption Price. If, on any date, the amount available in the Redemption Account for mandatory redemption is less than the amount of all accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes to the Redemption Date plus the Redemption Price on such date, the Issuer shall not redeem the Notes until such date as the -59- amount in the Redemption Account equals or exceeds the amount of any accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes plus the Redemption Price, in each case as of such later Redemption Date. In case of any such mandatory redemption, the Issuer shall, deliver to the Holders and the Trustee a notice of redemption in the manner provided in Section 1303. SECTION 1303. Notice of Redemption. (a) Notice of redemption pursuant to this Section 1303 shall be given in the manner provided for in Section 106 and (i) within 10 Business Days after the deposit of amounts in the Redemption Account sufficient to redeem the Notes in full in accordance with Section 1302 and (ii) not less than thirty (30) nor more than sixty (60) days prior to the Redemption Date, to the Holders, but failure to give such notice in the manner herein provided to the Holder of any Note designated for redemption, or any defect in the notice of any such Holder, shall not affect the validity of the proceedings for the redemption of any other Note. The Redemption Date shall be as specified by the Issuer but shall be not less than (30) nor more than sixty (60) days after the notice of redemption is provided as set forth above. (b) Any notice that is mailed to the Holders in the manner herein provided shall be conclusively presumed to have been duly given, whether or not the Holder receives the notice. (c) All notices of redemption shall state: (i) the Redemption Date, (ii) the Redemption Price, (iii) that on the Redemption Date, the Redemption Price (together with accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest), if any, on the Notes to the Redemption Date) will become due and payable upon each Note, and that Additional Interest with respect to the Notes will cease to accrue or be payable and the principal amount of the Notes will cease to accrete on and after said date, and (iv) the Place of Payment where such Notes are to be surrendered for payment of the Redemption Price. SECTION 1304. Notes Payable on Redemption Date. (a) Notice of redemption having been given in accordance with Section 1303, the Notes shall, on the Redemption Date, become due and payable at the Redemption Price thereof (together with accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest), if any, on the Notes to the Redemption Date), and from and after such Redemption Date, Additional Interest shall cease to accrue and shall no longer be payable and the principal amount of the Notes will cease to accrete. Upon surrender of any Note for redemption in accordance with said notice, such Note shall be paid by the Issuer at the Redemption Price, together with accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) to the Redemption Date. -60- (b) If any Note called for redemption shall not be so paid upon surrender thereof for redemption, the principal and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) shall, until paid, bear interest from the Redemption Date at 11% per annum provided, however, that future Additional Interest in accordance with Section 301(c) shall no longer be due and payable. ARTICLE FOURTEEN DEFEASANCE AND COVENANT DEFEASANCE SECTION 1401. Issuer's Option to Effect Defeasance or Covenant Defeasance. The provisions of this Article Fourteen shall apply to the Notes, and the Issuer may, at its option by a Management Committee's Consent, effect defeasance of the Notes under Section 1402, or covenant defeasance under Section 1403 in accordance with this Article Fourteen. SECTION 1402. Defeasance and Discharge. Upon the Issuer's exercise of the option provided in Section 1401 applicable to this Section 1402 the Issuer shall be deemed to have been discharged from its obligations with respect to the Outstanding Notes on the date the conditions set forth in Section 1404 are satisfied (hereinafter, "defeasance"). For this purpose, such defeasance means that the Issuer shall be deemed to have paid and discharged the entire indebtedness represented by the Outstanding Notes, which shall thereafter be deemed to be "Outstanding" only for the purposes of Section 1405 and the other Sections of this Indenture referred to in (a) and (b) below, and to have satisfied all of its other obligations under such Notes and this Indenture insofar as such Notes are concerned (and the Trustee, at the expense of the Issuer, shall execute proper instruments acknowledging the same), except for the following which shall survive until otherwise terminated or discharged hereunder: (a) the rights of Holders of such Outstanding Notes to receive, solely from the trust fund described in Section 1404(a) and as more fully set forth in such Section, payments in respect of the principal of and Additional Interest (and interest on accrued and unpaid Additional Interest) with respect to such Notes when such payments are due; (b) the Issuer's obligations with respect to such Notes under Sections 305, 306, 307, 308, and 1102; (c) the rights, powers, trusts, duties and immunities of the Trustee hereunder and (d) this Article Fourteen. Subject to compliance with this Article Fourteen, the Issuer may exercise its option under this Section 1402 notwithstanding the prior exercise of its option under Section 1403. SECTION 1403. Covenant Defeasance. Upon the Issuer's exercise of the option provided in Section 1401 applicable to this Section 1403, (a) the Issuer shall be released from its obligations under Sections 1104 through 1116, inclusive, and Sections 1201 through 1208, inclusive and (b) the occurrence of any event specified in Section 701(c) (with respect to any of Sections 1104 through 1116, inclusive, and Sections 1201 through 1208, inclusive) shall be deemed not to be an Event of Default on or after the date the conditions set forth in Section 1404 are satisfied (hereinafter, "covenant defeasance"). For this purpose, such covenant defeasance means that the Issuer may omit to comply with and shall have no liability in respect of any term, condition or limitation set forth in any such Section or clause, whether directly or indirectly, by -61- reason of any reference elsewhere herein to any such Section or clause or by reason of reference in any such Section or clause to any other provision herein or in any other document and any such omission shall not be deemed to be an Event of Default, but, the remainder of this Indenture and such Notes shall be unaffected thereby. SECTION 1404. Conditions to Defeasance or Covenant Defeasance. The following shall be the conditions to application of either Section 1402 or Section 1403 to the Outstanding Notes: (a) The Issuer shall irrevocably have deposited or caused to be deposited with the Trustee (or another trustee satisfying the requirements of Section 808 who shall agree to comply with the provisions of this Article Fourteen applicable to such trustee) as trust funds in trust for the purpose of making the following payments, specifically pledged as security for, and dedicated solely to, the benefit of the Holders, an amount sufficient, in the opinion of an internationally recognized firm of independent public accountants expressed in a written certification thereof delivered to the Trustee, to pay and discharge, and which shall be applied by the Trustee (or other qualifying trustee) to pay and discharge, the principal of and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Outstanding Notes through and on the Maturity Date (or Redemption Date, if applicable). (b) In the case of an election under Section 1402, the Issuer shall have delivered to the Trustee an Opinion of Counsel stating that (i) the Issuer has received from, or there has been published by, the Internal Revenue Service a ruling, or (ii) since the date of execution of this Indenture, there has been a change in the applicable United States federal income tax law, in either case to the effect that, and based thereon such opinion shall confirm that, the Holders of Outstanding Notes will not recognize income, gain or loss for federal income tax purposes as a result of such defeasance and will be subject to federal income tax on the same amounts, in the same manner and at the same times as would have been the case if such defeasance had not occurred. (c) In the case of an election under Section 1403, the Issuer shall have delivered to the Trustee an Opinion of Counsel to the effect that the Holders of Outstanding Notes will not recognize gain or loss for United States federal income tax purposes as a result of such covenant defeasance and will be subject to United States federal income tax on the same amounts, in the same manner and at the same times as would have been the case if such covenant defeasance had not occurred. (d) The Issuer shall have delivered to the Trustee an Officer's Certificate to the effect that the Notes, if then listed on any securities exchange, will not be delisted as a result of such deposit. (e) No Default or Event of Default with respect to the Notes shall have occurred and be continuing on the date of such deposit or, insofar as Bankruptcy Events of Default are concerned, at any time during the period ending on the one hundred twenty-first (121st) day after the date of such deposit (it being understood that this condition shall not be deemed satisfied until the expiration of such period). -62- (f) Such defeasance or covenant defeasance shall not cause the Trustee to have a conflicting interest as defined in Section 809 and for purposes of the Trust Indenture Act with respect to any securities of the Issuer. (g) Such defeasance or covenant defeasance shall not result in a breach or violation of, or constitute a default under, this Indenture or any other material agreement or instrument to which the Issuer is a party or by which it is bound. (h) The Issuer shall have delivered to the Trustee an Officer's Certificate and an Opinion of Counsel, each stating that all conditions precedent provided for relating to either the defeasance under Section 1402 or the covenant defeasance under Section 1403 (as the case may be) have been complied with, and that such defeasance or covenant defeasance shall not result in the trust arising from such deposit constituting an "investment company," as defined in the Investment Company Act of 1940, as amended, or such trust shall be qualified under such act or exempt from regulation thereunder. SECTION 1405. Deposited Money to Be Held in Trust; Other Miscellaneous Provisions. (a) All money (or other property as may be provided hereunder) (including the proceeds thereof) deposited with the Trustee or other qualifying trustee (collectively for purposes of this Section 1405 and Section 1406, the "Trustee") pursuant to Section 1404 in respect of Outstanding Notes shall be held in trust and applied by the Trustee, in accordance with the provisions of the Notes and this Indenture, to the payment, either directly or through any Paying Agent (including the Issuer acting as its own Paying Agent) as the Trustee may determine, to the Holders of all sums due and to become due thereon in respect of principal of and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes, but such money need not be segregated from other funds except to the extent required by law. (b) Anything in this Article Fourteen to the contrary notwithstanding, the Trustee shall deliver or pay to the Issuer from time to time upon Issuer Request any money (or other property and any proceeds therefrom) held by it as provided in Section 1404 which, in the opinion of an internationally recognized firm of independent public accountants expressed in a written certification thereof delivered to the Trustee, is in excess of the amount thereof which would then be required to be deposited to effect an equivalent defeasance or covenant defeasance, as applicable, in accordance with this Article Fourteen. SECTION 1406. Reinstatement. If the Trustee or any Paying Agent is unable to apply any money in accordance with Section 1405 by reason of any order or judgment of any court or governmental authority enjoining, restraining or otherwise prohibiting such application, then the Issuer's obligations under this Indenture and the Notes shall be revived and reinstated as though no deposit had occurred pursuant to Section 1402 or 1403, as the case may be, until such time as the Trustee or Paying Agent is permitted to apply all such money in accordance with Section 1405; provided, that if the Issuer makes any payment of principal of or accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) with respect to any Note following the -63- reinstatement of its obligations, the Issuer shall be subrogated to the rights of the Holders of such Note to receive such payment from the money held by the Trustee or Paying Agent. ARTICLE FIFTEEN MEETINGS OF HOLDERS OF NOTES SECTION 1501. Purposes for Which Holders' Meetings May Be Called. A meeting of Holders may be called at any time and from time to time pursuant to this Article Fifteen for any of the following purposes: (a) to give any notice to the Issuer or to the Trustee, or to give any directions to the Trustee, or to waive or to consent to the waiving of any Default hereunder with respect to the Notes and its consequences, or to take any other action authorized to be taken by Holders pursuant to Article Seven; (b) to remove the Trustee with respect to the Notes pursuant to Section 810; (c) to consent to the execution of an indenture or indentures supplemental hereto with respect to the Notes pursuant to Section 1002; or (d) to take any other action authorized to be taken by or on behalf of the Holders of any specified amount of the Notes under any other provision of this Indenture or under applicable law. SECTION 1502. Call of Meetings by Trustee. The Trustee may at any time call a meeting of Holders to be held at such time and at such place in New York County, New York, for any purpose specified in Section 1501 as the Trustee at the time shall determine. Notice of every meeting of Holders, setting forth the time and the place of such meeting and in general terms the action proposed to be taken at such meetings shall be given by the Trustee, in the manner provided in Section 106, not less than twenty (20) nor more than one hundred twenty (120) days prior to the date fixed for the meeting, to the Holders. SECTION 1503. Issuer and Holders May Call Meeting. In case the Issuer, pursuant to a Management Committee's Consent, or the Holders of at least ten percent (10%) of the Outstanding Notes, shall have requested the Trustee to call a meeting of Holders by written request setting forth in general terms the action proposed to be taken at the meeting, and the Trustee shall not have made the mailing of the notice of such meeting within twenty (20) days after receipt of such request, then the Issuer or the Holders in the amount above specified may determine the time and the place in New York County, New York, for such meeting and may call such meeting to take any action authorized in Section 1501 by giving notice thereof as provided in Section 1502. SECTION 1504. Persons Entitled to Vote at Meeting. To be entitled to vote at any meeting of Holders, a person shall be (a) a Holder of one or more Notes or (b) a person appointed by an instrument in writing as proxy for a Holder. The only persons who shall be entitled to be present or to speak at any meeting of Holders shall be the persons entitled to vote at such meeting and -64- their counsel and any representatives of the Trustee and its counsel and any representatives of the Issuer and its counsel. SECTION 1505. Determination of Voting Rights: Conduct and Adjournment of Meeting. (a) Notwithstanding any other provisions of this Indenture, the Trustee may make such reasonable regulations as it may deem advisable for any meeting of Holders, in regard to proof of the holding of Notes and of the appointment of proxies, and in regard to the appointment and duties of inspectors of votes, the submission and examination of proxies, certificates and other evidence of the right to vote, and such other matters concerning the conduct of the meeting as it shall think fit. Such regulations may provide that written instruments appointing proxies, regular on their face, may be presumed valid and genuine without the proof specified in Section 104 or other proof. Except as otherwise permitted or required by any such regulations, the holding of Notes shall be proved in the manner specified in Section 104 and the appointment of any proxy shall be proved in the manner specified in said Section 104 or by having the signature of the person executing the proxy witnessed or guaranteed by any bank, banker, trust company or firm satisfactory to the Trustee. (b) The Trustee shall, by an instrument in writing, appoint a temporary chairman of the meeting, unless the meeting shall have been called by the Issuer or by Holders as provided in Section 1503, in which case the Issuer or the Holders calling the meeting, as the case may be, shall in like manner appoint a temporary chairman. A permanent chairman and a permanent secretary of the meeting shall be elected by vote of the Holders of a majority in principal amount of the Notes represented at the meeting and entitled to vote. (c) At any meeting, each Holder of a Note or a proxy shall be entitled to one vote for each $1,000 principal amount of Notes held or represented by it. The chairman of the meeting shall have no right to vote other than by virtue of Notes held by him or instruments in writing as aforesaid duly designating him as the person to vote on behalf of other Holders. Any meeting of Holders duly called pursuant to Section 1502 or 1503 may be adjourned from time to time to a place, date and time announced at such meeting, and the meeting may be held as so adjourned without further notice. (d) At any meeting duly called pursuant to this Article Fifteen, the presence of persons holding or representing Notes in an aggregate principal amount sufficient to take action upon the business for the transaction of which such meeting was called shall be necessary to constitute a quorum; provided, that if less than a quorum be present, the persons holding or representing a majority of the Notes represented at the meeting may adjourn such meeting with the same effect, for all intents and purposes, as though a quorum had been present. SECTION 1506. Counting Votes and Recording Action of Meeting. The vote upon any resolution submitted to any meeting of Holders shall be by written ballots on which shall be subscribed the signatures of the Holders or of their representatives by proxy and the serial numbers and principal amounts of the Notes held or represented by them. The permanent chairman of the meeting shall -65- appoint two inspectors of votes who shall count all votes cast at the meeting for or against any resolution and who shall make and file with the secretary of the meeting their verified written reports in duplicate of all votes cast at the meeting. A record in duplicate of the proceedings of each meeting of Holders shall be prepared by the secretary of the meeting and there shall be attached to said record the original reports of the inspectors of votes on any vote by ballot taken thereat and affidavits by one or more persons having knowledge of the facts setting forth a copy of the notice of the meeting and showing that said notice was given as provided in Section 1502. The record shall show the serial numbers of the Notes voting in favor of or against any resolution. The record shall be signed and verified by the affidavits of the permanent chairman and secretary of the meeting and one of the duplicates shall be delivered to the Issuer and the other to the Trustee to be preserved by the Trustee, the latter to have attached thereto the ballots voted at the meeting. Any record so signed and verified shall be conclusive evidence of the matters therein stated. ARTICLE SIXTEEN COVENANTS OF HOLDERS OF NOTES SECTION 1601. Treatment of Notes as Indebtedness for Tax Purposes. Each Holder of a Note by its acceptance of such note covenants and agrees to treat such Note as indebtedness for United States federal income tax purposes. -66- IN WITNESS WHEREOF, the parties hereto have caused this Indenture to be duly executed as of the day and year first above written. Power Contract Financing III, LLC, as Issuer By: /s/ ERIC PRYOR ------------------------------------- Name: Eric Pryor Title: Senior Vice President WILMINGTON TRUST COMPANY, as Trustee, Accounts Agent, Paying Agent and Registrar By: /s/ JAMES J. McGINLEY ------------------------------------- Name: James J. McGinley Title: Authorized Signer EXHIBIT A Definitions "Accountant" means a Person engaged in the practice of accounting who (except when this Indenture provides that an Accountant must be Independent) may be employed by or affiliated with the Issuer or an Affiliate of the Issuer. "Accounts" has the meaning specified in Section 501 of this Indenture. "Accounts Agent" means the Person named as the "Accounts Agent" in Section 501 (a) of this Indenture until a successor Accounts Agent shall have become such pursuant to the applicable provisions of this Indenture, and thereafter "Accounts Agent" shall mean such successor Accounts Agent. "Accreted Value" has the meaning set forth in Section 301(b). "Act" when used with respect to any Holder, has the meaning specified in Section 104 of this Indenture. "Additional Interest" has the meaning set forth in Section 301(c). "Administrative Agent" means, initially, Lord Securities Corporation pursuant to the original Administrative Services Agreement and, thereafter, any other Person that has entered into an Administrative Services Agreement with the Issuer. "Administrative Services Agreement" means the Administrative Services Agreement, dated as of the date of this Indenture, between the Administrative Agent and the Issuer as originally executed and as it may from time to time be supplemented, amended or restated pursuant to the applicable provisions thereof, and any replacement agreement substantially in the form of the Administrative Services Agreement between a replacement Administrative Agent and the Issuer and entered into as contemplated by the Consent. "Affiliate" of any specified Person means any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control" when used with respect to any specified Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; the terms "controlling" and "controlled" have meanings correlative to the foregoing. "Applicable Permit" means, at any time, any Permit that is necessary to be obtained by or on behalf of the Issuer or PCF for the Issuer or PCF to (a) conduct its business or (b) enter into or perform its obligations or enforce its rights under any agreement to which such Person is a party, in each case in accordance with all applicable legal requirements. A-1 "Assignment and Security Agreement" means the Assignment and Security Agreement among the Issuer, the Trustee and the Accounts Agent, for the benefit of the Trustee and the Holders, dated as of the date of this Indenture, as originally executed and as it may from time to time be supplemented, amended or restated pursuant to the applicable provisions thereof. "Bankruptcy Event" shall be deemed to occur, with respect to any Person, if that Person shall institute a voluntary case seeking liquidation or reorganization under the Bankruptcy Law, or shall consent to the institution of an involuntary case thereunder against it; or such Person shall file a petition or consent or shall otherwise institute any similar proceeding under the Bankruptcy Law, or shall consent thereto; or such Person shall apply for, or by consent or acquiescence there shall be an appointment of a receiver, administrator, administrative receiver, liquidator, sequestrator, trustee or other officer with similar powers for itself or any substantial part of its assets; or such Person shall make a general assignment for the benefit of its creditors; or such Person shall admit in writing its inability to pay its debts generally as they become due; or if an involuntary case shall be commenced seeking liquidation or reorganization of such Person under the Bankruptcy Law or any similar proceedings shall be commenced against such Person under the Bankruptcy Law and (a) the petition commencing the involuntary case is not timely controverted, (b) the petition commencing the involuntary case is not dismissed within 60 days of its filing, (c) an interim trustee is appointed to take possession of all or a portion of the property, and/or to operate all or any part of the business of such Person and such appointment is not vacated within 60 days or (d) an order for relief shall have been issued or entered therein; or a decree or order of a court having jurisdiction in the premises for the appointment of a receiver, administrator, administrative receiver, liquidator, sequestrator, trustee or other officer having similar powers over such Person or all or a part of its property shall have been entered; or any other similar relief shall be granted against such Person under the Bankruptcy Law. "Bankruptcy Event of Default" means the events described in clause (i) of Section 701 of this Indenture. "Bankruptcy Law" means Title 11, United States Code, and any other state or federal insolvency, reorganization, moratorium or similar law for the relief of debtors, or any successor statute. "Business Day" means, each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which banking institutions in the same jurisdiction as the Corporate Trust Office of the Trustee or of any relevant Place of Payment or other relevant location are authorized or obligated by law or executive order to close. "CES" means Calpine Energy Services, L.P. "Clearstream Luxembourg" means Clearstream Banking, societe anonyme. A-2 "Closing Date" means June 2, 2004, being the date of issuance and delivery of the Initial Notes. "Collateral" has the meaning ascribed thereto in the Assignment and Security Agreement. "Collections" means all distributions payable to the Issuer from PCF pursuant to the PCF Indenture (other than the PCF Reserve Proceeds) and all earnings on Permitted Investments made with funds in the Accounts. "Collections Account" has the meaning set forth in Section 502(a) of this Indenture. "Commission" means the U.S. Securities and Exchange Commission, as from time to time constituted, created under the Securities Exchange Act, or, if at any time after the execution of this Indenture such Commission is not existing and performing the duties now assigned to it under the Trust Indenture Act, then the body performing such duties at such time. "Consent" means the Consent and Agreement, dated as of the date of this Indenture, among the Administrative Agent, the Issuer and the Trustee as it may from time to time be supplemented, amended or restated pursuant to the applicable provisions thereof. "Corporate Trust Office" means the corporate trust office of the Trustee, at which, at any particular time, its corporate trust business shall be principally administered, which office on the date of execution of this Indenture is located at Rodney Square North, 1100 North Market Street, Wilmington, Delaware 19890, except that with respect to presentation of Notes for payment or for registration of transfer or exchange, such term shall mean the office or agency of the Trustee at which, at any particular time, its corporate agency business shall be conducted. "Default" means any condition or event that, with the giving of notice or lapse of time or both, would become an Event of Default. "Dollar" or "$" means a dollar or other equivalent unit in such coin or currency of the United States of America as at the time shall be legal tender for the payment of public and private debts. "DTC" means The Depository Trust Company, its nominees and successors. "DTC Participants" or "Participants" has the meaning set forth in Section 306(b) of this Indenture. "Euroclear" means the accounts of purchasers at the Euroclear System. A-3 "Event of Default" has the meaning specified in Section 701 of this Indenture. "Federal Bankruptcy Code" means Title 11 of the United States Code or any other Federal Bankruptcy Code hereafter in effect. "Fee Agreement" means the Fee Schedule, dated as of the date of this Indenture. "Financing Document" means, individually, the Indenture, each Security Document, each Note, the Fee Agreement and any and all purchase agreements, filings and other instruments evidencing, securing or relating in any way to the Collateral or any other Financing Document, as shall from time to time be executed and delivered to the Trustee by or on behalf of the Issuer or any other Person pursuant to or as contemplated by this Indenture; collectively, the "Financing Documents." "GAAP" means, as of any date of determination, generally accepted accounting principles then in effect in the United States of America, applied on a consistent basis. "Global Note" or "Global Notes" collectively or individually, as the case may be, has the meaning set forth in Section 201(g) of this Indenture. "Global Note Holder" has the meaning set forth in Section 306(a) of this Indenture. "Governmental Agency" means any public legal entity (including a court of law) or public agency of the United States, whether created by federal, state or local government or any other legal entity now existing or hereafter created, or now or hereafter owned or controlled, directly or indirectly, by any public legal entity or public agency of the United States. "Government Approval" means any authorization, approval, consent, waiver, exception, license, filing, registration, ruling, permit, tariff, certification, exemption and other action or requirement by or with any Governmental Agency. "Holder" means the Person in whose name a Note is registered in the Security Register. "Indebtedness" means with respect to any Person, (a) any liability of such Person (i) for borrowed money, or under any reimbursement obligation relating to a letter of credit, or (ii) evidenced by a bond, note, debenture or similar instrument (including a purchase money obligation) given in connection with the acquisition of any businesses, properties or assets of any kind (other than a trade payable or a current liability arising in the ordinary course of business), or (iii) for the payment of money relating to any obligations under any capital lease of real or personal property which has been recorded as a capitalized lease obligation, (b) all redeemable stock issued by such Person (the amount of Indebtedness represented by any involuntary liquidation A-4 preference plus accrued and unpaid dividends), (c) any liability of others described in the preceding clause (a) that the Person has guaranteed or that is otherwise its legal liability; and (d) (without duplication) any amendment, supplement, modification, deferral, renewal, extension or refunding of any liability of the types referred to in clauses (a), (b) and (c) above. For purposes of determining any particular amount of Indebtedness under this definition, guarantees of (or obligations with respect to letters of credit supporting) Indebtedness otherwise included in the determination of such amount shall not also be included. "Indenture" means this instrument as originally executed and as it may from time to time be supplemented or amended by one or more indentures supplemental hereto entered into pursuant to the applicable provisions hereof. "Independent," when used with respect to any specified Person, means a Person who (a) is in fact independent of the Issuer and any other obligor upon the Notes and of any Affiliate of the Issuer or of such other obligor, (b) does not have any direct financial interest or any material indirect financial interest in the Issuer or in any such other obligor or in any Affiliate of the Issuer or of such other obligor and (c) is not connected with the Issuer or any such other obligor or any Affiliate of the Issuer or of such other obligor as an officer, member employee, promoter, underwriter, trustee, partner, director or Person performing similar functions. Whenever it is herein provided that any Independent Person's opinion or certificate shall be furnished to the Trustee, such Person shall be appointed by an Issuer Order and approved by the Trustee in the exercise of reasonable care and such opinion or certificate shall state that the signer has read this definition and that the signer is Independent within the meaning hereof. "Independent Investment Banker" means Morgan Stanley & Co. Incorporated, or its successor. "Independent Managers" means the Issuer's Class B managers, as provided for in the LLC Agreement. "Initial Notes" means the Notes due 2010 of the Issuer issued on the Closing Date for so long as such securities constitute Restricted Securities. "Issuer" means the Person named as the "Issuer" in the first paragraph of this Indenture until a successor Person shall have become such pursuant to the applicable provisions of this Indenture, and thereafter "Issuer" shall mean such successor Person. "Issuer Request" or "Issuer Order" means a written request or order signed in the name of the Issuer by its President or a Vice President or the President or Vice President of the Administrative Agent acting on behalf of the Issuer and delivered to the Trustee. "Lien" means any security interest, mortgage, pledge, hypothecation, assignment, assignment in trust, deposit arrangement, encumbrance, lien (statutory or other), or preference, priority or other security agreement (including, without limitation, any conditional sale or other title retention agreement, any financing lease having substantially the same A-5 economic effect as any of the foregoing, and the filing of any financing statement under the Uniform Commercial Code of any state of the United States or comparable law of any jurisdiction). "LLC Agreement" means the limited liability company operating agreement of the Issuer, dated as of May 26, 2004. "Lord Engagement Letter" means that certain letter agreement from Lord Securities Corporation to the Issuer, dated as of May 26, 2004. "Majority Holders" means Holders of not less than fifty-one percent (51%) of the Outstanding Notes (voting as a single class). "Management Committee" means the management committee of the Issuer. "Management Committee's Consent" means a copy of a consent certified by a Responsible Officer of the Issuer to have been duly adopted by the Management Committee and to be in full force and effect on the date of such certification, and delivered to the Trustee. "Material Adverse Effect" means an event, occurrence or condition which has or could reasonably be expected to have a material adverse effect on (a) the business, operations, property, condition (financial or otherwise) of the Issuer, (b) the rights or remedies of the Trustee in respect of the Notes or Holders of such Notes under the Financing Documents, (c) the ability of the Issuer or PCF to perform its obligations under the Financing Documents or the Material Agreements to which it is a party or (d) the validity, enforceability or priority of the Liens on the Collateral. "Material Agreement" means, individually, the Member Interest Purchase Agreement, the Administrative Services Agreement, the Consent, the PCF LLC Agreement and the LLC Agreement; collectively, the "Material Agreements." "Maturity," when used with respect to any Note, means the date on which the principal of such Note becomes due and payable as therein or herein provided, whether at the Maturity Date or by declaration of acceleration, notice of redemption or otherwise. "Maturity Date" means February 5, 2010. "Member" has the meaning set forth in the LLC Agreement. "Member Interest Purchase Agreement" means the Member Interest Purchase Agreement, dated as of June 2, 2004, between CES and the Issuer. "Moody's" means Moody's Investors Service, Inc. A-6 "Morgan Stanley & Co. Incorporated" means Morgan Stanley & Co. Incorporated, a Delaware corporation. "Non-U.S. Person" means a Person that is not a "U.S. Person" as defined in Regulation S and certified to the Trustee and the Registrar by such Person. "Notes" means, collectively, the Initial Notes and the Unrestricted Notes, as amended or supplemented from time to time in accordance with the terms of this Indenture, that are authenticated and delivered pursuant to this Indenture; individually, a "Note," "Notice of an Actionable Event" means (a) a certificate of any Holder that an Event of Default has occurred or (b) whether or not any certificate or notice thereof shall have been delivered to the Trustee, a Bankruptcy Event of Default. A Notice of an Actionable Event has been "given" (i) in the case of a Bankruptcy Event of Default, when such Bankruptcy Event of Default occurs or (ii) in the case of any other Notice of an Actionable Event, when the certificate referred to in clause (a) of the immediately preceding sentence has actually been received by a Responsible Officer of the Trustee. A Notice of an Actionable Event has been "rescinded" when, after a Notice of an Actionable Event (other than in connection with a Bankruptcy Event of Default) has been given, the Majority Holders have subsequently delivered to a Responsible Officer of the Trustee a certificate stating that such Event of Default has been waived or cured or when, after a Bankruptcy Event of Default, such Bankruptcy Event of Default is no longer continuing and a Responsible Officer of the Trustee has received a certificate to this effect from the Majority Holders or the Issuer, provided, that a Notice of an Actionable Event may not be rescinded without the consent of the Holders of all of the Notes unless all payments on account of the principal of and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) with respect to the Notes, other than amounts of principal of and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) with respect to any Outstanding Notes that have become due solely by reason of a declared acceleration as provided in Section 702 or interest thereon for any overdue payments of principal of or Additional Interest (and interest on accrued and unpaid Additional Interest), on the Notes, and an additional amount sufficient to reimburse the Holders for the reasonable costs and expenses incurred in connection with the giving and rescinding of any such Notice of an Actionable Event shall have been paid prior to the entry of any judgment in respect of such amounts. A Notice of an Actionable Event is "outstanding" at all times after such Notice of an Actionable Event has been given until such time, if any, as such Notice of an Actionable Event has been rescinded. "Officer's Certificate" means a certificate that meets the requirements of Section 102 and is signed on behalf of the Issuer by the Chairman of the Board, the Chief Executive Officer, the President, the Chief Operating Officer, the Chief Financial Officer, the Treasurer, any Assistant Treasurer, the Controller, the Secretary of any Vice President of the Issuer. A-7 "Opinion of Counsel" means a written opinion of counsel, who may be counsel for the Issuer or the Administrative Agent, acting on behalf of the Issuer, including an employee of the Issuer or the Administrative Agent, acting on behalf of the Issuer, and who shall be acceptable to the Trustee. "Outstanding," when used with respect to Notes, means, as of the date of determination, all Notes theretofore authenticated and delivered under this Indenture, except: (a) Notes theretofore cancelled by the Trustee or delivered to the Trustee for cancellation; (b) Notes, or portions thereof, for whose payment or redemption money in the necessary amount has been theretofore deposited with the Trustee or any Paying Agent (other than the Issuer) in trust or set aside and segregated in trust by the Issuer (if the Issuer shall act as its own Paying Agent) for the Holders of such Notes; provided, that if such Notes are to be redeemed, notice of such redemption has been duly given pursuant to this Indenture or provision therefor satisfactory to the Trustee has been made; (c) Notes, except to the extent provided in Sections 1402 and 1403 of this Indenture, with respect to which the Issuer has effected defeasance and/or covenant defeasance as provided in Article Fourteen; and (d) Notes which have been paid pursuant to Section 309 of this Indenture or in exchange for or in lieu of which other Notes have been authenticated and delivered pursuant to this Indenture, other than any such Notes in respect of which there shall have been presented to the Trustee proof satisfactory to it that such Notes are held by a bona fide purchaser in whose hands such Notes are valid obligations of the Issuer; provided, that for purposes of Section 303 of this Indenture and for purposes of determining whether the Holders of the requisite principal amount of the Outstanding Notes have given any request, demand, authorization, direction, notice, consent or waiver hereunder or are present at a meeting of Holders for quorum purposes, and for the purpose of making the calculations required by Trust Indenture Act Section 313, the requisite principal amounts of the Outstanding Notes shall be determined based upon the Principal Amount at Maturity, and Notes owned by the Issuer or any other obligor upon the Notes or any Affiliate of the Issuer or of such other obligor shall be disregarded and deemed not to be Outstanding, except that, in determining whether the Trustee shall be protected in making such calculation or in relying upon any such request, demand, authorization, direction, notice, consent or waiver, only Notes which the Trustee knows to be so owned shall be so disregarded. Notes so owned which have been pledged in good faith may be regarded as Outstanding if the pledgee establishes to the satisfaction of the Trustee the pledgee's right so to A-8 act with respect to such Notes and that the pledgee is not the Issuer or any other obligor upon the Notes or any Affiliate of the Issuer or such other obligor. "Paying Agent" means the Trustee or any other Person (including the Issuer acting as Paying Agent) authorized by the Issuer to pay the principal of or interest on any Notes on behalf of the Issuer. "Payment Date" has the meaning set forth in Section 301(c). "Payment Month" means a month beginning on the fifth (5th) day of a calendar month and ending on the fourth (4th) day of the next succeeding calendar month. "PCF" means Power Contract Financing, L.L.C., a Delaware limited liability company. "PCF Financing Documents" has the meaning given in the PCF Indenture. "PCF Indenture" means that certain Indenture dated as of June 13, 2003 between PCF and Wilmington Trust Company. "PCF LLC Agreement" means the limited liability company operating agreement of PCF, dated as of June 11, 2003. "PCF Material Agreements" has the meaning given to "Material Agreements" in the PCF Indenture. "PCF Notes" means the 5.200% Senior Secured Notes due 2006 and the 6.256% Senior Secured Notes due 2010 issued pursuant to the PCF Indenture. "PCF Reserve Account" means that certain Reserve Account created pursuant to and in accordance with the terms of the PCF Indenture. "PCF Reserve Investments Account" means that certain Reserve Investments Account created pursuant to and in accordance with the terms of the PCF Indenture. "PCF Reserve Proceeds" means, without duplication, (i) all amounts released from time to time from the PCF Reserve Account or the PCF Reserve Investments Account, plus (ii) from and after the Reserve Investments Release Date, all earnings on amounts in the PCF Reserve Account, in each case regardless of which of PCF's accounts such amounts are actually distributed to the Issuer from; provided, however, that any such amounts applied to costs, expenses and payments of PCF due and payable pursuant to the PCF Indenture at the time such amounts are so released or earned shall be excluded from, and shall not constitute, PCF Reserve Proceeds. In calculating PCF Reserve Proceeds, all funds of PCF not comprising amounts described in clauses (i) and (ii) of the preceding sentence that are then available under the PCF Indenture for payment of costs, expenses and payments of PCF due and payable by PCF pursuant to the A-9 PCF Indenture shall be deemed to have been applied to any such costs, expenses and payments prior to application of amounts described in such clauses (i) and (ii). "PCF Working Capital Account" means that certain Working Capital Account created pursuant to and in accordance with the terms of the PCF Indenture. "Permanent Regulation S Global Note" has the meaning set forth in Section 201(e) of this Indenture. "Permit" means any action, approval, consent, waiver, exemption, variance, franchise, order, permit, authorization, right or license of or from a Governmental Agency. "Permitted Investments" means the following investments maturing, in each case, not less than one (1) Business Day before the Payment Date next following the date such investment is made; provided, however, that in the case of any investment pursuant to clause (b) of this definition which is made with the Trustee, such investment may mature on such Payment Date: (a) any direct obligations of, or obligations fully and unconditionally guaranteed by, the United States of America, or any agency or instrumentality of the United States of America, the obligations of which are fully and unconditionally backed by the full faith and credit of the United States of America; (b) demand and time deposits in, certificates of deposit of, bankers' acceptances issued by, or federal funds sold by any depository institution or trust company incorporated under the laws of the United States of America or any state thereof and subject to supervision and examination by federal and/or state authorities, or incorporated under the laws of any other jurisdiction, so long as at the time of such investment or contractual commitment providing for such investment the unsecured commercial paper or other unsecured short-term debt obligations of such depository institution or trust company have at least the Required Credit Rating from Moody's and Standard & Poor's; (c) repurchase obligations with respect to any security described in clauses (a) or (b) above, in each case entered into with either (i) a depository institution or trust company (acting as principal) which in respect of its short-term unsecured debt has credit ratings of at least the Required Credit Rating from Moody's and Standard & Poor's or (ii) a money market fund maintained by a broker which in respect of its short-term unsecured debt has at least the Required Credit Rating from Moody's and Standard & Poor's; (d) unsecured debt securities bearing interest or sold at a discount issued by any corporation incorporated under the laws of the United States of America or any state thereof which have at the time of A-10 such investment at least the Required Credit Rating from Moody's and Standard & Poor's; (e) unsecured commercial paper which has at the time of such investment a rating of at least the Required Credit Rating from Moody's and Standard & Poor's; and (f) investments in money market funds or money market mutual funds which have at the time of such investment at least the Required Credit Rating from Moody's and Standard & Poor's (including such funds for which the Trustee or any of its Affiliates is investment manager or advisor and for which the Trustee or any of its Affiliates may receive a fee). "Person" means any individual, corporation, partnership, joint venture, limited liability company, association, joint-stock company, trust, unincorporated organization or government or any agency or political subdivision thereof. "Physical Note" or "Physical Notes" collectively or individually, as the case may be, has the meaning set forth in Section 201(g) of this Indenture. "Place of Payment" means, when used with respect to the Notes, the place or places where the principal of and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) with respect to the Notes are payable as specified as contemplated by Sections 301(e) and 1102 of this Indenture. "Predecessor Note" of any particular Note means every previous Note evidencing all or a portion of the same debt as that evidenced by such particular Note and, for the purposes of this definition, any Note authenticated and delivered under Section 308 of this Indenture in exchange for or in lieu of a mutilated, destroyed, lost or stolen Note shall be deemed to evidence the same debt as the mutilated, destroyed, lost or stolen Note. "Principal Amount at Maturity" shall mean the aggregate face principal amount of the Notes at the Maturity Date, which shall be $84,997,000. "Private Placement Legend" has the meaning set forth in Section 202(a) of this Indenture. "Property" means any asset, revenue or any other property, whether tangible or intangible, real or personal, including, without limitation, any right to receive income. "QIB" means a "Qualified Institutional Buyer" under Rule 144A. "Redemption Date" when used with respect to any Note to be redeemed, means the date fixed for such redemption by or pursuant to this Indenture. A-11 "Redemption Price" means, as of any Redemption Date, the Accreted Value of the Notes on such Redemption Date, during the applicable period indicated in Section 301(b) hereof. "Registrar" means the Trustee, until a successor Registrar shall have become such pursuant to the applicable provisions of this Indenture, and, thereafter, "Registrar" shall mean such successor Registrar. "Registration Statement" means a registration statement with respect to the Notes meeting the requirements of the Securities Act. "Regular Record Date," means, with respect to any Payment Date, any Redemption Date or date of acceleration (as provided in Section 702), the date which is fifteen (15) Business Days immediately preceding such Payment Date, Redemption Date or date of acceleration. "Regulation S" means Regulation S under the Securities Act. "Regulation S Global Note" has the meaning set forth in Section 201(e) of this Indenture. "Regulation S Physical Note" has the meaning set forth in Section 201(f) of this Indenture. "Resale Restriction Termination Date" means the date that is two years after the later of the original issue date and the last date on which the Issuer or any Affiliate of the Issuer was the owner of a Note (or any Predecessor Note). "Reserve Account" has the meaning specified in Section 503(a) of this Indenture. "Reserve Investments Release Date" means the date on which, following the consent of Moody's and Standard & Poor's to the release of funds from the PCF Reserve Investments Account, the trustee under the PCF Indenture releases such funds in accordance therewith. "Responsible Officer" means, with respect to any person other than the Trustee or the Issuer, a duly elected or appointed authorized and acting officer, agent or representative of such Person. "Responsible Officer" when used with respect to the Trustee, means the chairman or any vice-chairman of the board of directors, the chairman or any vice-chairman of the executive committee of the board of directors, the chairman of the trust committee, the president, any Vice President, the secretary, any assistant secretary, the treasurer, any assistant treasurer, the cashier, any assistant cashier, any trust officer or assistant trust officer, the controller or any assistant controller or any other officer of the Trustee customarily performing functions similar to those performed by any of the above-designated officers, and also means, with respect to a particular corporate trust matter, any other officer to whom such matter is referred because of his knowledge of and familiarity with the particular subject. "Responsible Officer" when used with respect to the Issuer means, A-12 unless the context otherwise requires, the managing member, president, chief executive officer, chief financial officer, vice president, principal accounting officer or treasurer of the Issuer or any of the foregoing officers of the Administrative Agent acting on behalf of the Issuer or other executive officer of the Issuer or the Administrative Agent acting on behalf of the Issuer who in the normal performance of his or her operational duties would have knowledge of the subject matter relating to any certificate, report or notice to be delivered or given under this Indenture or knowledge of any Default or Event of Default thereunder. "Restricted Security" has the meaning assigned to such term in Rule 144(a)(3) under the Securities Act; provided, that the Trustee shall be entitled to request and conclusively rely on an Opinion of Counsel with respect to whether any Note constitutes a Restricted Security. "Rule 144A" means Rule 144A under the Securities Act. "Rule 144A Global Note" has the meaning set forth in Section 201(d) of this Indenture. "Rule 144A Information" has the meaning set forth in Section 1110 of this Indenture. "Secured Parties" means the Trustee, the Holders and the accounts agent under the Assignment and Security Agreement and each of their respective successor, transferees and assigns. "Securities Act" means the Securities Act of 1933, as from time to time amended. "Securities Exchange Act" means the Securities Exchange Act of 1934, as from time to time amended. "Security Document" means, individually, the Assignment and Security Agreement, the Consent and all UCC financing statements required by this Indenture in connection with the Collateral; collectively, the "Security Documents." "Security Register" has the meaning specified in Section 305(a) of this Indenture. "Standard & Poor's" means Standards & Poor's Rating Services. "Temporary Regulation S Global Note" has the meaning set forth in Section 201(e) of this Indenture. "Trust Indenture Act" means the Trust Indenture Act of 1939 as in force on the date this Indenture was executed, except as provided in Section 1005 of this Indenture. A-13 "Trustee" means the Person named as the "Trustee" in the first paragraph of this Indenture until a successor Trustee shall have become such pursuant to the applicable provisions of this Indenture, and thereafter "Trustee" shall mean or include each Person who is then a Trustee hereunder. "Trustee Fees" means the amount of fees, expenses (including reasonable attorneys fees and expenses) and indemnities due to the Trustee, the Accounts Agent, each Paying Agent and the Registrar under this Indenture, the Fee Agreement and the other Financing Documents. "Uniform Commercial Code" or "UCC" means the Uniform Commercial Code as in effect from time to time in the State of New York and any other jurisdiction the laws of which control the creation or perfection of security interests under the Security Documents. "United States" or "U.S." means the United States of America (including the states and the District of Columbia), its territories, its possessions and other areas subject to its jurisdiction. "Unrestricted Notes" means one or more Notes that do not and are not required to bear the restrictive legends set forth in Section 202. "U.S. Person" has the meaning ascribed to such term in Regulation S and certified to the Trustee and the Registrar by such Person. "U.S. Physical Note" has the meaning set forth in Section 201(f) of this Indenture. "Vice President" when used with respect to the Issuer or the Trustee, means any vice president, whether or not designated by a number or a word or words added before or after the title "Vice President." A-14 EXHIBIT B Form of Face of Note Power Contract Financing III, LLC Senior Secured Note due 2010 THIS SECURITY WAS ISSUED WITH ORIGINAL ISSUE DISCOUNT UNDER SECTION 1272, 1273 AND 1275 OF THE INTERNAL REVENUE CODE OF 1986, AS AMENDED. YOU MAY CONTACT THE CHIEF FINANCIAL OFFICER OF THE ISSUER, AT 50 West San Fernando Street, San Jose, Ca 95113, WHO WILL PROVIDE YOU WITH ANY REQUIRED INFORMATION REGARDING THE ORIGINAL ISSUE DISCOUNT. CUSIP [__________] No. [__________]__$[________] Power Contract Financing III, LLC, a Delaware limited liability company (the "Issuer," which term includes any successor under the Indenture hereinafter referred to and as defined on the reverse hereof), for value received, promises to pay to [_________], or its registered assigns, the outstanding principal sum of [WRITTEN AMOUNT] ($[amount]), at the Maturity Date. Prior to the Maturity Date, the principal amount of this Note will be deemed to be equal to the Holder's pro rata portion of the Accreted Value set forth in Annex A hereto. Except to the extent set forth below, Additional Interest payments will be made to the Holders in semi-annual installments on February 5 and August 5 of each year, commencing on August 5, 2004 and ending on the Maturity Date (or if any such Payment Date is not a Business Day, then the next succeeding Business Day), to the extent sufficient funds are available in the Collections Account on any such Payment Date to make such Additional Interest payments. On any date that Additional Interest is due and payable on a day other than a Payment Date, the accrued and unpaid Additional Interest due with respect to the period immediately preceding such date shall be prorated based on the number of days elapsed since the last Payment Date to such date divided by the number of days elapsed since the last Payment Date to the next Payment Date, based upon a 360-day year of twelve 30-day months. Any Additional Interest that is not paid on the applicable Payment Date will be added to the Additional Interest payable on the next Payment Date. Such past due amounts will be payable (to the extent sufficient funds are available in the Collections Account to make such payments) prior to amounts then scheduled to be paid. All accrued Additional Interest that is not paid when due (whether on the applicable Payment Date or following any redemption or acceleration of the Notes) will bear interest (to the extent lawful) at a rate of 11% per annum, computed on the basis of a 360-day year of twelve 30-day months. All principal of the Notes that is not paid when due (whether on the Maturity Date or following any redemption or acceleration of the Notes) will bear interest (to the extent lawful) at a rate of 11% per annum, computed on the basis of a 360-day year of twelve 30-day months. B-1 The Additional Interest so payable, and that is paid or duly provided for, on any Payment Date, Redemption Date or date of acceleration (as provided in Section 702 of the Indenture) will, as provided in the Indenture, be paid to the Person in whose name this Note (or one or more Predecessor Notes) is registered at the close of business on the Regular Record Date applicable to such Payment Date, Redemption Date or date of acceleration. Principal of the Notes that is payable will be paid to the Person in whose name such Note is registered at the close of business on the Maturity Date, Redemption Date or date of acceleration (as provided in Section 702 of the Indenture), as applicable. Reference is hereby made to the further provisions of this Note set forth on the reverse hereof, which further provisions shall for all purposes have the same effect as if set forth at this place. Terms used but not otherwise defined in this Note shall have the meanings as defined in the Indenture. The provisions of this Note do not purport to be complete and are subject to, and qualified in their entirety by reference to, the provisions of the Indenture. Unless the certificate of authentication hereon has been executed by the Trustee referred to below by manual signature, this Note shall not be entitled to any benefit under the Indenture or be valid or obligatory for any purpose. IN WITNESS WHEREOF, the Issuer has caused this Note to be duly executed manually or by facsimile by its duly authorized officers. POWER CONTRACT FINANCING III, LLC By ------------------------------------- Name: Title: [President/Vice President] Attest: By ------------------------------------------ Name: Title: [Secretary/Assistant Secretary] B-2 CERTIFICATE OF AUTHENTICATION Dated: ------------------------------ This is one of the Senior Secured Notes due 2010 of the Issuer described in the Indenture. Wilmington Trust Company, as Trustee By ------------------------------------- Authorized Signatory B-3 Form of Reverse Side of Note Power Contract Financing III, LLC Senior Secured Note due 2010 1. Principal and Interest. At the Maturity Date, the principal amount of this Note will equal the principal amount set forth on the face hereof. Prior to the Maturity Date, the principal amount of this Note will be deemed to be equal to the Holder's pro rata portion of the Accreted Value set forth in Annex A hereto. The Issuer will pay any principal due with respect to this Note in the manner set forth below. Additional Interest on this Note will be payable semi-annually on each Payment Date, commencing on August 5, 2004, to the Holders on a pro rata basis in the amounts set forth in Annex B hereto, to the extent sufficient funds are available in the Collections Account on such Payment Date to make such Additional Interest payment. Any Additional Interest that is not paid on the applicable Payment Date will be added to the Additional Interest payable on the next Payment Date. Any principal or Additional Interest not paid when due will bear interest (to the extent lawful) at a rate of 11% per annum, computed on the basis of a 360-day year of twelve 30-day months. 2. Method of Payment. (a) Principal of this Note that is payable will be paid to the Person in whose name such Note is registered at the close of business on the Maturity Date, Redemption Date or date of acceleration (as provided in Section 702 of the Indenture), as applicable, upon presentation and surrender of such Note at the office or agency of the Issuer in New York County, New York, maintained for such purpose or such other place as may be designated for such purpose pursuant to the Indenture, provided, that, upon written request from any Holder of Outstanding Notes in the aggregate principal amount of $1,000,000, payments of principal of such Notes shall be made by wire transfer to such Holder. (b) Additional Interest (and interest on accrued and unpaid Additional Interest) on this Note which is payable, and that is paid or duly provided for, on any Payment Date, Redemption Date or date of acceleration (as provided in Section 702 of the Indenture) will be paid to the Person in whose name such Note (or one or more Predecessor Notes) is registered at the close of business on the Regular Record Date applicable to such Payment Date, Redemption Date or date of acceleration at the office or agency of the Issuer in New York County, New York, maintained for such purposes pursuant to Section 1107 of the Indenture or, at the option of the Issuer, may be paid by check mailed to the address of the Person entitled thereto pursuant to Section 310 of the Indenture as such address appears in the Security Register; provided, that (i) upon written request from any Holder of Outstanding Notes in the aggregate principal amount of $1,000,000, all payments with respect to the Global Notes and Physical B-4 Notes the Holders of which have given wire transfer instructions to the Trustee by the Regular Record Date shall be required to be made by wire transfer of immediately available funds to the accounts specified by the Holders thereof; and (ii) the final payment of Additional Interest (and interest on accrued and unpaid Additional Interest) with respect to this Note shall only be made upon presentation and surrender of such Note at the office or agency of the Issuer in New York County, New York, maintained for such purposes pursuant to Section 1107 or such other place as may be designated pursuant to the Indenture. 3. Registrar. The Trustee will act as the Registrar. 4. Indenture; Limitations. The Issuer issued the Notes under an Indenture dated as of June 2, 2004 (the "Indenture"), between the Issuer and the Trustee. The terms of the Notes include those stated in the Indenture and those incorporated into the Indenture by reference to the Trust Indenture Act. The Notes are subject to all such terms and Holders are referred to the Indenture and the Trust Indenture Act for a statement of all such terms. To the extent permitted by applicable law, in the event of any inconsistency between the terms of this Note and the terms of the Indenture, the terms of the Indenture shall control. The aggregate maximum principal amount at maturity of Notes issued on the Closing Date is $84,997,000. 5. Mandatory Redemption. The Issuer shall apply (i) PCF Reserve Proceeds deposited in the Redemption Account prior to February 1, 2010 and (ii) amounts transferred from the Collections Account following an optional redemption of the PCF Notes in full to the Redemption Account prior to February 1, 2010, first, to make payments of accrued and unpaid Additional Interest on the Notes to the Redemption Date and second, to redeem the Notes at the Redemption Price. The Redemption Price of the Notes will be equal to the Accreted Value of the Notes on the Redemption Date during the applicable period set forth in Annex A hereto. Any such mandatory redemption shall only be required, and shall only occur, if the amount on deposit in the Redemption Account equals or exceeds the amount of any accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes to the Redemption Date plus the Redemption Price. If the amount available in the Redemption Account for mandatory redemption is less than such amounts, the Issuer shall not redeem the Notes until such date as the amount in the Redemption Account equals or exceeds the amount of any accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes plus the Redemption Price, in each case as of such later Redemption Date. Notice of a redemption will be mailed at least 30 days but not more than 60 days before the Redemption Date set forth in such notice to the B-5 Holders at each Holder's address as it appears in the Security Register. On and after the Redemption Date, Additional Interest will cease to accrue on the Notes. 6. Denominations; Transfer; Exchange. The Notes are issued only in registered form without coupons and initially only in minimum denominations of $100,000 and any integral multiple of $1,000 above that amount; provided, that initial purchases of the Notes by purchasers who are institutional "accredited investors" who are not Qualified Institutional Buyers shall be in minimum amounts of $250,000; and provided, further that, after initial issuance, Notes may be issued upon exchange or transfer in such amounts as may be necessary to evidence the entire unpaid Principal Amount at Maturity of any Note surrendered or exchanged. A Holder may register the transfer or exchange of Notes in accordance with the Indenture. The Issuer may require a Holder, among other things, to furnish appropriate endorsements and transfer documents and to pay any taxes and fees required by law or permitted by the Indenture. The Issuer need not register the transfer or exchange of any Notes that will be redeemed. Also, it need not register the transfer or exchange of any Notes for a period of 15 days the Notes will be redeemed. 7. Persons Deemed Owners. A Holder may be treated as the owner of a Note for all purposes. 8. Treatment of Notes as Indebtedness for Tax Purposes. Each Holder of a Note by its acceptance of such Note covenants and agrees to treat such Note as indebtedness for United States federal income tax purposes. 9. Unclaimed Money. If money for the payment of principal or Additional Interest (or interest on accrued and unpaid Additional Interest) remains unclaimed for two years after the date that all amounts payable by the Issuer to the Trustee or the Holders under any Financing Document have been finally and irrevocably paid to the Trustee for the benefit of the Holders, the Trustee will pay the money back to the Issuer at its request. After that, the Holders entitled to the money must look solely to the Issuer for payment and all liability of the Trustee will cease with respect to money deposited with the Trustee or held in trust by the Trustee and returned to the Issuer as unclaimed money. 10. Discharge Prior to Redemption or Maturity. If the Issuer irrevocably deposits, or causes to be deposited, with the Trustee money sufficient to pay the then outstanding principal of, Additional Interest and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes through and on the Redemption Date or the Maturity Date, as the case may be, the Issuer will be discharged from the Indenture and the Notes, except in certain circumstances for certain sections thereof, as provided in the Indenture. B-6 11. Amendment; Supplement; Waiver. Subject to certain exceptions, the Indenture or the Notes may be amended or supplemented with the consent of the Majority Holders of any Outstanding Notes, and any existing default or compliance with any provision may be waived with the consent of the Majority Holders (other than for a default in the payment of the principal of or accrued and unpaid Additional Interest (or interest on accrued and unpaid Additional Interest) with respect to any Note or in respect of a covenant or provision of the Indenture that cannot be modified or amended without the unanimous affirmative vote of all Holders) of the Outstanding Notes. Without notice to or the consent of any Holder, the parties thereto may amend or supplement the Indenture or the Notes to, among other things, cure any ambiguity, defect or inconsistency; provided, that such cure shall not materially adversely affect the interests of the Holders. 12. Restrictive Covenants. The Indenture contains certain covenants, including, without limitation, covenants with respect to the following matters: (i) Indebtedness of the Issuer; (ii) restricted payments; (iii) transactions with Affiliates; (iv) fundamental change; and (v) compliance with Material Agreements. 13. Successor Persons. When a successor person or other entity assumes all the obligations of its predecessor under the Notes and the Indenture, the predecessor person will be released from those obligations. 14. Remedies for Events of Default. If an Event of Default (other than a Bankruptcy Event of Default) occurs and is continuing, then and in every such case the Trustee, upon the direction of Holders of no less than 25% principal amount of the Outstanding Notes (for an Event of Default with respect to a default in the payment of principal or Additional Interest) or the Majority Holders of the Outstanding Notes (for any other Event of Default other than a Bankruptcy Event of Default), shall declare the principal amount of all the Notes as of such date to be due and payable immediately, by a notice in writing to the Issuer (and to the Trustee, if given by the Holders), and upon receipt of such notice the then applicable principal amount of the Notes (as provided in Section 301(b) of the Indenture) and any accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest), and all other unpaid fees, costs, charges and other amounts due under the Notes, shall become immediately due and payable. If a Bankruptcy Event of Default occurs, the then applicable principal amount of the Notes (as provided for in Section 301(b) of the Indenture) and accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) and other amounts payable under the Outstanding Notes, shall become immediately due and payable. The Trustee may require B-7 indemnity reasonably satisfactory to it before it enforces the Indenture or the Notes. Subject to certain limitations, the Majority Holders may direct the Trustee in its exercise of any trust or power. 15. Trustee Dealings with Issuer. The Trustee under the Indenture, in its individual or any other capacity, may become the owner or pledgee of Notes and may make loans to, accept deposits from, perform services for, and otherwise deal with, the Issuer and its Affiliates as if it were not the Trustee; provided, that no conflicting interest results. 16. No Recourse. No recourse under or upon any obligation, covenant or agreement contained in this Note, the Indenture or any Security Document, or because of any indebtedness evidenced thereby, shall be had against any incorporator, past, present or future, member, manager, officer or director, as such, of the Issuer or the Issuer's members, or of any successor, either directly or through the Issuer or the Issuer's members, as the case may be, or any successor, under any rule of law, statute, or constitutional provision or by the enforcement of any assessment or by any legal or equitable proceeding or otherwise, all such liability being expressly waived and released by the acceptance of the Notes by the Holders and as part of the consideration for the issuance of the Notes. Nothing contained herein shall, however, limit the liability of any Person for any fraud, gross negligence or willful misconduct on their part. The obligations to pay the principal of and all accrued and unpaid Additional Interest (and interest on accrued and unpaid Additional Interest) on the Notes are solely the Issuer's obligations and any recourse against the Issuer for failure to satisfy its obligations under the Notes is limited to the Collateral. 17. Authentication. This Note shall not be valid until the Trustee manually signs the certificate of authentication on the other side of this Note. 18. Governing Law. The Indenture and this Note shall be governed by, and construed in accordance with, the laws of the State of New York, applicable to agreements negotiated and concluded by residents of, and to be performed in, the State of New York. The Issuer will furnish to any Holder upon written request and without charge a copy of the Indenture. Requests may be made to Power Contract Financing III, LLC, 50 West San Fernando Street, San Jose, California 95113, Attention: President. B-8 ANNEX A to Note ACCRETED VALUE SCHEDULE FOR NOTE For the period -------------- Aggregate Accreted Commencing on: Through: Value of the Notes: -------------- ------- Date of offering August 5, 2004 $63,976,859 August 6, 2004 February 5, 2005 $65,271,638 February 6, 2005 August 5, 2005 $66,894,693 August 6, 2005 February 5, 2006 $68,291,596 February 6, 2006 August 5, 2006 $70,020,349 August 6, 2006 February 5, 2007 $71,526,650 February 6, 2007 August 5, 2007 $73,740,666 August 6, 2007 February 5, 2008 $75,755,380 February 6, 2008 August 5, 2008 $78,114,324 August 6, 2008 February 5, 2009 $80,282,117 February 6, 2009 August 5, 2009 $82,669,289 August 6, 2009 February 5, 2010 $84,997,000 B-9 Annex B to Note ADDITIONAL INTEREST PAYMENT SCHEDULE FOR NOTE Additional Interest Payment Date Payable Amount ------------ -------------- August 5, 2004 ............ $929,064 February 5, 2005 ............ $944,411 August 5, 2005 ............ $661,453 February 5, 2006 ............ $944,411 August 5, 2006 ............ $661,453 February 5, 2007 ............ $944,411 August 5, 2007 ............ $289,417 February 5, 2008 ............ $566,209 August 5, 2008 ............ $292,494 February 5, 2009 ............ $566,209 August 5, 2009 ............ $422,702 February 5, 2010 ............ $565,714 B-1 Form of Transfer Notice (To be executed by the registered Holder if such Holder desires to transfer this Note) To [__________] [----------] Attention: [__________] FOR VALUE RECEIVED the undersigned registered Holder hereby sells, assigns and transfers unto: Name of Assignee: --------------------------- Taxpayer Identification Number of Assignee: (Please print or typewrite name and address including zip code of assignee) [----------] [----------] [----------] the within Note and all rights thereunder, hereby irrevocably constituting and appointing [__________] attorney to transfer such Note on the books of the Issuer with full power of substitution in the premises. [THE FOLLOWING PROVISION TO BE INCLUDED ON ALL CERTIFICATES EXCEPT PERMANENT REGULATION S PHYSICAL NOTES] In connection with any transfer of this Note occurring prior to the date which is the earlier of the date of an effective Registration Statement or [__________] the undersigned confirms that without utilizing any general solicitation or general advertising that: [Check One] [ ](a) this Note is being transferred in compliance with the exemption from registration under the Securities Act of 1933, as amended, provided by Rule 144A thereunder. or [ ](b) this Note is being transferred other than in accordance with (a) above and documents are being furnished which comply with the conditions of transfer set forth in this Note and the Indenture. If none of the foregoing boxes is checked, the Trustee or other Registrar shall not be obligated to register this Note in the name of any Person other than the B-2 Holder hereof unless and until the conditions to any such transfer of registration set forth herein and in Section 307 of the Indenture shall have been satisfied. Dated: ------------------------------ By -------------------------------------- NOTICE: The signature to this assignment must correspond with the name as written upon the face of the within-mentioned instrument in every particular, without alteration or any change whatsoever. Signature Guarantee: TO BE COMPLETED BY PURCHASER IF (a) ABOVE IS CHECKED. The undersigned represents and warrants that it is purchasing this Note for its own account or an account with respect to which it exercises sole investment discretion and that it and any such account is a "qualified institutional buyer" within the meaning of Rule 144A under the Securities Act of 1933, as amended, and is aware that the sale to it is being made in reliance on Rule 144A and acknowledges that it has received such information regarding the Issuer as the undersigned has requested pursuant to Rule 144A or has determined not to request such information and that it is aware that the transferor is relying upon the undersigned's foregoing representations in order to claim the exemption from registration provided by Rule 144A. Dated: By -------------------------------------- NOTICE: To be executed by an executive officer B-3 EXHIBIT C Form of Certificate to Be Delivered upon Termination of Distribution Compliance Period on or after July 13, 2004 [date] Power Contract Financing III, LLC 50 West San Fernando Street San Jose, California 95113 Attn: Secretary Wilmington Trust Company, as Trustee Rodney Square North 1100 North Market Street Wilmington, Delaware 19890 Attn: Corporate Trust Office Re: Power Contract Financing III, LLC (the "Issuer") Senior Secured Notes due 2010 (the "Notes") Ladies and Gentlemen: This letter relates to U.S.$ 84,997,000 aggregate principal amount of Notes represented by the Regulation S Global Note (as defined in the Indenture) which bears a legend outlining restrictions upon transfer of such Regulation S Global Note. Pursuant to Section 201 of the Indenture (the "Indenture"), dated as of June 2, 2004, relating to the Notes, we hereby certify that we are (or we will hold such Notes on behalf of) a person who is not a U.S. person, as defined in Regulation S ("Regulation S") promulgated under the Securities Act of 1933, as amended (the "Securities Act") or who is a U.S. person who purchased such interests pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act. Accordingly, you are hereby requested to exchange the legended certificate for an unlegended certificate representing an identical principal amount at maturity of Notes, all in the manner provided by the Indenture. You and the Issuer are entitled to rely upon this letter and are irrevocably authorized to produce this letter or a copy hereof to any interested party in any administrative or legal proceedings or official inquiry with respect to the matters covered hereby. Terms used in this certificate have the meanings set forth in Regulation S. Very truly yours, [Name of Holder] By -------------------------------------- Authorized Signature C-1 EXHIBIT D Form of Certificate to Be Delivered in Connection with Transfers to Non-QIB Institutional Accredited Investors [date] Wilmington Trust Company, as Trustee Rodney Square North 1100 North Market Street Wilmington, Delaware 19890 Attn: Corporate Trust Office Power Contract Financing III, LLC 50 West San Fernando Street San Jose, California 95113 Attn: Secretary Re: Power Contract Financing III, LLC (the "Issuer") Senior Secured Notes due 2010 (the "Notes") Ladies and Gentlemen: In connection with our proposed purchase of $84,997,000 aggregate principal amount of the Notes: 1. We understand that the Notes have not been and will not be registered under the Securities Act of 1933, as amended (the "Securities Act"), and may not be sold except as permitted in the following sentence. We agree on our own behalf and on behalf of any investor account for which we are purchasing the Notes to offer, sell or otherwise transfer such Notes prior to the date which is two years after the later of the date of original issue and the last date on which the Issuer or any affiliate of the Issuer was the owner of such Notes, or any predecessor thereto (the "Resale Restriction Termination Date") only (a) to the Issuer, (b) pursuant to a registration statement which has been declared effective under the Securities Act, (c) for so long as the Notes are eligible for resale pursuant to Rule 144A under the Securities Act ("Rule 144A"), to a person we reasonably believe is a qualified institutional buyer under Rule 144A (a "QIB") that purchases for its own account or for the account of a QIB to whom notice is given that the transfer is being made in reliance on Rule 144A, (d) pursuant to offers and sales to Non-U.S. Persons (as defined in the Indenture pursuant to which the Notes were issued) that occur outside the United States within the meaning of Regulations S under the Securities Act, (e) to an institutional "accredited investor" within the meaning of subparagraph (a)(1), (2), (3) or (7) of Rule 501 under the Securities Act that is acquiring D-1 the Notes for its own account or for the account of such an institutional "accredited investor" for investment purposes and not with a view to, or for offer or sale in connection with, any distribution thereof in violation of the Securities Act or (f) pursuant to any other available exemption from the registration requirements of the Securities Act, subject in each of the foregoing cases to any requirement of law that the disposition of our property and the property of such investor account or accounts be at all times within our or their control and to compliance with any applicable state securities laws. The foregoing restrictions on resale will not apply subsequent to the Resale Restriction Termination Date. If any resale or other transfer of the Notes is proposed to be made pursuant to clause (e) above prior to the Resale Restriction Termination Date, the transferor shall deliver a letter from the transferee substantially in the form of this letter to the Trustee, which shall provide, among other things, that the transferee is an institutional "accredited investor" within the meaning of subparagraph (a)(1), (2), (3) or (7) or Rule 501 under the Securities Act and that it is acquiring such Notes for investment purposes and not for distribution in violation of the Securities Act. We acknowledge that the Issuer and the Trustee reserve the right prior to any offer, sale or other transfer prior to the Resale Restriction Termination Date of the Notes pursuant to clauses (d), (e) and (t) above to require the delivery of an Opinion of Counsel (as defined in the Indenture pursuant to which the Notes were issued) certifications and/or other information satisfactory to the Issuer and the Trustee. 2. We are an institutional "accredited investor" (as defined in Rule 501(a)(1), (2), (3) or (7) of Regulation D under the Securities Act) purchasing for our own account or for the account of such an institutional "accredited investor," and we are acquiring the Notes for investment purposes and not with a view to, or for offer or sale in connection with, any distribution in violation of the Securities Act and we have such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of our investment in the Notes, and we and any accounts for which we are acting are each able to bear the economic risk of our or its investment. 3. We are acquiring the Notes purchased by us for our own account, or for one or more accounts as to each of which we exercise sole investment discretion and have authority to make, and do make, the statements contained in this letter. 4. You are entitled to rely upon this letter and you are irrevocably authorized to produce this letter or a copy hereof to any interested party in any administrative or legal proceeding or official inquiry with respect to the matters covered hereby. Very truly yours, D-2 [Insert Name of Transferor] By -------------------------------------- Name: Title: Dated: ------------------------ Upon transfer, the Notes should be registered in the name of the new beneficial owner as follows: Name: Address: Taxpayer ID Number: D-3 EXHIBIT E Forth of Certificate to Be Delivered in Connection with Transfers Pursuant to Regulation S [date] Power Contract Financing III, LLC 50 West San Fernando Street San Jose, California 95113 Wilmington Trust Company, as Trustee Rodney Square North 1100 North Market Street Wilmington, Delaware 19890 Attn: Corporate Trust Office Re: Power Contract Financing III, LLC (the "Issuer") Senior Secured Notes due 2010 (the "Notes") Ladies and Gentlemen: In connection with our proposed sale of $84,997,000 aggregate principal amount of the Notes, we confirm that such sale has been effected pursuant to and in accordance with Regulation S ("Regulation S") under the Securities Act of 1933, as amended (the "Securities Act"), and, accordingly, we represent that: (1) the offer of the Notes was not made to a person in the United States and the proposed transferee is a Non-U.S. Person (as defined in the Indenture pursuant to which the Notes were issued); (2) either (a) at the time the buy order was originated, the transferee was outside the United States or we and any person acting on our behalf reasonably believed that the transferee was outside the United States or (b) the transaction was executed in, on or through the facilities of a designated off-shore securities market and neither we nor any person acting on our behalf knows that the transaction has been prearranged with a buyer in the United States; (3) no directed selling efforts have been made in the United States in contravention of the requirements of Rule 903(b) or Rule 904(b) of Regulation S, as applicable; and (4) the transaction is not part of a plan or scheme to evade the registration requirements of the Securities Act. In addition, if the sale is made during a distribution compliance period and the provisions of Rule 903(c)(3) or Rule 904(c)(1) of Regulation S E-1 are applicable thereto, we confirm that such sale has been made in accordance with the applicable provisions of Rule 903(c)(3) or Rule 904(c)(1), as the case may be. You and the Issuer are entitled to rely upon this letter and are irrevocably authorized to produce this letter or a copy hereof to any interested party in any administrative or legal proceedings or official inquiry with respect to the matters covered hereby. Terms used in this certificate have the meanings set forth in Regulation S. Very truly yours, [Insert Name of Transferor] By -------------------------------------- Name: Title: Dated: ------------------------ E-2 EXHIBIT F Form of Issuer Order and Officer's Certificate of Power Contract Financing III, LLC Wilmington Trust Company as Trustee under the Indenture, dated as of June 2, 2004, between Wilmington Trust Company and Power Contract Financing III, LLC Attention: Corporate Trust Department Re: Delivery to Trustee of $84,997,000 Power Contract Financing III, LLC Senior Secured Notes due 2010 Ladies and Gentlemen: The undersigned, Power Contract Financing III, LLC (the "Issuer"), hereby delivers to you, in your capacity as Trustee under the above-referenced Indenture (the "Indenture"), $84,997,000 in aggregate principal amount of the Issuer's Senior Secured Notes due 2010 (the "Notes"). This Issuer Order and Officer's Certificate (this "Issuer Order") is delivered pursuant to Section 303(c) of the Indenture and terms used and not otherwise defined herein have the respective meanings assigned to such terms in the Indenture. The Notes delivered with this Issuer Order are [Initial Notes/Unrestricted Notes], are to be issued as [Physical Notes/Global Notes] in accordance with the terms of the Indenture and are to be authenticated as of the date of this Issuer Order. The Issuer hereby directs that you authenticate the Notes and, if applicable, deliver each of such Notes to the respective Holder thereof or to special New York counsel for such Holder, acting on such Holder's behalf, in accordance with Section 303(c) of the Indenture. The Issuer hereby certifies that the Notes delivered with this Issuer Order have been duly executed by the Issuer and that all conditions precedent to the issuance of the Notes contained in the Indenture have been fully complied with. Very truly yours, POWER CONTRACT FINANCING III, LLC By: ------------------------------------- Name: Title: [President/Vice President] Dated: ------------------------------- F-1 EX-31 4 ex31-1.txt Exhibit 31.1 CERTIFICATIONS I, Peter Cartwright, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Calpine Corporation (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 /s/ Peter Cartwright ------------------------ Peter Cartwright Chairman, President and Chief Executive Officer Calpine Corporation EX-31 5 ex31-2.txt Exhibit 31.2 CERTIFICATIONS I, Robert D. Kelly, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Calpine Corporation (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 /s/ Robert D. Kelly ----------------------- Robert D. Kelly Executive Vice President and Chief Financial Officer Calpine Corporation EX-32 6 ex32-1.txt Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Calpine Corporation (the "Company") on Form 10-Q for the period ending June 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), each of the undersigned does hereby certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge, based upon a review of the Report: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company. /s/ Peter Cartwright /s/ Robert D. Kelly - ----------------------------- ----------------------------- Peter Cartwright Robert D. Kelly Chairman, President and Executive Vice President and Chief Executive Officer Chief Financial Officer Calpine Corporation Calpine Corporation Dated: August 9, 2004 A signed original of this written statement required by Section 906 has been provided to Calpine Corporation and will be retained by Calpine Corporation and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----